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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Seminar of the Securities Analysts Association of Japan, Tokyo, 22 December 2009.
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Masaaki Shirakawa: Macroprudence and the central bank Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Seminar of the Securities Analysts Association of Japan, Tokyo, 22 December 2009. * * * Introduction It is my honor to speak today at the Securities Analysts Association of Japan. I believe that most of you here today have been directly or indirectly involved in the securities market, and that, needless to say, efforts by many related parties are essential for the sound growth of the securities market. One critical element of such efforts is the expert provision of securities analysis, and in this, securities analysts have been playing an important role. The Securities Analysts Association of Japan was established in 1962 in order to train such securities analysts, and since then has consistently and greatly contributed to the development of Japan’s securities market. So let me start by expressing herewith my sincere respect for the Association’s many years of effort. Sparked by the recent global financial crisis, there have been active discussions on how to prevent a recurrence of such a crisis. Those discussions cover securities market as well as financial markets more generally and the financial system. Last week, the Basel Committee on Banking Supervision (Basel Committee), for example, announced a package of proposals on capital adequacy rules and liquidity regulations and made this available for consultation until mid-April 2010. 1 Given that the recent crisis originated in the United States and Europe, there appear to be some mixed feelings at Japanese financial institutions about the discussions in progress. However, any instability in the global financial system inevitably affects Japanese financial institutions. Moreover, just as one of the causes of the recent crisis was that concerned parties in the United States and Europe had not sufficiently learned the lessons from the bubble and financial crisis in Japan and the Asian financial crisis, so Japanese financial institutions might face similar problems in the future if they fail to sufficiently learn the lessons from the recent financial crisis in the United States and Europe. For this reason, it is important for Japanese financial institutions to actively take part in these discussions. Because discussions revolve around a large number of issues, it is difficult to summarize them in a few simple words. However, when it comes to lessons from the crisis and measures to prevent a recurrence, the most important keywords in my view are “liquidity” and “macroprudence.” Against this background, today I would like to focus on the role of “macroprudence” and discuss initiatives by the Bank as well as efforts that private market participants and public authorities should make to ensure the stability of the financial system. 2 Basel Committee on Banking Supervision, “Strengthening the Resilience of the Banking Sector” and “International Framework for Liquidity Risk Measurement, Standards and Monitoring,” Consultative Documents, December 2009. On the importance of the concept of liquidity in discussing the causes of and policy responses to the recent crisis, see Shirakawa, M., “Liquidity” and “Payment and Settlement Systems”, speech given at the Center for Advanced Research in Finance, The University of Tokyo, November 2008, and Borio, C., “Ten Propositions about Liquidity Crises,” BIS Working Papers, No. 293, November 2009. I. Microprudence and macroprudence I should start with an explanation of the concept of “macroprudence,” but in order to do so, it is useful to first explain the concept of “microprudence,” with which it contrasts. It could be said that microprudence describes the conventional ideas behind the policy approach to ensure financial system stability. Simplifying somewhat, microprudence consists of the idea that if the management of individual financial institutions is sound, the financial system, which is the aggregate of individual financial institutions, should be stable, and regulations and supervision should therefore focus on realizing soundness at such micro level. On the other hand, the idea underlying the concept of macroprudence is that stability of the financial system cannot be achieved solely by such micro-level efforts, and that it is necessary to assess risks in the financial system as a whole by taking account of the interconnectedness of economic activities, financial markets, and the behavior of financial institutions, and to take conscious steps to base institutional design and policy responses on such assessments. As I will discuss in detail later, relying on only one of the two approaches is not sufficient to ensure financial system stability. Rather, both approaches are necessary, and one of the key lessons from the recent global financial crisis is that we need to pay greater heed to the approach that incorporates what the term “macroprudence” seeks to capture. In order to see what this means specifically, let us consider the background of the recent financial crisis. Background of the global financial crisis The recent financial crisis may have reached a global scale and involved new financial products and players, but essentially it is a classic example of the rise and collapse of an economic bubble. 3 In the period preceding the recent crisis, especially around the mid2000s, the United States and some European economies experienced a large-scale credit bubble. It was the bursting of that credit bubble that triggered the financial crisis, which was further aggravated by the failure of Lehman Brothers in the autumn of 2008. During the bubble period, risk-taking was excessive. Looking at the behavior of financial institutions, for example, this involved the accumulation of excessive leverage and maturity mismatches between assets and liabilities. Typically, excessive leverage is taken to refer to an increase in debt beyond a point where there is an appropriate balance between capital and debt. More generally, however, excessive leverage can be taken to mean excessive risk-taking, including off-balance transactions, relative to the capital base. At a time of financial crisis, excessive leverage will show itself in capital shortages and solvency problems suffered by financial institutions. On the other hand, the term “maturity mismatch” refers to the financing of long-term assets using short-term debt, and in the run-up to the recent financial crisis, there was a considerable increase in such mismatches. A typical example of this is structured investment vehicles (SIVs). These SIVs invested in medium- to long-term securitized products related to subprime mortgages and raised funds by issuing short-term asset-backed commercial papers with those securitized products as underlying assets. However, once some kind of a shock occurs, funding becomes difficult, and such liquidity risks materialize not only in terms of the domestic currency but also in terms of foreign currencies. In the recent global financial crisis, apart from the United States, U.S. dollar liquidity risk was particularly serious for European financial institutions and, as you will know, Japanese financial institutions, too, faced shortages of U.S. dollar funds from the autumn of 2008 through the beginning of 2009. Once there is a liquidity shortage, financial institutions are forced to sell their assets, resulting in a fall in asset prices, and, for financial institutions as a whole, further intensifies liquidity shortages. Thus, during the financial crisis, the The extent of the financial crisis, however, has differed across regions, and financial systems in Asia, including Japan’s, have proved to be relatively robust. For details, see Shirakawa, M., “Reforming the Framework of Financial Regulation and Supervision: An International and Asian Perspective,” speech given at the Bank Negara Malaysia – Bank for International Settlements High Level Seminar in Malaysia, December 2009. negative spiral intensified as capital shortages and liquidity shortages mutually affected each other. Responses based on microprudence Crises – as I just discussed – appear in the shape of capital and liquidity shortages suffered by financial institutions. Therefore, a natural regulatory and supervisory approach to prevent the recurrence of a crisis is to sufficiently raise the minimum levels of required capital and liquidity financial institutions should hold. This approach focuses on reducing the possibility that individual financial institutions fail and could therefore be described as a response based on microprudence. With regard to capital shortages suffered by financial institutions, the recent crisis revealed a variety of issues. One of these is that the most remarkable increase in leverage took place not in the traditional banking business but outside the banking business. For example, financial institutions held securitized products on their trading books, for which risk weightings under capital adequacy regulations are small, although they later turned out to be highly risky financial products. While the size of trading books was less than 10 percent of total assets for Japanese financial institutions, for some financial institutions in the United States and Europe, it reached about 40 percent. Consequently, when risk-asset based capital ratios were used as a yardstick, major financial institutions’ leverage, at least superficially, did not seem that excessive, and their capital bases appeared sufficient. Investments in securitized products by major financial institutions were carried out through SIVs they had set up, and the funding for these SIVs was provided through credit from their parent financial institutions. As a result, as later revealed, risks were shouldered by the parent financial institutions themselves. In a case such as this, the necessary regulatory and supervisory response would have been to accurately gauge the risks carried by financial institutions and the necessary capital, and to require individual financial institutions to hold more capital. Can problems be solved through microprudence alone? Such regulatory and supervisory responses based on microprudence are necessary and their importance should not be underestimated. As I will explain in detail later, the Bank also conducts on-site examinations and off-site monitoring of financial institutions, carrying out various examinations of financial institutions’ capital, liquidity, and risk management, and giving necessary advice. However, I believe that the recent global financial crisis has shown that it is difficult to achieve financial system stability and to contribute to the sustainable growth of the economy, which is the ultimate aim of financial system stability, relying only on such regulation and supervision based on microprudential principles. The first reason is that without considering the relationship between economic and financial activities, it is essentially impossible to determine the optimal level of capital and liquidity requirements. If absolute priority is given to financial system stability, then capital and liquidity requirements inevitably have to be raised significantly, but the inherent role expected of financial institutions is to engage in leveraging and maturity mismatches between assets and liabilities. Financial institutions carry out financial intermediary functions with a certain amount of capital, raising funds with short-term debt instruments and investing in long-term assets, and provide value added through the provision of liquidity and settlement services. If financial institutions cannot properly fulfill their financial functions, the economy will not grow. Of course, in reality, a capital adequacy ratio of 100 percent is not required, but as highlighted here, conventional regulation and supervision has also in fact been based on some sort of macroeconomic assessment of the relationship between the financial system and economic activity as well as the interaction between financial systems. However, I believe that efforts to take such a macroeconomic perspective into account in a more systematic manner have been insufficient. The second reason why I think microprudence alone is insufficient is that financial institutions’ incentives are greatly affected by macroeconomic factors. On this point, I recall the famous remark made before the surfacing of the subprime mortgage problem by the then CEO of a major financial institution that “while the music is playing, you have to dance.” If, in the future, benign economic conditions similar to that time, namely high economic growth, low inflation, low interest rates, and low market volatility continue for a long time, would managers of financial institutions and investors choose different management and investment strategies? Moreover, even if one were to choose a different strategy oneself, what strategy would one expect competitors to take? Following this line of reasoning, it becomes clear that there will always be someone who takes on the risks. Ultimately, the risks in the financial system as a whole are affected not only by micro-level incentives but to a great extent also by macro-level incentives, that is, the economic and financial environment. If we follow this line of reasoning, in order to ensure the stability of the financial system, microprudence, which secures the soundness of individual financial institutions, and macroprudence, which pays attention to risks to the financial system as a whole, are both equally necessary. II. Macroprudential perspectives There are various ways in which to assess risks in the financial system as a whole from a macroprudential perspective, that is, from a perspective that pays attention to the interconnectedness between economic activity, financial markets, and financial institutions’ behavior. Recently, two perspectives or “dimensions” have been recognized as important: the first concerns the cross-sectional risk at a particular point in time, while the second concerns the evolution of risk in the future. The cross-sectional dimension The “cross-sectional dimension” concerns risks in the financial system as a whole at a particular point in time and particularly focuses on the interconnectedness of the risks of each financial institution’s portfolio and financial products. When the loans and investments of a financial institution are concentrated in a specific industry, the financial institution assumes a large risk. The concentration of loans to the real estate industry is a classic example. And what goes for a specific financial institution goes also for the financial system as a whole. Even if the exposure of each individual financial institution is not concentrated in a specific industry, if many financial institutions are taking similar positions, the financial system as a whole assumes a large risk. If there is a shock that affects the value of a specific type of exposure, for example, the value of real estate, financial institutions will try to reduce their exposure to such assets all at the same time, but when all financial institutions take the same action, such a reduction of exposure will be difficult. Under these circumstances, market liquidity of the assets in question and funding liquidity decline significantly, and that will further exacerbate losses. Such herding behavior is called “crowded trade” and can arise for a variety of reasons. While it typically arises through a convergence of market participants’ view of economic prospects, it can also be spurred by a convergence of risk management methods. As financial techniques advance, the management of risk also becomes more complicated. In this situation, the incentive for financial institutions that do not have sufficient resources to develop their own risk management methods to adopt the risk management methods developed by other financial institutions increases. When this kind of situation becomes widespread, not only does financial institutions’ exposure to types of assets become similar, but market swings also become volatile as the timing of transactions becomes more synchronized. The time dimension The second macroprudential dimension, the “time dimension,” concerns dynamic changes in risks, focusing on how risks inherent in the financial system change over time. In the run-up to a crisis, as seen in the period prior to the recent crisis, benign economic conditions continue for some time, economic actors become too optimistic in their risk assessment, and their risk tolerance increases. As a result, as economic actors’ risk-taking stance becomes more aggressive, asset prices rise and leverage increases, leading to even more aggressive risk-taking stances. Our understanding of such endogenous changes in the risk-taking stance, that is, the risk-taking channel, is extremely limited. What is clear, however, is that such changes are greatly influenced by the economic and financial environment, as I mentioned earlier. Financial imbalances that accumulate in the process of risk-taking cannot be sustained indefinitely and eventually balance sheet adjustments will take place. Such adjustments proceed gradually in the beginning. However, triggered by some kind of a shock, a crisis will emerge in the form of funding liquidity shortages and become more severe as confidence among market participants in each other collapses. This phenomenon that the profit-seeking behavior of financial institutions amplifies the financial and economic cycle is referred to as “procyclicality” and is another important dimension of assessment apart from the aforementioned cross-sectional network perspective. III. Approaches taking account of macroprudence With the importance of macroprudence having been recognized, what sort of approaches should central banks and regulatory and supervisory authorities take to protect the stability of the financial system? Monetary policy First, it is necessary for the central bank to take a macroprudential perspective in the conduct of monetary policy. Needless to say, the purpose of monetary policy is to contribute to sustainable growth through price stability. Looking back at price developments in the past quarter century, inflation gradually declined and it can be said that many central banks have been successful in terms of achieving price stability. However, in terms of financial system stability, the frequency of bubbles and financial crises has increased in the past quarter century, with major episodes including Japan’s financial crisis following the burst of the bubble, the East Asian financial crisis, the credit bubble in the United States and Europe, and the recent global financial crisis. Moreover, ironically, all these bubbles arose in an environment of low inflation. While the causes of bubbles are complex, one major cause in all cases has been the emergence of a sense, amid continued benign economic conditions of high growth, low inflation, and low interest rates, that liquidity is always available at the drop of a hat. While I do not think that accommodative monetary conditions alone can lead to a bubble, it seems that it also cannot be denied that expectations of a prolonged accommodative monetary environment lead to excessive leverage and maturity mismatches, thereby accelerating the generation of a bubble. Price stability is an extremely important policy objective for a central bank, but if a central bank conducts monetary policy by just watching short-term price developments, this may induce large economic fluctuations and result in harming price stability in the medium- to long-term. Although a frequently used phrase in this context is that there is “a trade-off between price stability and financial system stability,” this should in fact be understood in the sense that the true trade-off lies between “current economic stability and future economic stability.” The intensified discussions following the recent financial crisis on the appropriate monetary policy framework, including discussions in countries that have adopted inflation targeting, reflect these considerations. Therefore, in the conduct of monetary policy, it is necessary to get into the habit of assessing the economy both through the lens of price developments and through the lens of financial imbalances. This is exactly what the Bank of Japan with its assessment of monetary policy from “two perspectives” aims at. Financial supervision based on risk assessment of the financial system as a whole Second, I would like to emphasize the importance of proper supervision. The experience of the recent crisis reconfirmed that the behavior of financial institutions sometimes becomes excessive, and proper supervision is necessary to prevent that from happening. In this context, it is of course important for supervisory authorities to assess the soundness of individual financial institutions by focusing on risks unique to those financial institutions and to provide the appropriate supervision. In addition, it is also important to assess, while noting the “dimensions” I have explained, the risk in the financial system as a whole and utilize the information gained to conduct supervision of individual institutions. This may be a typical example of “easier said than done,” but it represents an unavoidable challenge. Designing financial regulation and supervision The third point concerns the design of financial regulation and supervision taking account of a macroprudential perspective. Various discussions on this issue are going on at the moment and one of them focuses on reviewing capital adequacy requirements from the perspective of mitigating procyclicality. Concerning capital adequacy ratios for banks, one issue that has been identified is the procyclicality caused by the decrease in credit risk during an economic boom and the increase in credit risk during a recession, but profits and losses related to financial market transactions show a similar procyclical tendency. When benign financial and economic conditions continue for a certain period, the market risk being estimated by using data obtained during that period is likely to underestimate the actual size of the risk. As a result, during an economic boom, financial institutions lend aggressively as their capital bases increase due to high profits, leading to further increases in lending through, for example, a further rise in asset prices. Similarly, the reverse occurs during a recession. Discussions are therefore underway on how to mitigate such procyclicality, with ideas including the lengthening of the period assets are included in risk accounting to avoid excessive fluctuation in risk-weighted assets and whether to introduce a framework for countercyclical capital buffers. The underlying idea of such a framework is to implement capital adequacy rules in a countercyclical manner by requiring financial institutions to build up capital when economic conditions are favorable, which could then be drawn down when economic conditions deteriorate. I believe that proposals to use capital adequacy regulations to mitigate procyclicality and reinforce capital bases go in the right direction and are likely to contribute to financial system stability. However, from a macroeconomic perspective, it must be avoided that the strengthening of regulations impairs economic stability. For this reason, it is important to secure flexibility, for example, in the procedure and timing of the implementation of new capital adequacy rules by taking financial and economic conditions in countries around the world into account. In this regard, as also articulated in the consultative proposals for the review of rules recently released by the Basel Committee, the new rules should be implemented once financial conditions have improved and economic recovery is ensured. The accounting system The accounting system is also an element affecting the behavior of financial institutions in addition to monetary policy and financial regulation and supervision. The accounting system directly affects the assessment and profitability of assets held by financial institutions. For instance, from autumn 2008, as the functioning of markets declined, prices of securitized products fell all at once, leading to concerns about capital shortages at financial institutions. This further paralyzed market functioning and intensified the downward spiral. This course of events illustrated once more that the method of assessing financial products and the accounting system overall affect financial institutions’ behavior and the financial system. Therefore, various international discussions are taking place to design a system in the field of accounting that could contribute to financial system stability. For example, it was shown that when market liquidity appeared to have dried up, it was possible to value financial assets at prices calculated by models. There are also proposals regarding a revision of loan loss provisions. The reason is that current accrual basis accounting methods tend to reinforce procyclicality as banks’ profits are rapidly squeezed when economic conditions deteriorate because banks have to increase provisions. While provisioning methods on the basis of expected losses, which allow for earlier recognition of future losses, are currently being discussed, my view is that it is necessary to consider such proposals from a variety of aspects, such as to what degree they would fulfill the intended goal of mitigating procyclicality, whether they can be put into practice, and whether they will be able to ensure transparency, which after all is the primary role of accounting. IV. The role of the Bank of Japan Having explained the role of macroprudence, I would now like to explain the role of the Bank in ensuring stability of the financial system. I would like to emphasize the following five points in particular. The first point is that the Bank of Japan not only aims at price stability but also financial system stability. The Bank of Japan Act clearly stipulates that one of the Bank’s institutional objectives is “to ensure smooth settlement of funds among banks and other financial institutions, thereby contributing to the maintenance of stability of the financial system.” The fact that the Bank of Japan during the recent financial crisis decided to implement measures that are extraordinary for a central bank, such as the purchase of stocks held by financial institutions and the provision of subordinated loans, was ultimately to achieve the objective stipulated in the Bank of Japan Act. The second point is that the Bank plays the role of “lender of last resort.” The Bank of Japan is “the bank of banks” and can contribute to ensuring financial system stability by providing funds as the lender of last resort when it judges this to be necessary to prevent the materialization of systemic risk. To avoid that the provision of funds gives rise to moral hazard, the Bank has clarified its basic thinking in the form of the so-called “four principles for special loans.” The third point is that the Bank collects various types of information from financial institutions to secure the objective of ensuring the stability of the financial system. While macroprudence is important, as a prerequisite for that, microprudence is also critical. As long as the Bank extends loans to financial institutions as the “lender of last resort,” it needs to have sufficient knowledge of financial institutions’ business performance and the quality of their assets. For this reason, the Bank of Japan Act grants the Bank the right to conduct on-site examinations of financial institutions that have deposit accounts with the Bank. Of course, it is conceivable that a situation arises where, by the time a financial institution comes to the Bank, it is already too late. Therefore, in conducting on-site examinations, the Bank not only carries out inspections but also provides various kinds of advice and guidance when the need arises. In addition to conducting such on-site examinations, the Bank also strives to gauge the business performance and risk management, such as the liquidity management, of a wide range of financial institutions, including securities companies, through daily off-site monitoring. At a time that financial markets are undergoing substantial changes, it is important to have a channel for obtaining information directly from financial institutions – something that was strongly reaffirmed in the phase from the autumn of 2008 onward. The fourth point is that the Bank conducts risk assessments of the financial system as a whole. The Bank analyzes and assesses the financial system as a whole from a macroprudential perspective by making use of information from individual financial institutions as well as information obtained through its daily monetary policy operations and operation of the payment and settlement system. At the same time, the Bank strives to use the macro-assessment obtained in this way to inform its on-site examinations and off-site monitoring. However, although everyone would agree that integrating macro and micro perspectives is an important task, to do this properly, research is indispensable. Because they are charged with the conduct of monetary policy, the necessary organizational culture to assess the economic situation based on macroeconomic analyses is well established within central banks. As for us at the Bank of Japan, we will continue to attach great importance to the information and insights we gather through on-site examinations, off-site monitoring, and the Bank’s banking business, and to strive to accurately gauge the risks to the financial system as a whole through our macroeconomic analyses and research activities. The fifth point is that the Bank is participating in the international discussions on regulation and supervision and is engaged in the review of such regulation and supervision. Reflecting the globalization of finance, there is a growing tendency for the broad framework of financial regulation and supervision to be determined in international discussions. The Bank, together with the Financial Services Agency (FSA), has been taking part in discussions on financial regulatory and supervisory reform at various international forums such as the Basel Committee on Banking Supervision and the Financial Stability Board, and I myself have been attending many of those forums. Given that a robust global financial system is in the common interest of all countries, I believe it is critical for each country to contribute to the construction of internationally consistent rules and to establish a regulatory and supervisory framework that properly reflects differences between countries, such as in their financial structure. The Bank will continue to make contributions in these areas. When comparing systems to ensure financial system stability immediately before the recent crisis from a central bank’s point of view, countries can be divided into two groups. In one, which includes the United States, Italy, the Netherlands, and many Asian countries, regulation and supervision was carried out by the central bank, either alone or in cooperation with other authorities. In the other group, which includes the United Kingdom and Australia, the central bank was not involved in regulation and supervision. Japan could be regarded as falling in between these two groups: the Bank of Japan does not have regulatory authority over financial institutions, but, as mentioned earlier, based on provisions in the Bank of Japan Act, it conducts on-site examinations of financial institutions and provides various kinds of advice and guidance when the need arises. Financial regulatory and supervisory systems around the world have been decided upon reflecting differences in countries’ financial structure, stage of economic development, and historical background, and thus there is no uniform set-up that is correct for all countries. Be that as it may, the recent crisis has shown clearly that it is indispensable for central banks to be involved in one form or another in ensuring the stability of the financial system and that central banks should play a significant role in the area of macroprudential supervision. Here in Japan, we have a system where the FSA, which is in charge of financial administration dealing with regulation and supervision, and the Bank of Japan, which is the central bank, cooperate with each other and each fulfills its respective functions to ensure the stability of the financial system. While it seems fair to say that Japan’s financial system has remained relatively stable compared with those of the United States and Europe during the recent crisis, the Bank will, in cooperation with the FSA, continue to strive to ensure the stability of the financial system. Closing remarks In closing, I would like to say a few words about the importance of information infrastructure in ensuring financial system stability. In order to analyze the financial system as a whole, it is essential to have information that is accessible to investors and other market participants. On this point, disclosure regarding risks inherent in individual financial institutions and specific financial products is critical. In addition, from a macroprudential perspective the importance of statistics that cover financial markets as a whole needs to be underscored. At the beginning, I pointed out as one of the causes of the recent global financial crisis the widening of maturity mismatches at financial institutions with regard to liquidity and the lack of a habit to check such developments on a macro basis. Although, with the crisis having erupted, we now have the benefit of hindsight, the locational banking statistics released quarterly by the Bank for International Settlements do show a remarkable increase in U.S. dollar maturity mismatches for financial institutions from advanced economies, and particularly European economies, in recent years. 4 Moreover, although the experience of past bubbles clearly shows that fluctuations in real estate prices have a great impact on the financial system, in Japan, for example, little price information on real estate transactions has been gathered and the statistics in this field are far from satisfactory. Although the compilation of such statistics places a burden on those providing the data, such data represents one critical part of the information necessary to ensure the stability of the financial system. While I have pointed out the importance of disclosure information and statistics concerning financial institutions and financial products, it goes without saying that what is ultimately required is a proper analysis based on such information. During the recent crisis, trust in credit rating information declined. Regarding credit ratings, various problems have been highlighted. 5 But while these are indeed important issues, it would not be very balanced to criticize only credit ratings. I mentioned that when thinking about macroprudence, two dimensions are important, that is, the cross-sectional dimension and the time dimension, but to properly reflect these two dimensions in the analysis of securities seems like a particularly difficult challenge. However, if this challenge is not addressed, the value of micro analysis also declines. At any rate, it goes without saying that the role played by securities analysts, who are experts in this kind of analysis, is substantial. One major element that underpins liquidity in financial markets is variety, and in that regard the role of securities analysts who provide variety of analysis based on their independent judgment is quite important. Information is given meaning through the knowledge, experience, and philosophy of experts, and in this regard, too, we have high hopes and expectations of securities analysts. Thank you. For a more detailed discussion of this issue, see the March 2009 issue of the Financial Markets Report. See, for example, “Stocktaking on the Use of Credit Ratings” by the Joint Forum under the aegis of the Basel Committee on Banking Supervision, the International Organisation of Securities Commissions, and the International Association of Insurance Supervisors, June 2009.
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, to the Board of Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 24 December 2009.
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Masaaki Shirakawa: Japan’s economy in 2009 – review of the year and challenges ahead Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, to the Board of Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 24 December 2009. * * * Introduction I am honored to have this opportunity to address the representatives of Japan’s economy that are gathered here today. This year is just over a week remaining to its end. Looking back, when I addressed this forum exactly one year ago, the economies of Japan and the world were in the midst of a panicked contraction of economic activity associated with the occurrence of a global financial crisis. Since then governments and central banks around the world have launched various policy measures, firms have made significant production adjustment and other painstaking efforts, and Japan’s economy and overseas economies have been picking up since around spring. However, amid the after-effects of the bursting of the global credit bubble, uncertainties surrounding the future remain high and many issues must be resolved in order that the global economy can return to a new, sustainable growth path, and shift to the so-called “new normal”. Today, I will first review economic and financial developments in 2009, then describe the Bank’s thinking on the conduct of monetary policy and conclude with an outline of the challenges Japan’s economy needs to tackle from next year onward. I. Developments in the global economy I would like to start by discussing global economic developments. In my end-of-year speech last year, I said that the reason for the recent economic downturn was the bursting of a global-scale credit bubble. The process of the economic downturn may be summarized in the following two factors. The first factor is the unwinding of excess accumulated globally until the mid-2000s, mainly in the United States and Europe. We can call this a process in which problems of households’ excess debts, firms’ excess production capacity, and financial institutions’ impaired assets are being addressed, or in other words, a process of making repairs and adjustments to the balance sheet. During this process, economic agents restrain spending activity, and chronic downward pressure is exerted on the economy. The second factor is the panicked contraction of economic and financial activity due to the financial crisis caused by the failure of Lehman Brothers in the autumn of 2008. While balance-sheet adjustments exert chronic downward pressures as I just explained, the panicked contraction had acute effects on the economy. The main reason that the global economy started to pick up from early spring this year is that the second factor, the contraction of financial and economic activity, started to calm. In fact, due to the provision of liquidity by central banks around the world and government measures to restore the financial system, global financial markets have, regained a considerable degree of stability, a major difference from the situation one year ago. At the same time, however, it is becoming clear that considerable pressure from balancesheet adjustment, which I mentioned as the first factor, remains in the U.S. and European economies. Therefore, there is an increasingly stark contrast between the slow recovery of advanced economies, and the faster recovery of emerging and commodity-exporting economies. Specifically, in advanced economies, particularly in the United States and Europe, balance-sheet adjustments are still being made and as a result domestic demand is struggling to gather momentum, while emerging and commodity-exporting economies have been recovering at a faster pace than was expected in the spring of 2009. Against a backdrop of the need to improve standards of living and social infrastructure, many emerging and commodity-exporting countries are generally exhibiting a trend of strong domestic demand. On top of that, in these economies increased fiscal expenditure has been more effective in creating domestic demand through a strong multiplier effect, as, unlike the advanced economies, they face relatively minor pressure from balance-sheet adjustment. And, an inflow of funds from advanced economies, where interest rates are low, has helped growth by increasing lending and boosting asset prices. Moving on to the outlook for the global economy, on the whole, the recovery trend is likely to continue due partly to advanced economies picking up, and also to the high growth of emerging economies, but uncertainties regarding the outlook are judged to remain high. There are both upside and downside risk factors. Major downside risk factors include possible consequences of balance-sheet adjustment in the United States and Europe as well as the gradual waning of policy effects. Meanwhile, although the strength of emerging economies is an upside risk factor, it is worth mentioning that, if capital inflows from advanced to emerging economies continue, this could lead to a rapid overheating and subsequent plunge in emerging economies. Moreover, the recent so-called “Dubai shock,” which is fortunately calming, has served to reinforce the perception that attention should be paid to risk factors on the global financial front. II. Developments in Japan’s economy Next, I would like to discuss the current state of and outlook for Japan’s economy. Amid the global economic downturn that I have just described, Japan’s economy deteriorated significantly, due mainly to an unprecedented decline in exports and production. Thereafter, as overseas economies improved and progress was made in inventory adjustment both at home and abroad, exports and production started to recover. Furthermore, as demand for automobiles and electrical appliances, which were subject to tax reductions and subsidies, started to increase, Japan’s economy bottomed out from around this spring, and can now be judged to be picking up. However, the level of economic activity remains low, signs of improvement have mostly been supported by the government’s stimulus measures, and it is judged that there is not yet sufficient momentum for a self-sustaining recovery. Turning to corporate financing, you may vividly remember that, around this time last year, issuance in the CP and corporate bond markets was difficult due to the effects of the failure of Lehman Brothers in 2008, those markets are now showing considerable improvement. In the CP market, issuance rates for CP have declined noticeably and issuance rates for some high-rated CP are even below yields on government bills. The corporate bond market has also been active. In addition to a decline in issuance rates, we have seen a rush in issuance since the summer, while firms have shifted the emphasis of their fund-raising from short-term funds to long-term funds. Large firms’ financial positions have been improving, supported in part by a pick up in their sales and profits and also by a considerable improvement in the issuing conditions for CP and corporate bonds. However, the management at many large companies seem to have not completely loosened the reins about their future financial position despite high levels of liquidity on hand, given their vivid memory of the difficulties experienced since the autumn of 2008 and persistent uncertainties regarding the economic outlook. Moreover, the Bank is fully aware of the fact that, although policy effects from the government’s emergency guarantee program have appeared, the financial position of small firms remains weak, as improvements in their sales and profits are lagging. As such, although Japan’s corporate financing has been showing signs of improvement, the situation as a whole remains severe. Regarding Japan’s economic outlook, we expect that the pace of improvement will remain moderate up to around the middle of fiscal 2010 as pressure to adjust production capacity and employment is likely to remain. Indeed, the pace of economic recovery may slow temporarily, particularly around early next spring, when the effects of various economic stimulus policies are expected to subside. This tendency will be stronger in regional economies that depend heavily on public investment. However, in my view, it is unlikely that the recovery of the economy will stall at that time. This is because, advanced economies, including Japan, have made clear that they intend to continue with economic stimulus measures until economic recovery is assured. Also, the strength of domestic private demand in emerging economies is likely to remain self-sustaining. Nevertheless, we recognize that the recovery path will not be a smooth one, and the Bank will examine the economic situation without any predetermined view. Next, looking at prices during this period, the year-on-year rate of change in the consumer price index (CPI) fluctuated widely due to the effects of petroleum product prices. After registering a sharp increase of 2.4 percent in the summer of 2008, it turned negative in the spring of 2009, and in August 2009, posted the largest decline on record of minus 2.4 percent. As the effect of last year’s surge in oil prices fades, the rate of decline in the CPI is expected to shrink to around minus 1 percent. Developments thereafter will be key to the outlook for prices. Based on the economic outlook I outlined earlier, as economic slack dissipates the pace of decline in the CPI will tend to gradually moderate. However, if the pace of recovery in the economy is gradual, we should expect that downward pressure on prices would remain for a considerable period. The root cause of a continuous decline in prices, that is, the phenomenon referred to as deflation, is weaker aggregate demand compared to the supply capacity of the economy as a whole. Therefore, to emerge from such a situation, it is vital to strive to continuously improve the supply-demand balance of the overall economy. In relation to this, two approaches will be necessary, namely efforts to generate short-term demand and improving medium- to longterm expectations for income growth that reflect increases in productivity. As these are closely related to the Bank’s conduct of monetary policy and to challenges Japan should tackle, I would like to discuss them again later. III. The Bank of Japan’s conduct of monetary policy Next, I would like to discuss the Bank of Japan’s conduct of monetary policy. I explained earlier that we can summarize the causes of the global economic downturn since the autumn of 2008 based on two factors. Similarly, the measures implemented by the central banks of major economies, including the Bank of Japan, may be categorized into two factors, namely measures to address the acute problems brought about by the financial crisis, and measures to address the chronic effects of balance-sheet adjustment. As for the acute problems arising from the financial crisis, many central banks have conducted various measures to restore the necessary market functioning, which had seriously deteriorated, by providing ample liquidity to the financial markets and by, for example, purchasing certain financial assets, focusing on markets whose functioning was impaired. The Bank of Japan has also introduced various temporary measures, including extraordinary measures for a central bank, such as outright purchases of CP and corporate bonds. It might be safe to say that these measures by central banks have been effective in restoring stability in financial markets and facilitating corporate financing. Therefore, the majority of central banks in advanced economies, such as the Federal Reserve (FRB) of the United States and the European Central Bank, have already announced their intention to unwind these emergency measures. To align with those moves, the Bank of Japan has also recently announced that it will cease outright purchases of CP and corporate bonds at the end of 2009 as scheduled. Moreover, in order to be extra careful, the Bank of Japan will let special funds-supplying operations to facilitate corporate financing remain in effect until the end of March 2010, to cover the fiscal year-end, before being replaced by ordinary fundssupplying operations. Our revision of these temporary measures is predicated on our thinking of selecting the most effective method for fund provision, in accordance with changes in financial market conditions. For example, as I explained earlier, one consequence of the Bank’s measures was that issuance rates on some high-rated CP fell below yields on government bills. Therefore, investors exited the CP market and a side effect of the measures, shrinkage in market size, became more pronounced. If the temporary measures are maintained, the functioning of the CP market, which is important for firms’ short-term fund raising, might in fact be damaged. Given that an improvement of the issuance conditions for CP has been achieved, special measures such as outright purchases by the central bank should be withdrawn. Instead, it would be more effective for improving the flow of funds if the regular funds-supplying operations, which accept a wide range of collateral, are actively used. While the Bank reviewed the temporary measures from this perspective, it goes without saying that one of the Bank’s most important purposes is ensuring stability in financial markets. I would like to reiterate that the Bank will be prepared to act swiftly and decisively if concerns arise that financial market stability might be compromised. While the central banks of major economies, including the Bank of Japan, have generally addressed the acute problems brought about by the financial crisis, as regards the chronic effects of balance-sheet adjustment they have expressed the intention of maintaining an accommodative financial environment. For example, from autumn to the end of 2008 the Bank of Japan reduced the policy rate to 0.1 percent, a level of interest rates of effectively zero. As for the future conduct of monetary policy, the Bank has announced that it will maintain the extremely accommodative financial environment and provide consistent support to Japan’s economy to overcome deflation and return to a sustainable growth path with price stability. At the beginning of December, since there was concern over a risk that international financial developments and instability in the foreign exchange market might adversely affect economic activity through worsened business sentiment, the Bank promptly held an unscheduled Monetary Policy Meeting and introduced a new funds-supplying operation in order to further enhance monetary easing. This operation employs the conventional framework of fundssupplying operations against pooled collateral, introduces a fixed interest rate set equal to the extremely low policy interest rate of 0.1 percent, and provides to the money market ample longer-term funds with a term of three months. The Bank plans to provide approximately 10 trillion yen through this operation. We expect that the longer-term money market rates, known as interest rates on term instruments, will decline further, and such effects have already started to appear and the financial markets appear to have regained some stability. Moreover, at the Monetary Policy Meeting held in mid-December, the Bank clarified again its thinking on price stability. In 2006, the Bank introduced what is called an “understanding of medium- to long-term price stability” (hereafter “understanding”), which outlines the Bank’s understanding of price stability that should be taken into account when discussing monetary policy, and released a numerical expression, a year-on-year rate of change in the CPI that “falls in the range approximately between 0 and 2 percent.” This time, in order to prevent the expression “approximately” from inviting misunderstanding, we decided to employ clearer words to express the Policy Board’s intention to not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent and that the midpoints of most Policy Board members’ understanding are around 1 percent. The agreed new expression was that each Policy Board member’s understanding “falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board members’ ‘understanding’ are around 1 percent.” I believe that dissemination of the Bank’s outlook for economic activity and prices as well as its stance for the conduct of monetary policy, which I explained earlier, and its thinking on price stability will accordingly have a certain impact on the formation of interest rates in the financial markets. While keeping in mind its understanding of medium- to long-term price stability, the Bank will continue to make wide-ranging assessments of various risk factors and strive to achieve the proper conduct of monetary policy. In doing so, based on lessons learnt from the bursting of the recent global credit bubble, I believe it is crucial to also pay attention to the possible accumulation of financial imbalances observed, for example, in asset prices and credit aggregates. IV. Global financial crisis and Japan’s economy Next, I would like express my views on what kind of challenges Japan’s economy will face in 2010 onward. In conducting economic policy, or, in the management of firms formulating future strategy, it is critical to consider the lessons Japan should draw from the experience of the recent global financial crisis. In order to consider this, in my view, it is necessary to recognize the following two facts. The first fact is that, as has often been pointed out during the recent economic downturn, the plunge in economic activity in Japan was the largest among the advanced economies. Comparing internationally the trough levels of real GDP by taking as the benchmark the April–June quarter of 2008, which is before the global financial crisis broke out, real GDP in the United States, where the global financial crisis originated, declined by less than 4 percentage points, while that in Japan decreased by more than 6 percentage points, which was the largest fall among the advanced economies. The second fact is that Japan’s financial system remained relatively robust, compared with those of the United States and Europe. For example, although various credit spreads in financial markets, such as the yield premium of corporate bonds against that of government bonds, did widen in Japan as well, but compared to other countries the degree of widening was small. Another example is bank lending. In the United States and Europe, following the outbreak of the global financial crisis the year-on-year growth rates of bank lending declined sharply by more than 10 percentage points over a period of one year and few months. Meanwhile in Japan, there was not such a sharp decline in the year-on-year growth rate of bank lending. Such marked difference is also observed in terms of the size of central bank balance sheets. In the United States, as credit markets had almost ceased to function, the central bank had no choice but to step in to take the place of the credit market, which resulted in a significant expansion of the FRB’s balance sheet. Meanwhile, in Japan, the situation did not become so extreme. Japan’s financial markets were also affected significantly, but not in as extreme a fashion as the U.S. markets. As a result, the Bank of Japan’s balance sheet was not expanded as much as that of the FRB. Then, why was the decline in Japan’s economic activity particularly pronounced even though its financial system remained relatively robust? I believe that the answer to this question is key for discussing the future of Japan’s economy. In terms of the components of demand, the substantial fall in economic activity was particularly evident in exports. While some interpret this as a weakness due to dependency on external demand and hold the view that Japan’s economy needs to make a full-fledged shift from being an external demand-dependent economy to being a domestic demanddriven one, I do not go along with such a view. I say this because Japan’s percentage dependency on exports is in the mid-teens range, which is slightly higher than the United States, but clearly lower than in advanced economies in Europe. For example, export trade accounts for approximately 40 percent of GDP in Germany and over 25 percent in the United Kingdom and France, and in this context, Japan’s economy is hardly external-demand dependent. Rather than taking this view, we should pay attention to the rapid changes in the environment surrounding Japan’s manufacturing industry before and after the global financial crisis. Specifically, in my view, there are three key points. First, the global financial crisis had a pronounced impact on areas of industry in which Japan has a competitive advantage. The global financial crisis paralyzed the financial intermediation function around the globe and uncertainties regarding the outlook increased. This directly hit expenditure, mainly for business fixed investment and consumer durables, that is susceptible to the fund-raising environment such as bank lending or the degree of uncertainty about the future, and dealt a major blow to production in the Japanese manufacturing industry, which supplies such goods globally. Second, the impact of the adjustment of excesses and balance-sheet adjustment also tended to become significant. Up to the mid-2000s when the global economy enjoyed high growth supported by the credit bubble, there was a worldwide boom in spending on consumer durables. The Japanese manufacturing industry, which had established a comparative advantage in these areas, greatly benefited from this boom. However, in retrospect, and setting emerging economies aside, the boom in the United States and Europe was based on overly optimistic expectations and was unsustainable. And the balance-sheet adjustments in the United States and Europe, which ensued with the unwinding of the boom, directly hit Japanese manufacturing industry. And third, there was a reaction to the considerable depreciation of the yen from the mid2000s. To determine the effects of changes in exchange rates on export competitiveness, it is necessary to take into account differences in price fluctuations at home and abroad as well as the weights of trade. Looking at the real effective exchange rate of the yen, adjusted for these factors, we see that from around 2005 to mid-2007 it depreciated by more than 20 percent, and remained at its lowest level in the past 20 years, which supported a considerable increase in Japan’s exports. However, since the outbreak of the global financial crisis in the autumn of 2008, the yen appreciated rapidly and has recently been trading around its level in the early 2000s. This suggests that the portion of exports supported by the depreciation of the yen since the second half of the 2000s has been eliminated. Based on these observations, the lesson that can be learned from the experience of the global financial crisis is not that Japan’s economy needs to make a full-fledged shift from being external demand-dependent to being domestic demand-driven, but that it is important that the global economy aims to achieve sustainable growth. Given that globalization is irreversible, it is not appropriate to see external demand and domestic demand as opposing concepts. I would emphasize that, for Japan’s economy, it is both important to reap the fruits of global economic growth and to lay the groundwork for expanding domestic demand. V. Five challenges Based on the lessons learned from the recent crisis and looking at the prospects for Japan’s economy from next year onward, various challenges lie ahead. Here, I would like to raise five challenges Japan should tackle. First, the shift to what has been called the “new normal.” The growth pattern we experienced up to the mid-2000s that was supported by the global credit bubble is not expected to recur, nor should we expect it to recur. Nobody knows what specifically the “new normal” will be, and we are in the process of exploring a sustainable new growth mechanism. However, the size of the decline from the prior economic boom and the fact that this process requires a certain amount of time may provoke calls for protectionism and excessive regulation. Japan and others must seek to prevent such a situation. The second challenge is to review various systems reflecting the ever-evolving global economic environment. In each country where firms are exposed to global competition, they are constantly seeking to make use of their comparative advantages. Amid factors such as population decline that could contract the domestic market in the medium to long term, in order to reap fruits of the global economic growth Japan must constantly review systems that stipulate conditions for competition so that Japanese firms can maximize their management efforts. At the same time, firms are required to strive to take a diverse range of innovative approaches. The third challenge is to actively participate in the creation of global rules. Currently, various moves are taking place to establish new international rules to address global environmental issues and others. Moreover, there are active developments to take the initiative in rulesetting at the corporate level. To reap the fruits of global economic growth, it is essential for public authorities and private firms to strive to actively participate and take the initiative in such moves. In the financial field also, discussions are underway toward revising global financial regulations to reflect the lessons learned from the recent crisis. The Bank of Japan is also actively taking part in this process, through the G20 meetings and various venues for international discussion. The fourth challenge is to develop various safety nets. In order for the economy to grow in a sustainable manner, it is essential to have sustainable expansion of private consumption. In order to lay the foundations for this, and to allow individuals to take the initiative in various fields, it is essential to enhance households’ sense of security about their future lives by providing various safety nets. The fifth challenge is to emerge from a mood that can be called “irrational pessimism.” In the same way that “irrational optimism” creates a bubble, “irrational pessimism” will certainly not have positive effects on economic activity either. Of course, the economy will not improve just by sentiment, and what is most important is to formulate a solid growth strategy and strive actively to establish a new growth mechanism. In order to do so, however, sentiment matters. In the context of its role in realizing economic and financial stability a central bank can be compared to “an anchor,” and I believe that a central bank is expected to serve as a well-balanced anchor in terms of economic analysis and information dissemination. Closing remarks I have pointed out five challenges for Japan’s economy. As such challenges are met, productivity rises, and the public starts to expect a future increase in income we will then have reached a point at which demand can start a strong, full-fledged expansion. And that is the time when we will truly feel that Japan’s economy has emerged from a situation called deflation. For Japan’s economy to emerge from deflation and return to a sustainable growth path with price stability will ultimately require consistent endeavor between policymakers such as the Bank of Japan and private sector entities in their own fields. By listening to opinions and criticisms from you in the coming year, I will reaffirm that the Bank of Japan will continue to make consistent efforts to meet our challenges. Thank you.
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 29 January 2010.
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Masaaki Shirakawa: Japan’s economy and monetary policy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 29 January 2010. * * * Introduction I am privileged to have the opportunity to speak before such a large audience today. Thinking back, this time last year, the global economy and financial markets were in the midst of a rapid and large decline, and I think many business managers were seized by the fear that no bottom was in sight. Policy makers at home and abroad also tackled the situation with a sense of nervousness that one wrong policy step might result in a 1930s-style Great Depression. Fortunately, one year on, today, as a result of the intense efforts of private firms and the prompt implementation of various unconventional policy measures by governments and central banks around the globe, the downturn of the global and Japanese economies has been brought to a halt and activity has started to pick up. While economic conditions are improving, this improvement to a great extent owes to the support provided by the various policy measures, and the level of economic activity in advanced economies still remains below that prior to the Lehman shock. I imagine that, from the perspective of business managers, the “fear of no bottom in sight” may have gone, but the “anxiety of no future in sight” may remain significant. Today, I would like to talk about recent financial and economic developments at home and abroad, the thinking behind the Bank’s conduct of monetary policy, and medium- to long-term challenges for Japan’s economy. I. Developments in the global economy The mechanisms underlying the downturn and the recovery While the main topic of today’s speech is Japan’s economy, in the short-term, economic conditions in Japan will greatly depend on developments in the global economy, as has been the case in the past year. As you are well aware, the global economy, sparked by the failure of Lehman Brothers in the autumn of 2008, faced a panicked contraction of financial and economic activity stemming from a liquidity crisis. As we all know, the most basic premise for economic transactions to take place is the confidence that counterparties will honor their obligations. However, following the failure of Lehman Brothers, confidence among financial market participants in counterparties collapsed and fund providers such as financial institutions and institutional investors became extremely cautious regarding the creditworthiness of their counterparties. Nagging suspicions spread in many financial markets, and the funds necessary for economic activity did not circulate easily. The effect, as it were, was like an unintended sudden financial tightening on a global scale. Firms and consumers were not able to raise funds and thus were forced to cut back on their spending. Moreover, due to heightened anxiety, many started to restrain their spending. As a result, the global economy experienced the acute symptoms of what could be described as an instantaneous evaporation of demand. Reflecting the characteristics of this crisis, what was affected the most were capital goods and durable consumer goods. Since Japan’s strength lies in exactly these kinds of goods, that is, automobiles, electrical machinery, general machinery, etc., Japan’s economy was severely affected. And for the same reason, despite the fact that they were not the epicenter of the financial crisis, not only Japan but also many other East Asian economies, including South Korea, Taiwan, and Singapore, were among those that experienced the most severe downturn in economic activity immediately after the crisis. The global economy bottomed out around the spring of last year and is now in a stage of recovery. The growth forecast for the global economy for 2010 by the International Monetary Fund has been edging up over time, from 1.9 percent in April 2009, to 3.1 percent in October, and to 3.9 percent in the forecast released this week. Underlying these revisions are the progress made in inventory adjustments and the effects of various policy measures by governments and central banks. Let us take a look at the recovery process in more detail. The major driving force of the current recovery are emerging and developing economies, and the share of these economies in global growth is forecasted to reach 70 percent in 2010. In contrast, although the United States, Europe, and other advanced economies have emerged from the sharp recession, there has not yet been sufficient momentum for a self-sustaining recovery. At the root of the panic sparked by the failure of Lehman Brothers was the structural problem of balance-sheet adjustments. Toward the mid-2000s, households and firms especially in the U.S. and several European economies borrowed excessively from financial institutions based on the optimistic assumption that asset prices, such as home prices, would keep on rising, boosting consumption and investment. Financial institutions provided funds to support such behavior of households and firms and continued to increase lending. However, once asset prices started to decline, such developments reversed almost instantaneously. In order to reduce debts that had increased excessively during the asset price bubble, firms and households were forced to cut back on consumption and investment. Efforts to reduce debts led to a decrease in aggregate demand and a fall in asset prices. Financial institutions also had to restore balance between bloated assets and excessive risks on the one hand and capital bases on the other. In this process, it inevitably became difficult for financial institutions to engage in active risk-taking such as the extension of new loans. While the repair of balance sheets is an unavoidable process to return economies to a sustainable growth path, it should be noted that the process in the meantime exerts continuous downward pressure on economies. If the plunge in economic activity following the Lehman shock can be described as the “acute symptoms” of the financial crisis, then the balance sheet adjustments are a “chronic illness” that will continue to affect economies. In contrast, emerging and commodity-exporting economies have recently been recovering at a more rapid pace than expected. The rapid recovery of emerging and commodity-exporting economies is mainly attributable to three factors. First, with their populations growing, potential domestic demand in these countries is strong to start with, driven by buoyant consumption associated with rising living standards and the need for expanding social infrastructures. A typical example is China, where demand for durable consumer goods such as televisions and automobiles is extremely strong. Moreover, in emerging and commodity-exporting economies, social infrastructure, such as roads and electric power plants, is still underdeveloped relative to the population. If such infrastructure improves, there is the potential for further increases in demand for automobiles and home electronics. Second, the emerging and commodity-exporting countries themselves have also implemented aggressive economic stimulus measures in response to the recent crisis. Unlike the advanced countries, the emerging and commodity-exporting economies were not facing a problem of balance sheet adjustments, and potential demand was strong to start with, so that the multiplier effects of fiscal stimulus measures are likely to have been significant. And third, there have been massive flows to emerging and commodity-exporting economies of funds for risk-taking that could not find sufficient investment opportunities within advanced economies. Therefore, in the emerging and commodity-exporting economies, economic recovery has been underpinned by an increase in domestic bank lending and a rise in real estate prices. This trend has also been accelerated by the fact that many emerging and commodity-exporting economies have adopted inflexible exchange rate regimes tying their currencies to the U.S. dollar. However, if accommodative monetary conditions continue too long, this could lead to an overheating of emerging and commodity-exporting economies or turmoil in financial markets, or, in the future, to an economic downturn due to a reversal of capital flows. Therefore, some countries have already started taking policy measures on the monetary policy front such as raising policy interest rates. The outlook This was a quick review of the mechanisms underlying the plunge and recovery of the global economy following the failure of Lehman Brothers. One of the important issues in forecasting future developments is how to assess the monetary and fiscal policies that have played such a major role in the current recovery process. During the current economic recovery, the various policy measures taken by central banks have exerted substantial effects. Although policy rates in the major economies had reached virtually zero at the end of 2008 and there remained no room for further rate reductions, credit spreads, which had jumped during the crisis, nevertheless narrowed significantly and credit availability recovered as a result of various unconventional measures. In other words, even though the policy rates at which central banks provide funds to financial markets had reached the lower bound, monetary easing was substantially enhanced through measures to promote financial market stability. Another thing I would like to add with regard to monetary easing is that, in contrast with the past, the effects of monetary easing in the advanced economies have been greater in other economies, especially emerging economies, than in the advanced economies themselves. With respect to the transmission mechanisms of the effects of monetary easing, textbook examples include increased bank lending and capital investment due to a decline in interest rates and rising exports owing to exchange rate depreciation. However, the transmission mechanisms of the effects of monetary easing are also changing in tandem with the globalization of financial markets. In the current situation, in part because advanced economies face the problem of balance sheet adjustments, one mechanism that might become important is the stimulus provided to advanced economies’ exports and domestic capital investment through the recovery in emerging markets. In terms of macroeconomic policy, the role of fiscal policy has also been important. Since the failure of Lehman Brothers, governments have, in response to the rapid economic and financial contraction, injected public capital into financial institutions and have implemented large-scale fiscal stimulus measures. Such large-scale policy interventions were indispensable to maintain financial system stability and stem the plunge in economic activity. Yet, while these measures have been achieving their intended purposes, at the same time, fiscal deficits have increased and government debt has risen markedly. It can be said metaphorically that, in the recent crisis, the governments assumed the risks and debt that the private sector could not shoulder. However, as economic and financial market stability has returned, participants in global financial markets have started to pay greater attention to the risks the governments shouldered and the associated problems, namely the issues of fiscal deficits and fiscal discipline. What is interesting in relation to this is the Fed’s purchases of Treasury securities during March to October last year. In conducting such purchases, the Fed repeatedly emphasized that the purchases were neither public financing by the central bank nor aimed at guiding long-term interest rates to specific levels. The emphasis, despite the fact that the Fed’s purchases of Treasury securities were much smaller than the Bank’s purchases of government bonds relative to the size of the economy, could be seen as part of its determination to maintain confidence in its monetary policy. Under these difficult circumstances, what kind of monetary and fiscal policies are desirable is something that ultimately each country needs to decide for itself based on its own economic and financial conditions. In terms of the basic stance of policy conduct, advanced economies at present are placing priority on economic recovery, while emerging economies are beginning to pay greater attention to the potential overheating of their economies. What is important in the end is that the global economy as a whole is brought back to a sustainable growth path. With this goal in mind, it is necessary for policy authorities to carry out the appropriate policies while firmly maintaining confidence in their policies. II. Economic and price developments in Japan Based on the developments in the global economy just described, I would now like to discuss economic and price developments in Japan. Let us first consider the situation Japan’s economy finds itself in at the moment. The fluctuations in the economy are shown most vividly in the index of industrial production. Taking as the period immediately before the Lehman shock the July–September quarter of 2008 and setting the index of industrial production to 100, the level of activity dropped to 66 in February 2009. The drop was particularly pronounced in the automobile and electronic parts industries. Thereafter, production started to increase from March and recovered to a level of 86 in December. Since the index of industrial production essentially covers manufacturing industry, which accounts for only 20 percent of Japan’s economy overall, to gauge overall economic activity, it is necessary to look at developments in real GDP. After falling sharply in the October–December quarter of 2008 and the January–March quarter of 2009 at annualized quarter-on-quarter rates of 10 percent, average real GDP growth in the next two quarters was about 2 percent. For the October–December quarter of 2009, privatesector forecasts put growth at a similar rate. The level of real GDP in the October–December 2009 quarter is expected to be about 95 when taking the level immediately before the Lehman shock as 100. Looking at the pick-up of the economy in terms of final demand items shows that exports, on a quarter-on-quarter basis, expanded by over 10 percent both in the April–June and the July–September quarters of 2009 and continued to expand by about 9 percent in the October–December quarter, with exports to East Asian economies accounting for more than half of that increase. Private consumption has been picking up, particularly of durable consumer goods such as automobiles and electronic appliances, due to the effects of various policy measures, although the employment and income situation remains severe, as illustrated by decreasing bonus payments. Business fixed investment, too, following a continuous slide from the April–June quarter of 2008, is bottoming out. Not a few firms have been considering shifting investment to emerging markets, where expansion in demand is expected. However, since the level of business fixed investment has already declined considerably, if exports and production continue to increase, the capacity utilization rate will increase and business fixed investment will bottom out and start to increase. Housing investment has recently been showing signs of bottoming out. In contrast, public investment has started to level off. Based on this assessment, the Bank judges that Japan’s economy is picking up. However, this pick-up reflects various policy measures taken at home and abroad, and there is not yet sufficient momentum for a self-sustaining recovery in domestic private demand. Moreover, given that the recent pick-up of the economy centers on the manufacturing sector, there are disparities in the degree of improvement between regions where manufacturing firms are concentrated and other regions. Furthermore, there are also disparities among firms, with the situation differing between large firms, small firms, and micro businesses. The question is how the economy will develop. The baseline scenario is that the economy is likely to continue picking up on the back of improvements in overseas economies and the effects of economic policy measures. However, the pace of improvement in Japan’s economy is likely to be moderate until around the middle of fiscal 2010, since the pace of recovery in the global economy is likely to remain moderate and, in Japan, pressure for adjusting employment and wages is likely to remain. Going forward, as balance-sheet adjustments in the United States and Europe make fair progress, in Japan the improvements in the corporate sector originating from exports are likely to spill over to the household sector. Therefore, in fiscal 2011, Japan’s economic growth is likely to clearly accelerate. In terms of figures, the economic growth rate is projected to be around 1 percent for fiscal 2010 and around 2 percent for fiscal 2011. However, the Bank is fully aware that the baseline scenario is accompanied by various uncertainties, and thus will continue to examine economic developments without having any prejudgment. I will now turn to price developments in Japan. Since I will discuss the so-called “deflation issue” in a moment, let me, for the time being, simply look at the figures. Since 2008, consumer prices have been swinging widely due mainly to the fluctuations of prices of petroleum products and other commodities. The year-on-year rate of change in the consumer price index (CPI) excluding fresh food peaked at 2.4 percent in the summer of 2008, followed a downward trend thereafter, and posted the largest decline on record, minus 2.4 percent, in August 2009, mainly because of the base effect of the previous year’s surge in oil prices. Subsequently, with the fading of the effects of the decline in the price of petroleum products, the rate of decline in the CPI in December moderated to a year-on-year rate of change of minus 1.3 percent. Looking ahead, the pace of the year-on-year decline in the CPI is expected to continue moderating due mainly to the gradual improvement of the supply and demand balance associated with the pick-up of the economy. However, given that the recovery started from a level of unprecedented weakness in demand and the pace of economic recovery going forward is expected to be moderate, downward pressure on prices is likely to remain for a considerable period. The Policy Board members’ forecasts of the year-on-year change in the CPI released early this week is around minus 0.5 percent for fiscal 2010 and around minus 0.2 percent for fiscal 2011. III. The thinking behind monetary policy Let me now explain the thinking behind the Bank’s conduct of monetary policy. Earlier, I pointed out the two causes of the global economic slump: the acute symptoms sparked directly by the financial crisis and chronic illness due to balance sheet adjustments. The policy responses of Japan and other countries were taken to address these two causes. Regarding the acute symptoms, many central banks took measures such as the purchase of particular financial assets in markets that had ceased functioning to prevent a worsening of the financial crisis and to ensure the flow of funds necessary for private economic activity, working to restore the functioning of markets. The Bank also took policy steps that are unconventional for a central bank such as the outright purchase of CP and corporate bonds. In this regard, there has been some criticism that the Bank has not implemented sufficient monetary easing, which is based on the argument that the relative increase in the Fed’s balance sheet has been greater than that in the Bank’s. Such criticism shows a complete misunderstanding of the facts. The significant expansion of the Fed’s balance sheet simply reflects the unfortunate situation that the functioning of U.S. capital markets, which account for about 70 percent of firms’ fund raising, had seriously declined and there was no alternative but for the Fed, as the central bank, to completely take over the role of the markets. Although the functioning of corporate bond and CP markets in Japan declined, the financial system, when compared with those of the United States and Europe, nevertheless remained relatively stable. This is partly the result of the various efforts made based on the bitter experience since the latter half of the 1990s. It is for these reasons that the Bank’s balance sheet has not expanded as much as that of the Fed. Rather, the size of the Bank’s balance sheet already expanded significantly before the crisis. Global financial markets have been regaining stability thanks to the extraordinary measures implemented by central banks around the world. Therefore, reflecting the improvements in financial markets, central banks overseas have been winding up various crisis measures in a sequenced manner since last summer. In Japan, too, since the functioning of CP and corporate bond markets has recovered, the Bank wound up its outright purchases of CP and corporate bonds at the end of December 2009. Nevertheless, as I always stress, the Bank is prepared to act swiftly and decisively should concerns that financial market stability might be hampered re-emerge. With the response phase to the financial crisis behind us, the key policy challenge now is to how to guide the economy onto a sustainable growth path. While the Bank lowered the interest rate level to virtually zero by reducing the policy interest rate to 0.1 percent at the end of 2008, given the outlook for economic activity and prices described earlier, the Bank considers it necessary to maintain the extremely accommodative financial environment. At the beginning of December 2009, the Bank introduced a new funds-supplying operation so as to further enhance easy monetary conditions. With this operation, the Bank provides ample longer-term funds to the money market at an extremely low interest rate of 0.1, which is equivalent to the policy rate, by employing the existing framework of funds-supplying operations against pooled collateral, which accept a wider range of collateral such as Japanese government securities and corporate bonds. The Bank recognizes that it is a critical challenge for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability. As the central bank, we will continue to make every effort to contribute to achieving this goal. IV. The “deflation issue” and achieving sustainable growth Finally, I would like to refer to the so-called “deflation issue.” Recently, in discussions of various economic phenomenon, they have increasingly been argued in association with deflation. Therefore, it is all the more important to correctly understand the cause of deflation. Since the 1990s, inflation has been falling worldwide. Reasons for this include the success of central banks’ monetary policies aimed at price stability and the substantial decline in costs as planned economies made the transition to the market. However, the arguments frequently heard today are not about this general decline in inflation but about why the inflation rate in Japan is lower than in other advanced economies. In fact, Japan’s inflation rate as measured by the CPI has been about 2–3 percentage points lower than that of other advanced economies even in the bubble period in the late 1980s. There are three possible reasons why inflation in Japan has been low for a protracted period. First, rationalization of the distribution system and deregulation. While one rarely hears it mentioned today, from the 1980s to the mid-1990s, high prices in Japan, that is, the need to address the difference between domestic and foreign prices, were frequently identified as a major issue with regard to Japan’s economy. Rationalization of the distribution system and deregulation were implemented to address the issue. Rationalization of the distribution system, together with globalization, led to an increase in low-priced imports. Moreover, deregulation exerted downward pressure on prices by reducing margins in industries and of firms that were protected by regulation in the past. While this was an extremely challenging situation for firms that were subject to such competitive pressures, it also meant an increase in real purchasing power for consumers and a rise in productivity for Japan’s economy as a whole. The second potential reason is the continuous decline in wages since the latter half of the 1990s. Since the bursting of the bubble economy, Japan’s economy has undergone a severe and unavoidable adjustment process. Looking at the labor market from a macroeconomic perspective, since the latter half of the 1990s, managers and workers in Japan have put priority on maintaining employment, and to do so, workers accepted reductions in wages. Comparing consumer prices in Japan with those in other advanced economies, what stands out is the decline in service prices, implying that while flexible wage adjustments have been effective in terms of preventing an increase in unemployment, in return, they have put consistent downward pressure on the prices of labor-intensive services. The third potential reason, which I believe is the most important one, is that expectations for future economic growth have declined. This decline in growth expectations has been further spurred by the aging and shrinking of Japan’s population. The decline in growth expectations appears to have dampened investment in the corporate sector and heightened anxiety over future income in the household sector and thereby restrained private consumption. This contraction in spending by firms and households seems to have induced a vicious cycle in that it led to a further deterioration in aggregate supply and demand conditions in the economy, which in turn further reduced growth expectations. Ultimately, at the root of the aforementioned decline in wages, there is a lack of demand due to the decline in growth expectations. In any case, the root cause of deflation is a lack of demand. Then, what should be done to resolve this lack of demand? In this regard, some point out the need for demand-boosting measures large enough to close the output gap. However, the output gap after all compares the demand for goods and services based on existing needs and supply capacity for goods and services that meet such needs. With the unprecedented global bubble having burst, it is unlikely that there will be sufficient demand for the existing supply capacity for goods and services. On the other hand, potential needs such as with regard to nursing and caring are substantial. The challenge, therefore, is to make efforts to convert potential needs into actual demand, and turning this into reality requires entrepreneurs and innovators. Concerning policies to counter deflation, some argued that “if the central bank were to increase its balance sheet, then deflation would come to an end.” However, both the Bank in the first half of the 2000s, in implementing quantitative easing, and the Fed since 2007 significantly expanded their balance sheets; yet, there have been no corresponding price rises. Based on such experience, the argument that “if the central bank were to increase its balance sheet, then deflation would come to an end” is rarely discussed in the United States and Europe. What is clear is that, when the stability of the financial system is in danger, expansion of the central bank’s balance sheet, that is, the provision of liquidity, is extremely effective in preventing a downward price spiral by ensuring the stability of the financial system. And that is exactly what the Bank of Japan did. However, once financial system instability is overcome, an increase in liquidity alone cannot resolve deflation. We need to look squarely at the root causes underlying the deflation issue. Prices are often considered as the temperature of the economy. It is not possible to artificially raise only the temperature for a prolonged period. Rather, in order for the temperature to follow an upward trend, it must be based on genuine health-promoting measures and, in some cases, an appropriate cure. The same applies with regard to the response to deflation. The important thing in order to apply the brakes to a moderate downward trend in prices is to raise trend growth expectations. Put differently, with the recognition that it is indispensable to make steady efforts to raise productivity, we need to tackle this challenge. In this regard, there is no “magic wand.” Here, I would like to point out two basic elements that are important in overcoming deflation and achieving sustainable economic growth. The first is the importance of making the most of global demand, especially from emerging and developing economies, which are expected to enjoy high growth. At present, the penetration rate of automobiles in China is about 4 percent. This more or less matches the level in Japan in the first half of the 1960s when motorization started in earnest. In Japan, it took 30 years for the penetration rate of automobiles to reach 50 percent. While the road of growth for emerging economies may not be even, the potential opportunities provided by the growth of these markets are vast, as many people recognize. Given that globalization is steadily progressing, it would not be appropriate to see external demand and domestic demand as opposing concepts. I would like to emphasize that for Japan’s economy it is important to both reap the fruits of global economic growth and to lay the groundwork for expanding domestic demand. The second point that I think is important in overcoming deflation is the need to establish a supply system that corresponds to potential demand and thereby raise productivity. In order to make the most of the demand from expanding new markets in emerging and developing economies, we need to change the goods supplied and the supply system by taking into account the characteristics of individual markets. If we are able to provide goods and services that meet potential demand, sales will increase and consequently productivity will rise. While discussions of “productivity” typically refer to producing existing products efficiently, unlocking potential demand and establishing the necessary supply system also raises productivity. What is important, therefore, are efforts by firms to adapt existing human and management resources to new markets in order to link potential needs with actual demand. Moreover, in order to support such efforts at the firm level, it is critical to review systems and mechanisms so as to ensure the flexibility of Japan’s economic structure in response to changes in the economic environment at home and abroad. For example, both firm entry rates and firm exit rates in Japan are about 5 percent, which is roughly half of the corresponding rates in the United States, suggesting that Japan’s economic metabolism is low. While there is not enough time today to go into this in detail, to improve this situation and create a mechanism in which productive resources are smoothly transferred to areas where there is a strong need for them, the role of financial markets is also important. In addition, the necessary social safety net should be put in place to deal with adverse effects arising during the process. These are two of the issues I think are important to raise the potential growth rate of Japan’s economy. Looking back at Japan’s economy in the past, we have a record of overcoming difficulties and achieving prosperity through people’s wisdom and efforts. To truly bring Japan’s economy back onto a sustainable growth path, proactive efforts such as the ones I just mentioned are essential. While the process of putting such efforts into practice will not be without pain, it is unavoidable given the drastic economic changes taking place on a global basis. In this regard, what somewhat worries me is the recent mood of pessimism that fails to recognize the strengths of Japan’s economy. For example, while Japan’s financial system has remained relatively stable during the recent crisis, this fact seems to be underappreciated. Similarly, regarding the growth of emerging economies only as a threat is not a very well-balanced view. For instance, it has been estimated that if motorization in China and India were to progress at the same pace as in Japan when it was about to enter the era of high-speed growth, more automobiles than those now existing in the world will be produced. If this does indeed occur, the burden on the global environment will be extremely large, but, by the same token, this suggests that demand for environmental technology, which Japan is good at, will also increase. Of course, Japan should not be complacent about its environmental technology, but I think it is important to remember to perceive the growth of emerging economies as a positive challenge. Closing remarks I have talked about the various challenges Japan’s economy faces, and the Bank will do its utmost as the central bank to support your efforts. While a central bank carries out many functions, if you ask me what its most fundamental role is, I would say it is to contribute to economic development by maintaining confidence in the currency. Such confidence, I would like to stress once again, provides a vitally important anchor. In order to fulfill this role, the Bank must be an organization that assesses the situation accurately, explains its assessment to the public, and acts decisively. I would like to conclude my speech today by emphasizing that the Bank is acutely aware of the important role it has to play. Thank you.
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a Meeting with Business Leaders, Kagoshima, 24 February 2010.
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Hirohide Yamaguchi: Japan’s economy and monetary policy Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a Meeting with Business Leaders, Kagoshima, 24 February 2010. * * * Introduction I am honored today to have this opportunity to speak and to exchange views with business leaders in Kagoshima Prefecture. I will express my gratitude for your cooperation in interviews with the staffers from the Kagoshima Branch and for the Bank of Japan’s surveys. Information obtained from these interviews and surveys is invaluable and utilized fully in assessing economic and financial developments and conducting monetary policy. Kagoshima Prefecture and the Bank have a deep-rooted relationship. The founder of the Bank, Mr. Masayoshi Matsukata, and the first governor of the Bank, Mr. Shigetoshi Yoshihara, were both born in Kagoshima Prefecture. I have been looking forward to visiting the place which these two important figures, who were founding fathers to the Bank, hailed from. Before exchanging views with you, I will talk about economic conditions and price developments in Japan. I. Economic conditions in Japan The current state of the economy I will first talk about the current state of Japan’s economy. Japan experienced a sharp and substantial economic downturn from the autumn of 2008 to early 2009, which could be described as “falling off a cliff.” Fortunately, however, the economy stopped worsening in the spring of 2009 and has been picking up since then. There are three reasons behind the pick-up in Japan’s economy. First is the fact that overseas economies have started to recover. Especially emerging economies, such as China, have been growing at a faster pace than expected. Currently, emerging economies are rushing to build infrastructures, such as roads and electrical power systems. Moreover, in China for example, the penetration rates of televisions and automobiles are gradually increasing along with the rise in people’s income level. Emerging economies are experiencing a similar phenomenon as what Japan experienced during its high-growth period, when, along with an improvement in the transportation network, the socalled three major household items were penetrated into every family. Emerging economies are enjoying high growth due to the fact that, in addition to robust business fixed investment and private consumption, large-scale economic stimulus measures have been implemented to address the financial crisis since the autumn of 2008 and the effects of monetary easing around the world have been spreading. How about the situations in the U.S. and European economies, where the financial crisis began? These advanced economies have also started to pick up, thanks to the implementation of large-scale fiscal policy measures and substantial monetary easing. The financial crisis had inflicted serious damage on these economies, and they have been suffering from various after-effects. For example, financial institutions still hold a considerable amount of impaired assets, and remain cautious about extending loans. In terms of households, the hearty consumer appetite has now receded, because their purchased housing has declined in value and they are heavily indebted at the same time. Those problems have been continuing to weigh on the U.S. and European economies in achieving a full-fledged recovery. The second reason behind the pick-up in Japan’s economy is that firms have been performing inventory restocking both at home and abroad. Firms have made rapid production and inventory adjustments in response to the fall in demand. Thereafter, as economies gradually regained stability, prospects for sales started to improve. Firms are now in the phase to increase inventories so as to attain an appropriate inventory level. And the third reason is that domestic policy measures have been contributing significantly to the pick-up in Japan’s economy. For example, supported by measures to promote the sale of durable consumer goods, such as the eco-point system and tax reductions on purchases of environmentally friendly cars, sales of electrical appliances and automobiles increased sharply. Moreover, due in part to successive implementation of economic measures, public works increased and contributed to the pick-up in the economy. With those three reasons in the background, the continued increases in exports and production have been the driving force for the pick-up in Japan’s economy. Hitting bottom in March 2009, exports have been increasing for nine consecutive months, and similarly, production has been increasing for ten consecutive months after hitting bottom in February 2009. By industry, the performance of automobile-related and electrical machinery industries has been particularly good. Furthermore, since wide-ranging industries are related to the industries of automobiles and electrical machinery, their good performance has contributed to the recovery in production in industries that supply materials and parts. While exports and production have continued to exhibit a steady increase, so far, recovery in domestic private demand, including business fixed investment and private consumption, has not gained momentum. Business fixed investment is only at a stage where its decline has been coming to a halt. According to the Tankan (Short-Term Economic Survey of Enterprises in Japan), the Bank’s quarterly survey on firms, many firms, regardless of size or industry, are still responding that they feel that their capital stock is excessive. Moreover, a cautious investment stance can be derived from their capital investment plans for the current through next fiscal years. Household consumption is similar to business fixed investment in that it lacks momentum for recovery. The substantial reduction in winter bonus payments and the unemployment rate at an elevated level have also been accountable for this. While sales of electrical appliances and automobiles, which have been underpinned by policy measures, have been brisk, sales at department stores and supermarkets have continued to decrease. Moreover, as seen from the fall in sales in the food-service and travel industries, consumers have been tightening the purse strings. As explained, the current state of Japan’s economy exhibits a vivid contrast between brisk exports and production on one hand, and sluggish domestic private demand, on the other. Based on such recognition, at the Monetary Policy Meeting held last week, the Bank made an assessment, “Japan’s economy is picking up mainly due to various policy measures taken at home and abroad, although there is not yet sufficient momentum to support a selfsustaining recovery in domestic private demand.” Outlook for the economy Now, what is the outlook for the economy? It depends on how the two contrasting factors develop. Namely, whether exports and production can maintain their favorable conditions, and whether momentum will build up for a self-sustaining recovery in domestic private demand. In that regard, it is likely that the pace of increase in exports and production is bound to slow down. The momentum for restocking is bound to diminish as inventory approaches an appropriate level. It will also become difficult to expect the economic stimulus measures taken at home and abroad to exert the effects that they have initially had. On the other hand, it appears to take some more time before we can see a visible improvement in momentum for self-sustaining recovery in private demand. As mentioned earlier, firms have been cautious for business fixed investment. Moreover, as anxiety over employment and income conditions is yet to be dispelled, it is difficult for households to loosen the purse strings. Taking those points into account, the momentum for the pick up in the economy might decrease, albeit temporarily. At that point, the regions that depend heavily on public works might strongly feel that the pace of improvement in the economy is slow. That said, the economy is expected to regain momentum from the summer of this year. Overseas, emerging economies are expected to continue growing at a high pace. In the United States and Europe, the growth rate is likely to increase as the after-effects of the financial crisis wear off. As a result, Japan’s exports and production are expected to maintain their favorable conditions, and that benefit will spread to exporting firms as well as their related firms in Japan. If exports and production increase, firms’ sales will increase and corporate profits will improve. Since capacity utilization will increase as the production level rises, the firms’ sense of excessive capacity will fade away, albeit moderately, and their motivation for business fixed investment could be stimulated. Furthermore, such favorable conditions in the corporate sector are likely to spread to the household sector. As corporate profits further improve, expansion in new employment and recovery in wages will likely take place. Moreover, the decline in anxiety about employment and future income will also have positive effects on household consumption. As such, Japan’s economy as a whole is expected to gradually increase its growth rate, with the improvements in the corporate sector originating from exports spilling over to the household sector. The Bank releases every quarter its outlook for economic activity and prices for about two years ahead. The real economic growth rate is projected to decline significantly in fiscal 2009 to minus 2.5 percent, but gradually go up to 1.3 percent in fiscal 2010 and 2.1 percent in fiscal 2011. Of course, the economy changes daily. If the external environment and behavioral patterns of firms and households change, the outlook might be revised upward or downward. Of those uncertainties, let me touch on two factors that I consider to be especially important. One is developments in overseas economies. As I have explained so far, Japan’s economic outlook will be affected greatly by overseas economic developments. Of those, emerging economies including China have been recovering at an unexpectedly high pace. In that regard, it might well be the case that those economies grow more than expected again. However, as those emerging economies are growing at a high pace, we need to be aware of the risk that the economy might overheat. Since the United States and Europe still suffer the after-effects of the financial crisis, there is uncertainty about the outlook for their economies. In particular, there are varying views on how the impaired assets of financial institutions and excess debts of households will be cleared. In Japan, it took extremely long to resolve the impaired assets problem for financial institutions after the burst of the bubble. Whether such history will repeat warrants attention. The other factor is whether firms can come up with a vision for the future. In the outlook I have mentioned earlier, firms are expected to decide on business fixed investment and new employment as the economy gradually improves. However, at present, it is even more difficult to foresee the future, due partly to the financial crisis. If a pessimistic view for the future spreads, firms’ spending activity will contract more than necessary. While it is a fact that Japan’s economy faces many challenges, it is critical to raise firms’ expectations of growth to meet those challenges. I will come back to that point later. II. Price developments in Japan Current conditions and the outlook for prices Before moving to a longer-term issue of firms’ growth expectations, I will touch on the current conditions and outlook for prices in Japan. The consumer price index (CPI) inflation rate, excluding fresh food and on a year-on-year basis, rose to 2.4 percent in the summer of 2008, but the pace of increase moderated thereafter, and has been in the negative territory since the spring of 2009. In particular, the decline accelerated toward the summer of 2009 to mark a record –2.4 percent decline. Thereafter, the decline gradually moderated, and has recently been about –1 percent. On the back of such recent price developments, there are mainly two factors at work. One is the effects of developments in commodity prices, represented by crude oil prices. The other is the aggregate balance of domestic supply and demand. The first factor, the prices of commodities such as crude oil, nonferrous metals, and grains, surged from the beginning of 2007 to the summer of 2008, followed by a sharp decline. In particular, since the autumn of 2008 when the financial crisis occurred, the decline in global demand and the sudden contraction of financial institutions’ funds supply led to a plunge in commodity prices. That, through a decline in the prices of foods and petroleum products, such as gasoline and kerosene, reflecting a decline in import prices, exerted downward pressure on overall prices. The main reason why the rate of decline in the overall prices accelerated toward the summer of 2009 was that the plunge in commodity prices affected the prices with a time lag. Since then, however, commodity prices have been picking up as the global economy and financial markets have restored stability. Recently, prices of petroleum products are putting somewhat upward pressure on the overall prices. As such, the developments in commodity prices have affected Japan’s prices substantially for the past one to two years. The balance of aggregate supply and demand in the economy, the second factor, has been affecting the trend of price developments. Since the autumn of 2008, the economic downturn induced a state in which demand is well short of supply. Therefore, not only the prices of petroleum products and foods but also the prices of wide-ranging products declined. Of the items surveyed in compiling consumer prices, 60 to 70 percent registered a decline. While Japan’s economy has been picking up during the past year, a significant imbalance between demand and supply has been continuing, reflecting the plunge in economic activity preceding the pick-up. Japan’s economy is expected to continue improving, but given that the pace of improvement is likely to remain moderate, downward pressure on prices will persist for the time being. The Bank’s outlook projects that the rate of change in the CPI, year on year, will remain slightly negative until fiscal 2011, although the pace of decline will continue to moderate. While I have mentioned two factors that affect price developments, there is another important factor. That is people’s view of future prices, or, put simply, price perspective. In the real world, many prices are set on a daily basis. Not to mention the prices of products and services, wages, which are compensation for labor, are also a type of prices. The outlook for prices will also have an effect on determining those prices. For example, if a view is entrenched that prices will decline significantly, such view will put downward pressure on the determination of actual prices and wages. While people’s price perspective is an important factor, one cannot directly observe firms’ and households’ views on prices. Therefore, the Bank tries to analyze and gauge such views by using various forms of research, including its own surveys, and financial market data. In light of such analysis, it is judged that firms’ and households’ medium- to long-term price expectations have not changed substantially. I have so far explained the current state and outlook for prices. However, like the outlook for economic activity, the outlook for prices is also associated with various uncertainties. If you look at quite recent CPI developments, a pace that the decline in prices moderates seems to have been somewhat slower compared with the extent of improvement in the aggregate balance between supply and demand, although it is difficult to accurately gauge such aggregate balance. Moreover, since the constant price decline, namely deflation, has been persisting, whether the view on prices might shift downward warrants due attention. Inclusive of that point, the Bank will carefully check future price developments. Issues regarding deflation Now, I will briefly talk about the “deflation issue.” The fundamental cause of deflation is deterioration in the balance between demand and supply. Somewhat metaphorically, prices are compared to the temperature of the economy. If we follow this metaphor, deflation, that is a situation in which the temperature of the economy has fallen, reflects the fact that the physical fitness of Japan’s economy has declined. Attention should not only be paid to deflation as an outcome, but also to the risk that deflation may deteriorate economic activity. Recently, it seems to me that there are increasing examples of discussions that relate various economic problems to deflation. Therefore, it is all the more important to carefully discuss what adverse affects deflation might have on the economy. There are some problems that deflation can cause in the economy. For example, from the perspective of a central bank, there is a problem of the so-called “zero interest rate bound,” which is the problem that monetary policy actions are constrained since interest rates cannot be reduced to below zero. Today, I will discuss somewhat in detail the deflation issue particularly in terms of corporate management. Since the cause of deflation is a lack in demand, sales will inevitably fall in volume. A fall in the prices of products, together with such a fall in the volume of sales, will substantially reduce firms’ sales. Of course, if firms manage to correspondingly reduce production costs and fixed costs, profits – the most important element in corporate management – will be secured despite a decline in sales. The problem lies in the fact that reduction on various costs is difficult. Economic history reveals episodes in which deflation further aggravated economic deterioration. Such episodes show that, given that ex-post reduction in the nominal amount of corporate debts was difficult, economic activity deteriorated further through pressure on corporate profits and increase in the burden to repay debts. Another problem is that a decline in sales and corporate profits might contract firms’ future growth expectations and firms might tend to refrain from challenging new business fixed investment or technological innovation. Famous U.K. economist John Maynard Keynes expressed entrepreneurs’ challenging spirit as “animal spirit.” In the economy under deflation, it becomes difficult to secure such animal spirit. For example, under deflation, firms tend to focus more on how to increase the price competitiveness of the existing products rather than developing a new field. We should recognize that such price competitiveness alone will make it difficult to gain momentum for growth. So far I have pointed out, from the perspective of corporate management, several possibilities that deflation itself might induce deterioration in economic activity. To get back to what I was referring to the temperature of the economy, we are aware not only of a decline in temperature owing to bad health but also of a risk that a decline in temperature might worsen illness. The existence of such risk is what makes overcoming deflation all the more important. To overcome deflation, it is necessary to consistently continue with therapy for the fundamental cause of a demand shortage. At the same time, to avoid creating a situation in which the economy will be aggravated, originating from deflation, that is, deflation inducing deflation, it is important to act on firms so that their business sentiment will not weaken. In doing so, a key will be the recovery in private demand, including business fixed investment and household consumption. Raising firms’ growth expectations will be the basic premise for the recovery, as I mentioned earlier. In that regard, the challenge of overcoming deflation is directly linked with the challenge for Japan’s economy in a longer perspective. III. Medium- to long-term challenge confronting Japan’s economy Japan’s longer-term challenge is to regain the confidence of firms and households in the outlook for Japan’s economy in the long term. To achieve this, we must discuss the issue of where to find Japan’s source of energy to achieve sustainable growth over the long term. It seems to me that those issues are frequently discussed by dividing demand into two large categories, namely domestic demand and external demand, and considering which of the two is of greater importance. In doing so, the phase of economic expansion from 2002 is often cited. Since the driving force for economic activity during this phase was the substantial increase in exports, it tended to give the impression that Japan’s economy was led by external demand. The major reason why this phase of economic expansion ended was the sharp deterioration in overseas economies triggered by the failure of Lehman Brothers in the autumn of 2008. From that experience, what tends to be drawn out is a lesson that economic growth led by domestic demand is desirable rather than vulnerable economic growth that is dependent on overseas economies. However, we should not neglect the fact that, even though the economic expansion from 2002 originated from exports, there was active business fixed investment aimed at exports. Moreover, through the effect of creating employment and wealth effects from rising stock prices, private consumption also increased. In that light, I believe that we should not make a simple choice between domestic and external demand, but rather we should see them as two mutually important elements for growth, including their transmission mechanisms. Currently, Asia is increasing its presence as the growth center of the global economy. Japan has a considerable advantage that it is closely located to the area with great growth momentum. To make the most of the benefits from globalization and capture demand from the area that is growing strikingly are the shortcut for Japan in gaining the energy for economic growth. There are also views that pay attention to the negative connotations of globalization, such as severe competition with overseas products and shift of production bases to overseas by business counterparts. However, income gained through globalization has been invested domestically, and as a result, it has exerted positive effects on the domestic economy, too. I believe that it is necessary not to turn away from globalization by claiming its negative aspects only, and to actually take globalization positively, actively taking its advantages. The next question is how to capture the benefits from growth in overseas economies. To that end, it is important to increase exports to growing markets, such as those in Asia. In emerging economies, huge markets are being formed. From now on, as people’s level of income increases further, the level of products and services that people seek is also likely to rise. This is a great opportunity for Japan, given its strength in relatively high-end products. It should be noted that the areas in which growth is expected are not limited to durable consumer goods and general machinery, which have been Japan’s major exporting items, or the environment-related areas, where Japan currently takes the lead in technology. For example, quality agricultural products or unique local specialties are the areas in which potential demand is great. Also, while it may be difficult to conjure from the word “exports,” tourism, which invites foreign tourists to Japan, also means exporting added value in the form of services. Considering these points, I believe that the areas that are rich in tourism resources have potential for high growth. Moreover, there are other channels for capturing the benefits from overseas economies. Especially, profits from overseas investment are increasing substantially. If firms manage to tailor production technologies, which have been fostered in the severe environment for competition in Japan, and detailed services, such as logistics and retails that have responded to the high requirements of consumers in Japan, to the needs of overseas local markets, there is sufficient room for further raising their profitability. Of course, it is also necessary to use the energy for growth, captured from overseas economies through these channels, to activate the domestic economy. In years to come, amid the low birth rate and the aging population, Japan will face an unprecedented shrinkage of population that no other country has experienced. If we look only at this aspect, it will be a burden in activating the domestic market. At the same time, however, there are business opportunities brought about by changes in the demographics. In this light, businesses targeted at the elderly, not only in terms of medical care and welfare, but also development of products and services tailored to the needs of the elderly, have substantial potential for expansion and diversification. I believe that there remains sufficient room for potential growth in Japan. The question is how to convert growth potential into actual growth. This cannot be achieved without firms’ technological innovations in accordance with changes in the demand structure. At the same time, I emphasize the significance of the roles of the finance and policy authorities in supporting firms’ efforts to this end. For example, to survive in growing markets, particularly those in Asia, firms around the world are fiercely competing against each other. In this situation, Japanese firms have the strength since their technological skills are high to start with and, assured by such skills, the quality of their products is also high. However, unless such strength matches the needs from new markets, it will not be possible to fully capture potential demand. Firms need to make technological innovations in various aspects, including thorough market research and pricesetting strategies, in addition to product development. I used the term “technological innovations” to refer to the overall corporate efforts to capture such potential demand. From the viewpoint of firms, the promotion of technological innovations means that there will be correspondingly additional costs, since they will need to invest in human and management resources. Looking back, since the 1990s, the growth rate of the economy and the inflation rate have remained low in Japan. And, while low interest rates continued for a prolonged period and large-scale public investments were implemented constantly, the metabolism of the economy tended to be low, and some firms and parts of the corporate sector with low productivity remained. As a result, firms’ profit expectations overall seem to have declined, preventing their endeavors to promote drastic technological innovation. I believe it will also be necessary to reconsider what factors are needed to be effective in further encouraging firms’ attempts to achieve technological innovations. As a factor that will support firms’ efforts toward technological innovations, I believe that finance plays one of the crucial roles. The basic function of finance is to search for businesses and projects with prospects, and allocate funds to them. For firms, who are the borrowers, the hurdle in embarking on a new business will be less difficult as they can gain funds from financial institutions and financial markets. At the same time, it is important for the financial side to encourage firms’ efforts in improving profitability, by setting lending standards that correspond to projects with low profitability. There are many small firms with high technological skills in Japan. Surveys on firms show that the smaller the size of business, the more firms that answer that their financial positions are weak. If their technological skills are not fully used due to financial constraints, it will cause a significant loss for the overall economy, too. Therefore, I hope that financial institutions will make careful assessments and facilitate the smooth provision of funds to businesses and projects with prospects. Of course, the authorities also play important roles. During the process in which firms promote technological innovation, not all the cases will lead to success. Moreover, if a sector grows by introducing new technologies, behind that might be a sector that has been left behind from the wave of technological innovation. For the economy as a whole, it is necessary that, through such a process, human resources and funds are transferred smoothly to more growing areas. However, it is not always true that a person who worked in a different area until yesterday can easily adapt to a new environment today. In that regard, I believe that the policy authorities should work to enhance economic metabolism through the smooth transfer of human and management resources, and to prepare a safety net to alleviate potential friction associated with such transfers. IV. The role of the Bank of Japan I have explained the challenges confronting Japan’s economy. Those challenges should be tackled steadily by private firms and the authorities from their respective standpoints. Of course, the Bank should also play an important role in that context. For the immediate challenge of overcoming deflation, the Bank considers the following two approaches as important and is steadily carrying them out. The first is to aim at removing the fundamental cause of deflation. That means to resolve the disparity between supply and demand in a sustainable manner. Based on such a viewpoint, the Bank has been implementing drastic monetary easing. The target level of the policy rate, an overnight interest rate, was reduced to 0.1 percent in December 2008 and has remained there since then. The 0.1 percent level of effectively zero interest rate is currently the lowest policy rate among central banks around the globe. Moreover, in December 2009, the Bank introduced a new funds-supplying operation to encourage a further decline in longer-term interest rates in the money market through provision of ample funds. As a result, the effectively zero interest rate is spreading to funds with even longer maturities. Through implementing those measures, the Bank aims at preparing an extremely accommodative financial environment and thereby promoting firms’ capital investment and household consumption. The other approach is to prevent people’s view on prices from worsening. In that regard, the Bank further clarified the stance that it is important to achieve a state that the year-on-year rate of change in the CPI is positive. That is part of the approach to stabilizing people’s view on prices. For Japan’s economy to overcome deflation and return to a sustainable growth path with price stability, the Bank will continue to consistently make contributions. And, if judged necessary, due, for example, to economic and price developments as well as changes in financial conditions, the Bank is always prepared to implement appropriate measures at an appropriate timing. Moreover, as for the other medium- to long-term challenge of exploring a long-term vision of Japan’s economy, the best contribution the Bank can make as a central bank will be to support the economy in achieving a sustainable growth with price stability. The Bank will strive to achieve economic and price conditions in which there is little future uncertainty, so that firms can actively expand their business with confidence. Concluding remarks I have been explaining Japan’s economic conditions and the challenges confronting Japan. To conclude, let me talk about my impression about Kagoshima’s economy. Kagoshima’s industrial structure may be characterized by the fact that the weight of exportrelated firms are little, compared with the national average, while that of the agriculture, forestry, and fisheries industry and the construction industry is considerable. For that reason, it might perhaps be difficult to feel the pick-up in the economy originating from exports. In fact, I have been informed that, through interviews by the Bank’s Kagoshima branch, many firms recognize the lagging improvement in the business environment, and express concern about the outlook for the economy. Nevertheless, room for potential growth in this region is by no means small. First of all, this region has a big advantage over other regions in Japan since it is close to the growing East Asian region. For example, I have heard that efforts are being made to deepen the Shibushi port-based trade relationship with Asian countries. Since Asian countries are expected to continue to grow, Kagoshima has a great chance to make a leap forward through expansion of sales channels to these markets, and research on markets needs as well as development of products tailored to such needs. Kagoshima also has high potential for growth in exploring tourism demand from other areas in Japan as well as the Asian region since it is blessed with rich tourism resources such as a world heritage and many hot spring resorts. On this point, the start of Kyushu shinkansen line’s full service will largely help to invite tourists from both within Japan as well as overseas. Above all, Kagoshima’s strength lies in its rich specialties, as represented by livestock products and liquor. I have heard that Kagoshima has been making a prefecture-wide agricultural promotion based on the key words of “foods and agriculture,” and it is expected that such efforts will pay off. Those specialties will be traced back to various painstaking efforts to overcome severe agricultural conditions of volcanic ash soil. People of the region have overcome unfavorable conditions through various devices and have achieved the growth in Kagoshima’s economy. That overlaps what is required for Japan’s economy in the years to come. I hope that you will further make forward-looking efforts in search of new opportunities. The Bank will also make consistent efforts so that firms can have bright visions toward the future.
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Speech by Mr Seiji Nakamura, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Fukuoka, 4 February 2010.
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Seiji Nakamura: Japan’s monetary policy and developments in economic activity and prices Speech by Mr Seiji Nakamura, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Fukuoka, 4 February 2010. * I. The current economic situation A. Overseas economies * * The world economy has been on a moderate recovery path, supported by fiscal stimulus measures such as the promotion of car sales and accommodative monetary policies implemented around the world. Increased production, reflecting progress in inventory adjustment and a recovery in trade, also contributed to the recovery. The International Monetary Fund (IMF) saw the economic recovery as sustained, and on January 26, 2010 revised upward its outlook for world economic growth in 2010 to 3.9 percent, up 0.8 percentage points from its forecast released in October 2009. The high growth in emerging economies such as China has been upholding the economic activity of industrialized countries, including Japan, through increased trade. Emerging economies have marked higher-than-expected growth as the balance sheet problems of financial institutions and individuals were small relative to those of industrialized countries. As a result, the stimulus measures within these economies were particularly effective. The strong domestic demand boosted by a virtuous cycle of production, income, and spending, inflow of overseas capital, and recovery in exports to industrialized countries also contributed to the high growth. For example, in China, the real GDP growth rate for the October-December quarter of 2009 increased 10.7 percent from a year earlier, and growth remains particularly strong in areas such as personal consumption and fixed asset investment. Furthermore, exports, which had been sluggish, saw double-digit month-onmonth growth in December, spurred by high-value-added products such as high-tech goods and electrical machinery, and turned positive on a year-on-year basis for the first time in 14 months. In order to maintain robust growth, the Chinese government appears to have started to implement preemptive measures to cool down the overheating seen in part of the real estate market, as well as the surge in bank lending. Emerging economies, including China, are expected to maintain high growth for the time being. Given that these economies are now the main engines of the world economy, it is necessary to watch out for any signs of a possible economic bubble and monitor the sustainability of their economic growth. In industrialized countries, economic conditions are improving, although the pace of recovery has been moderate as it has had to cope with the need to alleviate various structural imbalances, such as excessive consumption and the heavy debts accumulated ahead of the financial crisis. Such imbalances have been apparent in that the net assets of U.S. households had decreased by almost 20 percent from their peak, while consumer loan delinquency rates have been increasing. Also, banks have been maintaining their tight lending attitudes and the amount outstanding of lending has been decreasing. In the United States, real GDP for the October-December quarter of 2009 registered 5.7 percent growth and the economy as a whole has been recovering, although the level of economic activity is still low and a full-fledged recovery is likely to require more time. Personal consumption seems to be leveling off as Christmas sales in 2009 recovered slightly from the previous year, when sales had fallen sharply due to the effects of the collapse of Lehman Brothers, the so-called Lehman shock, and new car sales on an annualized basis exceeded 10 million units for four consecutive months. The housing market has also been recovering, although uncertainty remains, and commercial real estate prices continue to fall. The unemployment rate remains high, at 10 percent, without any prospect of an early recovery in the job market. The economy in Europe has been recovering, with exports acting as the main driving force, although domestic demand has been weak as evidenced by the decline in retail sales (excluding cars) in December from a year earlier, when sales had fallen sharply due to the effects of the Lehman shock. Looking ahead, however, economic activity could be hindered by balance sheet adjustments in the financial sectors of European nations as well as in some governments including that of Greece. Therefore, the pace of economic recovery in Europe is likely to be more moderate than that in the United States. B. The Japanese economy The downturn in the Japanese economy following the Lehman shock, with the accompanying steep decline in exports and production, was more severe than that in the United States and Europe. This reflected Japan’s industrial structure, which is susceptible to the effects of world economic deterioration. The Japanese economy had been underpinned by buoyant exports of transport equipment, electrical machinery, and general machinery directed mainly to the United States and Europe, supported by the weak yen. Since these sectors had come to account for an increasingly large share of Japan’s production, the sudden nearly 40 percent decline in exports forced substantial curtailment of production and inventory. The impact was particularly large in the automobile sector, which is linked to a wide range of related industries. Although the Japanese economy deteriorated significantly, exports and production have started to pick up since hitting bottom in February 2009, due to recovery in overseas economic conditions, mainly in emerging economies such as China, and progress in inventory adjustments at home and abroad. However, it is important to add that December 2009 levels of exports and production were 78 percent and 87 percent, respectively, of those in September 2008, just before the Lehman shock. In the area of domestic demand, private consumption is picking up as a whole, with increased sales of cars and household electrical appliances resulting from economic stimulus measures. There are some signs that housing investment has stopped decreasing, since the number of housing starts, a leading indicator, increased for four consecutive months until December 2009. The ratio of job offers to applicants also improved for four consecutive months, but the unemployment rate has remained high, at 5.1 percent, and the perception of an excessive workforce remains prevalent among employers. Nominal wages per employee are declining and consumers’ spending appetite has not improved. Although the decline in business fixed investment has finally started to come to a halt, a number of firms are cautious about making new investments in Japan given that the outlook for a recovery in demand is unclear and there is a strong sense of excessive capital stock. In sum, although economic activity is picking up, momentum to support a self-sustaining recovery is weak because production and exports remain at low levels, and any improvements so far have been largely supported by various stimulus measures at home and abroad. II. The bank’s policy responses since autumn 2008 I will now talk about various policy measures the Bank has taken in response to the unprecedented turmoil in economic and financial conditions since autumn 2008. Prior to the failure of Lehman Brothers in 2008, many firms in Japan sought to reduce on-hand liquidity in order to increase capital efficiency under extremely accommodative financial conditions. After the Lehman shock, however, firms faced a rapid financial contraction, making their procurement of funds through CP and corporate bonds extremely difficult. This critical situation caused firms, small and large, to worry about the availability of funds, thereby raising tensions in financial markets. In response to the turmoil in economic and financial conditions, the Bank took various steps to ensure market stability; for example, lowering the policy rate in two stages from 0.5 percent to 0.1 percent in October and December 2008, and providing ample liquidity to the markets, including unlimited U.S. dollar funding. Furthermore, the Bank adopted exceptional measures such as outright purchases of CP and corporate bonds to support a recovery in market function. Also, through its special funds-supplying operations to facilitate corporate financing, the Bank provided an unlimited amount of funds to counterparties at a fixed rate of 0.1 percent against corporate debt submitted as collateral. Through these efforts, the Bank helped firms deal with difficulties in funding through markets and also encouraged interest rates to decrease. Having achieved the intended purpose of restoring the proper functioning of these markets, the Bank decided to terminate outright purchases of CP and corporate bonds at the end of December 2009. Meanwhile, it decided to extend special funds-supplying operations to facilitate corporate financing until the end of March 2010, and thereafter to continue providing ample liquidity through conventional policy measures. At the unscheduled Monetary Policy Meeting held on December 1, 2009, the Bank decided to introduce a new operation to provide funds amounting to approximately 10 trillion yen, with a term of three months at a fixed interest rate of 0.1 percent. This decision was prompted by the need to support economic recovery from the financial side against the background of increased risk that international financial developments and foreign exchange market instability since the latter half of November 2009, such as the occurrence of Dubai’s debt crisis, might adversely affect economic activity by impacting business and household sentiment. The Bank’s basic stance on monetary policy at present is to provide support to the Japanese economy in order to overcome deflation and return to a sustainable growth path with price stability. To this end, the Bank aims to maintain the extremely accommodative financial environment by providing ample liquidity to meet the demand in financial markets. I believe it is important for the Bank to maintain this basic stance on monetary policy. At the same time, the Bank should not have any predetermined view regarding the future path of monetary policy, but should take measures that would be most appropriate on each occasion in response to changing economic and financial conditions. III. Domestic price developments A. Price developments Inflationary concerns heightened around the world in July 2008, when crude oil prices hit 140 dollars per barrel and, in Japan, the consumer price index excluding fresh food (core CPI) rose 2.4 percent from the previous year. However, in August 2009, the core CPI fell 2.4 percent year on year, while inflationary concerns abated significantly, reflecting the drop in prices of natural resources triggered by the slowdown in the world economy and the outflow of speculative funds from commodity markets prompted by the financial crisis. In December 2009, the rate of decline in the core CPI marked a 1.3 percent fall as the effects of the setback in crude oil prices receded, and is expected to continue to diminish in line with a moderate economic recovery. In the interim assessment of the October 2009 Outlook for Economic Activity and Prices released on January 26, 2010, the median forecast for the core CPI was minus 1.5 percent for fiscal 2009, minus 0.5 percent for fiscal 2010, and minus 0.2 percent for fiscal 2011. Although the CPI is forecast to remain in negative territory until the end of fiscal 2011, the rate of decline is expected to moderate. The government’s plan to make high school tuition effectively free, due to be implemented during fiscal 2010, might cause the rate of decline to accelerate. However, it is necessary to accurately grasp the basic price trend by adjusting for the effect of temporary factors caused by institutional changes. B. Deflation The term “deflation” is mostly used to describe a continued fall in general prices, or otherwise to indicate a drop in asset prices or economic stagnation. Nowadays, however, the term seems to be used quite carelessly in various situations. The current heated price competition among Japanese retailers and other service providers is considered to be causing a deflationary phenomenon, and is viewed by some as a problem. Consumers are growing wiser and more price conscious, spending frugally and purchasing only essential items in needed quantities. An increasing number of firms have been adapting to such changes in consumer behavior and taking action to entice consumers by providing new products and services that meet the shift in demand, or lowering sales prices by eliminating unnecessary functions. The price revisions resulting from such efforts by firms should be considered separately from the problem of deflation. The sustained decline in prices in Japan is due to a combination of factors. For example, Japanese firms have placed a higher priority on the continuity of employment and business than on maintaining the wage level, and also on maintaining long-term business relationships and gross sales volume than on profitability. These and other factors have allowed the price level in Japan to remain low for a longer period than in the United States and Europe. The ongoing fall in prices has also been triggered by recent market movements, namely, the decline in oil prices in reaction to their surge to more than 140 dollars per barrel in 2008, as well as the sharp decline in global demand resulting from the financial crisis. Therefore, in view of the current economic outlook that the recovery will be sluggish, demand – which is well short of supply at present – is unlikely to recover quickly, and the downward pressure on prices will not ease in the short term. The Bank’s current policy measures have been helping to underpin demand, by encouraging money market rates to decline and by providing ample liquidity to financial institutions. Fiscal measures have also been taken to stimulate demand for consumer durables. Further restructuring efforts in the private sector are necessary to achieve sustained growth in demand. In other words, it is vital that the Bank, the government, and the private sector each play their part and jointly work to boost demand. The frequently voiced opinion that, to end deflation, the Bank should provide massive amounts of liquidity to private financial institutions as a quick fix to overcome the situation, ignores longer-term issues that have major implications for the future. Looking back at the Bank’s quantitative easing policy implemented from 2001 to 2006, the Bank provided ample liquidity to financial institutions via their current accounts held at the Bank, but private banks’ lending to other private sector entities did not rise relative to the increase in the outstanding balance of current account deposits, indicating that the policy’s direct impact on ending deflation was small. Recently, the Bank’s accommodative stance on money market operations has enhanced the sense of an abundance of liquidity, causing market rates, including those on longer-term instruments, to decline further toward 0.1 percent, which is the rate applied to the complementary deposit facility. Nevertheless, due to weak corporate demand for funds, the Bank’s ample supply of funds once more has failed to lead to an increase in bank lending, although financial institutions have not been averse to lending. In sum, the ordinary operation of the transmission mechanism of monetary easing has not been working. Based on this observation, I believe that Japan will not be able to end deflation via policy measures such as simply increasing the supply of liquidity. In addition to the Bank’s contribution to price stability, it is essential that all economic entities work together to create demand at home and abroad through innovation and steady day-to-day efforts, to ensure, and attain the prospect of, higher income over the medium- to long-term through increased productivity. C. Announcement of the “Understanding of Medium- to Long-Term Price Stability” After the Monetary Policy Meeting on December 18, 2009, the Bank reiterated its “Understanding of Medium- to Long-Term Price Stability” in order to gain an accurate understanding of its thinking on price stability in the conduct of monetary policy. The announcement was made in an attempt to clearly show the Bank’s commitment to fight deflation by eradicating any impression that the public and market participants may have held that the Bank was an “inflation fighter, but not a deflation fighter,” and was not making serious enough efforts to end deflation. In its statement, the Bank specified that the Policy Board does not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent, and that the midpoints of most Policy Board members’ “understanding” are around 1 percent. IV. The outlook and risk factors for the future conduct of monetary policy A. The outlook The Bank discusses economic activity and prices at the Monetary Policy Meetings held each month. Semiannually, in April and October, it releases the Outlook for Economic Activity and Prices, known as the Outlook Report, in which the Bank makes public its forecasts for economic activity and prices for the next two to three years, and three months after their release conducts interim assessments of the reports. In the latest interim assessment released after the Monetary Policy Meeting held on January 25 and 26, 2010, the median of the Policy Board members’ forecasts for year-onyear real GDP growth was minus 2.5 percent for fiscal 2009, 1.3 percent for fiscal 2010, and 2.1 percent for fiscal 2011, indicating that the economy was developing basically in line with the Bank’s outlook released in October 2009. The Japanese economy is likely to improve gradually, reflecting recovery in overseas economies. Although there remains the risk of a temporary leveling-off by around the middle of fiscal 2010, as the effects of various policy measures taken at home and abroad wane, the general upward trend is unlikely to be broken, with the growth rate rising to well above the potential growth rate in fiscal 2011, underpinned by a self-sustaining recovery in overseas economies, particularly emerging economies. The recovery in overseas economies, however, is likely to be moderate because considerable time may be required to overcome the various distortions accumulated in the global economy, mainly in industrialized countries. Therefore, it will take some time for the Japanese economy to achieve a full-fledged recovery. Given the sluggishness in the economies of industrialized countries, it is necessary for Japanese firms to reach out to consumers in emerging economies, which have a rapidly expanding middle class. Developments in the share of Japan’s exports during the 2000-2009 period show that the U.S. share decreased by almost half, from 29.7 percent to 16.1 percent, while that of China trebled from 6.3 percent to 18.9 percent, making China Japan’s largest trading partner in terms of both exports and imports. The share of exports to Asian economies as a whole increased from 41.1 percent to 54.2 percent, while that of the United States and the EU member states combined dropped from 46.0 percent to 28.6 percent, underlining an accelerating expansion in the share of emerging markets. Japanese firms had held an advantage in producing and selling high-value-added products and services, mainly to industrialized countries, but are not yet adept enough to satisfy the demand in emerging economies centered on inexpensive, low-specification products and services. Moreover, many Japanese firms have long considered emerging economies mainly as efficient production bases for exports to European and U.S. markets; therefore, much work needs to be done to retarget them as potential markets, by developing and producing new marketoriented products in a low price range, establishing sales networks, and providing staff training. Japanese firms are said to be slow to localize business lines in emerging economies. When I visited rapidly developing inland China last year, I saw some U.S. and European firms successfully advancing quickly into the cities of Chongqing and Chengdu and localizing their business models, whereas there were only a few Japanese firms that were aggressive in localizing their operations. The local deputy mayor had mentioned this situation. Given the geographical proximity to emerging economies with markets of high growth potential, Japanese firms, including those in nonmanufacturing sectors, have a good chance of expanding their shares in these growing markets. B. Risk factors There are both upside and downside risk factors to take into account in considering the outlook for the Japanese economy. The former include a possible upswing in the economic growth of emerging economies and commodity-exporting countries resulting from accommodative financial environments and economic stimulus measures in various countries. The latter relate to the possible consequences of balance-sheet adjustments in the United States and European countries, as well as Japanese firms’ medium- to long-term expectations of future economic growth. Regarding prices, primary commodity prices could rise in reflection of increasing demand among emerging economies and commodityexporting countries enjoying rapid growth; meanwhile, a prolonged sluggishness in the Japanese economy could add downward pressure on medium- to long-term inflation expectations, accelerating the decline in prices. The balance of risks remains somewhat tilted to the downside because of the extremely large negative impact of the financial crisis, yet not to the degree seen a year earlier. In order to lower break-even points or reach out to consumers in the markets of emerging economies, many corporate managers are in a restructuring process of withdrawing from unprofitable areas of business, selling loss-making sections or merging them with other companies, exploring new business areas, and reviewing supply and production as well as research and development capabilities. For this reason, firms might close down existing domestic production facilities and transfer them overseas. Even if overseas economies fully recover, domestic business fixed investment would be restrained and a recovery in the employment situation would be limited. For example, production of information and communications equipment for the Japanese market, such as flat-panel televisions and cellular phones, is being transferred overseas, increasing the share of imported equipment. Research and product development is also being transferred and localized as a result of improved business infrastructure. Transfers of research and production overseas, to emerging economies in particular, are likely to increase steadily. Whether this trend will accelerate and lead to a hollowing-out of the Japanese manufacturing sector is a matter of concern. As a result of the aggressive fiscal policies designed to underpin the economy after the Lehman shock, fiscal deficits and government debt have increased to a very high level in many countries. Now that the panic-like phenomena in the economy and financial markets have subsided, concerns are growing around the world about the sustainability of government debt. For example, in Greece, the new government elected in October 2009 made public that the fiscal deficit was larger than previously announced. This disclosure prompted a downgrade of the sovereign debt rating for Greece, leading to a sharp rise in interest rates. In the euro area, Portugal, Italy, Ireland, and Spain are also thought to be having serious fiscal-deficit problems, and interest rates are rising in these countries. There was evident concern in the European Central Bank’s comments in a statement issued after a meeting of the Governing Council on January 14: “The very large government borrowing requirements carry the risk of triggering rapid changes in market sentiment, leading to less favourable medium and long-term market interest rates. This, in turn, would dampen private investment and thereby weaken the foundations for sustained growth. Moreover, high levels of public deficit and debt would place an additional burden on monetary policy and undermine the credibility of the provisions of both the Treaty on European Union and the Stability and Growth Pact as a key pillar of Economic and Monetary Union. The Governing Council therefore calls upon governments to decide and implement in a timely fashion ambitious fiscal exit and consolidation strategies based on realistic growth assumptions, with a strong focus on expenditure reforms.” The predicament in the euro area should have given enough warning to the United States, the United Kingdom, and Japan in consideration of their own severe fiscal conditions. It is extremely difficult to generate balanced measures for short- and longer-term issues, namely, for continued short-term fiscal support and medium- to long-term fiscal consolidation, when the level of economic activity remains low and the pace of recovery in private demand is sluggish. However, we must bear in mind that depending too heavily on temporary emergency measures could trigger larger problems in the future. Therefore, it is necessary to review such measures in a timely manner and thoroughly discuss fiscal restructuring over a medium- to long-term period in order to achieve balanced and sustainable growth.
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Statement by Mr Masaaki Shirakawa, Governor of the Bank of Japan, concerning the Bank's "Semiannual Report on Currency and Monetary Control" before the Committee on Financial Affairs, House of Councillors, Tokyo, 13 April 2010.
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Masaaki Shirakawa: Recent economic and financial developments and the conduct of monetary policy Statement by Mr Masaaki Shirakawa, Governor of the Bank of Japan, concerning the Bank’s “Semiannual Report on Currency and Monetary Control” before the Committee on Financial Affairs, House of Councillors, Tokyo, 13 April 2010. * * * Introduction The Bank of Japan submitted to the Diet its Semiannual Report on Currency and Monetary Control for the second half of fiscal 2008 and the first half of fiscal 2009 in June and December 2009, respectively. I am pleased to have this opportunity to talk about the recent developments in Japan’s economy and present an overall review of the Bank’s conduct of monetary policy. I. Developments in Japan’s economy Japan’s economy has been picking up mainly due to improvement in overseas economic conditions and to various policy measures, although there is not yet sufficient momentum to support a self-sustaining recovery in domestic private demand. The trend of pick-up is becoming more evident. Exports and production have been increasing mainly against a backdrop of robust growth in emerging economies. According to the March Tankan (ShortTerm Economic Survey of Enterprises in Japan) released at the beginning of April, business sentiment has been improving, with such improvement spreading to the nonmanufacturing industry and small firms, in addition to large manufacturing firms. Business fixed investment is leveling out, and private consumption, notably durable goods consumption, is picking up mainly due to policy measures, despite the continued severe employment and income situation. As for the outlook, the Bank projects that the pace of improvement of the economy is likely to be moderate for the time being, and it judges that the risk of the economy deteriorating substantially again, the risk of the so-called “double dip,” about which market participants had expressed concern, has diminished considerably. Thereafter, as improvements in the corporate sector originating from exports are expected to spill over to the household sector, the growth rate of the economy is likely gradually to rise. Financial conditions, with some lingering severity, have shown increasing signs of easing. Firms’ borrowing rates from banks have continued to decline due in part to the fact that financial institutions’ lending stance has become active, in addition to monetary easing by the Bank. Issuing conditions for CP are more favorable than in the period prior to the Lehman shock. Issuing conditions for corporate bonds have also been favorable, and even those for low-rated corporate bonds have shown signs of improvement. Meanwhile, although many small firms still see their financial positions as weak, the overall financial positions of firms, including small ones, have continued to show signs of easing. The CPI (excluding fresh food) is declining on a year-on-year basis due to the substantial slack in the economy as a whole, but the decline leveled out in August 2009 and the moderating trend of decline has continued. The outlook for the trend change in prices is determined by the aggregate supply and demand balance and the medium- to long-term inflation expectations. It should be noted that, statistically, the year-on-year rate of change in the CPI will decline for a year due to the introduction of subsidies for high school tuition and other policy measures in fiscal 2010, but in assessing the trend change in prices, it is necessary to exclude such one-off factors. In terms of the trend change in prices, with medium- to long-term inflation expectations likely to be stable, the year-on-year rate of decline in the CPI (excluding fresh food) is expected to continue to moderate as the aggregate supply and demand balance improves gradually. While I have thus far explained the baseline scenario for economic activity and prices, the Bank is also fully aware of the risks concerning such scenario. Upside risks to the scenario are developments in emerging and commodity-exporting economies. The robust growth of emerging and commodity-exporting economies has driven the pick-up of Japan’s economy. If the growth in those economies further accelerates, it will pose an upside risk to economic activity in Japan. Meanwhile, downside risks, although somewhat diminished, include the possible consequences of balance-sheet adjustments in the United States and Europe as well as potential changes in firms’ medium- to long-term growth expectations. Moreover, attention should continue to be paid to various recent international financial developments and their effects. With regard to prices, there is a risk that inflation will rise more than expected in the event of a rise in commodity prices due to higher growth rates in emerging and commodity-exporting economies. On the other hand, there is also a risk that the rate of inflation might decline due, for example, to a decline in medium- to long-term inflation expectations. II. Conduct of monetary policy The Bank recognizes that Japan’s economy is faced with a critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. Therefore, the Bank has been implementing various measures, taking into account the two factors that determine the trend change in prices. As a measure to prompt an improvement in the aggregate supply and demand balance, in terms of interest rates, the Bank has kept the policy rate at the effectively zero level. To encourage a further decline in longer-term interest rates in the money market, the Bank introduced in December 2009 a new funds-supplying operation, through which funds with a maturity of three months are provided at an extremely low interest rate of 0.1 percent, and the total amount of loans to be provided through this operation was set at approximately 10 trillion yen. The total amount of loans was increased to 20 trillion yen in March 2010. In terms of funds provision, the Bank has been providing ample funds through various fundssupplying operations, including the new operation. Furthermore, the Bank has made its stance clear that it will consistently maintain the extremely accommodative financial environment. As for inflation expectations, the other determinant of prices, the Bank has, to prevent people’s expectations for prices from declining, clearly showed its stance, in the form of the “understanding of medium- to long-term price stability,” that it is critical to achieve a positive year-on-year rate of changes in the CPI. To overcome deflation and achieve a sustainable economic growth with price stability, the Bank will continue to consistently make contributions as central bank.
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bank of japan
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Speech by Mr Tadao Noda, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shiga, 4 March 2010.
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Tadao Noda: My answers to the frequently asked questions regarding monetary policy Speech by Mr Tadao Noda, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shiga, 4 March 2010. * * * Introduction I was appointed as a member of the Policy Board of the Bank of Japan in June 2006 after having worked mostly at a bank and also at firms in the private sector, for a total of 37 years. Thus, my background does not make me a central banker in the strictest sense. However, since my appointment as a full-time Bank officer, I am able to draw on my experience in the private sector in day-to-day deliberations and discussions on monetary policy and the Bank’s operations. Today, in this speech, I will present my views by means of answering frequently asked questions (FAQs) about economic and financial developments and the conduct of monetary policy. Broadly speaking, I will discuss the following three FAQs. I. Where is Japan’s economy heading? II. How is the Bank’s monetary policy conducted? III. What is the cause of, and remedy for, the issue of deflation? I. The outlook for Japan’s economy: where is it heading? I will first discuss where Japan’s economy is heading. A. The current situation: the economy has been picking up, but the momentum to support self-sustained recovery is still weak Japan’s real GDP growth rate was in the range of 2–3 percent from fiscal 2003 to fiscal 2006, but dropped to 1.8 percent in fiscal 2007. In fiscal 2008, economic conditions deteriorated substantially and the economy registered negative growth of 3.7 percent. After the failure of Lehman Brothers, extreme cautiousness spread in many financial markets and the flow of funds necessary for economic activity contracted, rapidly reducing global demand. Demand in Japan fell sharply, mainly in leading industries – notably automobiles, electronic machinery, and general machinery – and the economy was affected more heavily by the global financial crisis than that of the United States, where the crisis started. Since the beginning of fiscal 2009, Japan’s economy has been picking up, as shown by the relatively large growth in the real GDP growth rate on a quarter-on-quarter basis for two quarters – the April–June and October–December quarters – although it registered 0 percent growth for the July–September quarter. Exports have been increasing due to the improvement in overseas economies. Private consumption has also been picking up, mainly due to the strong sales of some durable goods, namely automobiles and electrical appliances, which have been supported by the government’s economic stimulus measures that favor energy-efficient products. Regarding the outlook for Japan’s economy, it is expected to follow a sustainable recovery path reflecting improvement in overseas economies, although the recovery may not be smooth. The world economy decelerated significantly following the failure of Lehman Brothers in September 2008. Currently, however, economic conditions around the world have generally continued to recover moderately due to the effects of economic stimulus measures by governments and inventory restocking. The U.S. and European economies remain in the early stages of recovery, but the pace continues to be moderate due to prolonged balancesheet adjustments. 1 However, economies in Asia, including China, have continued to grow at a relatively rapid pace, in line with the improvement in domestic demand. The world economy as a whole is expected to continue recovering moderately. 2 Japan’s exports are likely to continue increasing, reflecting these economic conditions overseas. 3 It should be remembered, however, that the situation provides little grounds for optimism because the level of economic activity remains low. Although exports and production have continued to increase, their levels in the January–March quarter of 2010, the most recent quarter, were 16 percent below their peak levels reached in the January–March quarter of 2008, and the real GDP growth rate in the October–December quarter of 2009 was also 6 percent below its peak. 4 The low level of economic activity indicates that the levels of firms’ profits and production are low and that firms consider their capital stock and employment to be excessive. Unfortunately, under these circumstances, firms need to be cautious with respect to increasing their business fixed investment and employment. Private consumption, excluding durable goods consumption that has been supported by the effects of policy measures, is also likely to remain sluggish amid the severe employment and income situation. In other words, the momentum for self-sustaining recovery in domestic private demand is still weak. Let me explain the view of the Bank’s Policy Board regarding the economic outlook as of January 2010. The median of the seven Policy Board members’ forecasts for real GDP growth was minus 2.5 percent for fiscal 2009, 1.3 percent for fiscal 2010, and 2.1 percent for fiscal 2011. In other words, the Bank’s baseline scenario projects that after two consecutive years of negative growth in fiscal 2008 and 2009, the economy will return to positive growth from fiscal 2010 to fiscal 2011. 5 If we regard the level of GDP at its most recent peak marked in fiscal 2007 as 100, then the level of GDP is likely to be 94 in fiscal 2009, 95 in fiscal 2010, and still only 97 in fiscal 2011. Global structural adjustments, rather than a passing phase of a regular business cycle, lie behind the current global economic downturn. During the worldwide boom after 2002, various imbalances or excesses were accumulated on a global scale, and the difficulties in adjusting these imbalances are currently stifling the global economic recovery. For more details, see the speech “Recent Economic and Financial Developments and the Conduct of Monetary Policy” I delivered at a meeting with business leaders in Nagano in July 2009, a summary of which is available on the Bank’s web site. According to the World Economic Outlook released by the International Monetary Fund (IMF) in January 2010, the year-on-year growth rate of the world economy decelerated to 3.0 percent in 2008, from much higher rates of around 5 percent a year between 2002 and 2007. Although the growth rate plunged to minus 0.8 percent in 2009, the largest negative growth since World War II, it is projected to recover to a positive rate of 3.9 percent in 2010 and 4.3 in 2011. Japan’s exports depend on the situation in overseas economies. As mentioned later, it is highly uncertain as to whether they will continue recovering. However, the Organisation for Economic Co-operation and Development (OECD) composite leading indicator and the New Orders Index within the Manufacturing ISM Report On Business released by the Institute for Supply Management in the United States, both of which are regarded as leading indicators of Japan’s exports, continue to show improvements. I believe that exports are likely to continue increasing, at least for the time being. Comparing the recent levels of production, the real GDP growth rate, and exports with those before the January–March quarter of 2008, they are at the levels reached in the first half of the 2002, 2005, and 2006 calendar years, respectively. Every April and October, the Bank releases its Outlook for Economic Activity and Prices (the Outlook Report), and in the intervening January and July makes interim assessments of the outlook laid out in the Outlook Report. In the interim assessment made in January 2010, the Policy Board members took the view that growth prospects remain broadly unchanged compared with the Bank’s projections presented in the October 2009 Outlook Report. B. Risk factors for Japan’s economy: downside risks have been moderating I have explained the baseline scenario of the outlook for Japan’s economy. I will now describe the risk factors or uncertainties involved in the scenario that warrant attention. Compared with the risk assessment presented in the October 2009 Outlook Report, upside and downside risks have started to become more balanced as a whole due to the fasterthan-expected growth in emerging economies. 1. Developments in overseas economies Exports continue to be the driving force behind Japan’s economic recovery, and if the improvement in overseas economies is hampered, then the baseline scenario that Japan’s economy has picked up and will follow a sustainable recovery path might not be achieved. This suggests that the largest risk factor for Japan’s economy may well be developments in overseas economies. Growth in the U.S. and European economies, the main engine of overseas economies, has been dragged down by the situation in the household and banking sectors: households are reviewing their balance sheets and enduring firms’ severe employment adjustments, which are fundamental factors working to restrain household spending, while banks are reducing their lending as they hold impaired assets, which are still expanding, on their balance sheets. Situations such as these might exert downward pressures on economic activity for an extended period. In addition, there remains the risk that financial activity once again might be adversely affected by the sluggish economic activity. In China and other emerging economies, where infrastructure investment had been considerable even before the financial crisis, governments’ expansionary macroeconomic policies introduced after the financial crisis have stimulated economic activity further. In addition, the inflow of capital has become aggressive against the background of global investors’ increased appetite for risk-taking in the expectation that the low interest rate policy in industrialized countries will continue. The increase in capital inflow has pushed up growth in emerging economies through, for example, a rise in asset prices. These factors combined have contributed to a faster-than-expected recovery in emerging economies. This is reassuring in terms of supporting economic recovery in industrialized countries through improvement in exports, but there are growing concerns about upside risks such as the rise in overall prices and asset prices in some emerging economies. Moreover, the uptrend in commodity prices is continuing, as evidenced by the fact that West Texas Intermediate (WTI), the benchmark for crude oil prices, rose to a level more than double the recent low of 34 U.S. dollars per barrel, marked at the end of 2008, partly due to the expectation of increased demand in emerging economies. This suggests that an acceleration of capital inflow to emerging economies is a warning sign of the upside risk. Also demanding attention is the possibility that a rapid unwinding of international capital flows might occur in a situation where global investors’ expectations change significantly due to certain shocks, and this in turn could cause disruptions in financial markets and financial systems. It is therefore important, in view of the situation in international capital flows, to carefully examine whether there has been growing pressure in the markets for future adjustments that could potentially lead to a crisis. 2. Effects of policy measures taken worldwide The second risk factor for Japan’s economy is the uncertainty regarding the effects of various policy measures taken by countries around the globe. Economic stimulus measures by governments have been one of the key driving forces behind the global economic recovery achieved so far, but if such policy effects wane before private demand starts a full-fledged self-sustaining recovery, it is possible that economic activity will deviate downward from the projected growth path. Japan and many industrialized countries are facing the difficult issue of how to strike a balance between improving fiscal discipline and avoiding economic slowdown, as they suffer from deteriorating fiscal balances and have only limited capacity for further government spending. 6 The market has started to direct its attention to the risk that deterioration in fiscal balances might push up long-term interest rates and thereby reduce the effects of monetary policy. The so-called sovereign risk is considered to be an extension of that risk. In fact, Greece, which is suffering the most serious fiscal deficit problem among the European Union member states, has experienced a sharp rise in long-term interest rates. This is an illuminating example of how loss of confidence in fiscal sustainability might trigger a significant negative market response. Therefore, it is important that governments clearly show the future course of fiscal consolidation, or improvement of fiscal discipline, and steadily proceed with it at an appropriate time. 3. Possible changes in firms’ medium- to long-term growth expectations The third risk factor for Japan’s economy is the possible changes in firms’ medium- to longterm expectations of future economic growth. In the baseline scenario that Japan’s economy has picked up and will follow a sustainable recovery path, it is projected that firms again will increase spending on fixed investment and employment. If emerging economies are expected to maintain sustainable high growth while Japan’s economic growth is increasingly expected to remain slow, there is a risk that investment in and lending to emerging economies might escalate but domestic spending might continue to be suppressed. It is said that many firms are considering increasing the share of their overseas production. How such a shift to overseas production might affect not only domestic fixed investment and employment, but also the structure of imports and exports, warrants careful monitoring. 7 II. The Bank’s monetary policy: how is it conducted? So far, I have talked about the current situation and the outlook for Japan’s economy. Next, I will explain how the Bank has conducted monetary policy. A. Measures taken by the Bank: treading an unprecedented path Since September 2008, when the turmoil in global financial markets and the financial systems in the United States and Europe increased in severity, the Bank has undertaken various measures. These measures can be broadly divided into the following: (1) reductions in the policy interest rate; (2) provision of ample funds; and (3) restoring the proper functioning of financial markets. 1. Reductions in the policy interest rate Let me begin with interest rate policy. The Bank lowered its target for the uncollateralized overnight call rate – that is, the policy rate – in October and again in December 2008, to In his State of the Union address on January 27, 2010, U.S. President Barack Obama proposed a three-year freeze on government spending – excluding that related to national security, Medicare, Medicaid, and Social Security – and emphasized the need to improve fiscal discipline, saying that “if we don’t take meaningful steps to rein in our debt, it could damage our markets, increase the cost of borrowing, and jeopardize our recovery”. At the same time, he gave due consideration to avoiding an economic slowdown by making this freeze take effect next year, not this year. In cases where Japanese firms establish their production bases abroad, there would be an increase in Japan’s exports of capital goods and intermediate goods, which are needed for overseas production, and in its imports of consumer goods produced by Japanese firms abroad. In Japan, although the ratio of overseas production has been rising, exports of intermediate goods, mainly transport equipment, have expanded. Recently, however, re-imports of information and communication electronics equipment produced abroad have started to increase. 0.1 percent, or virtually zero percent. The policy interest rate has remained at that level since then. 2. Provision of ample funds The second measure involves the provision of ample funds. Financial market stability is a prerequisite for sustainable economic growth. It is therefore vital that a central bank provide ample funds to financial markets when they face a situation of extremely tight liquidity. Based on such thinking, the Bank has provided ample funds while guiding the policy interest rate in an appropriate manner to achieve the targeted level, through various money market operations that I will talk about later. Let us look at, for example, the amount outstanding of funds provided as at the calendar year-ends of 2007, 2008, and 2009. In 2007, during which we saw no particular market disruptions, the provision of funds as at year-end amounted to 33 trillion yen. In contrast, the amount at the 2008 year-end reached nearly 40 trillion yen, reflecting the significant instability in financial markets following the failure of Lehman Brothers, or the “Lehman shock”. The Bank has continued to provide ample funds to maintain the extremely accommodative financial environment, even after financial markets started to regain stability in the middle of 2009. The amount outstanding of funds provided as at the 2009 year-end amounted to 42 trillion yen. 3. Restoration of the proper functioning of individual financial markets The third measure is aimed at restoring the proper functioning of individual financial markets. To this end, the Bank started outright purchases of CP and corporate bonds, both of which are unprecedented and exceptional measures for a central bank, from January and March 2009, respectively. These measures were effective in restoring the functioning of the CP and corporate bond markets while markedly improving their issuing conditions. 8 Given that the purpose to restore market functioning had been achieved, these measures were completed at the end of 2009. Issuing conditions for CP and corporate bonds have remained favorable. B. Selection of policy measures: examining the positive and negative effects So far, I have outlined the measures taken by the Bank. Next, I will try to explain an issue about which I am often questioned, namely, what are the determinants the Bank deems important when making monetary policy decisions, or more specifically, when choosing which measures to take? The Bank has been aggressive in its decision to take exceptional measures in response to the sharp economic downturn and malfunctioning of some financial markets after the Lehman shock. At the same time, however, it has been cautious in deciding on measures that potentially could hurt Japan’s economy. In the deliberation process, I take great care, just as in corporate management, to carefully examine from a long-term perspective both the positive and negative effects of various policies, and select the optimum measures for Japan’s economy. Outright purchases of corporate financing instruments such as CP and corporate bonds to facilitate corporate financing should be regarded as exceptional measures for a central bank, for the following reasons. First, they involve directly shouldering a greater degree of individual private firms’ credit risk and, consequently, a relatively high probability of incurring losses that will ultimately be borne by the taxpayer. And second, they carry the risk of damaging the financial health of the Bank and ultimately undermining confidence in the currency and monetary policy. The Bank nevertheless decided to introduce such exceptional measures, with the conditions that the measures be temporary until the market functions again, and that upper limits to total purchases be set. C. Reduction of interest rates on term instruments: the most effective way to support the economy The Bank’s policy rate is the uncollateralized overnight call rate. Since the Lehman shock, however, I have attached importance to the reduction of longer-term interest rates – that is, interest rates on term instruments. This is because corporate and household loans in many cases are based on these rates and, thus, I believe the most effective way to support the economy is to lower them. The Bank introduced a new means of providing the money markets with ample longer-term funds with three-month maturity at a fixed rate of 0.1 percent, which is equivalent to the policy rate – namely, a special funds-supplying operation to facilitate corporate financing, and a fixed-rate funds-supplying operation against pooled collateral. 9 Interest rates on term instruments by nature are not suitable as target policy rates with specific figures 10; however, stabilizing such rates at low levels has been effective in pushing down the interest rate burden for the country’s economic activity. D. Outright purchases of Japanese Government Bonds (JGBs): the risk of a rise in long-term interest rates warrants attention As an example of the policy measure to which possible negative side effects require careful attention, I would like to put forward the case of outright purchases of JGBs. The Bank conducts its monetary policy through market operations – providing funds to, and/or absorbing them from, financial markets on a daily basis. At the same time, as part of its objective of supplying ample funds, the Bank purchases 21.6 trillion yen worth of JGBs a year so as to reduce the burden of day-to-day short-term operations by steadily supplying long-term funds. Will the Bank further increase outright purchases of JGBs as a means of monetary easing? This is another question that I am often asked. It is necessary to consider the risk that outright purchases might be misinterpreted as a means of facilitating government financing by monetizing public debt. This could cause adverse side effects, such as a rise in long-term interest rates that diverge from the outlook for economic activity. The benchmark long-term rate in Japan has been stable in the range of 1.0–1.5 percent, although the country’s ratio of public debt to GDP is the highest among industrialized countries. 11 However, there is no guarantee that Japan will be able to continue to increase public debt over the long run while The Bank introduced the special funds-supplying operation to facilitate corporate financing and the fixed-rate funds-supplying operation against pooled collateral in January and December 2009, respectively. Both operations provide longer-term funds with three-month maturity at a fixed rate of 0.1 percent, which is equivalent to the policy rate. These operations differ over the range of eligible collateral: that eligible for the former operation is limited to corporate debt, as it aims to facilitate corporate financing, while in the latter case, the Bank accepts collateral that includes Japanese government securities. The former operation will be completed at the end of March 2010, in view of the improvement in firms’ funding conditions and of the Bank’s intention to expand operation schemes by accepting a wider range of collateral. LIBOR and TIBOR are reference rates offered by reporting banks and are not the actual rates applied to transactions; therefore, they sometimes fall short of being adequate market indicators. For details, see “BOX 4: London Interbank Offered Rate (LIBOR)” in the January 2010 issue of the Financial Markets Report, which is available on the Bank’s web site. According to the OECD Economic Outlook published in November 2009 (No. 86), the ratio of government debt to GDP projected for 2009 was 189.3 percent in Japan, far exceeding that of the United States (83.9 percent), the United Kingdom (71.0 percent), and Greece (114.9 percent), with the average of the OECD countries at 90.0 percent. Meanwhile, the rating agency Standard & Poor’s downgraded its outlook for Japan’s sovereign AA ratings from “stable” to “negative”. The IMF, in its Global Financial Stability Report Market Update released in January 2010, cited Japan and the United Kingdom as countries under growing market pressure for an increase in their government debt issuance, as evidenced by the widening of sovereign credit default swap (CDS) spreads. maintaining long-term rates at the current low levels. 12 As I have mentioned when explaining the second risk factor for Japan’s economy, a rise in long-term interest rates is a major risk faced by many industrialized countries. It is important to bear in mind that, when the Federal Reserve and the Bank of England started outright purchases of government securities in 2009, long-term interest rates in both economies soared after a temporary initial fall. 13 The Bank will continue purchasing JGBs in order to ensure provision of long-term funds, while making clear that the purchases are in no way intended for government financing. 14 E. The positive and negative effects of providing ample funds: alleviating market anxiety while maintaining market functioning Regarding the provision of liquidity to financial markets, it is also necessary to consider both the positive and negative effects. As I mentioned earlier, the Bank has continued to supply ample funds. However, even in such a situation, the Bank frequently has been asked whether it will resume the quantitative easing policy 15 it adopted in the past, and whether it will expand the size of its balance sheet. I evaluate the positive effects of quantitative easing as follows: it is effective in alleviating market anxiety and stabilizing financial markets when the financial system is under great strain, as was the case when the policy was adopted in Japan in 2001. But its effects are significantly limited in terms of stimulating the spending activities of economic entities and raising the level of prices. Regarding the size of a central bank’s balance sheet, I consider the expansion of reserves held at the central bank to be the by-product of various fundssupplying operations, and believe the total amount of reserves does not directly indicate the degree of monetary easing. 16 The more important point is how far the massive amount of Long-term interest rates in Japan are stable at low levels in spite of the extremely large government debt outstanding compared with other industrialized countries. This has been attributed to factors unique to Japan’s bond market, namely, that there are ample domestic surplus funds backed by high private-sector savings, and JGBs are mostly purchased and held by residents in Japan. However, in view of the fiscal burden that will be required to support the aging society, it is uncertain whether domestic sources of funds alone might continue to assume such a burden. The surplus in household funds is on a downward trend and firms might cease to hold surplus funds due to the changes in corporate investment behavior. For more information concerning empirical studies on, and overseas examples of, the effects of outright central bank purchases of government securities on long-term interest rates, see the speech “Recent Economic and Financial Developments and the Conduct of Monetary Policy” I delivered at a meeting with business leaders in Nagano in July 2009, a summary of which is available on the Bank’s web site. Federal Reserve Chairman Ben S. Bernanke has repeatedly commented that purchases of Treasury securities were not conducted with the aim of targeting a particular interest rate, nor monetizing federal debt. The Federal Reserve and the Bank of England completed their purchases of long-term government securities in October 2009 and January 2010, respectively. From March 2001 to March 2006, the main operating target for the Bank’s money market operations was changed from a specific interest rate – the uncollateralized overnight call rate – to the amount of funds – the total outstanding balance of current accounts held by financial institutions with the Bank which include reserve balances. Specifically, the guideline for market operations was set as “The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around XX trillion yen”. This type of money market operations was called a “quantitative easing policy” because it was conducted by achieving the target aimed at the financial quantitative indicator. At present, the Bank provides ample funds by conducting various operations, setting the operating target not at a quantitative indicator but at the policy interest rate. On this point, the research paper from the Federal Reserve Bank of New York, entitled “Why Are Banks Holding So Many Excess Reserves?”, written by Todd Keister and James J. McAndrews, and released in December 2009, concludes that “the liquidity facilities and other credit programs introduced by the Federal Reserve in response to the crisis have created, as a by-product, a large quantity of reserves in the banking system”; and “The total quantity of reserves in the banking system reflects the scale of the Fed’s policy initiatives, but conveys no information of the initiatives’ effects on the bank lending or on the economy more broadly”. funds provided by the Bank to financial institutions is passed on to firms and households – in other words, to what extent the policy has effects on the increase in bank lending. This depends on firms’ and households’ demand for funds and banks’ lending attitude. Currently, the year-on-year rate of change in bank lending is negative as a result of the sluggish demand for funds. Against this background, the abundant funds supplied by the Bank to financial institutions have been accumulating as excess reserves at the Bank, underlining a growing sense of an abundance of liquidity. At present, the Bank does not supply funds by setting its operating target at the outstanding balance of current accounts, as was the case with the past “quantitative easing policy”. The Bank, however, is providing a sufficient amount of liquidity to meet market demand, creating a sense of confidence regarding the availability of liquidity. Considering this, I believe that the current operations have effects similar to those of the “quantitative easing policy” conducted in the past. With regard to negative effects, it is important to avoid impairing the proper functioning of markets. If a central bank’s intervention is excessive and the markets become excessively dependent on funds provided through the Bank’s market operations, the intervention itself may impair the proper functioning of markets, thereby defeating its intended purpose. 17 In this sense, the past “quantitative easing policy” may have had a negative impact on market functioning, because the amount of funds provided by the Bank was set as the operating target. In comparison, the Bank provides the sufficient amount of liquidity that markets require, while maintaining their proper functioning. III. The issue of deflation: what is the cause and remedy? Having discussed the Bank’s conduct of monetary policy, I now turn to the third topic for today: the issue of deflation. I will touch upon the current state of prices in Japan, before moving on to the cause of and remedy for deflation. A. Price movements in Japan: deterioration in the supply and demand balance exerts downward pressure The year-on-year pace of decline in the consumer price index (CPI) excluding fresh food, or the core CPI, has been moderating due to the prices of petroleum products, which are lower than their high levels of a year ago. However, the year-on-year rate of decline in the CPI excluding food and energy – the core-core CPI, which is said to indicate the underlying trend in prices – continues to accelerate. 18 Households are curtailing spending due to the continued decrease in household income, and firms are responding to this situation by lowering the retail prices of their goods/services. 19 Deterioration in the supply and demand balance in the economy as a whole, as well as the fundamental weakness in consumption – except in the case of a small number of certain durable goods – are adding downward pressure on the price formation process. In Japan, the quantitative easing policy and zero interest rate policy resulted in a sharp decline in the volume of market transactions that did not involve the Bank. This caused a weakening in the infrastructure of money markets. More specifically, credit lines were cut or terminated, the number of fund managers was reduced, and trade expertise suffered a decline in proficiency. Considering the time and money it took to rebuild the market infrastructure and increase market activity, it is very important that proper market functioning be maintained. The CPI in the Tokyo metropolitan area for February 2010 showed a slight decrease in the number of items for which prices declined. However, data on a nationwide basis show a continued increase in the number of items for which prices declined. There has been a gradual increase in the number of firms adopting a strategy to avoid excessive price-cutting competition. As of January 2010, the median outlook for the core CPI by the seven Policy Board members was minus 1.5 percent in fiscal 2009, minus 0.5 percent in fiscal 2010, and minus 0.2 percent in fiscal 2011. The members had expected that the downward pressure on prices would gradually diminish as the supply and demand balance improved with the recovery in the economy, but prices would continue to decline – deflation would continue – even in fiscal 2011, or the final fiscal year of the projection period. One of the problems with deflation is that nominal debt, wages, and interest rates do not change in proportion to the decline in the price level, and therefore remain high in real terms. As a result, spending comes under pressure from several angles, adversely affecting economic activity. Given that the pace of improvement in the aggregate supply and demand balance is expected to be moderate, it is important to pay close attention to future developments in the economy and prices. B. The fundamental cause of deflation: lack of demand I will now talk about the cause of deflation. Since the 1990s, inflation rates have been falling worldwide, reflecting the substantial decline in costs as planned economies joined the world of the market economies. During this worldwide trend, Japan’s inflation rate has been lower than that of other industrialized countries since the bubble period in the late 1980s. Until the mid-1990s, the high prices in Japan were pushed down by rationalization of the distribution system and deregulation. Since then, prices have continued to decline due to various additional factors, including: (1) the continuous decline in wages as a result of managers and workers in Japan placing priority on maintaining employment during the adjustment phase following the bursting of the economic bubble; and (2) restrained demand reflecting the decline in expectations for future economic growth resulting from the aging and shrinking of Japan’s population. Ultimately, these factors point to the fundamental cause of deflation – lack of demand. C. Remedy for deflation: unlocking and capturing potential demand It is necessary that we confront and find a way to tackle this fundamental cause of deflation: the lack of demand. Deflation cannot be solved just by generating sustainable demand that is large enough to close the output gap, as the problem does not lie solely on the demand side. What is important is where to unlock demand and how to capture it on the supply side. Given that the output gap has been historically large following the bursting of the global bubble, it would be unrealistic to expect that demand will recover to meet the existing supply capacity for goods and services, as that would mean a reemergence of a bubble economy. Looking back on Japan’s history, the economy has grown by unlocking and capturing potential demand through various efforts and innovations undertaken by firms. 20 Besides the rapidly expanding demand in neighboring East Asian countries 21, potential demand in Japan is not inconsiderable in areas such as medical and nursing care, environmental conservation, and tourism. 22 Recently, for example, production of certain high-tech products – liquid crystal display (LCD) televisions, light emitting diode (LED) products, and solar cell modules – is exceeding levels seen before the Lehman shock. The number of visitors from China has hit a record high, helped in part by the July 2009 lifting of a ban on private tours to Japan, although the total number of foreign tourists is declining. For example, whereas the average ratio of job offers to applicants in Japan has been substantially below 1, that for health and medical care, social welfare, and nursing care has been above 1. Actively working to correct this mismatch will improve the situation in the labor market while at the same time unlocking potential demand. Taking policy actions to support firms’ efforts to unlock and capture new demand is also important, and in this regard, I believe the top priority is to eliminate uncertainty about the future. For example, households are said to be restraining their spending in an effort to increase savings because of anxiety about the future of social security and medical systems. I am particularly concerned about the weak consumption by the younger generation, which is a sure reflection of their strong sense of insecurity. 23 The success of the child allowance program included in the government’s budget for fiscal 2010, as well as its economic impact in terms of the marginal propensity to consume, hinge on the extent to which such uncertainty is alleviated. For Japan, more than any other country, it is of paramount importance to boost productivity given that the population has started to decline. Growth in productivity in the manufacturing sector has been increasing since 2000, but that in the nonmanufacturing sector, which accounts for a large share of the economy, has been lackluster. There is no quick solution to improving productivity, but a key move is to create actual demand by reallocating existing managerial resources – personnel, production capacity, and money – in such a way as to meet potential demand. 24 In order to support such efforts, it is necessary to flexibly revise the existing systems and frameworks in response to changes in the economic environment at home and abroad, while securing a social safety net. If demand achieves a sustained recovery throughout the economy, this will lead to an improvement in supply and demand conditions in the labor market. I mentioned earlier that a continuous decline in wages is one of the causes of deflation. A sustained recovery in the labor market would lead to a rise in nominal wages, thus having a positive effect on prices. Moreover, were economic recovery accompanied by a rise in productivity to continue, real wages would increase, leading to higher living standards. D. Boosting demand and easing monetary conditions: monetary easing is one of the necessary conditions to overcome deflation The Bank’s statement released on December 18, 2009 shows its strong commitment: “The Bank recognizes that it is a critical challenge for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability. To this end, the Bank will continue to consistently make contributions as central bank. In the conduct of monetary policy, the Bank will aim to maintain the extremely accommodative financial environment”. Furthermore, in the same statement, regarding the “understanding of medium- to long-term price stability” (the level of inflation that each Policy Board member understands, when conducting monetary policy, as being consistent with price stability over the medium to long term; hereafter “understanding” 25), which is expressed in terms of the year-on-year rate of change in the According to the Family Income and Expenditure Survey, a breakdown of expenditure by householder age group shows that, in 2009, people aged 60 years and over increased their spending from the previous year, while spending by those younger than 60 decreased. The younger the age group, the larger the rate of decline. Furthermore, the results of the Survey of Household Economy show that purchases of durable goods, which have been increasing due to the effects of economic stimulus measures, are growing notably among people aged 50 and over. Some economic stimulus measures taken since the 1990s might have blocked economic metabolism and hindered productivity improvement by keeping managerial resources in inefficient sectors. For example, as a result of public works projects, managerial resources stayed in the construction industry, known for its low productivity. Taking into account the “understanding”, the Bank assesses the economic and price situation from “two perspectives” and then outlines its thinking on the future conduct of monetary policy. The “first perspective” involves assessing the most likely outlook for economic activity and prices through fiscal 2011. The “second perspective” assesses the risks considered most relevant to the conduct of monetary policy, including risks that have a longer time horizon than the “first perspective”. CPI, the Bank made clear that the Policy Board does not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent, and that the midpoints of most Policy Board members’ “understanding” are around 1 percent. 26 The Bank’s commitment to maintain the extremely accommodative financial environment, as well as its clarification of the “understanding”, have had an adequate effect on stabilizing the price expectations and shaping the interest rate expectations of market participants, thereby helping to reduce interest rates on term instruments, which, as I mentioned earlier, is the Bank’s most effective way to support the economy. In summary, maintaining the extremely accommodative financial environment is one of the necessary conditions for overcoming deflation. Another is confronting the fundamental cause of deflation – that is, the lack of demand – and making steady efforts to unlock and capture potential demand, as well as to improve productivity. The Bank of Japan will maintain the extremely accommodative financial environment to underpin demand from the financial side. In my view, action should be taken swiftly and decisively when deemed necessary, based on an assessment of economic and financial activity and prices from the “two perspectives”. In the same December 18 statement, the Bank made clear that “in order to realize sustainable economic growth with price stability, it is necessary to make wide-ranging assessments of risk factors, including accumulation of financial imbalances observed in, for example, asset prices and credit aggregates”. This recognition is based on the experience of the recent global financial crisis that too much emphasis on price developments could result in overlooking other serious risks. This is a reconfirmation of the Bank’s view on the importance of assessing risks from the “second perspective”. The “understanding”, reviewed in April 2009, was expressed in terms of the year-on-year rate of change in the CPI and fell in the range approximately between 0 and 2 percent, with most Policy Board members’ median figures at around 1 percent.
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Statement by Mr Masaaki Shirakawa, Governor of the Bank of Japan, concerning the Bank's Semiannual Report on Currency and Monetary Control before the Committee on Financial Affairs, House of Representatives, Tokyo, 20 April 2010.
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Masaaki Shirakawa: Japan’s economy and the conduct of monetary policy Statement by Mr Masaaki Shirakawa, Governor of the Bank of Japan, concerning the Bank’s Semiannual Report on Currency and Monetary Control before the Committee on Financial Affairs, House of Representatives, Tokyo, 20 April 2010. * * * Introduction The Bank of Japan submitted to the Diet its Semiannual Report on Currency and Monetary Control for the second half of fiscal 2008 and the first half of fiscal 2009 in June and December 2009, respectively. I am pleased to have this opportunity to talk about the recent developments in Japan’s economy and present an overall review of the Bank’s conduct of monetary policy. I. Developments in Japan’s economy Japan’s economy has been picking up mainly due to improvement in overseas economic conditions and to various policy measures, although there is not yet sufficient momentum to support a self-sustaining recovery in domestic private demand. The trend of pick-up is becoming more evident. Exports and production have been increasing mainly against a backdrop of robust growth in emerging economies. According to the March Tankan (ShortTerm Economic Survey of Enterprises in Japan) released at the beginning of April, business sentiment has been improving, with such improvement spreading to the nonmanufacturing industry and small firms, in addition to large manufacturing firms. Business fixed investment is leveling out, and private consumption, notably durable goods consumption, is picking up mainly due to policy measures, despite the continued severe employment and income situation. As for the outlook, the Bank projects that the pace of improvement of the economy is likely to be moderate for the time being, and it judges that the risk of the economy deteriorating substantially again, the risk of the so-called “double dip”, about which market participants had expressed concern, has diminished considerably. Thereafter, as improvements in the corporate sector originating from exports are expected to spill over to the household sector, the growth rate of the economy is likely gradually to rise. Financial conditions, with some lingering severity, have shown increasing signs of easing. Firms’ borrowing rates from banks have continued to decline due in part to the fact that financial institutions’ lending stance has become active, in addition to monetary easing by the Bank. Issuing conditions for CP are more favorable than in the period prior to the Lehman shock. Issuing conditions for corporate bonds have also been favorable, and even those for low-rated corporate bonds have shown signs of improvement. Meanwhile, although many small firms still see their financial positions as weak, the overall financial positions of firms, including small ones, have continued to show signs of easing. The CPI (excluding fresh food) is declining on a year-on-year basis due to the substantial slack in the economy as a whole, but the decline leveled out in August 2009 and the moderating trend of decline has continued. The outlook for the trend change in prices is determined by the aggregate supply and demand balance and the medium- to long-term inflation expectations. It should be noted that, statistically, the year-on-year rate of change in the CPI will decline for a year due to the introduction of subsidies for high school tuition and other policy measures in fiscal 2010, but in assessing the trend change in prices, it is necessary to exclude such one-off factors. In terms of the trend change in prices, with medium- to long-term inflation expectations likely to be stable, the year-on-year rate of decline in the CPI (excluding fresh food) is expected to continue to moderate as the aggregate supply and demand balance improves gradually. While I have thus far explained the baseline scenario for economic activity and prices, the Bank is also fully aware of the risks concerning such scenario. Upside risks to the scenario are developments in emerging and commodity-exporting economies. The robust growth of emerging and commodity-exporting economies has driven the pick-up of Japan’s economy. If the growth in those economies further accelerates, it will pose an upside risk to economic activity in Japan. Meanwhile, downside risks, although somewhat diminished, include the possible consequences of balance-sheet adjustments in the United States and Europe as well as potential changes in firms’ medium- to long-term growth expectations. Moreover, attention should continue to be paid to various recent international financial developments and their effects. With regard to prices, there is a risk that inflation will rise more than expected in the event of a rise in commodity prices due to higher growth rates in emerging and commodity-exporting economies. On the other hand, there is also a risk that the rate of inflation might decline due, for example, to a decline in medium- to long-term inflation expectations. II. Conduct of monetary policy The Bank recognizes that Japan’s economy is faced with a critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. Therefore, the Bank has been implementing various measures, taking into account the two factors that determine the trend change in prices. As a measure to prompt an improvement in the aggregate supply and demand balance, in terms of interest rates, the Bank has kept the policy rate at the effectively zero level. To encourage a further decline in longer-term interest rates in the money market, the Bank introduced in December 2009 a new funds-supplying operation, through which funds with a maturity of three months are provided at an extremely low interest rate of 0.1 percent, and the total amount of loans to be provided through this operation was set at approximately 10 trillion yen. The total amount of loans was increased to 20 trillion yen in March 2010. In terms of funds provision, the Bank has been providing ample funds through various fundssupplying operations, including the new operation. Furthermore, the Bank has made its stance clear that it will consistently maintain the extremely accommodative financial environment. As for inflation expectations, the other determinant of prices, the Bank has, to prevent people’s expectations for prices from declining, clearly showed its stance, in the form of the “understanding of medium- to long-term price stability”, that it is critical to achieve a positive year-on-year rate of changes in the CPI. To overcome deflation and achieve a sustainable economic growth with price stability, the Bank will continue to consistently make contributions as central bank.
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a Meeting with Business Leaders, Miyagi, 21 April 2010.
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Kiyohiko G Nishimura: Japan’s economy and monetary policy Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a Meeting with Business Leaders, Miyagi, 21 April 2010. * * * Introduction I am honored today to have this opportunity to speak and to exchange views with business leaders in Miyagi Prefecture. I will express my gratitude for your cooperation in interviews with the staffers from the Sendai Branch and for the Bank of Japan’s surveys. Information obtained from those interviews and surveys is invaluable and utilized fully in assessing economic and financial developments and conducting monetary policy. Before exchanging views with you, I will talk about economic and financial developments in Japan as well as the thinking of the conduct of monetary policy. I will also briefly touch on the challenges Japan’s economy faces for its growth. I. Economic conditions in Japan Overseas economies With progress in economic globalization, developments in Japan’s economy are under significant influence of overseas economic developments. The plunge in Japan’s economy after the failure of Lehman Brothers in the autumn of 2008 was attributable to the worldwide economic dive triggered by the financial crisis, the epicenters of which were the United States and Europe. Therefore, I will first talk about overseas economies. In response to the rapid deterioration in international financial markets and in the global economy following the failure of Lehman Brothers, the governments and central banks around the globe took bold policy measures. Partly due to the effects of those measures, international financial markets have regained stability. For example, in money markets in which financial institutions mutually trade short-term funds, the transaction volume once plunged to the extent “liquidity evaporated.” It is now in a state that money markets are awash with low cost funds, and extremely low interest rates have been continuing. The real economy is the same as the international financial markets and Overseas Economies in terms of bottoming out from the substantial deterioration which continued until the beginning of 2009 and has been improving since then. The global economy has been recovering moderately led by robust growth in emerging economies. There are several reasons emerging economies were among the first to recover and continue to grow strongly. First, domestic demand, including business fixed investment and private consumption, was potentially strong. In emerging economies, the purchasing power of households has risen and is expected to rise in accordance with an expansion of the economy. Therefore, emerging economies, which attracted attention as production bases for advanced economies, have also become increasingly attractive as products markets. To capture such promising markets, firms in advanced economies have been increasing the number of production and sales bases for local products. In addition, local firms have also been increasing their production by introducing technologies and sales know-how from advanced economies. A virtuous cycle, in that such an increase in business activity stimulates consumption through a rise in the purchasing power of households, which in turn further increases business activity, is expected to continue. Expectations for the future are also pushing up demand at present. Second, fiscal and monetary policies carried out as a financial crisis response in various countries significantly exploited the potential demand. For example, in China, purchase support measures for automobiles and television sets were taken and a large-scale fiscal expenditure was set partly for improving infrastructure. Accommodative monetary conditions in advanced economies resulted in providing low cost funds to the markets, and those funds are flowing into emerging economies in which high growth is expected. That brought about an improvement in funding conditions and a rise in stock prices, which contributed to increasing business activity and promoting consumption through an increase in income. By contrast, while the U.S. and European advanced economies have been recovering, momentum has been lacking. In the United States, while the number of workers has started to increase and consumption has been holding up well, house sales and house prices have been stagnant and the unemployment rate has been close to 10 percent. In European countries, where economic ties with high growing East Asian regions are weak, the improvement has been further lagging. Moreover, financial institutions are shouldering large impaired assets and taking a cautious stance in extending loans and households are taking a cautious consumption behavior due to the heavy debt burden. Those are the problems common to the United Stated and Europe. They are the “balance-sheet problem,” namely, the problem of how to repair the impaired asset conditions. As you remember, it dragged the economy for a protracted period also in Japan after the burst of the bubble. As for the outlook, it is projected that overseas economies will continue to improve while stability in international financial markets will be maintained. Emerging economies will continue to expand, and the U.S. and European economies will gradually increase their degree of recovery, even though balance-sheet problems need time to resolve. However, such outlook is associated with various uncertainties. First, in international financial markets, the recovery in the depth of market transactions and in market liquidity has still been delayed for longer-term transactions. In addition, triggered by the problems concerning fiscal deficits in some European countries, fiscal soundness and fiscal sustainability have been drawing increasing attention in various countries. Second, there are many uncertain factors concerning the outlook for overseas economies. If the aforementioned resolution of balance-sheet problems in the United States and Europe takes more time than expected, such delay will drag down the economies accordingly. In addition, there is nascent concern about overheating in emerging economies. In China, real estate prices, mainly in the city areas, have been rapidly increasing. Such increase is recently observed in the inland areas, in addition to the costal areas. Moreover, the growth rate of wages and prices has been gradually increasing. Also, in many other emerging economies, concern over inflation has been emerging. In those economies, while policy interest rates have been raised and lending restraint measures have been taken, the authorities have been forced to perform difficult maneuvers on those policy measures. If the restraint measures are too strong, it would be a sudden brake on the main engine of those economies. On the other hand, if the restraint measures are insufficient, it will be an upside risk for economic activity in the short run. However, in the future, it will become necessary to substantially correct the excesses and that might end up in destabilizing those economies. Particularly, the outlook for the Chinese economy warrants attention. Amid the trend of establishing the global division of labor that makes the most of development in information and telecommunications technology, China has been growing at a pace that can be called as “explosive” and has become in part the world’s factory. In the process of growth, advanced economies had overcome constraints in terms of human resources, technology, and finance, and evolved after passing several stages. However, by benefiting from globalization in technology and finance, China is achieving a development that overcomes those constraints at once and has several development stages co-existing simultaneously. It should be noted that, if such growth continues, it cannot be denied that, at one point, a bottleneck might emerge in terms of the labor force and resources, leading to a rapid increase in inflationary pressure, or the economy might reach the growth ceiling. In such a case, Japan’s economy will be affected significantly. In other emerging economies, with varying degrees, rapid changes might take place due to the effects of information and telecommunications technology advancement and globalization. We need to continue to deliberately examine developments in overseas economies, including advanced and emerging economies, and the national authorities’ conduct of macroeconomic policy. The current state of the economy Based on the developments in overseas economies, I will now turn to Japan’s economy. Japan’s economy has been picking up due mainly to the improvement in overseas economies and the effects of various policy measures. Exports, mainly to high growing emerging and commodity-exporting economies, have been increasing since the spring of 2009. Correspondingly, the level of capacity utilization in domestic firms is gradually picking up. Although there is not yet sufficient momentum to support a self-sustaining recovery, consumption, backed mainly by demand for eco-friendly automobiles and electrical appliances that has been underpinned by policy measures, is picking up. Moreover, it has become evident that the decline in business fixed investment has been leveling out. The economy is likely to continue picking up. On the back of favorable conditions in overseas economies, exports and production are likely to increase somewhat more than projected and, albeit with some swings, to perform firmly. Policy support will continue for the time being, as represented by an extension of the purchase support measures for electrical appliances that have been highly effective. In addition, the fact that housing starts have started to increase is a welcoming sign. When houses are built, there are spillover effects on electrical appliances and furniture. Markets have once been concerned about the so-called “double dip,” but we judge that the possibility of the economy experiencing another plunge has fairly receded. Then, how about the sustainability of the recovery going forward? The point is, when the effects of economic stimulus measures taken during the financial crisis dissipate, whether there is sufficient momentum for a self-sustaining recovery in private demand to offset the waning effects of stimulus measures. If private demand has not recovered sufficiently, the once concerned plunge in the economy will take place at a delayed timing. However, if the improvements in exports and production are sustained, capacity utilization will improve and profits will recover through an increase in sales. Then conditions will be in place for business fixed investment to recover, and the broad-based recovery will be in sight, and it will gradually extend to small firms that compose the bases of industries and to households through wages and dividends. If the uptrend continues, to the extent the runaway is long, the base for economic recovery will firm up. The timing of the recovery spreading over to small firms and households needs to be considered with a certain margin. Firms that shoulder exports and production are exposed to severe pressure of international competition. There is a possibility that, from a viewpoint of maintaining competitiveness, overseas investments might be considered first and returns to employees might be restrained. In addition, parts procurement has spread to overseas and thus the extent of spillover to domestic affiliated firms appears to have reduced. As a result, we need to recognize a possibility that the spillover effects of the recovery on small firms and households might be delayed. As for the economic outlook, there are other various uncertainties both upside and downside. Of those, uncertainty about developments overseas is what I have mentioned earlier. Moreover, as uncertainty originated at home, developments in firms’ growth expectations are extremely important. Since the outbreak of a financial crisis, firms rapidly intensified their cautious stance for the future. While the stance gradually improved thereafter, I persistently hear from firms’ management that they cannot have confidence about the future. If pessimism about the future strengthens, it will result in contracting business activity. In that regard, a survey by the Cabinet Office conducted on large firms showed that firms’ medium- to long-term growth expectations have been maintained. However, the dominant majority in terms of the number of firms and the number of workers is small firms. According to the Tankan (Short-Term Economic Survey of Enterprises in Japan) released at the beginning of this month, what stands out is the fact that, while small firms’ business sentiment has improved, it has lagged behind, compared with the pickup in large firms and in the economy as a whole. It is important to promptly dispel uncertainties surrounding the economy and offer prospects for future growth. I will explain my views on the challenges for Japan’s economic growth later. Price developments in Japan I will now talk about price developments. The year-on-year rate of change in consumer prices has been declining, while the pace has been moderating since last August to around –1 percent recently. We hear from firms that it is difficult to raise sales prices as consumers are sensitive to prices due to their tight purse strings, and as competition is harsh among firms. The Tankan showed that output prices have not risen, compared with the improvement in business sentiment and the rise in input prices. Nevertheless, it can be said that some beams of light are starting to break through a thick cloud of deflation. First, there is a subtle change in firms’ price-setting behavior and consumers’ purchase behavior. With your cooperation, the Bank conducted a survey on firms’ price-setting behavior at the beginning of this year. The results, which were published in our January Regional Economic Report, showed that there were signs in some firms to avoid endless price competition and try to differentiate in aspects other than prices. The impression obtained through various surveys and interviews is that there are subtle and gradual signs on the consumers’ front to purchase quality products by paying reasonable prices. Second, the effects of exports and production bottoming out in the early spring of 2009, and the economy as a whole picking up since then, will gradually materialize from now on. A rule of thumb is that there is about one year lag until changes in the economy affect the inflation rate. In that sense, it could be said that from the middle of 2009 to the spring of 2010 was a period in which the effects of the economic plunge from the autumn of 2008 to the spring of 2009 put strong downward pressure on prices with a time lag. And the effects of the pickup in the economy since the spring of 2009 can be considered to spread over to prices only from now on. Third, reflecting the aforementioned changes in firms’ price-setting behavior and the lagged effects of the pickup in the economy, there are some changes in the trend of prices. Have you ever heard of expressions such as the consumer price index excluding fresh food or the consumer price index excluding food and energy? Those are the price indexes that, in order to gauge the trend changes, exclude the swings by temporary factors such as weather and commodity price fluctuations, and the year-on-year rate of decline in those price indexes has been moderating. There is also a way to automatically exclude a certain portion of items that register significant price fluctuations. The consumer price index compiled in that way is called the “trimmed-mean” consumer price index. The year-on-year rate of decline in consumer prices in terms of trimmed mean index accelerated toward the autumn of last year, but it has been moderating recently for three consecutive months. Taking those into account, as the economy is likely to continue picking up and the aggregate supply and demand balance improves, the moderating trend in the decline in prices is expected to continue. Of course, there are uncertainties about the outlook for prices. Because of that, it is necessary to surely confirm the steps toward overcoming deflation. In the following, I will raise two points that warrant attention in considering the outlook for prices. First, the risk stemming from overseas economies. There are risks both in the direction of deflation and inflation. On one hand, buoyant business fixed investment is continuing in emerging economies. If that results in excess supply worldwide, it will increase deflationary pressure. On the other hand, while accommodative monetary conditions are maintained in major economies, if a view that such conditions will become protracted more than necessary takes hold, there is a risk that a new type of credit “bubble” might be generated, for example, in emerging economies, and also exert unexpected effects on Japan. Moreover, consumption of resources and energy in emerging economies has been increasing explosively, which, depending on the situation in supplying economies, could abruptly push up commodity prices in the future. If prices in emerging economies rise due partly to an increase in wages, it might spread over to the prices of Japan’s import products and others. In such a case, unlike energy that cannot be substituted by domestic products, it would affect prices in Japan through a path of gearing demand toward domestic products whose relative expensiveness will decline. Second, people’s view on prices. If people increasingly foresee that deflation will continue, it will put downward pressure on prices. In that regard, as long as viewed from survey data, people’s medium- to long-term inflation expectations have been maintained at about 1 percent. However, such expectations are subjective in that it might change in the future. It has been said that people’s view on prices tends to be affected by past price changes. In that regard, what warrants attention is that the waiver of high school tuition has been in effect since April, which is estimated to push down consumer price inflation by around 0.5 percentage points. The effects of such one-off factors disappear in 12 months, and thus should be considered separately from the trend change in consumer prices. Nevertheless, since the effects will accelerate the pace of the price decline on surface for the time being, a possibility of that affecting people’s view on prices warrants vigilance. Domestic financial conditions Next, about domestic financial conditions. In the money market, the effects of monetary easing by the Bank have been gradually spreading and the interest rates including those of a longer term have declined to extremely low levels. The effects of monetary easing have spread to firms’ funding costs, including the borrowing rates from banks. In addition, issuing conditions for CP have become favorable, more than those seen prior to the failure of Lehman Brothers. Issuing conditions for corporate bonds have also been favorable, with signs of improvement recently spreading to those for low-rated corporate bonds. The Tankan showed that firms’ financial positions have been improving as a whole. However, many small firms, due partly to the lagged improvement in their businesses, still see their financial positions as tight. Nevertheless, the overall move toward easing has been continuing, including small firms. This point has also been confirmed by various surveys targeted at smaller firms than the Tankan. Against such a backdrop, it can be judged that domestic financial conditions, with some lingering severity, have shown increasing signs of easing. II. Monetary policy Taking into account the developments in economic activity and prices, I will move on to the conduct of monetary policy. The Bank wound up outright purchases of CP and corporate bonds at the end of December 2009, and special funds-supplying operation to facilitate corporate financing at the end of March 2010. The special funds-supplying operation to facilitate corporate financing is an operation, by which the Bank extends loans to its counterparts for an unlimited amount against the value of corporate debt, including loans on deeds and corporate bonds, submitted as collateral. These had been introduced temporarily as extraordinary measures during the financial crisis. Behind the introduction of these measures were an excessive sense of anxiety prevailing in part of financial markets and the considerable decline in the functioning of the markets, such as the plunge in transaction volume and the disappearance of appropriate pricing. Subsequently, as financial markets restored their functioning, the adverse effects stemming from those measures, such as the shrinkage of the market scale and distortion in price formation in the markets, were seen. Therefore, the Bank decided to wind up these temporary measures and to consistently maintain accommodative monetary conditions by taking the most appropriate funds-supplying measures according to the changes in the market situation. It is not correct to gauge the winding up of those measures as the holding back of monetary easing. The Bank recognizes that Japan’s economy is faced with a critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. To this end, the Bank will continue to consistently make contributions as central bank. There is no change in such a stance. Policy responses that should be taken when a great shock like a financial crisis occurs are, in a sense, clear. Timely, targeted, and temporary stopgap measures are required there. The temporary measure to cope with the rapid decline in market functioning in CP and corporate bond markets was a good example. By contrast, the stagnation of the economy as symbolized in deflation is a deep-rooted problem, and a response to it will be different in nature from that to a financial crisis. Like there is no quick fix for lifestyle diseases, we believe it important, while significant effects are not seen immediately, to consistently maintain accommodative monetary conditions. The Bank reduced the policy rate to virtually zero percent. In addition, to further enhance accommodative monetary conditions, the Bank introduced a measure to encourage a decline in the longer-term interest rates in December 2009. It is a measure to provide three months’ funds against a broad range of collateral in an amount of 10 trillion yen at a fixed low rate of 0.1 percent. Thanks partly to the measure, not only market interest rates but also firms’ funding costs have declined further. The amount to be provided through the measure was substantially increased to 20 trillion yen in March. That step was to expand the measure to encourage a decline in longer-term interest rates while coping with the fact that, from April onward, fund provision through special funds-supplying operations to facilitate corporate financing from the Bank will decline. The Bank’s decision on further easing at a time when the economy has been somewhat improving more than projected was considered by some as an unexpected decision. However, since it continues to be the case that some time is needed for Japan’s economy to return to a sustainable growth path with price stability, we judged it necessary to ensure the improvements in economic activity and prices through an additional easing measure. I believe that this point will be understood easily if the following is taken into account. There is a risk that, when firms’ activity has contracted, the effects of low interest rates might not be fully exerted. As long as firms do not have willingness, low interest rates do not necessarily lead to an increase in investment and employment. By using an old saying, we sometimes say “you can lead a horse to the water, but you can’t make him drink.” Put it the other way round, what would happen if you bring him to the water at a time when the exhausted horse has somewhat regained strength? We might be able to say that the horse is more likely to drink water and might start to run around vividly again. In such a way, we believe that the additional accommodative measure taken by the Bank this time will contribute to ensuring the improvements in economic activity and prices. Since interest rates are already at extremely low levels, room for a further decline by monetary easing is naturally limited. However, that does not suggest that monetary easing has reached its limit. Because, for firms, the level of funding rates matters in its relation to the rate of return. Even if a firm can raise funds at low costs, power to stimulate firm’s business will be limited when there are few promising investment projects. By contrast, amid continued low interest rates, if the economy recovers and projects with high profitability increase, the usability of funds obtained at low costs will considerably improve. It is expected that the economy will continue picking up and firms’ rate of return to further improve. In those circumstances, the Bank states clearly that it will maintain the extremely accommodative monetary conditions. This means that the effects of monetary easing will become further pronounced in the future. III. Challenges for Japan’s economic growth In the rest of my speech, I will touch on the challenge toward the growth of Japan’s economy. The challenge of how to raise the ability of Japan’s economy to create value-added. The environment has been changing significantly. Information and telecommunications technology has increasingly facilitated the adjustment of global positioning for production and sales bases. In addition, while the recovery in consumption in the United States and Europe has been sluggish, emerging economies have been increasing their presence. In Japan, the wave of the aging population, which is progressing at the fastest pace in the world, has been quietly approaching China and Asian economies. Japanese firms have adhered to “high-quality manufacturing” and “finely-tuned services.” The resulting “coordination-type” products, which are exhaustively coordinated from the stage of parts designing and firms make constant improvements in even after entering the stage of bulk production, have been accepted particularly by the U.S. and European markets. Typical are automobiles. At the other end of those, there are “combination-type” products. Those are the products of total design, which separate the products into several modules, standardize interface between the modules, and combine or assemble those to make final products. A good example is a personal computer that consists of such modules as CPU, a mother board, and a liquid crystal display monitor. The recent progress in information and telecommunications technology has made it possible to make products that will to some extent meet consumers’ preferences by procuring high quality modules from the world and just assemble them. The combination-type products are spreading. Just for assembling, emerging economies, in which wages and land rents are low, have an advantage. To that extent, the advantage of coordination-type products, in which Japanese firms can exert their strength, has declined. Japanese firms still maintain high technological competitiveness in the production of core modules and processing equipment. However, technology transfer from Japan to emerging economies has been further progressing, and the gap between the two economies has been narrowing. I have often heard that Japan should be all right since it has “manufacturing DNA” that no other country has. The reality is that such DNA has gradually been transferring to emerging economies through the shift of Japanese firms’ production bases overseas and associated transfer of product development sections. Having said that, in general terms, it may not be an appropriate policy for Japanese firms to convert to a combination-type structure. That is because, that case might lead to abandoning the strength Japanese firms have accumulated, in addition, to be forced to compete in terms of costs with firms in emerging economies. What is necessary now for Japanese firms is not to be complacent about technological advantages, but to develop coordination-type products that respond speedily to and are finely-tuned to consumers’ needs, and generate a new market itself. Such high value-added markets might not necessarily be large. However, if firms cover broadly even such niche markets, those markets as a whole will provide a significant profit opportunity for firms. In that regard, population aging that has been progressing in Japan could be a catalyst. Consumer needs of the elder generation are highly versatile than younger generations, to the extent that elderly people have wide dispersion in income and asset formation. If firms can make finely-tuned responses to those needs, it will lead to stimulating potential demand, namely, exploiting niche markets. In the near future, population aging will progress in China and many overseas economies. If Japanese firms can move ahead in product development and accumulation of business know-how in the aging population, it will lead to an increased chance for those firms to benefit from the first mover’s advantage overseas in the future. However, challenging various niche areas ahead of other firms entails risk. On this point, there are critics who argue that, by referring to the fact that the establishment rate of firms in Japan remains at about half that in United States and Europe, Japanese DNA is stabilityoriented to start with and lack venture spirits. However, in the past, there were times when the establishment rate in Japan was comparable to that in countries around the world. Stability-oriented DNA is a mere perception. We expect firms to aggressively exert entrepreneurship. At the same time, it is also important for the public sector to prepare an environment in which challenges to new businesses can easily take place. Concluding remarks The economy in this region has been picking up, while there is lingering severity in private demand, including business fixed investment and private consumption. Against such a backdrop, Miyagi Prefecture has set a goal of “achieving the wealth prefecture Miyagi, and striving to achieve gross production of 10 trillion yen,” and has been making efforts to vitalize the industries from various perspectives. I have learned that many companies were already attracted to the region. Moreover, Sendai City has a broad-based ability to pull in customers as the largest commercial city in the Tohoku region, and largescale facilities have recently been opened one after another. Of course, the environment surrounding the regional economy, including intensified competition with overseas and the decline in public works, is by no means favorable. However, the region is full of attractions, with one of the nation’s largest granaries, a wealth of fishery resources, many research institutions, and ample traditional craft industries. The region has high potential for growth. Today, I am scheduled to visit various places such as the central shopping area in front of Sendai Station. I believe it is a valuable opportunity to gain firsthand knowledge about the reality of the regional economy that cannot be gauged through statistics and the media. Moreover, as called as “a city of trees,” boulevard trees here are beautiful, and I can just imagine that it might be dazzlingly beautiful when green shoots burst out all together through early summer. Like those green shoots, I am also looking forward to closely seeing your efforts toward growth.
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Economic Club of New York, New York, 22 April 2010.
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Masaaki Shirakawa: Revisiting the philosophy behind central bank policy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Economic Club of New York, New York, 22 April 2010. * * * Introduction Thank you for your kind introduction. It is a great pleasure and an honor to have the opportunity to speak today at the Economic Club of New York, with its over one hundred years of history at the heart of the world’s financial markets. 1907, the year this esteemed Club was founded, is also remembered as the year when the United States was struck by a nationwide banking crisis. There had been a few unsuccessful attempts to set up a central bank before the crisis, but in the aftermath of the Panic of 1907, the momentum to establish one strengthened, and the Federal Reserve System was created in 1913. Interestingly enough, the Bank of Japan, the Federal Reserve and the Economic Club of New York have had ties since the early days. Mr. Benjamin Strong, the first President, or at that time the Governor, of the Federal Reserve Bank of New York spent three months in Japan in 1920, developing a strong personal bond with the then Governor of the Bank of Japan, Junnosuke Inoue 1. On his return to the United States, Governor Strong donated many volumes of books to the Bank of Japan on the US financial system and the Federal Reserve. One of those books was, “A History of Currency in the Unites States”, written by the first Chairman of this Club, Mr. Barton Hepburn 2. The book can still be found in our Bank’s library, and by observing the red underlines on the pages of the book, I can comprehend that my predecessors had thoroughly read this book to study how the US had dealt with the financial crisis. Speaking of financial crises, Japan experienced a severe financial crisis in the 1920s, and this led to the introduction of on-site examinations of financial institutions by the Bank of Japan, which continues to be a valuable source of information for the central bank today. For several decades after this crisis, the Japanese financial system did not face serious strains to its stability. However, from the mid-1990s to the early part of the 2000s, we were once again hit by a major financial crisis. In the case of the US, the current financial crisis which started in August 2007 is the worst crisis since the Great Depression-era. I assume many of you who are sitting here today had known of past financial crises, but did not expect to actually experience a crisis of this scope and magnitude during your life times. When we were experiencing our own bubble more than twenty years ago, I myself certainly did not anticipate the severity of the crisis which we were to experience. Japan experienced its crisis more than ten years ago, but watching the US-triggered financial crisis unfold and spread across the global financial system, I cannot but help feel a sense of déjà vu. There are a number of similarities between these two episodes, for example, optimism immediately after the bursting of the bubble, delay in implementing some key policy measures, a prolonged economic downturn, hostility towards financial institutions, criticism aimed at supervisors, regulators and central bankers, to name some. The current crisis has not reached the end of its cycle yet. However, as far as I can see at the moment, two pressing issues have emerged. First, we must bring the global economy back to a sustainable growth path. Second, we must prepare measures to prevent the recurrence of such a crisis. The Bank of Japan is making our utmost efforts to tackle these See Governor Strong’s remarks at the Tokyo Ginko Club (The Tokyo Bankers Club) during his stay in Japan [Strong (1920)]. Hepburn (1915). two challenges, working in cooperation with the Federal Reserve and other authorities. If we were to find a silver lining in the financial crisis, it would be that it has given all of us, including financial institutions, non-financial corporations and policymakers, the opportunity to rethink the validity of the mindset upon which business strategies are developed, and of the philosophy behind the policy conduct that we had become so accustomed to. In what follows, I would like to elaborate on these issues. Why do financial crises repeatedly occur? Why do financial crises, and for that matter bubbles which precede them, occur repeatedly? Many reasons are given – lax risk management, excessive leverage, existence of financial institutions which are perceived to be too-big-to-fail, failure of supervision, excessively accommodative monetary policy and the list goes on. I generally agree with such assessments, but we also need a holistic perspective which cannot be captured just by focusing on individual causes. From this perspective, I would like to emphasize that, what one could term as a “cycle of confidence” which evolves over a very long time horizon, plays a decisive role. Success breeds confidence which unfortunately turns into over-confidence or even arrogance. Complacency also sets in. The collapse of the bubble based upon this overconfidence leads now to under-confidence, which is followed by rebuilding efforts. Then the cycle begins once again. During the latter half of the 1980s, Japan’s economic performance stood out among the advanced economies. While growth in the other G7 countries averaged 3.4%, the Japanese economy grew at an annual rate of 5.1%. The inflation rate measured by CPI was on average 3.9% in the G7 countries excluding Japan, while it was 1.1% in Japan. Although inflation targeting became popular later in the 1990s, if one were to apply the criteria used by countries adopting inflation targeting, Japan would have received an “A+” during the latter half of the 1980s. Externally, through a continuously large current account surplus, Japan became the world’s largest net creditor nation. In this benign environment, the Japanese became over-confident. Of course, there were worrying signs. The extension of credit increased sharply and asset prices boomed in the latter half of the 1980s. However, an “irrational bull sentiment” engulfed society, drowning out such concerns. With regard to land prices, the belief that land prices would never fall overwhelmed people’s mind. Naturally, the need for monetary policy to switch to a tightening mode was discussed. In fact, excluding one source of information, all of the economic data such as high growth, tight labor markets, surge in bank lending, and bloated asset prices were pointing to the need for withdrawing accommodative monetary policy. The only exception was the rate of inflation. Stable prices were a strong rebuttal against the Bank of Japan, which was trying to take away monetary ease. Entering into the 1990s, the landscape changed dramatically with the bursting of the bubble, and the Japanese economy came up against huge difficulties. The average growth rate fell from 5.1% in the latter half of the 1980s to 1.5% in the 1990s. As a result, extreme pessimism containing irrational elements, or what one can call “irrational bear sentiment”, emerged. There are multiple reasons for the sluggish performance of the Japanese economy in recent years and it would be inappropriate to over-emphasize the impact of the bursting of the bubble or asset deflation. However, there is no doubt that the bubble and its ensuing collapse had major implications for the long-term health of the Japanese economy. This “cycle of confidence” seems to apply not only to the Japanese economy, but also to the US economy. Since the mid-1960s, the performance of the US economy started to deteriorate, and the late-70s and early-80s were the worst period, facing both high inflation and low growth, or in another word, stagflation. However, policy efforts to revitalize the US economy began precisely during this testing time. Chairman Volcker’s efforts to tame inflation and deregulation under the Reagan administration, both were set in motion during this difficult period, and the efforts gradually began to bear fruit over a long period of time. The rate of growth of the US economy accelerated from 3.1% in the 1980s to 4.0% in the latter half of the 1990s. This economic expansion briefly paused at the beginning of the new century due to the collapse of the IT bubble, but accelerated once again after a relatively short period. There was much discussion regarding the macro economy and how to interpret the decrease in the volatility of the growth rate and inflation rate. The phrase “Great Moderation” was repeatedly mentioned. In this environment, a very bullish view regarding the economic outlook prevailed. There was much debate about whether the rise in house prices was a bubble or not. However, the basic messages we repeatedly heard from both policymakers and academia here in the United States were, that “there will not be a nationwide decline in house prices” and that “even if a bubble were to burst, it would be manageable through aggressive monetary easing”. With regard to the financial system, the presumption was that the risk management of US and European banks were much more sophisticated and efficient than that of Japanese banks 3. Unfortunately, as we all know now, such optimistic views proved to be wrong. Both the Japanese case and US case show how damaging over-confidence can be. Why couldn’t policy makers put on the brakes? I have taken you through a quick assessment of the recent bubbles in Japan and the United States from the perspective of a “cycle of confidence”. But looking around the globe, such episodes are not confined to these two cases. Just looking back at the last quarter of a century, there was the bubble and its collapse in the Nordic countries during the 1980s, and the Asian Miracle followed by the Asian currency crisis in the 1990s, to name a few. Human beings know that sometimes we become over-confident and our actions become excessive. That is why we have developed pre-set mechanisms to put on the brakes. The private sector has various devices. For example, financial institutions have internal risk management sections. Market discipline is extended by shareholders, creditors and counterparties to guard against excesses by senior management of financial institutions. Meanwhile, central banks and financial regulators and supervisors also function as a braking device. Unfortunately, in these crisis episodes, the devices in both the private and public sectors failed. The failure of these two sets of devices entails very important issues, but in the interest of time, I will focus only on the public-sector device. As a central banker, I believe we need to examine critically and thoroughly the failures of central banks and financial regulators and supervisors. Conduct of monetary policy First of all, let me touch upon the conduct of monetary policy. There has already been considerable debate about the relationship between monetary policy and emergence of bubbles. One thing is clear: over-confidence is the core factor which breeds a bubble. In that sense, bubbles do not transpire from expectations of a continuation of low interest rates alone. This is, however, only a half of the truth. The other half is that bubbles do not materialize without expectations that low interest rates will continue. For me, the key question, which applies to many central banks including both the Bank of Japan and the Federal Reserve, is that, why we, as central banks, maintained interest rates at such a low level, in spite of the uneasiness we felt at that time toward the bubble-like symptoms. There are three possible reasons. First, the economic environment has evolved in a way that imbalances in the economy do not readily show up in the form of changes in the price of goods and services. The success in attaining price stability lent support to public confidence in the central bank’s conduct of monetary policy. As a result, inflation expectations of private sector economic entities became well-anchored to a low target inflation rate. Thus, imbalances in the economy began See Tett (2009). to appear in forms other than inflation of goods and services. Imbalances materialized in different forms such as increases in asset prices and growth of credit extension. Second, some political, economic and social dynamics influenced central bankers, and it became difficult for them to conduct monetary policy based on factors other than the inflation rate. This mechanism is quite subtle. The logic that price stability is a precondition for economic stability and that the independence of the central bank is necessary for price stability, became gradually but firmly established in the 1990s. At the same time, the granting of independence naturally called for the strengthening of accountability. An easily identifiable benchmark was desired. The framework which best fulfilled such needs was inflation targeting. However, under an inflation targeting regime, the debate tends to center on the relationship between the target inflation rate and the actual or expected inflation rate. As a result, the cost of justifying adjustments in monetary policy becomes quite high in the eyes of central bankers, when such adjustments are aimed to deal with imbalances which appear in forms other than price indices. Economists focused their attention to the linkage between the output gap and the inflation rate, while awareness toward financial imbalances was limited. Factors which could not be captured through movements in the price of goods and services fell through the cracks. Institutional changes to transfer the responsibility for financial regulation and supervision away from the central bank also accelerated this trend. Third, the meaning of the danger of slipping into deflation was not necessarily correctly understood in a well balanced manner. In this context, Japan’s so-called “lost decade”, the experience after the collapse of the bubble, was often cited as an evident example, emphasizing the harmful effects of the continuous decline in the price of goods and services 4. However, the serious difficulties that Japan faced were overwhelmingly caused by the fall in asset prices rather than the drop in the general rate of inflation. In the Japanese case, real estate prices in major metropolitan areas dropped by 70 to 80 percent from their peaks, while the cumulative fall in CPI was three percentage points between 1997 and 2004. Nonetheless, the Japanese experience was misinterpreted. The prevalent mood at that time can be easily noted in documents such as the IMF’s World Economic Outlook released in April 2003 5 and the transcripts of the 2003 Jackson Hole Economic Symposium hosted by the Federal Reserve Bank of Kansas City 6. When the Federal Reserve reduced the target for the federal fund rates in June 2003, the aim to avoid “an unwelcome substantial fall in inflation” was provided as the reason for its action. Looking back, during this period, while the risks of deflation were highlighted quite strongly, the subtle role of interest rates to dynamically allocate resources tended to be disregarded. And it was exactly during this period that the seeds of the crisis were sown in the form of the expansion of credit and leverage, and the increase in maturity mismatches. Financial regulation and supervision Let me now move on to financial regulation and supervision. Since the mid-2000s, central banks and supervisors had sent out warning signals on the perceived excesses of various transactions through financial stability reports and speeches. However, beyond such steps, too few remedial actions were taken vis-à-vis individual financial institutions. Of course, it is always quite difficult to take preemptive action on individual financial institutions. But going beyond such general comments, I believe the following reasons can be given for this constraint. With regard to the appropriateness of the phrase, “lost decade”, see Shirakawa (2009). See Box1.1 “Could Deflation become a Global Problem?”, IMF (2003). Federal Reserve Bank of Kansas City (2003). First, confidence in the effectiveness of private sector self-regulation or the disciplinary mechanisms built into financial markets may have been too strong. The continued benign conditions of the macro economy also had an effect. In the “Wealth of Nations”, Adam Smith emphasized the benefits of free competition. However, it seems he was also concerned about leaving market forces alone to dictate all aspects of economic activity. Case in point is the area of finance. He noted that if the rate of interest were to become too high, the greater part of the money would be lent to prodigals and projectors, and money would be kept out of the hands of sober people 7. Before the current crisis, I had not made much of these words by Smith, but now I have come to feel that I need to assess its implications more carefully. Second, authorities became more cautious about the discretionary use of their supervisory powers. Regulation is a necessary tool in maintaining financial stability, but it is not possible to design regulation beforehand which can be applicable to all future situations. Therefore, effective supervision becomes important. What becomes necessary is a form of supervision which is adaptable to each financial institution’s unique risk profile. Naturally, such supervision must involve some elements of discretion. However, as the pressure for stringent and prompt accountability increased, supervisors became more cautious about exercising such discretionary powers. Third, both central banks and supervisory agencies were lacking the perspective of assessing the risks of the financial system as a whole. The traditional philosophy of regulation and supervision was that if the health of individual financial institutions is maintained, the stability of the financial system will also be preserved. However, as the crisis has shown, the interactions among financial institutions as well as between the financial system and real economy played a critical role. In that sense, it was crucial to assess and act against the risks to the financial system as a whole. However, such a macro-prudential perspective was not well established. Revisiting the philosophy behind policy I have examined the reasons why both monetary policy and regulatory and supervisory policy were not successful in putting on the brakes. Through such considerations, one feels afresh the strong influences of the policy philosophy of policymakers, and furthermore, of the conventional wisdom surrounding policymakers which influence their behavior. As Keynes pointed out, “sooner or later, it is ideas, not vested interests, which are dangerous for good or evil” 8. It is perhaps time that we revisit the philosophy behind monetary policy and financial regulation and supervision which we have become so accustomed to in recent years. Currently, my views on the direction for reassessment which I find necessary are the following three points. First, the importance of the objective of central bank policy. Usually, the objective of monetary policy is defined as price stability. In fact, such a definition seemed to be totally reasonable until recently. However, it has now been acknowledged that the role expected of central banks does not match one-to-one with price stability. The experience of the bubble shows that even when prices are stable, the economy can experience huge swings. What is expected of central banks is the attainment of a stable financial environment which provides a basis for sustainable growth. Price stability is certainly one important element of the stability of monetary conditions. However, it is not confined to this. Rather, when a central bank becomes too fixated on short-term price stability, this may complicate the attainment of the ultimate objective of sustainable growth. See Smith (1776). See Keynes (1936). Second, the importance of effectively gauging the stability of the financial environment. Central banks need to pay attention to a broad range of financial indicators, encompassing credit, leverage, and maturity mismatches. A “stable financial environment” is an abstract concept and there is no single indicator which can totally capture economic and financial conditions. However, I would say the same is also true for prices. Measuring prices of goods and services enabled by new technology is really daunting task. Price of a search engine is a good example. Even if we seem to have found a single effective indicator, given that it cannot provide a complete picture of continuously changing economic and financial conditions, we must continue to review carefully a wide range of indicators. It is a demanding task, but we must undertake this challenge. Third, the importance of a healthy amount of discretionary powers. The public sector needs appropriate discretionary powers, both in the area of monetary policy and financial supervision. In spelling out the conditions for exercising the “lender of last resort” function of the central bank, Gerald Corrigan used the words “constructive ambiguity” 9 when he was President of the Federal Reserve Bank of New York. In recent years, the pendulum had swung substantially toward transparency. However, at the end of the day, the role of central banks, regulators and supervisors is to prevent instability of the economy and financial markets, which could materialize if simply left to the free-market competition. If actions of policy makers were based on mechanical rules which could be fully incorporated into the behavior of market participants, this may rather end up being a source of instability for the market and economy. I believe it is time to bring the pendulum back, at least to some extent, toward allowing more room for discretionary measures. Concluding remarks The points I have raised today mean going back to the basics of central banking. But, this does not mean returning to central banks of the past. The raison d’être of the central bank to achieve stable financial environment which would enable the achievement of sustainable growth remains unchanged. However, both the economy and financial markets are evolving continuously. After the end of World War II, until relatively recently, a stable financial environment was almost synonymous with price stability. Also, we were quite used to a financial system structure where the health of commercial banks was almost synonymous with financial system stability. However, having experienced the current crisis, we have come to realize that such understandings are now outdated. When central banks are celebrating success, new problems may be beginning to emerge in the private sector quietly. By the same token, when central banks are facing difficult challenges, the green shoots to resolve the problem may already be beginning to grow in the private sector. Risks always materialize but in new appearance. In this regard, central banks need to continuously be in a learning mode. As with private-sector economic entities, complacency is the most dangerous risk for central banks. We need to be humble as numerous challenges await the global economy. My colleagues and I at the Bank of Japan will continue to come to grips with these challenges, working in cooperation with fellow central bankers, and financial supervisors and regulators. In finishing my remarks, I would like to request you in the private sector for your continued support and assistance, so that central banks can continue to progress. Thank you very much for your kind attention. See Corrigan (1990). References Corrigan, E. Gerald, “Statement before the United States Senate Committee on Banking, Housing and Urban Affairs,” Washington D.C., May 3, 1990. Federal Reserve Bank of Kansas City, Symposium proceedings “Monetary Policy and Uncertainty: Adapting to a Changing Economy”, 2003. Hepburn, A. Barton, A History of Currency in the United States, New York: Macmillan, 1915. International Monetary Fund, World Economic Outlook, April 2003. Keynes, John Maynard, The General Theory of Employment, Interest and Money, 1936. Shirakawa, Masaaki, “Way Out of Economic and Financial Crisis: Lessons and Policy Actions,” Speech at Japan Society in New York, 2009, available at http://www.boj.or.jp/en/type/press/koen07/ko0904c.htm. Smith, Adam, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776. Strong, Benjamin, “Speech by Benjamin Strong, Governor of the Federal Reserve Bank of New York, at the Tokyo Ginko Club, May 24, 1920,” Papers of Benjamin Strong, file 1000.4, Federal Reserve Bank of New York Archive. Tett, Gillian, Fool’s Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe, Simon & Schuster, 2009.
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Speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Kochi, 25 March 2010.
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Hidetoshi Kamezaki: Recent economic and financial developments in Japan Speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Kochi, 25 March 2010. * I. Economic developments A. Global economy * * First, let me provide an overview of economic developments worldwide until recently. After the global economic slowdown due to the bursting of the IT bubble and the confusion over the severe acute respiratory syndrome (SARS) in the early 2000s, the global economy enjoyed a period of high growth led by strong demand from emerging economies. Industrialized countries also maintained relatively high growth, as the prolonged period of low interest rates stimulated investment and consumption. However, in the United States, amid the declining risk awareness among investors, loans to borrowers with a deficient credit history – that is, subprime mortgages – were extended based on the assumption of evergrowing home prices. Housing investment consequently increased, pushing up home prices further, which in turn encouraged homeowners both to take out loans using their houses as collateral, and to boost their spending. Behind this phenomenon, European and U.S. financial institutions purchased and pooled a large number of mortgage claims, restructured them into securitized products – for which credit ratings appeared high as a result of financial engineering – and then sold those products to investors worldwide. However, when U.S. home prices started to fall after reaching a peak around the middle of 2006, the virtuous circle based on the assumption of ever-growing home prices began to reverse. U.S. households that borrowed beyond their means defaulted on their payment obligations, while there was a marked increase in the losses suffered by European and U.S. financial institutions as well as investors worldwide that had purchased mortgage-related securitized products, all as result of the decreased creditworthiness of mortgage-related products that backed those securitized products. This brought about the turmoil in European and U.S. financial markets around summer 2007, and against this background, the failure of Lehman Brothers in September 2008 triggered the global financial crisis. It led to a vicious circle – that is, an adverse feedback loop between financial and economic activity – in which the difficulties and failures of financial institutions and the turmoil in financial markets left funding for firms and households unstable, while the resultant deterioration in economic activity in turn had a negative impact on financial institutions and markets. In this phase, global economic conditions, including those of emerging economies, deteriorated substantially, although just before the emergence of the global financial crisis, it was widely acknowledged that there had been a decoupling between the economic slowdown in industrialized countries and the strength in emerging economies. The subsequent aggressive monetary and fiscal policies taken around the world to support the economy helped initiate progress in the adjustment of excessive inventories, starting around spring 2009. Since then, the global economy as a whole – despite some national and regional differences – stopped worsening and headed toward a moderate recovery. Looking at developments by region, the U.S. economy was recovering, albeit at a moderate pace, supported by the 780 billion U.S. dollar stimulus package and a rescue package for financial institutions that faced financial difficulties. However, there has been no notable improvement in weak areas of the economy, such as housing markets, commercial real estate markets, employment, and small financial institutions’ business conditions. Therefore, there is concern that adjustments made by various economic entities to still-fragile balance sheets might continue to be a drag on economic growth. In the euro area, albeit with some national differences, economic activity is picking up, supported by an increase in exports led by the global economic recovery. However, the pace of recovery in domestic demand is lagging, mainly due to weak private consumption reflecting anxiety about employment in the future. In particular, the expanding fiscal deficits in some countries, such as Greece, Spain, and Portugal, has caused concern in financial markets, thereby putting downward pressure on the economy in the euro area as a whole. Since all European Union member states, including these countries, are required to reduce fiscal expenditures as laid down in the Stability and Growth Pact, I will pay attention to future economic developments in the area, including the effects of expenditure reduction efforts. The U.K. economic activity has started to pick up, mainly due to an increase in exports boosted by the depreciation of the pound sterling. In Asia, the Chinese economy has continued to grow at a relatively rapid pace, mainly because of the hike in fixed asset investment due to the 4 trillion renminbi stimulus measure adopted immediately after the Lehman shock. China’s exports have also been growing recently, owing to the global economic recovery. The current concern, therefore, relates to the overheating of the economy, and the authorities have started to implement measures to restrain this. The economy is unlikely to decelerate in 2010, however, partly because of the effects of the World Exposition to be held in Shanghai. Nonetheless, if the measures to restrain overheating are insufficient, attention should be paid to the possibility that the rise in real estate prices might accelerate further, driving the economy into a full-scale bubble. Economic conditions in the NIEs and the ASEAN countries are recovering as a result of increased exports and production – supported mainly by demand from China – which are leading to improvement in private consumption and a pick-up in business fixed investment. The Indian economy has also continued to grow at a relatively rapid pace, with its exports and domestic demand being generally favorable. In sum, the global economy as a whole is experiencing a moderate recovery, a trend that is likely to continue despite there being various risks. Yet, the contrast between the situations in industrialized countries and in emerging and commodity-exporting economies is likely to become even more striking. Specifically, in industrialized countries, the momentum of selfsustaining economic recovery is likely to be only moderate due to strong adjustment pressure persisting on various economic entities’ balance sheets, while in the emerging and commodity-exporting economies, where there is no such pressure, strong growth has been achieved partly due to an indirect effect of fiscal and monetary policies taken around the world. B. Japan’s economy I will now turn to Japan’s economy. The post-bubble period of Japan’s economy is often referred to as the “lost decade” or the “15 lost years,” but the economy actually experienced three phases of expansion during the period. In particular, the expansionary phase that began in 2002 lasted more than five years, marking the longest period of postwar expansion, supported by the high growth in the global economy. However, in autumn 2007, Japan’s economy fell into a contraction phase, reflecting the downturn in the U.S. economy. Japan’s economy then deteriorated rapidly, as if rolling downhill, following the turmoil in the financial markets triggered by the Lehman shock and the subsequent steep decline in exports and production. Several points could be noted as reasons for the economy of Japan having deteriorated far more severely than that of the United States and Europe where the recent financial crisis originated. First, Japan’s economy was hit hard by the downturn in the global economy because manufacturing industries of durable goods, such as general machinery, electrical machinery, and transport equipment, account for a large share of the overall economy, and the ratio of exports in such industries is high. Second, these manufacturing industries are linked to a wide range of domestic industries, and therefore the fall in exports broadly affected domestic industries, including those that do not directly engage in export-related activities. Since then, as the global economy has stopped worsening and is headed toward recovery, Japan’s exports and production hit bottom at the beginning of 2009, since when it has been recovering, mainly in the area of items meeting demand from China. Japan’s economy has ceased to deteriorate and started to pick up, despite the increasingly severe employment and income situation, on the realization of the positive effects of the government’s stimulus measures that favor energy-efficient products, such as tax reductions applied to purchases of environment-friendly cars and the eco-point system for electrical appliances. However, there has not yet been sufficient momentum for self-sustaining recovery in domestic private final demand. In terms of economic outlook, it is expected that the effects of inventory restocking and policy measures, which have been driving growth, gradually will abate. Against this background and given the severe employment and income situation, there may be a leveling off in the area of private consumption, which has been picking up recently. Meanwhile, business fixed investment is likely to pick up gradually as firms can no longer postpone investment plans, especially in light of pressing replacement demand. In sum, I expect that the trend toward gradual economic recovery will continue. The situation warrants careful attention, however, as many firms remain cautious about increasing domestic investment and employment due to uncertainty concerning the outlook. II. Price developments in Japan A. The recent situation and the outlook Next, I will talk about price developments against the background of the recent economic situation I have just described. International commodity prices, which have a major impact on Japan’s domestic prices, surged at the start of the new century as commodity markets tightened due to strong demand from and robust growth in emerging economies, compounded by an inflow of speculative funds. Commodity prices then plunged as a result of the rapid unwinding of speculative funds from commodity markets, prompted by the Lehman shock and the subsequent financial market turmoil and global economic deterioration. These commodity prices, however, have since resumed an upward trend in response to the recent moderate recovery in the global economy. Some items in the consumer price index (CPI) excluding fresh food (the core CPI), such as the prices of petroleum products and food, started to show a definite rise around the end of 2007, reflecting the surge in international commodity prices. In the middle of 2008, the yearon-year rate of increase in the core CPI was around 2.5 percent, marking the largest rise since the early 1990s if we exclude the effect of the 1997 consumption tax increase. Subsequently, commodity prices fell, causing the year-on-year rate of change in the core CPI to a decline. In summer 2009, the rate of decline in the core CPI hit roughly 2.5 percent, marking the sharpest fall ever. The pace of decline in the core CPI has recently been moderating, underpinned by the rise in prices of petroleum products. However, in January the CPI excluding food and energy, or the core-core CPI, which is not usually susceptible to fluctuations in commodity prices, fell 1.2 percent year on year, marking the largest drop so far. Regarding the outlook, the pace of decline in the core CPI is expected to slow, as the robust economic growth in emerging economies is likely to keep commodity prices high and the negative output gap is likely to narrow as the economy recovers. However, it is unlikely that an upturn in the trend of the core CPI will be achieved easily, since: the negative output gap has been narrowing only moderately; there have been declines in both the inflation rate currently perceived by households and that expected twelve months out; and the proportion of households expecting prices to be lower in a year’s time has increased. Such perceptions could affect firms’ price-setting behavior. B. The cause of deflation Japan’s economy is currently experiencing deflation, a sustained decline in the general price level. While the inflation rates in major economies have been declining since the 1990s and marked a further fall after the Lehman shock, it is only in Japan that inflation has marked a high negative rate in terms of the core-core CPI. 1. Output gap One cause of deflation in Japan is its large negative output gap. When demand falls well short of supply capacity for products, suppliers may opt to restrain rises in sales prices, or reduce prices, to attain sales volumes. If this happens across the economy, the inflation rate will falter. According to an International Monetary Fund (IMF) projection in the World Economic Outlook, the output gap in Japan has remained consistently negative since the second half of the 1990s, albeit with some cyclical fluctuations, and has been larger than in other major economies. I believe this can be attributed to the excess supply capacity – a legacy of the insufficient restructuring of industries, including their production facilities – that remained out of line with sluggish domestic demand. There are a number of reasons for the weakness in domestic demand, but the major one is the lack of forward-looking investment since the bursting of the economic bubble, as a result of the prolonged balance-sheet adjustments conducted by various economic entities. In particular, the delay in financial institutions’ disposal of impaired assets has weakened their financial intermediary functions, thereby impairing their ability to provide sufficient funds for new areas of growth. Although balance-sheet adjustments had been progressing significantly from around 2005, the Lehman shock, which occurred before such adjustments had been completed, triggered a plunge in overseas demand and, subsequently, a rapid widening of the negative output gap, which in turn led to the present deflationary situation. 2. Inflation expectations Although movements of the output gap and the inflation rate do not show a clear correlation, a close look at data of the past phases reveals that a widening of the negative output gap was followed by a decline in the inflation rate. However, over the long term, the actual inflation rate has edged down even when the output gap has remained at the same level. It is assumed that this is due to a decline in the medium- to long-term inflation expectations among various economic entities. No one would rush to buy a product when he/she expects its price to fall or remain almost unchanged. In such a situation, suppliers would set lower prices to stimulate consumers’ spending appetite. If this trend spreads across the economy, the actual inflation rate will decline even when the output gap is at the same level. The reason for the decline in medium- to long-term inflation expectations in the period from the 1970s to the first half of the 1990s is that a rise in the prices of goods and services, together with inflation expectations for the general price level, were contained by a combination of factors such as stable crude oil prices, the continued appreciation of the yen and resultant pressure to reduce the difference between domestic and foreign prices, as well as deregulation and other measures to promote competition. Nevertheless, since the latter half of the 1990s, the correlation between the output gap and the actual inflation rate has been stable. At present, it seems that there is no major change in medium- to long-term inflation expectations. However, as I noted earlier, there has been a decline in the inflation rate that households anticipate twelve months out, and the proportion of households expecting prices to be lower in a year’s time has increased. If such a view leads to a decline in medium- to long-term inflation expectations, it could become difficult to overcome deflation. Therefore, a change in inflation expectations is an important factor that requires careful monitoring. C. The cost of deflation The main reason for Japan’s current deflationary situation is the widening of the negative output gap. Deflation is disadvantageous for suppliers of goods and services but advantageous for consumers. This phenomenon seems like a zero-sum game on the surface, so, why is deflation said to have negative effects on the economy? Price fluctuations, whether declines or otherwise, give rise to extra costs for society. For example, sales price revisions incur costs for deliberations and negotiations prior to settling on a price, and then for changing price tags. Such extra costs must be borne by some entities within the economy. Furthermore, price revisions for a large number of products at varying times and differing scales could hinder the efficient allocation of economic resources, while uncertainty regarding price fluctuations would also add risk premiums to transactional costs. In some cases, it might become difficult to conclude long-term contracts, thereby affecting plans for consumption and investment. In addition, if price fluctuations cause a change in the value of financial assets and liabilities that are fixed in nominal terms, or in the real value of transactions and wages, distortions would arise in income distribution. Such distortions would give rise to a sense of unfairness among those in different functional roles, such as lenders and borrowers, or employers and employees. The possible loss of trust in social fairness and equality would affect work ethic and incentives. One of the costs unique to deflation is that real interest rates cannot decline to the level corresponding to that of economic activity, since nominal interest rates do not fall below zero. Furthermore, a rise in the real value of debt and the resultant increase in the burden on the debtor may eventually lead to economic deterioration. In such a case, the real value of creditors’ assets would increase, but, since debtors’ propensity to consume out of income is generally higher than creditors’, consumption in the overall economy would shrink. Therefore, attention should be paid to the fact that there are costs unique to deflation. III. Measures taken by the Bank The Bank is gradually ending the measures that have been implemented to deal with the “acute symptoms” manifested in the rapid contraction of financial market activity following the Lehman shock in September 2008. At the same time, the Bank is putting forward additional measures to dispel “chronic illness,” namely deflation. Next, I will elaborate on the Bank’s monetary policy measures implemented since the Lehman shock. A. Measures to address the acute symptoms, or the rapid financial contraction Immediately after the failure of Lehman Brothers, financial market participants throughout the world became overly cautious about their counterparts’ creditworthiness, and there were cases where even financially sound institutions found it difficult to acquire funds. During such a rapid financial contraction, which we have described as acute symptoms, a central bank is the sole provider of liquidity. Thus, from the day after the failure of Lehman Brothers, the Bank successively injected abundant liquidity into the money market by conducting sameday funds-supplying operations. Subsequently, it implemented measures to provide ample liquidity to financial markets, such as increasing the amount of outright purchases of Japanese government bonds and introducing U.S. dollar funds-supplying operations against pooled collateral. In Japan, it was the CP market that faced a particularly serious shortage of liquidity as market participants withdrew their funds from the market, fearing the risk of corporate failures. Firms that could no longer acquire funds through CP issuance flocked to banks for financing. As banks tried to respond to the increased demand for loans, they found themselves unable to afford to supply sufficient funds for small firms or firms with low credit ratings, or for repo transactions. In this way, the liquidity shortage spread to various markets. To address this situation, the Bank, in addition to increasing the frequency and size of CP repo operations, introduced outright purchases of CP as a temporary measure. This was a highly exceptional step, in that a central bank took on the credit risks of individual private firms. The underlying objective was to facilitate corporate financing and resolve the liquidity shortage in the CP market by helping to restore confidence in CP underwriting among market participants. In addition, the Bank introduced a series of temporary emergency measures to facilitate corporate financing, including: (1) the easing of the rating requirement for corporate debt to be accepted as eligible collateral; (2) the special funds-supplying operation to facilitate corporate financing (hereafter the special operation), through which the Bank provided longer-term funds for an unlimited amount against the value of corporate debt pledged as collateral at a very low fixed interest rate; and (3) outright purchases of corporate bonds with a short residual maturity. Furthermore, in order to ensure the accommodative financial environment, the Bank reduced the policy interest rate – that is, the uncollateralized overnight call rate – from 0.5 percent to 0.1 percent, which is the lowest level in the world. In order to provide ample liquidity through maintaining the policy interest rate at this low level, the Bank also introduced the complementary deposit facility, whereby interest is made payable on excess reserve balances held at the Bank by financial institutions. At the same time, the Bank introduced temporary measures to secure the stability of the financial system, given that the strains in global financial markets and the subsequent fall in stock prices and rise in credit costs have greatly affected financial institutions’ intermediary function and financial soundness. Such measures include the stock purchases held by financial institutions to help them reduce the market risk associated with stock holdings and the provision of subordinated loans to banks to help them maintain sufficient capital bases. B. Completion of measures to address acute symptoms after markets regained stability Subsequently, as the economy stopped worsening and headed toward recovery, while financial markets regained stability, the amount of financial institutions’ bids for central bank funds started to fall short of the offered amount in the Bank’s outright purchases of CP and corporate bonds. In the CP market in particular, the issuance rates on high-rated CP occasionally fell below yields on treasury bills, which in theory must command greater creditworthiness. Furthermore, auction rates on ordinary funds-supplying operations tended to decrease to such low levels that the advantages of the relatively low rates offered in the special operation were eliminated. As a result, the Bank decided to end some of the temporary measures adopted to deal with the acute symptoms. For instance, the Bank decided in October 2009 to complete outright purchases of CP and corporate bonds, as well as the special operation, at the end of December 2009 and March 2010, respectively. C. Measures to address chronic illness, or deflation The Bank is firmly committed to continuing its policy of maintaining the extremely accommodative financial environment, given the moderate pace of economic recovery and weak momentum for price increases. In fact, the policy interest rate is being maintained at a low level of 0.1 percent and the complementary deposit facility remains in operation. Furthermore, on December 1, 2009, in order to enhance easy monetary conditions, the Bank introduced a new fixed-rate funds-supplying operation against pooled collateral (hereafter the fixed-rate operation), whereby a large amount of funds totaling approximately 10 trillion yen are to be provided at an extremely low fixed interest rate. This operation has contributed to encouraging a decline in longer-term interest rates. On March 17, 2010, the Bank decided to expand the measure to encourage a decline in these rates by increasing the amount of funds to be provided through the fixed-rate operation to approximately 20 trillion yen, from the previous amount of approximately 10 trillion yen. Meanwhile, the Bank emphasized its stance on fighting deflation. Regarding the “understanding of medium- to long-term price stability” (the level of inflation that each Policy Board member understands, when conducting monetary policy, as being consistent with price stability over the medium to long term; hereafter “understanding”), the Bank made it clear that the Policy Board does not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent, and that the midpoints of most Policy Board members’ “understanding” are around 1 percent. IV. Moving toward sustainable economic growth As I have just explained, the Bank is making use of various policy tools to maintain the extremely accommodative financial environment to overcome deflation. In the money market, the interest rates applied for the Bank’s funds-supplying operations have declined to 0.1 percent, and there are even cases in which financial institutions’ bids fall short of the Bank’s offers. Market participants have become increasingly confident that they can acquire sufficient funds at a low interest rate. Various types of interest rates have declined, including those for funds transactions between financial institutions, market rates on Japanese government securities, corporate bonds, and CP, as well as loans extended to firms and households. It is hoped that the effects of monetary easing will further spread to other types of interest rates, encourage vigorous activity by various economic entities, and in due course lead to economic growth. However, a decline in interest rates alone may not be enough to stimulate activity by private sector entities, namely, firms and households, and thereby raise the level of overall economic activity. So, what is necessary to encourage vigorous activity on the part of firms and households? My belief is that the various economic entities need to free themselves from concerns about the future and regain confidence in their ability to achieve sustainable economic growth. In the post-World War II period, Japan has achieved high economic growth supported by the continuous efforts of the Japanese people, who are hard-working by nature, and the belief that they could achieve their high aim of catching up to the economic standards of European countries and the United States. Yet, it seems that the Japanese people were unable to set a new target once the goal of catching up had been achieved, and the ambition to achieve further economic growth has weakened. This may be a factor behind the significant economic slowdown since the 1990s. In this situation, the government’s “New Growth Strategy (Basic Policies)” released in December 2009 is very meaningful, as it presents the objective with which the public would seek to achieve sustainable economic growth. The measures laid down in the new policies include Asia-focused strategies geared to benefit from growth in Asian markets; measures to boost domestic demand – an issue requiring immediate action – with particular focus on sectors related to environmental protection, energy, and an aging population with fewer children, as well as farming and other food-related sectors. This is very much in line with my viewpoint, as neglecting these sectors would inevitably lead to a decline in Japan’s overall economic strength, whereas proper attention would surely lead to the development of promising businesses within these sectors. However, concrete plans for the new policies have not yet been announced. I understand that such plans will be provided in the “Growth Strategy Implementation Plan,” which is scheduled to be released by June 2010 with more specific and additional measures. I look forward to the release of the effective plans, so that concrete measures aimed at new economic growth can be set in motion as early as possible. Growth strategies – however ideal they might appear – can only serve to raise suspicions regarding future sustainable growth, as well as add to the fears of fiscal bankruptcy and a large increase in taxation, if they result in a further ballooning of the fiscal deficit, because Japan suffers from by far the largest government debt of any industrialized country. Thus, it is very important that the government’s medium-term fiscal framework and fiscal management strategy, also to be ready by June 2010, include measures to establish a sustainable fiscal structure and present fiscal restructuring measures to ensure future economic and fiscal soundness, thereby maintaining market confidence. I am always aware that the Bank should implement policy measures proactively when necessary, and its decision on March 17, 2010 to take an additional measure to enhance easy monetary conditions was based on such thinking. The Bank will continue to make the utmost effort to encourage various economic entities to regain confidence in their ability to attain sustainable economic growth.
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Opening speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2010 International Conference, hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 26 May 2010.
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Masaaki Shirakawa: Future of central banks and central banking Opening speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2010 International Conference, hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 26 May 2010. * I. * * Introduction Good morning. I am very pleased to address the Bank of Japan international conference. On behalf of my colleagues at the Bank of Japan, I welcome all the participants from central banks, international organizations, and academia. The global financial crisis which started in the summer of 2007 poses a renewed but fundamental question on the role of a central bank. This year’s conference focuses on this timely theme of “Future of Central Banking under Globalization.” In exploring the future of central banks, I set my benchmark at the monetary and financial system and the environment surrounding central banks at the time when I started my career at the Bank of Japan in 1972. In those days, on the Monetary policy front, central banks did not obtain sufficient understanding and support about their primary objective of achieving price stability from politicians and the public at large. In the mid-1970s, shortly thereafter, double-digit inflation became a crucial challenge for central banks in major countries. And many central banks were yet to establish their independence. The foreign exchange rate system for the advanced countries was in a transition period from the adjustable peg under the Bretton Woods system to the floating rates. As for the financial system, the banks” activities were still highly regulated, and the memory of a financial crisis became faded just as a remote past event. The situation changed significantly after that. 1 Macroeconomic performance improved considerably. Many central banks established their independence, and succeeded in improving the understanding on their role from politicians and the public. “Quiet Revolution” called by Alan Blinder can be understood along such a trend. 2 The theory of monetary policy also advanced considerably. 3 Just when we feel comfortable with the positive developments, which just I mentioned, the situation has already been changing gradually, thereby posing a new challenge for central banks. That is, asset-price and credit bubbles and subsequent economic stagnation and financial crises after the burst of bubbles. Japan faced that challenge first, and then countries in various parts of the world experienced similar challenges one after another. In view of the current global financial crisis, we clearly know that we are facing the new challenge. But, to what extent did central bank policymakers predict the current situation a couple of decades ago? Instead of venturing into a long-term future, I will rather narrow my focus on a near-term future. Cagliarini, Kent, and Stevens (2010), Caruana (2010), and Crockett (2010) provide excellent reviews on development in the macroeconomy, the financial system, and the international currency system, respectively. See Blinder (2004). Clarida, Galí, and Gertler (1999) say that research on monetary policy reaches a stage of a “science of monetary policy” by establishing a number of useful principles for optimal monetary policy with fairly general applicability. II. Performance of central banks Central banks in the world do not play the exactly same roles, reflecting their historical backgrounds. But to consider the nature of modern central banking, we need to focus on three aspects. First, a central bank provides central bank money with ultimate safety and liquidity and operates payment and settlement systems. Second, a central bank conducts monetary policy to guide the level of interest rates for achieving price stability. Third, a central bank plays a key role in maintaining financial system stability. About the third role, a central bank has a unique role as a lender of last resort, and, more or less, it shares the important role of financial regulation and supervision. I begin by reviewing the performance of central banks in the three areas. Central bank money and payment and settlement systems First, speaking of central bank money and payment and settlement systems, large-value payments settled through central bank accounts have increased significantly, reflecting the growing financial market transactions. At the same time, the settlement methods have also changed drastically. In the early 1970s, only the Fedwire, run by the US Federal Reserve System, employed the real-time gross settlement (RTGS) system, which immediately settles funds transfer instructions between central bank accounts on an instruction-by-instruction basis. Most of the remaining systems employed the deferred net settlement (DNS) system, which settles funds transfer instructions between central bank accounts on a netted amount basis at fixed points in time. The Bank of Japan carried out most of settlements either at nine o’clock in the morning, one or three o’clock in the afternoon. 4 However, most of the central banks in the world, including the Bank of Japan, have moved to RTGS systems. 5 As for foreign exchange transactions, Continuous Linked Settlement (CLS) started its operation in 2002. The system settles foreign exchange transactions in 17 currencies on a payment-versus-payment (PVP) basis between seven o’clock in the morning to noon, central European time. Those fixed hours, which were enabled by the extension of operating hours of central bank systems, are often called the “five-hour window” linking settlements on the globe. The observations, just I mentioned, are very limited, but they clearly show a dramatic improvement in the safety and efficiency of payment and settlement systems. That was proven resilient under the current financial crisis, as a result of steady and tremendous efforts to reduce settlement risk by all the parties concerned in the past. Monetary policy Next, let me move on to reviewing the performance of monetary policy. Although inflation accelerated from the 1970s to the early 1980s, it then started declining noticeably around the mid-1980s. In the 1990s, inflation came down to a low and stable level where central banks in major countries could declare a victory in the battle against inflation. In parallel, public understanding about monetary policy was enhanced in two points: price stability as the primary objective, and the importance of central bank independence to that end. However, bubbles have often emerged since central banks just won the battle against inflation. As I mentioned earlier, Japan first experienced that problem in the second half of the 1980s. Around that time, Japan delivered a remarkably good macroeconomic performance, compared with other advanced countries. Real GDP growth reached 5.1 percent in Japan, while the average of other G-7 countries stayed at 3.4 percent. CPI The settlement time at five o’clock was introduced in 1993 when the Zengin system moved from next-day settlement to same-day settlement. See Shirakawa (2009). inflation came down to 1.1 percent in Japan, while the average of other G-7 countries remained at 3.9 percent. Japan received high marks in performance criteria for inflation targeting, which would prevail later on. At that time, there was debate about the necessity of exiting extremely accommodative monetary policy in Japan. In fact, all the macroeconomic indicators except for one showed the necessity of withdrawing monetary easing: high economic growth, tight labor market conditions, rapidly growing bank lending, and bloated asset prices. The outlier indicator, however, was exactly CPI inflation. As a result, low inflation stood against the Bank of Japan, and delayed the policy reversal toward tightening. What happened later on was the expansion and burst of an asset-price and credit bubble and the subsequent financial crisis. Since then, many countries had the same experience that price stability would not automatically ensure macroeconomic stability. To digress a little bit, before the current crisis, a safety margin against the zero lower bound of nominal interest rates was often pointed out as one of the justifications for targeting a small but positive rate of inflation. In the end, major countries found themselves virtually constrained by the zero lower bound under the current crisis. Looking back at the serious economic downturn after the failure of Lehman Brothers, very few think that reducing interest rates by a few percentage points, enabled by having a higher target rate of inflation, would have materially changed a recovery path of the economy. 6 That suggests how devastating damage financial system instability inflicts on the economy. We have learnt two things from our experiences in the last few decades. First, price stability and financial system stability are both prerequisites for macroeconomic stability. Second, price stability itself is desirable, but it entails a complex mechanism for destabilizing the financial system, if combined with over-confidence in economic agents and unfounded expectations about the prolonged low interest rates. 7 Financial system So, I will move on to reviewing the performance of central banks in the third role, the achievement of financial system stability. In the early 1970s, a major financial crisis seemed remote to many countries, including Japan. Of course, some financial crises occurred after that, such as the Secondary Banking Crisis in the United Kingdom and the S&L Crisis in the United States, while they were far from a full-fledged crisis affecting the entire economy and the financial system. Such a situation, however, changed significantly in the 1990s. First, financial crises have occurred more frequently than before. That is apparent from the recent episodes: Japan’s crisis, the Nordic crisis, the East Asian crisis, the LTCM crisis, the Russian crisis, and the current global financial crisis. In addition, financial crises have increased their magnitude. Second, financial crises have occurred on a more global scale than before. Japan’s financial crisis was an isolated event for the global financial system, albeit a serious event for Japan. However, the subsequent crises strengthened their global nature. The crisis after the failure of Lehman Brothers was truly a global financial crisis. Third, financial crises have a bit different nature, compared with the past. Financial crises always surface in the form of a liquidity shortage. Under the current crisis, the shortage of market liquidity, in addition to funding liquidity, did matter. In addition, such liquidity shortage became extremely acute in the shadow banking system, which is outside the traditional banking sector. Blanchard, Dell’Ariccia, and Mauro (2010) point out that it is necessary to examine costs and benefits of raising an inflation target in light of the current financial crisis. See White (2006). III. New and difficult challenges from success As the last couple of decades show, central banks have achieved a great success in stabilizing prices as well as economic activity. As a result of such success, central banks seem to ironically face new and difficult challenges. 8 I will next explain such difficult challenges. Changes in the manifestation of economic imbalances First, the imbalances in the economy are unlikely to appear immediately in the form of imbalances in general prices. A benign macroeconomic condition tends to make economic agents irrationally bullish, and change their risk perception in a laxer direction. Low inflation, however, tends to delay the reversal of easy monetary policy. Under such a situation, overconfidence, if created by some reasons, ignites an increase in asset prices, expansion of credit and leverage, and extension of maturity mismatches. If the imbalances in the economy had appeared in the form of a rise in general prices, a central bank would have relatively easily been able to respond by orthodox monetary tightening. The imbalances in the economy, however, appeared in the form of financial imbalances. Then, why have general prices become less responsive to the imbalances in the economy? One reason, often pointed out, lies in the enhanced credibility for a central bank in conducting monetary policy. In that case, firms do not change their product prices immediately, when they perceive general price fluctuations as just temporary. Another reason is related to the tendency toward non-price competition. Firms are concerned that a simple raise in the prices results in losing their customer bases in a low inflation environment, and that a simple reduction in the prices just invites subsequent price reductions by competitors. Although I basically agree with the analyses, just I mentioned, I conjecture that a more fundamental reason lies in the fact that price measurement itself has become hard in recent years. Of course, in theory, the price index is supposed to trace quality-adjusted prices over time. In practice, however, value added and attendant risk are hard to be identified, as the economy becomes more information-driven, service-oriented, and network-intensive. 9 A case in point is financial services consumers purchase from financial institutions. Financial services are about risk assessment. As our experience of the financial crisis shows, however, such risk assessment turned out to be inadequate. If an ideal quality adjustment method had been available to us, quality adjusted prices of financial services would have increased reflecting their declined quality. Such a statistical treatment has hardly been implemented in practice, and the situation seems to remain the same in the future. Policy responses after the burst of a bubble The second difficult challenge is that a policy response, if successful in the short term, does not necessarily imply a success in the long term. Central banks moved swiftly and aggressively, countering a serious economic downturn stemming from the burst of the bubble. We have to be aware that such policy responses could cause other risks, including the emergence of an asset-price and credit bubble. Given the increase in the frequency and magnitude of bubbles since the 1990s, I mentioned earlier, we need to have a longer time horizon to tell whether a policy response will succeed or not. Shirakawa (2010) points out a mechanism of so-called the “cycle of confidence” behind the bubble and financial crisis. See Varian (2001). Central bank in democratic society The third difficult challenge is related to the fact that a success in policy responses poses a new problem as to what responsibility a central bank should bear in democratic society. Confronted with the financial and economic crises, central banks in major countries have all introduced unconventional policy measures. In that regard, the Bank of Japan was the first to experience a financial crisis, and, thus, was the first to employ unprecedented measures. Since the late 1990s, the Bank of Japan has been moving aggressively as a lender of last resort, including the funds provision to the securities firm. The Bank of Japan also launched various unprecedented measures, such as a stock purchase program from financial institutions and the outright purchase of asset backed commercial papers and asset-backed securities. Thus, it is my regret that innovations in the Bank of Japan’s policy responses have not been well recognized. In fact, under the current financial crisis, major central banks have also taken unprecedented policy measures, just like the Bank of Japan did. Unconventional policy measures taken by a central bank involve quasi-fiscal policy elements, such as potential taxpayers’ burden incurred by a loss from such operations, and intervention in resource allocation at a micro level. In the midst of a crisis, a central bank faces growing demand for introducing unconventional policy measures, which involve more or less quasifiscal policy elements. Since a central bank generally thinks that such measures need to be decided and implemented by government in democratic society, a central bank falls into a difficult position, when decisions by government are just postponed. The border between pure monetary policy and quasi-fiscal policy sometimes becomes ambiguous. Looking back at the experiences of various countries since the 1990s, when their central bank law had clauses for making some quasi-fiscal policy measures possible, they decided to carry out such measures after careful consideration. Once a crisis was overcome, with the help of such unconventional policy measures, central banks were criticized for violating the fundamental rule in democratic society. As a result, such a situation is likely to undermine credibility for central banks, and thus affect their policy performance. IV. Tasks for central banks As I discussed so far, central banks face new and difficult challenges at the moment. With considering such difficult challenge, I will point out some tasks in addressing such difficult challenges. Understanding of a primary mandate for a central bank The first is the understanding of a primary mandate for a central bank. Without social understanding on that point, central bank independence and, eventually, central bank credibility itself are likely to be undermined. I think that a primary mandate for a central bank should be to achieve a stable financial environment, that is, a financial environment that is consistent with, and contributes to, sustainable economic growth. Price stability is certainly one important element in achieving a stable financial environment. That is, however, not the sole factor. When a central bank feels constrained by short-term developments too much, that is more likely to amplify macroeconomic fluctuations. After all, deposit money, which has a major share in broad money, is created as a product of maturity mismatches and leverage of private financial institutions. A central bank needs to adequately monitor the financial environment, including such behavior of financial institutions. Macroprudential perspectives, recently reemphasized in light of the current global financial crisis, should be understood as examining the interactions between the real and financial sides of the economy, considering the behavior of private financial institutions. Such an analysis is an essential task for a central bank, although it is a typical example of “easier said than done.” In addition, macroprudential analyses and perspectives are crucially important in conducting monetary policy as well as designing financial regulations and supervising financial institutions. Financial infrastructure The second is the efforts to improve the financial infrastructure. In achieving a stable financial environment, while monetary policy certainly plays an important role, we need to avoid overstating the effectiveness of the fine-tuning policy, given our incomplete knowledge. As is well known, we have difficulty in measuring the output gap and inflation in an accurate manner. It is even more so in projecting such indicators. We also need to pay attention to the risk of destabilizing the economy, due to a recognition lag. By contrast, we can count more on assured benefits from enhancing the financial infrastructure, as evident from the observation that such efforts are very effective in staving off the aggravation of the current global financial crisis. In that respect, one of the most important tasks is to improve cross-border funding markets. International monetary system In discussing the future of central banking, I cannot conclude my speech without touching upon the international monetary system. 10 In that regard, we sometimes hear the arguments for macroeconomic policy coordination to facilitate the adjustments of global imbalances. The current-account imbalances themselves are an adjustment mechanism for the differences in savings and investment patterns due to the variations in the level of economic growth and demographics between countries. So the imbalances themselves are not necessarily evil. What should be adjusted is unsustainable imbalances, but, as the current global financial crisis shows, those imbalances are caused primarily by internal imbalances, reflecting inappropriate management of macroeconomic policy and financial regulations and supervisions. I well understand the necessity of reforming the international monetary system as a long-term task, but I should emphasize the bottom line that each country should make every effort to put its own house in order. Having said that, we need to recognize new challenges we are facing in an international context. As the role of globally operating financial institutions and investors expands, easy monetary policy in one country comes to influence other countries. We thus observe a phenomenon that the insulating effect of the floating exchange system does not always work perfectly, as it is described in textbooks. One example is the growing effects of carry trade. Considering such changes in the transmission channel of monetary policy, I am wondering whether and to what extent we need to alter our way of thinking on monetary policy management for the advanced countries or an international key currency country. That seems to remain an open question. V. Institutional culture for a central bank As discussed so far, central banks are facing wide-ranging challenges. In any event, the fiat money system is a system to control money with wisdom. To that end, the institutional culture and human capital accumulation in such culture are crucially important for a central bank. 11 In closing my remarks today, let me touch upon some aspects of the institutional culture for a central bank I deem important. We see some renewed interests in the international monetary system. See, for example, Padoa-Schioppa (2010) for that line of arguments. Williamson (1999) discusses the governance of public institutions. Oritani (2010) analyzes the governance and organization of a central bank using the institutional economics. The first aspect in the central bank culture is banking operations. A central bank is not just an ivory tower to discuss the macroeconomy and the financial system in an abstract manner. Rather, a central bank itself is a bank, which implements policy actions through banking operations, as in the case of monetary policy as well as a lender of last resort. Those operations require wide-ranging operational knowledge, such as collateral haircut setting, counterparty selection, payment and settlement of funds and securities, and debt-collection from failed financial institutions. In addition, such knowledge is also useful in assessing the subtle working of the financial system and its interaction with the macroeconomy. In introductory textbooks, money is described as a mechanical concept just as a product of the monetary base and the money multiplier. Such a way of understanding of money misses the important role played by money. As I noted earlier, money is created as a product of maturity mismatches and leverage in financial transactions. That implies that a central bank is unable to understand developments in the financial system and the macroeconomy without hands-on knowledge on how banks operate. The current global financial crisis clearly shows that point. The second aspect is to keep learning. The economy, including the financial system and financial markets, is changing all the time. When we have confidence in acquiring knowledge on something, the situation has already started changing before we know it. One such example is financial system instability after achieving price stability. We are unable to write fully state-contingent rules and contracts. Actual markets are inevitably incomplete markets in economists’ terminology. A central bank can be regarded as a device for dealing with such incompleteness. If that is the case, a central bank needs to make use of all the available knowledge in understanding the developments in the economy and their implications, and mapping out necessary policy actions. Thus, a central bank needs to put emphasis on the institutional culture of constant learning. 12 The third aspect is the integration of wide-ranging areas of knowledge. Taking an example of monetary policy, a central bank generally relies heavily on the macroeconomic theory in conducting monetary policy. The economic theory plays an important role in providing a framework for understanding a complex world. At the same time, we should be careful that sticking to one specific theory potentially distorts our views. Historical knowledge is also useful. Looking back at the history of financial crises, we are stunned by the common mentality of “this time is different.” 13 In addition, knowledge on banking operations, just I mentioned, is also indispensable. A central bank needs to make constant efforts to produce synergy effects between monetary policy and prudential policy wings by overcoming some differences in the cultures of the two policy wings. The fourth aspect is cooperation among central banks. We expect that economic activity and financial market transactions will continue to grow across borders, but we do not imagine that sovereign nations will disappear in the foreseeable future. In that case, cooperation between central banks will become increasingly important in achieving financial system stability. Under the current global financial crisis, central banks have communicated with each other intensively at various levels, from top central bankers to mid-class staffers, which surely becomes considerable wealth for the future of the central bank community. VI. Closing remarks Central bank conferences reflect the institutional culture of central banks, and this conference entails such aspects more clearly with its title of “future of central banking.” I am See King (2005) for the importance of learning for central banks. See Reinhart and Rogoff (2009). convinced that the one-and-a-half-day conference will give us profound insights into the future of central banks and central banking. Thank you very much. References Blanchard, Olivier, Giovanni Dell’Ariccia, and Paolo Mauro, “Rethinking Macroeconomic Policy,” IMF Staff Position Note, 2010. Blinder, Alan S., The Quiet Revolution: Central Banking Goes Modern, Yale University Press, 2004. Cagliarini, Adam, Christopher Kent, and Glenn Stevens, “Fifty Years of Monetary Policy: What Have We Learned?,” Paper presented at the 50th Anniversary Symposium of the Reserve Bank of Australia, February 2010. Caruana, Jaime, “Financial Stability: 10 Questions and About Seven Answers,” Paper presented at the 50th Anniversary Symposium of the Reserve Bank of Australia, February 2010. Clarida, Richard, Jordi Galí, and Mark Gertler, “The Science of Monetary Policy: A New Keynesian Perspective,” Journal of Economic Literature, Vol. 37, pp. 1661–1707, 1999. Crockett, Andrew, “What Have We Learned in the Past Fifty Years About the International Financial Architecture?,” Paper presented at the 50th Anniversary Symposium of the Reserve Bank of Australia, February 2010. King, Mervyn, “Monetary Policy: Practice ahead of Theory,” Speech at Mais Lecture, May 17, 2005. Oritani, Yoshiharu, “Public Governance of Central Banks: An Approach from New Institutional Economics,” BIS Working Papers No. 299, 2010. Padoa-Schioppa, Tommaso, “The Ghost of Bancor,” Speech at Louvain-la-Neuve, February 25, 2010. Reinhart, Carmen M., and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly, Princeton University Press, 2009. Shirakawa, Masaaki, “Toward Development of Robust Payment and Settlement Systems,” Speech at a Symposium Commemorating the 25th Anniversary of the Center for Financial Industry Information Systems, November 13, 2009, available at http://www.boj.or.jp/en/type/press/koen07/ko0911d.htm. ——— “Revisiting the Philosophy behind Central Bank Policy,” Speech at the Economic Club of New York, April 22, 2010, available at http://www.boj.or.jp/en/type/press/koen07/ko1004e.htm. Varian, Hal R., “Markets for Information Goods,” in Kunio Okina and Tetsuya Inoue eds., Monetary Policy in a World of Knowledge-based Growth, Quality Change and Uncertain Measurement, Palgrave, pp. 85–99, 2001. White, William R., “Is Price Stability Enough?,” BIS Working Papers No. 205, 2006. Williamson, Oliver, “Public and Private Bureaucracies: A Transaction Cost Economics Perspective,” Journal of Law, Economics and Organization, Vol. 15(1), pp. 306–342, 1999.
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan National Press Club, Tokyo, 31 May 2010.
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Masaaki Shirakawa: Japan’s economy and innovation Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan National Press Club, Tokyo, 31 May 2010. * * * Introduction It is a great honor for me to have the opportunity to speak to you today at the prestigious Japan National Press Club. The last time I spoke here was in May 2008, immediately after I became Governor of the Bank of Japan. Looking back at developments since then, it is no exaggeration to say that the global economy has gone through a tumultuous two years. The subprime mortgage problem triggered by the plunge in the U.S. housing market was followed by the Lehman shock, and, more recently, events surrounding fiscal conditions in some European countries such as Greece have cast a large shadow on international financial markets. Having said that, however, it is also a fact that, following a severe downturn, the global economy bottomed out around spring 2009 and has since been on a recovery trend. Looking ahead, there remain factors that warrant attention, including the issues in Europe I just referred to; nevertheless, the global economy this year is expected to achieve a relatively high growth rate of about 4 percent, mainly due to the strong growth in emerging and commodityexporting economies. Against the backdrop of these developments in the global economy, Japan’s economy is also following a recovery trend. At the end of April, the Bank released its semiannual Outlook for Economic Activity and Prices, which presents the Bank’s assessment of the prospects for economic activity and prices over the next two years. 1 The baseline scenario in the report suggests that Japan’s economic growth rate will gradually rise toward fiscal 2011 and that the year-on-year rate of change in the consumer price index (CPI), which is negative at present, may enter positive territory in fiscal 2011. While it would be encouraging if these projections materialize, at the same time, this is unlikely to be sufficient to lift the sentiment of business managers and the public at large. The key issue is the growth path to which Japan is expected to return following the current recovery phase. If the growth path has shifted downward, then naturally sentiment will not improve much. From this perspective, the job of the central bank is not only to present objectively its assessment of the outlook for the next two years, but also to state its view on the fundamental challenges facing Japan’s economy and the efforts necessary to meet those challenges. To state the conclusion in advance, a key issue in meeting the challenges is the role of innovation in economic activity. Therefore, in addition to current economic and price developments, what I would like to talk about today are the fundamental challenges facing Japan’s economy and the necessary responses by focusing on the role of innovation. I. Japan’s economy Baseline scenario for economic activity and prices Let me first explain developments in Japan’s economic activity and prices. Japan’s economy is starting to recover moderately, induced by improvement in overseas economic conditions. The main reason is the strong growth in emerging and commodityexporting economies. These countries have been growing faster than forecasted by See the April 2010 Outlook for Economic Activity and Prices released by the Bank of Japan on May 1, 2010. international and private organizations, and forecasts continued to be revised upward. Against this background, Japan’s economy has also been growing faster than envisaged at the beginning of this year as a result of, for example, continuing high growth in exports. In addition, recently, first signs pointing toward a self-sustaining recovery in domestic private demand have gradually begun to appear. That is, with exports and production continuing to increase, business fixed investment is showing signs of picking up. As for private consumption, in addition to the pick up in sales of electrical appliances and automobiles, which were boosted by policy measures, the declining trend of sales at department stores has been coming to a halt since the turn of the year. Moreover, the severity in the employment situation has eased somewhat, with non-scheduled hours worked increasing and the ratio of job offers to applicants on an uptrend. Nevertheless, the employment and income situation remains severe on the whole, which warrants continued attention. The baseline scenario for the outlook is that Japan’s economy is likely to follow a recovery trend. The eco-point system and subsidies for energy-efficient cars are expected to be wound up in the course of fiscal 2010 and their demand-boosting effects will dissipate gradually. On the other hand, exports and production are likely to continue increasing on the back of strong growth in emerging and commodity-exporting economies, and business fixed investment is also likely to pick up. In addition, as business activity increases, the employment and income situation is likely to gradually improve, and growth in private consumption and housing investment is expected to accelerate. Based on these projections, Japan’s economy, following a contraction of 1.9 percent in fiscal 2009, is expected to grow by around 2 percent in both fiscal 2010 and 2011. Let me now turn to price developments. On a year-on-year basis, the CPI excluding fresh food continues to decline, although the pace of decline has been slowing since it peaked in August last year at minus 2.4 percent. In April 2010, it was minus 1.0 percent excluding the effects of subsidies for high school tuition fees. Moreover, recently, the number of CPI components for which prices are declining has almost stopped increasing, and consumer surveys suggest that the percentage of consumers expecting prices one year ahead to rise has been steadily increasing, while that of consumers expecting prices to decline has been falling. Past experience tells us that, in Japan, changes in prices tend to lag about one year behind changes in the aggregate supply and demand balance. Looking at recent developments, the aggregate supply and demand balance in Japan has been improving since around the spring of 2009, and the effects of that improvement may now be gradually starting to spread to prices. As mentioned at the beginning, the Bank projects that the year-on-year rate of change in the CPI will remain negative for fiscal 2010, but will enter positive territory in fiscal 2011. Risk factors As just described, Japan’s economy is making steady progress toward returning to a sustainable growth path with price stability, helped by the improvements in overseas economic conditions. The Bank is fully aware of both upside and downside uncertainties regarding the outlook for the economy. On one hand, if emerging and commodity-exporting economies achieve faster growth, Japan’s domestic private demand could recover at a faster pace than expected through spillovers from an increase in exports. On the other hand, Japan’s economy could decline if developments in fiscal conditions in Greece and other economies further intensify strains in international financial markets or exert downward pressure on the global economy. Also, the consequences of balance-sheet adjustments in the United States and Europe continue to demand vigilance. The Bank will continue to thoroughly examine these various risk factors without having a predetermined view. II. Fundamental problems Japan’s economy faces So far, I have talked about the outlook for Japan’s economy in the next two years, but what is equally important as such short-term outlook is the medium- to long-term growth path of Japan’s economy. At present, we often hear pessimistic views about the future of Japan’s economy and the reason for this mainly seems to be a lack of confidence in Japan’s medium- to long-term growth potential. In fact, from a long-term perspective, Japan’s economic growth rate is on a downtrend. I believe that the greatest challenge Japan’s economy is facing now is the decline in the potential growth rate as well as the shrinking of the population and sluggish productivity growth underlying this. It could be said that the deflation in Japan is also a manifestation of the fundamental problem facing the economy, namely the decline in growth expectations. Consequently, what I would now like to talk about next is the growth potential of Japan’s economy. The rise and fall in the growth rate Let me start by considering Japan’s experience during the high-speed growth era. The average rate of economic growth from 1955 through 1973 was 9.3 percent. The first reason why such high growth was possible is buoyant domestic demand in the form of business fixed investment and private consumption. The contribution of domestic demand to the aforementioned growth rate during the high-speed growth era was 9.5 percentage points, while the contribution of net external demand, that is, exports minus imports, was minus 0.3 percentage points. While the contribution of net external demand was negative, this does not mean that external demand, and in turn the global economy, did not contribute to Japan’s economic growth. The reason why the contribution of net external demand made a small negative contribution was that not only exports increased but also imports, as a result of the growth in domestic demand, increased considerably. In other words, it can be said that Japan achieved rapid economic growth precisely because it was able to access global markets through foreign trade and direct investment. This is the second reason why it was possible for Japan to enjoy high growth. After the rapid growth from the mid-1950s to the beginning of 1970s, the pace of growth slowed gradually. Nevertheless, Japan’s growth rate still exceeded that of other advanced economies up until the 1980s. However, following the burst of the bubble, Japan’s economic growth rate declined significantly in the 1990s and has been at the lower end among the G7 countries in the 1990s and 2000s (see Appendix). There are two major factors that underlie the decline in the growth rate. The first is the decline in labor force growth due to the low birth rate and population aging. The growth rate of Japan’s labor force was about 1 percent in the 1980s, but fell to almost zero in the 1990s and has plunged to minus 0.6 percent since 2000. This is in stark contrast with developments in the United States, where the labor force has consistently grown at a rate of more than 1 percent since the 1980s. The second major factor for the drop in the growth rate is the decline in productivity growth in the economy as a whole. While the growth rate of GDP per worker in Japan was 3.2 percent in the 1980s, the highest among the G7 countries, it declined rapidly to 0.9 percent in the 1990s. In the 1990s, the world experienced a substantial transformation through the rapid development of information and communication technology and the intensification of global competition; however, Japan during this period was busy overcoming the various “excesses” in production capacity, debt, etc., that had built up during the bubble period, and thus was not able to grapple with these new challenges head-on. To be more precise, while the declining trend in productivity growth seems to have begun before the start of the bubble, this was masked by the temporary demand increase during the economic boom in the bubble period. At any rate, individual firms found it difficult to engage in forward-looking economic activities in line with the changes in the global economy, and responses to the new challenges were delayed. Another element is that, at the same time, adjustments of “excesses” did not always progress smoothly and that may have resulted in preserving inefficient sectors of Japan’s economy. Against this backdrop, the environment continued to be such that the efforts of high-productivity firms and market entry of promising new firms were not sufficiently rewarded, leading to a decline in productivity growth in the economy as a whole. In the preceding discussion I treated labor force and productivity trends as independent factors, but they are interrelated. As the aging of the population progresses and the share of the population that requires support from the generations still in work increases, this could affect the work incentives for the generations still in work through channels such as an increase in the fiscal burden. Thus, a country’s demographic trends and the vitality or energy of its society as a whole, or the productivity of the economy as a whole, are intricately intertwined and cannot be considered separately. Ways to raise Japan’s growth potential In order to raise growth expectations for Japan in the future, it is necessary to address the factors underlying the decline in the growth rate that I just mentioned and transform the economy into one that people believe will achieve growth in the future. To address the first factor, the decline in the labor force, the very least is to make consistent efforts to raise the labor force participation rate of women and the elderly. To address the second factor underlying the decline in the growth rate, that is, the decline in productivity growth, a key point is how individual firms can tap new demand. The term “rise in productivity” carries the connotation of producing existing products at lower costs. Of course, this aspect is important. However, when there are dynamic changes in customer needs, raising productivity also means tapping new demand and increasing sales by establishing a supply system that matches such new demand. Due to economic globalization, the range of potential customers has rapidly increased also for Japanese firms. The explosive spread of personal computers and the internet has rapidly reduced the distance between firms and customers, and, in this respect, the gap between large and small firms has shrunk. The low birth rate and population aging in advanced economies and major structural changes such as the shift to a low carbon economy bring with them new customer needs. While it is a difficult task to discover potential demand that cannot be easily discerned, transforming such potential demand into actual demand and linking this with a rise in productivity is something that firms should perceive as a challenge and that would provide one approach to innovation, as I will explain later. Japan’s economic strengths Unfortunately, through what mechanisms innovation takes place nobody can say for certain. However, innovation is not likely to take place unless there is sufficient energy to overcome the kind of pessimism many currently feel in Japan with regard to the future. Of course, when growth is actually sluggish and the reason for this is a decline in productivity growth, such pessimism is not entirely unfounded. On the other hand, however, I feel that there is also a tendency for the strength of Japan’s economy to be underestimated and the pessimism to be overdone. With regard to well-founded pessimism, it is necessary to accurately recognize the essence of the underlying issues and squarely address them. At the same time, we cannot allow ourselves the luxury of indulging in groundless pessimism. It is important to calmly recognize the relative strengths of our country and utilize them to the maximum extent possible. Earlier, I identified trends in the labor force and productivity growth as factors responsible for the decline in Japan’s growth potential since the 1990s. These trends in themselves are a fact. To provide some detail, while the average rate of change in the labor force declined over the past two decades, productivity growth plunged in the 1990s, but has recovered somewhat since 2000. Looking at the growth rate of GDP per worker since 2000, this was 1.6 percent for Japan, which was again higher than for European countries and, among the G7 countries, second only to the United States, which registered 1.8 percent. This growth in GDP per worker is the first strength of Japan’s economy that I would like to highlight. Strenuous efforts to raise productivity will continue to be a driving force of Japan’s economic growth. The second strength is Japan’s high level of technology as a whole. For example, Japan ranks second in the number of international patent applications next to the United States, and the number has been steadily increasing. In addition, according to a research by the Ministry of Internal Affairs and Communications, Japan ranks first among advanced countries in terms of the number of researchers per capita. What is important for Japan is how to effectively use this fundamental strength and link it with tapping new demand. Third, Japan’s financial system is considerably more stable than those in the United States and Europe. The issuing environment in the CP and corporate bond markets had become favorable again by around autumn last year. Financial institutions’ lending attitudes, as viewed by firms, have also become favorable. Compared with the United States and Europe, which face the structural problem of balance-sheet adjustments and have to contend with a tight lending stance by financial institutions, it can be said that Japan’s economy is in a superior position. And fourth, Japan has strong economic and historical ties with, and is geographically close to, the rest of East Asia, which currently is the most rapidly expanding region in the world. It is now widely recognized that China is no longer merely a production base but also the world’s premier consumption market, demanding versatile goods and services. China has already become number one in the world in terms of car sales and internet users, and markets are expected to further expand as the social infrastructure, such as roads and telecommunication, develops. It is necessary for Japan to seize the development of Asia as a golden opportunity to foster innovation. III. Growth and innovation What is innovation? I have thus far talked without explaining in detail the term innovation. While in Japan, the term innovation has often been used interchangeably with “technological revolution,” Joseph Schumpeter, who first introduced the term to the field of economics, understood it in a broader sense. Stressing in particular the role of innovation as a driving force of economic development, he distinguished five different types, namely the introduction of a new good, the introduction of a new method of production, the opening of a new market, the conquest of a new source of supply of raw materials, and the carrying out of the new organization of any industry. Thus, innovation is a very broad concept that embraces various new efforts by firms to capture new demand and is not limited to the field of technology. Given the current situation in Japan, it seems necessary to recognize again the original meaning of the term “innovation.” With regard to Japan’s manufacturing sector, it has recently been pointed out that the gap in technological prowess vis-à-vis other East Asian countries has been rapidly shrinking, and even in the area of process innovation, which used to be Japan’s forte, Japan has been losing its edge. Against this backdrop, firms, or entrepreneurs, need to take on new challenges. In fact, many Japanese firms have recently been pursuing strategies consisting of setting up local production bases or establishing new sales networks in order to capture demand for infrastructure or the consumption demand of the wealthy and the middle classes in emerging economies. Moreover, firms have actively explored new alliances or organizational forms between firms that are not constrained by traditional arrangements such as business affiliations or business groupings, as illustrated, for instance, by the promotion of cross-border supply chain management to respond promptly to customer demand. This applies even to nonmanufacturers and small-sized firms. While business efforts such as developing new sales channels, reviewing suppliers and processing methods, and reorganizing management structures are routine at firms, adding the new challenge of capturing potential demand could lead to these routine efforts developing into innovations. The role of financial institutions With regard to innovation and raising productivity, another aspect I would like to emphasize is the important role played by financial institutions. Schumpeter stressed the role of “the banker” in providing funds to entrepreneurs and support efforts toward innovation. In Japan, too, it was mainly financial institutions, particularly banks, that provided long-term risk money to firms and nurtured many growing firms for a long period after the war. Recently, there have been signs that financial institutions are taking a more strategic approach to such business, actively providing loans or business support to firms that develop proprietary technologies or expand abroad, or to projects in promising areas related to the environment, energy, medical care, and nursing care. Of course, for risk money to be supplied to firms, it is important that there exist a variety of financial markets and investors. That being said, in Japan, the role of capital markets in the provision of such risk money is relatively small, and with regard to fostering venture businesses, the situation in Japan hardly matches that in the United States. Although various initiatives in these areas by concerned parties are currently underway, I think that, for the time being, financial institutions will continue to play a central role in promoting innovation in Japan. The economy is made up of a variety of firms and industries with differing rates of productivity growth. This means that financial institutions play the extremely important role of gauging borrower firms’ future profitability and growth potential and of making loan decisions and setting loan conditions. It is therefore strongly hoped that financial institutions hone their ability to identify firms with growth potential and thereby contribute to the growth of Japan’s economy. At the same time, in order for financial institutions to make such a contribution, it is important that the role of financial intermediation is properly appreciated also in Japan. The role of policy makers Now let me talk about the role policy makers play in innovation. While in every respect it is private economic agents that are the bearers of innovation, policy makers play an important role in creating an environment that is conducive to innovation. The first area in which policy makers play an important role is the development of the framework under which firms conduct their business. This means that regulations and taxes have to be reviewed constantly as the situation requires so as not to impede firms’ innovative efforts and to help firms earn the fruit of such efforts in the form of corporate profits. In this regard, we need to be aware that just as Japanese firms are exposed to global competition, Japan’s business framework is also subject to international competition. The second contribution policy can make is to enhance the flexibility of economic structures so that productive resources such as labor and capital can move smoothly from areas where there is a low need to areas where there is a high need. To this end, the most important thing is a policy conduct that does not impede competition. The third policy contribution is the provision of various safety nets. Innovative activity is not always crowned by success and carries the risk of failure. Moreover, the economic metabolism is a process that is inevitably accompanied by pain for some sectors. Therefore, it is essential to establish social safety nets that mitigate the pain for firms and individuals and allow them to tackle new business ventures with a sense of security. Finally, the fourth area in which policy makers play a role is in the appropriate conduct of fiscal and monetary policies to reduce swings in economic activity and prices. Less uncertainty over future economic conditions and inflation means that, to that extent, firms can pursue innovation without concern. However, while the provision of safety nets and the implementation of countercyclical policies are desirable and effective measures when the economy suffers a large temporary shock, if those measures go too far, they may impede the economic metabolism and even reduce productivity. For that reason, policy makers need to strike a delicate balance in their policy conduct. On this point, there have been various discussions regarding the current events in Europe. Since the Lehman shock, aggressive fiscal policies implemented in many countries played a significant role in stemming the economic plunge. However, at the same time, fiscal policies are not a “cornucopia” and eventually nations have to repay their public debt through the value added generated by economic activity. Therefore, confidence in fiscal sustainability is critical and once it is lost, economic activity can be severely hurt through rapid changes in financial markets. Keeping this point in mind, policy makers should work to appropriately conduct policies so as to maintain sufficient market confidence. In this regard, current events seem to have served as a “wakeup call” to many countries. IV. The Bank’s policy responses Aggressive monetary easing Finally, let me briefly touch on policy responses by the Bank of Japan given the economic and price developments discussed earlier. Aware of the great importance of overcoming deflation and returning Japan’s economy to a sustainable growth path with price stability, the Bank has continued to implement a policy of strong monetary easing. The policy rate was lowered to 0.1 percent, that is, effectively zero. Moreover, to encourage a further decline in longer-term interest rates in the money market, the Bank introduced in December 2009 a new funds-supplying operation, through which funds with a maturity of three months are provided at a fixed rate. As a result of these measures, market rates and bank lending rates have been declining. The Bank will continue to maintain the extremely accommodative financial environment so as to help the economy achieve a self-sustaining recovery in domestic private demand. Another important responsibility of the Bank is to ensure financial market stability. As I mentioned at the beginning, strains in short-term U.S. dollar markets heightened from the beginning of May against the backdrop of fiscal problems in some European economies. These developments carry the risk of reducing liquidity in or destabilizing financial markets around the world, including Japan. Therefore, the Bank, in cooperation with other major central banks, has re-established U.S. dollar funds-supplying operations, which had been highly effective during the financial crisis in 2008. The Bank has been working to ensure financial market stability by responding flexibly in terms of funds-supplying operations whenever there were grave problems in financial markets. The re-establishment of U.S. dollar funds-supplying operations is one example of the Bank’s flexible response. Not only the current problems in Greece, but also many other issues remain in international finance that still warrant attention. The Bank, while cooperating with overseas central banks, will continue to make every effort to ensure the stability of financial markets. Funds provision to help strengthening the foundations for economic growth As I have explained today, the most important challenge for Japan’s economy at present is to raise its growth potential, and to this end, promoting innovation is indispensable. Moreover, to do so, the role of private financial institutions is also important. Taking these points into account, the Bank, in addition to its policy of monetary easing and measures to stabilize financial markets explained earlier, has announced its intention to introduce fund- provisioning measures for strengthening the foundations for economic growth. While the specifics of these fund-provisioning measures are being examined through an exchange of views with financial institutions, basically, the Bank is considering to provide funds to financial institutions – which through their lending and investment provide the financial resources for strengthening the foundations for economic growth – based on the actual amount of such lending and investment. To support financial institutions’ efforts in this respect, the Bank is thinking about providing loans of longer-term funds at a rate equivalent to the policy rate, which is 0.1 percent at present, in a manner that enables financial institutions to obtain loans longer than one year. Of course, the Bank is fully aware that raising the growth potential essentially is something that can only be achieved through the efforts of the private sector, and such efforts will be supported by the government from the institutional side. Clearly recognizing this, and taking into account the fact that the issue facing Japan is one of declining growth expectations, which in turn considerably contributes to the current fall in prices, the Bank concluded that it should use the central banking functions it is endowed with to help strengthening the growth foundations of Japan’s economy from the financial side. This is consistent with the mission of monetary policy in the Bank of Japan Act, which stipulates that “currency and monetary control by the Bank of Japan shall be aimed at achieving price stability, thereby contributing to the sound development of the national economy.” In this regard, we at the Bank are paying attention to the following two points. First, the aim of this measure is to provide temporary support from the funding side for initiatives taken by financial institutions at their own accord and does not imply that the Bank will be involved in the allocation of funds to individual industries or firms. And second, the measure should not inhibit the future conduct of monetary policy. The measure will be conducted while maintaining the soundness of the Bank of Japan’s balance sheet and without constraining interest rate policy by, for example, setting a limit on the total loan amount. Concluding remarks Time is running out, so I will try to wrap up my speech. The following three conclusions can be drawn. First, at present, Japan’s economy is making steady progress toward returning to a sustainable growth path with price stability. However, we need to continue to be vigilant for both upside and downside risks such as higher growth in emerging and commodity-exporting countries and international financial developments. Second, the most important challenge for Japan’s economy is the downward trend in the potential growth rate, and we need to squarely address this problem. The so-called deflation problem is, in my view, also a manifestation of the fundamental problem Japan is facing, namely, the decline in growth expectations. And third, in order to put the brakes on the decline in the potential growth rate and productivity growth, efforts at innovation are more important than ever. To this end, in addition to the efforts by individual firms, it is important to achieve an optimal allocation of resources and raise the metabolism of the economy. The decline in the growth rate is a phenomenon that has gradually progressed over a long period of time. Therefore, raising the potential growth rate will also be a long-drawn-out process. If there was a magic wand that could resolve the problem immediately, somebody would already have used it. The economy is a complex network. For that reason, to escape from the current low growth equilibrium, above all what is necessary is the will to resolve the current problems. And, based on that will, the only way to do so is for private economic agents and policy makers to make the necessary efforts based on their respective roles. The Bank, too, will continue to consistently make contributions as a central bank while listening carefully to various opinions.
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Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Panel Session "Financial Development and Regulatory Coordination under New Circumstances", at Lujiazui Forum Annual Meeting 2010, Shanghai, 26 June 2010.
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Kiyohiko G Nishimura: Financial regulations – Asian perspectives Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Panel Session “Financial Development and Regulatory Coordination under New Circumstances”, at Lujiazui Forum Annual Meeting 2010, Shanghai, 26 June 2010. * * * First of all, I would like to express my sincere gratitude to the hosts for inviting me to the Lujiazui Forum and especially to this panel on financial reforms. I am particularly delighted to be given the opportunity to discuss the pressing issue of financial reform, which will shape the future landscape of the global economy. In this short presentation, I would like to argue the following two points: Firstly, the financial innovations of the past quarter century have blurred the dividing line between banks and non-banks. These developments have made it possible to shift risk back and forth between the banking system and capital markets. It has become difficult to locate exactly where ultimate risk lies, and the banking system has found itself so often vulnerable to the volatility of capital markets. The Volcker Rule and related financial reform proposals are designed to rectify these problems. Secondly, however, we should recognize the significant regional differences in banks’ business models along this bank/non-bank spectrum. Financial reforms should thus follow a carefully-timed and well-balanced approach, taking explicit account of regional and functional heterogeneity. Banks more like non-banks and non-banks more like banks: rationale for the Volcker Rule It may sound a bit farfetched, but the global financial crisis of the last few years might have been brought about partly by banks becoming more like non-banks and non-banks becoming more like banks. Some banks are now non-bank-like, as exemplified in the current financial jargon used to describe these banks’ business practices, such as “originate to distribute model” and “prop trading”, while some non-banks have become bank-like, as the phrase “shadow banking system” suggests. The financial innovations behind these changes are in essence welcome developments, helping to improve efficiency by shifting risk among economic agents. However, they have made it increasingly difficult to locate the whereabouts of ultimate risk. Vital information regarding banks’ risk exposures has been literally “lost in transformation” in the originate-todistribute model and various proprietary derivative trades. We have been unable to identify what risks a particular bank has been exposed to, and, as a consequence, those facing the financial system as a whole. As we all know only too well, heightened concern over counterparty risks led to severe dysfunction in financial markets, particularly after the collapse of Lehman Brothers and the bailout of AIG in September 2008. The problems surfaced most acutely in the United States. Thus we have observed the bold attempts at regulatory overhaul in the U.S., of which the so-called Volcker Rule has become something of an icon. In my understanding, the Volcker Rule is designed to deter banks from taking excessive risk in capital markets, where volatility is inherently high and in which bankers do not necessarily have informational advantage in predicting market developments. Rather, the Volcker Rule urges banks to return to their traditional stronghold of commercial banking business, in which they can utilize their informational advantage based on long-term relationships with their customers. In other words, the rule attempts to insulate long-horizon relationship banking from the occasional brutality of the sometime short-horizon capital markets. In this way, we can prevent the possible misuse of public assistance given to banks. The rationale for the Volcker Rule could be applied to liquidity risk management as well. That is, commercial banks should not rely too much on fickle wholesale funding, but should focus more on stable deposits based on long-term relationships with their customers. Asian perspectives of heterogeneity: don’t put carnivorous lions and herbivorous elephants in the same cage Here I cannot help feeling that this rule is quite congenial to the traditional Japanese, and probably Asian, view of what banks are. In Japan, loans constitute roughly half of corporate debt financing, and deposits roughly three quarters of banks’ balance sheets. Long-term relationships are the rule, not the exception. I believe this dominant role of the banking sector in the financial system is more or less similar in the rest of Asia as well. It is no coincidence that financial systems in the Asia region have remained relatively stable during the current crisis: we have not suffered a serious deterioration in confidence or market dysfunction, since our banks have largely remained as traditional banks, and shadow banking had at most a limited presence. In order to prevent another global financial crisis of this magnitude, we truly need a thorough and internationally harmonized overhaul of financial regulations, as is currently being undertaken by various international regulatory bodies. However, as mentioned before, proper consideration must be given to the regional heterogeneity of banks’ business functions, especially in the bank/non-bank spectrum. The difference is not arbitrary but reflects real structural differences between regions. In particular, it would be unrealistic to always assume that “one size fits all”: We should not put carnivorous lions and herbivorous elephants in the same cage. We should also follow a well-balanced approach that properly recognizes the synergetic cross-effects of item-by-item regulations. An appropriate criterion should be the combined effects of all item-by-item regulations. Simply focusing on the “marginal effects” of individual measures may be misleading, even though they have good individual rationale. At the same time, we should be aware of a possible trade-off between the long-term benefits and short-term costs of stronger regulations. Such regulations may indeed enhance financial stability and economic prosperity in the long run, but the hasty implementation of stringent regulations may hamper a fragile recovery, such as we find ourselves in now. Let me stop here for further discussion. Thank you for your kind attention.
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Toyama, 21 July 2010.
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Hirohide Yamaguchi: Japan’s economy and monetary policy Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Toyama, 21 July 2010. * * * Introduction I am honored today to have this opportunity to speak and to exchange views with business leaders in Toyama Prefecture. I will express my gratitude for your cooperation in interviews with the staffers from the Kanazawa branch and the local office in Toyama and for the Bank of Japan’s surveys. Information from these interviews and surveys is invaluable and utilized fully in assessing economic and financial developments and conducting monetary policy. Before exchanging views with you, I will talk about the recent economic and financial developments as well as the conduct of monetary policy. I. Global economic developments Advanced economies and the balance-sheet problem Before talking about Japan’s economy, I will begin with the developments in the global economy. In the past several years, the global economy experienced a great turmoil. On the financial front, starting with the subprime mortgage problem in the U.S. housing market, the global financial crisis broke out in the autumn of 2008, triggered by the failure of Lehman Brothers. Hand in hand with that, the global economy deteriorated rapidly and significantly. Since the spring of 2009, the global economy has been emerging from such plunge. However, the improvement in economic conditions in the United States and Europe has been modest, and international financial markets have recently become increasingly volatile triggered by the fiscal problem in Greece and some European countries. The financial crisis and the fiscal problem I have just mentioned might seem to be a different phenomenon at a glance, but, in fact, they have a common underlying factor that has shaped a big picture of the global economy in the past several years. That was the problem of “balance-sheet adjustment” associated with the burst of a credit bubble in the United States and Europe. In those economies, toward the mid-2000s, households and firms made excessive borrowing on the premise that asset prices such as housing Prices would rise and, in retrospect, made excessive investments and consumption. In response, financial institutions lent aggressively and continued to increase credit. In such a process, not only mortgages but also financial activity in general overheated, including new types of transactions such as in securitized products. Such phenomenon has spread internationally and capital inflows to European peripheral countries, including recently highlighted Greece, have overheated. Such developments were reversed rapidly once asset prices such as housing prices started to fall. In those circumstances, households and firms had to cut back on their consumption and investments to reduce their borrowing that had accumulated, namely to repair the impaired balance sheets. Moreover, financial institutions had to struggle with the disposal of massive impaired assets, and were thus forced to take a cautious stance in new lending. That was exactly a process of balance-sheet adjustment Japan suffered in the 1990s after the burst of the bubble economy. When the economy shoulders such a problem, its effects would manifest themselves in two ways. First is the so-called “chronic symptom” and strong downward pressure would continue to be put on financial markets and the economy until there appear prospects for balancesheet adjustments to complete. The other is a sudden change in conditions triggered by some factors. The global financial crisis following the failure of Lehman Brothers was indeed a shock that corresponded to such “acute symptom.” While the economies in the United States and Europe have managed to recover from the “acute symptom,” thanks to various policy measures by the national governments and central banks around the globe, it can be said that the “chronic symptom” still weighs heavily on those economies. Here, let me touch on the recently highlighted issue of concern over fiscal deterioration, which is called sovereign risk using the word sovereign that means nation. While the Greek problem has been taken up in this connection, fiscal deficits in Greece did not worsen all of a sudden. The fact was that the massive borrowing from overseas Greece made in excess of its capacity amid the global investment boom toward the mid-2000s has surfaced following the burst of the credit bubble. Although the sheer size of the Greek economy is only some 2 percent of the European economy, it generated a connotation in the market that there might be other countries that have also heavily been relying on unrealistic external borrowing. As a result, in the financial markets, the creditworthiness of the government bonds issued by those countries has declined, leading to a hike in interest rates and concern over adverse effects on financial institutions that held those government bonds. Meanwhile, the fiscal balance in the major advanced economies in the United States and Europe also deteriorated rapidly in the process of crisis responses, since they increased fiscal spending significantly by assuming risks and debts of the private financial institutions that were suffering from balance-sheet adjustments. Through the responses to the crisis, the problem of balance-sheet adjustments has partly shifted from the private sector to the public sector. That also intensified the market’s concern over sovereign risk. It can be seen that the sovereign risk problem that has become one destabilizing factor in international financial markets also closely relates to a big wave of the burst of a credit bubble and ensuing balance-sheet adjustments. High growth of and challenges for emerging and commodity-exporting economies Another critical axis in gauging the picture of the global economy is the developments in emerging and commodity-exporting economies. Looking at the World Economic Outlook by the International Monetary Fund (IMF), the global economy is expected to grow at a fairly high rate of more than 4 percent in 2010 and 2011 after recording the first negative growth in the post-war period in 2009. Of the growth, indeed 70 percent is attributable to emerging economies, which shows that those economies are the driving force for the global economy. Several factors are at play behind the robust growth in emerging economies. First, those economies are in the process of catching up with advanced economies in living standards, and thus they are characterized by strong potential demand for consumer durable goods and infrastructure investments. In addition, unlike the United States and Europe, those economies do not have the burden of balance-sheet adjustments and thus a virtuous cycle between production, income, and expenditure has worked effectively, resulting in strong growth in domestic demand including private consumption and business fixed investment. Second, Asian emerging economies including China have become a global production base for IT-related goods. Demand for new IT products such as smart phones and flat-screen televisions has recently been increasing globally. Asian emerging economies have been taking full advantage of a growth opportunity that can be called “a new IT boom.” Third, funds that could not find good investment opportunities in advanced economies have been flowing in massively to emerging economies, which have been stimulating the economies through assets transactions and investment activity. While such inflow of funds from advanced economies would be an appreciating factor for the foreign exchange rate, many emerging economies are adopting fixed foreign exchange rate policies and are containing the appreciation of the foreign exchange rate. That has further reinforced accommodative monetary conditions. While I do not go into details today, there is an aspect that the low interest rate policy in advanced economies has had a greater economic stimulus on emerging economies than on their own economies through cross-border capital flows. While emerging economies are growing faster than expected against a backdrop of the above factors, they are now facing a critical turning point. In those countries, as a result of continued high growth and active capital inflows, the overheating of the economy, including a rise in inflation and asset prices, has become pronounced. Thus, in many of those countries, monetary policy has been tightened mainly by raising policy rates and flexibility in the foreign exchange rate policy has been enhanced. It is also critical from a perspective of the global economy whether such policy conduct turns out to be effective and enables those economies to secure sustainable growth while containing the overheating. II. Developments in Japan’s economy Economic conditions Based on the developments in the global economy, I will next talk about Japan’s economy. Like the global economy, Japan’s economy bottomed out in the spring of 2009 and has been picking up, and we judge now that it shows further signs of a moderate recovery. The driving force for the recovery is an increase in exports and production. Namely, exports have been increasing on the back of especially high growth in emerging economies and global expansion in demand for IT-related goods, and production has been increasing in a wide range of areas such as automobiles, electrical machinery, and capital goods. Therefore, profits in the manufacturing sector have been improving rapidly. According to the June Tankan (Short-Term Economic Survey of Enterprises in Japan) released recently, current profits at large manufacturers for fiscal 2010 are expected to increase by 44 percent from the previous year. Moreover, the improvement in manufacturing firms’ profits has been leading to the improvement in business conditions of their trading partners, namely, some nonmanufacturing firms engaged in, for example, transportation and information services. Furthermore, such improvement in business performance has gradually started to encourage favorably firms’ spending activity including business fixed investment. The Tankan showed that business fixed investment by large firms is expected to increase, year on year, for both manufacturers and non-manufacturers, and that of manufacturers is expected to increase, year on year, for all firms including small firms. Compared with such improvement in the corporate sector, as for the household sector, the improvement in the employment and income situation has been lagging. Nevertheless, overtime payments have been increasing, in tandem with the increase in production, and some large firms have started to increase their bonuses from this summer. In those circumstances, private consumption, especially that of consumer durable goods, has been picking up due mainly to the effects of various policy measures such as those to support the purchase of eco-friendly cars and the eco-point system for electrical appliances. Therefore, induced by the improvement in overseas economic conditions, positive moves of increase in exports spreading to domestic private demand have gradually been seen. When we compare the recent real GDP growth rates on an annualized basis, they were 4.6 percent for Japan, 5.6 percent for the United States, and 0.5 percent for the euro area in the October–December quarter of 2009, and 5.0 percent for Japan, 2.7 percent for the United States, and 0.8 percent for the euro area in the January–March quarter of 2010, respectively. It might be surprising, but in fact the recent growth rate of Japan’s economy has been, on average, the highest among the advanced economies. Nevertheless, many might not realize that. There might be several factors in the background. Although Japan’s economy shows further signs of a moderate recovery, the level of economic activity has not sufficiently increased. Or, since the recovery is export-led, depending on whether the benefits would spread directly, there are great differences according to regions and industries. Perhaps the greatest factor might be that people are concerned about the fact that they cannot have future growth prospects for Japan’s economy, or, in other words, it has become difficult to create a growth picture. While I will later talk about our views and policy responses on this issue, let me next explain price developments in Japan as a topic closely related to the issue. Prices As for prices in Japan, the year-on-year rate of decline in the consumer price index (CPI) has been gradually slowing, after registering the largest decline of 2.4 percent in the summer of 2009. A special one-off factor of subsidy for high school tuition has been pulling down the year-on-year rate of change in the CPI by around 0.5 percentage points since April 2010, and the latest figure, excluding such effects, has showed that the rate of decline slowed to 0.7 percent. There are mainly two factors behind the slowing pace of decline in consumer prices, namely the improvement in the aggregate supply and demand balance of the domestic economy as a whole, and an uptrend in commodity prices represented by crude oil prices. The aggregate supply and demand balance of the economy as a whole has been improving moderately since the spring of 2009. Since the past experience tells us that, once the supply and demand balance starts to improve, its effects start to influence prices with a time lag of around one year, the effects of the picking up of the economy since last year have finally surfaced on the price front. As for the outlook, although it is difficult to foresee developments in commodity prices, the aggregate supply and demand balance is likely to continue to improve if the economy follows a recovery path. Therefore, the year-on-year rate of decline in the CPI is expected to continue to slow, and likely to enter positive territory in fiscal 2011. What is important here is whether Japan’s economy will return to a sustainable growth path, and, through such a process, the aggregate supply and demand balance that lies behind the price developments will improve in a sustainable manner. Put metaphorically, prices are the body temperature of the economy. A fundamental reason of deflation, namely, a continuous price decline, is a lack of basic strength, or, in other words, growth potential of the economy. Therefore, to fundamentally overcome deflation, it is essential to increase the growth potential of Japan’s economy from a medium- to long-term perspective. Interim assessment Let me now touch briefly on the interim assessment of the April 2010 Outlook for Economic Activity and Prices (the Outlook Report). The Bank publishes the outlook for economic activity and prices over the next two years every quarter – April and October Outlook Report and interim assessments in between. In the interim assessment released last week, the forecast of the real growth rate for fiscal 2010 became higher than what had been projected in April. That was mainly due to the faster than expected increase in exports against a backdrop of acceleration of growth in emerging economies. As for fiscal 2011, the growth prospects remain broadly unchanged. The median of the Policy Board members’ forecasts was 2.6 percent for fiscal 2010 and 1.9 percent for fiscal 2011. With regard to prices, the CPI (excluding fresh food) is expected to develop broadly in line with the projections presented in April. Specifically, the median of the Policy Board members’ forecasts, the year-on-year rate of change, was minus 0.4 percent for fiscal 2010 and plus 0.1 percent for fiscal 2011. We need to be attentive to the fact that those forecasts are associated with both upside and downside risks. With regard to economic activity, there are some upside risks such as an even faster growth in emerging and commodity-exporting economies. As downside risks, international financial developments warrant attention. In particular, attention should be paid to the effects of developments in fiscal and financial conditions in some European economies on international finance and the global economy. Such upside and downside risks to deviate from the forecasts have become somewhat large in both directions compared with the time of April. With regard to prices, there is a possibility that inflation will rise more than expected due to a rise in commodity prices brought about by higher growth rates in emerging and commodity-exporting economies, while there is also a risk that the rate of inflation might decline due, for example, to a decline in medium- to long-term inflation expectations. III. Medium- to long-term challenge for Japan’s economy Japan’s economic growth rates in medium to long term Now let me turn to the issue of medium- to long-term growth of Japan’s economy. The annual growth rate of Japan’s economy declined significantly from around 4.5 percent, on average, in the 1980s to around 1.5 percent in the 1990s, and to less than 1 percent in the 2000s. Even considering that the adjustment process since the 1990s after the burst of the bubble has been grueling, the decline in the economic growth rate has been conspicuous. Gross domestic product (GDP), which is the fruit of a country’s economic activity, is the multiplication of the number of workers and the value-added that workers per capita produce in one year, namely, productivity on a value-added basis. Therefore, economic growth, or the increase in GDP, will be determined by two elements: growth in the number of workers and the growth in productivity. When viewing the decline in Japan’s economic growth rate from such a perspective, one can see that a key challenge for Japan’s Economy is how to raise productivity in the future. Japan’s labor force, namely, the population between 15 and 64 years old, already started to decline from the second half of the 1990s, and the number of actual workers has started to decline slightly, on average, since 2000. To maintain and raise growth rate when the number of workers is unlikely to grow, there is no way but to raise productivity. Raising productivity itself is an important issue, regardless of change in demographics, and it becomes increasingly important in a situation when it is difficult to expect growth in the labor force. Specifically, the productivity growth rate measured by the aforementioned per capita valueadded has been declining from an annual average of 3.2 percent in the 1980s to about 1 percent since the 1990s. Such a decline in productivity is attributable to the following factors. At the time of the 1990s, the global economy was at a critical juncture of dramatic development in information and communications technology and the intensification of global competition. However, Japan’s economy was busy with adjusting excess facilities and debts that had piled up during the bubble period, and thus was not able to make positive efforts in response to the structural changes taking place in the global economy. Therefore, it could be the case that Japan was not able to develop technology or tap the market to expand new demand, which might have resulted in lowering the productivity of the economy as a whole. Moreover, it could also be the case that, during that period, metabolism had not proceeded sufficiently in the process of reducing “excesses,” and that might have resulted in keeping inefficient parts of the economy. Furthermore, the fact that the economy tumbled into a vicious circle – a declining trend in the growth rate lowered firms’ and households’ growth expectations in the future, which in turn further withered firms’ and households’ spending activity – also seems to be a reason for the decline both in the economic growth rate and productivity during that period. To raise productivity Then, what should be done to raise productivity in the future in a sustainable manner? What is important on this point is how individual firms tap new demand. A rise in productivity is sometimes interpreted as producing the existing products more efficiently or reducing costs. While a rise in productivity indeed has such aspects, it is not necessarily limited to those. Moreover, it appears difficult to raise the productivity of the economy as a whole only through such rationalization in the production process of the existing products or reduction of costs including labor costs. Amid consumer needs becoming diversified and evolving, it is important for firms to tap new demand and prepare a supply system that will meet such demand, thereby increasing their sales and profits. Japan’s challenge of raising productivity requires tapping potential demand and creating new value-added, and thus is an issue that relates to both the demand side and the supply side of the economy. Let us consider the case of cell phones as an example. On the back of an explosive spread of cell phones, there seems to have been potential needs of consumers to make phone calls any time at any place. What embodied such potential consumer needs into a product of cell phone was the firms’ efforts. Firms strived to develop information technology and prepare a supply system including building production lines of portable terminals. As a result, demand for cell phones increased explosively, and cell phones prevailed rapidly in a short period. Consumers have now obtained the convenience of making phone calls any time at any place. Also, profit opportunities for telecommunications firms and portable terminal manufacturers have increased, resulting in raising productivity of the economy as a whole. In tapping potential demand, high technology as represented by cell phones would not be the only key. In fact, there are not a few local firms that have succeeded in tapping potential demand by utilizing unique expertise, local specialty goods, and a home-court advantage. While the main players that make such efforts are business managers, as a factor to support such efforts, financial institutions also play a critical role. By focusing on that point, the Bank has started a new policy initiative. In closing, let me move on to the Bank’s conduct of monetary policy. IV. Policy actions by the Bank of Japan The Bank’s monetary policy since the Lehman shock in 2008 can be summarized in three types. First, measures to repair financial markets in response to the financial crisis; second, aggressive monetary easing in response to the economic plunge; and third, a new approach toward strengthening the foundations for economic growth. Various temporary measures to repair market function First, measures to repair the market function. Having been affected by the global financial crisis since the autumn of 2008, the market functioning of Japan’s financial markets also declined rapidly, although the overall market sentiment has been significantly stable compared with that in the United States and Europe. The issuance of CP and corporate bonds became difficult and corporate funding became tight. To cope with such a rapid decline in market functioning, the Bank promptly introduced various extraordinary measures such as outright purchases of CP and corporate bonds. Subsequently, due partly to the coordinated actions of central banks, the global financial turmoil stabilized and the functioning of Japan’s financial markets improved, and those measures have been phased out since the end of 2009. Ensuing financial market developments illustrate that market transactions have rather become active after the completion of those measures. However, as I have mentioned earlier, due mainly to the fiscal problems in some European countries, strains increased in the U.S. dollar money market in May. Therefore, the Bank, in coordination with major central banks, re-established the U.S. dollar funds-supplying operations that were once completed in February 2010. Including those fiscal and financial developments in Europe, there remain the factors that warrant attention in international finance. The Bank will, in coordination with other central banks, continue to make every effort to ensure financial market stability. Aggressive monetary easing Second, to address the critical situation following the failure of Lehman Brothers and under the recognition that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability, the Bank has been continuing with aggressive monetary easing. Specifically, the target level for the overnight call rate, the policy rate, was reduced to 0.1 percent in December 2008 and has remained unchanged since then. The effective zero interest rate of 0.1 percent is the lowest policy rate among the central banks around the globe. Moreover, to encourage a decline in longer-term interest rates, the Bank introduced in December 2009 a new funds-supplying operation to provide 3-month funds to financial institutions at a low interest rate of 0.1 percent, the same as the policy rate. The amount provided by that measure has now reached 20 trillion yen. With a series of those measures, borrowing interest rates for firms and households have been declining. The stimulative effects from the low interest rates would further increase, due to the improvement in corporate profits. As I have mentioned earlier, Japan’s economy shows further signs of a moderate recovery. Based on high growth in the global economy as the IMF forecasts, the baseline scenario for Japan’s economy is likely to be that the recovery trend will be maintained in the future. At the same time, there are still many uncertainties such as developments in the U.S. and European economies and volatile developments in international financial markets reflecting fiscal and financial conditions in Europe. The Bank will consistently maintain extremely accommodative financial conditions and thereby will aim at contributing to the recovery of Japan’s economy. Fund-provisioning to support strengthening the foundations for economic growth And third, the Bank took a new approach to addressing the most important challenge Japan’s economy is facing, namely, to raise medium- to long-term growth potential. In this regard, the Bank introduced a new fund-provisioning framework to support, from the financial side, private financial institutions’ own efforts toward strengthening the foundations for economic growth. The Bank is preparing to make the first fund-provisioning at around the end of August. On June 25, the Bank selected counterparty financial institutions for the fundprovisioning through public application, which were as many as 66. Not only mega-banks but also a wide range of financial institutions, including regional banks I and II as well as shinkin banks, became counterparties. I have hoped a variety of financial institutions, both in terms of business and in terms of region, to use the fund-provisioning framework to make positive efforts toward strengthening the foundations for economic growth, by utilizing their business and regional characteristics. Therefore, it was quite encouraging to see a number of financial institutions applying for the fund-provisioning framework. The new fund-provisioning measure supplies long-term and low interest rate funds to private financial institutions in accordance with their efforts in terms of lending and investment toward strengthening the foundations for economic growth. We expect private financial institutions to utilize the fund-provisioning measure, taking it as an opportunity to expand lending and investment to businesses that will contribute to raising productivity and creating new demand. Strengthening the foundations for economic growth is not necessarily limited to promoting technological revolution. The measure can also be used for loans and investment projects that would support positive efforts by regional small firms including regional revitalization business. We highly expect regional firms, in cooperation with financial institutions, to launch positive efforts toward tapping demand and raising productivity. The Bank’s decision to implement the fund-provisioning measure was based on the recognition that merely maintaining accommodative financial conditions as the Bank has been pursuing could not directly address Japan’s medium- to long-term challenge of the declining trend in growth potential. Normal monetary policy assumes a transmission mechanism in which a central bank provides liquidity, thereby lowers market interest rates as a whole and stimulates economic activity. When productivity has been declining, it would be difficult to raise the growth rate in a sustainable manner even if market interest rates and lending rates have declined. Deflation in Japan is, as I have mentioned earlier, a phenomenon that Japan’s problem of trend decline in productivity is directly related. If the fund-provisioning measure serves as a “catalyst” for private financial institutions in pursuing efforts toward strengthening the foundations for economic growth, it would contribute to raising productivity of Japan’s economy and consequently to overcoming deflation. While the fund-provisioning measure is one new measure to support strengthening the foundations for economic growth, the ways to support strengthening the foundations for economic growth are not necessarily limited to the measure the Bank has introduced. For example, if market participants consider schemes such as securitizing loans and investments that would relate to the strengthening of foundations for economic growth, the Bank is willing to actively cooperate in establishing a market for such purposes. Moreover, if such securitized products are to be nurtured, there will be room for exploring ways to accept those securitized products as eligible collateral for the Bank’s operations. We will continue to make sufficient considerations while exploring various possibilities. Concluding remarks Today I have talked about Japan’s economic situation, its challenges, and the Bank’s conduct of monetary policy. In closing, I will offer my impression about Toyama’s economy. Looking at the industrial structure of this region, against a backdrop of ample water resources, diligent people, active attraction of enterprises, and improved infrastructure, this region is one of the best “manufacturing prefectures” on the Japan Sea where the manufacturing businesses such as chemicals like medicine, general machinery, electrical machinery, and metal products like aluminium building materials have been locally integrated. In addition, this region is famous for “a business of Etchu Toyama traveling medicine salesperson,” which has a history dating back more than 300 years. The business had systems such as the fare collection system, which hands drugs first and collects money later for the amount of drugs actually used, and use of books, which contain various kinds of customer and sales information. Those systems could be said as a revolutionary business model that leads to credit card business, customer data management, and inventory management at present. Such tradition of making cutting-edge approaches toward industrial promotion and economic development has been handed down from generation to generation. As for the recent economic situation of the regional economy, the branch informed me that “it has been steadily picking up, led by the manufacturing industry, although there is still some lingering severity on the employment front.” This region has growth potential including “the integration of manufacturers with high technology,” “comparative advantage in being located close to Japan Sea rim countries that have been growing rapidly,” and “rich tourism resources.” Upon thoroughly utilizing the fund-provisioning scheme we newly introduced, I expect this region to fulfil its growth potential and expect you all to continue to strive for the development of the regional economy. For firms to be able to have bright prospects for future growth, the Bank will consistently make efforts as a central bank.
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Summary of a speech by Ms Miyako Suda, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Wakayama, 3 June 2010.
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Miyako Suda: The current situation of and outlook for Japan’s economy and the conduct of monetary policy Summary of a speech by Ms Miyako Suda, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Wakayama, 3 June 2010. * * * I. Japan’s economy and prices and the conduct of monetary policy A. Developments in financial markets 1. Developments in global financial markets and the situation in Greece The topic I would like to discuss today is the current situation of, and outlook for, Japan’s economy and the Bank of Japan’s conduct of monetary policy. Let me begin by looking at developments in global financial markets. Following the unprecedented turmoil triggered by the failure of Lehman Brothers in September 2008, global financial markets regained stability from around the spring of 2009 due to various measures taken by governments and central banks around the world. The LIBOR–OIS spread, an indicator of counterparty credit risk, has narrowed to levels significantly below those seen before the Lehman shock. Recently, however, signs of instability have reemerged due to concerns over fiscal problems in some European countries, particularly Greece, and uncertainty regarding financial regulation in the United States and Europe. The crisis in Greece has caused large fluctuations in stock prices and foreign exchange rates around the world, increasing investors’ risk aversion and deepening the fiscal woes of other European countries. In what follows, I would like to review recent developments in global financial markets, focusing in particular on the situation surrounding Greece. The Greek debt crisis was triggered by a loss of confidence in Greece’s official statistics and its ability to repay its debt. In October 2009, the new administration in Greece announced that the country’s budget deficit in 2009 would be far greater than previously estimated. The significant revision gave rise to concerns about the reliability of Greece’s official statistics and fiscal discipline, prompting a large rise in Greece’s sovereign risk premium. In January this year, the Greek government submitted to the European Commission a three-year plan to cut its budget deficit, and in April, the 16 euro area member states agreed on a 30-billion euro financial support package. At that stage, Greece was still able to procure funds relatively smoothly through the issuance of government securities. However, Greece’s sovereign risk premium increased rapidly from the end of April to early May, following a further revision to its budget deficit estimate, a sharp downgrading of Greek government bonds by a major credit rating agency, and successive news reports about the escalation of street protests in Greece. In response, worldwide stock prices tumbled and foreign exchange rates fluctuated sharply. For example, the Dow Jones Industrial Average experienced its largest recorded intraday points fall on May 6, 2010. To address this situation, the European Union agreed on a 500 billion euro emergency loan package, the European Stabilization Mechanism, with the International Monetary Fund (IMF) pledging additional funds. The European Central Bank (ECB), for its part, decided to intervene in euro area public and private debt securities markets through the Securities Markets Programme, while adopting a fixed-rate tender procedure with full allotment in the regular three-month longer-term refinancing operations (LTROs), a six-month LTRO with full allotment, and U.S. dollar liquidity-providing operations. Furthermore, the Greek government announced additional fiscal consolidation measures, which gradually are helping to ease the severe strains in financial markets. However, fiscal deficits are not a problem for Greece alone. Rather, this problem is shared by all countries that responded to the rapid economic deterioration with large-scale expansionary fiscal measures in the aftermath of the Lehman shock. However, the problem has become particularly acute in the euro area, with its strict fiscal rules enshrined in the Stability and Growth Pact and its single common currency, which means that countries cannot use exchange rate adjustments to modify trade between member states. This basic constraint is identical for countries other than Greece, such as Portugal, Italy, Ireland, and Spain, on which attention has recently focused. These countries face structural problems in terms of managing fiscal policy and maintaining competitiveness under a single currency. Consequently, fiscal reconstruction is likely to be a painful and time consuming process and financial markets are likely to remain wary of the sovereign risks of these five countries and the credit risks of financial institutions with large exposure to them. Against this background, stock prices have remained weak in the United States and Europe, while the LIBOR–OIS spreads for the U.S. dollar and euro are expected to continue to widen. In the foreign exchange market, the euro is tending to be weak. In sum, global financial markets remain unpredictable, requiring continued close monitoring. 2. Developments in Japanese financial markets Turning to Japanese financial markets, interest rates, particularly those on term instruments, have been declining since the beginning of 2009 in tandem with the improvement in the functioning of various markets as a result of the stabilization in global financial markets. In December 2009, the Bank introduced a new market operation, which provides funds at a fixed rate against pooled collateral, to counter instability in global financial markets following the financial crisis triggered by the surfacing of payment rescheduling problem of government-affiliated firms in Dubai, and to quell any concerns that market confidence might deteriorate in the face of increased news reports about deflation. In addition, in order to further lower interest rates on term instruments, the Bank, in March 2010, sharply increased the volume of funds provided through the new funds-supplying operation, and interest rates on term instruments have been declining since. On the other hand, while stock prices were on an upward trend from the spring of 2009 due to improved economic sentiment, they have been falling sharply since the beginning of May in tandem with the decline in U.S. and European stock prices reflecting the emergence of the problems surrounding Greece. Along with the fall in stock prices, risk avoidance among investors has grown, leading to increased purchases of government bonds and a moderate downward trend in long-term interest rates. In the foreign exchange market, the dollar has been trading at around 90 yen, while the euro has weakened significantly against the yen. As for the environment for corporate financing, firms’ cash inflow has improved, reducing demand for external funds and narrowing the issuing spreads even on debt securities issued by firms with low credit ratings. In view of the improvement in the corporate financing environment, the Bank terminated the special measures introduced after the Lehman shock: outright purchases of CP and corporate bonds were wound up at the end of December 2009, while special funds-supplying operations to facilitate corporate financing were terminated at the end of March 2010. The termination of these measures has had no major impact on markets, but given the current marked instability in stock prices and foreign exchange rates, the Bank is paying close attention to the effects of developments in risk aversion. B. The current situation of the economy and prices As I explained earlier, uncertainty remains regarding developments in global financial markets, but an increasing number of recently released economic indicators show that signs of an economic recovery in Japan are becoming more broad-based. Following the assessment at the Monetary Policy Meeting on April 6 and 7, 2010, that Japan’s economy “has been picking up,” the Bank raised its assessment at the meeting on May 20 and 21, stating that the economy shows further signs of a moderate recovery. However, as I have repeatedly mentioned, developments in global financial markets have recently been unstable, and attention should be paid to how they affect economic activity in Japan. I would now like to discuss in detail the current situation for each demand component and then consider the outlook as well as risk factors for the economy. First, real exports, the main engine of Japan’s economic growth, have been increasing, especially to emerging and commodity-exporting economies, and here particularly those in Asia. Let us look at the global economic and price situation forming the background to the increase in Japan’s exports. The U.S. economy, for example, is recovering at a moderate pace. Private nonfarm payroll employment has started to clearly increase, and retail sales data provide signs of a recovery in a broad range of business areas. However, with the unemployment rate still high and the average duration of unemployment at a new peak, credit card lending remains tight and the pressure on households to adjust their balance sheets continues to weigh on the recovery of private consumption. Similarly, in the housing market, home price indices have been slow to recover, and mortgage delinquency rates and the number of foreclosures have been rising. Against this background, the pace at which the recovery in the corporate sector has been spreading to the household sector has remained moderate. Economic activity in the euro area has been picking up as a whole, with some differences in growth by country. The pace of recovery, however, remains moderate compared to that in the United States. In the euro area, exports and production continue to increase, but private consumption has been weak, reflecting persisting adjustment pressure on households’ balance sheets against the background of the severe employment situation and the fact that consumer sentiment has deteriorated somewhat due, for example, to the growing severity of the situation in Greece. On the other hand, emerging and commodity-exporting economies continue to show robust growth underpinned by strong domestic demand. In China, due mainly to the effects of the expansionary macroeconomic policies, bank lending has expanded by more than 20 percent from a year earlier and retail sales and fixed asset investment are at much higher levels than in 2009. The strong domestic demand in China has stimulated economic activity in other countries in the region such as the NIEs and the ASEAN countries through increased exports to China. As a result, these economies continue to show high growth supported by a virtuous circle of growth in production, income, and spending. As for the price situation in overseas economies, a disinflationary trend in the United States and Europe continues. Specifically, in the United States, the year-on-year rate of increase in the consumer price index (CPI) for all items less energy and food, or the core CPI, has continued to slow, registering 0.9 percent in April, the smallest increase since January 1966. In the euro area, the year-on-year rate of increase in the core CPI declined to 0.8 percent in April, the lowest since the introduction of the index. These developments in the United States and Europe imply that the deterioration in the aggregate demand and supply balance in these economies has been exerting downward pressure on prices. On the other hand, inflationary concerns are intensifying in emerging economies. In China, in particular, real estate prices in 70 major cities in April marked the largest year-on-year increase on record and the year-on-year increase in the CPI in April was the highest in a year and a half. Turning to domestic demand in Japan, public investment has been decreasing since the second half of fiscal 2009. On the other hand, corporate profits have been following a recovery trend due mainly to increased production and labor cost restraint. Reflecting these developments, business fixed investment has leveled out and started to show signs of picking up, as evidenced by the continued increase in shipments of capital goods, a coincident indicator of business fixed investment. The employment and income situation remains severe, but gradually signs of a recovery are emerging: the unemployment rate has peaked out, and nominal wages per employee increased by 1.5 percent in April year on year, registering a positive figure for the second consecutive month. Against this background, private consumption, notably of durable goods, has picked up due to the effects of policy measures such as tax reductions on purchases of environmentally friendly cars and the introduction of the eco-point system, which favors energy-efficient products. It should be noted, however, that the substantial increase in sales of electrical appliances through March was due to a rush of demand prior to tighter application of the eco-point system for flat panel televisions, and that sales at department stores, which marked a quarter-on-quarter increase in the first quarter of 2010 for the first time since the fourth quarter of 2007, have been sluggish since the beginning of April, largely due to weak sales of apparel reflecting unfavorable weather conditions. Although some market participants regard the improved sales of luxury goods as a sign of a self-sustaining recovery, I believe that the situation in private consumption still requires careful monitoring. Meanwhile, the decline in housing investment has almost leveled out, as evidenced by, for example, improved sales of newly built condominiums in the Tokyo metropolitan area. Reflecting the situation in domestic and overseas demand I just described, production has been rising. The decline in inventories has almost leveled out, and the shipment-inventory balance, on the whole, has improved to a level where there are no inventory adjustment pressures. Looking at developments in prices in Japan, the pace of the year-on-year decline in the CPI (excluding fresh food) – which posted the largest fall on record, minus 2.4 percent, in August 2009 – has started to decelerate with the effects of the drop in the prices of petroleum products following their surge in 2008 waning. The moderating trend in the pace of decline in the CPI has continued against the background of the gradual improvement in the aggregate demand and supply balance. Recently, the rate of change in the CPI has been hovering around minus 1 percent once the effects of subsidies for high school tuition fees are taken out. C. Outlook for the economy and prices Japan’s economy is starting to recover moderately, induced by the improvement in overseas economic conditions. The Bank’s projections for economic activity in Japan are as follows: while the effects of various policy measures are likely to wane, emerging and commodityexporting economies are likely to maintain high growth, and the momentum for a selfsustaining recovery in Japan’s domestic private demand is expected to gradually gather pace; Japan’s economy therefore is likely to be on a recovery trend. 1 For these projections to materialize, it is important that improvements in the corporate sector feed through to the household sector supported by a virtuous cycle of increased production, income, and spending. However, considering Japan’s experience during the economic recovery phase since 2002, the pace with which improvements in the corporate sector feed through is likely to remain moderate. Moreover, uncertainties regarding the economic outlook have been heightening due to instability in global financial markets reflecting concerns over fiscal problems in some European countries. I will discuss these risk factors later on, and would now like to address the outlook for each demand component. To begin with, Japan’s real exports are likely to continue increasing, especially those to emerging and commodity-exporting economies. Examining developments in the world economy, on which developments in Japan’s exports depend, emerging and commodityexporting economies are likely to continue achieving strong growth led by domestic demand, which in turn should contribute to a continued moderate recovery in the U.S. and European economies. Specifically, the momentum for a self-sustaining recovery is expected to gradually become more pronounced in the U.S. economy with a continued improvement in the employment and income situation. Nevertheless, the pace of economic recovery will likely remain moderate, given that it will take considerable time for the housing market to For details, see the April 2010 Outlook for Economic Activity and Prices released on May 1, 2010. recover, and that adjustment pressure on households’ balance sheets will continue to be a constraint on a recovery in consumption. The economy of the euro area is also expected to continue recovering moderately, with exports, partly due to the weak euro, expected to grow, which in turn will boost production. However, the pace of economic recovery in the euro area is expected to be more moderate than that in the United States, not only because adjustment pressure on households’ balance sheets and sluggish consumer confidence stemming from unstable financial market conditions are likely to persist for some while at a time when the employment and income situation remains severe, but also because stringent fiscal consolidation measures required of countries facing serious fiscal problems will exert downward pressure on economic activity in the euro area. Turning to domestic demand in Japan, the momentum of recovery in private consumption might temporarily weaken in the latter half of fiscal 2010 as the effects of policy measures gradually wane. Nevertheless, the underlying trend of a recovery is not likely to be interrupted given the continued improvement in the employment and income situation. Business fixed investment, which has stopped declining, is expected to gradually start picking up, given that machinery orders (private demand, excluding orders of shipbuilding and orders from electric power companies), which are a leading indicator of machinery investment, are expected to have risen in the April–June quarter for the third consecutive quarterly increase. Housing investment will likely continue recovering moderately: the number of housing starts – a leading indicator of housing investment – is starting to recover as a result of support measures and adjustments in condominium prices. Reflecting such developments in demand both at home and abroad, production is likely to continue rising as a trend. The industrial production index may temporarily become weak in the October– December quarter, that is, the quarter immediately after the purchase support for eco-friendly cars expires, but the uptrend in production is expected to remain intact with the continued increase in demand both at home and abroad. 2 As for prices, under the assumption that medium- to long-term inflation expectations remain stable, there are prospects that the year-on-year rate of change in the CPI (excluding fresh food) could turn positive in fiscal 2011 as the aggregate demand and supply balance moderately improves. D. Risk factors Next, I will discuss the risk factors relevant to the outlook I have just talked about. The three risk factors that I am particularly concerned about at present are: (1) developments in global financial markets; (2) the sustainability of growth in emerging and commodity-exporting economies; and (3) a decline in the expected growth rate of the economy. The outlook is becoming increasingly uncertain due to these risk factors which at present I see as tilted to the downside. Regarding the first factor, global financial markets have become volatile due to a number of reasons including: (1) the fiscal deficit problem in some European countries; (2) balancesheet problems at European financial institutions; (3) the effect on the United States and Europe of the adoption of more stringent financial regulations, including the restrictions on short selling in Germany; and (4) expectations that monetary policy will be tightened in China. While all of these factors require close attention, I am particularly concerned about developments with regard to the fiscal deficit problem in some European countries, such as Portugal, Ireland, Italy, Greece, and Spain. As I pointed out at the beginning of this speech, When assessing developments in the industrial production index, it should be noted that the index is greatly influenced by the distortion caused by seasonal adjustments. For details, see footnote 8 of the May issue of the Monthly Report of Recent Economic and Financial Developments, released by the Bank of Japan on May 25, 2010. the fiscal deficit problem in some European countries arises from the difficulties of an economic system based on a common currency, the euro. Therefore, the road to recovery may be long and painful due to the need for severe fiscal consolidation. Such worries are at the root of the significant volatility in stock prices and foreign exchange rates around the world, which in turn may have a negative impact on private consumption and business fixed investment not only in Europe but also in Japan through a deterioration in household and corporate sentiment. Furthermore, a possible downturn of the economy of the euro area as a result of rigorous fiscal consolidation measures may affect Japan’s exports to some extent. There is also a risk that weakness in European financial markets could spread to other countries through losses incurred by European financial institutions. Other risks that require attention include that expansionary macroeconomic policies in countries such as China are adjusted too quickly or too slowly. The second risk factor concerns the sustainability of growth in emerging and commodityexporting economies. At present, these countries are enjoying high economic growth and are expected to maintain high levels of growth. However, a further increase in the inflow of funds to these countries as a result of global monetary easing could lead to excessive investment activity and position-taking, possibly triggering an overheating of these economies or a surge in primary commodity prices. A price surge in primary commodities could affect the Japanese economy by leading to a downturn in corporate profits through a deterioration in the terms of trade or by pushing down private consumption. Furthermore, if economies overheat, the subsequent unwinding of excesses could cause a sharp downturn of the global economy and destabilize financial markets. In fact, in China, expectations of a tightening of monetary policy have recently induced volatility in stock prices, while international commodity prices, such as those of crude oil, have started to fall as investors are becoming more cautious about taking on risks. If these trends gain further momentum, prices in industrialized countries, including Japan, may be affected somewhat through funds flowing out of emerging and commodityexporting economies and international commodity markets, causing a further decline in international commodity prices. The third risk factor is a decline in the expected growth rate resulting from domestic structural trends such as: (1) corporate efforts to restrain wages to survive global competition; (2) the growing economic divergence between large and small firms as well as between large cities and regional areas; and (3) the aging and shrinking of the population. A decline in the expected growth rate could hamper the virtuous circle of production, income, and spending. Furthermore, it could lead more firms to increase business fixed investment overseas rather than in Japan. In fact, the results of the Annual Survey of Corporate Behavior (Fiscal 2009) conducted by the Cabinet Office show that 55.7 percent of responding manufacturers were planning to increase and strengthen overseas production. Also, if expansionary macroeconomic policies are maintained for longer than is necessary, this could lower the expected medium- to long-term growth rate of domestic demand by slowing down the response to structural changes, keeping resources in inefficient areas, and delaying improvements in productivity in the economy as a whole. E. Monetary policy for the immediate future So far, I have talked about developments in financial markets at home and abroad, the economy, and prices, as well as the risk factors relevant to the outlook with regard to these. I will now move on to the issue of the Bank’s monetary policy. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. To this end, the Bank will continue to consistently make contributions as the central bank. In the conduct of monetary policy, the Bank will aim to maintain the extremely accommodative financial environment. Furthermore, in view of the current state of the Japanese economy, and recognizing the need to strengthening the foundations for economic growth, the Bank has decided to introduce a new initiative to contribute to the strengthening of the foundations for economic growth. Specifically, the Bank decided, through the provision of funds, to support efforts by private financial institutions that would help to strengthen the foundations for economic growth, and on May 21, 2010 announced a preliminary framework for this initiative. At present, the Bank is exchanging views with a wide range of financial institutions and firms in order to formulate concrete plans for the initiative. The provision of funds by a central bank specifically to strengthen the foundations for economic growth is an unprecedented measure. Such a move could increase the risk of: (1) distorting resource allocation in the private sector; (2) reducing the flexibility of monetary adjustments by lengthening the duration of assets held by the Bank; and (3) negatively affecting the soundness of the Bank’s balance sheet. The decision to resort to such a measure reflects the acute concern of the Bank over the prolonged weakness of the Japanese economy. In the Outlook for Economic Activity and Prices (hereafter the Outlook Report) released on April 30, the Bank stated at the opening that: (1) the presence of emerging and commodity exporting economies in the global economy is growing; (2) in advanced economies, the outstanding amount of public debt has risen to unprecedented levels; (3) discussions have proceeded regarding a review of financial regulation and supervision; and (4) Japan – where domestic demand is expected to decline against the backdrop of an aging and shrinking population – faces the critical challenge of raising real economic growth and productivity. The report also states that the Bank takes into account “these medium-to long-term changes in, and challenges facing, the global economy and Japan’s economy” when examining the outlook for economic activity and prices. This statement is based on the belief that firms’ expectations for economic growth, and hence the outlook for growth, will change if each and every one of us moves forward and takes action to tackle these structural changes. 3 These problems ailing the Japanese economy are already well known. Various prescriptions have been provided on how to deal with these structural changes and problems. However, the absence of any effective measures and concrete results has given rise to a growing sense of despair among the public. Estimates of future population trends in Japan underline the pressing need for per capita productivity to rise if growth expectations are to be maintained. II. The potential growth rate and deflation I will now talk about the vital necessity to raise the potential growth rate in order to get out of the deflationary impasse. A comparison of the growth rate of consumer prices in the United States, Europe, and Japan shows that, after the collapse of Lehman Brothers, the CPI (excluding food and energy prices, which tend to be volatile) declined in Japan alone, even though Japan was outside the epicenter of the financial crisis. In terms of the downward trend in inflation, this has been quite similar in the United States, Europe, and Japan, so that the reason why prices in Japan have been falling is that the inflation rate was low to start with. In any case, in order to find out why Japan alone is experiencing deflation, it is necessary to look into why the inflation rate has been low in Japan compared with the United States and Europe from the latter half of the 1990s. I will now look into this issue from a medium- to long-term perspective. On this point, I agree with the view of Yutaka Yamaguchi, a former Deputy Governor of the Bank of Japan, outlined in a speech delivered to the Colloque Monétaire International at the Banque de France on October 8 and 9, 1999: “Nevertheless, looking back on the experiences of the Bank of Japan during the 1990s, I believe that central banks are counted on to determine quickly any major structural changes in economies, analyze accurately their implications, and explain them persuasively to the public at large.” For details, see “Monetary Policy and Structural Policy: A Japanese Perspective,” available on the Bank’s web site at http://www.boj.or.jp/en/index.htm. A. Negative productivity shocks A major factor behind the prolonged deflation in Japan since the 1990s is the negative output gap, which has prevailed for a long time. One of the reasons often cited recently for this negative output gap is the slowdown in productivity growth – that is, negative productivity shocks. 4 I will now discuss these negative productivity shocks and their relation with the output gap, which is the cause of deflation. The reasons for Japan’s slower growth trend from the 1990s, compared with those of the United States and Europe, can be attributed to successive negative productivity shocks. The first shock is the rapid advance in population aging and decline. The second is the continuing IT revolution and the intensification of global competition based on the increased supply capacity of emerging markets. It has been argued that against the background of these major structural changes, corporate governance in Japan, being bound by past success, has shown insufficient adaptability and flexibility. 5 The third factor is that these negative productivity shocks coincided with the disposal of nonperforming loans following the burst of the real estate bubble. 6 To be more specific, following the burst of the real estate bubble of the late 1980s, manufactures were busy dealing with excesses in production capacity, employment, and debt, while financial institutions were unable to perform their credit intermediation function properly because they were preoccupied with the disposal of nonperforming loans. It is thought that these factors combined put downward pressure on labor input, capital input, and total factor productivity. 7 Indeed, the pace of labor productivity growth in Japan moderated from the 1990s onward. Also, during this period, there was limited room for reducing interest rates and it therefore was impossible to ease monetary policy to the extent required for countering the decline in the potential growth rate. At the same time, growth expectations for the economy have also been weighed down by anxiety about the future stemming from the large fiscal deficit and problems regarding the pension system. The decline in growth expectations has pushed down people’s permanent income expectations, leading to general restraint in consumption and investment. Since supply can be adjusted only relatively slowly, the demand and supply balance deteriorated, exerting downward pressure on prices. Thus, the significant and prolonged downward pressure on prices in Japan has been caused by the intermittent negative production shocks that occurred during the 1990s. Given this environment, firms placed greater emphasis on profitability by further restraining wages against the background of the slow rise in labor productivity, causing unit labor costs (labor costs per unit of output) to trend downward in contrast with the situation in the United States and Europe. The downward pressure on wages has been strong because of (1) the tendency in Japan to restrain personnel costs through wage adjustments rather than job cuts, (2) the increased tendency of firms to shift production overseas in the search for low-cost labor, and (3) the weakening of labor unions. In addition, fierce competition particularly among nonmanufacturers also contributed to lower inflation rates. It has been argued that the productivity gap of the nonmanufacturing sector vis-à-vis manufacturing was partly responsible for pushing up services prices (according to For details, see Fumio Hayashi and Edward Prescott, “The 1990s in Japan: A Lost Decade,” Review of Economic Dynamics, 5, pp. 206–235, 2002. See Yoshikazu Morimoto, Wataru Hirata, and Ryo Kato, “Global Disinflation,” research paper released by the Bank of Japan in June 2003 (available on the Bank’s website). See Masaaki Shirakawa, “Japan’s Economy and Innovation,” speech given at the Japan National Press Club in Tokyo on May 31, 2010 (available on the Bank’s website). See Masayuki Nakayuki, Akira Otani, and Shigenori Shiratsuka, “Distortions in Factor Markets and Structural Adjustments in the Economy,” IMES Discussion Paper Series, No. 2004-E-4 (available on the Bank’s website). the structural inflation theory), but this tendency has lessened as a result of increased competition since the 1990s. 8 Furthermore, medium- to long-term inflation expectations – another large factor affecting prices – appear to be lower in Japan than in other countries. This is probably due to the decline in growth expectations mentioned earlier, coupled with the fact that inflation rates in Japan have been comparatively low in the past. Survey results suggest that long-term price expectations have been relatively stable in a range between 0 and 2 percent since the latter half of the 1990s and that fluctuations in expectations seem to correlate with the potential growth rate. Based on these findings, it may be said that the decline in the potential growth rate in Japan since the 1990s exerted downward pressure on prices by triggering a decline in demand exceeding that in the potential growth rate, which in turn lowered the expected growth rate at the time, which then negatively affected medium- to long-term inflation expectations. In other words, the main cause of deflation appears to be the decline in the potential growth rate brought about by various external shocks, which in turn gave rise to a more guarded view with respect to growth prospects. As for the outlook, the potential growth rate is likely to remain low. The aging of the population will not only reduce the ratio of the working population, but will lead to a fall in investment and the capital stock as the saving rate declines, and increase the downward pressure on economic growth per capita. In addition, the decline in the population must also be taken into account. This, over time, will add further downward pressure on economic growth overall. If these developments lower the expected growth rate even more, prices will come under further downward pressure. B. Importance of maintaining the public’s confidence in policymakers It follows from the foregoing that in order to achieve sustainable economic growth with price stability, it is essential to raise the potential growth rate. In view of the limited room for lowering interest rates, the opinion has been voiced that fiscal spending, which has an immediate effect, should be increased without hesitation. However, given the huge outstanding amount of public debt in Japan, thoughtlessly increasing fiscal spending could damage public confidence in the conduct of fiscal policy. Especially amid the growing concern about fiscal sustainability following the escalation of fiscal strains in Greece, a policy of fiscal expansion could rouse anxiety about possible tax increases and the health of the pension scheme, and, in turn, restrain consumer spending. If this happens, the demand and supply balance of the overall economy will deteriorate, increasing deflationary pressure. Loss of confidence in the conduct of fiscal policy will not only lead to a rise in interest rates and the cost of repayments, but also damage the balance sheets of financial institutions holding government securities and exert downward pressure on the economy from the financial side. Credibility is also vital for central banks. If a central bank provides funds or is perceived to be doing so for fiscal spending when the room for increases in fiscal spending is limited, its credibility as an independent policymaker will be tarnished. Its ability to achieve price stability through the conduct of monetary policy will be in doubt and interest rates will rise as a result. 9 Let us consider this by focusing on the government’s budget constraint. Since fiscal deficits require the issuance of government securities, the government’s intertemporal On the low labor productivity in the nonmanufacturing sector, see “Stagnation and Structural Adjustments of Nonmanufacturing Industries during the 1990s,” research paper released by the Research and Statistics Department of the Bank of Japan, February 1999. This is a summary of the Japanese-language original released in February 1999. For details, see “Central Bank Independence, Transparency, and Accountability,” remarks by Ben S. Bernanke, Chairman of the Board of Governors of the Federal Reserve System, at the Institute for Monetary and Economic Studies International Conference, Bank of Japan, on 25 May 2010. budget constraint, in real terms, and taking the present discounted value of the fiscal surplus, is given by the following equation: Outstanding balance of government securities issued/price level = present discounted value of the fiscal surplus (in real terms). Fiscal expansion lowers the present discounted value of the fiscal surplus. Thus, if we take the interest rate level as given, for the outstanding balance of government securities in real terms to decline, the price level needs to rise. However, although such a rise in the price level would spell the end of deflation in Japan, it would give rise to concerns that the government was planning to accumulate debt and then inflate it away. Therefore, no matter how strongly the central bank is committed to ensuring price stability, it will find it difficult to maintain credibility. Ultimately, such a path will destabilize the economy and prices. Lessons learned from the past are that credibility, once lost, is hard to be restored. For the present, the economy and prices are moving largely in line with the main scenario presented in the April 2010 Outlook Report, and the year-on-year rate of change in the CPI is likely to return to positive territory in fiscal 2011. In this situation, efforts should be made to raise the productivity of the overall economy and increase the potential growth rate in order to end deflation and reduce the fiscal deficit.
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Asian Development Bank Institute ADBI - Central Bank of Malaysia Bank Negara Malaysia BNM Conference on Macroeconomic and Financial Stability in Asian Emerging Markets, Kuala Lumpur, 4 August 2010.
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Kiyohiko G Nishimura: Macro-prudential lessons from the financial crises – a practitioner’s view Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Asian Development Bank Institute (ADBI) – Central Bank of Malaysia (Bank Negara Malaysia/ BNM) Conference on Macroeconomic and Financial Stability in Asian Emerging Markets, Kuala Lumpur, 4 August 2010. * * * I would like to express my sincere gratitude to the hosts for inviting me to the ADBI– Bank Negara Malaysia Conference, and especially to this timely session: Macroeconomic Frameworks to Support Financial Stability. In this presentation, I will touch on the issues of financial stability and central bank policies, based on two episodes of financial crisis: one dating from 20 years ago in Japan, and the other from two years ago in the United States. I first present one “stylized account” from a macro-prudential perspective of the buildup in financial imbalances that led eventually to the financial crisis in the late 1980s in Japan. Then, I illustrate the startling similarities between the recent US subprime-triggered experience and that of Japan in the 1980s. Examining these two crises, I will draw four implications for macro-prudential policy which are likely to be universally relevant, particularly in emerging economies. The message is simple and straightforward: Beware. So-called macro-prudential measures may not always be sufficient. This leads to the final topic, the role of monetary policy during the buildup of financial imbalances, a role which I would argue is, in a word, crucial. I will explain why in the course of this presentation. 1. Financial imbalances in 1980s Japan: a stylized account I first present one “stylized account” from a macro-prudential perspective of the buildup to financial imbalances in Japan in the late 1980s. 1 This account is intended to be rather descriptive and schematic in the way that macro-prudential issues are highlighted. It is admittedly simplistic, but I believe this is a good starting point for discussion. Deregulation-induced “financial innovations” and financial anomalies A number of “financial innovations” introduced as a result of deregulation appear to have played a role in the late 1980s bubble in Japan. Under the designation of Financial Liberalization, deregulation sparked the arrival of new products such as CPs and large time deposits with unregulated rates, which nourished the atmosphere of profit-seeking through these “financial technology” products. 2 Financial Liberalization was a gradual process that started in the late 1970s and spanned twenty years. Around 1986, signs of “financial anomaly” emerged, brought about by the innovations associated with Financial Liberalization. The most notable anomaly was the apparent no-risk arbitrage opportunity for large non-financial corporations. In 1985, banks became allowed to offer large time deposits with no regulation on their rates. Banks then offered short-term large time deposits to major non-financial corporations with rates higher This stylized account is partly based on Hattori, M., H. S. Shin and W. Takahashi, “A Financial System Perspective on Japan’s Experience in the Late 1980s”, IMES Discussion Paper 2009-E-19, Bank of Japan, 2009. These technologies were known at the time as zai-teku in Japanese. than the corresponding-term CP rates. Thus, large non-financial corporations could profit from raising funds by issuing CPs and depositing them in these unregulated large time deposits (BOJ 1989 3). By a similar token, 3–6 month unregulated time deposit rates were substantially higher than short-term prime lending rates (see Chart 1). Chart 1 Time deposit rates and prime lending rates Note: “3–6 month time deposit rate (unregulated, new receipts)” is the average interest rate on newly received time deposits with unregulated interest rates of terms between 3 and 6 months. “3 month time deposit rate (regulated, new receipts)” is the interest rate set by the regulation on newly received 3 month time deposits. Regulations on time deposit interest rates were abolished in 1993. The end-of-month data for 3 month time deposit rate (regulated, new receipts) are available up to May, 1992. Source: Economic Statistics Annual, Bank of Japan. These anomalies were often explained as banks’ investment in “customer capital” in large non-financial corporations. These large non-financial corporations, who were once the good customers of the banks, had gained increasingly good access to capital markets through deregulation. If the banks could obtain and keep long-term customer relations with these corporations, the banks could profit from their clients’ increased financial and other activities through increased fees and commissions. This was not an implausible position, since the banks themselves were being gradually deregulated and allowed to expand their business into securities markets and other activities. Favorable capital market conditions and loosening of lending standards At the same time, banks’ profits surged and their capital positions strengthened, as shown in Chart 2. Banks tapped capital markets to raise capital easily, and their leverage ratio declined dramatically from around 160 in 1986 to around 60 in 1989, as shown in Chart 3. Bank of Japan, “Shouwa 63 nendo no kinyuu oyobi keizai no doukou (the Financial Markets and Economy in 1988),” (in Japanese), in Chosa Geppo, May, pp 1–61, 1989. Chart 2 Net income/loss of Japanese banks Chart 3 Leverage Note: All domestically licensed banks, excluding member banks of the Second Association of Regional Banks. Source: Economic Statistics Annual, Bank of Japan. With strong profit positions, loosened capital constraints through new equity issues, and substantial inflows of time deposits from large non-financial corporations, bank lending to real estate-related sectors surged, as did lending to small enterprises (see Charts 4 and 5), partly compensating for lackluster growth in lending to large non-financial corporations. Around this time, anecdotal evidence also emerged to suggest that banks had loosened their lending standards. Some banks transferred their loan-examination function from the loanexamination division of their headquarters to the loan-making divisions. Hence, the ratio of loan examination officers at the headquarters declined sharply in the 1980s, as shown in Chart 6. Chart 4 Breakdown of corporate borrowers by size Note: All banks, excluding member banks of the Second Association of Regional Banks. Total outstanding loans used for calculations are outstanding loans and discounts to domestic corporate borrowers, excluding overdrafts. Large enterprises are corporations with capital of 1 billion yen or more and more than 300 regular employees. For the wholesale trade industry, the criterion for the number of regular employees is more than 100 persons. For the retail and service industries, it is more than 50 persons. Small enterprises are unincorporated enterprises as well as corporations with capital of 100 million yen or less or with regular employees of 300 persons or fewer. For the wholesale trade industry, the definition is corporations capitalized at 30 million yen or less or with 100 regular employees or fewer. For the retail trade and service industries, it is corporations capitalized at 10 million yen or less or with 50 regular employees or fewer. Outstanding loans for medium-sized enterprises are calculated by excluding those for small enterprises and large enterprises from total outstanding loans. Figures are deflated by GDP deflators. Total borrowings in 1975 in real terms = 100. Source: Economic Statistics Monthly, Bank of Japan and National Accounts, Cabinet Office. Chart 5 Bank lending to real estate-related sectors Note: All banks, excluding member banks of the Second Association of Regional Banks. Real estate-related sectors include real estate, construction, and non-bank financial. Total outstanding loans used for calculations are outstanding loans and discounts to domestic corporate borrowers, excluding overdrafts. Outstanding loans to the non-bank financial industry are the sum of those to the other financial industry and the lease industry. Figures are deflated by GDP deflators. Total lendings in 1975 in real terms =100. Source: Economic Statistics Monthly, Bank of Japan and National Accounts, Cabinet Office. Chart 6 Ratio of examining officers at the headquarters by bank-type and year Source: Figure 1 in Fukao, K., K. G. Nishimura, Q.-Y. Sui and M. Tomiyama, “Japanese Banks’ monitoring activities and the performance of borrower firms: 1981–1996,” International Economics and Economic Policy, 2 (2005), 337–362. Overlooked signs of excessive optimism Around this time, there were signs of excessive optimism among investors, especially in property markets. Chart 7 illustrates the price-to-rent ratio in residential property markets in Tokyo, 4 based on hedonic price and rent price indexes of condominiums, and taking due account of vast differences in quality. (Rents here are market-determined new-contract rents, not institutionally rigid continuing-contract rents. 5) This ratio surged from around 23 in 1986, which in retrospect looked like the long run average, to around 40 in one year, suggesting substantial overheating in property markets. After a short pause, the price-to-rent ratio shot up to a peak of around 50 in the fall of 1990 (even after the collapse of the stock markets). However, it should be noted here that this quality-adjusted price-to-rent ratio has only recently become available. In the late 1980s, only appraisal price indexes for residential and commercial lands were available, with a substantial lag of half a year. There were no reliable rent data. Thus, there were no contemporaneous hard data showing investors’ excessive optimism in property markets, though there were lots of anecdotes of property investors’ excessive optimism. Moreover, in retrospect, the government itself was overly optimistic: it anticipated a substantial scarcity of office space partly because of internationalization of the Japanese financial markets in its “Metropolitan Reconstruction Plan” (1985), and in “The 4th National Comprehensive Development Plan” (1987). See Shimizu, C., T. Watanabe, and K. G. Nishimura, “House Prices in Tokyo: A Comparison of Repeat Sales and Hedonic Measures” mimeo, Reitaku University and Hitotsubashi University, 2010. There is sizable rigidity in continuing rents partly because of institutional factors. The CPI rent is the weighted average of market-determined new-contract rents and institutionally rigid continuing rents with more weight on the latter. See Shimizu, C., T. Watanabe, and K. G. Nishimura, “Residential Rents and Price Rigidity: Micro Structure and Macro Consequences”, Journal of Japanese and International Economies 24 (2010) 282–299. Chart 7 Price-to-rent ratio of Tokyo residential area Source: Author’s calculation. Central bank policy Facing investors’ excessive optimism and banks’ loose lending standards, the Bank of Japan used its then-conventional window guidance to control banks’ lending volumes. Although the direct control of lending through the practice of window guidance was criticized as a discretionary measure contrary to market principles, window guidance at a time of seemingly excessive optimism could be interpreted as one form of macro-prudential measure, albeit a crude one, to dampen excessive optimism through the exercise of moral suasion. However, as financial deregulation got under way, window guidance proved to be ineffective and failed to curb loans outstanding in the late 1980s. What was the monetary policy stance at that time and the public’s expectations about the policy? Around 1986, the market expectation was that the easy monetary policy would continue for a substantial period. This was partially due to the government’s commitments in the international policy coordination pledged during that period. There were also confounding issues at the time: the fallout of Black Monday (October 19, 1987), the fear of a recession stemming from the substantial appreciation of the yen, and the lack of significant inflationary signs in the CPI. In fact, the policy rate was cut from 5% in December 1985 to 2.5% in February 1987, and remained unchanged for more than two years. Then, as we know only too well, the stock market began to drop in January 1990, falling from more than 38,000 to around 16,000 in two and a half years. 6 The quality-adjusted Tokyo condominium price index continued to climb up until October of 1990 to triple the price of 1986, and then declined by about 30% in three years. 7 It continued declining through the 1990s, with the price in 2000 being approximately the same as that of 1986. 2. Similarity of the recent US experience to that of Japan in the 1980s When considering this stylized account, one cannot help noticing the similarities between Japan’s experience in the 1980s and recent events in the United States triggered by the subprime mortgage crisis. The Nikkei index was 38,915 on December 29, 1989 and 15,951 on June 30, 1992. These quality-adjusted house price indexes are in Shimizu, C., T. Watanabe, and K. G. Nishimura, “House Prices in Tokyo: A Comparison of Repeat Sales and Hedonic Measures” mimeo., Reitaku University and Hitotsubashi University, 2010. First, financial innovations were at least partly responsible for the buildup of financial imbalances. Securitization was thought to improve risk allocation, as risk was now borne by those who were more able to bear it. This reduced risk premiums (equilibrium or sustainable) for previously very risky investments, such as subprime mortgages. The financial sector could earn substantially higher profits from originating and distributing these securitized products. Taking advantage of this and other innovations, banks’ profits increased and their capital market standing became more solid. Second, there were signs of financial anomalies and loose lending standards. For example, CDO squares based on CDOs, which were in turn based on subprime mortgage pools, sometimes had a thick AAA tranche. It was argued that their pricing was based on a model proven to track the history well, but the history was usually too short to assure the model’s sustained reliability. Again as we know only too well, their assumed correlations turned out to be wrong. In addition, there were reports of “low doc loans” and “no doc loans,” especially in subprime mortgages. 8 Third, there seemed to be signs of excessive optimism, at least in the booming states, though not as obviously as in late 1980s Japan. Unlike in late 1980s Japan, semicontemporaneous house price indexes were available in the United States, including OFHEO (now FHFA) and Case-Shiller indexes, taking account of vast differences in quality of housing stock. In some parts of the United States, notably Los Angeles and Miami, price increases accelerated in the early 2000s, and more than doubled from 2001 to 2006. Unfortunately, there were no corresponding (new-contract) rent data, comparable to that shown before for Japan, with which to gauge excessive investor optimism by calculating price-to-rent ratios. However, since there was no report showing substantial rent increases relative to CPI in these areas, it might be appropriate to assume that the real price change coincided with the change in the price-to-rent ratio. Then, the real house-price change in ten large US cities (whose residents constitute roughly 10% of the US population) was comparable to that in Tokyo (where a similar percentage of the Japanese population lives) in the late 1980s, as shown in Chart 8. Chart 8 Real house price developments in the United States and Japan Source: S&P Case-Shiller Indexes, RRPI Indexes, US and Japanese CPI. “Low doc loans” and “no doc loans” are mortgage loans that require less than full documentation of income, employment, and assets. The course of central bank policy in the United States is well known, and I will not repeat it in detail here. I will just point out that firstly, whatever macro-prudential measures were implemented at that time, were inadequate to curb excessive optimism, and secondly, monetary tightening was “measured” and long-term rates remained relatively low, stirring debates about this “conundrum”. 3. Beware of anomalies and excessive optimism: implications for macroprudential policy So what lessons should we draw from these two episodes? Each crisis seems different from every other, so I should avoid oversimplification. However, the following four points are likely to be universally relevant, and especially so from the perspective of emerging economies. Firstly, financial innovations often provide fertile ground for financial excesses or imbalances. This may not be surprising, since innovations sometimes make old knowledge obsolete: Veterans become novices and pros become amateurs. The old prudential measures look out of date. We are told that “this time is different,” and that we should embrace these new ways of thinking. Often, these new ways of thinking disguise excessive optimism, as exemplified in the two episodes we have discussed. So, Beware. Secondly, in the process of the buildup of imbalances, there are often signs of anomalies. In the past, these anomalies were often ignored as being isolated and having no macro significance, or explained as rational choices, such as investment for future returns. But if these anomalies are found to coexist with other signs of excessively optimistic investor forecasts, these are likely signs of the buildup of financial imbalances. This point is especially relevant if the signs are found saliently in property markets, which usually move slowly. Thirdly, timely information about excessive investor optimism is of utmost importance in this regard. Price-to-rent ratios in property markets are one indicator of investor sentiment. Whereas information about price-to-earnings ratios is easily available in stock markets, corresponding (properly quality-adjusted) price-to-rent ratios in property markets are not easily available. This has, and still does pose a serious problem for macro-prudential policy, especially for emerging economies where property markets are becoming increasingly important. To have timely information about proper price-to-rent ratios, or at least price indexes that are reliable and internationally comparable, is not only important for assessing the magnitude of financial imbalances that need rectifying, but also vital to communicate with the public, both inside and outside of the country. In this respect, it is highly recommended that price indexes be constructed consistent with prospective United Nations recommendations (due next year) on residential property price indexes, and that these indexes be published regularly in a timely manner. The Japanese price-to-rent ratios presented before are calculated from large data sets using hedonic regression methods, and are available monthly with approximately two weeks’ lag. Fourthly, if investors are excessively optimistic, a modest increase in capital requirements and leverage restraints may not be sufficient to curb such unwarranted optimism. The case in point is the increase in banks’ new stock issues in Japan in the late 1980s and the dramatic decline of their leverage ratio during the buildup of the financial imbalances. This point is also relevant in contemplating maximum loan-to-value ratio requirements as macro-prudential policy. When the price doubles in a few years, it is relatively easy to comply with seemingly stringent maximum loan-to-value requirements, since the property’s assessed value increases in tandem with market prices. To curb excessive loans, it is important to have measures to restrain leverage. But at the same time we should better understand their limitations. They may be effective in some cases, especially for rather small buildups of financial imbalances, but perhaps not in other cases. 4. Excessive optimism and policy expectations: implications for monetary policy Finally, let me turn to the role of monetary policy during the buildup of financial imbalances, and consider the implications of the analysis so far. There are two strands of thought on this issue. One strand emphasizes that monetary policy is a blunt instrument affecting activity across a wide variety of sectors, many of which may not be experiencing speculative activity. To dampen speculative bubbles may require substantial changes in interest rates, which may hurt unaffected sectors. So in principle, it is better to use macro-prudential measures to counter financial imbalances, rather than monetary policy. 9 The other strand of thought points out that letting financial imbalances balloon and then collapse may be too costly to bear, depending on the magnitude of these imbalances. Moreover, although regulatory reforms and other macro-prudential measures are now under consideration in addressing the issue of the buildup of financial imbalances, there remains substantial uncertainty about their effectiveness in the real world. It is therefore not wise to rule out categorically the use of monetary policy to address the issue of financial imbalances. Monetary policy could be used in tandem with macro-prudential measures, if, firstly, substantial imbalances are building up and, secondly, regulatory policies have proved to be insufficient. 10 In retrospect, events in Japan in the late 1980s seem to support the second view. In particular, that episode satisfied the two requirements for the use of monetary policy in addition to macro-prudential measures to counter the buildup of financial imbalances. Let me summarize what the stylized account of late 1980s Japan shows from the perspective of monetary policy. Around 1986, investors’ expectations of investment returns were substantially elevated, especially in property markets, though grossly erroneously in retrospect. And at the same time, market expectation was that monetary easing would continue and the policy rate would remain low for a substantial period. This combination of elevated investment-return expectations and market expectation of continuously low policy rates accelerated property investment, both residential and commercial, though especially the latter. Property investment is a long-term, irreversible investment. It is a lengthy process from starting to find a lot to final dedication, and once built for a particular purpose, it is difficult to change usage. This is especially important in Japan, where some urban redevelopment may take years. Thus, not only the current policy rate but also the expectations of its future course have a significant effect on investment decisions. Consequently, the expectation of continuing monetary easing significantly encouraged property investments, and particularly those in commercial properties. Because of the inherent irreversibility, the excessive optimism inflicted a huge scar on Japanese commercial property markets. The quality-adjusted commercial land price index of Tokyo’s central business districts was 2.161 in 1999 (1975 index = 1), down from its height 16.556 in 1990. 11 It is mind-boggling to imagine how this 87% decline in commercial land prices in the heart of Tokyo, which is the center of the Japanese economy, affected business activity in general. The same is true for residential property markets, though to a lesser extent. Moreover, since investment in industrial sectors is often long-term and irreversible, This view has been expressed notably by many Federal Reserve officials in the past. This view is articulated in White, W., “Is Price Stability Enough?” BIS Working Paper No. 205, April 2006, Bank for International Settlements. See Figure 1 in Shimizu, C., and K. G. Nishimura, “Biases in appraisal land price information: the case of Japan”, Journal of Property Investment and Finance, 24 (2006) 150–175. they also suffered serious overcapacity and misallocation problems caused by the excessive optimism of the late 1980s and its subsequent collapse. In retrospect, taking account of the devastating effects of excessive optimism and also the ineffectiveness of macro-prudential measures (in particular, window guidance as explained before), few would disagree that monetary policy should have played a role in attempting to rein in excessive optimism, provided that this had been detected at the time. This episode teaches two lessons about the role of monetary policy and its relation to macroprudential measures in the process of the buildup of financial imbalances. Firstly, when excessive optimism prevails in the market, macro-prudential measures alone may prove to be insufficient, and we may need monetary policy on top of these macroprudential measures to rein in such excessive optimism. When investors are overly optimistic, asset prices go up to make it easy for banks to comply with, for example, increased capital-buffer requirements and more stringent loan-to-value ratio requirements. Moreover, when financial imbalances are sizable, they are likely to broadly affect many sectors of the economy, as exemplified by 1980s Japan, and this may justify the use of monetary policy. Secondly, when excessive optimism prevails and investment-return expectations rise erroneously, the central bank should be careful to avoid nourishing expectations of prolonged low interest rates relative to their long-run, sustainable levels. These expectations are likely to fuel investment activities further, especially in property markets. This increases the magnitude of possible future winding down. 12 In this respect, there is an important informational factor through which the central bank’s action or inaction influences market expectations. When excessive optimism emerges, a lack of action by the central bank may convey the wrong signal to the public. The central bank is responsible for the price stability that ultimately ensures the stability of economic activity. If there is no correspondent increase in prospects for economic growth, a sharp increase in investment return expectations may lead to strong pressure on prices, raising concerns over inflation. If the central bank does not show concern over inflation when investment return expectations are raised, this may be interpreted as a sign that the central bank has also raised its expectations for growth potential and is thus “underwriting” market expectations. In practice, the most difficult task in combating excessive investor optimism and the buildup of financial imbalances is to detect the excess as early as possible in a transparent way. Unfortunately, at the time of writing, conventional macroeconomic models are of little help in detecting excesses, though progress has been made in incorporating some characteristics of financial imbalances and thus in explaining their propagation mechanism. Taking account of this state of our understanding, it seems to me that significant efforts in the following two areas are needed from the practitioner’s viewpoint. Firstly, it may be desirable to develop and operationalize so-called early warning indicators, to detect signs of a buildup in financial imbalances and to rein them in as early as possible before it is costly to do so. Attempts to develop early warning indicators are sometimes criticized as ad hoc because of the lack of microeconomic foundations, so to speak. However, what we face are “tail risk” phenomena or more precisely, unknown unknowns, where past regularities apparently no longer hold true. In this respect, though atheoretical, the development and continuing improvement of early warning indicators is valuable in discerning factors that might be important though somewhat overlooked in conventional thinking. In the semi-annual Outlook Reports of the Bank of Japan, the Policy Board examines this possibility routinely in the second perspective of the two-perspective examination of economic conditions. Secondly, it is important (though admittedly not easy) to have timely and persuasive market information related to the possible buildup of financial imbalances, particularly information about investor optimism. As has been shown before, the Japanese government (or more precisely, some of its divisions) was partly responsible for the excessive optimism of the late 1980s. This suggests that it is not an easy task at all to convince the market (and parts of the government) plagued by excessive optimism. Many central banks and international institutions are working to obtain first-hand broad asset market information that is as reliable and as timely as possible. Here market intelligence plays an important role in detecting signs of anomalies in these markets. In doing so, we should also duly recognize heterogeneity among regions. These are challenging tasks for emerging-economy central banks, especially with respect to property markets, which are traditionally not the main focus of central bank business, and anomalies originating in financial innovations, which often “mutate” and “disguise” themselves in subtle ways. We usually regard financial crises as rare events, and most of the time, our model of the economy evolves around some form of economic equilibrium in a linear, though stochastically stable way. In reality however, we too often find, very painfully, that these rare events are not in fact rare, and the economy moves rather drastically from stability to instability in a short period time. The case of Japan in the late 1980s and the recent US case highlight dramatically this pattern of crisis occurrence. To contemplate best practices in macro-prudential and monetary policy, we should take proper account of our intellectual limitations in modeling the real economy, and at the same time, we should be practical in coping with the many-faceted problems of financial crises. I will stop here for now. Thank you for your kind attention.
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Euromoney Japan Capital Markets and Global Borrowers Congress, Tokyo, 15 September 2010.
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Kiyohiko G Nishimura: Maintaining stability and enhancing accessibility of financial markets – Japanese financial market infrastructure in the past and the future Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Euromoney Japan Capital Markets and Global Borrowers Congress, Tokyo, 15 September 2010. * * * Introduction I am delighted and honored to have been invited to speak today at the Euromoney Japan Capital Markets and Global Borrowers Congress. In order to strengthen the Japanese financial markets amid globalization, it is important, first, to maintain market stability, and second, to ensure a high degree of accessibility. Today, I would like to talk about these two points. Maintaining market stability means securing market liquidity even during times of stress and is crucial to the support of the economic activities of financial institutions and firms. This relationship is often compared to the human circulatory system. The functioning of the circulatory system is often taken for granted. Likewise, financial institutions and firms may not pay much attention in normal times to funding liquidity and market liquidity that enhances the funding liquidity. They gain a painful appreciation of the vital importance of market liquidity, however, if – like the circulatory system – it stops functioning. Therefore, I would first like to talk about the current conditions of the increasingly important market liquidity in the Japanese financial markets. Then I will touch on the measures for enhancing market stability in Japan, focusing particularly on the improvement of market infrastructure. Specifically, I will describe how, during the financial crisis in 2008, Japanese financial markets remained relatively stable compared to the United States and Europe. Next, I will outline the efforts to stabilize the Japanese financial markets after the financial crisis, through comparison with those in the United States and Europe. Another important aspect of the financial markets today is enhancing accessibility of the markets. International funds transactions by financial institutions and investors have made financial markets increasingly borderless. Japanese financial markets have been facing fierce competition with financial markets in Asian emerging economies that have recently expanded their presence in the global economy, as well as those in the United States and Europe. Thus, the Japanese financial markets need to adapt to accelerating globalization by preparing market infrastructure with a high degree of accessibility. In this regard, I would like to explain the measures taken to improve the accessibility of infrastructure in Japanese financial markets amid global competition. Then, in closing my remarks, I will talk briefly about the importance of market participants’ initiatives and the role of the Bank of Japan in ensuring stability and enhancing accessibility of the Japanese financial markets. I. Financial crisis in 2008: the United States, Europe, and Japan In the past quarter-century, international funds transactions have expanded considerably amid economic and financial globalization. Under these circumstances, the turmoil and dysfunction in the U.S. financial markets stemming from the failure of Lehman Brothers Holdings Inc. in the autumn of 2008 spread rapidly around the world, and global financial market conditions deteriorated significantly. Particularly in the United States and Europe, the concerns of market participants deepened over counterparty risk. Against this background, the money markets suffered markedly increased strain, with liquidity drying up particularly for term funding and LIBOR climbing sharply. For example, U.S. dollar and euro LIBOR-OIS spreads – which represent the premium for liquidity and counterparty risks in interbank markets – widened sharply after the financial crisis, showing a rapid heightening of tension in the money markets that deal with interbank transactions (see “U.S. dollar” and “euro” in Chart 1). With regard to funding conditions for firms in the United States and Europe, downgradings of firms grew in number due to the significantly deteriorating environment for corporate profits after the failure of Lehman Brothers. This rapidly heightened uncertainty about the firms’ ability to repay their debt. Subsequently, credit spreads on U.S. and European corporate bonds, including those with high ratings, widened rapidly, and liquidity in corporate bond markets decreased significantly (see “United States” and “Europe” in Chart 2). Following the market turmoil, global financial markets generally regained stability from around the spring of 2009 due to bold policy measures taken by governments and central banks around the world. From January 2010, however, triggered by the fiscal problem in Greece, European financial markets became unstable, as seen in the growing concerns about fiscal conditions in peripheral European countries and the financial soundness of European financial institutions. Turning to Japan, financial markets became unstable immediately after the failure of Lehman Brothers, affected by the turmoil in the global financial markets. Recent developments in Japanese financial markets, however, have been relatively stable. For example, in Japan’s money markets, interest rates came under upward pressure after the failure of Lehman Brothers, but concerns over counterparty risk were limited to the transactions mainly with foreign financial institutions. Thus, although the yen LIBOR-OIS spread also widened, the rise was relatively marginal compared to the U.S. dollar and euro LIBOR-OIS spreads. Moreover, the effects of monetary easing by the Bank of Japan have recently been gradually spreading and the interest rates in the money market, including those of a longer term, have declined to extremely low levels (see “yen” in Chart 1). With regard to funding conditions for firms in Japan, the issuing conditions for corporate bonds deteriorated, following those in the United States and Europe. Risk tolerance of major corporate bond investors, such as banks and life insurance companies, declined due to issuers’ worsening financial conditions after the failure of Lehman Brothers and a steep fall in stock prices at that time. However, looking at corporate bonds rated AA or higher, which accounted for the majority of corporate bonds in terms of the total amount issued, the widening of credit spreads was limited even after the financial crisis, compared with that of BBB-rated corporate bonds. This differed from the United States and Europe, where credit spreads on corporate bonds even with high ratings widened significantly (see “Japan” in Chart 2). Thus, it may be said that Japanese financial markets have shown – in relative terms – some stability against the shocks of the current financial crisis. II. Measures to stabilize financial markets after the crisis Based on the experience of the recent crisis, market participants strongly reconfirmed that ensuring financial market stability during times of stress was important. With this in mind, market participants at home and abroad have been taking measures to strengthen the infrastructure for financial market stability. A. Measures to stabilize financial markets in the United States and Europe In the United States and Europe, market participants have recognized issues such as market transparency and risk assessment regarding over-the-counter (OTC) derivatives transactions including credit default swap (CDS) trading, and have discussed measures to strengthen market infrastructure related to the settlement and clearing system, such as the wide use of the central counterparty (CCP). Two of the most notable measures are review of the fails practice and reform of the repo market in the United States. In the United States, after the failure of Lehman Brothers, an unprecedented number of fails occurred in Treasury transactions. In response to this, acting jointly, the Treasury Market Practices Group (TMPG) and the Securities Industry and Financial Markets Association (SIFMA) swiftly discussed and reviewed the fails practice. In May 2009, fails charges were introduced in order to prevent frequent occurrence of fails under low interest rate conditions. As for tri-party repo transactions that are common in the U.S. general collateral (GC) repo market, in addition to Treasuries, mortgage-backed securities, agency debt, and corporate bonds had been accepted as collateral. As these three securities’ prices declined, however, margin calls arose and haircuts were raised. As a result, liquidity in the repo market decreased significantly. Based on this experience, in September 2009 the Payments Risk Committee (PRC), a private-sector group of senior U.S. bank officials sponsored by the Federal Reserve Bank of New York that identifies and analyzes risk in payments and settlement systems, formed the Tri-Party Repo Infrastructure Reform Task Force. The task force has been reviewing collateral management and settlement practices. B. Measures to stabilize financial markets in Japan As I mentioned earlier, at the time of the crisis, the Japanese government bond (JGB) and credit markets have remained relatively stable. This was because the Japanese financial system, which had experienced a financial crisis in the 1990s, showed relative resilience compared with the systems in the United States and Europe. In addition, the introduction of a delivery-versus-payment (DVP) mechanism for settlement of JGBs eliminated principal risk. Furthermore, a JGB clearing institution, the Japan Government Bond Clearing Corporation (JGBCC), accepted transactions between parties as a CCP, assumed the seller’s obligation to every buyer and the buyer’s obligation to every seller, and provided guarantee for settlement of those obligations. This reduced the settlement risk in the secondary market for JGBs as a whole and prevented a chain reaction of default in JGB settlement. We should welcome the fact that a worst-case scenario was avoided in Japanese financial markets, as I have just described. This does not necessarily mean, however, that Japanese market infrastructure is sufficiently developed to ensure stability in times of crisis compared to the United States and Europe. Indeed, the current financial crisis revealed issues that were unique to Japan and different from those in the United States and Europe. Specifically, the existing fails practice did not work as expected. As a result, the pace of JGB settlement was delayed significantly since fails occurred frequently in the secondary market for JGBs. In order to reduce the risk of fails, most market participants refrained from starting new repo transactions. Repo transactions are collateralized with government securities that command high creditworthiness. As a safer and more secure funding tool than uncollateralized transactions, they are expected to play an important role in ensuring liquidity in emergency situations. In reality, however, liquidity in the JGB repo market decreased, reflecting market turmoil mainly due to a steep increase in fails. Based on these experiences, market participants have started to review the fails practice in order to further establish it, and have recognized, for example, that improving risk management by shortening the JGB settlement cycle is a priority issue for examination. C. Reviewing the fails practice The working group of the Japan Securities Dealers Association (JSDA) has discussed and reviewed specific measures to further establish the fails practice. Measures such as the introduction of fails charges will be effective from November 1, 2010. Some end-investors have been cautious up to now about accepting the fails practice, and it is vital for the review to help them come to understand the fails practice and establish it by developing business operations to handle fails. I hope that the fails practice will be further established and an environment will be developed in which market liquidity is not only maintained in normal times but also secured or quickly recovered during times of stress, thus strengthening the stability in the Japanese repo market. D. Shortening the JGB settlement cycle and other measures As I mentioned, materialization of principal risk was avoided in the settlement of JGBs. Market participants, however, became well aware of the liquidity risk that they could not receive bonds and funds as scheduled, during times of stress where default and settlement fails were likely to occur frequently. Generally in the JGB markets, outright transactions are settled three days after the trade date (a T+3 settlement cycle), whereas in the United States and United Kingdom they are settled one day after the trade date (a T+1 settlement cycle) and in Germany two days after the trade date (a T+2 settlement cycle). The settlement cycle in Japan is thus longer than that in the United States and Europe, and the same applies to repo transactions. Market participants have accordingly been discussing measures to shorten the JGB settlement cycle in order to decrease the amount of unsettled outstanding positions of outright and repo transactions of JGBs. It has been pointed out that the pace of intra-day settlement of JGBs by the JGBCC was delayed after the failure of Lehman Brothers. In response to this, policies have been laid out to strengthen the JGBCC’s governance and enable it to take actions in order to enhance the funding arrangements in emergency situations such as defaults of the JGBCC participants and to improve transparency concerning how to allocate bonds subject to settlement fails. The Bank of Japan has been supporting such private-sector initiatives. I hope that in the process of further establishing the fails practice, the JGB settlement cycle will be shortened and the functions of the JGBCC will be further enhanced, so that the stability against market stress is further increased in the secondary market for JGBs. III. Challenges to improve accessibility under global competition In the corporate bond and stock markets, market participants have engaged in efforts and discussions to improve the accessibility of market transactions, while ensuring market stability. A. Enhancing the corporate bond markets As I stated earlier, it could be said that markets for corporate bonds rated AA or higher maintained a certain level of functionality during the current financial crisis. For corporate bonds rated A or lower, however, firms faced increased difficulty in issuing these bonds, or issuance conditions deteriorated, after the failure of Lehman Brothers. Accordingly, many large firms began to shift their funding to bank loans from corporate bond issuance during the crisis. Given these experiences, market participants became more aware of the fact that the Japanese corporate bond markets did not function sufficiently as a channel for funding by firms and that it was necessary to make efforts to enhance market liquidity. Looking at the financial structure, the following are recognized as priority issues in the Japanese corporate bond markets. First, Japanese firms depend heavily on bank loans as a means of funding, and the size of the corporate bond markets is smaller than that in the United States. Second, the range of market participants in the corporate bond markets does not have sufficient diversity – the “other side of the coin” of what I have just mentioned. In fact, issuers consist mainly of firms with high ratings and the major investors are domestic banks and life insurance companies. And third, as corporate bond issuance by firms is not active, the secondary market for corporate bonds has not been well developed. Accordingly, a JSDA conference for enhancing the corporate bond markets discussed measures to foster a favorable environment for issuance of and investment in corporate bonds, including those with low ratings, and to bring in a wider range of investors. A report on the matter was released in June 2010. The report listed the following issues for consideration. For issues related to the primary markets, first, examination to accept corporate bonds will be reviewed to enhance the accessibility of issuers. Second, a provision and disclosure of covenants of corporate bonds and corporate bond management will be reviewed to promote the investors’ holdings of corporate bonds with low ratings. Moreover, for issues related to the secondary markets, development of the infrastructure to provide information on market prices is currently under discussion to facilitate appropriate investment decisions by investors and determination of issuance environment by issuers. The Bank of Japan hopes that market participants will continue to take initiatives to strengthen market infrastructure, thereby improving stability and accessibility in the corporate bond markets. B. Strengthening infrastructure in the stock markets In Japanese stock markets, measures have been taken to improve the accessibility of transactions amid fierce competition with, for example, financial markets in Asian emerging economies. Specifically, in January 2010, the Tokyo Stock Exchange (TSE) launched “arrowhead”, the next-generation trading system for cash equity products. Due to developments in IT, the environment surrounding the stock exchanges has changed significantly, and a trading system called algorithmic trading, which automatically enters trading orders based on a certain data processing mode, has become popular among market participants. In other countries, as order placement and execution processing have accelerated, high-frequency trading (HFT) has become common. Therefore, the introduction of arrowhead meets the needs of investors at home and abroad to automate and accelerate the transactions. In addition, the TSE has been exchanging opinions with market users on the extension of trading hours, such as abolishing noon recess, which is uncommon in other major countries. In Japan, the share of stock trading through a proprietary trading system (PTS), a trading system created by private firms, accounts for less than 1 percent of total listed stock trading, but in July 2010 one of the major companies from abroad started to offer a PTS. If the polarization of stock trading between stock exchange and off-exchange transactions leads to competition among these transactions, the utilization of the PTS, together with the measures taken by the TSE that I mentioned, is likely to help provide investors with more trading opportunities and activating transactions. In the United States, the sudden stock market plunge in May 2010 – the so-called “flash crash” – increased concern among market participants about financial market instability resulting from active algorithmic trading and the polarization of trading due to widespread offexchange transactions. In this regard, price limits set for each stock issue may have contributed to market stability in Japan. Market participants, however, should pay careful attention to market stability given the trend of automation and acceleration of transactions in Japanese financial markets. IV. Toward more stable and accessible market infrastructure A. Strengthening market infrastructure The experience of the recent crisis has reconfirmed that it is important to secure a stable source of liquidity in financial markets at all times. In strengthening market infrastructure, we should work toward reinforcing the financial market stability against stress, while at the same time considering measures to enhance accessibility with the aim of promoting active transactions. In Japan, in order to address issues based on the experiences after the failure of Lehman Brothers, trading systems and market practices have been steadily established, in consideration of both market stability and accessibility. I hope that such initiatives and discussions will proceed further and Japanese financial markets will become stable markets that are credible to market participants and accessible markets that meet the needs of various investors and in funding. B. Role of the central bank In closing my remarks, I would like to talk about the role of the Bank of Japan in strengthening market infrastructure. The effects of the central bank’s monetary policy spread to the overall financial market and the real economy through various transactions by market participants and arbitrage trading between markets. The money market is where a central bank conducts daily money market operations that are essential to implement its monetary policy. The Bank plays a role in providing market infrastructure by operating the Bank of Japan Financial Network System (BOJ-NET), which is a settlement system for funds and Japanese government securities (JGSs), and by providing payment and settlement services. Thus, the Bank recognizes that it is also crucial to strengthen market infrastructure equipped with a high degree of accessibility while maintaining market stability. The Bank will continue to support market initiatives to strengthen infrastructure as much as possible through communication with the market, and will actively contribute to such initiatives by improving settlement infrastructure through, for example, the construction of the new BOJ-NET. Thank you very much for your kind attention. Chart 1 Tension in the interbank market: LIBOR-OIS spreads (3-month) Notes: 1. (1) and (2) indicate the BNP Paribas shock (on August 9, 2007) and the failure of Lehman Brothers (on September 15, 2008), respectively. 2. Data up to September 10, 2010. Source: Bloomberg. Chart 2 Tension in the corporate financing market: corporate bond spreads (AA-rated) Notes: 1. Corporate bond yields in Japan are obtained from “Reference Price (Yields) Table for OTC Bond Transactions”, and those in the United States and Europe are calculated by the Bank of America Merrill Lynch. 2. The indicated rating of corporate bonds in Japan is of R&I, and those in the United States and Europe are of Moody’s, S&P, and Fitch. 3. 3- to 7-year maturity for Japan; 3- to 5-year maturity for the United States and Europe. 4. Data up to September 10, 2010. Sources: Bank of America Merrill Lynch; Japan Securities Dealers Association.
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Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Second International Journal of Central Banking IJCB Fall Conference, Tokyo, 16 September 2010.
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Masaaki Shirakawa: Uniqueness or similarity? Japan’s post-bubble experience in monetary policy studies Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Second International Journal of Central Banking (IJCB) Fall Conference, Tokyo, 16 September 2010. * I. * * Introduction I am very pleased to have a chance today to address the IJCB Conference. In particular, this conference is very timely and appropriate in two aspects. First, as everybody here is well aware, this conference focuses on a very important theme for central bank policymakers in the current situation, “Monetary Policy Lessons from the Global Crisis.” Second, whether intentionally or not, this conference is held in Japan, the country often quoted as a precedent on that theme. 1 In fact, we hear heated discussions in the United State as to whether the United States will fall into “deflation in the Japanese style” or the “lost decade like Japan” (Chart 1). 2 The line of discussions generally has something in common in interpreting Japan’s experience. That is, a weak economic performance is attributed mainly to the failures of Japan’s policy authorities or the factors peculiar to the Japanese economy and society. I cannot completely deny Japan’s uniqueness, but I should also emphasize that we can find a lot of similarities between Japan’s experience and our experience in the recent global financial crisis. At various international conferences I attended in the early 2000s, I explained the Japanese situation many times, but never imagined that zero interest rates and quantitative easing would be adopted by other central banks in the advanced economies. I believe many of central bank officials thought the same way. In short, Japan’s experience provides too important and general food for thought to say that Japan is just unique. Nevertheless, I have the impression that Japan’s experience is often discussed, based on casual reading of related facts. Taking this opportunity, I will articulate my thoughts on how to make use of Japan’s experience since the burst of a bubble in making monetary policy studies. 3 II. Seven facts on Japan’s economy since the burst of a bubble The Japanese economy after the burst of a bubble is often referred to as the “lost decade.” 4 Real GDP growth remained just 1.5 percent on average in the 1990s, which declined significantly from 4.6 percent in the 1970s and 4.4 percent in the 1980s (Chart 2). 5 CPI inflation reached its peak of 3.3 percent in January 1991 soon after the burst of a bubble, started declining shortly thereafter, and turned negative in 1998 (Chart 1, shown earlier). Looking at policy responses, on the monetary policy front, the Bank of Japan’s (BOJ’s) first policy rate reduction after the burst of a bubble was carried out in July 1991, one year after See, for example, Ahearne et al. (2002), Krugman (1998), and Posen (1998). See, for example, Bullard (2010) and Rogoff (2010). In my speech today, I focus on Japan’s experience after the burst of a bubble. See also Okina, Shirakawa, and Shiratsuka (2001) for discussions on the cause of the bubble since the late 1980s and its lessons for monetary policy. With regard to the appropriateness of the phrase, “lost decade,” see Shirakawa (2009). In the 2000s, the average growth rate recovered slightly, and stayed at 1.7 percent until 2007 before the collapse of Lehman Brothers. the peak of land prices (Chart 3). 6 Overnight interest rates came down to 0.5 percent and virtually reached zero interest rates in 1995, four years after the BOJ started the policy rate reductions. 7 On the fiscal policy front, aggressive stimulus measures were taken in two periods: soon after the burst of a bubble and from 1998 to 1999 (Chart 4). After the introduction of the quantitative easing policy, the contributions of fiscal expenditure to real GDP growth remained negative. On the financial system policy front, capital injections into undercapitalized financial institutions started in 1998. The amount of injected public funds relative to nominal GDP finally reached 2.5 percent in Japan. Compared to the United States in the recent crisis, the amount of injected public funds was smaller in the United States, and remained 1.5 percent of nominal GDP, but the capital injections were carried out much faster in the United States. Those are the quick summary of macroeconomic conditions and policy responses after the burst of a bubble in Japan. When making use of Japan’s experience in monetary policy studies, I want to draw your attention to the following facts. First, Japan experienced business cycle expansions and contractions three times each since the low-growth 1990s (Chart 5). 8 That seems contrary to the impression from the phrase of the “lost decade” that Japan has remained stagnant all the time since the 1990s. Whenever some signs of recovery were observed in Japan, expectations that the economy would finally escape from stagnant conditions and enter a full-fledged recovery were rising. Based on such Japan’s experience, I attempted to draw public attention to the risk of falling into false optimism by using the phrase of a “false dawn,” when we saw some signs of economic recovery in advanced economies in the spring of 2009. 9 Second, Japan did not experience a sharp and drastic economic contraction on the scale that we experienced after the failure of Lehman Brothers. Looking at Japan’s real GDP trend, the largest decline was recorded in the first quarter of 1998 by −1.9 percent. That decline, however, was smaller than those in many countries, including Japan, after the failure of Lehman Brothers in the fall of 2008 (Chart 6). Even during the period from 1997 to 1998, when Japan’s financial crisis was severest, the level of real GDP remained higher than the average level of 1989, when Japan was at the peak of the bubble period. Third, Japan showed economic growth on a per worker basis comparable to the United States in the 2000s, although significantly declined from the 1980s (Chart 7). At the same time, Japan delivered a weaker performance in real GDP growth. Obviously, the differences between real GDP growth and real GDP growth per worker reflect the declines in the workforce in Japan. 10 In any event, in analyzing the Japanese economy after the burst of a bubble, it is essential to take account of changes in potential growth, which is determined by productivity growth and demographic changes. Fourth, Japan has experienced deflation, but its severity has been contained at a mild level. Consumer price inflation turned negative in 1998, and from 1997 to 2010 it declined by −3.3 percent on a cumulative basis, and −0.3 percent on an annualized basis (Chart 8). 11 In The intervals between the peak of land/housing prices and the first policy rate reduction are almost the same in Japan and the United States. Okina and Shiratsuka (2002) make an assessment on the BOJ’s monetary policy actions before and after the burst of a bubble based on the Taylor rule. In Japan, the President of the Economic and Social Research Institute, Cabinet Office, decides on the reference dates of business cycles, based on the discussions in the Investigation Committee for Business Cycle. See Shirakawa (2009). That tendency becomes more evident, by comparing real GDP growth per man-hour. See Hayashi and Prescott (2002). The latest figure for the Japanese CPI is July 2010. the meantime, long-term inflation expectations remained generally unchanged, and anchored around 1 percent (Chart 9). Japan’s deflation since the second half of the 1990s is a rare experience in the post-war advanced economies, but the scale of the price decline is far smaller, compared to the period of the Great Depression when the United States registered a CPI decline of 24 percent in the 1930s (Chart 10). Fifth, Japan has experienced deflation not only in goods prices but also in services prices. Compared with the United States, the difference in consumer price inflation is mainly attributed to services prices (Chart 11). That reflected flexible adjustments in nominal wages in Japan, since the service sector is basically labor-intensive. Sixth, Japan has not experienced a deflationary spiral. More precisely, Japan has not experienced the phenomenon after the burst of a bubble that a decline in prices induces a decline in economic activity, thereby leading to a further decline in prices. 12 Instead, Japan has experienced the longest recovery, just in duration without considering its strength, from 2002 under mild deflation (Chart 12). Seventh and finally, the BOJ introduced various innovative policy measures (Chart 13). 13 The zero interest rate policy was first introduced by the BOJ in 1999. The “quantitative easing policy,” which set a target for money market operations on the outstanding amount of current account balances at the central bank and expanded such balances far above the required reserve levels, was also first introduced by the BOJ in 2001. The BOJ expanded its balance sheet size considerably. From 1995 when overnight interest rates fell down to virtually zero, the ratio of the BOJ’s balance sheet size to nominal GDP increased by more than 20 percentage points at its peak (Chart 14). That increase in the ratio for the BOJ is twice as large as that in the U.S. Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of England (BOE) in the recent crisis. In addition, the level of the ratio for the BOJ is still higher than that for the Fed, the ECB, and the BOE. As the target level of the current account balances was raised, the maturities of short-term funds-supplying operations became lengthened. In the final stage of the quantitative easing policy, the average maturities exceeded six months, and the longest one reached eleven months. In addition, an experimental policy measure of commitment to the future course of monetary policy was first introduced by the BOJ. Under the quantitative easing policy, for example, the BOJ made a commitment to continuing with the quantitative easing policy “until core CPI inflation becomes stably zero or above.” The BOJ also adopted “credit easing” in the current terminology. The assets purchased included asset-backed securities (ABSs) and asset-backed commercial papers (ABCPs). The BOJ purchased stocks held by financial institutions to reduce market risk associated with stockholdings, which was one of the biggest risk factors in potentially destabilizing the financial system. As I have reviewed so far, the BOJ introduced various unprecedented measures under the uncharted circumstances during the period from the late 1990s to the early 2000s. Innovative aspects of such policy measures were not well recognized at that time, but, in retrospect, such measures involved most of the elements in the unconventional policy measures taken in the recent global financial crisis. For example, Posen (2010) noted that Japanese deflation remained stable over the course of the 1990s rather than accelerated. For the overview of empirical studies on the effects of the BOJ’s monetary policy measures in the 2000s, including the quantitative easing policy, see Ugai (2007). III. Four similarities in economic conditions and policy responses after the burst of a bubble Based on the facts in Japan’s experience after the burst of a bubble, I will next point out four observations that are common to economic conditions and policy responses after the burst of a bubble in the two cases: one is the U.S. and European economies in the recent crisis and the other is the Japanese economy since the 1990s. I will also elaborate on their implications in analyzing economic conditions and monetary policy after the burst of a bubble. Sluggish economic recovery and balance-sheet adjustment The first similarity concerns the fact that it took fairly long before restoring the full-fledged recovery path after the burst of a bubble. 14 In Japan, it was 2003 when the economy went back to the steady recovery path, and it thus took more than ten years since the burst of a bubble. In the U.S. and European economies, the adjustment is still continuing, and the duration of the adjustment period is yet to be confirmed. However, we can safely say that it will take some time before restoring the full-fledged recovery path. That is because the balance-sheet adjustment produces significant downward pressure on the economy in the process of resolving various “excesses” accumulated during a bubble period. 15 The forms of “excesses” vary from country to country. In Japan, they were “three excesses” in the business sector: employment, production capacity, and debt (Chart 15). 16 It is essential to explicitly incorporate an adjustment mechanism of “excesses” in analyzing the economy after the burst of a bubble. As a related issue, before the crisis it was frequently argued that a financial system with welldeveloped capital markets, in addition to a sturdy banking system, was more robust to a shock than a bank-centric financial system, since both the bank channel and the capital market channel worked in a complementary manner. 17 It seems, however, such a view needs to be reconsidered. Effects of dysfunctional interbank money markets The second similarity lies in the fact that the sharp contraction of economic activity after the burst of a bubble occurred when interbank money markets became destabilized. In Japan, as I mentioned earlier, it was the period from 1997 to 1998 when real GDP declined the most, and it was the fall of 1997 when interbank money markets became destabilized (Chart 16). 18 In the recent global financial crisis, real GDP in advanced economies, including the United States and European countries, registered the largest decline during the period from the fourth quarter of 2008 to the first quarter of 2009. Such a massive decline was attributed to the malfunction of interbank money markets, triggered by the failure of Lehman Brothers. The two cases have the common starting point of an interbank market participant default. 19 See Reinhart and Rogoff (2009), and Reinhart and Reinhart (2010) for the detailed discussions on recovery patterns after crises. Nakakuki, Otani, and Shiratsuka (2004) make a quantitative assessment on the effects of structural adjustments on economic growth in Japan. For the issues on the “three excesses,” see the 2003-05 issues of the BOJ’s Outlook for Economic Activity and Prices. See Greenspan (1999). The failure of medium-sized Sanyo Securities in 1997 led to the first default in interbank money markets in the postwar period in Japan. That triggered sudden liquidity contraction in interbank money markets, immediately spilling over to a wide-range of financial markets. See Nakaso (2001) for the details on Japan’s financial crisis and the BOJ’s role as the lender of last resort. When Sanyo Securities failed, the default of one billion yen in the interbank money markets occurred. Given the serious adverse effects of the failure of medium-sized Sanyo Securities on interbank money markets, at the time of the subsequent and larger failure of Yamaichi Securities, the BOJ committed to providing an unlimited amount of liquidity, thereby enabling its orderly resolution. 20 Such policy responses staved off a global financial crisis starting in Japan. 21 A series of observations, just I mentioned, show that ensuring funding liquidity is one of the most important prerequisites for achieving stable economic activity, and, to that end, it is crucial to stave off the malfunction of interbank money markets. In addition, I emphasize the importance of differentiating two things in analyzing the economy after the burst of a bubble: the phase of “acute pains” arising from the malfunctioning interbank money markets and the phase of “chronic illnesses” from balance-sheet adjustments. Weakened credit channel The third similarity can be found in the fact that the transmission channels of conventional monetary policy, explained in standard textbooks, did not seem to work well after the burst of a bubble. A typical example can be found in the credit channel. In Japan, the growth in bank lending decelerated rapidly after the burst of the bubble, and continued to remain stagnant for a long time (Chart 17). The growth in bank lending finally turned positive in 2005. Looking at the United States and European countries, the growth in bank lending is still continuing to decline, and the pace of the decline is much faster than that in Japan after the burst of the bubble. In addition, the expansions in the monetary base did not induce an increase in money supply nor bank lending (Chart 18). Before the outbreak of the recent global financial crisis, quantitative easing was frequently proposed as a measure against deflation. Nevertheless, we hardly observe the fact that massive expansions in central bank balance sheets result in an increase in inflation in advanced economies. 22 Such fact suggests that conventional monetary policy becomes substantially constrained under the economic circumstances with zero interest rates and ongoing balance-sheet adjustments. The effectiveness of unconventional policy measures under the dysfunctional financial system The fourth similarity is related to the fact that various unconventional measures taken by central banks in a crisis produced significant effects on stabilizing the financial system, and thus contributed to minimizing the economic downturn. 23 In particular, such unconventional measures were the most effective in the situation that the overall function of the financial Although the defaulted amount was relatively small, market participants became suddenly cautious about counterparty risk. Due to such policy actions, the liabilities owned by Yamaichi Securities were replaced by those for the BOJ. Of course, an international spillover of the shock could have occurred, if complex securitization schemes had been extensively used at that time. Yamaichi Securities played an important role as one of the four big securities companies in Japan and actively conducted overseas businesses. Due to massive off-the-book liabilities, so-called stock shuffle (loss compensation), Yamaichi’s funding became increasingly tight both at home and abroad. Yamaichi finally decided to go into the voluntary closure of its securities business in November 1997. When Yamaichi failed, the BOJ extended uncollateralized lending in order to support the orderly wind-down of its transactions, some of which turned out to be irrecoverable at the conclusion of Yamaichi’s bankruptcy procedures in January 2005. Posen (2009), using the inflation data in the G7 countries, noted that the only periods where excessive monetary growth led to sustained rises in inflation were during the early and mid-1970s. Bernanke (2009) emphasizes that point. system, including credit markets, deteriorated due to the malfunction of interbank money markets. The success of such measures is essentially due to central banks’ undertaking of counterparty risk and credit risk. Such central banks’ risk-taking is certainly crucial in the phase of “acute pains.” Thus, when examining the effectiveness of monetary policy, or more broadly central bank policy in general, it is crucial to make a clear distinction between the phase of “acute pains” and the phase of “chronic illnesses.” IV. Things to remember in Interpreting Japan’s experience So far I have discussed the common factors in economic conditions after the burst of a bubble. At the same time, there exist some factors peculiar to Japan’s experience. In monetary policy studies, we need to interpret Japan’s experience with consideration for some differences. Differences in the phase of adopting unconventional measures First, we need to take account of the differences in the phase of adopting unconventional measures. In the malfunction of interbank money markets, unconventional measures were proven effective by Japan’s experience as well as the global financial crisis this time. 24 The real issue here is whether unconventional measures, especially quantitative easing or credit easing, are effective in the phase of “chronic illnesses” after such crisis subsides. Empirical studies on Japan mostly show that quantitative easing produced significant effects on stabilizing the financial system, while it had limited effects on stimulating economic activity and prices. Such empirical analyses on the United States and the United Kingdom seem yet to be available at this moment. 25 But it seems very difficult to differentiate between the effects from the conventional interest rate channel and those from unconventional measures. That is because such unconventional measures were introduced in the phase of “acute pains” with considerably higher nominal interest rates and credit spreads than those in Japan. By contrast, Japan virtually faced the zero lower bound of nominal interest rates in the second half of 1995, and thus stimulative effects from the conventional interest rate channel were exhausted before the introduction of the zero interest rate policy in February 1999. The effects of demographic changes and productivity declines Second, we need to consider developments on the supply side and the potential growth rate. As standard macroeconomic theory emphasizes, long-term growth is determined by labor force growth and productivity growth. In Japan, labor force growth peaked in the mid-1970s, decelerated thereafter, and turned negative in the mid-1990s (Chart 19). When assessing the factors behind the long-lasting economic stagnation over one or two decades, it is important to focus more on analysis of the real side of the economy. 26 See Ugai (2007) for comprehensive survey on empirical studies on the effects of the quantitative easing policy in Japan. See also, for example, Gagnon et al. (2010) and Joyce et al. (2010) for empirical studies on the recent experience in the United States and the United Kingdom, respectively. Bean et al. (2010) also provide a broader review of monetary policy responses in the recent global financial crisis. Ugai (2007) concludes that effect of expanding the monetary base and altering the composition of the BOJ’s balance sheet, if any, is generally smaller than that stemming from the policy commitment. Hayashi and Prescott (2002) argue that growth theory, treating the economic productivity as exogenous, accounts well for the Japanese lost decade, and call for the analysis about policy change that allows productivity to grow rapidly. See also Rogoff (2010). Such decline in the potential growth rate, and associated downward revision of the public expectations about the future growth rate, seem to produce downward pressure on prices. 27 In fact, there exists a significantly positive correlation between the potential growth rate and long-term expectations about inflation in Japan, in contrast to other advance countries (Chart 20). Several interpretations are possible on that observation. For example, it can be considered that a decline in the potential growth rate induces a persistent and significant decline in the natural rate of interest, thus making it difficult for monetary policy to produce sufficient easing effects. Alternatively, economic growth expectations are revised downward, reflecting a decline in the potential growth rate, and a subsequent increase in the discounted present value of future net tax burden and debt-repayment burden to the private sector are likely to restrain private expenditure. Differences in labor practice Third, we also need to pay attention to the differences in labor practice. Japan’s labor practice has a general feature that the dismissal of regular workers is relatively difficult, compared to the U.S. labor practice. As a result, labor costs of regular workers entail the nature of quasi-fixed costs. Under such circumstances, firms have an incentive to cover the fixed costs by lowering sales prices. Price declines in the early stage of the post-bubble period are partly explained by such mechanism. 28 As disinflation progressed, Japan tended to set wages in a more flexible manner. Such flexibility in wage setting was attained not only through a reduction in bonus payments and an increase in the number of non-regular workers, but also the downward revision of fixed compensation for regular workers (Chart 21). As mentioned earlier, compared to the United States, price declines in Japan were attributed mostly to declines in services prices. That reflected flexible downward revisions of nominal wages. The propensity to consume in Japan’s household sector increased even under deflation, partly owing to the fact that price declines were driven by unstorable services prices (Chart 22). 29 The difference in labor practice is one factor behind the observation that deflation was the severest in Japan among major countries, but never turned into a deflationary spiral. Although ultimately labor practice is determined endogenously, we need to incorporate the differences in labor practice in analyzing the short- to medium-term developments in deflation. Developments in external demand Fourth, we need to take account of an increase in external demand as one of the driving forces behind Japan’s recovery (Chart 23). As I mentioned earlier, the Japanese economy needed the resolution of “three excesses” in the business sector before restoring the fullfledged recovery path. In addition, such recovery in the Japanese economy was also attributed to the increase in external demand since 2003, which was supported by high growth in the global economy under the global credit bubble as well as the depreciation of the Japanese yen. Under the current circumstances, advanced economies need to gain momentum for recovery without relying on the “external” demand, since many economies are affected by the burst of a bubble. See Kimura et al. (2010) and Fujiwara, Hirose, and Shintani (2008). See Kuroda and Yamamoto (2005). The increasing trend in the propensity to consume is also influenced by the aging population. In that sense, we need further analysis with considering the differences in the recovery mechanism after the burst of a bubble, depending on whether one country experiences a bubble or many countries in the world experience a bubble. V. Future research challenges To conclude my speech today, I will touch upon the challenges to monetary policy studies based on our experience of the financial crisis. 30 That said, we are fully aware that many issues have been already raised on various occasions. I thus focus on some relevant, but often missing items in the research agenda related to both conventional and unconventional monetary policies. Speaking of conventional monetary policy, I stress the importance of deepening our understanding about the effectiveness of aggressive policy rate reductions after the burst of a bubble. Before the burst of the bubble this time, the majority view was that aggressive policy rate reductions enabled us to stave off a sharp and serious economic contraction. 31 Such optimistic view was challenged by a severe economic contraction in the recent global financial crisis. Such aggressive policy rate reductions are certainly needed to mitigate the economic downturn. Still, we need to recognize some facts in an extremely low interest rate environment. First, when short-term nominal interest rates come down to an extraordinarily low level, the smooth functioning of interbank money markets is undermined and the margin for financial institutions is also reduced. As a result, incentives to extend loans at financial institutions are weakened, resulting in the diminished monetary easing effects. 32 Second, protracted low interest rates play an important role in preventing an economic downturn, but, at the same time, they tend to delay adjustment in excesses accumulated during the period of bubble expansion. In addition, they also tend to delay the rejuvenation of businesses. 33 Third, expectations about the continuation of low interest rates for a considerable period into future are a necessary condition for a bubble. A bubble does not emerge just from easy monetary policy alone, and, at the same time, it does not emerge without expectations about the continuation of easy monetary policy. In any event, the productivity trend after the burst of a bubble is one of the key factors in defining the macroeconomic performance. If a shock hitting the economy is huge, but temporary, and the natural rate of interest does not decline so much, policy commitment to continuing low interest rates produce certain easing effects through intertemporal substitutions. But, otherwise, policy commitment cannot be effective enough. The comments just I made do not deny the necessity of aggressive policy rate reductions after the burst of a bubble at all. My main point here is that we need to pay more attention to the effects of financial market dynamics caused by behavioral economics elements of market participants. Let me turn to another line of research I think important, that is, unconventional monetary policy. As I discussed earlier, unconventional monetary policy was highly effective against the “acute pains” in the recent financial crisis. We invented various unconventional policy For the importance of revisiting the philosophy behind central bank policy and independence of a central bank in democratic society, not just for monetary policy making, see Shirakawa (2010a, b). See Greenspan (2002), and Mishkin (2007). See Bernanke (2010), and BOE (2009). BIS (2010) points out such possibility. See also Rajan (2010). measures out of necessity. Nevertheless, it is difficult to say that we have a reliable theoretical basis for such policy. We had no choice to “think while running” in formulating such unconventional policy measures. In that sense, I have the impression that it is the translation of accumulated “tacit knowledge” within central banks into practice. 34 Central banks thus need to make efforts to transform their “tacit knowledge” into “explicit knowledge.” Through the experience of the recent crisis, I fully recognize that liquidity and counterparty risk are the two most important concepts in conducting a study on unconventional monetary policy. In the recent crisis, various unconventional measures, such as dollar funds-supplying operations and outright purchase of CPs, produced substantial effects. That suggests the necessity of further deepening our understanding of liquidity and counterparty risks. In particular, we need to explore the essential conditions for the smooth functioning of financial markets, especially short-term money markets and foreign exchange markets, with consideration of the behavioral characteristics of market participants and the market microstructure. We thus need to make use of such studies in various activities of central banking, ranging from daily operations to system designs for money market operations, payment and settlement systems, and financial regulation. In closing, I am sure discussions at this conference will be constructive and meaningful. Thank you. For example, Saito, Suzuki, and Yamada (2010) show that markets are able to create collateral assets (relatively safe bonds) in a crisis endogenously by using a model in which a country-specific catastrophic shock was shared between two countries in the presence of solvency constraints. They then discuss a possibility that such endogenous creation of collateral assets in a crisis can be interpreted as a central bank intervention against a crisis. References Ahearne, Alan G., Joseph E. Gagnon, Jane Haltmaier, Steven B. Kamin, Christopher Erceg, Jon Faust, Luca Guerrieri, Carter Hemphill, Linda Kole, Jennifer Roush, John Rogers, Nathan Sheets, and Jonathan Wright, “Preventing Deflation: Lessons from Japan’s Experience in the 1990s,” International Finance Discussion Papers, 2002-729, Board of Governors of the Federal Reserve System, 2002. Bank for International Settlements, “80th Annual Report,” 2010. Bank of England, “Minutes of the Monetary Policy Committee Meeting March 4 and 5, 2009,” 2009. Bean, Charles, Matthias Paustian, Adrian Penalver, and Tim Taylor, “Monetary Policy after the Fall,” Paper presented at the Federal Reserve Bank of Kansas City’s Annual Economic Symposium, August 28, 2010. Bernanke, Ben S., “Reflections on a Year of Crisis,” Speech at the Federal Reserve Bank of Kansas City’s Annual Economic Symposium, August 21, 2009. ________, “The Economic Outlook and Monetary Policy,” Speech at the Federal Reserve Bank of Kansas City’s Annual Economic Symposium, August 27, 2010. Bullard, James, “Seven Faces of “The Peril”,” Federal Reserve Bank of St. Louis Review September-October Issue, 2010. Fujiwara, Ippei, Yasuo Hirose, and Mototsugu Shintani, “Can News Be a Major Source of Aggregate Fluctuations? A Bayesian DSGE Approach,” IMES Discussion Paper Series E-16, Bank of Japan, 2008. Gagnon Joseph, Matthew Raskin, Julie Remache, and Brian Sack, “Large-Scale Asset Purchases by the Federal Reserve: Did They Work?” Federal Reserve Bank of New York Staff Report No. 441, 2010. Greenspan, Alan, “Do Efficient Financial Markets Mitigate Financial Crises?” Speech before the 1999 Financial Markets Conference of the Federal Reserve Bank of Atlanta, October 19, 1999. ________, “Opening Remarks,” Speech at the Federal Reserve Bank of Kansas City’s Annual Economic Symposium, August 29, 2002. Hayashi, Fumio, and Edward C. Prescott, “The 1990s in Japan: A Lost Decade,” Review of Economic Dynamics, 5, 2002, pp. 206–235. Joyce, Michael, Ana Lasaosa, Ibrahim Stevens and Matthew Tong, “The Financial Market Impact of Quantitative Easing,” Bank of England Working Paper No. 393, 2010. Kimura, Takeshi, Takeshi Shimatani, Kenichi Sakura, and Tomoaki Nishida, “The Role of Money and Growth Expectation in Price Determination Mechanism,” Bank of Japan Working Paper (forthcoming), 2010. Krugman, Paul R., “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity, 2, 1998, pp. 137–187. Kuroda, Sachiko, and Isamu Yamamoto, “Wage Fluctuations in Japan after the Burst of the Bubble: Downward Nominal Wage Rigidity, Payroll, and the Unemployment Rate,” Monetary and Economic Studies, 23 (2), 2005, pp.1–30. Mishkin, Frederic S., Monetary Policy Strategy, The MIT Press, 2007. Nakakuki, Masayuki, Akira Otani, and Shigenori Shiratsuka, “Distortions in Factor Markets and Structural Adjustments in the Economy,” Monetary and Economic Studies, 22 (2), Institute for Monetary and Economic Studies, Bank of Japan, 2004, pp. 71–99. Nakaso, Hiroshi, “The Financial Crisis in Japan during the 1990s: How the Bank of Japan Responded and the Lessons Learnt,” Bank for International Settlements Papers, 6, 2001. Okina, Kunio, Masaaki Shirakawa, and Shigenori Shiratsuka, “The Asset Price Bubble and Monetary Policy: Experience of Japan’s Economy in the Late 1980s and its Lessons,” Monetary and Economic Studies, 19 (S-1), Institute for Monetary and Economic Studies, Bank of Japan, 2001, pp. 395–450. ________, and Shigenori Shiratsuka, “Asset Price Bubbles, Price Stability, and Monetary Policy: Japan’s Experience,” Monetary and Economic Studies, 20 (3), Institute for Monetary and Economic Studies, Bank of Japan, 2002, pp. 35–76. Posen, Adam S., Restoring Japan’s Economic Growth, Institute for International Economics, 1998. ________, “Getting Credit Flowing: A Non-Monetarist Approach to Quantitative Easing,” Speech at CASS Business School, London, October 26, 2009. ________, “The Realities and Relevance of Japan’s Great Recession: Neither Ran nor Rashomon,” Peterson Institute for International Economics Working Paper Series 10–7, 2010. Rajan, Raghuram G., Fault Lines, Princeton University Press, 2010. Reinhart, Carmen M., and Vincent R. Reinhart, “After the Fall,” Paper presented at Jackson Hall Conference, 2010. ________, and Kenneth Rogoff, This Time is Different: Eight Centuries of Financial Folly, Princeton University Press, 2009. Rogoff, Kenneth, “Japan’s Slow-Motion Crisis,” Commentary at Project Syndicate, March 2, 2010. Saito, Makoto, Shiba Suzuki, and Tomoaki Yamada, “Can Cross-Border Financial Markets Create Endogenously Good Collateral in a Crisis?,” IMES Discussion Paper Series, No. 2010–E–19, 2010. Shirakawa, Masaaki, “Way out of Economic and Financial Crisis: Lessons and Policy Actions,” Speech at Japan Society in New York, April 23, 2009 (available at http://www.boj.or.jp/en/type/press/koen07/ko0904c.htm). ________, “Revisiting the Philosophy behind Central Bank Policy,” Speech at the Economic Club of New York, April 22, 2010a (available at http://www.boj.or.jp/en/type/press/koen07/ko1004e.htm). ________, “Future of Central Banks and Central Banking,” Opening Speech at 2010 International Conference hosted by the Institute for Monetary and Economic Studies, Bank of Japan, May 26, 2010b (available at http://www.boj.or.jp/en/type/press/koen07/ko1005a.htm). Ugai, Hiroshi, “Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses,” Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, 25(1), 2007, pp. 1–48.
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Summary of a speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Sapporo, 28 July 2010.
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Hidetoshi Kamezaki: Recent economic and financial developments in Japan Summary of a speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Sapporo, 28 July 2010. * I. The economy and prices A. The current economic situation * * Following the precipitous deterioration in the wake of the Lehman shock in the fall of 2008, Japan’s economy, since bottoming out in spring 2009, has been showing signs of a moderate recovery. The main driving force of the recovery has been improvement in overseas economic conditions, as a result of which Japan’s exports and production have been increasing, while business fixed investment is showing signs of picking up. Moreover, the government’s economic stimulus measures favoring environment-friendly products have contributed significantly to the pick-up in private consumption. Overseas economies have continued to recover moderately, underpinned by the effects of both stimulus measures adopted around the world and inventory restocking. Looking at developments by region, the Chinese economy has continued to manifest high growth, supported by the surge in fixed asset investment spurred by a large stimulus package of 4 trillion renminbi, although recently the pace of growth has slowed somewhat. The U.S. economy has been recovering at a moderate pace, supported by a massive stimulus package of 780 billion U.S. dollars. European economies overall are also picking up – although there are some differences across countries – led by increases in exports and production partly due to a decline in their currencies. Recovery in the euro area, however, has been weaker than in other regions because stimulus measures adopted in the region were relatively small in scale, economic structures lack flexibility, and credit uncertainty triggered by the fiscal problems in Greece remains. Against this background, Japan’s exports to all regions continued to increase. This has brought about production growth, led business fixed investment to pick up and caused household income to stop declining. The key elements of the government’s economic stimulus measures favoring energy-efficient products are the eco-point system for electrical appliances, as well as tax reductions and subsidies for purchases of environment-friendly cars. These measures, together with the greatly improved cost performance of the products, the switchover from analogue to digital terrestrial broadcasting, and the extended lifespan of automobiles, have tapped potential replacement demand and had a significant positive effect on the sales of products covered by these measures. In addition, it seems that the measures have provided consumers with an incentive to visit retail stores and encouraged them to purchase products to which the stimulus measures do not apply, such as DVD recorders that are compatible with flat-panel TVs and the latest home cleaning robots. This increase in spending on durable consumer goods has had a positive effect on the economy by increasing production. In sum, Japan’s economy has been supported by two major engines of growth, namely, the improvement in overseas economic conditions and the government’s economic stimulus measures favoring environment-friendly products. However, because the recovery remains weak in areas that have not directly benefited from these developments, many people have yet to feel that the economy overall is recovering. Moreover, although Japan’s economy enjoyed relatively high growth of around 5 percent at an annualized rate from the end of 2009 through the beginning of 2010, the level of economic activity remains lower than before the Lehman shock. It is, thus, too early to say that a self-sustaining upturn in domestic private demand is fuelling a robust recovery. B. The economic outlook Next, I will talk about the outlook for Japan’s economy. The effects of the two factors that have so far been the engines of economic growth are likely to weaken. Specifically, overseas economies, including those that currently are growing at a rapid pace, seem likely to slow to more steady and sustainable rates of growth as the effects of inventory restocking and stimulus measures abate. The uptrend in Japan’s exports is expected to continue, but the pace of increase is likely to moderate gradually. Durable goods consumption is expected to fall temporarily in reaction to the termination of the government’s economic stimulus measures favoring energy-efficient products: subsidies for purchases of environment-friendly cars expire at the end of September, while the eco-point system for electrical appliances expires at the end of December. New factors should be taken into account, however. For example, the government’s child allowances, which started in June, are expected to help support private consumption. Moreover, business fixed investment and household income are likely to pick up, reflecting an improvement in the capacity utilization rate and in corporate profits. Supported by these factors, Japan’s economy should assume a moderate recovery trend. The outlook I just presented, however, is subject to various upside and downside risks. One upside risk is that growth in emerging and commodity-exporting economies might accelerate. Recently, a growing number of emerging and commodity-exporting economies have been shifting away from accommodative monetary policies, while in China, the government has implemented measures to curb the overheating of the real estate market. However, if capital from industrialized economies – which are persisting with accommodative monetary policies – continues to flow into these countries and thereby exacerbates overheating in asset markets, it could boost growth. These developments could then pose an upside risk to Japan’s economy by means of an increase in exports. Such developments would not be wholly desirable since overheating in emerging and commodity-exporting economies would inevitably lead to a tightening of policies, which might then pose a downside risk to Japan’s economy. When considering downside risks, the growing instability in global financial markets warrants attention. The fiscal problems in Greece and some other European countries will not only lead to a deterioration in domestic demand in these countries as a result of fiscal austerity measures, but also exert downward pressure on European economies as a whole in a number of ways. These include fiscal consolidation in other countries, as they attempt to avoid a similar fate; the weakening of the financial intermediary function of financial institutions that own sovereign debt issued by countries stricken by the crisis; and a decline in the propensity to consume, as a result of uncertainties surrounding overall markets. The direct impact on Japan’s economy is likely to be minimal, as its lending to countries in the region is inconsiderable, while exports to Europe account for only about 10 percent of the total. However, for China and the United States – the major destinations of Japanese exports – Europe accounts for about 20 percent of exports and Japan could, therefore, be indirectly affected. Furthermore, it is necessary to be aware of downside risks, stemming from the effects of the yen’s appreciation against the euro, on Japan’s export competitiveness, as well as the impact of financial market instability on firms’ funds procurement. C. Price developments I will now move on to prices. Commodity prices, which have a major impact on price developments in Japan, have been on a rising trend, reflecting high growth in emerging economies. As a result, recent import prices have been about 10 percent above year-ago levels, after having plunged more than 30 percent year on year in summer 2009. In addition, the domestic corporate goods price index (CGPI), which measures fluctuations in prices of goods traded between firms in Japan, has risen somewhat above levels for the same period a year ago. The consumer price index (CPI) excluding fresh food (the core CPI), which measures the price of goods and services purchased by households, has been declining on a year-on-year basis since March 2009, indicating deflation. However, following the largest year-on-year decline of 2.4 percent in August 2009, the pace of decline has been moderating as a trend. Meanwhile, the pace of decline in the CPI excluding food and energy, or the core-core CPI, which is not usually susceptible to commodity price fluctuations, has also been moderating recently, after marking the largest fall of 1.2 percent at the beginning of 2010. These developments, apart from the rise in commodity prices, probably occurred because the Japanese economy bottomed out and started recovering around spring 2009, and the effects of the narrowing of the negative output gap began to be reflected in prices with a lag of about one year. The year-on-year rate of decline in the core CPI is likely to continue slowing, reflecting the rise in commodity prices and the narrowing of the negative output gap, and the rate of change in the CPI may even enter positive territory in fiscal 2011. There are, needless to say, both upside and downside risks associated with the outlook for prices, just as for economic activity. The upside risks include an upswing in commodity prices caused by stronger-than-expected growth in emerging economies. On the other hand, price developments could deviate downward from the outlook if pessimism among the public spreads due to a slower-than-expected recovery of the economy. A decline in the medium- to long-term inflation expectations of various economic entities could trigger a fall in the actual inflation rate. Thus, risks associated with price developments require careful monitoring. II. Measures taken by the Bank Next, I will elaborate on the Bank’s policy measures since the start of the recent global financial crisis. A. Measures to address the rapid financial contraction In order to address the rapid financial contraction triggered by the failure of Lehman Brothers, the Bank successively conducted same-day funds-supplying operations and introduced U.S. dollar funds-supplying operations as emergency measures to provide liquidity for financial markets. Furthermore, the Bank decided to introduce outright purchases of CP and corporate bonds, based on the recognition that a significant decline in the functioning of markets, such as the serious shortage of liquidity in the CP and corporate bond markets, was causing a tightening of overall corporate financing conditions. In addition, the Bank introduced a series of temporary emergency measures to facilitate corporate financing, including the easing of the rating requirement for corporate debt to be accepted as eligible collateral and the special funds-supplying operation to facilitate corporate financing, through which the Bank provided 3-month funds for an unlimited amount against the value of corporate debt pledged as collateral at a fixed interest rate of 0.1 percent. Furthermore, in order to ensure an accommodative financial environment, on both October 31 and December 19, 2008, the Bank reduced the target level of the policy interest rate (the uncollateralized overnight call rate), bringing it down from 0.5 percent to the current 0.1 percent. In order to provide ample liquidity through maintaining the policy interest rate at this low level, the Bank also introduced the complementary deposit facility, whereby interest is made payable on excess reserve balances held at the Bank by financial institutions. At the same time, the Bank introduced temporary measures to secure the stability of the financial system, given that the strains in global financial markets and the subsequent fall in stock prices and rise in credit costs had greatly affected financial institutions’ intermediary function and financial soundness. Such measures include the purchase of stocks held by financial institutions to help them reduce the market risk associated with stock holdings and the provision of subordinated loans to banks to help them maintain sufficient capital bases. Since then, the Bank has been gradually bringing to an end some of its temporary measures as financial markets have regained stability. In May 2010, however, in order to address the increased strains in global financial markets triggered by the fiscal problems in Greece and some other European countries, the Bank re-established the U.S. dollar funds-supplying operations that had been wound up at the beginning of February 2010. B. Measures to address deflation Although financial markets have been gradually regaining stability and the economy is showing signs of a moderate recovery, the Bank recognizes that Japan’s economy still faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. For this reason, the Bank reiterated its commitment to fight deflation. Regarding the “understanding of medium- to long-term price stability” (the level of inflation that each Policy Board member understands, when conducting monetary policy, as being consistent with price stability over the medium to long term; hereinafter “understanding”), the Bank, at the Monetary Policy Meeting held in December 2009, made it clear that the Policy Board does not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent, and that the midpoints of most Policy Board members’ “understanding” are around 1 percent. On this basis, the Bank continues to maintain the policy rate at the extremely low level of 0.1 percent. Moreover, in order to ease monetary conditions further by encouraging a decline in longer-term interest rates, the Bank in December 2009 introduced a new fixed-rate fundssupplying operation against pooled collateral (hereinafter fixed-rate operation), whereby funds with a maturity of three months are provided at an extremely low interest rate of 0.1 percent. The total amount of loans to be provided through the fixed-rate operation was first set at approximately 10 trillion yen in December 2009, but this was increased to approximately 20 trillion yen in March 2010. C. Introduction of the fund-provisioning measure to support strengthening the foundations for economic growth Through the measures I have mentioned so far, the Bank has been providing ample funds to financial markets and financial institutions. However, the funds have not been sufficient to feed into the economy and bring about strong growth. Therefore, as the central bank, the Bank examined ways in which it could support financial institutions, in their efforts in terms of lending and investment, in a way that would help strengthen the foundations for economic growth. As a result of deliberations, the Bank on June 15, 2010, decided to introduce a new fund-provisioning measure to strengthen the foundations for economic growth. The measure provides funds for financial institutions, reflecting their efforts in terms of lending and investment to strengthen economic growth at a loan rate equivalent to the Bank’s policy interest rate, which currently is only 0.1 percent. The duration of each loan provided by the Bank is one year in principle, and the maximum duration of the loans is four years, including rollovers. With this measure, the Bank hopes to offer the broadest support possible for the various efforts that financial institutions make on their own initiative. The Bank will start providing funds by around the end of August 2010 and new loans will be disbursed quarterly. The measure is temporary and the Bank set March 31, 2012, as the deadline for new loan applications, so that financial institutions would accelerate their implementation of lending and investment. The Bank has already started making necessary preparations to provide funds through this measure. On June 25, the Bank announced it had selected 66 counterparty financial institutions for fund-provisioning through public application. Not only major banks, but also a wide range of other financial institutions, including regional banks, became counterparties. Each counterparty submitted its plan for strengthening the foundations for economic growth to the Bank, which is currently evaluating each counterparty’s eligibility based on the amount of lending and investment carried out under the plan in the April-June quarter of 2010. Based on the evaluation, the Bank will determine how much it will lend in its first disbursement. Let me next explain the background to the Bank’s decision to introduce this fund-provisioning measure. III. Strengthening the foundations for economic growth A. Deflation As I mentioned earlier, Japan is experiencing deflation. Price instability, including deflation, has various negative effects on the economy and society. For instance, it reduces the efficiency of resource allocation, restrains economic activity by making economic outlook uncertain, and distorts income distribution by changing the real value of contracts, assets and liabilities, which are typically in nominal terms. In addition, there are problems particular to deflation. For example, it has been pointed out that debtors with a high propensity to consume tend to restrain their spending when the real value of their debt rises, weighing down the economy. In addition, due to the zero bound on nominal interest rates, real interest rates do not fall to the level required by the level of economic activity. Declining inflation rates are a trend shared by all major economies around the world. It is only in Japan, however, that prices in terms of the CPI excluding food and energy (the corecore CPI) have been falling. The main reason for this is the large output gap, which has remained consistently negative since the second half of the 1990s. What is more, the gap has been much larger than in other major economies. This is attributable to the excess supply capacity that has not been adequately adjusted relative to the level of domestic demand, which has stayed sluggish since the bursting of the economic bubble. Weakness in domestic demand was prolonged by the delay in balance-sheet adjustments by various economic entities and the lack of forward-looking expenditure since the bursting of the economic bubble. In particular, the delay in the disposal of impaired assets by financial institutions weakened their financial intermediary functions, impairing their ability to provide sufficient funds for new areas of growth. The pressure on various economic entities to adjust their balance sheets has more or less disappeared since the beginning of 2000. However, the prolonged period of weak domestic demand has been compounded by the recent onset of population decline, pushing down economic entities’ expectations for economic growth and forestalling forward-looking expenditure. The Lehman shock in 2008 dealt another serious blow to demand and its impact continues to this day. One reason that supply capacity has not been sufficiently adjusted despite stagnant demand is that, as a result of various regulations and protection measures, factors of production have remained in areas from which demand has shifted away. There is a possibility that inflation expectations will lessen if expectations for future economic growth continue to decline and the output gap does not narrow steadily. In this case, consumers of goods and services may put off spending, while suppliers may cut prices further to stimulate demand. Under these circumstances, although the output gap remains unchanged, prices may fall further and deflation may become even more difficult to quell. At present, medium- to long-term inflation expectations remain stable and it is important to make sure that they do not decrease. B. Overcoming deflation In order for Japan’s economy to overcome deflation, it is necessary to narrow the negative output gap. To this end, demand has to be expanded. The task is not impossible and there are various areas with potential demand to be tapped, such as sectors related to the provision of healthy and safe food, the environment, and population aging. An example of such latent demand is the recent government measures that sharply increased demand for environment-friendly durable goods. Needless to say, it is also important to follow developments in overseas demand. As I mentioned earlier, economic growth in emerging and commodity-exporting economies has been astounding, and it is very likely that their demand for Japanese goods and services still has much room for growth. The issue at stake is how to tap such demand. The government’s “New Growth Strategy” and “Fiscal Management Strategy,” both announced in June, may provide some pointers. The “New Growth Strategy” aims to create a strong Japanese economy on the basis of the measures for demand creation that I just mentioned, together with steps to overcome constraints on the supply of goods and the circulation of funds to be implemented in accordance with a specific timetable. The “Fiscal Management Strategy,” meanwhile, aims to restore a sound and sustainable fiscal structure in a way that is consistent with the “New Growth Strategy.” In any event, it is vital that these measures be implemented swiftly and on schedule. Moreover, private economic entities, in addition to tapping new areas of demand, need to improve productivity through new manufacturing technology and by shifting capital and labor to areas with higher productivity. The “New Growth Strategy” can support such efforts. It could be argued that higher productivity will increase supply, which would cause a further widening of the output gap. However, it should be pointed out that higher productivity would raise the demand for products of highly productive firms and workers; that the anticipation of such an increase in future demand would raise current demand; and that, thus, the efficiency of resource allocation could be improved, which in turn would expand demand overall. The Industrial Revolution in Britain provides evidence of the pivotal role played by increased productivity in a nation’s growth. During the Industrial Revolution in the early nineteenth century, the Luddite movement emerged in which workers destroyed machines that deprived them of their jobs. Mechanization, however, increased productivity and enhanced Britain’s growth potential, paving the way for the subsequent ascendancy of the British Empire. There is no doubt that enhancing productivity is indispensable for Japan given the aging and decline of the population. While it will be difficult to avoid the problems arising from a declining population in the short term, increased productivity can help to avoid a decline in the potential growth rate and maintain the vitality of the Japanese economy. C. Measures taken by the Bank The fund-provisioning measure to support strengthening the foundations for economic growth introduced by the Bank on June 15, 2010, aims to support private financial institutions’ efforts of their own accord to provide funds required by private economic entities to find new demand and enhance productivity. It is hoped that the move will help to increase potential output growth, narrow the output gap, and eventually bring deflation to an end. In this sense, the measure is consistent with the principle stipulated in Article 2 of the Bank of Japan Act that the Bank will aim at “achieving price stability, thereby contributing to the sound development of the national economy.” Instead of merely expressing the objective in words, the Bank is taking action in the belief that this policy will work as a catalyst for private economic entities to join in to achieve a common goal. I am constantly aware that the Bank always must be ready to proactively implement the appropriate policies. Going forward, the Bank should continue to be proactive and do its utmost to bring Japan’s economy back to a sustainable growth path with price stability.
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 27 September 2010.
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Masaaki Shirakawa: Japan’s economy and monetary policy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 27 September 2010. * * * Introduction I am privileged to be here today to speak and exchange views with business leaders from the Kansai region. I would like to take this opportunity to express my deep gratitude to you for your cooperation with the Bank of Japan’s branches in Osaka, Kobe, and Kyoto. At present, the greatest concern for the time being for you as business leaders must be the recent appreciation of the yen and its impact on Japan’s economy. Before we exchange views, I will first outline developments in the global economy and associated trends in the foreign exchange markets. I will then speak about Japan’s economic situation and the Bank’s thinking on monetary policy. I. Developments in the global economy I will start with developments in the global economy. Since the spring of 2009, the global economy, driven particularly by emerging economies, has continued to grow at about 5 percent on an annual basis. While it is natural to have high growth rates as the global economy has been recovering from the plunge following the Lehman shock, the growth rate figures have substantially exceeded the average annual growth rate of 3.9 percent over the 10 years prior to the Lehman shock. However, the pace of growth has slowed somewhat recently, partly because the effects of various demandboosting policy measures introduced in response to the financial crisis in the advanced economies of the United States and Europe have started to recede and emerging economies have been shifting away from accommodative monetary policies. In the United States, while production continues to increase on the back of buoyant exports, concern has increased about a possible slowdown in the U.S. economy as many indicators related to domestic demand, especially indicators of private consumption and housing, have been pointing since the second half of July to a slower economic recovery. Economic activity in the euro area is recovering moderately as a whole, but economic disparities in the area have widened: while exports and production in the main economies, especially Germany, have been boosted by the depreciation of the euro, economic growth in peripheral countries such as Greece has been sluggish as both the public and private sectors are mired in excessive debt. Meanwhile, emerging economies are growing robustly. In this situation, many emerging countries have been moving away from accommodative monetary policies as they seek to contain economic overheating and follow more sustainable economic growth paths. Although the rate of global economic growth is still at a high level, it has been slowing. Nevertheless, the global economy’s recovery trend appears to remain intact. The International Monetary Fund forecasts that the global economy will continue to achieve growth rates of over 4 percent in the coming years, projecting growth of 4.6 percent in 2010 and 4.3 percent in 2011. Nevertheless, the Bank considers that, regarding the outlook, the downside risks to the U.S. and European economies and their potential impact warrant more attention. The U.S. economy is burdened by balance-sheet adjustments similar to those experienced in Japan following the collapse of the bubble. Therefore, it has become more difficult for it to grow but easier for it to deteriorate. Federal Reserve Board Chairman Ben S. Bernanke has also expressed the view that the U.S. economy would continue to expand in the second half of 2010, albeit at a relatively modest pace, and it was reasonable to expect some pickup in growth in 2011. He also stated that macroeconomic projections were inherently uncertain, and the U.S. economy remained vulnerable to unexpected developments. II. Developments in the foreign exchange markets Bearing these global economic developments in mind, we can now turn to the recent developments in the foreign exchange markets. Looking back at movements in the U.S. dollar-yen exchange rate, the yen traded at around 90 yen against the U.S. dollar until the middle of 2010, but then appreciated since August and temporarily reached the range of 82–83 yen. The key factor behind the appreciation appears to be heightened uncertainty about the outlook for the global economy, particularly the U.S. economy. Until around the spring of 2010, there were discussions in the United States on how to make the shift away from the accommodative monetary policies put in place after the financial crisis. However, as indicators suggesting the weakness in the U.S. economy have been released successively since the summer, as I mentioned earlier, the discussions about monetary policy exit strategies have been put on hold. In these circumstances of heightened uncertainty over the global economy, investors worldwide have increasingly avoided risks and purchased currencies that are considered to be relatively safe. For example, since July, the yen has risen by 3 percent, and the Swiss franc by 8 percent, against the U.S. dollar. Moreover, the yen has appreciated not only against the U.S. dollar and the euro but also against fellow East Asian currencies: for example, it has traded at levels close to its record high against the Korean won. Needless to say, the appreciation of the yen weighs directly on the profits and profitability of exporting firms. And in the current situation, it can also significantly affect business sentiment and consequently the outlook for Japan’s economy, by increasing uncertainty over the global economy. In these circumstances, an intervention was conducted in the currency markets for the first time in six and a half years. The Japanese government has made it clear that it will continue to pay due attention to developments in the foreign exchange markets, and will take decisive actions, including interventions, if it deems it necessary. Likewise, the Bank also has great interest in and will pay close attention to developments in the foreign exchange markets and their impact. III. Developments in and medium- to long-term challenge for Japan’s economy Developments in Japan’s economy I will now move on to economic activity and prices in Japan. The Bank assesses that Japan’s economy shows further signs of a moderate recovery. Exports and production continue on an increasing trend, albeit at a slower pace compared with the pace of increase of more than 20 percent per year that had been seen since the spring of 2009. As for domestic private demand, business fixed investment is showing signs of picking up, albeit at a low level, as corporate profits continue to steadily improve. The employment and income situation remains severe, but the degree of severity has eased somewhat as the number of employees and wages have increased slightly. Private consumption has been picking up. Particularly, buoyed by the effects of the extremely hot summer this year, sales at convenience stores, especially of beverages, have been increasing recently, as have sales of air conditioners supported by the eco-point system. And as you know, there was also a last-minute increase in demand for automobiles ahead of the expiration of subsidies for purchasing energy-efficient cars. As for the outlook, the pace of economic improvement is likely to slow for the time being due to the ending of the boost from the extremely hot summer and to the absence going forward of the recent last-minute increase in demand for durable consumer goods. Looking back, partly because Japan experienced the sharpest economic downturn among advanced economies following the financial crisis in the fall of 2008, Japan’s economy subsequently recovered at the fastest pace. In any event, as factored into the forecasts presented in the Outlook for Economic Activity and Prices released in April, the Bank has been fully aware that the pace of economic recovery is likely to slow over the second half of fiscal 2010 as inventory restocking runs its course and the effects of policy measures wane. However, it should be noted that in Japan, unlike in the United States and Europe, balance-sheet adjustments are not weighing on the economy and both financial markets and the financial system are stable. This suggests that an accommodative financial environment has been in place to support the economic activity of firms and households. Given this, assuming that overseas economies maintain their moderate recovery, the trend of recovery itself in Japan is not likely to be interrupted. On the price front, the year-on-year decline in the consumer price index (CPI) reached a record level of 2.4 percent in the summer of 2009 and has been moderating gradually thereafter. The decline has recently slowed to around 0.6 percent, if the effects of subsidies for high school tuition are excluded. The pace of decline is expected to continue to slow as the economy follows a recovery path and the aggregate supply and demand balance improves. The outlook I have just described is the Bank’s baseline scenario for economic activity and prices, but the Bank fully recognizes that this scenario contains a high degree of uncertainty. There is increasing uncertainty about the outlook for the global economy, especially the U.S. economy, and the foreign exchange and stock markets have been unstable. There is also a possibility that private consumption and production could decline substantially if the effects of the ending of the boost from the extremely hot summer and the absence going forward of the recent last-minute increase in demand for durable consumer goods such as automobiles are larger than expected. Based on these points, the Bank deemed it necessary to pay attention to the downside risks to Japan’s economic activity and prices. Medium- to long-term challenge confronting Japan’s economy I have outlined the current situation of Japan’s economy. At present, it shows further signs of a moderate recovery. But putting aside such short-term economic developments, what many people see as the greatest problem for Japan’s economy is that they do not have confidence in Japan’s medium- to long-term growth potential, or in other words, that they are finding it difficult to envisage a blueprint for growth. In fact, Japan’s economic growth rate is on a declining trend. Aside from the high-growth era when the average annual rate of economic growth was slightly below 10 percent, in the 1980s the average annual growth rate was around 4.5 percent, which exceeded the growth rates of other advanced economies. However, following the collapse of the bubble, Japan’s annual growth rate declined significantly to around 1.5 percent in the 1990s. It has then increased somewhat since the turn of the millennium, but the trend decline in the growth rate continues. In this situation, people will have lower expectations concerning future income growth and their spending and investment will be restrained, which will in turn lead to price declines. The deflation in Japan should be understood as a manifestation of the fundamental problem facing the economy, namely the decline in growth expectations. Even though Japan’s economic growth rate is trending downward, the GDP growth rate per worker, or, in other words, the productivity growth rate, has been 1.6 percent per year on average over the past decade. The rate has declined from earlier levels but exceeds the 0.8 percent level in European countries and is still comparable to the 1.8 percent level in the United States. At present, the percentage of the population aged 15 or older that is in employment, that is, the employment rate, is about 60 percent. If this rate declines further with the aging of the population, raising productivity will become an even more critical challenge. In attempting to raise productivity, it is important to recognize that, given the fierce global competition, doing so by cost reduction and improvement in cost structure alone has its own limits for the economy as a whole. For example, about 90 percent of the CPI inflation differential between Japan and the United States in the past 10 years was attributable to the difference in the rate of decline in service prices. This appears to reflect the fact that, in Japan, nominal wages have been adjusted flexibly. Of course, cost reduction should be an important part of firms’ strategies to enhance competitiveness, and Japanese firms have achieved productivity rises through their drastic efforts to cut costs. However, in a situation where the population is declining and existing domestic markets are starting to shrink, it is essential to create new markets that can enable firms to enjoy high profits, in order to raise the productivity of Japan’s economy as a whole. On this point, one view is that exploring new areas and creating new added value should be part of firms’ growth strategies. These strategies of exploring new, uncontested market places are known as “blue ocean” strategies. The search for such “blue oceans” is essential for sustainable productivity growth. This can be achieved by private firms’ innovative efforts and financial institutions’ support in the form of providing funds for such efforts. The policy authorities also play an important role in creating such an environment. The Japanese government is making efforts to achieve its growth strategies for Japan’s economy and I expect that they will be implemented steadily in the future. At the same time, the Bank has been considering ways to contribute to raising Japan’s growth potential by making use of the central bank’s functions. As a result, in June 2010 the Bank decided to introduce a new fund-provisioning measure to support efforts to strengthen the foundations for economic growth. IV. Thinking behind monetary policy Let me now explain the Bank’s thinking behind the conduct of monetary policy. As I mentioned earlier, Japan’s economy faces the cyclical challenge of returning to a sustainable growth path with price stability and the medium- to long-term challenge of overcoming the trend decline in the growth rate. The Bank, while keeping in mind these two challenges, conducts monetary policy with a focus on the following three points. First, pursuing powerful monetary easing. The Bank has lowered the policy interest rate to 0.1 percent, virtually zero. It also introduced a new funds-supplying operation, which is called the “fixed-rate operation,” and by substantially increasing the amount of funds provided through the operation, has been encouraging a decline in market interest rates and further enhancing and spreading accommodative monetary conditions. Second, ensuring financial market stability. If financial institutions face difficulty in smoothly raising funds from the markets, they excessively restrain their lending and other financial activities, and this in turn seriously affects economic activity. The Bank will continue to fulfill its critical role of ensuring financial market stability. And third, supporting efforts to strengthen the foundations for economic growth. As I mentioned before, in June 2010 the Bank introduced a new fund-provisioning measure through which it will provide long-term funds at a low interest rate to private financial institutions that are making efforts in terms of lending and investment to strengthen the foundations for economic growth. At the beginning of September, the Bank conducted the first loan disbursement through the measure, providing 47 financial institutions with a total of 462.5 billion yen. The Bank anticipates that the measure will act as a catalyst to further stimulate private firms’ efforts to strengthen the foundations for economic growth. The number of financial institutions that intend to participate in the fund-provisioning measure to make efforts to strengthen the foundations for economic growth has exceeded 100. In addition, with the introduction of the measure, a considerable number of financial institutions established new dedicated funds as well as investment and lending schemes. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. To this end, the Bank will continue to consistently make the utmost contributions as a central bank with a focus on the three points that I have just mentioned: pursuing powerful monetary easing, ensuring financial market stability, and supporting efforts to strengthen the foundations for economic growth. From the second half of 2009 to the first half of 2010, during which time the global economy posted relatively high growth, based on the experience after the collapse of the bubble in Japan the Bank made a very conservative judgment that, as balance-sheet adjustments were weighing on the U.S. and European economies, the pace of recovery in the global economy was likely to remain moderate and downside risks were prone to increase. As such, the Bank is the only central bank among advanced economies that has further enhanced monetary easing since December 2009. The Bank has also introduced a new measure to support efforts to strengthen the foundations for economic growth. As these initiatives suggest, the Bank has been actively introducing various new measures to support Japan’s economy from the financial side, aiming to overcome deflation and return to a sustainable growth path with price stability. The Bank will continue to carefully consider the outlook for economic activity and prices, and, if it deems it necessary, will take policy actions in a timely and appropriate manner upon considering the effects and side-effects of various policy measures.
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2010 Institute of International Finance IIF Annual Membership Meeting, Washington DC, 10 October 2010.
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Masaaki Shirakawa: Economic policy challenges lying ahead – two years after the crisis Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2010 Institute of International Finance (IIF) Annual Membership Meeting, Washington DC, 10 October 2010. * I. * * Introduction I am honored to be invited today to address the Annual Membership Meeting of the Institute of International Finance. I wondered how I would be able to contribute most to discussions at this meeting without overlapping other participants’ presentations, and I decided to talk about economic policy challenges lying ahead, especially monetary policy challenges, with consideration of Japan’s experience. In fact, there are increasing discussions in the United States recently as to whether the United States will fall into “deflation in the Japanese style” or the “lost decade like Japan”. In Japan, CPI inflation reached its peak of 3.3 percent in January 1991 soon after the burst of the bubble, started declining shortly thereafter, and turned negative in 1998 (Chart 1). When overlaying U.S. CPI inflation from 2007 on Japanese CPI inflation after the burst of the bubble, we find a striking similarity in the inflation developments between them. Looking at the growth in bank lending, the pace of the declines in the United States and European countries is much faster than that in Japan. Of course, I do not have the answer to the tough question I raised shortly before. Nevertheless, concerning Japan’s experience, I do not think that either way of thinking is appropriate: to fear a specter, nor to take Japan’s experience just as unique. The United States and European countries obviously have an advantage of learning from Japan’s experience. 1 Japan was a lonely forerunner. II. Japan’s economy after the burst of the bubble Let me begin by making a quick summary of Japan’s experience. First, it took fairly long to restore the full-fledged recovery path after the burst of the bubble (Chart 2). Japan started recovering in a full-fledged manner in 2003 long after the burst of the bubble in the early 1990s. Until then, Japan experienced two business cycle expansions and three contractions in the “lost decade”. Whenever some signs of recovery were observed in Japan, expectations that the economy would finally escape from stagnant conditions and enter a full-fledged recovery were rising. Based on such Japan’s experience, I attempted to draw public attention to the risk of falling into false optimism by using the phrase of a “false dawn”, when we first saw some signs of economic recovery in advanced economies in the spring of 2009. 2 For a comparison between Japan’s experience after the burst of the bubble and the U.S. and European experience in the recent financial crisis, see Shirakawa, Masaaki, “Uniqueness or Similarity? – Japan’s PostBubble Experience in Monetary Policy Studies –”, Keynote Address at Second IJCB Fall Conference hosted by the Institute for Monetary and Economic Studies, the Bank of Japan, September 16, 2010 (available at http://www.boj.or.jp/en/type/press/koen07/ko1009c.htm). See Shirakawa, Masaaki, “Way out of Economic and Financial Crisis: Lessons and PoliCY Actions”, Speech at Japan Society in New York, April 23, 2009 (available at http://www.boj.or.jp/en/type/press/koen07/ko0904c.htm). Second, the sharp contraction of economic activity after the burst of the bubble in Japan occurred when interbank funding markets became destabilized. That decline, however, was much smaller than those in many countries, including Japan, after the failure of Lehman Brothers in the fall of 2008. Looking at real GDP data, Japan recorded the largest decline by 1.9 percent in the first quarter of 1998, but, in the recent global financial crisis, even the United States, which showed the smallest decline after the failure of Lehman Brothers, registered the huge decline by 3.0 percent during the period from the fourth quarter of 2008 to the first quarter of 2009 (Chart 3). The two cases have the common trigger of an interbank market participant default. Third, Japan has experienced mild deflation, but has not experienced a deflationary spiral, by which I mean that a decline in prices induced a decline in economic activity, thereby leading to a further decline in prices. Consumer price inflation turned negative in 1998, and from 1997 to 2007, before the current crisis, it declined by 3.3 percent on a cumulative basis, and 0.3 percent on an annualized basis (Chart 4). Under mild deflation, however, Japan registered the longest recovery from 2002 to 2007, just in duration without considering its strength (Chart 5). Fourth, labor practice significantly influenced inflation developments. For example, about 90 percent of the difference in consumer price inflation between Japan and the United States is attributed to services prices, which are strongly influenced by developments in the labor market (Chart 6). Let me elaborate on the effects of labor practice on inflation developments in more detail. As inflation declined in Japan, wages tended to be set in a more flexible manner. Such flexibility in wage setting was attained not only through a reduction in bonus payments and an increase in the number of non-regular workers, but also the downward revision of fixed compensation for regular workers (Chart 7). Since the service sector is more labor-intensive than the manufacturing sector, flexible downward revisions of nominal wages caused declines in services prices, thereby inducing deflation. As you may be well aware, Japan experienced smaller increases in unemployment rates. Their flip side was mild deflation. Since the second half of the 1990s, management and labor in Japan have put priority on maintaining employment, and to do so, workers have accepted reductions in wages. By contrast, European countries had more rigidity in wage setting, and thus they were less likely to experience deflation at least in the short term, but needed to endure higher unemployment rates. Such differences in wage and employment developments in Japan and the European countries are the results of social choice after considering various costs, and do not necessarily imply whether one system is better than the other. Turning to the fifth and last point on Japan’s experience, demographic changes affected the Japanese economy significantly. Japan delivered a weaker performance in real GDP growth. At the same time, in terms of labor productivity growth, Japan still showed a comparable performance to the US, although Japan had lost a superior performance in the 1980s (Chart 8). Obviously, the differences between Real GDP growth and labor productivity growth reflect the declines in the workforce in Japan. In any event, in extracting implications from Japan’s “lost decade”, it is essential to analyze not only short-term aggregate demand movements but also changes in the potential growth trend, which is determined by productivity growth and demographic changes. III. Major and common challenges for advanced countries Then, what should we consider in mapping out near-term economic policies in each country? Of course, the answer to that question varies from country to country, depending on economic conditions. Based on Japan’s experience, I will offer my thoughts on major economic policy challenges that are common to advanced countries despite the differences in economic conditions. First, we definitely need to maintain financial system stability. Using the metaphor, the economy after the burst of a bubble can be divided into two phases: the phase of “acute pains” arising from the malfunctioning interbank money markets and the phase of “chronic illnesses” from balance-sheet adjustments after such acute pains recede. It is very important to stave off the acute pains, which are likely to trigger a sharp contraction of economic activity and potentially produce devastating effects on the economy. In May 2010, major central banks reintroduced dollar-fund supplying operations when dollar-funding markets showed signs of tension, again reflecting increased concern over sovereign debts problems in peripheral European countries. Such measure was implemented with consideration of the importance of maintaining the stability in interbank funding markets. Second, we need to continue with the unprecedented easy monetary policy, given the current economic conditions. In fact, many advanced countries have maintained very accommodative monetary policy. The Bank of Japan (BOJ) also decided recently to implement a comprehensive monetary easing policy in order to further enhance monetary easing. That included three measures: (i) clarification of maintaining virtually zero interest rates; (ii) clarification of the time horizon to maintain the virtually zero interest rate policy; and (iii) establishment of an asset purchase program to purchase various financial assets, such as government securities, commercial paper (CP), corporate bonds, exchange-traded funds, and real estate investment trusts and to conduct the fixed-rate funds-supplying operation against the pooled collateral. Third, we need to accept the fact that, once a country experienced a bubble, it will take fairly long to rise up from the bottom in the aftermath of the burst of a bubble, and restore the fullfledged recovery path, despite various unprecedented policy efforts. As Japan’s experience shows, it is the hard fact that the economy will be unable to achieve a strong recovery without resolving “excesses” accumulated during a bubble period. The form of “excesses” varies from country to country. In Japan, they were “three excesses” in the business sector: employment, production capacity, and debt (Chart 9). In that context, we sometimes hear an argument that “the delayed monetary policy responses caused the economic stagnation”. It is true that the BOJ failed to fully recognize the significant magnitude of adverse effects soon after the burst of the bubble, like other central banks. But it is also true that the BOJ carried out innovative monetary policy measures on a large scale as a pioneering effort. For example, the BOJ reduced the overnight interest rate to virtually zero in the second half of 1995, of which level corresponds to the current policy interest rates in the United States and European countries. The BOJ also expanded its balance sheet size considerably. From 1995 when the overnight interest rate fell down to virtually zero, the ratio of the BOJ’s balance sheet size to nominal GDP increased by more than 20 percentage points at its peak (Chart 10). That increase in the ratio for the BOJ was twice as large as that in the U.S. Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of England (BOE) in the recent crisis. In addition, the BOJ made a policy commitment to continuing the quantitative easing policy “until core CPI inflation becomes stably zero or above”. The BOJ adopted “credit easing” in the current terminology, ahead of central banks in the world. The BOJ purchased asset-backed securities (ABSs), asset-backed commercial papers (ABCPs), and even stocks held by financial institutions to reduce market risk associated with stockholdings, which was one of the biggest risk factors in potentially destabilizing the financial system. In retrospect, the BOJ introduced various unprecedented measures under the uncharted circumstances during the period from the late 1990s to the early 2000s. Such measures involved most of the elements in the unconventional policy measures taken in the recent global financial crisis. Nevertheless, it took a fairly long before the Japanese economy restored the full-fledged recovery path. And that fact suggests the severity of the balance sheet adjustments I have mentioned earlier. In any event, without sufficient public understanding about the fact that we need a long time to complete balance sheet adjustments, the delay in the recovery in the macroeconomic performance is likely to provoke social discontent. That tends to create the social climate, which is prone to induce policy measures inconsistent with economic efficiency. That leads to the fourth point in economic policy challenges. Fourth, we need to pay more attention to the importance of maintaining the flexibility of the economic structure. As I discussed earlier, Japan’s “lost decade” was crucially attributed to the decline in population and productivity. In that sense, if foreign countries mistakenly draw the most crucial lesson from Japan’s experience as the necessity of short-term stimulative policy measures, they will face a risk of writing the wrong policy prescription. I do not go into the details of economic policy in each country, but I think that it is crucial to maintain the flexibility of the economic structure to smoothly reallocate labor and capital from the lower productivity sector to the higher productivity sector. That is, however, not necessarily easy, given the social climate after the burst of bubble, just I mentioned. Fifth, we cannot rule out the possibility that the current unprecedented easy monetary policy in many advanced countries, if continued for an extended period, will produce unintended consequences. Under the easy monetary condition, inefficient businesses tend to be preserved, and economic rejuvenation also tends to be delayed, thereby reducing the productivity growth. Although easy monetary policy is needed, it alone cannot solve the problem. Structural reform is indispensable. Also, it cannot be denied that such easy monetary condition is likely to contribute to the emergence of another bubble. In fact, the prolonged low interest rates in the early 2000s, in the aftermath of intensified deflationary concern stemming from the burst of the dot-com bubble, partly contributed to the global credit bubble. A crisis comes to the surface with a different face every time. The current recovery in advanced countries is basically supported by strong growth in emerging countries. Thus, if the strong growth in emerging countries turns out to be the one entailing the bubble-like nature, advanced countries as well as emerging countries themselves will be affected significantly. As for equity price developments, advanced countries still stay far below the level before the failure of Lehman Brothers, while a few emerging countries are reaching an all-time high due partly to capital inflows from advance countries. In some sense, it can be said that monetary easing in advanced countries has exerted stimulative effects through capital outflows to emerging countries. That suggests a significant change in the transmission mechanism of monetary policy from the conventional mechanism we generally assume. Sixth, we need to implement financial reform in a well-balanced manner. In light of the lessons from the recent crisis, it is a fairly appropriate direction of the reform to strengthen the existing capital requirement. At the same time, it is also necessary to avoid undermining the economic recovery in raising capital requirements. In that regard, I appreciate that the new capital standards, so called “Basel III” agreed at the meeting of the Group of Central Bank Governors and Heads of Supervision in September, ensures a good balance between the two requirements. I do also want to emphasize that we need to find the right balance between stricter regulation and intensified supervision. Regulation alone, especially in the form of more regulatory capital, will not prevent the next crisis. The risk profiles of financial institutions vary across firms and countries, and they change over time. Thus, regulation needs to be effectively combined with rigorous supervision and close monitoring. IV. Closing remarks I have discussed the points to be remembered in discussing near-term economic policies at this critical juncture. But I have stopped short of showing a specific direction of policy actions. Such policy actions should be mapped out by the policy authorities and people concerned with consideration of economic conditions. Given that a crisis comes to the surface with a different face every time, what I can say here is that central bankers as well as executives of private financial institutions, who are all at this meeting, need to be humble enough to pay attention to various possibilities with consideration of historical lessons. Thank you for your attention.
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Comments by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the International Monetary Fund European Central Bank Federal Reserve Bank IMF ECB FRB High-Level Conference "Rethinking Central Banking", Session 1: Which central bank policy areas warrant a rethink, Washington DC, 10 October 2010.
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Masaaki Shirakawa: Revisiting monetary policy Comments by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the International Monetary Fund / European Central Bank / Federal Reserve Bank (IMF/ECB/FRB) High-Level Conference “Rethinking Central Banking”, Session 1: Which central bank policy areas warrant a rethink, Washington DC, 10 October 2010. * * * Introduction Let me first thank the organizers, the IMF, the ECB and the Fed for organizing this timely seminar. The crisis and continuing adjustment process is clearly pushing for a rethink of multiple aspects of central bank policy. The seminar is divided into three sessions and there are separate sessions on macro-prudential policy and financial stability. I will focus my remarks on monetary policy, but since central bank policy must be discussed in its totality, please forgive me for slightly venturing into areas covered in the following sessions. Lean or clean The experience during and after the crisis has, I believe, given a rather clear direction with regard to the “lean or clean” debate, if I may borrow the words of my friend Bill White. 1 In other words, the issue is “should monetary policy lean against the wind to prevent the emergence of bubbles or should it simply clean up the mess after the bubble has burst?” The prevailing view before the crisis was that monetary policy should focus on price stability and rather than trying to prevent bubbles, monetary policy should step in aggressively to mop up the mess after it has burst. Certainly monetary policy has been effective in reducing the macroeconomic impact from the initial shocks caused by the bursting of the bubble. Many central banks in advanced economies have brought down interest rates close to zero to support economic recovery this time. Unconventional measures, such as the large scale purchases of assets, have been introduced as well, in order to support malfunctioning financial markets. These measures have certainly helped to stave off a global depression. Clearly without such innovative measures by central banks, the situation would have been much worse. However, the magnitude of the economic downturn, the loss of jobs, and the declining pace of economic recovery in the major economies, highlight that the cost of allowing bubbles to develop is so large that the “clean-up” strategy by itself is insufficient. Actions to prevent the accumulation of financial imbalances are also necessary. Now let me look at this issue from the “leaning” side. The question would be, “what is the relationship between low interest rates or long periods of accommodative monetary policy and the emergence of bubbles?” Here it is important to keep in mind the behavior of market participants as Professor Rajan has argued previously. 2 Institutional investors, in many cases, develop their investment strategies targeting a nominal rate of return, taking into consideration past experience. Insurance firms and pension funds often commit to a fixed rate of return to policy holders. Since investment manager fees are linked to the size of assets under management, managers would aim to raise nominal rates of return to attract customers. These lead to search for yield tendencies or a more active risk taking stance in a low interest rate See White (2009). This paragraph draws on Rajan (2010, ch. 5). environment, and in the build-up to the recent crisis, supported the growth of sub-prime related securitization with high ratings and surprisingly high nominal returns. Investors had either knowingly or unknowingly taken on large credit and liquidity risk. Such behavior had been amplified in the low interest rate environment where liquidity was plentiful. “Tail risks” which were hard to detect in such an environment were piling up in investor portfolios and financial institution balance sheets. Another element that would strengthen such activity would be the expectation that a low interest environment and accommodative monetary policy would continue. This would be influenced by multiple elements such as economic conditions, inflation expectations and the central bank policies. Since the 1990s, inflation targeting was introduced in many countries as a framework to enhance transparency and accountability of monetary policy. This helped to anchor inflation rates as well as inflation expectations. At the same time, due to the design of this framework, markets and economists began to narrowly focus on the output gap and inflation rate in assessing the future path of monetary policy. In a stable inflation environment, this tended to create search for yield tendencies by heating the expectation that very low interest rates will continue. Arguments against leaning against the wind There are various arguments against the view that monetary policy should play a role in leaning against the wind. Let me raise two here. One argument would be that it is difficult to detect asset price related bubbles. The counter argument would be that higher asset prices per se are not the problem, but rather the buildup of imbalances such as excessive leverage and maturity mismatches which are interlinked with the large rise in asset prices are the problem. Central banks with access to micro information of individual financial institutions which enables them to effectively monitor both economic and financial conditions, are in the best position to detect such imbalances and certainly need to consider what policy actions they can take. A second argument would be that imbalances such as excess leverage would be best dealt with through supervisory and regulatory measures. The use of micro-prudential tools is certainly called for. But that does not rule out the use of monetary policy. In the Japanese experience, when the Bank of Japan used to conduct window guidance many years ago, there was also the academic debate on whether it alone can be effective in curtailing excessive bank lending. The conclusion was that in a very loose monetary environment, arbitrage behavior would weaken the effects of window guidance. On the other hand, monetary policy on its own could not complete the job. It would become more effective when monetary policy and micro-prudential policies are used in a complimentary fashion. 3 Challenges in leaning against the wind I do acknowledge that there are also challenges even if we were to agree that central banks should lean against the wind. What conditions need to be fulfilled so that the central bank can effectively lean against the wind? Certainly the central bank will need to be independent in making its assessment that unsustainable imbalances are building up in the economy and that it may be necessary to take away the punch bowl in the midst of the party. However, formal independence would not be sufficient. 4 A broad social consensus would be necessary. There would need to be an See also Shirakawa (2010a). What responsibility a central bank should bear in democratic society is discussed in Shirakawa (2010b). understanding that if financial imbalances were allowed to build-up, for example through a rise in asset prices and increase in leverage, the social and economic cost of its collapse would be substantial, and thus pre-emptive policy measures to cool such actions would be appropriate and necessary. Without such a broad consensus, it would be quite difficult for the central bank or any other public authority to embark on policy measures to take away the punch bowl, which will be quite unpopular in the short run. Another challenge would be how to frame monetary policy, especially in the public policy debate. The importance of the framing effect should not be underestimated. The phrase “inflation targeting” has had both a positive and negative effect on the public understanding of monetary policy and as a result on its implementation. 5 It has enhanced the transparency and accountability of monetary policy in many countries and has helped improve public awareness of the price stability goal of monetary policy. However, looking back to the period as the bubble accumulated, I have the impression that a literal and narrow understanding of “inflation targeting” going beyond its original intention gradually took hold. Though perhaps not acknowledged, this began to constrain the flexible implementation of monetary policy based on overall macroeconomic and financial conditions. Once a narrow understanding becomes engrained in the public mind, it will be quite difficult for the central bank to move beyond this narrow boundary and to act flexibly to an evolving situation, such as a situation where imbalances which could harm long-term growth may be accumulating, although the inflation rate itself is stable. That is why the Bank of Japan has introduced a framework which incorporates the positive elements of inflation targeting while trying to avoid the possible pitfalls. We publish a numerical definition of price stability which we call “understanding of medium- to long-term price stability”, and in order to avoid the possible pitfalls, adopted a framework based on two perspectives. Under the first perspective, we assess whether the main scenario for the future path of the economy and prices over a two year time horizon is consistent with price stability while achieving sustainable growth. Under the second perspective, we examine various upside and downside risks associated with the main scenario. A more extended time horizon is also assessed. As the experience of the bubble and its burst shows, we need to consider an event with low-probability but extremely high costs. A third dimension is the global aspect of monetary policy. The developments before and after the crisis have reconfirmed the extent of globalization of the world economy and financial system. Although monetary policy is only one aspect, monetary conditions especially in major currency areas influence the behavior of market participants and thus global capital flows. For example, during the credit bubble period till 2007, the current account imbalance for the euro area was quite small, that is to say, investments and savings in the region were generally balanced. However, the increase in gross cross-border lending during the mid2000s by the banking sector was quite dramatic. The increase in lending was substantial not only toward eastern and central Europe but also to Asia, and European banks have become the largest overseas creditors. The yen carry trade was also a form of large capital flows. In the traditional treatment of monetary policy transmission mechanism, the bank lending channel was mostly a domestic phenomenon. Now the global transmission effects through international active banks and global investors cannot be ignored. This in turn will likely have an effect on the policy decisions of central banks around the globe. This is probably another area where further study and discussions are warranted within the central banking community. See also Shirakawa (2010c). References Rajan, Raghuram G., Fault Lines, Princeton University Press, 2010. Shirakawa, Masaaki, “Revisiting the Philosophy behind Central Bank Policy,” Speech at the Economic Club of New York, April 22, 2010a (available at http://www.boj.or.jp/en/type/press/koen07/ko1004e.htm). ________, “Future of Central Banks and Central Banking,” Opening Speech at 2010 International Conference hosted by the Institute for Monetary and Economic Studies, Bank of Japan, May 26, 2010b (available at http://www.boj.or.jp/en/type/press/koen07/ko1005a.htm). ________, “Roles for a Central Bank – Based on Japan’s Experience of the Bubble, the Financial Crisis, and Deflation –,” Speech at the 2010 Fall Meeting of the Japan Society of Monetary Economics, September 26, 2010c (available at http://www.boj.or.jp/en/type/press/koen07/ko1009f.htm). White, William R., “Should Monetary Policy “Lean or Clean” ?,” Globalization and Monetary Policy Institute Working Papers No. 34, Federal Reserve Bank of Dallas, 2009.
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the high-level seminar on macro-prudential policies, Shanghai, 18 October 2010.
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Kiyohiko G Nishimura: Macro-prudential policy from an Asian perspective Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the highlevel seminar on macro-prudential policies, Shanghai, 18 October 2010. * * * I am honored to have been invited to this prestigious Conference, and particularly thrilled to have been given the opportunity to talk about macro-prudential policy from an Asian, or more specifically, Japanese perspective. This perspective is important in considering macroeconomic policy in general, and, in my opinion, all the more so given the current international discussions of regulatory reforms after the global financial crisis. In this short presentation, I will explain how the Bank of Japan has been actually implementing macroprudential policy to date, from this perspective, and the implications for the policy’s best practices. 1. Japanese macro-prudential policy Heightened interest in macro-prudence clearly reflects the severity of the recent global financial crisis, and the necessity to learn lessons from it. Central banks have been asking themselves whether they paid sufficient attention to the risks being accumulated in the financial system before the crisis, when inflation was moderate and stable. Regulatory authorities have come to regret a possible lack of concern in their policy perspectives, regarding the stability of the financial system as a whole. Now, with deep deliberation, policymakers are focusing on macro-prudential policy to fill the gap between macroeconomic policies and micro prudential policies, so as to avoid any future large-scale financial crisis. Here I would like to emphasize that, as a central bank, the Bank of Japan has a clear mandate to ensure not only price stability, but also financial system stability. Under this mandate, the Bank has been taking de facto macro-prudential measures since the 1990s. The Bank of Japan’s mandate with regard to the financial system is stipulated in Article 1 of the Bank of Japan Act. Clause 1 of this Article states that the purpose of the Bank is “to issue banknotes and to carry out currency and monetary control”. Furthermore, Clause 2 of the same Article states that the Bank’s purpose is “to ensure smooth settlement of funds among banks and other financial institutions, thereby contributing to the maintenance of stability of the financial system”. Thus, the Bank of Japan Act clearly requires the Bank to contribute to the stability of the financial system as a whole. To understand what should be done to fulfill this mandate, it is of utmost importance to realize that a distinctive feature of the Asian, and in particular, the Japanese financial system, is that bank lending plays a dominant role in financial intermediation. The non-bank sectors, such as securitization markets, are relatively less important. This is one of the reasons why Asian and Japanese financial sectors were not seriously affected by the financial crisis of 2008, a crisis which was triggered by the gross under-evaluation of the risks embedded in US subprime securitized loans and related structured products. However, the flip side of this coin suggests that the real economy in Japan could be gravely affected if the risk-taking capacity of the banking sector is seriously damaged. A financial crisis starts with excessive risk taking or an outbreak of euphoria, while its aftermath leaves the economy burdened with excessive risk aversion or a lack of animal spirits. Consequently, the objective of macro-prudential policy is, first, to detect and rectify financial anomalies that may signal excessive risk taking, and second, if a crisis does occur, to support and ensure the risk-taking capacity of the banking sector. Historically, the Bank of Japan has learned a lot from the experience of the burst of the bubble around 1990, and it has used this experience to prevent or at least to lessen the impact of the recent global financial crisis. So, I will begin by explaining the macro-prudential measures employed by the Bank of Japan in the aftermath of Japan’s financial crisis since the 1990s, and then I will outline the measures the Bank is implementing now to prevent any future crisis. After-crisis macro-prudential measures – purchase of stocks held by financial institutions Since 1990, the Bank of Japan has introduced a number of measures to restore the risktaking capacity of Japan’s banking sector, which had been hampered by problems relating to non-performing loans. Among these measures was the stock purchasing program introduced in the autumn of 2002, which could be interpreted as a proto-typical macro-prudential policy. The program was introduced when the risk-taking capacity of Japanese banks was severely eroded by non-performing loans. The Bank of Japan purchased stocks held by commercial banks, liberating the capital these banks held against the risks associated with their stock holdings, and thus improving their risk-taking capacity. Seen in this way, the Bank’s stock purchasing was akin to the counter-cyclical capital buffers now being discussed in international forums as a possible macro-prudential policy option. In February 2009, shortly after the global shock wave of seized financial markets, the Bank of Japan reinstituted the stock purchasing program as a temporary measure. Three months later, the Bank adopted another temporary facility to provide subordinated loans to banks. In this way, the Bank took various steps to prop up the risk-taking capacity of the financial system when it was placed under severe stress. Crisis-preventing measures – on-site examination and off-site monitoring Now I will illustrate the crisis-prevention measures taken by the Bank of Japan. Above all, I want to emphasize the utmost importance of the Bank’s on-site examination and off-site monitoring of individual financial institutions. Financial anomalies or imbalances are likely to be accumulated through undue risk-taking activities by individual financial institutions, and crises are usually triggered by their liquidity problems. Since the 1990s, some central banks in advanced economies, such as the Bank of England, have shifted their micro-prudential functions to newly established supervisory agencies. However, having learned the lessons of the latest financial crisis, there has been a tendency to restore the micro-prudential functions back to the central banks again. Unlike these counterparts, the Bank of Japan has been continuously executing on-site examination and off-site monitoring over a wide range of individual financial institutions, including securities firms. The Bank of Japan’s on-site examination makes a thorough and comprehensive assessment of the risks of each financial institution, and strongly encourages the institution to take the necessary action to reduce them, where appropriate. The Bank’s off-site monitoring also enables a continuous evaluation of various risks. This off-site monitoring pays particular attention to liquidity risks, and allows the liquidity position of individual institutions to be assessed on a daily basis. These micro-prudential functions by the Bank are critical for identifying and responding to risks, since financial crises usually occur as a result of liquidity crises. Indeed, since the failure of Northern Rock in 2007, the importance of liquidity risk monitoring has been widely stressed in international forums. Moreover, every fiscal year, the Bank of Japan revises and publishes a document called “OnSite Examination Policy”. This document is based on the information obtained from on-site examination and off-site monitoring, as well as on other information concerning economic and financial conditions and the overall state of the financial system. The Bank examines individual financial institutions in line with the policy in this document. For their part, individual financial institutions are expected to take appropriate measures in light of this published examination policy, thus contributing to the stability of the financial system as a whole. “Two perspectives” of monetary policy Now let me turn to the relation between monetary policy and macro-prudential policy. Monetary policy does not directly reflect changes in asset prices or in the financial system. Nonetheless, there is a common understanding among advanced economies that variables such as asset prices and bank lending contain important information that should be brought to bear on monetary policy decisions. Since 2006, the Bank of Japan has adopted a framework for the conduct of monetary policy that consists of “two perspectives”. This means that the Bank may respond to changes in asset prices or credit expansion under the “second perspective”, that is, if there is reason to believe that such changes are “risk factors that significantly impact economic activity and prices”. Through this framework, while price stability remains the primary goal of its monetary policy, the Bank is able to respond flexibly to any excessive accumulation of financial risk. In this regard, the Bank’s monetary policy framework continued to provide appropriate monitoring of financial-sector risks in advance of the outbreak of the current global financial crisis. 2. In search of best practices in macro-prudential policy As the experience of the Bank of Japan suggests, there are a number of conditions that should be satisfied in order for macro-prudential policy to be effective. Scope of monitoring – adequate information First of all, I would like to emphasize the importance of both micro- as well as macroinformation in pursuing macro-prudential policy. In many cases, financial crises are triggered by risk accumulation in individual financial institutions. Moreover, most of the policy tools being discussed in the context of macroprudential policy, such as changes in the required capital ratio, loan loss provisions ratio or loan-to-value ratio, are intended to be applied to individual institutions. This means that it is all the more important for the central bank to have in hand adequate information from microperspectives, in order to pursue macro-prudential policy in an effective manner. Here liquidity issues should also be duly emphasized. Financial crises usually break out as liquidity crises. Thus, it is absolutely necessary for the central bank to know where in the market liquidity tension exists, and who is under extreme tension, in order to identify and respond effectively to liquidity problems. Quarterly-disclosed balance sheet figures may be grossly insufficient for such crisis management operations. We only have to recall that the capital adequacy ratio of Lehman Brothers was double-digit, even immediately before its collapse. Indeed, the information obtained through the Bank of Japan’s on-site examination and off-site monitoring has proved to be extremely useful, and enabled the Bank to respond swiftly to the liquidity drain in the recent global financial crisis. Consistency among macro-prudential, micro-prudential and monetary policy Secondly, consistency with other policies is another important precondition for the efficiency of macro-prudential policy. To put it another way, macro-prudential policy alone is not likely to bring financial stability, without consistent macro-economic policy and micro-prudential policy. When the asset bubble was at its height, Japan’s regulatory authorities tried to impose a ceiling on the aggregate amount of real estate-related bank loans. Although the term “macroprudence” was not on everybody’s lips at that time, the restriction imposed on overall real estate-related lending had a strong tinge of macro-prudential policy. Unfortunately, such regulation was not able to stabilize the whole financial system. A similar instance is also found in the current global financial crisis. In recent discussions on macro-prudential policy, the counter-cyclical provisioning in Spain has often been mentioned as one of the few macro-prudential responses that have actually been implemented. Although such ground-breaking policy efforts by the Spanish authorities are commendable, the current state of the Spanish banking system seems to underline the difficulty of responding to asset price bubbles solely with macro-prudential tools. Since we do not yet have a good track record of averting financial crises solely with macro-prudential policy tools, it would be prudent for policymakers to assume that macro-prudential policy can only succeed when other policies are conducted in a consistent manner so as to influence market expectations effectively. It seems to me that the precise definition of macro-prudential policies, in isolation from monetary and micro-prudential policies, does not lead to productive discussion. Rather, we should recognize that all these policies partly overlap. Based on this understanding, it is necessary to make use of all available resources, always with a macro-prudential viewpoint, so as to maintain overall financial stability. Cross-border perspectives – avoid straightjacket measures Thirdly, I would like to stress the importance of cross-border perspectives on macroprudential policy. The business models of financial institutions differ substantially, reflecting the different needs for financial services in each country. Moreover, we should also recognize the significant differences in legal and regulatory frameworks for financial services among jurisdictions, as a consequence of the authorities’ best efforts to tailor them to the people’s needs. In some jurisdictions a traditional “buy-and-hold” model is dominant, in which banks generally rely on stable household deposits in their funding and make commercial loans. In such cases it is especially important for supervisors to grasp credit risks in banks’ loan portfolios. However, in other jurisdictions, where an “originate-to-distribute” model with market-based wholesale funding is more pronounced, supervisors should pay more attention to liquidity structure, the risk-profile of structured products and where the ultimate risk lies. “Level-playing-field” is undoubtedly important. Nonetheless, what we really need is a playingfield that should lead to fair competition among financial institutions of different types and backgrounds, both in a theoretical and a practical sense. Thus, a global regulatory framework should have sufficient flexibility in order that regulators can take account of regional and functional heterogeneity. A one-size-fits-all regulation, which some institutions in a specific jurisdiction could more easily circumvent, might eventually prove rather harmful to social welfare. Moreover, too rigid regulation might encourage less-transparent entities to replace banks’ businesses and thereby stimulate “shadow-banking” in some countries. A one-size-fits-all approach, which would put carnivorous lions and herbivorous elephants in the same cage, can never produce good results. We need to strike the right balance between rules and discretion in financial regulation, making full use of the “Three Pillars” framework of the Basel Accords, especially Pillar II. I also reiterate that liquidity issues are critical, especially from a cross-border perspective. Central banks are strongly required to monitor liquidity risk, and provide liquidity if necessary, so as to contain cross-border spillovers. In this regard, the Bank of Japan, through its off-site monitoring, observes closely the liquidity position of branches, subsidiaries and affiliates of overseas financial institutions. Moreover, bilateral swap agreements between major central banks, such as the Fed, the ECB and the BOJ, contributed to the containment of crossborder spillovers during the initial stages of the global financial crisis. Looking back at the history of central banks, most of those established before the Second World War were brought into existence for the purpose of restoring order to a financial system in turmoil. Macro-prudential perspectives are therefore nothing new to central banking. Rather, macro-prudence might be part of the original reason why an economy needs a central bank. Ultimately, it could be argued that all the activities of central banks, from issuing banknotes to operating payment and settlement systems, acting as the lenderof-last-resort and implementing monetary policy, cannot be pursued without a “macroprudential perspective”. Thank you for your attention.
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Hiroshima, 20 October 2010.
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Kiyohiko G Nishimura: Japan’s economy and monetary policy – comprehensive monetary easing and strengthening of the foundations for economic growth Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Hiroshima, 20 October 2010. * * * Introduction First of all, I would like to express my sincere gratitude for your cooperation in interviews and surveys conducted by the Hiroshima branch of the Bank of Japan. Information from these interviews and surveys is invaluable and utilized fully in our business operations. Before we exchange views, I will first explain economic developments at home and abroad. I will then speak about the Bank’s thinking on monetary policy by focusing on recentlyintroduced “Comprehensive Monetary Easing” and the “Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth.” I. Overseas economic developments The pace of growth in overseas economies has been slowing. Here I will explain the developments in the Unites States and emerging economies, which have a particularly significant impact on Japan’s economic activity and prices. In the United States, while a relatively strong recovery was forecasted around this spring due mainly to the policy effects, anxiety about the future increased as a series of weak economic indicators such as GDP and employment were released in August. Since some favorable data such as durable goods orders were released in September, I have been maintaining the view that the U.S. economy has been recovering moderately. However, compared with this spring, the possibility of prolonged low growth has increased. Economic growth in the United States has been restrained partly because the household sector has been burdened by debt such as mortgage payments and thus has been constrained from consuming. The process of restoring the sound asset condition by repaying debt is called “balance-sheet adjustment,” and is a factor in lowering spending in a continuous manner following the burst of “a bubble.” As seen in the case of Japan, such adjustments are bound to take time and thus we have been holding the view that the recovery in the U.S. economy, where the household sector faces significant balance-sheet adjustment pressure, will remain modest. Yet, if there is an increase in the growth of employee income or a rise in house prices, the debt repayment capacity of the household sector will increase and the adjustments will be completed in relatively a short period. Thus, the U.S. employment- and housing-related indicators are particularly drawing attention. A typical employment-related indicator is the unemployment rate. It surged to about 10 percent after the Lehman shock, slightly declined around this early spring, rose again thereafter and has remained at an elevated level. House sales picked up due to the effects of preferential tax breaks for buyers of residential houses, but plunged immediately after the tax breaks expired at the end of April and have remained at a low level thereafter. Meanwhile, house prices have been more or less unchanged following the significant decline. As you can see, employment and housing conditions are weaker than expected, and thus it is becoming likely that “balance-sheet adjustments” might take more time than previously envisaged. Emerging economies are also slowing, although their adjustments are relatively light. From a longer-term perspective, there is a strong possibility that those economies will maintain stable high growth as there is robust potential domestic demand toward spreading durable goods and building social infrastructure. Some emerging economies have been shifting away from accommodative policies to prevent the economies from overheating, but there are still many economies whose measures to contain overheating are not considered to be sufficient, and thus there remains a risk of overheating that the pace of growth in emerging economies might accelerate amid continued capital inflows. At the same time, since sizable exports have been made from those countries to the United States, the slowdown in the U.S. economy might have no small effect on emerging economies and such downside risks also require vigilance. II. Developments in economic activity and prices in Japan Japan’s economy has been showing signs of recovery until recently. This summer, sales of air conditioners and beverages were buoyant due to the extremely hot weather, and a lastminute increase in demand ahead of the expiration of the subsidies for purchasing energy efficient cars turned out to be extremely large. Both factors have elevated the economy. However, amid increased uncertainty due mainly to fiscal problems in European peripheral countries and the outlook for the U.S. economy, global investors have become increasingly risk averse, which increased demand for the yen that was considered as a relatively safe currency and resulted in the yen’s appreciation. In addition, overseas economies have slowed, and the pace of growth in exports has recently been rather moderating. Taking into account that exports, which have been leading economic activity, have been showing weak signs, it is appropriate to judge that Japan’s economy still shows signs of moderate recovery, but that the pace of recovery is slowing down. While the economic outlook is to be examined in the Outlook for Economic Activity and Prices that will be published after the next Monetary Policy Meeting on October 28, compared with the outlook presented in the Bank’s July interim assessment, the economic growth rate is likely to be somewhat lower than expected. During this fiscal year, the slow recovery pace is likely to continue mainly due to the slowdown in overseas economies and the expected decline following the last-minute increase in demand ahead of the expiration of subsidies for energy efficient cars. The fact that the recent appreciation of the yen is deteriorating business sentiment is also a big factor in putting downward pressure on economic activity. In the recently-released September Tankan (Short-Term Economic Survey of Enterprises in Japan), business conditions D.I. has substantially improved, compared with three months ago, but the D.I. is forecasted to deteriorate considerably in three months ahead, suggesting that firms have come to be cautious due partly to the appreciation of the yen. However, when looking from a somewhat longer perspective, Japan’s economy is expected to return to the moderate recovery path as emerging economies with high growth potential will complete the current mild adjustment phase. While there are various risks associated with such outlook, we need to keep an eye on developments in overseas economies, mainly the U.S. economy. An important risk factor unique to Japan would be developments in car sales in the future, and I think that there is considerable uncertainty associated with the sales. From August through early September, the last-minute increase in demand ahead of the expiration of the subsidies for purchases of energy efficient cars was extremely large, which might suggest that consumers have become sensitive to prices. While it is expected that car sales will plunge for some time following the expiration of the subsidies, what pace the sales will subsequently recover will be critical since that would gauge the strength of Japan’s potential demand. Moreover, the automobile industry has a wide range of supporting industries and its developments affect business conditions of many small- and medium-firms, and thus, from such a viewpoint, the developments warrant close attention. As for prices, the year-on-year decline in the CPI (excluding fresh food) has been slowing. However, the possibility that weaker-than-expected economic activity will affect price developments requires vigilance. Moreover, there is a risk that the yen’s appreciation will lower consumer prices not only through worsening economic activity but also through changes in import prices. 1 Given those circumstances, it has become more likely that the return of Japan’s economy to the sustainable growth path with price stability will be delayed than previously envisaged. III. Comprehensive monetary easing Under the situation in which “it has become more likely that the return of Japan’s economy to the sustainable growth path with price stability will be delayed,” it is necessary to further enhance monetary easing. On that basis, at the Monetary Policy Meeting on October 4 and 5, the Bank decided to carry out “Comprehensive Monetary Easing,” or “Comprehensive Easing” for short, composed of the following three measures. First, a change in the guideline for money market operations. The most fundamental policy of the Bank is to guide the overnight rate, that is, the interest rate applied in the market where banks borrow or lend money only overnight, to a pre-determined target rate. At the Monetary Policy Meeting on October 4 and 5, the Policy Board changed the target rate for the overnight rate from “at around 0.1 percent” to “at around 0 to 0.1 percent.” While the Bank said it has been maintaining the extremely low interest rate level of virtually zero percent, this time it changed the target interest rate to further clarify that it has been pursuing the virtually zero interest rate policy. If the Bank is to make further ample liquidity provision through, for example, a purchase of assets I will mention later, there might be strong downward pressure on the overnight rate. In that situation, if the Bank tries to maintain the overnight rate at around 0.1 percent, some flexibility in market operations might be lost. That is another reason the Bank allowed the overnight rate to shift downward. Second, the clarification of a condition that the virtually zero interest rate will be maintained. The Bank, regarding the criterion for being consistent with price stability, indicates that on the basis of the year-on-year rate of change in the CPI, each Policy Board member’s judgment falls in a positive range of 2 percent or lower, and that the midpoints of most Policy Board members’ judgment are around 1 percent. The Bank calls this criterion the “understanding of medium- to long-term price stability” (the “understanding”). At the Monetary Policy Meeting on October 4 and 5, the Policy Board confirmed that the Bank will maintain the virtually zero interest rate policy until it judges that the price stability is in sight from a medium- to longterm perspective. What I would like to emphasize here is that the Bank employs as its judgment criterion, whether developments in the inflation rate expected in the future, not the rate at the moment, is consistent with the “understanding.” 2 Given that it takes some time for the effects of monetary policy to spread, in order to achieve price stability from a long-term perspective, it would be necessary to pay attention not only to the short-term inflation rate at the moment but also to the forecast of how the future inflation rate will develop and to consider its consistency with the “understanding.” Moreover, it is essential to learn from the experience that stability in economic activity and prices from a long-term perspective was undermined in the emergence and bursting of the recent global credit bubble, as a result of significant risks While rather technical, as for the CPI, effects of a revision of the base year should also be noted. The change in the base year from 2005 to 2010 is scheduled to be made in the summer of 2011. In general, a year-onyear change in the CPI tends to be overestimated as it goes farther from the base year, and such distortion tends to be corrected at the time of a base year revision. Namely, at the time of base year revision in 2011, it is likely that the year-on-year changes in the CPI will be revised downward. While it is difficult to estimate the degree of downward revision at this point, we should keep in mind a possibility that, looking back in the future, the degree of decline in the CPI could have been larger than previously recognized. This thinking is similar to that called “forecast targeting,” which uses whether a forecast will reach the target rate as a judgment criterion. including the accumulation of financial imbalances being overlooked. In other words, if one becomes complacent about the current price stability and overlooks the accumulation of financial imbalances such as a “bubble,” there is a possibility that the economy will face a continued decline in prices after the burst of a “bubble.” The Bank stated that it will maintain the virtually zero interest rate policy on condition that examination of risk factors, including the accumulation of financial imbalances, does not reveal any problems. Third, the Bank will specifically examine a program to purchase financial assets. The program aims at purchasing various financial assets, such as government securities, commercial paper, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). That deserves some detailed explanation. Taking a firm for an example, when it raises funds, it is conventional to pay higher interest rates than those of safe assets such as government bonds. That is because fund providers request adding interest rates worth the factors such as a firm’s default risk. The interest rates on safe assets are called risk-free interest rates and the additional interest rates are called risk premiums. The added interest rates depend on the probability of a firm’s default as well as to what extent fund providers’ want to avoid risk, namely, the degree of risk aversion. The stronger anxiety about the future and risk aversion are, the bigger the added interest rates become. Taking into account that there is little room for short-term interest rates to decline, the measure taken this time aims to encourage the decline in longer-term risk-free interest rates and risk premiums on risk assets, to pursue further enhancement of monetary easing. 3 The Bank has been encouraging a decline in slightly longer-term risk-free interest rates by utilizing what we call the “fixed-rate operation,” through which the Bank provides funds with a maturity of three or six months at a low interest rate of 0.1 percent. This time the Bank decided to encourage the decline in further longer-term interest rates by purchasing longterm government bonds and corporate bonds with a remaining maturity of about one to two years. Moreover, to reduce risk premiums, the Bank will examine the purchases of ETFs and J-REITs. While such purchases are the first attempt for the Bank, its risk-taking through the purchases could have an effect of reducing risk premiums of stocks and real estate. 4 Such purchases of assets are extraordinary measures for a central bank, especially the purchases of financial assets to encourage a decline in risk premiums. Interest rates of riskfree assets have already become rather low and there is little room, albeit some in longerterm interest rates, for further reduction. Nevertheless, firms’ funding activity has not become active. Therefore, the Bank decided that it was appropriate to further support firms’ forwardlooking activity from a financial side by encouraging a reduction in risk premiums. The asset purchase should be examined deliberately also from a viewpoint of national burden. If prices of purchased assets decline, the consequent losses will be borne by the Bank. Since the Bank makes payments to the national treasury out of earnings obtained through the issuance of the currency, if the Bank incurs losses, it will eventually become a public burden in that the national treasury could not receive payment it was supposed to When there is strong anxiety about the future of the economy, namely, when there is the so-called Knightian uncertainty, there is a tendency that aversion against assets that are considered to be risky, such as stocks and real estate, becomes excessive and demand for those assets declines, leading to risk premiums of those assets remaining high (Meanwhile, it could happen at the same time that demand concentrates on assets whose risks are considered to be small, thereby lowering risk premiums of those assets). In such a case, there is a possibility that the central bank’s purchase of risk assets will lead the central bank to play a role as a “catalyst” to alleviate the tendency of excessive risk aversion. For reference, please see Nishimura, K.G., and H. Ozaki, “Irreversible Investment and Knightian Uncertainty,” Journal of Economic Theory, 136 (2007), 668–694. For the purchases of ETFs and J-REITs, the Bank needs to seek approval from the government and it will do so in due course. receive. The reason the Bank puts emphasis on its financial soundness and is cautious about carrying out a policy that takes such risk is that, it considers it natural for a central bank to be cautious about a policy that could risk the public burden. Nevertheless, taking into account the outlook for economic activity and prices as well as the situation in which there is little room for further reduction in short-term interest rates, the Bank judges it appropriate to take certain risks. To clarify that the measure is an extraordinary and temporary one, the Bank will newly establish a program on its balance sheet and manage separately from other assets held for different purposes. Meanwhile, since the fixed-rate operation, through which the Bank provides financial institutions with funds with a maturity of three or six months at a low interest rate of 0.1 percent, has the same purpose of encouraging a decline in longerterm interest rates through the purchase of assets, the Bank judged it appropriate to manage the operation under this program. The Bank will examine the size of the program centering on about 35 trillion yen, which is the sum of assets to be newly purchased – about 5 trillion yen – and the size of the fixed-rate operation – about 30 trillion yen. IV. Fund-provisioning to support strengthening the foundations for economic growth The “Comprehensive Easing” I have described can be considered as a policy, when a decline in future demand is worried but is expected to pick up after some time, to support such return of the demand or to underpin the demand by powerful monetary easing. The challenges Japan’s economy is faced with are not only the temporary decline in demand. It faces the medium- to long-term challenge of overcoming the trend decline in the growth rate that would still remain even after the temporary decline in demand is resolved. In other words, elevating the economy in a sustainable manner is considered to be an important challenge. Taking the developments after the Lehman shock as an example, demand declined rapidly and temporarily due partly to inventory adjustments, but picked up as time passed. On the other hand, global demand for, for example, automobiles, which had been at a high level amid the “credit bubble” in the United States prior to the Lehman shock, will not pick up so easily. In the world following the burst of the credit bubble, to return to the previous high level and to further grow, there is no choice but to increase the strength for growth through the efforts such as further innovation in product development and sales network formulation. On the basis of such recognition, the Bank introduced the “FundProvisioning Measure to Support Strengthening the Foundations for Economic Growth.” In what follows, I will explain my views about the background against which the Bank introduced the measure. Let me first overview the changes in the environment surrounding Japan’s economy. Japan has been faced with the low birth rate and the aging population for a long period. Meanwhile, emerging economies, especially in Asia, have been growing rapidly. Therefore, the main demand has shifted from the youth and middle-aged to the aged people, and from advanced to emerging economies, and it has been required to establish a supply system of products and services that could meet such new demand. Looking at the history of hit products as an example of such changes in demand, the main purchasers of the so-called 3Cs – color television sets, air conditioners, and cars – were young couples and were a relatively homogeneous group. By contrast, recently, demand for low calorie foods preferred by elders and services that deliver purchased products to elders with weak mobility have been growing, and the purchasers have become heterogeneous. The development of information technology has also brought a significant environmental change. For example, even in a traditional industry like agriculture, it has become possible to directly provide information to customers through the internet and deliver products. Firms now have to tap the new demand by utilizing such information technology and establishing a supply system that promptly responds to the niche, diversified demand of high-mix, lowvolume production. Amid such changing environment, while Japanese firms have been trying to reform their supply system to incorporate new types of demand, there seems to be much room remaining for further reform. So far as the new demand goes, the supply system is lagging far behind potential demand. Meanwhile, because the transition of the supply system has not been sufficiently progressing, there remains a substantial supply capacity for the old-type demand. Therefore, the output gap with respect to the old-type demand is in the state of excess supply, and firms have no choice but to reduce the prices of their products and services. The fact that the transition to a supply system corresponding to the new demand has not sufficiently progressed seems to be a major factor behind the phenomenon called deflation Japan is plagued with. To promote the transition of the supply system, it goes without saying that firms play a significant role. I also hope that financial institutions will enhance their risk management capacity and increase fund provisioning to firms that are promoting supply system transition. The policy authorities also need to play their respective roles in preparing an environment that encourages innovative activity of firms and financial institutions. If the authorities’ policy becomes a certain trigger to lead to an increase in fund provisions to firms that are trying to reform their supply system, a virtuous cycle can be generated in which financial institutions accumulate the know-how, enhance their risk management capability, and provide further funds. A related example is that, in the United States, venture capital has been playing an important role in nurturing firms, and what triggered an increase in investments by the venture capital was said to be a law revision to relax the restrictions on investments by corporate pension funds in venture capital funds. The accumulation of know-how in the process of managing the increased inflow of funds seemed to have enabled venture capital funds to increase their yields and generated a virtuous cycle of attracting further investment funds. In my view, the Bank’s “Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth” could be a trigger for the transition of the supply system. The measure is not only different from the conventional monetary policy of controlling the policy rate, but also a completely new and unique measure even among the so-called unconventional policy measures. Therefore, we have received many opinions mainly at the outset of the introduction that “it is not a policy measure a central bank should take.” Nevertheless, I believe that if the transition of the supply system is to be promoted by the measure and firms become able to tap the new demand, it will contribute to overcoming deflation and thus will be consistent with the mission of monetary policy of “achieving price stability, thereby contributing to the sound development of the national economy” as stipulated in the Bank of Japan Act. Moreover, financial institutions’ accumulation of knowhow to provide funds to new areas and the expansion of their business bases will not only contribute to the sound development of the national economy but also increase financial institutions’ profitability and increase their capital strength, thereby also contributing to “financial system stability,” which is the other objective of the Bank. In designing the “Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth,” the Bank has aimed at supporting as broad as possible the various approaches taken by financial institutions on their own initiatives. Therefore, it has been designed so that many financial institutions can participate in, and, in terms of areas and plans, due attention has been paid to make an extremely flexible framework so as not to inhibit financial institutions’ voluntary approach. Moreover, by striking a balance between the views that exploiting innovative areas needs time and that the time limit is necessary in letting financial institutions use the measure as soon as possible, the lending period was set for a maximum of four years. The 47 participating financial institutions at the first round of loan disbursement carried out on September 6 included various types of financial institutions such as the major banks, regional banks, and shinkin banks and covered a wide area geographically. The areas of loan disbursement expanded to all the 18 areas illustrated by the Bank, centering on “environment and energy business” and “medical, nursing care, and other health-related business,” and, besides, there was a range of plans in local industries. Moreover, the average duration of lending or investment projects was 8.2 years, suggesting financial institutions’ stance to support over time the firms’ efforts to exploit innovative areas. Such financial institutions’ efforts have been showing depth and width in line with the intention of the measure, which I feel quite encouraging. Concluding remarks Today I have focused on the economic situation at home and abroad as well as “Comprehensive Monetary Easing” the introduction of which was decided in October and “Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth” introduced in June. The Bank will continue to carefully examine the outlook for economic activity and prices, and take policy actions in an appropriate manner as a central Bank. As I have mentioned earlier, to meet the critical challenge of reforming the supply system, which is faced by Japan’s economy, the role of the policy authorities and, even more than that, of firms and financial institutions would be crucial. To meet the challenge, it is necessary to respond to the new demand created in accordance with the changes in the economic environment such as a rise in emerging economies as well as to nurture new businesses that tap potential demand. In that regard, in Hiroshima Prefecture, manufacturing industry including automobile, machinery, and steel has been actively engaged in exporting to Asian countries and has been exerting their strength. Moreover, there are not a few firms, inclusive of nonmanufacturers, which were established here and developed to run nation-wide business, and thus this region seems to be equipped with a basis to nurture new businesses. This region already holds a variety of elements necessary for growth such as a geographical merit that it is close to other Asian countries, ample tourism resources with two world heritage sites and the rich natural environment, a distinguished reputation as an international city, and high education level with Japan’s fourth highest college advancement rate. That shows that the region has enormous potential. On the financial front, financial institutions in Hiroshima Prefecture have been pursuing forward-looking approaches such as establishing a system to support firms that are strengthening their businesses toward Asian countries. Moreover, several financial institutions have participated in the Bank’s “Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth” and have been using it as an opportunity to expand new lending methods that enable long-term lending. I sincerely wish you every success in your endeavor to achieve growth and I also hope that the economy of this region will further fulfill its potential.
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Address by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Annual Conference of the International Association of Deposit Insurers IADI, Tokyo, 27 October 2010.
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Kiyohiko G Nishimura: The importance of developing financial safety nets and the role of central banks Address by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Annual Conference of the International Association of Deposit Insurers (IADI), Tokyo, 27 October 2010. * I. * * Introduction I am greatly honored and particularly delighted to have been invited to address this annual conference hosted by the International Association of Deposit Insurers (IADI). Two years have passed since the global financial crisis triggered by the failure of Lehman Brothers. Authorities world-wide have made great efforts to contain the further deepening of the crisis and this process has confirmed the crucial importance of deposit insurance and other safety nets. However, at the same time, it has also become clear that there remain a number of issues to be addressed, in order to prevent any future crisis of such magnitude. As deposit insurance plays a central role in financial safety nets, it is of utmost importance for senior officials of deposit insurance organizations and relevant authorities world-wide to have the chance to discuss first-hand and intensively among themselves the future of financial safety nets. This conference is one such occasion. In my address today, I will talk about several issues which I believe are key to the development of effective financial safety nets, and about the role of central banks in maintaining financial stability. II. Stability of the financial system and financial safety nets Current international discussions Lively discussions are underway in various international forums as part of the effort to build a resilient financial system. The issues under consideration include (i) strengthening financial regulation and supervision, (ii) developing effective resolution regimes, (iii) raising the coverage limit of deposit insurance, and (iv) developing financial market infrastructures. All of these discussions are aimed, in one way or another, at preventing the failure of financial institutions and/or at containing financial crises. In this sense, these discussions all contribute to the improvement of financial safety nets in a broader sense, as they serve to protect the financial system from various kinds of shock. Let me touch on some recent developments on these issues. With respect to financial regulation, a new framework for the quality and quantity of bank capital was agreed on in Basel last month. I believe the new standards are attainable for Japanese banks through efforts such as the accumulation of retained earnings, although the banks still need to improve their profitability as well as strengthen their capital bases. One of the main tasks in the international forums hereafter is to deal with the moral hazard associated with systemically important financial institutions (SIFIs), in other words, the “too big to fail” problem. Specific measures to tackle this problem are under discussion at the Financial Stability Board (FSB) and elsewhere. Regarding deposit insurance, temporary measures such as blanket deposit guarantees or raising coverage limits were introduced during the crisis in the United States, Europe, and a number of Asian countries. Some of these measures have been maintained and become permanent. The importance of striking the right balance in developing financial safety nets Although the development of financial safety nets is important, a wider and stronger safety net is not always the ideal. In order to maintain financial stability in the long run, striking the right balance is necessary in a number of areas. Therefore, I would like to talk further about some crucial issues in the development of financial safety nets, using “balance” as a keyword. Balance between stronger regulation and macroeconomic recovery First of all, balance is needed between stronger regulation and macroeconomic stability. The global economy has been on a moderate recovery path since the spring of 2009. However, balance-sheet adjustments in the United States and Europe are still underway, and many advanced economies are facing the zero lower bound on short-term interest rates, as well as the need for fiscal consolidation. Under these conditions, it is essential for us to be especially wary that the regulatory reforms currently under discussion do not undermine the recovery of the global economy as a whole. Balance between the development of financial safety nets and moral hazard Secondly, balance is needed between development of financial safety nets and limiting moral hazard. We obviously need to prevent the failure of financial institutions as much as possible and ensure sufficient protection for depositors in case a financial institution should fail. However, this should not be at the risk of inducing moral hazard, which could consequently destabilize the financial system in the long run. As I mentioned, measures are being discussed to address the moral hazard problem associated with financial institutions that are regarded as being systemically important or “too big to fail”, and therefore, considered to have implicit public support. Tackling the “too big to fail” problem also highlights the importance of balance in the context of curbing excess risktaking by financial institutions, while ensuring market dynamism and encouraging innovative financial activities. Having said this, we should consider some crucial points when contemplating measures for problems associated with SIFIs. First of all, if it becomes revealed to the market that a financial institution is to be treated as a SIFI, this could in fact induce moral hazard. In addition, looking back at the experience of Japan’s financial crisis, whether an institution is systemically important or not depends on the condition of the financial system, and also on the effectiveness of the existing resolution regime. Furthermore, considering the essence of the moral hazard problem, the question of how to deal with SIFIs needs to be contemplated from various perspectives. For example, we need to take into account perspectives on containing the crisis as well as preventing it, and the balance between regulation and supervision. To be specific, capital surcharges should not be the only measure for dealing with SIFIs. There are many, not mutually exclusive, alternatives to capital surcharges, such as liquidity surcharges, strengthened supervision, and improvements in resolvability. I believe it would be appropriate for each country to choose the best practice from such measures or their combinations, depending on the environment surrounding its own financial system. Balance in the size of financial safety nets among jurisdictions; need for global coordination Thirdly, balance in the size of financial safety nets is needed among jurisdictions. With the globalization of financial institutions’ operations, they have become more interconnected. Likewise, households now have more foreign assets such as foreign currency deposits and foreign bonds. These circumstances indicate the increasing importance of having a crossborder perspective when developing financial safety nets. For example, regarding deposit insurance, a large-scale deposit shift between countries in Europe was observed in the fall of 2008 due to gaps in deposit insurance coverage. Some Asian countries raised their coverage limits in order to maintain the competitiveness of their banks. These examples demonstrate the importance of global coordination in the designing of deposit insurance. Another issue revealed in the aftermath of the failure of Lehman Brothers is the need for a resolution regime that facilitates the orderly wind-down of failing financial institutions in a cross-border context. Obviously, each country’s legal system depends substantially on its particular social framework, and convergence of resolution regimes is not easy. It is also not necessarily appropriate. However, it is becoming more important for authorities to have a good understanding of their respective resolution regimes and to communicate closely in the actual resolution process. In the aftermath of the recent crisis, the establishment of crisis management groups among supervisory authorities and central banks for internationally active financial institutions has been an important step forward in this regard. It is necessary for the authorities concerned to continue coordinated work on this issue. III. The role of central banks in maintaining financial stability The experience of the financial crisis has brought renewed attention to the role of central banks in financial safety nets, which in turn contribute to financial stability. This has led to the assignment of macro-prudential roles and financial regulatory authority to central banks in the United States and Europe. In this respect, the Bank of Japan has had an important role in both micro- and macroprudential dimensions for maintaining financial stability. From a micro-prudential perspective, the Bank conducts on-site examination and off-site monitoring of a wide range of financial institutions including securities firms, and urges improvement in risk and business management when necessary. From a macro-prudential perspective, the Bank implements appropriate policy measures based on its analysis and assessment of the condition of the financial system as a whole by utilizing the information obtained from financial institutions as well as from the markets. Measures taken by the Bank from a macro-prudential perspective during the crisis include resumption of stock purchases held by banks, and provision of subordinated loans. In this way, the Bank of Japan plays a critical role in maintaining the stability of Japan’s financial system. The Bank will continue to make every effort, in both micro- and macroprudential dimensions, to ensure and maintain this financial stability. Thank you very much for your attention.
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Kisaragi-kai meeting, Tokyo, 4 November 2010.
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Masaaki Shirakawa: Japan’s economy and monetary policy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Kisaragi-kai meeting, Tokyo, 4 November 2010. * * * Introduction I am privileged to have an opportunity to speak before such a large audience. Having said that, the timing of today’s speech has become somewhat uneasy for me. The Policy Board of the Bank of Japan has decided last week to bring forward the next Monetary Policy Meeting to today and tomorrow to discuss and decide the principal terms and conditions for purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) with a view to starting such purchases promptly. Therefore, in my speech today, based on the Outlook for Economic Activity and Prices released last week, I will talk about the developments in the global economy, and then mainly about Japan’s economic and price developments and the Bank’s “comprehensive monetary easing.” While I make clear at the beginning that there will be no information that implies the decision to be made at tomorrow’s Monetary Policy Meeting, I hope that my speech today will be of any use in enhancing your understanding on economies at home and abroad, as well as on the Bank’s monetary policy. I. Developments in the global economy The developments in the global economy since the failure of Lehman Brothers I will start with the developments in the global economy. The global economy plunged after the failure of Lehman Brothers in September 2008. Behind that economic downturn were two factors. The first factor was a panicky contraction of economic and financial activity due to the financial crisis triggered by the failure of Lehman Brothers. That brought about acute effects on the economy. The second factor, which could be said as more fundamental, was the unwinding of various excesses that had been accumulated globally up to the mid-2000s mainly in the United States and Europe. That was a disposal process of excesses such as excess debt in the household sector, excess production capacity in firms, and impaired assets of financial institutions. Namely, the process of repairing and adjusting balance sheets. During the repair and adjustment process, spending activity of each economic entity will be restrained. Consequently, chronic downward pressure will be exerted on the economy for a protracted period. The global economy leveled out in the spring of 2009 and started to pick up, and that was mainly because the first-mentioned acute symptom settled. Thanks to liquidity provision by central banks and measures such as capital injections into financial institutions by the governments, the panicky contraction of economic and financial activity calmed down. With the settling of the acute symptom, the demand-boosting measures taken in each country in response to the financial crisis became further effective and firms’ moves toward inventory restocking progressed. As a result, the global economy has been growing at an annual rate close to 5 percent since the second half of 2009. However, the recovery pace of the global economy has recently been slowing. As firms’ inventory restocking, which has been leading the recovery, has run its course, in advanced economies, the effects of various demand-boosting measures have been waning. For example, after the expiration of the homebuyer tax credits in June, the U.S. home sales have been sluggish. In Japan, new passenger-car registration in October declined by about 30 percent, on a year-on-year basis, following the last-minute significant increase in demand ahead of the expiration of subsidies for purchasing energy efficient cars. Emerging economies have been still growing at a high rate, but the pace of growth has started to slow somewhat. That slowdown in the pace of growth is partly attributable to the fact that, in response to the increased upward pressure on general prices and residential house prices in accordance with rapid economic growth, emerging economies have been making adjustments to their accommodative monetary conditions. However, measures to restrain overheating are necessary policy responses from the perspectives of restraining overheating in economic activity and asset prices and ensuring sustainability of economic expansion. The Bank judges that if sustainable growth in emerging economies is to be secured by those measures, it will have favorable effects on the global economy in the long run. Future of the global economy While the pace of economic recovery has been somewhat slowing since the mid-year, the Bank judges that the recovery trend in the global economy will be maintained. That view is widely shared in many of the forecasts of international organizations and the private institutions. For example, according to the world economic outlook by the International Monetary Fund (IMF), the global economy is projected to grow at a relatively high pace of more than 4 percent from 2011. In that regard, it is, above all, emerging economies that are expected to play the role of leading the global economy. There are several major reasons why a continued high growth in emerging economies is expected. First, it can be pointed out that there has been strong domestic demand from the beginning such as activation of consumption activity in accordance with the improvement in living standards and the needs for establishment of social infrastructure. A typical example is China. Urbanization has been rapidly progressing in China, and the urban population in China has rapidly increased from 200 million to 600 million in the past 30 years. The number of the so-called “million cities” in Japan, a country considered to have a high population concentration, was five in 1955, when the highgrowth period began, or twelve at present. In China, the number already reached 190 cities in 2008 and is expected to increase further in the future. Progress in urbanization generates massive housing constructions as well as demand for establishing utilities including electricity, gas, and water. The fact that expressways, which correspond to the total road length of Japan’s expressways, have been built almost annually since 2005 is also a typical example showing the great demand for infrastructure in China. Therefore, emerging economies have, potentially, a capacity to achieve a relatively high growth rate. Second, it can be pointed out that the large-scale accommodative monetary policies in advanced economies have led to an increase in capital inflows to emerging economies, thereby accelerated the economic expansion in emerging economies. Meanwhile, in advanced economies, the pace of recovery is likely to remain moderate for the time being, since those economies are burdened by the balance sheet adjustments. According to the IMF’s world economic outlook, the contribution to the global growth was 60 percent by advanced economies and around 30 to 40 percent by emerging and commodity-exporting economies until the 1980s and 1990s. The relationship between advanced and emerging and commodity-exporting economies was reversed and became 30 percent by advanced economies and 70 percent by the others in the 2000s, and the difference between the two groups of economies further widens in the projections for 2010 and 2011. Since such marked difference in the pace of future economic recovery between advanced economies and emerging and commodity-exporting economies will have a significant implication from a viewpoint of achieving sustainable growth of the global economy, I will explain again later. Uncertainty about the future of the global economy As I have just explained, a baseline scenario shared by, for example, the Bank and international organizations, is that the global economy is likely to maintain the recovery trend, led mainly by emerging economies, and follow the sustainable growth path, but such projection is associated with some uncertainties. Here, taking also into account the focus of interest at recent international meetings, I will explain two points I think particularly important. One is the uncertainty about the outlook for advanced economies and the other is, amid the difference in the pace of recovery between advanced and emerging economies, the effects accommodative monetary policies in advanced economies will have on the global economy through capital flows. Let me explain the first point. As I mentioned at the beginning of the speech, from the second half of 2009 to early spring 2010, when the acute symptom after the failure of Lehman Brothers settled and the economy was recovering rapidly, there were, from our point of view, somewhat optimistic views about the future of the economy dominant in the United States and European countries. The forecasts by international organizations and private institutions were constantly revised upward and U.S. and European stock prices were on an uptrend. When looking at the yield curve of interest rates in the U.S. dollar markets, up to early spring 2010, it factored in a possibility that the Federal Reserve will raise the federal funds target rate by the end of 2010. However, since the summer of 2010, triggered by a standstill in improvement in many indicators of the U.S. economy, such as employment- and housing-related ones, a pessimistic view spread that the balance sheet adjustments in the households and financial institutions might continue for a considerable period and thus might substantially slacken the pace of recovery in the U.S. and European economies. The fact that resolving the balance sheet problems takes time is exactly what Japan has experienced since the 1990s. Therefore, many in Japan including the Bank have seemed to consider that the pace of economic growth in the United States and Europe, which were burdened by balance sheet adjustments, might remain moderate. On the other hand, the dominant view in the United States has appeared to be more optimistic about the effects of the balance sheet adjustments compared with the views in Japan. Putting aside whether such recognition was correct or not, a feeling that prompt and effective policy responses have been implemented taking into account Japan’s experience might also have been behind such view. However, after looking at the ensuing sluggish developments in economic activity, concern whether the economy might tumble into deflation or protracted stagnation has started to be felt. 1 Let me next explain the second factor that has induced uncertainty about the future of the global economy, namely, amid the stark difference in the pace of recovery between advanced and emerging economies, the effects of accommodative monetary policies in advanced economies on the global economy through, for example, capital flows and foreign exchange rates. In many advanced economies, the pace of economic recovery has been sluggish and inflation rates are projected to be lower than what is considered desirable. As a result, those countries have been conducting accommodative policies. However, as advanced economies at present are in the virtually zero interest rate environment while being burdened by balance sheet adjustments, aggressive monetary easing will not lead to an increase in bank lending and thus, in that regard, stimulus effects on the domestic economy will be unlikely. As a result, it has been pointed out that accommodative monetary conditions in advanced economies have probably induced an excessive capital inflow to emerging economies and brought about risk-taking in those economies, and thus have become one of the reasons for Also see Masaaki Shirakawa, “Uniqueness or Similarity? – Japan’s Post-Bubble Experience in Monetary Policy Studies – ,” keynote address delivered at the Second IJCB Fall Conference entitled “Monetary Policy Lessons from the Global Crisis” hosted by the Institute for Monetary and Economic Studies, September 16, 2010 (available at http://www.boj.or.jp/en/type/press/koen07/ko1009c.htm). the overheating in those economies. It has also been pointed out by emerging economies about a difficulty that, if they raise interest rates while advanced economies are continuing with accommodative monetary policies, capital inflows to emerging economies will further increase against the background of the interest rate differential, thereby offsetting the effects of measures taken to restrain overheating of the economy. There have also been various discussions concerning the policy conduct of emerging countries. For example, if an emerging country’s foreign exchange system lacks sufficient flexibility and its foreign exchange rate is maintained at low levels compared with economic fundamentals, that could, together with the effects of capital inflows from advanced economies, excessively stimulate economic activity in that emerging country, thereby resulting in generating economic and financial excesses and their unwinding over time. In such a case, both emerging and advanced economies would be affected in the form of destabilization in the economy. In addition, the issue of correcting unsustainable current account imbalances has been discussed as a global challenge. In the situation where the foreign exchange rates, which should serve as one of the adjusting valves to cope with such imbalances, lack flexibility, it could become a factor in delaying the necessary adjustments. At the G20 meeting of Finance Ministers and Central Bank Governors held in October at Gyeongju, Republic of Korea, it was confirmed that, for the global economy, with an uneven pace of recovery among countries, to achieve a sustainable and balanced growth, not only efforts in macroeconomic policy but also those in regulation and structural reform would be necessary. The policy authorities in each country are required to carefully examine economic and price developments in each country or region and take necessary measures to achieve their stability. While it may seem to stating the obvious, I emphasize two points about its implications. One is, the policy authorities in each country have, after all, responsibility for the stability of their own economy. The other is, due to the advancements in the globalisation of the economy and financial markets, the extent to which each country’s economic and financial conditions as well as policy conduct affect each other has increased. Thus, policies that are supposed to be carried out to maintain the stability of domestic economic activity and prices need to be implemented by recognizing the path in which such policies affect the global economy and international financial markets and, in turn, affect again the domestic economy. It seems to be becoming more important for both advanced economies and emerging economies to consider the stability of their own economies in carrying out policies while taking account of mutual spillover effects of their policies. II. Japan’s economic activity and prices Taking into account the developments in the global economy, let me turn to Japan’s economic activity and prices. Current state of the economy On the back of an increase in exports and production due to the recovery in overseas economies and the boost from policy measures targeted at durable consumer goods, Japan’s economy has been improving. Given the sharp drop after the failure of Lehman Brothers, the pace of recovery has been considerably faster, compared with that in the United States and Europe. However, Japan’s exports and production, which have been leading the improvement in the economy, have recently been slowing. Exports were increasing at a pace of more than 40 percent, on an annual basis, since the spring of 2009, but the pace of increase became moderate since the middle of 2010 due partly to the slowdown in overseas economies and an inventory adjustment in information-related goods, and exports have become more or less unchanged in the July–September quarter. The Bank judges that the current state of Japan’s economy is in the process of a gradual recovery following the rapid pickup since the spring of 2009, but, as I have just explained, the signs of improvement have been weakening due partly to the slowdown in the pace of increase in exports and production. Outlook for economic activity and prices, and associating risk factors What is important here is how we can view the future of economic activity that once slowed. The Bank released last week the Outlook for Economic Activity and Prices, the so-called “Outlook Report.” To put the conclusion of the Report first, the Bank views that, in the second half of fiscal 2010, the pace of Japan’s economic recovery is likely to slow temporarily due to the factors such as the slowdown in overseas economies and the ending of the boost from policy measures targeted at durable consumer goods, as well as the recent appreciation of the yen. After entering fiscal 2011, albeit with some lingering effects of the yen’s appreciation, the economy is expected to return to the moderate recovery path, given that exports are projected to continue increasing as the growth rate of overseas economies is likely to rise again, and that firms’ sense of excessive capital stock and labor is likely to be dispelled gradually. Thereafter, in fiscal 2012, Japan’s economy is expected to continue growing at a pace above that in fiscal 2011, as the transmission mechanism by which the strength in exports and production feeds through to income and spending, will likely operate more effectively due to a continued relatively high growth in overseas economies, especially emerging and commodity-exporting economies. Showing that in term of the midpoints of Policy Board members’ projection, Japan’s economy is projected to grow annually at 2.1 percent in fiscal 2010, 1.8 percent in fiscal 2011, and 2.1 percent in fiscal 2012. The key to the outlook for prices is not only the outlook for economic activity but also developments in people’s inflation expectations in the medium to long term. On this point, judging from various surveys, no significant change has been observed and such inflation expectations seem to have been stable. On that basis, the Bank considers that the year-onyear pace of decline in the CPI excluding fresh food is expected to continue slowing as the aggregate supply and demand balance improves gradually. However, given that the drop in demand after the financial crisis was considerable and the pace of economic recovery has been moderate, the pace of improvement in the supply and demand balance is likely to remain moderate, and the timing of the year-on-year rate of change in the CPI entering the positive territory is likely to be sometime in fiscal 2011. As the rate of growth for the fiscal year, following 0.1 percent in fiscal 2011, the pace of growth is expected to increase to 0.6 percent in fiscal 2012. While taking some more time, Japan’s economy is expected to steadily move toward the sustainable growth path with price stability. The outlook for economic activity and prices is associated with various risk factors. In particular, in the area of economic activity, there are some upside risks including faster growth in emerging and commodity-exporting economies. However, amid continued heightened uncertainty about the future, especially for the U.S. economy, attention should also be paid to downside risks to Japan’s economy. Regarding the outlook for prices, there is a possibility that inflation will rise more than expected mainly due to an increase in commodity prices brought about by high growth rates in emerging and commodity-exporting economies, while there is also a risk that the rate of inflation will fall due, for example, to a decline in medium- to long-term inflation expectations. The Bank will carefully check, including those factors, whether Japan’s economy is steadily making strides to the sustainable growth path with price stability. III. Conduct of monetary policy Let me turn to the Bank’s conduct of monetary policy, taking into account the developments in economic activity and prices at home and abroad. The Bank recognizes that Japan’s economy is faced with an extremely important challenge of emerging from deflation and returning to the sustainable growth path with price stability. Based on that recognition, the Bank has been making utmost contributions as a central bank through vigorous policy responses based on the three-pronged approach of pursuing powerful monetary easing, ensuring stability in financial markets, and providing support in strengthening the foundations for economic growth. In terms of pursuing powerful monetary easing, the Bank has lowered twice the policy rate, which was at the lowest level in the world at 0.5 percent even before the failure of Lehman Brothers. In addition, by increasing longer-term funds provision to financial institutions, the Bank has been influencing directly the interest rates of longer terms of 3-month and 6-month. As a result, Japan’s interest rates have been stable at extremely low levels, compared with those in the United States and Europe, and firms’ funding costs have still been declining. In terms of ensuring stability in financial markets, the Bank has been endeavoring to spread a sense of security on the funding front in financial markets through, for example, providing a large amount of liquidity. Moreover, from a viewpoint of strengthening the foundations for economic growth, and to support voluntary efforts by firms and financial institutions toward raising Japan’s productivity, the Bank prepared a framework for providing funds up to four years at a low interest rate equivalent to the policy interest rate, and has already been implementing it. Having said that, as I explained earlier, the signs of improvement in Japan’s economy are likely to wane and the situation in which the pace of economic improvement remains slow is expected to continue for the time being. Uncertainty about the future, especially about the U.S. economy, has also been high. In those circumstances, the Bank judged that it has become more likely that the timing of Japan’s economy emerging from deflation and returning to the sustainable growth path with price stability will be delayed, and at the beginning of October implemented “comprehensive monetary easing” to further enhance monetary easing in a front-loaded manner. In order to pursue further accommodative effects by means of monetary policy under the situation in which there is little room for further lowering short-term interest rates, there is no way but to step into a new territory beyond that of traditional monetary policy and to employ a wide range of policy measures in the Bank’s policy toolkit, thereby enhancing policy effects. On the basis of such thinking, the Bank has decided to encourage a decline in longer-term market interest rates and a reduction in risk premiums and at the same time to implement the following three measures as a package. Change in the guideline for money market operations As the first measure, the Bank changed the guideline to encourage the uncollateralized overnight call rate from the previously set “at around 0.1 percent” to “at around 0 to 0.1 percent.” In the future, if further ample liquidity is provided through the implementation of the asset purchase program that I will explain later, there might be days when the uncollateralized overnight call rate becomes substantially lower than 0.1 percent. To meet the purpose of lowering longer-term market interest rates and reducing risk premiums through comprehensive monetary easing, the Bank considered it effective to explicitly allow such swings in the overnight call rate. Moreover, it will also serve to show further clearly that the Bank has been adopting the virtually zero interest rate policy. From a viewpoint of achieving monetary easing effects, it should be noted that an excessive decline in the overnight rate could have adverse effects of inducing a decline in yield rates on investments of financial institutions and investors and a decline in margins on interest rates, thereby hampering the financial intermediation function. What the Bank is aiming at after all is to prepare an environment in which the effects of monetary easing will be exerted to a maximum extent. By taking into account such viewpoints, the Bank judges that the current combination of “around 0–0.1 percent” for the guideline for the uncollateralized overnight call rate and 0.1 percent for a complementary deposit facility is the most appropriate. Such combination of the target interest rate and interest rate on reserves has also been introduced overseas. In the United States, the Federal Reserve has adopted the combination of 0 to 0.25 percent for the target range for the federal funds rate and 0.25 percent interest rate for financial institutions’ reserves. Clarification of the policy time horizon based on the “understanding of medium- to long-term price stability” As the second measure, the Bank clearly stated that it will continue the virtually zero interest rate policy until it judges that price stability is in sight. Longer-term interest rates are affected substantially by the market’s expectations concerning how short-term interest rates will evolve in the future. The measure taken this time aims at encouraging a decline in longer-term interest rates by influencing the market expectations on short-term interest rates developments through clarifying the Bank’s ideas of policy conduct, which has significant effects on the formulation of short-term interest rates. At the same time, the Bank also clarified that it will use the “understanding of medium- to long-term price stability” (hereafter “understanding”) as a criterion for judging whether price stability is in sight. The “understanding” is the level of inflation rate that each of the nine Policy Board members understands as being consistent with price stability over the medium to long term, and is now illustrated as “on the basis of a year-on-year rate of change in the CPI, it falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board members’ understanding are around 1 percent.” Two effects can be expected from the second measure. First, by explicitly showing the medium- to long-term inflation rate that the Bank has in mind in conducting its policy, there would be effects of giving the people an indication about the future inflation rate and of stabilizing medium- to long-term inflation expectations – an anchoring effect. Second, by linking explicitly the medium- to long-term inflation rate deemed desirable with the conduct of monetary policy, there could also be an effect of making the thinking of monetary policy conduct clear. Those views are common to the so-called inflation targeting. However, inflation targeting tends to often invite, partly due to its naming, the impression that policy will be conducted by merely focusing on the inflation rate. Being easy-to-understand is of course important, but, at the same time, it is necessary to avoid falling into the so-called “pitfall of easy-to-understand” by conducting monetary policy looking away from the complex structure of the economy. Among central bankers and academics, discussions have already evolved from discussions on the old-type inflation targeting that focuses only on short-term price stability to the framework for “flexible inflation targeting,” in which flexibility in policy conduct is enhanced, and countries that actually adopted inflation targeting have been shifting toward implementing a flexible policy framework. For example, in England, while the annual rate of inflation based on the consumer price index is substantially higher than the inflation target of 2 percent and has been hovering above 3 percent since January 2010, the Bank of England has not tightened monetary policy but rather been discussing further enhancing accommodative monetary conditions. On the back of the move not to focus too much on short-term price stability but to aim at ensuring stability of economic activity and prices from a long-term perspective, there is bitter experience of the past at home and abroad. For example, during Japan’s bubble period in the second half of the 1980s, consumer prices had been extremely stable and the average year-on-year inflation rate of the five years was 1.0 percent. Also, through the mid-2000s in the run-up to the recent global financial crisis, an optimistic assessment has spread in the United States that the economy finally achieved an ideal combination of high growth and low inflation and a phrase “Great Moderation” has been widely used to express such a situation. However, as revealed a few years later, just when the phrase was used, financial imbalances, such as an excessive rise in asset prices and excessive debt, which caused the recent global financial crisis were accumulating. In that regard, the Bank introduced a framework for assessing the economic and price situation from two perspectives – a baseline scenario of the outlook for economic activity and prices, and risk factors and, on that basis, it conducts monetary policy. The framework was adopted by incorporating the merits of other countries’ policy conduct frameworks, including the aforementioned inflation targeting, and also paid due consideration to the demerits. And thus, the Bank believes that its policy framework is a more advanced one for monetary policy. Based on such line of thinking, the Bank, in clarifying the policy time horizon, confirmed that the criterion for continuing the virtually zero interest rate policy is the “understanding of medium- to long-term price stability,” and the policy will be continued on condition that no problem will be identified in examining risk factors, including the accumulation of financial imbalances that could threaten economic and price stability from a long-term perspective as the conditions. Establishment of an asset purchase program The third measure is to establish a program for carrying out, for example, asset purchases. In order to aim at a decline in longer-term market rates and a reduction in various risk premiums, the Bank decided this time to purchase a variety of financial assets. Specifically, as a temporary measure, the Bank will establish a program on its balance sheet and purchase various assets, such as government securities, commercial paper (CP), as well as exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). The sum of those assets to be purchased was set to be about 5 trillion yen. The total size of the program, including the fixed-rate operation, was set to be about 35 trillion yen. If the Bank’s risk-taking asset purchases could activate the investment stance of market participants and attract funds into the markets, it could work in the direction of reducing risk premiums. The Bank intends to begin the purchases as soon as possible. As mentioned in the beginning, the reason why the Monetary Policy Meeting was moved forward to today and tomorrow is to promptly discuss and decide on principal guidelines for the purchase of ETFs and J-REITs, which obtained the authorization by the government pursuant to the Bank of Japan Act, and to lay out a framework that can begin the purchases as soon as possible. The measures included in comprehensive monetary easing are extraordinary ones as monetary policy instruments of a central bank, and the Bank is fully aware of that. A policy measure to encourage a decline in longer-term interest rates and a reduction in various risk premiums will be implemented for the first time, and, in particular, a policy to purchase risk assets by a central bank itself shouldering, for example, credit risk is unprecedented in central bank policies. That might lead to taxpayers’ burden in case the purchases should eventually make losses, and will expand the extent of central bank’s involvement in micro resource allocation for individual industries or firms. While it goes without saying that the Bank devises ways to minimize such adverse effects as much as possible, still it cannot be denied that the asset purchases are approaching from the realm of traditional monetary policy of liquidity provision to the realm that has the character of fiscal policy to be shouldered by the government. The Bank has thoroughly considered a grave issue of to what extent those policies should be pursued based on a central bank’s own independent judgment in a democracy. Upon that consideration, the Bank has judged that, as a central bank which has been bestowed from the public the authority to create money, it is required as a responsibility to conduct more effective policies, if they can be devised, in a flexible manner for the economic and financial stability. The establishment of the Asset Purchase Program has been decided on the Bank’s own responsibility by taking into account such contradicting two factors and upon thorough insight into the economic and price situation. Therefore, as for the asset purchase, the Bank decided to bundle it into a program and manage separately so that not only the Bank itself but also market participants and the public will be able to examine the operations conducted under the program and the effects and side-effects of the program. Those are the Bank’s thinking about the comprehensive monetary easing. In the future policy conduct, as described in the Outlook Report, I believe it is important to carefully examine the outlook for economic activity and prices, and take policy actions in an appropriate manner. Closing remarks Today I have explained the developments in the global economy and the domestic economy, as well as the conduct of monetary policy since the failure of Lehman Brothers. As I have been mentioning on various occasions, and I am sure that you have also been recognizing, in terms of the challenges for Japan’s economy, the response to a more medium- to longterm challenge of a trend decline in growth potential is also critical, together with short-term and cyclical problems. In concluding my speech, I will briefly touch on that point. Looking back on Japan since the 1990s, the economic growth rate is on a declining trend, and the labor force has been declining after peaking in 1998 and the population started to decline from 2005. Such shift in demographics, especially the decline in the labor force, will have a significant impact on Japan’s economy like a body blow. That will be evident just by considering some issues such as whether there are prospects for any expansion in domestic markets, whether they can have stable employment and income in the future, and whether fiscal conditions are sustainable. If anxiety among the public spreads concerning those issues, it will restrain the current households’ consumption activity and firms’ business fixed investment. A more fundamental background behind stagnant demand over a long period, and the phenomenon of deflation under an output gap stemming from such stagnant demand, could be ascribed to the weakening of medium- to long-term growth expectations. At present, Japan’s economy is faced with difficult challenges, and thus it is essential to accurately and calmly recognize the big picture of Japan’s economy. Eventually, it is necessary that the activity of private firms, which are the central player of the economy, becomes spurred, and future growth expectations rise. On that point, in all ages, what blazed the economic path was the exertion of innovation by private firms. Innovation blazing a new area, in particular, does not emerge naturally nor being promoted by the efforts of specific firms or individuals. Respective and consistent efforts by each firm including financial institutions will, while favorably influencing each other, lead to elevating Japan’s economy as a whole. As I noted earlier, if the root cause of the problem is the decline in the labor force, there are many issues that society should address, including the increase in the labor-force participation rate of women and the elderly people. In any case, it is clear that, if each economic entity considers institutions and practices as given and only takes an approach to pursuing optimization at a micro level for a continued existence of its own, it could lead to lowering the equilibrium level of the economy and is unlikely to produce the dynamism of Japan’s economic advancement. Of course, to bolster such vigorous activity of the private sector, including firms, preparation of the environment by the public sector including the government will be important. At present, the government is making efforts to increase growth potential, and the efforts are expected to pay off, combined with the efforts by the firms. The Bank also continues to make utmost efforts. Since the second half of 1990s, the Bank has been hammering out new various policy measures. Looking back, those measures seemed very innovative as suggested by the fact that the most of the policies introduced by the central banks in Europe and the United States after the global financial crisis had already been adopted by the Bank. On the quantity side, the Bank entered the low interest rate level, which is currently reached by the European and U.S. counterparties, in the middle of 1990s, and since then its balance sheet has been expanding substantially. That may be part of the reason why the Bank’s aggressiveness tends to have been underappreciated. However, in terms of the ratio of a central bank’s assets size to nominal GDP, the Bank’s ratio is bigger than that of central banks in the United States and Europe, which have increased significantly through the recent financial crisis. The Bank is also the largest in terms of the extent of increase in the ratio after being faced with a low interest rate environment like the present. On the quality side, the Bank has been introducing new measures which are not seen in other countries, including a fund-provisioning measure to support strengthening the foundations for economic growth this year. And this time, the Bank has taken a step further to encourage a reduction in longer-term market rates and risk premiums by asset purchases. The success of that measure depends on whether the private sector, making use of the accommodative financial environment to be realized due to the measure, tries for new challenges and whether an environment in which such a try is enabled is prepared. In that sense, the efforts made by the private sector, the government, and the central bank are essential. The Bank will continue to make contributions as a central bank so that the effects of extremely accommodative monetary policy are fully exerted and will lead to the development of Japan’s economy.
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bank of japan
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Summary of a speech by Mr Tadao Noda, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shimonoseki, 15 September 2010.
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Tadao Noda: Recent economic and financial developments and the conduct of monetary policy Summary of a speech by Mr Tadao Noda, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shimonoseki, 15 September 2010. * I. * * Overseas economies I will begin by outlining the current situation of and outlook for the overseas economies. The world economy deteriorated significantly after the failure of Lehman Brothers, which filed for bankruptcy two years ago, but it has been recovering moderately since the second half of 2009. This recovery has been supported by the effects of both fiscal stimulus measures adopted around the world and inventory restocking in a bid to get them back to pre-slump levels. However, the pace of the global economic recovery has been slowing, as the effects of the stimulus measures and restocking have waned. A. The U.S. economy: burdened with balance-sheet adjustments and deceleration concerns The U.S. economy is recovering at a moderate pace, with the second preliminary estimate for the real GDP growth rate for the April-June quarter of 2010 marking 1.6 percent on an annualized quarter-on-quarter basis, but the rate has fallen from its peak of 5.0 percent for the October–December quarter of 2009. Given the gradual recovery in private consumption and business fixed investment, as well as the increase in exports, the main causes of the fall in GDP growth appear to have been the sharp rise in imports 1 and the slower growth in inventory investment. The U.S. economy is undergoing balance-sheet adjustments, to reduce the huge debt resulting from excessive consumption that had accumulated up to the 2008 financial crisis. With the very slow improvements in employment and income, recovery – particularly in household spending – lacks momentum. Housing investment weakened again as the boost in demand ahead of the expiration of the home-buyer tax credit diminished, and it is likely to be some time before we see a self-sustained recovery. The pace of economic recovery is expected to slow temporarily by the 2010 year-end, due to decelerating exports following completion of the restocking of inventories worldwide, and the waning of effects of the government’s economic stimulus measures, which will push down the growth rate temporarily. The economic recovery trend, however, is likely to be maintained, since exports, particularly to emerging and commodity-exporting economies, are expected to continue increasing, while private consumption and business fixed investment will probably remain on an upward trend amid an accommodative financial environment. B. The euro area economy: facing intraregional disparities and fiscal problems Turning to Europe, I will focus on the economic activity in the euro area. Economic activity in the euro area as a whole has been recovering moderately, with intraregional disparities increasing. The real GDP growth rate in the April-June quarter marked a large increase of 3.9 percent on an annualized quarter-on-quarter basis, up from the previous quarter’s When growth in imports exceeds that in exports, net exports (exports minus imports) decrease, pushing down GDP growth. The sharp increase in imports in the April-June quarter seems to have been only temporary. 1.3 percent. The increase mainly reflects a steady growth in exports due in part to the depreciation of the euro. The economy, however, has been facing two challenges that have arisen from fiscal issues, and have intraregional disparities. The first issue concerns fiscal consolidation. Looking at the April-June quarter’s real GDP indicators by country, Germany marked the highest growth since the country’s reunification in 1990 and was supported by strong exports. Meanwhile Greece, the first to adopt substantial fiscal tightening measures to combat its severe fiscal problems, saw declines for the seventh consecutive quarter. Although the extent of the area’s problems varies, fiscal consolidation must be carried out not only by the most seriously troubled countries such as Greece, but by all member states of the European Union. The second issue concerns stability in financial markets. Since the start of 2010, concern about fiscal problems in some European countries has caused the prices of government bonds in these countries to fall, leading to heightened anxiety about the soundness of European financial institutions that hold large amounts of the bonds. After the July release of the stress test exercise results for these institutions, European financial markets restored stability for a while, but a resurgence of fiscal problems in Ireland has revived market instability. It is anticipated that the two issues just mentioned will add downward pressure on the euro area economy, thereby moderating the pace of future economic recovery. The root of the two issues may lie in the use of a single currency, the euro, the structural factor unique to the area. Its introduction, while stimulating an increase in the euro area’s intraregional trade, expanded the fiscal and current account deficits of some European countries because of the disparity in productivity and competitiveness. Furthermore, fiscal policy is the only tool available to the member states, given that monetary policy has been centralized and that foreign exchange rates can no longer be adjusted to control deficits in the area. C. The Asian economy: adjusting for a soft landing Asian economies, free of the need for balance-sheet adjustments, have been the driving force of the world economy as they exhibit high growth as a whole led by recovery in domestic demand. Private consumption is expected to increase steadily with robust demand for durable goods reflecting the rising level of income and increase in the number of households resulting from progress in urbanization. Capital inflows from abroad will support the virtuous circle of growth in production, income, and spending, and so will help maintain strong growth. The risk of overheating has caused more economies to conduct tighter policies such as adjustments to accommodative monetary policy, but as a whole the financial environment remains lax. The Chinese economy, the most powerful engine of growth, continued to grow at a rapid pace and marked a double-digit real GDP growth rate of 10.3 percent on an annualized quarter-on-quarter basis for the April-June quarter of 2010, decelerating slightly from 11.9 percent in the previous quarter. Concerned about the hike in real estate prices, the Chinese government this April introduced measures, including a higher down-payment ratio for housing purchases, to restrain the increase in real estate transactions. These measures are expected to place added downward pressure on economic activity to a certain extent by slowing the pace of growth in fixed asset investments. This would be achieved by restraining the increase in real estate transactions and, at the same time, decelerating production growth, particularly of steel and other construction-related materials. As a result, the balance between orders and inventories in the manufacturing sector is improving at a slower pace, and the pace of economic expansion is expected to decelerate for a while. The Chinese economy, however, is likely to continue growing at a rapid pace into next year, as private consumption is expected to increase steadily, generated by higher income levels, while the government will be ready to intervene flexibly to help support the economy. II. Japan’s economy Next, I will outline the current situation of and outlook for Japan’s economy. A. The economy: recovering moderately, but with the self-sustaining momentum still weak Japan’s economy has been showing signs of a moderate recovery supported by the continued improvement in overseas economic conditions mentioned earlier. The real GDP growth rate for the April-June quarter of 2010 in the second preliminary estimate was 1.5 percent on an annualized quarter-on-quarter basis, showing a clear deceleration in growth compared to the previous two quarters. However, exports have been increasing; private consumption has been picking up, due to the government’s economic stimulus measures favoring energy-efficient products; and business fixed investment is showing signs of picking up, led by the increase in exports. Yet, the main economic indicators confirm that the level of economic activity remains lower than its recent peak. In this situation, there has been a persistent sense of excesses in capital stock and the workforce, and thus firms remain cautious about spending despite a notable improvement in corporate profits. Therefore, prospects for a self-sustaining recovery in domestic private demand remain uncertain. In terms of outlook, the economy is likely to recover at a moderate pace on the whole, with exports continuing to increase. However, the pace of increase in exports is likely to remain moderate for the time being, mainly due to the following: (1) the waning effects of inventory restocking in overseas economies; (2) the slowdown in the high growth of emerging economies, primarily reflecting tighter economic policies; and (3) the yen’s recent appreciating trend. A decline in private consumption seems inevitable in reaction to the waning effects of the government’s economic stimulus measures favoring energy-efficient products. Thus, the pace of recovery in Japan’s economic activity is likely to slow temporarily. Nevertheless, it is anticipated that Japan’s GDP growth rate for fiscal 2010 will exceed the potential economic growth rate. For reference, the median of the Policy Board members’ forecasts in July for real GDP was 2.6 percent for fiscal 2010, and 1.9 percent for fiscal 2011. 2 B. Prices: weaker downward pressure from the negative output gap Although prices continue to decline due to the substantial slack in the economy as a whole, the pace of decline is slowing as a trend due to the gradual improvement in the aggregate supply and demand balance. Excluding the effects of the special subsidies for high school tuition introduced in April 2010, the year-on-year pace of decline in the consumer price index excluding fresh food, or the core consumer price index (CPI), is gradually slowing. The median of the Policy Board members’ forecasts in July for the core CPI was at around minus 0.4 percent for fiscal 2010, and at around 0.1 percent for fiscal 2011. Every April and October, the Bank releases its Outlook for Economic Activity and Prices (the Outlook Report), and in the intervening January and July makes an interim assessment of the outlook laid out in the report. In October, the Policy Board will review its outlook by assessing the upcoming economic indicators and relevant information. C. Risk factors surrounding the outlook I believe the outlook just outlined for Japan’s economy and prices is the most probable scenario. Projections, however, are always subject to many uncertainties. Let me elaborate on major uncertainties that are also risk factors surrounding the outlook of the economy and prices in Japan. Since Japan’s economic recovery has been induced by improving overseas economic conditions, and a self-sustaining recovery in domestic demand remains uncertain, any delay in the recovery of overseas economies could derail Japan’s economy from a self-sustaining recovery path. Therefore, I consider that developments in overseas economies represent the greatest risk that Japan’s economy faces. 1. Risks posed by the U.S. economy The quarter-on-quarter slowdown in the real GDP growth rate for the April-June quarter and declines in many economic indicators released since July have sparked serious concern about the outlook for the U.S. economy. For example, forecasts by private-sector economists for the real GDP growth rate have been revised downward from a mean of around 3.0 to 3.5 percent for 2010 and 2011, to a mean of just below 3.0 percent for both years. I believe that these revisions are only corrections to the overoptimistic forecasts that resulted from an incorrect appraisal of the substantial pressure exerted on economic growth by the U.S. economy’s balance-sheet adjustments. The recent developments are in line with my forecasts: I had expected that the adjustment process would require a considerable amount of time and money, considering Japan’s long and harsh experience following the bursting of the economic bubble and the scale of excesses in the run-up to the recent financial crisis. 3 In addition, it is possible that a negative chain reaction of downside risks will emerge: a slowerthan-expected recovery in the employment situation or a renewed fall in housing prices would further delay adjustment in household balance sheets. This would affect the corporate sector negatively by restraining private consumption. 2. Risks posed by emerging and commodity-exporting economies In addition to the underlying strength of self-sustaining growth, economic activities in emerging and commodity-exporting countries are in part being supported by capital inflows from advanced countries, which are persisting with large-scale monetary easing. Should capital inflows continue and economic conditions in emerging and commodity-exporting economies turn out to be stronger than expected, the greater exports thereby generated could represent an upside risk for Japan’s economy. Nevertheless, if the aforementioned risk concerning the U.S. economy materializes and economic activities in advanced countries are weaker than expected, growth in emerging and commodity-exporting economies might come under downward pressure, generated by a decline in trading volume and an outflow of capital. Furthermore, although a growing number of countries are making adjustments to accommodative monetary policies, 4 a delay in adjusting policy appropriately could lead to economic overheating in the economies that fall behind the curve by delaying appropriate monetary policy adjustment. Should this be the case, in the short run Japan’s exports could rise even further, while at the same time the worsening in the terms of trade associated with The recently released annual revision of GDP data showed the saving rate for the April-June quarter increasing to 6.0 percent; the 3.9 percent in the pre-revision data rose to 6.2 percent in the post-revision data. This upward revision is notable as it reflects the magnitude of the pressure from balance-sheet adjustments. For reference, the average saving rate in the United States was about 2.8 percent from the beginning of 2000 through summer 2008 – the period when overspending seemed to have continued. Asian countries that have raised their benchmark interest rates include Malaysia and India in March, Taiwan in June, and South Korea and Thailand in July. In addition to the Asian economies, Australia and Brazil have been raising their policy interest rates. a rise in commodity prices could also pose a downside risk for private domestic demand in Japan. Moreover, in the medium to long term, if a sharp unwinding of excessive economic and financial activity takes place in emerging and commodity-exporting economies, the risk of deep adjustments in their economic activity would demand attention. 3. Risks in global financial markets caused by the situation in Europe Global financial markets have been unstable since the beginning of this year, due partly to growing fiscal problems in some European countries and subsequent growing concern about the financial system. As mentioned earlier, a structural factor – the use of a single currency – may lie at the root of the fiscal problems, and thus it is unlikely that there will be a quick resolution to the volatile situation in financial markets caused by the situation in Europe. 4. Risks related to Japan’s corporate sector The last risk posed by overseas economies relates to the corporate sector in Japan. If expectations are rising that demand in Japan will be lackluster, while expectations for sustainable growth among emerging economies increase, there is a risk that investment in and lending to emerging economies will expand and Japanese firms’ spending on business fixed investment and employment will be placed under undue restraint. According to the Survey on Planned Capital Spending, released by the Development Bank of Japan, the ratio of the Japanese manufacturing sector’s overseas capital investment (capital investment overseas divided by capital investment in Japan multiplied by 100) for fiscal 2010 was a record high of 57.2 percent. 5 Furthermore, according to the Annual Survey of Corporate Behavior, conducted by the Cabinet Office, the ratio of overseas production has been on an upward trend. Recently, an argument arose linking the yen’s appreciation to the hollowing out of domestic industry. However, I believe it necessary to view this issue from a medium- to long-term perspective, linking it to the issue of productivity and the potential growth rate. I will expand on this topic later in more detail. III. Conduct of monetary policy A. Policy responses by the Bank of Japan Next, I will outline some of the Bank’s monetary policy measures, implemented since the Lehman shock in 2008. Policy measures become operative and effective through synergy, however, for the sake of explanation, I will categorize them into three types according to their objectives. 1. Measures responding to cyclical economic changes: pursue powerful monetary easing Measures taken in response to cyclical economic changes were designed to overcome deflation and return to a path of sustainable growth for Japan’s economy, which had deteriorated significantly following the Lehman shock. The Bank undertook interest rate policy, lowering its target for the uncollateralized overnight call rate – the policy rate – by 0.2 percentage point both in October and December 2008, to 0.1 percent, or virtually zero percent. Since then, the policy rate has remained at that level. The Bank has also been encouraging longer-term interest rates to decline. In December 2009, it introduced a fixed-rate funds-supplying operation against pooled collateral (hereafter the fixed-rate The survey was conducted in June this year with valid responses by 2,270 firms (1,357 firms were surveyed concerning their ratio of capital investment overseas). The ratio of capital investment overseas in the manufacturing sector peaked at 54.8 percent in fiscal 2005, but declined gradually to 42.0 percent in fiscal 2009, after which it rose to 57.2 percent in fiscal 2010. This fluctuation does not necessarily represent an upward deviation from the past trend, given the sharp decline from fiscal 2008 to fiscal 2009. operation) to provide three-month funds to financial institutions at a low interest rate of 0.1 percent, the same as the policy rate. Moreover, the Bank decided to start providing additional funds with a six-month term in August 2010. The total amount of loans to be provided through the fixed-rate operation will increase to approximately 30 trillion yen, of which some 20 trillion yen would be available under the existing three-month term operations. In this way, the Bank is working to further enhance easy monetary conditions by providing ample and flexible funds to the money markets. 2. Measures to stabilize financial markets: promote recovery from the “acute symptom” The stabilization of financial markets benefits the economy because the effects of monetary policy spread to the economy through financial markets. With the failure of Lehman Brothers, confidence in the overall financial market was suddenly undermined and the functioning of the market deteriorated substantially. In a bid to recover from the resulting situation, which has been described as an “acute symptom,” the Bank adopted a number of measures, including the outright purchases of CP and corporate bonds in early 2009, in response to a fall in the number of CP and corporate bonds transactions; and special funds-supplying operations, collateralized by corporate debt, to facilitate corporate financing that provided funds to financial institutions with funds at a low interest rate equivalent to the policy rate. These steps – completed by March 2010 after market functioning had been restored – were exceptional, in that the central bank had taken on individual private firms’ credit risks, which would appear on its balance sheet. 3. Measures addressing structural issues of the economy: support strengthening the foundations for economic growth The third category of policy measures relates to Japan’s economy from a medium- to longterm perspective. The growth rate had remained high until the start of the 1970s, when it started declining gradually, before dropping sharply following the bursting of the economic bubble at the beginning of 1990s, after which the rate has been declining. Prices have been deflationary since the end of the 1990s in terms of the year-on-year change in the CPI. The fundamental cause of deflation is a lack of demand, caused by a protracted negative output gap. A decline in the growth rate seems to have been the cause of the sluggish demand as it dampened the public’s expectations for future economic growth, or in other words, expectations for an increase in wages. From a macroeconomic perspective, economic growth comprises growth in both labor productivity and the number of employed. With the birth rate declining and the number of those employed not likely to rise, labor productivity must be raised if growth expectations are to increase and deflation is to be overcome. While the measures to address cyclical economic changes, involving more or less short-term economic fluctuations, would solve the lack of demand, they alone would be ineffective in addressing the medium- to long-term issue of raising productivity. 6 Bearing this in mind, the Bank has searched for ways in which it could utilize its functions to raise the potential growth rate through higher productivity. Thus, in June 2010 it introduced a new fund-provisioning framework to support, from the financial side, private financial institutions’ efforts of their own accord toward strengthening the foundations for economic growth. In March 2010, at a meeting with business leaders in Shiga Prefecture, I made the following statement in “My Answers to the Frequently Asked Questions regarding Monetary Policy,” based on the same awareness I have now: “Maintaining the extremely accommodative financial environment is one of the necessary conditions for overcoming deflation. Another is confronting the fundamental cause of deflation – that is, the lack of demand – and making steady efforts to unlock and capture potential demand, as well as to improve productivity.” The first loan disbursement under the new fund-provisioning measure was executed on September 6, involving a total of 462.5 billion yen, disbursed to 47 financial institutions, and covering 1,342 investments and lendings. The Bank hopes this fund provisioning will act as a catalyst for financial institutions in making efforts on their own initiative toward strengthening the foundations for economic growth. Having had years of experience in the business of loans at a private financial institution, I strongly expect the measure will stimulate bankers in charge of loan disbursement and credit screening to foster the innovation necessary to discover and nurture newly growing firms, eventually leading to improvements in financial institutions’ screening abilities and capacity to produce information. B. Future monetary policy The Bank has been enhancing easy monetary conditions through various measures, including those I have just outlined, and by also making clear its commitment to maintaining an extremely accommodative financial environment. I am certain that the synergy resulting from these measures has supported economic activity and helped clear the way to overcoming deflation by improving the aggregate supply and demand balance. As already noted, projections are always subject to uncertainties. Thus, it is necessary to examine closely the forthcoming economic data and information, so that necessary policy measures can be taken swiftly and decisively should downside risks threaten before deflation has been overcome, raising the possibility that the economic outlook might deteriorate significantly. Today, I have outlined some of the measures the Bank has implemented over the past two years since the collapse of Lehman Brothers. In addition, it implemented various pioneering measures from the latter half of the 1990s to the early 2000s that are similar to those adopted by central banks in other major countries in response to recent financial crises. The selection of appropriate policy measures and enhancing of policies require that their possible effects on the economic outlook be taken into consideration, based on domestic and overseas expertise. The selection of suitable measures requires that the costs which may arise from the implementation of measures, their efficacy, potential risks, and means to prevent such risks from materializing should be considered ahead of time. It is necessary, in addition, to keep up-to-date information regarding the effectiveness, probable costs, and side effects of policy measures, since they reflect changes in the economic and financial situation, as well as fiscal and institutional structures.
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Bauhinia Distinguished Talk hosted by the Bauhinia Foundation Research Centre, Hong Kong SAR, 23 November 2010.
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Masaaki Shirakawa: Advanced and emerging economies – two-speed recovery Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Bauhinia Distinguished Talk hosted by the Bauhinia Foundation Research Centre, Hong Kong SAR, 23 November 2010. * I. * * Introduction Good evening. Today, I am indeed honored to have this precious opportunity to give a speech here in the beautiful and dynamic city of Hong Kong. I would like to begin by expressing my heartfelt thanks to the Bauhinia Foundation Research Centre and the Chairman, Mr. Anthony T. Y. Wu for kindly providing such an honorable occasion to speak in front of our distinguished audience. As you are well aware, financial business is the biggest industry in Hong Kong. Did you know, however, that the financial relationship between Hong Kong and Japan was forged shortly after Hong Kong appeared in modern history? In 1871, three years after the foundation of the Meiji Government, Japan began to issue its first modern currency. The government of the time acquired its minting machinery from the former English Minting Authority in Hong Kong, and invited the engineers to Japan, asking them to issue silver coins of the same weight and quality as those used in Hong Kong. While there are a variety of stories claiming to account for the origin of the name of the Japanese currency, the yen, one of these stories tells us that in fact the yen derives its name from the silver Hong Kong one yuan coin (Slide 1). Financial institutions have also been active since the very early days in helping build close associations between Hong Kong and Japan. The Hong Kong and Shanghai Banking Corporation Limited, familiar worldwide as HSBC, was established in Hong Kong in 1865. In the following year, 1866, HSBC opened its branch in Yokohama, and this contributed greatly to the development of trade finance in Japan. Among Japanese banks, the former Yokohama Specie Bank Limited, which is said to have been modeled after HSBC, opened its local office in Hong Kong in 1896. The strong economic ties between Hong Kong and Japan are not limited to financial services but extend also to trade in goods and services. Hong Kong is currently Japan’s fifth largest export partner (Slide 2). It must also be pointed out that this trade in products is not confined merely to industrial goods. Believe it or not, despite its total population of less than ten million, Hong Kong is the primary export destination for Japanese agricultural products, some of which may be re-exported to other regions, including mainland China. Japanese luxury fruits are very popular among Hong Kong’s gourmet residents. There is also a long-term relationship between Hong Kong and the Bank of Japan. The Bank of Japan opened a representative office in Hong Kong in 1957, aiming to ensure close appreciation of economic developments in the Asian region (Slide 3). Since then, our representatives at the Hong Kong office have been providing extremely valuable and enlightening reports to the Tokyo Head Office on monetary and economic developments in Hong Kong and East Asia, including those on the Asian currency crisis in 1997. We have been enjoying a very close and friendly relationship with the Hong Kong Monetary Authority, and I myself have solicited advice for today’s speech from my very close friend, Mr. Norman T. L. Chan, Chief Executive of the Hong Kong Monetary Authority. Let me now move on to the main subject. The title of my speech today is “Advanced and Emerging Economies: Two-speed Recovery,” and I would like to take this opportunity to express my views on the outlook for the global economy. I will also briefly touch upon several challenges for Asia and Japan from the perspective of ensuring economic developments between the two. II. Current state of the global economy I will start with the current state of the global economy. The global economy has been recovering at a modest pace, following its rapid decline after the Lehman shock. The current state can most accurately be described by what has already become a rather worn-out phrase, the “two-speed recovery.” According to the IMF World Economic Outlook released in October, the growth rate of the global economy was minus 0.6 percent in 2009, followed by a forecast plus 4.8 percent for 2010, and plus 4.2 percent in 2011 (Slide 4). Approximately 70 percent of the growth is contributed by emerging and resource-rich economies. Among those, the growth of Asian emerging economies stands out, and it can be said that Asian emerging economies are currently the growth center for the global economy, and have been a great driving force for its recovery since the global financial crisis. 1 Meanwhile, Japan’s economy has also benefited significantly from the growth of the Asian emerging economies. Japan’s exports dropped sharply from the end of 2008 to the beginning of 2009, owing to the financial crisis. However, after the spring of 2009, exports showed a significant increase, mainly to China, the ASEAN, and other major Asian economies (Slide 5). The Japanese economy has recovered at the fastest pace among the advanced economies, and one of the main reasons for this has been the significant increase in exports to Asia. Now, what projections can we make about future global economic developments? While the future of the global economy is fraught with uncertainty, I focus particularly on the following three points in making a projection. The first point relates to the advanced economies, especially to an assessment of their balance sheet adjustments. The credit bubbles in the mid-2000s were on a very large scale, particularly in the U.S. and the U.K. economies, and for that reason, it may well take some time for them to recover. Assessment of the effectiveness of macroeconomic policies in advanced economies is also an important element. There is already very limited room for deployment of monetary and fiscal policy in these economies. Given these circumstances, when can we expect the advanced economies to return to a full-fledged recovery path, and how robust will this return be? The second point I wish to raise relates to the growth prospects for the emerging economies. The growth potential of emerging economies may seem very large, but without the appropriate policy taken, the risk of a bubble cannot be ruled out. In addition, although this is not a pressing concern, the smooth transition from a high-growth economy to a mature economy will become one of the important policy challenges for the emerging economies in the longer term. The third point, which interlinks with the above two points, is the issue of capital flows and exchange rates, or more simply, the currency conflict under the “two-speed recovery.” III. Perspectives from the experience of the Japanese economy Japan’s experience over the past few decades offers a range of ideas when considering these three points. One of the most debated topics of economic policy over the past several months has been the large-scale asset purchase program implemented by the Federal IMF “World Economic Outlook,” October 2010. Asian emerging economies are here defined as China, India, Korea, Taiwan POC, Hong Kong SAR, Singapore, Thailand, Indonesia, Malaysia, Philippines, and Vietnam. Reserve. Meanwhile, many commentaries by economists and policy makers suggest that the program was intended to avoid “Japanese-style deflation” or “the lost decade in Japan.” Incidentally, if you search the keyword “Japanese-style deflation” on Google, the results have increased rapidly from about four hundred thousand entries during the first half of this year, to about a million during the period from July to mid-November. However, many are interested not only in Japan’s experience of deflation or “the lost decade.” When I talk to my friends in China, it surprises me to learn that in-depth studies are carried out on Japan’s experience during the high-growth period and after the Plaza Accord. Now, I would like to express my views on the above three points, by making reference to Japan’s experience. Balance sheet adjustments in advanced economies and their aggressive monetary easing Let me start with the issue of balance sheet adjustments or repair in advanced economies, particularly in the United States. Balance sheet adjustments were indeed an issue that Japan struggled to resolve after the burst of the bubble. Real GDP growth in Japan after the burst of the bubble decreased significantly to an annual average of 1.5 percent in the 1990s, down from 4.4 percent in the 1980s (Slide 6). After entering the 2000s, real GDP growth picked up somewhat to an average of 1.7 percent until 2007, but dipped again owing to the Lehman shock. Average real GDP growth for the 2000s was merely plus 0.7 percent. As for the inflation rate in Japan, the consumer price index has been on a mild downward trend since 1998 (Slide 7). As such, Japan’s economic performance has not been impressive in recent years, and this is why discussions in the United States often take place in the context of “avoiding the Japanisation” of the U.S. economy. However, such framing of the discussions occasionally makes me feel that Japan’s experience and its lessons may be misread. My understanding of the main causes for the decline in Japan’s growth rate can be summed up in the following three points. The first cause can be attributed directly to the burst of the bubble. During the formation of the bubble, driven by excess optimism about the future, firms expanded their business capacity and employment, and increased their debt. After the eventual bursting of the bubble, the so-called “three excesses” remained, namely excesses in business capacity, employment, and debt. The economy continues to suffer downward pressure as long as “such excesses” remain. It was not before the resolution of these “three excesses” in 2003 that Japan returned to a full-fledged recovery path (Slide 8). The second cause is the failure of Japanese firms in adapting to the changes in overall trends that took place globally from the late 1980s through the 1990s, namely deregulation, globalization, and the information and technology revolution. During this period, global markets were further integrated, and divisions of labor in production processes were extended on a global scale. Foreign firms increased their value added by optimally rearranging their production base and sales channels, and reduced costs by effectively expanding outsourcing. On the other hand, it was a significant challenge for Japanese firms to adapt to such circumstantial changes, since their business models were based on centralized control and integrated team production. The industrial model in Japan was supported by a highly skilled domestic labor force under the lifetime employment system. However, since Japanese firms were trapped in the memory of their past successes, they were left behind in adapting themselves to the major trend changes in the global economy. The third cause is the aging and declining population (Slide 9). There are a variety of channels through which demographic changes affect the economy. However, with other conditions being equal, domestic demand will naturally decrease in line with a decrease in population. Likewise from the supply side, a decrease in labor supply will reduce the growth rate. Owing to Japan’s rapidly aging population, the growth rate of productive population turned to be negative in 1995, and was minus 0.9 percent in 2009 on a year-on-year basis. The decline in population will also increase the fiscal burden on the working generation. How should we assess the risk of deflation, a question which relates to the debate on “the lost decade”? In fact, Japan has experienced a mild price decline of about 3 percent on a cumulative basis over a decade. However, the country has not experienced a deflationary spiral, where a decline in prices induces a decline in economic activity, thereby leading to a further decline in prices. This deflationary spiral is the strongest reason for fearing deflation. Instead, in terms of length, Japan experienced its longest post-war period of sustained recovery from 2002 to 2007, though not necessarily spectacular. Hong Kong has also experienced an increase and decline in prices in recent years. For every jurisdiction, it is not appropriate to isolate the issue of deflation from economic structure, in particular from wage setting. If we compare consumer price inflation between Japan and other advanced economies, the rate difference is mainly attributed to the development in the price of services (Slide 10). As the inflation rate declined, wages were set in a more flexible manner in Japan. This flexibility in wage setting was attained not only through a reduction in bonus payments and an increase in the number of non-regular workers, but also through the downward revision of fixed remuneration for regular workers in a flexible manner. Since services are more labor-intensive than the production of goods, the flexible adjustment of nominal wages resulted in a decline in the price of services, which became a cause of the deflation. Since the latter half of the 1990s, corporate management and employees in Japan have given priority to ensuring employment, and a decline in wages has therefore been accepted by the workers. As a flipside to a decline in wages and mild deflation, Japan has experienced an increase in its unemployment rate which is currently at 5.0 percent, but this increase has been much smaller than in the U.S. and European economies. Let me summarize the above argument by highlighting the implications for the current U.S. economy. First, it takes a significant time after the burst of a large bubble for an economy to complete its balance sheet adjustments and return to the path of full-fledged recovery. In this regard, the current U.S. economy may require some more time to repair its balance sheets. Aggressive monetary easing could reduce some of the pain arising from on-going balance sheet adjustments, but it will not extinguish the need for those adjustments. Second, even during the process of balance sheet adjustments, it is essential not to forget paying attention to the importance of the supply side of the economy. Although accommodative monetary policy is important so as to avoid sharp declines in demand, prolonged low interest rates may hinder the growth of productivity by devitalizing economic regeneration. In the longer term, the trend in economic growth rates is determined by supply side factors, namely the growth of the labor force and productivity. On this point, the United States seems to have the advantage over Japan in terms of its more flexible economic structure as well as higher population growth of approximately 1 percent, which is higher than that of Japan in the post-bubble period. However, during the prolonged economic downturn period after the burst of a bubble, policies that may harm long-term efficiency are often introduced in the climate of accumulated social frustrations. Preventing a decline in growth potential appears to be the key to avoiding “the lost decade” situation, although this is not an easy task for any economy. How long will the high growth of emerging economies be sustained? The above are my views on the balance sheet adjustments in advanced economies, which is the first point I wish to make in projecting the future developments of the global economy. My second point is on the sustainability of economic growth in emerging economies. Emerging economies have achieved remarkable growth in recent years. If we mathematically extrapolate from the average growth rates of the global economy and BRICs economies for the last ten years, the global share of the BRICs economies will reach more than 80 percent in 2040, although this is considered to be unrealistic. Even these high-growing economies will mature at some stage. Let me now make a simple comparison of Japan’s high economic growth in the past and China’s economic growth in recent years. Roughly speaking, China’s population is ten times greater than that of Japan, China’s per capita nominal income is onetenth of that of Japan, and, accordingly, the nominal GDP for the two countries is about the same. Japan’s high economic growth era started in the mid-1950s, and ended in the early 1970s. The average annual growth rate for this fifteen-year period reached about 10 percent (Slide 11). On the other hand, China’s high growth era began in the early 1990s, and the average annual growth rate for the first fifteen years was roughly the same as that of Japan during its high growth era. The difference between the two is that China is still continuing its high growth at an average of more than 10 percent. During a period of high growth, the supply of labor from rural agricultural areas is one of the key factors. If we compare the urban population ratios of Japan and China from this perspective, the current ratio for China is about the same as that of Japan during high growth era of the 1960s. 2 The automobile diffusion ratio for China has also reached about the same level as that of Japan in the 1960s, which indicates a consumption boom owing to improvements in income level. Based on such simple comparisons, China’s high economic growth is likely to continue for the time being. However, one of the important prerequisites for maintaining high growth is to avoid the formation of a bubble. The authorities in China are well aware of this. I would then like to share my understanding on how the bubble was formed in Japan in the latter half of the 1980s. It was a phenomenon that arose from the complicated interaction of the following factors. The first factor was the overconfidence that became so pervasive throughout Japan. Japan’s growth rate gradually declined after its high growth era ended in the early 1970s, and yet growth rates remained far greater than those of other advanced economies up until the 1980s. Inflation rates were quite subdued, and therefore, Japan boasted of itself being an honor student. It may sound like a joke, but there were even calculations in the late 1980s that the land value of the Tokyo metropolitan area alone was sufficient to purchase the whole United States. This economic background fostered overconfidence, and increased the aggressive behavior of many economic entities. The second factor was the lack of a sufficiently prudent financial supervision. Financial institutions considerably increased their lending to the real estate, construction, and nonbank sectors, and loosened their underwriting standards on loans, including collateral evaluation. As a result, the exposures of the financial institutions’ portfolios became extremely vulnerable to fluctuations in land prices. The third factor was the prolonged accommodative monetary policy. However, it is not so meaningful to simply state that monetary easing was one of the factors that contributed to the bubble. We need to examine in depth the social and economic background as to why monetary easing was continued for such a prolonged period. One of the reasons is the continuance of the low inflation rate. Another reason is that Japan had been under strong external pressure to squeeze its current account surplus. In order to reduce its current account surplus, Japan needed to expand domestic demand, and strong arguments developed around implementing accommodative monetary policy. Even after the economy had improved, concerns were often expressed, mainly by exporting firms, regarding the appreciation of the yen. These factors stood in strong opposition to withdrawing the accommodative monetary policy. For the comparison of development phases in Japan and China, for instance, see Muto, Matsunaga, Ueyama, and Fukumoto (2010), “On the Recent Rise in China’s Real Estate Prices,” Bank of Japan Review Series, No. 10-E-3. If there are lessons for high-growing emerging economies to learn from Japan’s experience, which might help them avoid a bubble, these can be summarized in the following three points. First, society, as a whole, needs to maintain a sense of discipline in order to avoid overconfidence, particularly in times of high growth. Second, I put an emphasis on the importance of the financial regulation and supervision. Especially given that each bubble is different, it is absolutely essential to have a supervisory framework from the perspective of macro-prudence to accurately grasp the overall risk. Third, monetary policy has to aim at domestic stability, which amounts to sustainable economic growth under price stability. We must bear in mind that focusing on foreign exchange rates and current accounts can be detrimental to the stability of the domestic economy. Financial and capital market developments under the “two-speed recovery” Let us now move on to my third point in making projections for the global economy. The third point relates to issues arising in financial and capital markets owing to the “two-speed recovery.” Currently, advanced economies, including Japan, are conducting extremely accommodative monetary policies to ensure their economic recovery. On the other hand, emerging economies are experiencing increasing capital inflows from advanced economies (Slide 12). These capital inflows mainly reflect the high growth prospects of emerging economies, together with the influence of interest rate differentials between advanced and emerging economies. A number of Asian emerging economies have observed their stock prices reaching new historical peaks (Slide 13). Real estate prices have increased at a substantial pace, and the rising trend in global commodity prices is also observed. In terms of the increase in asset prices, Hong Kong is no exception. Given these circumstances, emerging economies have been expressing concerns over the accommodative monetary policy in advanced economies, as it could lead to overheating in their domestic economies and the emergence of a bubble, and further to a possible reversal of capital flows in the future. Advanced economies are, on the other hand, expressing concerns that the foreign exchange rates of emerging economies are less flexible, and this may eventually threaten global sustainable growth by enlarging global imbalances. For reference, the foreign reserve assets of Asian emerging economies dropped slightly immediately after the Lehman shock, but recovered again and increased dramatically (Slide 14). How should we address this currency issue? Textbooks provide clear-cut answers, but have never sufficiently covered the variety of dilemmas that we have actually experienced in recent years, including carry trades, where low interest rate currencies are borrowed as a funding currency and invested in the financial assets of high-yield currencies. Even if the textbooks did provide us with clear-cut answers, these would not instantaneously help resolve the problems we face, as there are no binding powers to ensure their policy implementation across jurisdictions. In this regard, I would like to emphasize that a deep understanding of the textbook principles is important, but at the same time, thinking in a textbook manner alone is not sufficient. Allow me now to confirm a very basic principle from the textbooks. Central banks in every jurisdiction bear the ultimate responsibility for the price stability and economic stability of their jurisdiction. Whether an advanced or an emerging economy, it is natural and legitimate for central banks to take accommodative monetary policy to be strengthened further or otherwise corrected, depending on each economic situation. In relation to exchange rate fluctuations, under the free movements of international capital, fixing the exchange rate would inhibit autonomous monetary policy. Therefore, if the capital inflows to the emerging economies are causing overheating, the textbook answer for them would then be either to accept the appreciation of the currency, or to tighten monetary policy in response to the extent that it affects domestic prices and economic activity. This principle is indeed important. However, the textbooks we have do not consider the important economic reality at this moment, namely the zero interest rate bound and balance sheet adjustments. Given the zero interest rate bound, and given also that there are many economic entities exposed to balance sheet adjustments, it may be more difficult than in other circumstances for monetary easing policy to take effect through domestic economic entities. Rather, it tends to take effect through external channels, such as capital outflows and currency depreciation. The reality for those emerging economies receiving capital inflows is that, although the growth of their financial and capital markets may indeed have been remarkable in recent years, their markets are still small and less liquid compared with those of advanced economies. Hence, when there are large uncovered capital flows into the local currency stock and bond markets of emerging economies, the exchange rate and the price of securities tend to rise simultaneously. This further accelerates the inflows in a selffulfilling manner, as speculative money seeks the capital gains of currency as well as securities. Such superfluous capital inflows force down domestic bond yields, creating downward pressure on the lending rates of domestic banks, and may lead to a rise in asset prices. Allowing the currency to appreciate may help to deter capital inflows, but if inflationary pressures were suppressed by such currency appreciation, the low interest rate period may be extended owing to the apparent stable price conditions, resulting in the inability to prevent the overheating of the economy and the creation of a bubble. This would suggest that currency appreciation is also not a panacea. In either case, if emerging economies experience the formation and the burst of a bubble, the influence will also rebound to advanced economies. Several years ago, when Japan was implementing its quantitative monetary easing policy, there were criticisms from Asian colleagues that such a policy was promoting carry trades. There have been similar arguments, expressed even more vigorously, since the Federal Reserve recently implemented its large-scale asset purchase program. Although it is understandable for advanced and emerging economies to have their different views, what is essential for us is to acknowledge that we are all in the same boat when it comes to the globalized economy. There is as yet no clear-cut answer to these difficult issues, but I believe it is important that each jurisdiction embraces the following approach when implementing monetary policy. First, advanced and emerging economies need to rethink the meaning of domestic stability of both prices and economic activity, before actually implementing monetary policy. Every central bank aims at ensuring domestic stability for its jurisdiction at any time. However, in order to attain this objective under circumstances of economic and financial globalization, it is becoming important for central banks to take into account the impact that their own monetary easing or lack of flexibility on foreign exchange rates might have overseas, as well as the feedback effects on their jurisdictions. Second, it is also important to implement measures from a prudential policy perspective. In this regard, the Hong Kong Monetary Authority (HKMA) has sounded a warning since last year about the rapid increase in real estate prices, implementing a variety of policy measures, such as the lowering of the Loan-to-Value (LTV) ratio. These macro-prudential measures are particularly essential for Hong Kong, where a fixed foreign exchange rate regime has been adopted. An issue currently of global importance is how to design macroprudential measures appropriate to the situation of each domestic economy and to the degree of development in financial markets. IV. Economic development in Japan and other Asian economies So far, I have expressed my views on the outlook for the global economy. Next, in the little time remaining, I would like to change the topic and talk briefly about economic developments in Japan, with particular reference to the economic relationship with other Asian economies. The Japanese economy is facing a number of difficult challenges, as indicated by the declining trend of GDP growth rate. We, Japanese people, often tend to be rather selfreflective, which is also considered a virtue, but I feel that this tendency has been going too far recently. We should avoid being excessively either optimistic or pessimistic. Therefore, I will start by emphasizing the strengths of Japan’s economy. First, the growth rate of real GDP per worker in Japan, namely the growth rate of productivity, still bears comparison with that of the United States, although it is no longer what it once was (Slide 15). Second, Japan’s financial system is sound. Looking back at the time of the Lehman shock in the fall of 2008, Japan’s financial system was relatively more stable than those of the U.S. and European economies (Slide 16). Third, Japan has high technological competitiveness. For instance, Japan is at the global forefront of advances in environmental technology. Japan has also made advances, during the process of urbanization for example, in areas of high technology associated with infrastructure, including water supply, roads, railways, and harbors. Fourth, Japan has strong economic and historical ties with, and is geographically close to East Asian economies which together currently enjoy the most rapid growth in the world. Recent experience of the global economy suggests that, even in the age of globalization, the importance of geographic closeness still counts. After highlighting these strengths of Japan’s economy, I have to admit that it nonetheless faces many challenges. The most pressing challenge is, I think, coping with its demographic changes. Japan’s working population has been declining since the latter half of the 1990s, and the number of workers has also shown a declining trend since 1998. Under these circumstances, I believe, the particularly important issues we have to deal with are maintaining a sustainable fiscal balance, and increasing the rate of participation in the elderly and female workforce. Meanwhile, it is also vital that Japan continues to make efforts towards realizing the potential strengths that I mentioned earlier. Strengthening our cooperation with Asian economies is likewise crucial for this issue. Looking at the weight of East Asian economies in exports from Japan, it has increased from 30 percent in 1990 to 40 percent in 2000, and further up to 51 percent in 2009 (Slide 17). The weight of Asia in foreign direct investment from Japan has also been increasing steadily. As such, Japan’s relationship with Asian economies has been deepening further. Economic strategy in Asia is one of the important pillars in the Japanese government’s “New Growth Strategy” which was recently issued. As an example, I would like to mention again environmental technology. Japan was once plagued by low energy efficiency, which resulted in large fluctuations in the real economy as the energy price changed. This also caused serious environmental problems, including air and water pollution. In order to overcome these problems, mainly after the first oil shock, Japan made strenuous efforts to develop energy-efficient and environmentally-friendly technologies by bringing together both public and private sectors. As a consequence, energy unit efficiency in Japan has improved dramatically, and has become the most efficient in the world (Slide 18). 3 This has reduced the impact of resource price changes on domestic prices and the real economy while at the same time bringing environmental benefits, as there are now far fewer environmental disruption problems. The Asian emerging economies have much to improve in terms of environment, and I think there are many areas in which Japan can make a contribution. In terms of cooperation with Asia, finance is an equally important area. In fact, one of the recent key strategies for major Japanese financial institutions has been the strengthening of their business activities in East Asian economies. Developing financial markets in the region is also an important policy issue. According to a BIS survey as of April 2010, global foreign According to the Agency for Natural Resources and Energy of Japan, the efficiency of Japan’s energy consumption has improved by 37 percent during the past thirty years, and as a consequence, its total primary energy input per GDP became the lowest in the world. exchange transactions increased by 20 percent compared with that of three years ago. Among them, the share of Asian currencies in foreign exchange transactions is only less than 4 percent (Slide 19). However, given the significant presence of Asian economies in trade in goods and services, this share is expected to increase much further. As such, developing financial markets is important for the Asian region. For instance, there are still limits on the number of Asian currencies that can be settled via the international foreign exchange settlement system called Continuous Linked Settlement (CLS). It is also our task to introduce cross-border collateral arrangements in the region that would enable central banks to supply local currency liquidity against collateral which are financial assets in other jurisdictions. In Asia, there are distinct international financial markets, including Hong Kong, Singapore, and Tokyo. What is expected of the market participants and monetary authorities in those financial markets is to support the overall efficiency and stability of the financial intermediary by being competitive and cooperative with each other. In this regard, I have the deepest respect for one of the HKMA’s missions to promote and develop Hong Kong’s financial market into an international financial center, and for the innovative policy stance the HKMA has taken. V. Closing remarks As time is running out, I would like to conclude my speech. The future of the global economy is currently fraught with uncertainty, and we are facing a variety of challenges. For both Hong Kong and Japan, whether our economies will be able to take a desirable path depends significantly on global economic developments. From the perspective of the outlook for the global economy, I have raised three issues today, namely balance sheet adjustments in advanced economies, growth potential of emerging economies, and debates on currency conflict. The exact nature of these issues will change considerably, depending on the policy responses of each jurisdiction. It is therefore important for policy authorities around the world to promote better understanding and to cooperate closely with each other. Over the past decades, the world economy and financial markets have in fact been moving steadily towards globalization. However, at the same time, it is also true that we are still far away from perfect globalization. As typically observed in debates on currency conflict, the variety of challenges we are facing may reflect the complex reality of the global economy. Nevertheless, we need to make efforts to resolve these challenges. In this regard, the growing number of voices calling for reform of the international currency system seems to me a welcome development. At the same time, however, it is unrealistic to expect that such difficult challenges can be resolved in a short period of time. What is most important at this moment is the sincere commitment of each jurisdiction to learn the lessons of what others have experienced. There is much to be learned from this experience, particularly on issues relating to the formation and the bursting of bubbles, and on policy responses to financial crises. Moreover, it is important for us to exchange frank views on the challenges we are facing. While listening to recent debates on currency conflict, I am often reminded of the word “sympathy” as used by a great economist Adam Smith in his first but continuously revised book, “The Theory of Moral Sentiments.” What we need most fundamentally at this juncture is “sympathy” with each other, in Smith’s meaning of the term, bearing the situation of other economies in mind. I believe the current “two-speed recovery” presents a perfect example of the importance of such “sympathy.” We, the Bank of Japan, cooperating with other central banks and monetary authorities, should put all our efforts into ensuring sustainable economic growth under price stability, and the stability of the financial system. Thank you very much for your attention. Slide 1 Slide 2 Slide 3 Slide 4 Slide 5 Slide 6 Slide 7 Slide 8 Slide 9 Slide 10 Slide 11 Slide 12 Slide 13 Slide 14 Slide 15 Slide 16 Slide 17 Slide 18 Slide 19
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 29 November 2010.
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Masaaki Shirakawa: Japan’s economy and monetary policy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 29 November 2010. * * * Introduction I am honored to have the opportunity today to speak and to exchange views with business leaders from the Chubu region. I take this opportunity to express my deep gratitude for your cooperation with the Bank of Japan’s Nagoya Branch. As the Chubu region is one of the largest exporting bases of Japan, we at the Bank, myself included, always listen with great interest to the Nagoya branch manager’s report at the branch managers’ meeting held every three month. I am glad to be able today to hear your views directly. However, before we exchange views, I would first like to talk about economic and financial developments at home and abroad, and then discuss the Bank’s conduct of monetary policy. I. Developments in overseas economies I will start with developments in overseas economies. Overseas economies, which had plunged in the wake of the failure of Lehman Brothers in autumn 2008, leveled out around spring 2009 and picked up sharply from the second half of 2009. The pace of growth in overseas economies subsequently slowed somewhat as the inventory restocking carried out in the early phase of economic recovery ran its course and the demand-boosting effects of fiscal policy measures started to wane. However, international organizations project that the recovery trend itself will not be interrupted and that from 2011 growth in overseas economies as a whole will start to accelerate again, led by emerging economies that will continue to record high growth, particularly in domestic demand. The Bank shares this view. Specifically, the International Monetary Fund forecasts that the growth rate of the global economy will be 4.2 percent in 2011 and 4.5 percent in 2012. Those figures surpass the average of the ten years preceding the financial crisis, when the global economy recorded high growth (Chart 1). It should be noted that there are some uncertainties regarding the future outlook. The first uncertainty concerns the possible consequences of balance-sheet adjustments in advanced economies. In the United States and European advanced economies, the process of dealing with excessive household debt, excess production capacity in the corporate sector, and impaired assets in the financial sector, that is, the process of repairing and adjusting balance sheets, is continuing. During this, households and firms give priority to debt payment and have to restrain spending. Financial institutions’ proactive lending capacity is prone to decline. In these circumstances, the virtuous cycle of growth in production, income, and spending will not operate properly. Therefore, until balance-sheet adjustments are completed, it is likely that growth in advanced economies will be constrained and that they will remain prone to weakness. The second uncertainty concerns whether emerging economies, which continue to grow at high rates, will be able to make a soft landing onto a sustainable growth path. At present, many emerging economies have been shifting away from accommodative monetary policies. While these moves will put downward pressure on emerging economies in the short run, if implemented appropriately, they could provide a boon to the global economy in that they restrain economic overheating and help achieving more sustainable growth. Additionally, a third uncertainty that can be pointed out is that the large difference in the pace of economic recovery between advanced and emerging economies further complicates the mechanism of the emergence and spread of possible risks. The United States and European advanced economies are continuing to conduct very accommodative monetary policies. While the resulting decline in interest rates has helped to support the domestic economies, it has also given rise to capital flows from advanced to emerging economies in search of higher returns. The most fundamental reason for such capital flows is emerging economies’ high growth, but monetary easing in advanced economies also plays a role. Regarding the largescale monetary easing decided by the Federal Reserve (Fed) in early November, emerging economies have expressed heightened concern and anxiety about the possible overheating of their economies due to the acceleration of capital inflows and about the possible reversal of capital flows as a result of a policy change in Advanced economies in the future. Should one or more emerging economies experience a rise and subsequent burst of a bubble, this would not only have a large impact on the emerging economies concerned but also affect the global economy as a whole, including advanced economies. On the other hand, though, there are also various discussions going on concerning the management of exchange rate regimes in emerging economies. There is a possibility that if an emerging economy’s exchange rate regime lacks sufficient flexibility and its foreign exchange rate is held too low relative to economic fundamentals, this could, together with the effects of capital inflows from advanced economies, provide excessive stimulus to economic activity in that emerging economy, generating economic and financial excesses and, eventually, a correction of such excesses. These discussions on emerging economies’ foreign exchange rates remind me of developments in Japan’s economy following the Nixon shock and the Plaza Accord as well as various discussions occasionally held in Japan. Policy authorities in each country need to act appropriately taking the above developments in the global economy into account. In this context, I would like to emphasize the following two points. The first is that the first responsibility of policy authorities in each country is the stability of their own economy, and this holds true in any era. Second, however, the way to fulfill this responsibility has changed with the advance in economic and financial globalization. I feel that in the conduct of monetary and foreign exchange policies, it has become increasingly necessary to be aware of the global mechanisms of how one’s own policies and actions affect the world economy and international financial markets and of how these in turn affect one’s own economy. In this context, I think that Japan – through the experiences and lessons it holds, such as with regard to balance sheet adjustments, quantitative easing, and the conduct of policy following the Plaza Accord, which are all relevant to the various problems facing advanced and emerging economies today – can actively participate in discussions and contribute to global economic stability. II. Developments in foreign exchange markets While bearing in mind the developments in overseas economies, I will next touch upon developments in foreign exchange markets. Since summer 2010, the U.S. dollar has depreciated to the lowest level since the 1970s in terms of the trade-weighted nominal effective exchange rate, due mainly to market uncertainty about the future of the U.S. economy and associated market expectations of monetary easing (Chart 2). The yen at one time appreciated to near 80 yen against the dollar. However, following the Fed’s decision of additional monetary easing in early November, the yen has depreciated somewhat against the dollar. Meanwhile, with regard to exchange rates vis-à-vis Asian currencies, the yen has been following more or less the same trend against the Chinese renminbi as against the U.S. dollar, reflecting China’s foreign exchange rate policy. Against the Korean won, the yen appreciated around spring 2010, but has been more or less unchanged since then (Chart 3). In the short run, the appreciation of the yen depresses the revenue and profits of exporting firms, but the effects differ for each currency depending on the structure of trade and are not uniform. For example, Japan and Korea have recently been in heightened competition in the global market for many final goods such as electronic appliances and automobiles. For this reason, the relative value of the currencies greatly affects the competitiveness of each country’s exports. On the other hand, looking at the trade relationship between Japan and China, the two countries play much more complementary roles in the international supply chain, meaning that exchange rate effects differ. These issues are also highlighted in the reports from the Bank’s branches across Japan and the Bank, taking them into account, in detail examines foreign exchange rate developments and their effects with great interest. It should also be noted that, the appreciation of the yen, from a longer-term perspective, has the positive effect of bringing about an improvement of the terms of trade through a decline in import prices, that is, it leads to an increase in Japan’s overall real income. The Bank also pays attention to how developments in the foreign exchange market affect Japan’s economy from such a long-term perspective and how firms respond. III. Developments in Japan’s economy Let me now turn to developments in economic conditions in Japan. What I mean by economic conditions here are short-term developments in economic activity measured by indicators such as those related to GDP, corporate profits, and employment. On the other hand, I assume that business leaders such as yourselves probably associate with the term economic conditions developments that reflect more structural or longer-term factors in your region or industry. Keeping this subtle difference in mind, let me first talk about economic conditions in terms of short-term developments in economic activity. Japan’s economy has been improving on the back of the increase in exports and production brought about by the recovery in overseas economies and due to the effects of policy measures targeting durable consumer goods, but it seems that the recovery has been pausing since early autumn. Exports have recently been more or less flat mainly due to inventory adjustments in IT-related goods and the slowdown in overseas economies. As for private consumption, demand for cars has suffered a reverse following the last-minute increase in demand for energy-efficient cars ahead of the expiration of subsidies. In these circumstances, the increase in production has come to a pause. As for the outlook, it is projected that the pace of economic improvement will continue to be slow for the time being, mainly due to the slowdown in overseas economies and the waning effects of various policy measures, as well as the effects of the earlier appreciation of the yen. However, once we enter fiscal 2011, Japan’s economy is expected to return to a moderate recovery path, based on the following developments. Exports are projected to regain momentum as inventory adjustments in IT-related goods progress and growth in the U.S. economy, where additional policy measures were implemented, and in emerging economies, which are expected to recover from the slight adjustment phase caused mainly by the shift from accommodative monetary policy, accelerates again. Firms’ sense of excessive capital stock and labor is expected to dissipate gradually with the improvement in corporate profits, and spending by firms and households is projected to become active. Japan’s economy is expected to continue growing in fiscal 2012, and at a pace that exceeds that in fiscal 2011, as the transmission mechanism by which increased exports and production feed through to income and spending gains in strength (Chart 4). Next, I would like to talk about price developments. The consumer price index (CPI) in Japan registered a substantial decline of 2.4 percent in summer 2009, but since then the year-onyear pace of decline has been slowing steadily. The year-on-year rate of decline in the CPI for October slowed to 0.1 percent if the effects of subsidies for high school tuition are excluded. With regard to the outlook, as the aggregate supply and demand balance will gradually improve, the year-on-year change in the CPI is projected to enter positive territory in fiscal 2011 and thereafter rise through fiscal 2012 (Chart 5). Of course, the outlook presented here is subject to substantial uncertainty, since the economy changes continuously. Above all, as I will explain later, Japan’s economy faces the structural problem of a decline in the economic growth trend. In this situation, the Bank will carefully examine whether Japan’s economy is making steady progress toward a sustainable growth path with price stability while paying attention to the various risk factors regarding overseas economies highlighted earlier. IV. Conduct of monetary policy Let me next explain the Bank’s conduct of monetary policy. In early October, the Bank, with a view to further enhancing monetary easing, decided to implement comprehensive monetary easing, the so-called comprehensive easing, which bundles together the following three measures (Chart 6). First, the Bank changed the target for the uncollateralized overnight call rate from “around 0.1 percent” to “around 0 to 0.1 percent,” thereby further clarifying its adoption of a virtually zero interest rate policy. Second, the Bank clearly stated that it would continue the virtually zero interest rate policy until it judged that price stability was in sight, provided that no problems such as the accumulation of financial imbalances arise. Third, the Bank established an Asset Purchase Program that aims at purchasing various financial assets, such as government securities, commercial paper (CP) and corporate bonds, as well as exchange-traded funds (ETFs) and Japanese real estate investment trusts (J-REITs). The total size of the Program, including the existing fixed-rate operation, was set to about 35 trillion yen (Chart 7). These measures have the effect of supporting economic recovery through various channels. The first channel is that the recent monetary easing measures, by lowering funding costs for firms and households, will aid private sector economic activity from the financial side. Fed Chairman Bernanke, regarding the recently-decided additional monetary easing through large-scale purchases of longer-term Treasury securities, stated that the use of the term quantitative easing to refer to the policy was inappropriate, explaining that the aim was to achieve more accommodative financial conditions by lowering interest rates on securities of longer maturities. The Bank’s comprehensive easing is motivated by the same purpose in that it aims at achieving accommodative financial conditions through a decline in interest rates. Moreover, as part of comprehensive easing, the Bank decided to purchase risk assets such as ETFs and J-REITs, which is an extremely extraordinary step for a central bank. It is expected that, if the Bank’s purchase of risk assets, acting as a catalyst, leads market participants to take a more active investment stance, this will smooth the intermediation of risk money and firms’ funding conditions will improve further. The second channel is what is called the policy duration effect. As part of comprehensive easing, the Bank has made it clear that it “will maintain the virtually zero interest rate policy until it judges that price stability is in sight.” The Bank will judge whether price stability is in sight based on the understanding of medium- to long-term price stability (hereafter understanding), which the Bank releases separately. The understanding is the inflation rate level that each Policy Board member understands as being consistent with price stability over the medium to long term and takes the form that “on the basis of the year-on-year rate of change in the CPI, it falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board members’ understanding are around 1 percent.” Usually, in an economic recovery phase, there are various forecasts as to when the accommodative monetary policy will be changed and projections for the future level of interest rates consequently vary. However, with the recently announced framework in place, it is expected that stable projections about future interest rates will be formed in the markets and long-term interest rates will be stabilized. In this way, the policy duration effect could exert significant easing effects, especially when economic recovery progresses and corporate profits improve. The third channel is that the recent monetary easing measures, through their effect on business and household sentiment, will underpin the economy. The recent measures are likely to have been effective in stabilizing the sentiment of firms and households, which have been worried about the adverse effects of the slowdown in overseas economies and the appreciation of the yen. The Bank has been stating for quite a while that it “will carefully examine the outlook for economic activity and prices, and, if judged necessary, take policy actions in a timely and appropriate manner.” I believe that public confidence in the central bank’s conduct of monetary policy, by alleviating anxiety about a possible economic downturn, will boost the momentum for a self-sustaining recovery in Japan’s economy. In addition to the comprehensive easing I have just explained, in June 2010 the Bank introduced a new program through which it provides long-term funds at a low interest rate to private financial institutions in accordance with their efforts in terms of lending and investment to strengthen the foundations for economic growth. The reasoning underlying this measure is the Bank’s view that the decline in the growth trend of the economy has brought about sluggishness in business fixed investment and private consumption through a decline in firms’ and households’ growth expectations, which in turn is the fundamental cause of the current deflation. Related to this point is that when we look at Japanese firms’ funding conditions, overall, they have abundant on-hand liquidity. At the same time, deposits at financial institutions far exceed loans and financial institutions use those surplus funds to invest in securities such as government bonds. This suggests that the biggest problem is not a shortage of cash or currency but limited investment opportunities resulting from the decline in growth expectations. The Bank strongly hopes that these measures, by acting as a catalyst, will prompt discussions on this issue as well as efforts toward strengthening the foundations for economic growth. Concluding remarks As I have just mentioned and as you experience on a daily basis, the biggest challenge facing Japan’s economy is how to stop the decline in the potential rate of growth (Chart 8). Moreover, the fact that we as a country have not found an effective solution for this problem also affects short-term cyclical developments and is a fundamental cause of deflation. An economy’s growth potential is essentially determined by the rate of growth in the number of employed persons and in labor productivity. Japan’s labor force population peaked in 1998 and has been declining since, while the total population started to decline in 2005. For this reason, existing domestic markets in many areas, such as automobiles, have been shrinking. The demographic situation is a given. Thus, if the labor force participation rate for each age/sex group remains the same, the number of persons employed will decline further in the next ten years. What is obvious from this is that what is necessary for increasing the growth potential of Japan’s economy as a whole is to increase the labor force participation rate and raise productivity. With regard to the latter, even today, Japan ranks relatively high among the advanced economies in terms of labor productivity growth (Chart 9). Therefore, while it may not be easy to increase productivity growth, it is necessary. To this end, it is essential to create, at home and abroad, new markets where a large increase in demand can be enjoyed, that is, to create added value, thereby raising productivity in the economy overall. This applies not only to state-of-the-art products but also to, for example, services addressing the needs of an aging population. Services demanded by the elderly tend to be labor-intensive, but responding to such demand effectively will lead to an increase in added value in the form of an increase in labor income. It is important to note that in any era, it is firms that serve as the engine for economic growth. Financial institutions are expected to play their part by actively supporting firms’ vigorous efforts through their function as financial intermediaries. Meanwhile, the government needs to provide an environment that makes such efforts by private economic entities possible. It is necessary to constantly examine whether there are institutional factors that put Japanese firms at a disadvantage in global competition. The conclusion of free trade and economic partnership agreements currently being discussed, as well as issues related to tax and regulatory policies, are important issues that will affect the future management strategies of Japanese firms. For the sake of our children and grandchildren, we have a great responsibility to develop a vision for future economic growth. To this end, it is essential for private entities as well as policy authorities to sincerely examine what they can do from their respective standpoints, and make positive efforts in a specific manner. For its part, the Bank will consistently make contributions as the central bank.
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the International Paris-Europlace Financial Forum, Tokyo, 29 November 2010.
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Kiyohiko G Nishimura: Electronic trading and financial markets Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the International Paris-Europlace Financial Forum, Tokyo, 29 November 2010. * 1. * * Introduction I am honored and delighted to have been given the opportunity to speak at this International Financial Forum, organized by Paris EUROPLACE. Further, it gives me great pleasure to be alongside our long-time friend Christian Noyer, Governor of the Banque de France. Paris EUROPLACE has played an important role both in the growth of the financial industry and in the evolution of financial markets. In particular, it has provided various opportunities for discussion among its members, who represent a broad spectrum of the financial industry. I salute the members for their contributions. Growth in major economies has slowed substantially since the financial crisis of 2008, and it is now more than ever important to examine the ways in which the financial industry can regain credibility and strengthen macroeconomic fundamentals. This forum provides a timely opportunity to exchange views on the positioning of the financial industry for new growth opportunities. The key to growth in the financial industry is to find businesses which are in a position to grow domestically and internationally, and then to assist these businesses further by providing ready access to risk money. At the same time, we should improve the infrastructure of financial markets, through which money is funneled. In this respect, advances in information and communication technology (ICT) have already changed the landscape of financial markets, providing a set of powerful tools for financial institutions: These advances have increased the efficiency of trading and settlement, and proved useful in evaluating the price and risk of financial products. Today, I will focus on one of the most conspicuous ICT-induced changes, that is, the impressive developments made in recent years in the electronic trading of financial products. 1 2. Global expansion of electronic trading and the Japanese market I will start with an overview of the global expansion of electronic trading, which involves two elements. The first is automated order placement and trade execution, so-called algorithmic trading. The second is the substantial speed-up and improved efficiency in matching orders in the market, that is, the new generation of order-matching engines. Although these two elements have been present since the 1980s and 90s, their global application has been expanding and accelerating particularly rapidly in recent years, thanks to advances in Information and Communication Technology. Electronic trading has made especially dramatic developments in the equity and currency markets of major industrialized countries. As much as 60 to 70 percent of the amount traded in the United States, 2 and some 50 percent of that traded in Europe, 3 is executed The following is partly based on Sugihara, Y., 2010, “Approaches of Market Participants for the Reduction of Transaction Costs: Application of Algorithmic Trading and Trading Venues,” IMES Discussion Paper Series No. 2010-J-26, Institute for Monetary and Economic Studies, Bank of Japan (in Japanese). See Hendershott, T., C. M. Jones, and A. J. Menkveld, 2011, “Does Algorithmic Trading Improve Liquidity?” The Journal of Finance, forthcoming (February 2011). See Hendershott, T. and R. Riordan, 2009, “Algorithmic Trading and Information,” NET Institute working paper No. 09–08. electronically and automatically, according to surveys and recent studies of equity markets. In currency markets, about half of the amount traded is estimated to 3 involve algorithmic trading. 4 Although there is less electronic trading in the Japanese equity market than in the United States and Europe, it is currently a growing focus of attention. Arrowhead, the new ordermatching engine for cash products on the Tokyo Stock Exchange, has been operating smoothly and steadily since its launch at the beginning of this year. The results have been impressive. The order-response time of cash equity trades has been reduced to only a few milliseconds. Also, in February 2011, the Osaka Stock Exchange plans to launch J-GATE, a new high-speed order-matching engine for equity derivative trading. Proprietary trading systems (PTSs), which correspond to the multilateral trading facilities (MTFs) in Europe, still have only a small market share in Japan, but their trading volume is gradually increasing. In tandem with these infrastructural developments, algorithmic trading volumes seem to be increasing steadily in Japanese equity markets. Although no official statistics are available, 20 to 30 percent of all orders received by the Tokyo Stock Exchange are placed at colocation sites, 5 which are specially designed for automatic, high-speed trading. 6 This gives an indirect but clear indication of the growing importance of electronic and automated trades in Japan. 3. Positive effects of expanding electronic trading With its greater speed and diversified trading venues, electronic trading has changed the market microstructure of the financial world. Market participants’ trade execution strategies have changed dramatically. High-frequency trading has come to have a greater presence. High-frequency trading can be considered as a type of trading strategy similar to market making and short-term liquidity provision. Various execution strategies, derived and devised from the experience of traders and the results of computationally intensive research, have been transformed into computer algorithms and offered to various investors in the financial market. These changes have enabled institutional investors to take advantage of cutting-edge tactical executions. Depending on market conditions, many of the algorithmic trading strategies slice block orders into smaller child orders, to avoid the price changes caused by block-order executions, that is, so-called market impact. The expansion of algorithmic trading is leading to fundamental changes in the market: for example, orders are smaller but more numerous than before. This development in market microstructure has had a positive impact on market functioning, improving investment performance per risk capital through the reduction of transaction costs. In fact in the U.S. market, where algorithmic trading started earlier than other places, it has reduced market-making costs and narrowed bid-offer spreads significantly. 7 Moreover, recalling that algorithmic trading strategies for block trades are designed to reduce their See Table 2 in Chaboud, A., B. Chiquoine, E. Hjalmarsson, and C. Vega, 2009, “Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market,” Board of Governors of the Federal Reserve System, International Finance Discussion Papers, No. 980. Co-location is a service that allows market participants to install their devices at data centers of trading venues to minimize the physical distance between data centers and market participants’ devices. According to the Tokyo Stock Exchange. See Figure 1–3 in Hendershott et al., 2009, in footnote 2. There is an empirical study on the reduction of transaction costs as a result of MTF expansion in the recent European markets. For details, see Brandes, Y. and I. Domowitz, 2010, “Alternative Trading Systems in Europe: Trading Performance by European Venues Post-MiFID,” Journal of Trading, 5(3), pp.17–30. market impact, an empirical study has shown that this type of algorithmic trading contributes to stabilizing intra-day realized volatility. Thus, algorithmic trading may help stabilize market prices, under normal circumstances and most of the time. 8 There is an additional positive point. Electronic trading enables faster information propagation. Arbitrage trades between individual equities and between markets have increasingly been conducted automatically and at lightning speeds using algorithms. This is likely to boost the efficiency of the financial market and the allocation of scarce resources. 4. Three challenges posed by electronic trading Although the expansion of electronic trading has brought many positive effects, as noted, it also has its own negative side with respect to the proper functioning of financial markets. There are three crucial issues. The first issue is market vulnerability induced by the presence of electronic trading. In particular, algorithmic trading is vulnerable to unpredictable events. On May 6 of this year, the so-called Flash Crash caused a violent fluctuation in prices over some ten minutes in the U.S. equity market. The U.S. Commodity Futures Trading Commission and the Securities and Exchange Commission carried out a joint investigation into the incident. 9 Their Joint Report pointed out that, at the start of the Flash Crash episode, one algorithm’s automated execution of a very large sell order confused and dislocated other algorithms. As a result, many market participants, whether algorithmic or human, refrained from buying, and thus market liquidity decreased sharply, leading to unusual turbulence in several stocks. Some algorithm-based arbitrage trades contributed to spreading this market seizure to a wide range of individual stock prices, leading to the full-blown Flash Crash. Although algorithmic trading may contribute to market stabilization in normal times, this may not be the case when unexpected events or unknown unknowns occur. Mechanistic algorithms may not be able to respond properly to unexpected and unprecedented events in the same way as humans, who have common sense. In such circumstances, the human brain performs better than the digital computer. Thus, a mutually complementary relationship between algorithms and humans is absolutely crucial. In particular, safeguard should be considered, such as circuit breakers compatible with high-speed algorithmic trading. The Japanese equity market has not been immune from this type of market disruption. There have been several instances caused by large but erroneous orders that were filled instantly. Learning from these incidents, Japanese brokerage houses are now required to refrain from placing orders that exceed a threshold amount, to prevent the execution of mistaken orders. 10 Moreover, a new market safeguard has been introduced which is compatible with high-speed trading. Just in time for Arrowhead’s launch, the Tokyo 7 Stock Exchange instituted a new trading rule, requiring a one-minute pause at order-matching when sequential execution of a single order causes a large price impact which exceeds a certain price-change limit. The second question that electronic trading, or high-frequency trading in particular, poses to the market, is the issue of possible new ways of manipulating the market, and how to detect and prevent such illegal activities in the age of lightning-speed order execution. Some See Chaboud et al., 2009, in footnote 4. See U.S. Commodity Futures Trading Commission and Securities and Exchange Commission, 2010, “Findings Regarding the Market Events of May 6, 2010,” available at http://www.sec.gov/news/studies/2010/marketevents-report.pdf. See Article 5 in “Regulations Concerning the Establishment of an Order Management System by Association Members,” by the Japan Securities Dealers Association. algorithms incorporate information available on limit-order books to estimate current supplydemand imbalances that might be open to exploitation. Note that such information gathering activities are necessary for properly functioning markets, and that human dealers are also engaged in similar activities. At the same time, it is true that illegal attempts to manipulate the market may be hidden behind such information gathering activities. We all remember the many lengthy and complicated probes of illegal market manipulation in the past. The point is that high-speed algorithmic trading makes such illegal market manipulation ever more sophisticated and harder to detect. There is particular concern about plots involving algorithm traders alone. For example, one algorithm trader may try to drive the price in its favor by intentionally manipulating other algorithm traders by instant quote stuffing, which human traders could not recognize visually, being carried out at lightning speed. Since only algorithmic traders are involved, an investigation of this type of plot would entail scrutinizing a tremendous number of order records, making it difficult to detect illegal manipulations in a traditional way. Here, the appropriate application of information 8 technology can be most effective. To put it differently, regulators and overseers should arm themselves with technology comparable to that used by high-speed villains themselves, though there is still a long way to go in this area. The third issue, which is more technical but more profound in nature than the previous two issues, is the question of how to avoid over-reliance on high-frequency traders as liquidity providers. A research paper on the background to the Joint Report on the Flash Crash reveals an interesting fact. 11 Toward the end of the Flash Crash, some high-frequency traders intensified their activities as market liquidity declined dramatically. Declining market liquidity meant the absence of their usual trading counterparties, and thus these highfrequency traders repeated and intensified their automatic high-speed trading among themselves. Their activities led to sizable price volatility in a very short period of time. It should be noted here that, even though high-frequency traders supply liquidity to the market by offering a limit order and thus make a position when it is hit, these high-frequency traders try to close the position immediately after the original transaction. This is indeed why such traders are called “high frequency” traders. Consequently, when there are large demand-supply gaps among non-high-frequency traders in the beginning, it is not at all likely in the end that the liquidity provided by high-frequency traders is sufficient to fill these gaps. Moreover, if the market is dominated by mechanistic traders, who react to microscopic directional changes in 9 prices rather than to market fundamentals, market prices may deviate further and further from the fundamentals once a demand-supply gap emerges. The Flash Crash is a perfect example of this, where the end result was just the contrary to the supposed stabilization. This serves to remind us of the utmost importance of market diversity, with respect to sellers and buyers, their strategies, and their referenced information. I would like to insist again that, in order to make markets function well, it is essential to have both non-high-frequency investors and high-frequency traders, of various kinds. Just focusing on high-frequency traders is rather misleading in understanding the impact of electronic trading in financial markets. 5. Closing remarks As I have documented so far, advances in information and communication technology have sent ripples and waves over the entire financial industry, providing new opportunities for growth and efficiency. At the same time, these advances pose serious challenges to See Kirilenko, A., A. S. Kyle, M. Samadi, and T. Tuzun, 2010, “The Flash Crash: The Impact of High Frequency Trading on an Electronic Market,” preprint, available at http://ssrn.com/abstract=1686004. maintaining market stability and integrity. Thus, to take full advantage of these opportunities, we should work together to maintain the stability and integrity of the financial market and, thereby, the financial system itself. This should be done in a timely manner, so as to cope with the rapid developments in technology. As a market participant, the Bank of Japan will continue to promote the stability, efficiency, and integrity of the financial system. Thank you for your attention.
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Summary of a speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Tokushima, 22 September 2010.
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Ryuzo Miyao: Economic activity and prices in Japan and monetary policy Summary of a speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Tokushima, 22 September 2010. * I. Economic activity and prices A. Overview * * First, I will talk about the current situation of the Japanese economy. At present, an issue of concern is the possible negative impact of instability in foreign exchange and stock markets on corporate profits and business and consumer confidence. In this environment, there has been a slowing of exports to East Asian and other emerging economies that have driven the recovery from the sharp decline after the bankruptcy of Lehman Brothers. Private consumption, meanwhile, remains relatively firm, supported by the extremely hot summer this year and a last-minute increase in demand for durable consumer goods ahead of the expiration of government subsidies. On the whole, Japan’s economy shows further signs of a moderate recovery. B. Developments in overseas economies Let me now look at developments in those overseas economies that are influencing Japan’s export-driven recovery. Among the emerging economies, the Chinese economy has been boosted by fixed asset investment – comprising business fixed and real estate investments – as well as private consumption, as a result of major stimulus measures to the value of 4 trillion renminbi. Since the rapid growth accelerated speculative investment in real estate, making it difficult for middle-class citizens to buy housing, the authorities implemented a series of measures, including window guidance, to restrain the increase in real estate transactions. Subsequently, real estate investment slowed down and production and fixed investment in sectors related to construction decelerated. Still, the rate of economic growth remains high. With respect to those neighboring Asian nations whose economies have been spurred by exports to China, although the rate of expansion is showing signs of deceleration, growth remains high with domestic demand still robust. With regard to economic activity in the euro area, production has expanded due to increasing exports to emerging economies, although the growth differs by country. For example, in Germany its strong recovery has been the main driving force, with real GDP for the April– June quarter of 2010 having grown at an annualized 9 percent from the previous quarter. By contrast, Greece, which is saddled with the burden of fiscal consolidation, has recorded negative growth; and Spain, with its burst housing bubble, has not been able to find a way out of a low growth predicament. For the euro area as a whole, domestic demand, such as business fixed investment, is weak and the pace of economic recovery remains moderate. Moreover, with the slowing pace of growth in emerging economies, particularly in China, the growth rate of the euro area may slow down starting with exports, which have been the main engine driving recovery. Taking a look at recent developments in the U.S. economy, production has recovered due to both an increase in exports reflecting a weaker dollar and inventory rebuilding, although the household sector is under pressure from excessive debt and a delay in recovery in employment. Consumption and business fixed investment have experienced moderate recovery, reflecting a sharp improvement in the business performance of firms that have undergone restructuring and the effects of fiscal measures to stimulate the economy. At present, however, the pace of recovery is decelerating as the effects of stimulus measures wane. Regarding the outlook for overseas economies in the near future, it is expected that the pace of growth in emerging economies, particularly in China, will continue slowing, while the moderate pace of recovery in the U.S. economy will probably continue, due to slower growth in exports to emerging economies and weakening of the effects of economic stimulus measures. Starting in 2011, the growth rate of emerging economies is expected to pick up, which will help the U.S. and European economies resume a path of moderate recovery. Recently, however, I have become increasingly concerned about downside risks, mainly because the risk is rising that the U.S. economy may experience a protracted period of low growth. In the GDP data released in July, the growth rate of private consumption was revised sharply downward, revealing that the real value had yet to regain the pre-Lehman shock level. Furthermore, the personal saving rate was revised substantially upward, marking the highest level in the past 20 years, excluding periods of temporary increases (Chart 1). Meanwhile, housing investment, which had been recovering moderately, has resumed a sharp slide since the expiry of tax credits for homebuyers at the end of April, while monthly home sales have been at historically low levels. In the area of employment, the increase in the number of private-sector employees in the April–June quarter of 2010 has slowed to around 70,000 per month, while the growth in household income has been very slow. Initial claims for unemployment insurance have been at a high level of around 500,000 per week. These economic indicators suggest that the U.S. household sector has become extremely cautious about spending, reflecting the strong repayment pressure on those who purchased homes during the housing bubble, while the unemployed are having a hard time finding jobs. In this environment, the corporate sector cannot be confident of future economic expansion. This has made firms reluctant to increase employment or fixed investment even though their profits are increasing. This is why the risk is increasing that a recovery in household consumption will be delayed. In addition, changes may be taking place in areas that once were considered the main advantages of the U.S. economy. For example, while labor productivity may not attract a lot of attention, I keep a close watch on its data. Labor productivity is calculated by dividing real quarterly GDP by hours worked by the total number of employees. The data reflect growth in technological progress and increases in capital stock, and indicate a nation’s potential growth capability (Chart 2). During 2009, labor productivity in the United States rose sharply to the level of 2000 to 2005, the years of the “productivity growth explosion,” as a result of drastic corporate restructuring by means of personnel cuts in response to the economic crisis following the Lehman shock. Productivity growth, however, had been lackluster during the prosperous period of 2005 to 2008, and slipped into negative territory in the April–June quarter of 2010. It has been said that the strength of the U.S. economy lies in its high productivity backed by its ability to generate technological innovation. Over the past several years, however, excluding a short period in 2009, longer-term growth potential has tended to be sluggish. Thus, in the middle of August, the yield on the 10-year U.S. Treasuries declined to around 2.5 percent, probably due to the decrease in the expected economic growth accompanied by lower inflation over the longer term, rather than expectations of a temporary economic slowdown (Chart 3). C. The current situation of Japan’s economy Based on my views that I have just described regarding overseas economies and accompanying risk factors, I will now turn to the current state of Japan’s economy. Market participants are accelerating their yen-buying activity to avert risks, reflecting concern about the outlook for the U.S. economy as well as fiscal and economic conditions in Europe, while stock prices remain weak despite the favorable outlook for corporate profits, partly due to the appreciation of the yen (Chart 4). The negative effects of Japan’s current market conditions warrant attention since, if they continue, they would have a significant negative impact on corporate profits, as well as business and consumer confidence. At present, however, the mechanism for Japan’s self-sustaining economic recovery remains intact. Looking at recent developments in economic activity in more detail, exports continue to be on an uptrend, although there has been a deceleration in those to East Asian and other emerging economies that had supported Japan’s high export growth. Meanwhile, production has been increasing as a trend, although the pace of increase has been decelerating gradually when the effects of the distortion in seasonal adjustments are taken into account. Among domestic demand components, business fixed investment is showing signs of picking up, given the favorable business performance. According to the Financial Statements Statistics of Corporations by Industry, Quarterly, business fixed investment started to increase in the April–June quarter of 2010, after having declined throughout the January– March quarter. Private consumption has been generally picking up, as shown by (1) an increase in consumer spending on such items as beverages and air conditioners due to this year’s extremely hot summer, and (2) a significant increase in car sales in August, reflecting a last-minute increase in demand ahead of the termination of government subsidies for purchasers of environment-friendly cars. At the same time, housing investment has been leveling out: the number of housing starts increased for two consecutive months, and the contract rate on newly built condominiums in the Tokyo metropolitan area remains above 70 percent. There are signs that employment and income are improving, although the ratio of job offers to applicants remains low and the unemployment rate is relatively high. That said, household income has been improving moderately, reflecting the year-on-year rise in summer bonus payments. In assessing the trend in the consumer price index (CPI), it is necessary to exclude fresh food, the prices of which tend to be volatile, as well as the effects of subsidies for high school tuition, which are a one-off downside factor and part of the government’s economic stimulus measures to reduce the cost of high-school education. The CPI, excluding these two factors, has recently been hovering around minus 0.6 percent. It declined significantly in summer last year, but it now appears to be recovering. The year-on-year rate of decline has been narrowing mildly, and this trend is likely to continue, reflecting the narrowing negative output gap. Regarding the outlook for Japan’s economy, movements toward a self-sustained recovery are expected to continue. While the pace of improvement is likely to slow temporarily, partly due to a temporary slowdown of overseas economies and the waning effects of various demand-boosting policy measures, exports are likely to increase, reflecting the high growth in emerging economies such as in China, while business fixed investment and private consumption are expected to recover as corporate profits increase. As noted earlier, a downside risk that might necessitate revision of the above outlook is the growing possibility that the U.S. economy will see protracted low growth. Were this to happen, the outlook for the world economy would have to be revised downward. The resulting decrease in exports would adversely affect Japan’s economy and probably lead to increased risk aversion, thereby discouraging business fixed investment, new businesses, and household consumption. The deteriorating business and consumer sentiment could lead to prolonged sluggish economic activity. Despite the manifest downside risks outlined above, the emerging economies have shown impressive growth. It is true that, for the present, the economies of some Asian economies appear to be decelerating, mainly because of China’s economic slowdown. Yet this means that the risk is declining that an overheating economy might hurt sustainable economic growth. This might be compared to “speed control,” conducted for a limited period to ensure a higher rate of growth over the long term. If this were the case, it would be an upside risk for Japan’s economic outlook, given that Japan is strengthening its ties with other Asian countries. An upswing in these countries could partly offset the negative effects even if the U.S. economy experiences a period of low growth. D. Effects of foreign exchange markets on Japan’s economy Next, in order to understand the effects foreign exchange markets have on Japan’s economy, let me put the activities of foreign exchange markets in context. When prices of goods are stable or falling in a given country, the value of that nation’s currency is stable or rising and, other things being equal, the value of this particular currency should rise against other currencies. This is the basic idea of “purchasing power parity.” So, if we look at the purchasing power parity of the yen against the U.S. dollar (the ratio between prices in Japan and the United States), we see that the yen has been appreciating fairly consistently against the dollar, reflecting the weakness in Japanese prices relative to those in the United States since the introduction of a floating exchange rate regime in 1973 – even though the actual dollar/yen exchange rate is determined by a number of factors in addition to prices (Chart 5). Needless to say, a yen that is strong against the U.S. dollar curtails the profits of exportoriented firms, many of which are experiencing adverse business pressure that is affecting stock prices. As a result, the Bank of Japan is closely monitoring the impact of the strong yen and weak stock prices on the Japanese economy. Conversely, the appreciation of the yen pushes up profits of import-oriented firms and serves as a tailwind for those firms considering expanding operations by acquiring overseas firms. However, it should be remembered that a balanced view is important when discussing the effects of a strong yen. I will now give you an example of just such a balanced view. Trade statistics show that the weight of U.S. dollars used as settlement currency for exports declined slightly from 52.4 percent in the second half of 2000 to 48.6 percent in the first half of 2010, while that used for imports remained largely unchanged at slightly above 70 percent (Chart 6). However, looking at the value of dollar-denominated trade settlements, one can see that net imports have increased sharply. This is because trade with the United States, a large buyer of Japanese exports, is decreasing, while exports to and imports from rapidly growing Asian countries are growing and imports from the Middle East are increasing sharply. This expansion in net imports, in dollar terms, indicates the possibility that Japan’s settlement and trade structure now is less vulnerable than before to the negative effects of a strong yen. II. Monetary policy A. Recent conduct of monetary policy Japan’s economy shows further signs of a moderate recovery, with exports increasing, albeit at a slower pace, and demand components such as private consumption and business fixed investment generally picking up. However, amid heightened uncertainty about the future especially for the U.S. economy, foreign exchange and stock markets have recently been unstable. Accordingly, the Bank held an unscheduled Monetary Policy Meeting on August 30, 2010 and decided to introduce a six-month term in the fixed-rate funds-supplying operation against pooled collateral and start providing additional funds amounting to approximately 10 trillion yen with a six-month term. The Bank believes that the monetary easing measure, together with the government’s efforts, will be effective in further ensuring Japan’s economic recovery. Downside risks to Japan’s economy, however, still require close monitoring amid the growing uncertainty about the future, especially for the U.S. economy. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. With such recognition, the Bank has been striving to pursue powerful monetary easing. The Bank will continue to carefully examine the outlook for economic activity and prices and, if judged necessary, will take policy action in a timely and appropriate manner. B. Fund-provisioning measure to support strengthening of the foundations for economic growth The strong easing measure discussed so far is designed to work on short-term cyclical economic activity, but it is important that Japan maintain and enhance its medium- to long-term economic growth potential. Recognizing this, the Bank sought a way of contributing to such a task as the central bank, and in June 2010 introduced the fundprovisioning measure to support strengthening the foundations for economic growth, with loans totaling 3 trillion yen. This measure has the same characteristics as other fundprovisioning measures, in that it supplies funds against eligible collateral submitted to the Bank, but it differs in that the maximum duration of loans is four years and loans are provided to each counterparty based on the counterparty’s actual amount of lending and investment carried out as part of the plan to strengthen the foundations for economic growth submitted to the Bank. The fund-provisioning measure does not aim to fully fund the foundations for economic growth, but to act as a catalyst for financial institutions to make efforts toward strengthening the foundations for economic growth. The first new loan disbursement was carried out at the end of August 2010, involving more than 460 billion yen provided to 47 borrower financial institutions, ranging from major banks to shinkin banks, that span a wide range of business areas and regions. Records of individual investment or lending by these institutions submitted to the Bank, making them eligible to receive funds from the Bank’s first loan disbursement, show that investment and lending were conducted in broad areas: investment or lending in “environment and energy business” was particularly prominent, followed by investment or lending in “development and upgrading of social infrastructure,” “medical, nursing care- and other health-related business,” “business in the content creation industry,” and “disaster prevention business.” The results of the first new loan disbursement also show that loans were made for long-term investment or lending, and this meets the objective of the measure: the distribution of individual investment or lending by duration reveals that more than 80 percent of the investment or lending is designed to be carried out over a period of more than four years, with an average investment or lending term of 8.2 years. The new measure, intended to act as a catalyst for financial institutions, has gotten off to a relatively smooth start. As pointed out with regard to the U.S. economy, expectations for economic growth and expanded productivity have played an important role in achieving sustainable economic growth. In other words, without prospects for increases in income and demand, firms remain cautious about investing and households remain cautious about increasing consumption. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability, and that strengthening the foundations for economic growth implies improving productivity through innovation and structural changes. Improved productivity may give the impression that an increased supply of goods and services would widen the output gap – that is, the differential between supply and demand – and make it more difficult to overcome deflation. However, as many here will know, innovation and the application of technology often generate new high-value-added goods and services, thereby creating new demand. For example, the development of light emitting diodes (LEDs) – which have been produced in large quantities here in Tokushima Prefecture as light sources – has created new demand for products such as liquid crystal display televisions, fluorescent-type LED lamps for the home, and LED lighting for use on fishing vessels. Improved productivity thus means creating higher-value-added goods by making use of increased efficiency in labor and capital. As a scholar, even before I became a member of the Bank’s Policy Board, I have been very much interested in the effects of productivity on the economy. Using data available on Japan to conduct empirical studies, I found that improved productivity, while increasing supply, results in a major increase in demand and narrows the output gap. Bearing in mind the future for Japan’s economy, it is vital to create an environment that enables firms – from a medium- to long-term perspective – to show their “animal spirits” and willingness to meet challenges head on in order to achieve both greater competitiveness that could lead to higher productivity and create new value added. As I have said, the Bank’s fund-provisioning measure to support strengthening the foundations for economic growth is a catalyst for financial institutions, while its measures to enhance monetary easing – including the new market operation introduced in August – have helped the private sector achieve the same objective. Chart 1 Chart 2 Chart 3 Chart 4 Chart 5 Chart 6
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the symposium co-hosted by the University of Tokyo and Development Bank of Japan, Tokyo, 10 December 2010.
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Hirohide Yamaguchi: Challenges for Japan’s financial system after the financial crisis Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the symposium co-hosted by the University of Tokyo and Development Bank of Japan, Tokyo, 10 December 2010. * * * Introduction It is my great honor to have an opportunity to speak at a symposium co-hosted by the Center for Advanced Research in Finance, the University of Tokyo, and the Research Institute of Capital Formation, Development Bank of Japan. While the global financial crisis that erupted about two years ago, triggered by the failure of Lehman Brothers has not been completely over, the situation has significantly improved. Progress has also been made in establishing an international framework for preventing the recurrence of the recent global crisis in the future. Meanwhile, Japan’s Financial System has been relatively stable, compared with that in the United States and Europe, but some challenges have become clear as the effects of the crisis reached here in various forms. In those circumstances, it is indeed topical to discuss today how the future of Japan’s financial system should be, and I am looking forward to the discussions by the experts. For my part, I will briefly review the financial crisis and talk about the future of Japan’s financial system and challenges for Japanese financial institutions. I. Global financial crisis and Japan’s financial system A. The international financial system after the Lehman shock These two years following the failure of Lehman Brothers have been indeed a tumultuous period for the global economy and the international financial system. Following the failure of Lehman Brothers, a financial crisis erupted on a global scale, and the global economy deteriorated simultaneously and rapidly. Subsequently, due to the effects of exhaustive policy responses by the governments and central banks, the global economy gradually started to recover around the spring of 2009 and profits and funding conditions of major U.S. and European financial institutions improved significantly. However, against a backdrop of European fiscal problems including those in Greece and Ireland as well as heightened uncertainty about the future of the U.S. economy, there have been phases in which financial markets have become unstable again since the spring of 2010. In the United States and Europe, amid continued balance sheet adjustments, bank lending has been sluggish and credit costs have been somewhat at high levels. The international financial system is still in a fragile state. B. Effects on Japan’s financial system Looking at the impact of the global financial crisis on Japan’s financial system, there was relatively a large decline in the functioning of CP and corporate bond markets. On the other hand, the direct impact on financial institutions central to Japan’s financial intermediation remained relatively small, compared with that on U.S. and European financial institutions, and the stability of the financial system as a whole was maintained. Three reasons can be pointed out. First, and probably the major reason, was that Japanese financial institutions had been generally cautious about taking risks based on the experience of the financial crisis since the 1990s. Specifically, their investments in complex financial products such as collateralized debt obligation had been low and they had not adopted, unlike major U.S. and European financial institutions, the originate-to-distribute business model in a full-fledged manner. Second, in terms of incentive, there was relatively low pressure from shareholders who pursued short-term returns and the remuneration system of financial institutions’ managers was also not conducive to short-term risk-taking activity. Third, as a result of the efforts by the public authorities to enhance the robustness of the financial system, including an establishment of a resolution framework for financial institutions, concern about the surfacing of systemic risk did not heighten among depositors and market participants. Nevertheless, the global financial crisis has also affected Japan’s economy in various forms such as a deterioration in economic activity, a fall in stock prices, and a decline in market functioning. Japanese financial institutions have also been hit accordingly in the form of impairment due to a decline in stock prices and of an increase in credit costs. In the meantime, the challenges Japanese financial institutions have been faced with, such as the weakness of core profitability and vulnerability against stock price fluctuations, have been highlighted again. I will come back to the details later. II. Prospects for Japan’s financial system A. Changing environment surrounding Japan’s financial system The topic of today’s panel discussion is “Whither the Financial System?” It is quite a difficult question, but in the hope of providing some reference to the discussion, I offer some consideration of how Japan’s financial system should be after the financial crisis both from macro and micro perspectives. As it might be useful to consider first what changes are expected in the environment surrounding Japan’s financial system in the future, let me start with the following three points. Strengthening of global regulation and supervision First, financial regulation and supervision will be strengthened on a global basis. On regulations, vigorous discussions are ongoing internationally, and the issues covered are quite wide, ranging from banks’ capital adequacy and liquidity, leverage, remuneration, and accounting. In terms of supervision, the scope will be widened mainly to cover those which have not been taken up sufficiently in the past, such as the so-called shadow banking system. Let me talk about some recent developments. For example, in terms of banks’ capital, an internationally common new regulatory framework, namely, Basel III, has recently been agreed on. Both the quality and the quantity of bank’s capital will be enhanced, albeit gradually, through increasing the ratios of common equities and Tier I that have a high loss absorbing capacity at the time of bankruptcy. Like the so-called “Volcker Rule” in the United States, there are also moves to directly regulate banks’ high risk businesses such as proprietary trading and investment in hedge funds. Through next year, the issue of moral hazard associated with systemically important financial institutions (SIFIs), namely, the “too-big-to-fail problem,” is expected to be discussed, including how to specify SIFIs and what responses will be necessary in preventing the failure of the specified SIFIs or in minimizing the impact once they fail. If I can offer my opinion on that issue, given the essence of the issue of avoiding moral hazard, it would be desirable to take a flexible approach. Namely, in accordance with the situation in each country, appropriate responses should be chosen from various options including not only a bank capital surcharge but also a liquidity surcharge and strengthening of supervision, and establishment of a resolution framework. Increase in new demand for funds Second, as the contents of demand for funds financial institutions are faced with at home and abroad change, there is a possibility that new demand for funds will increase. For example, emerging economies are expected to continue to be the driving force of the global economy, and thus fund demand for improving infrastructure and for firms’ business fixed investment as well as for asset management associated with an accumulation of personal financial assets in those economies, is expected to further increase. Turning to the domestic areas, in the process of firms exploring new growth strategies and rebuilding the supply system for goods and services, there could be new fund demand for research and development as well as business relocation. Moreover, as the industrial structure is expected to change further, there will be increased importance of fund demand associated with corporate rehabilitation and realignment such as M&A finance and DIP finance and of fund demand from emerging companies that challenge new areas. Moreover, needs for asset management mainly by elderly people are expected to diversify and increase. Changes in business models for globally active major financial institutions Third, business models of globally active major financial institutions might change. Specifically, the originate-to-distribute business model that had been actively used prior to the crisis will relatively decrease in number and the proportion of commercial banking business that put more emphasis on the relationship with customers is likely to increase: that is called “back to basics.” Moreover, as business regulations such as the Volcker Rule will be implemented and regulation and supervision will be reviewed in order to restrain “too-big-tofail,” it is likely that the moves toward mere scale expansion and toward excessive risk-taking will be restrained. In terms of funding, as awareness about liquidity risk heightened considerably through the experience of the financial crisis, more emphasis would be put on retail deposits, which have more stability than short-term wholesale funding such as repo transactions. Such changes in business models of globally active major financial institutions could have an impact on the business models and the competitiveness of Japanese financial institutions. B. Future of Japan’s financial system: macro perspective I will next touch on how Japan’s financial system should be in the future from a macro perspective, namely, a perspective of financial system structure. Needless to say again, Japan’s financial system has long been characterized by financial intermediation centering on banks. In this situation, from a perspective of improving the functioning and stability of the financial system, many have argued as follows. It is desirable to have not only bank-based financial intermediation but also financial intermediation through the capital market, inclusive of the so-called market-based financial intermediation. To that end, it will be necessary to increase the supply of risk money and eventually enhance the diversification of households’ asset investment. In fact, many policy measures have been taken to bolster such moves, including enhancement in market infrastructure, improvement in market transparency, and investor protection. If we revisit the discussions based on the experience of the recent crisis, it can be summarized as follows. First, the complementarity of functioning between banks and capital market is important. While the functioning of corporate bond and CP markets declined significantly in Japan during the crisis, bank lending substituted the financial intermediation function during such phase and underpinned the rapidly deteriorating firms’ funding. Subsequently, when the functioning of the capital market was restored, bank lending started to decline. Therefore, it became clear again that the existence of multiple financial intermediation channels is important for the availability of firms’ funding and the robustness of the financial system. Second, the existence of multiple financial intermediation channels alone would not be sufficient to ensure financial system stability. Former Federal Reserve Board Chairman Greenspan once pointed out that one reason for Japan’s protracted crisis was that its financial intermediation was concentrated on banks, and the financial system like that in the United States, which has a variety of financial intermediation channels, would be more robust against shocks to the financial system and the real economy. However, the fact that the crisis deepened in the United States implies that such view is not necessarily correct. What is important is that each financial system participant maintains business soundness and pursues solid risk management, and, at the same time, that the regulatory and supervisory authorities and central banks recognize where the risks lie in the financial system as a whole from a macro perspective and take proper responses. Namely, I believe it is critical for financial system stability to maintain not only the robustness of the financial system structure but also self discipline of financial system participants and the risk capturing capability of the authorities at a high level as a whole. C. Challenges for Japanese financial institutions: micro perspective I will next talk about two specific challenges for Japanese financial institutions. I will touch on the challenges for the authorities in the final part of my speech. Selecting business models and sustained improvement in profitability The first and the biggest challenge for Japanese financial institutions is to raise their profitability in a sustained manner. Looking at the recent business performance of Japanese financial institutions, core profitability has been trending down due partly to a narrowing profit margin and declining lending outstanding. For that reason, an increase in profitability is an imminent challenge. In doing so, while it applies to every industry, it is essential to choose the optimal business model that utilizes an institution’s respective realms of expertise. As I have mentioned earlier, competition in commercial banking business, in which Japanese financial institutions are mainly engaged, is expected to intensify at home and abroad. Japanese financial institutions that receive domestic stable personal deposits have an advantage, including funding for overseas activities, in terms of resilience against liquidity risk. Moreover, a characteristic of Japanese financial institutions that traditionally put emphasis on the customer relationship is an important element in terms of “information production,” which is a key to conducting lending business, and could serve positively for businesses not only in Japan but also in overseas including Asian countries. Furthermore, Japanese firms and households, which are the main customers of Japanese financial institutions, are not in need of balance sheet adjustments like those in the United States and Europe. Therefore, in terms of the competitiveness of Japanese financial institutions compared with that of the U.S. and European financial institutions, I believe there is nothing to be pessimistic. With that recognition, what is necessary for Japanese financial institutions is, at first, to hone their skills in identifying firms with growth potential and continue to strive to find new borrowers and also tap new fund demand from the existing borrowers. While a fundamental problem Japan’s economy is faced with is a decline in medium- to long-term growth expectations, to overcome such problem, it is important that private firms promote their innovative activities and pursue a new source of growth at home and abroad. It is essential that financial institutions also firmly support such moves. In that regard, looking at the recent efforts by Japanese financial institutions, there have been proactive developments to utilize their respective characteristics, which is quite assuring. The major banks have been further expanding their businesses in Asian and other emerging economies regardless of customers’ nationality, and the regional banks have been making efforts to tap growth areas in the regions, including distinct local firms. I hope that Japanese financial institutions will establish their respective business models and pursue proactive efforts including tapping new fund demand, while skillfully gauging various changes in the business environment at home and abroad. Second, it is also important to raise the core profitability of the existing borrowing firms through enhancing their governance. It has often been said in Japan that corporate governance that raises a firm’s profitability has been weak. There are many views that, one way to overcome such weakness is to use equity funds, which have a strong tendency to search for yields, as leverage to strengthen corporate governance from outside. Financial institutions can play a significant role in that regard by being involved in creating investment funds. Moreover, the role of a financial institution as a lender is also not insignificant. Many Japanese financial institutions appear to have been relying too much on real estate collateral and personal guarantees when providing loans especially to medium and small firms, and governance after loan provision has not necessarily been sufficient. Financial institutions are required to bolster firms’ growth constantly through deepening the ongoing relationship with them. In complementing such support, lending that uses movable assets, such as inventories, or accounts receivables as collateral – the so-called asset-based lending – or that utilizes covenants for medium and small firms can be useful options. Third, it is intrinsically important for financial institutions to play a role in encouraging metabolism, for example, corporate realignment. At the same time, it is also important that financial institutions also aim at metabolizing themselves through mergers, consolidation, or unbundling, in accordance with their own business models. For example, financial institutions that aim to be globally active could pursue the advantage of scale or scope through mergers and acquisitions. By contrast, for financial institutions that aspire to enhance their presence in niche markets, limiting functions and concentrating resources could be an important option. Those financial institutions’ behavior is expected to not only improve management efficiency of individual financial institutions through increased competitiveness but also lead to increased profitability of the financial sector as a whole through efficient resource reallocation. Proper risk management The second challenge for Japanese financial institutions is proper risk management. In that regard, there is an increasing awareness among financial institutions, including those overseas, of the importance of the following: to gauge risk comprehensively, for example, by way of stress testing, without relying too much on specific quantitative methods such as VaR, and to share the recognition of risks not only in the risk management section but also including top management. In addition to such general challenge, a reduction in market risk associated with stockholdings, in particular, would be a specific challenge for the future. As for market risk associated with stockholdings, many Japanese financial institutions have recognized the magnitude of price volatility associated with stockholdings and have been taking steps to reduce such risk as a management priority. Nevertheless, the pace of reduction in stockholdings has somewhat slowed recently due partly to sluggish stock prices and thus the due amount of market risk associated with stockholdings still remains. Of course, stockholdings could have implications as a part of corporate governance or could play a role as a tool to gain total profits including fee revenues. Even in those cases, however, it is important to firmly identify the risks and returns. On that basis, if it is judged that the risk is larger, financial institutions are required to steadily promote efforts toward the reduction of their stockholdings. Concluding remarks While I have been talking about the challenges for Japanese financial institutions, the recent crisis left various lessons for the regulatory and supervisory authorities as well as central banks. In relation to ensuring financial system stability, one lesson might be that “it is important to gauge with a sharp distinction between micro-level risks, such as risks of individual financial institutions, and risks of the financial system as a whole.” By taking that point into account, the importance of the so-called macroprudence – which aims at accurately gauging the risks of the financial system as a whole, with due recognition of the relationship between economic activity, financial markets, and financial institutions, and taking necessary policy responses – has been increasingly recognized on a global basis. In that regard, the Bank of Japan has been, from a standpoint of conducting monetary policy, monitoring a wide range of economic and financial developments at home and abroad and making in-depth research and analyses, as well as striving to improve infrastructure, including financial markets and the payment and settlement system. In addition, the Bank has been gauging business conditions of individual financial institutions through on-site bank examination and off-site monitoring, and information and perspectives obtained through such processes have been utilized in gauging the condition of the financial system as a whole and in risk analyses, and published in the Financial System Report. Also, the Bank took measures such as purchases of banks’ stockholdings and provision of subordinated loans aiming at ensuring the stability of the financial system as a whole. The Bank has thus been making various efforts on the macroprudence front. Nevertheless, such efforts are only half done. For example, gauging macro risks is still not sufficient. From a viewpoint of strengthening macroprudential analysis, the Bank has been trying in the Financial System Report to broaden analyses to businesses other than banks, for example, insurance companies, to gauge macro financial imbalances, and to expand stress testing, but those efforts still remain at a stage of trial and error. In addition, the Bank is aware that, even if the macro risk is properly gauged, it still remains as a future challenge to examine what specific policy measures would be desirable to address the risk. The Bank will, including the responses to the challenges I have mentioned, continue with the efforts to ensure stability of the financial system.
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, prepared for the panel "The Future of Monetary Policy" at the 2011 American Economic Association Annual Meeting, Denver, Colorado, 7 January 2011.
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Kiyohiko G Nishimura: This time may truly be different – balance sheet adjustment under population ageing Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, prepared for the panel “The Future of Monetary Policy” at the 2011 American Economic Association Annual Meeting, Denver, Colorado, 7 January 2011. * 1. * * Introduction: population ageing This panel’s topic “The Future of Monetary Policy” is doubly opportune. Firstly, more than two years have past since the immediate fallout of the Lehman Brothers’ collapse, giving us time both to look back and to look forward. Secondly, we are not yet out of the woods and are still in the process of soul-searching; pursuing a better understanding of our economic environment and the appropriate monetary policy responses. In this presentation, I will give a perspective that may be different from other panelists: longer-run, more qualitative than quantitative. Specifically, to contemplate the future, I start from the fact that we are in the midst of a balance sheet adjustment process after the financial bubble burst, at a time when the population is ageing. This is not the simple balance sheet adjustment of the past, which took place with a growing young population. This is an acute balance sheet adjustment when the composition of the nation’s population is rapidly tilting toward the old. This is unprecedented in our modern history of economic growth. This ageing population is the result of people’s choices made many years ago when, after the Second World War, birth control became possible and substantial medical improvements were reducing child mortality and increasing longevity. These medical advances and the baby boom after the war, together with longer life expectancy, are true blessings for economic growth, bringing what are often called population dividends, with many young workers producing and few old people being supported. However, at some point in time, the trend had to be reversed. The significant point for us here is that the bubble we have experienced has coincided closely with the turning point in these demographic dynamics. Population ageing: inverse dependency ratio Let me show you some telling figures on the inverse dependency ratio, which indicates how many people of working age it takes to provide for one dependent person. The Japanese ratio peaked around 1990, and it was in the very next year, 1991, that the Japanese Bubble peaked. The peak of the US ratio was between 2005 and 2010, and the peak of the US Subprime Bubble was 2007 (Fig. 1.1). The economically troubled countries of the eurozone have a similar pattern to Japan and the United States. The ratios for Greece, Portugal and Spain have almost the same time profile, and all of them peaked around 2000–2005. The peak of the Spanish property boom was just after the ratio’s peak, and the financial problems of Greece also started at the same time. A particularly interesting case is Ireland, which showed a sharp rise in the ratio until around 2005. The bust of the country’s property market bubble was just a few years around the corner (Fig. 1.2). Incidentally, for the sake of completeness, I have included the figures for China (Fig. 1.3), whose ratio seems still to be rising rapidly, but will peak a bit later than in Euro-American countries. The peak will be around 2010–15, after which it will go down as rapidly as it is now going up. The inverse dependency ratios of many other Asian countries have a quite similar time profile to that of China. I am not suggesting any causality here, but simply pointing out the balance sheet adjustments after the bubble burst in Japan, United States and the eurozone, whether private or public, must be carried out as the population is ageing. I believe this fact has an important bearing on the future of monetary policy, especially unconventional monetary policy. BIS central bankers’ speeches In Section 2, I first examine the process of balance sheet adjustment after the bursting of a bubble and when the population is ageing, juxtaposing Japan in the 1990s and the United States in the 2000s. Then, in Section 3, I summarize the consequences of severe, prolonged balance sheet adjustment, as seen in Japan in the 2000s. Finally in Section 4, I identify the multi-faceted challenges central banks may face as a consequence of carrying out balance sheet adjustments under population ageing, and I explain the Bank of Japan’s policies to tackle these problems. 2. Balance sheet adjustment and the breakdown of the transmission mechanism Who leveraged during the bubble period? Japan and the United Sates In order to find out the effect of balance sheet adjustments after the bursting of a bubble, let me first clarify who leveraged during the bubble periods. In Japan, it was the corporate sector, especially small to medium-sized firms, which for the first time gained access to large banks after the so-called financial liberalization (Fig. 2.1). The corporate sector’s loan-to-GDP ratio increased by 29 percentage points in the ten years before the bubble burst in 1991. In the United States, it was the household sector that leveraged, especially in housing. The household sector’s housing loans-to-disposable income ratio jumped by 39 percentage points in the ten years before the bubble burst in 2007. Breakdown of the monetary transmission mechanism These sectors were interest-sensitive and thus constituted the “transmission gears” of the ordinary monetary transmission mechanism in the periods before the bubbles burst. That is, these leveraged sectors had been sensitive to policy rate reduction in business cycles. However, after the bubbles burst, these leveraged sectors became insensitive to policy rate reduction, because of the acute balance sheet adjustments. Large legacy shortfalls must be compensated for by current profit or income, period by period, and this process is slow and painful. This leads to a breakdown in the ordinary monetary transmission mechanism of policy rate change. To see this, let me first consider corporate investment in Japan. Figure 3.1 depicts manufacturing investment by the corporate sector. The shaded areas indicate recession, the black line is manufacturing investment in real terms, and the blue line shows the time profile of the policy rate. This figure shows that the policy rate cut prevented investment from falling sizably in the three business cycles before the bubble. In contrast, after the bubble burst, a sharp decline in the policy rate clearly failed to prevent a sharp decline in investment. Basically, the same picture is found in the corporate sector’s non-manufacturing investment (Fig. 3.2). In the United States, the household sector is the leveraged sector. Its most interest-sensitive demand components are demand for new homes and new automobiles. In Figure 3.3, again, the shaded areas depict recession, the black line is new home sales, and the blue line is the federal fund target rate. This figure shows that policy rate cuts at least prevented new home sales from falling further, and that they helped sales to pick up in the three business cycles before the bubble. However, a sharp decline in the policy rate after the bubble burst failed to prevent a sharp decline in new home sales. Qualitatively quite similar observations apply to new automotive sales (Fig. 3.4). Ageing population and property prices As suggested in the Introduction, Japan was faced with a rapidly ageing population after the bubble burst of 1991, while the United States is about to face its own version with a somewhat milder population ageing. There are many consequences of population ageing, such as differences in consumer preferences and technological adaptability between the BIS central bankers’ speeches young and the old, but I will concentrate on one particular issue that is pertinent to balance sheet adjustments, namely, the possible effects of population ageing on property prices. In Figure 4.1, the real land price (national average, for all purposes) is juxtaposed with the inverse dependency ratio from 1955 to date. This figure shows, firstly, that the relative abundance of young people coincided with sharply higher property prices. Secondly, in contrast, the relative abundance of old people seems to be leading to lower property prices. It should be noted here that declining property prices greatly aggravated the balance sheet adjustments of Japanese corporations. The US case is illustrated in Figure 4.2. In the United States also, an increasing reverse dependency ratio seemed to coincide with the property bubble. After the bubble burst of 2007, property prices seem to have followed the long run movement of the inverse dependency ratio, although it would be premature to draw any conclusions from this at the moment. 3. Prolonged balance sheet adjustment under population ageing: consequences What then are the consequences of severe and prolonged balance sheet adjustment under population ageing? Three adverse consequences can be identified. Declining mobility First, mobility declines, or in other words, the economy becomes “inflexible”. Since de-leveraging firms or households have to pay back all their debts before “moving” from their current position, they are often stuck with an “underwater” property. Population ageing strengthens this tendency. In the case of Japan, de-leveraging took place in the corporate sector, and thus firms became less mobile between industries and regions. In the United States, the household sector is de-leveraging, and thus household mobility has been reduced. Figure 5.1 depicts declining entrepreneurial mobility in Japan. This figure shows the creation and destruction of enterprises between pre-bubble (1981–1986), bubble (1987–1991), and post-bubble (1992–1996). It can be seen in this figure that, after the bubble burst of 1991, creation of enterprises was sharply reduced. In contrast, the increase in the rate of destruction was relatively mild. These two imply a “sticky industry structure,” a tendency to hang on to the past. Declining mobility is found in the household sector in the United States. Figure 5.2 shows changes in the householder mobility rate between 2005 and 2009. A sharp decline is found across all age groups. Since there is no such change in renters, this sharp decline suggests that the housing crash reduced householder mobility rates. Loss of non-tangible/human capital The second consequence of severe and prolonged balance sheet adjustment is the loss of non-tangible or human capital. De-leveraging firms and households suffering long underutilization or under-employment tend to lose their non-tangible or human capital. In Japan, this has been observed especially in small to medium-sized enterprises: loss of entrepreneurship, loss of human networks in skilled manufacturing, and loss of access to technological advances. In the United States, the long-term unemployed or underemployed risk losing their human capital. Problems in financial intermediation The third consequence of severe and prolonged balance sheet adjustment is the deterioration in financial institutions’ efficient functioning as financial intermediaries. This was most acutely observed in Japan during the several years after the bubble burst: a pile-up of BIS central bankers’ speeches non-performing loans seemed to lead to a breakdown in the “market selection mechanism” around 1997. Figure 6 shows the result of a large-scale panel analysis of Japanese firms, in which the total factor productivity of exiting and surviving firms is compared. Survival of the fittest is a basic premise of the natural selection mechanism. Thus, if the market mechanism works well, the productivity of successful and surviving firms should be higher than that of failing and hence exiting firms, at least on the average. In this figure, the shaded areas show cases where the productivity of failing and thus exiting firms is higher than that of surviving firms, which is an anomaly. In fact, the shaded areas are rather exceptional most of the time. However, if we look at the period 1996–97, the period of the financial crisis, we see many shaded areas indicating that more productive firms were exiting in many industries. This strongly suggests a breakdown in the natural selection mechanism. Results of acute B/S adjustment under population ageing: Japan in the 2000s So, what are the end results of acute balance sheet adjustment under population ageing? Some of these consequences can be seen in the Japanese situation in the 2000s. First, growth prospects declined. The average real GDP growth fell from 5% to 4 % in the 70s and 80s to around 1% in the 90s and 2000s. This implies the expected rate of return on investment in the 2000s is low, especially for small to medium-sized firms depending on domestic demand. In contrast, money (bank deposits) becomes relatively attractive as a store of value, given the price-stability pledge of the central bank. Ironically, this leads to an apparent breakdown of the historically-proven quantity-theoretic relationship between real activity and money stock. Moreover, not only is the policy rate very low, but so too are longer risk-free rates, judged by historical standards. Conventional monetary policy through the overnight policy rate is not as effective as before, and this means the economy is more vulnerable to a downside shock. Second, there are signs of coordination failure. Banks’ lending is sluggish, partly because of their inadequate functioning as an expert relationship banker. Here a vicious circle seems to be working. To begin with, banks lack expertise to assess investment in new fields, suffering as they are from problems with non-performing loans and under-investment in their loan officers’ human capital. Consequently banks do not lend. This means that new investments and new enterprises cannot get funding, and thus new markets falter. Then, banks miss the opportunities to accumulate new expertise, bringing them right back to the starting point of this vicious circle. Another coordination failure is found in capital markets, in the form of “excessive” risk aversion. Fearing unknown unknowns, investors shun investing in riskier securities. Their market then becomes thin and vulnerable to non-fundamental shocks. This means they themselves become prone to turning into unknown unknowns, thus the original fear is selffulfilling. These two types of coordination failure in financial markets result in an apparent lack of “animal spirits”. Third, we see a piling-up of government debt. This is partly the result of the substitution of public debt for private debt in the process of balance sheet adjustment, and partly due to the substitution of public demand for private demand during this period of declining growth. According to the OECD’s Economic Outlook, Japan’s General Government Gross Financial Liability-to-GDP Ratio in 2010 was 198%, compared with 93% in the United States. However, it should also be noted that, because of low long-term rates, the Government Net Debt Interest Payments-to-GDP is 1.2% in Japan, compared with 1.7% in the United States. BIS central bankers’ speeches 4. Multi-faceted challenges and unconventional monetary policy The consequences of Japan’s prolonged balance sheet adjustment under population ageing described so far lead us to a number of multi-faceted challenges. The first challenge is that of cyclical-stabilization: ensuring a return to sustainable growth with price stability, when the policy rate is near zero and longer-term risk-free rates are also very low. In Japan’s case, this also means overcoming deflationary pressures. The second challenge is to enhance the growth trend, or strengthen the foundations for growth. In other words, the challenge is to raise long-term growth prospects, especially in domestically-oriented growth. This should be done by solving the coordination failure in banking and capital markets described above. The third challenge is to avoid causing problems in national debt management. We should design and execute carefully measures to cope with the first and the second challenge, taking appropriate account of the current national debt situation as explained before, as well as general economic conditions. To tackle the first and the second challenges, the Bank of Japan instituted its Growth Foundation Strengthening Facility (GFSF) in June of last year and adopted Comprehensive Monetary Easing (CME) in October. To meet the challenge of “cyclical-stabilization”, the first part of the CME changed the guidance for the policy rate from 0.1% to the range between 0 and 0.1%, making clear the Bank’s Virtually Zero-Interest Rate Policy (VZIRP). For the second part of the CME, the Bank clarified its policy duration commitment: the Bank will continue its VZIRP until it judges price stability to be in sight on the basis of the Policy Board members’ understanding of price stability. With Policy Board members’ announced forecasts for two years ahead, this is similar to “forecast targeting” though not specific in numbers. The third part of the CME is the Asset Purchase Program, which is also designed to meet the cyclical-stabilization challenge. Its aim is to influence downward longer-term rates. The outright purchase of JGBs with remaining maturity of 1–2 years and T-bills is to reduce the term-premiums of risk-free rates, and the purchase of CPs and Corporate Bonds is to reduce both term-premiums and riskpremiums. The scheme to provide 3-month funds at the overnight rate already instituted was aimed at lowering rates longer than the overnight rate, and has been continued and included in this program. Moreover, the Asset Purchase Program is aimed at breaking another vicious circle in capital markets, that caused by “excessive” risk aversion. In this Asset Purchase Program, the Bank purchases riskier assets than it bought before: BBB-rated corporate bonds, and a-2 CPs. It also purchases ETFs and J-REITs directly from the market. The purchase is designed to act as a catalyst to induce investment in riskier assets, and thus help solving the coordination failure. To tackle the second, “trend-enhancement” challenge, or strengthening growth potential, the Bank instituted its Growth Foundation Strengthening Facility (GFSF) in the form of preferential fund-provisioning to support financial institutions’ own initiatives in lending and investing in new growth areas. It should be made clear here that it is not the Bank of Japan but participating financial institutions that determine which investment projects should be funded using this GFSF. Thus, the GFSF is designed to be a catalyst to induce banks to find new firms or new investment projects in their perceived growth areas. In this way, the GFSF is targeted at breaking the vicious circle of no lending resulting in no new markets and thus no demand for lending to start with. When implementing these measures to cope with cyclical-stability and trend-enhancing challenges, it is very important to take appropriate account of the third challenge, that of avoiding causing problems in national debt management. Specifically, it is crucial to avoid creating an impression of the “monetization” of government debts. Otherwise, the large scale purchase of JGBs may lead to a substantial and lasting ratcheting up of long-term rates, BIS central bankers’ speeches which would pose a serious problem for economic recovery and the financial position of the government. Taking this point into consideration, the Bank of Japan has already purchased about 22 trillion yen in JGBs annually, beside the Asset Purchase Program. By the same token, we should be very careful about the possibility that asset purchases may lead to capital losses, which could tarnish the credibility of the central bank. In the bubble years, we often heard talk of this being the beginning of a new age of prosperity and that, as the title of the popular book says, “this time is different”. Since the bubble burst, people have tended to think the collapse was simply a fleeting nightmare and that we will eventually be back to the old normal, just as before. That may be true. However, if we recognize the problems arising from acute balance sheet adjustments when the population is ageing, there is the distinct possibility that this time may truly be different. 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Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Saitama, 9 December 2010.
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Yoshihisa Morimoto: Economic activity and prices in Japan and monetary policy Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Saitama, 9 December 2010. * I. * * The global economy Economic activity in Japan is closely linked to global economic developments. Therefore, before discussing the Japanese economy, I will first take a look at trends in the world economy. From around 2005, the world economy grew at a rapid pace of around 5 percent annually, with China and other emerging economies gaining in prominence. The failure of Lehman Brothers in September 2008, however, brought this growth to a sudden halt, and the world economy marked negative growth in 2009 due to the severe contraction in the first half of the year. Causes of the sharp decline include the rapid deceleration in economic and financial activity due to the financial crisis triggered by the Lehman shock, and the corrections to the various excesses that had built up in the world economy since the mid2000s. By “excesses,” I am referring to overborrowing by households, excess production capacity in the corporate sector, and the large amount of nonperforming loans held by financial institutions. Measures to address the financial crisis implemented by governments and central banks around the world started to show effects from the second half of 2009. With the contraction in economic and financial activity having come to a halt, policy measures to stimulate demand provided a further boost. It should be noted, however, that the pace of economic growth has been slowing somewhat since summer 2010, as restocking of inventories that took place during the recovery phase came to an end and the effects of demand-boosting measures in the United States and other countries waned. The slowdown is also due in part to the unwinding of accommodative policies in emerging countries in order to keep economies from overheating. A. Advanced economies Let us look at advanced economies in more detail. The U.S. economy remains on a moderate uptrend. Although the effects of fiscal stimulus measures have been waning, exports to emerging and commodity-exporting economies have continued to increase and private consumption and business fixed investment have been rising moderately. Housing starts have remained at a depressed level after dropping sharply due to the expiry of tax credits for homebuyers, but are unlikely to fall further. As for the outlook, the U.S. economy is likely to continue recovering on the back of increasing exports and accommodative monetary policy. It must be added, however, that in the labor market employment conditions have not improved greatly, with unemployment, for example, remaining at a high level. Consequently, balance-sheet adjustments in the household sector – that is, the restoration of financial health, including the repayment of household debt – are unlikely to gather pace, so that the pace of recovery is likely to remain moderate. Economic activity in the euro area as a whole has been recovering moderately, with some differences in growth by country: Germany has performed strongly while other countries have lagged behind. Although the pace has been slowing, exports and production have continued to increase, while domestic demand components, such as private consumption, have been rising from the previous quarter. For the present, the euro area is likely to continue recovering moderately. However, attention needs to be paid to the effects of fiscal BIS central bankers’ speeches consolidation, which from next year will start in earnest also in the major economies, and to volatility in financial markets due to concerns over the public and private debt problems in some of the peripheral countries. B. Emerging and commodity-exporting economies Although emerging and commodity-exporting economies are often grouped together, they are a diverse group. Here, I will focus on the major East Asian economies, since they are most relevant to Japan. First, the Chinese economy has continued to show high growth of around 10 percent. Although the pace of increase in exports has been slowing due to a deceleration in overseas economies such as the United States, domestic demand, as indicated by retail sales and investment in fixed assets, has continued to show high growth. Like China, South Korea, Taiwan, Thailand, and other NIEs and ASEAN countries also experienced continued economic growth driven by domestic demand, although inventory adjustments in IT-related goods are casting a shadow on the outlook for exports. Overall, it is very likely that emerging and commodity-exporting economies will continue to show relatively high growth due to robust domestic demand and capital inflows from overseas. The pace of growth of the Chinese economy is likely to decelerate somewhat due, among other things, to government measures to restrain the increase in real estate transactions. However, given the continuing increase in private consumption, growth is nevertheless likely to remain relatively high. Economic conditions in the NIEs and ASEAN countries are expected to follow a recovery trend due to the inflow of overseas capital and increases in private consumption and business fixed investment. II. The Japanese economy Based on the above assessment of the world economy, I will now talk about economic activity and prices in Japan. Semiannually, in April and October, the Bank of Japan releases the Outlook for Economic Activity and Prices, known as the Outlook Report, in which it makes public its forecasts for economic activity and prices for the next two to three years, the background for its forecasts, and the associated risk factors. My speech today will from time to time refer to this report, in particular the October 2010 Outlook Report. A. Economic activity Real GDP growth for the July-September quarter of 2010 was relatively strong. Recent developments in production, however, indicate that the economic recovery seems to be pausing. The pause in the recovery can be attributed to various factors, including a decrease in demand following the last-minute rise in demand ahead of the expiration of subsidies for purchasers of environmentally friendly cars and the boost from the extremely hot weather, the deceleration in overseas economies, and inventory adjustments in IT-related goods. Looking at the situation for each demand component, real exports as a whole have recently been more or less flat, reflecting the following factors: (1) the effects of inventory adjustments in IT-related goods such as semiconductors in South Korea and Taiwan; (2) the deceleration in the U.S. economy; (3) the unwinding of accommodative monetary policies in emerging economies; and (4) the effects of the strong yen on exports of cars and other goods. However, given the strong domestic demand in emerging economies, Japan’s exports are unlikely to fall precipitously and are likely to recover in the longer term, providing support to the economy overall. Furthermore, production, which is likely to remain lackluster for a while due to the reasons mentioned above, is expected to gradually return to a moderate upward trend along with the recovery in exports. The Bank maintained its assessment of business fixed investment as “showing signs of picking up.” This rather cautious assessment, despite the fact that business fixed investment BIS central bankers’ speeches this fiscal year is likely to turn out to be higher than in the previous year, reflects the following: (1) the fact that firms continue to feel that their capital stock is still excessive; (2) the shift of production to overseas locations; (3) the deceleration in overseas economies; and (4) the appreciation of the yen. Yet, I frequently hear that there is considerable pent-up need for replacement investment and investment in environmentally friendly equipment, given that firms have held back on such investment since the collapse of Lehman Brothers. Barring any extreme external shocks, the pick-up in business fixed investment is therefore expected to gradually become more pronounced as a result of the improvement in corporate profits. Turning to the household sector, private consumption in the July-September quarter of 2010 was supported by the last-minute rise in demand ahead of the expiration of subsidies for purchases of environmentally friendly cars and the increase in the tobacco tax, in addition to the boost from the extremely hot weather. There was a clear decrease in sales of cars, with the exception of small cars with engine sizes of 660 cc or less, which in October and November were sharply down, by approximately 30 percent, from the same period a year earlier. I earlier mentioned some factors behind the current “pause” in the economic recovery. Among them, I have been most concerned about the drop in car sales because of the wide range of firms and industries encompassed by the automotive sector. With the drop in car sales having become a reality, the question now is the depth and length of the decline. Demand for cars has been brought forward for a year and half since the introduction of subsidies in April 2009, so the decline in car sales is likely to continue. That being said, though, one would expect the negative impact on the economy to be greatest immediately after the expiration of subsidies and to subsequently ease gradually. Therefore, private consumption is expected to gradually recover. Obviously, the timing of a full-fledged recovery of private consumption is not clear, since the employment and income situation is expected to remain severe. Developments in this area, together with housing investment, which has been recovering gradually, warrant a close watch. Against this background, if overseas economies, led by emerging and commodity-exporting economies, were to register higher growth, this would increase the likelihood of Japan’s economy returning to a recovery path fueled by an increase in exports. The October 2010 Outlook Report paints such a scenario for fiscal 2011 onward. The report also said that in “fiscal 2012, Japan’s economy is expected to continue growing at a pace above its potential, as the transmission mechanism by which the strength in exports and production feeds through into income and spending will likely operate more effectively amid the continued relatively high growth in overseas economies, especially emerging and commodity-exporting economies.” Although this is subject to a considerable margin of error, the Bank estimates that Japan’s potential growth rate during the projection period is around 0.5 percent. B. Prices Domestic corporate goods prices are expected to remain on a moderate uptrend for the time being, mainly due to the uptick in international commodity prices. The decline in the consumer price index (CPI; excluding fresh food) on a year-on-year basis is decelerating and is expected to continue decelerating as a trend as the aggregate supply and demand balance gradually improves. As stated in the projection in the Outlook Report for the period ending in fiscal 2012, it will take considerable time for the supply and demand balance to improve because the drop in demand after the financial crisis was considerable and the pace of economic recovery has been moderate. Therefore, the deceleration in the decline in the CPI on a year-on-year basis is likely to remain moderate and it will likely take until sometime in fiscal 2011 for the year-onyear rate of change in the CPI to enter positive territory. Thereafter, the rate of increase is expected to start rising through fiscal 2012. BIS central bankers’ speeches III. Risks to the outlook The above outlook for economic activity and prices suggests that the Japanese economy will be able to overcome deflation and return to a sustainable growth path with price stability, although it will take time. However, there are various upside and downside risks to economic activity and prices. A. Risks to economic activity In the October 2010 Outlook Report, the Bank listed the following as risk factors concerning the outlook for economic activity: (1) developments in advanced economies; (2) developments in emerging and commodity-exporting countries; (3) developments in business and household sentiment; and (4) firms’ medium- to long-term growth expectations. Regarding the first risk, economies burdened with balance-sheet adjustments, such as the United States, are unlikely to achieve strong growth and will remain prone to weakness until the adjustments are completed. U.S. household debt relative to income remains high. In Europe, financial markets remain volatile, as indicated by the recent surge in yields on Irish government bonds. Furthermore, the amount outstanding of public debt has increased considerably due to the implementation of vigorous fiscal policies. The implementation of fiscal consolidation measures, which will proceed further, might exert greater-than-expected downward pressure on individual economies and the global economy. Emerging and commodity-exporting economies are likely to maintain relatively high growth led by domestic demand, and in this situation the continued large-scale monetary easing in advanced economies might accelerate capital inflows to emerging and commodity-exporting economies. Stock and housing prices in these economies have been rising already. If economic conditions in these economies are boosted further, Japan’s economy could realize stronger-than-expected growth through the increase in exports to these economies. On the other hand, if economic and financial activity in these economies becomes excessive, there is a risk that this could, in the longer term, lead to a sharp reversal. Therefore, whether emerging and commodity-exporting economies will be able to achieve a soft landing and return to a sustainable growth path is an issue that warrants careful attention. A domestic issue that warrants attention is the possibility that fluctuations in business and household sentiment might affect economic activity. For example, the appreciation of the yen may on the one hand encourage mergers and acquisitions abroad – a positive development – but on the other it is also likely to exert downward pressure on the profits of exporters and might damage economic activity if this were to hurt business confidence and lead firms to change their behavior. A final point concerns firms’ medium- to long-term growth expectations. If firms are able to capture infrastructure and consumption demand in emerging and commodity-exporting economies, this would increase the possibility that economic activity will be stronger than projected. On the other hand, if firms’ growth expectations continue to shift downward, there is a risk that business fixed investment and private consumption could decrease more than expected. I believe that the risks to either side are equally important and that at present the upside and downside risks are broadly balanced. However, I will continue to carefully monitor developments concerning these risks. B. Risks to prices Risks to prices, in addition to the above four risk factors affecting economic activity, include a possible decline in firms’ and households’ medium- to long-term inflation expectations. If the pace of recovery in resource utilization of labor and production capacity remains moderate, firms and households might expect prices to fall, which in turn could affect actual prices. BIS central bankers’ speeches Other risks to prices that require careful observation include the high uncertainty in gauging the aggregate supply and demand balance and its impact on prices, as well as price changes due to fluctuations in international commodity prices and foreign exchange rates. IV. Monetary policy Let me now turn to the Bank’s conduct of monetary policy. The Bank recognizes that Japan’s economy is faced with the extremely important challenge of emerging from deflation and returning to a sustainable growth path with price stability. Based on this recognition, the Bank has been doing its utmost as the central bank, using a three-pronged approach consisting of (1) strong monetary easing, (2) ensuring stability in financial markets, and (3) providing support to strengthen the foundations for economic growth. Today, I would like to explain the Bank’s pursuit of strong easing through comprehensive monetary easing and the support for strengthening the foundations for economic growth to address the medium- to long-term issues faced by the Japanese economy. A. Pursuing strong monetary easing: the comprehensive monetary easing policy With regard to its pursuit of strong monetary easing, the Bank has reduced its policy interest rate twice since the Lehman shock and, by increasing longer-term funds provision to financial institutions through new funds-supplying operations, the Bank has been influencing directly longer-term interest rates such as 3-month and 6-month rates. As a result, market interest rates have been stable at extremely low levels and firms’ funding costs have been declining. However, at the Monetary Policy Meeting held on October 4 and 5, 2010, it was judged that the economic growth rate was likely to be somewhat lower than the projection presented in the July 2010 interim assessment, reflecting the slowdown in the U.S. economy since summer 2010 and the effect of the appreciation of the yen on business sentiment. It was also agreed at the meeting that, in view of the downside risks to the economic outlook, it had become more likely that the return of Japan’s economy to a sustainable growth path would be delayed compared to what had been projected earlier. In this context, what particularly caught my attention was the results of the September 2010 Tankan (Short-Term Economic Survey of Enterprises in Japan) released by the Bank. Although I had anticipated that firms’ view of future business conditions had deteriorated to some extent due partly to the decrease in demand following the expiry of government measures to boost demand, the extent to which it had deteriorated was larger than I had expected. The Bank has repeatedly stated that it will continue to consistently make contributions as the central bank so that Japan’s economy will overcome deflation and return to a sustainable growth path with price stability. Therefore, the members of the Policy Board, myself included, thought that the time had come for the Bank to express this stance more clearly, examine concrete measures, and take drastic measures. Moreover, it was important to announce these measures as a package rather than piecemeal policies. The purpose of this package is to further enhance monetary easing, and I personally felt that first of all it was important for the Bank to announce a change in the guideline for money market operations and clarify the Bank’s commitment regarding the time horizon based on the “understanding of medium- to long-term price stability” (hereafter the “understanding”). Regarding the change in the guideline for money market operations, the Bank lowered the target for the uncollateralized overnight call rate – the shortest interbank rate – from “at around 0.1 percent” to “at around 0 to 0.1 percent,” thereby clearly indicating that it was pursuing a virtually zero interest rate policy. As for the clarification of its commitment regarding the time horizon based on the “understanding,” Policy Board members agreed that (1) the Bank would maintain the virtually zero interest rate policy until it judged that price stability was in sight, and (2) the “understanding” would be appropriate as the basis for that judgment. The “understanding” is the level of inflation that each of the nine Policy Board members understands as being consistent with price stability over the medium to long term. BIS central bankers’ speeches The “understanding” at present falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board members’ understanding are around 1 percent. In considering policy options the Bank could take, the Bank’s options within the conventional monetary policy framework were limited, given that short-term interest rates – ranging from overnight to longer-term rates – were already at levels that left little room for a further decline. In these circumstances, the Bank decided on the establishment of the Asset Purchase Program (hereafter the Program) as the third measure in the comprehensive monetary easing package. Like other Policy Board members, I felt that the Bank should consider a variety of policy options without precluding measures that are temporary or extraordinary for a central bank, such as directly influencing longer-term rates and expanding the type of financial assets eligible for the Bank’s purchases. The details of the Program are as follows. The Bank established a program on its balance sheet to conduct outright purchases of various financial assets, such as Japanese government bonds (JGBs), CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs), and the fixed-rate funds-supplying operation against pooled collateral. The total amount of the Program will be about 35 trillion yen, consisting of about 5 trillion yen for purchases of financial assets and about 30 trillion yen for the fixed-rate funds-supplying operation against pooled collateral. The Bank has already begun purchasing JGBs and corporate bonds, and the first auction for the purchase of CP is scheduled for tomorrow, December 10, 2010. The Bank also decided to start purchasing ETFs and J-REITs in the near future. As the Bank has been explaining, this is a temporary and extraordinary measure for a central bank. Moreover, the Bank did not adopt this measure lightly, since it entails the critical issue of making sure that the risks involved in holding various risk assets are properly managed in order to ensure the financial health of the central bank of Japan. B. The bank’s measure to support strengthening the foundations for economic growth Lastly, I will move on to talk about the fund-provisioning measure to support strengthening the foundations for economic growth, which the Bank decided to introduce at the Monetary Policy Meeting held on June 14 and 15, 2010. The measure supplies long-term funds at a low interest rate against eligible collateral to financial institutions in accordance with their efforts in terms of lending and investment toward strengthening the foundations for economic growth. Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. To achieve this, the key, in my view, is to tap potential demand, and both economic entities in the private sector and the authorities need to continue to make steady efforts to this end. The main cause of the current deflation is the negative output gap, which largely reflects a long-term downtrend in the economic growth rate since the 1990s. However, looking again at major trends such as demographic developments and globalization, can we really say that Japan has nothing to gain from these trends? I do not think so. It all depends on one’s perspective. For example, demographic trends can be seen as a shrinking of the total and the working-age population, or they can be seen as an increase in the importance of the elderly. Similarly, global warming is an issue that requires an immediate response, but even more important is a medium- to long-term strategy covering the next 10 or 20 years. Regarding the fund-provisioning measure to support strengthening the foundations for economic growth, Bank of Japan Governor Masaaki Shirakawa has commented that, in addition to providing practical support through the provision of funds, he felt that it was more important to raise awareness of the challenges the economy faces. Having worked in the business world, I feel exactly the same. I believe what is needed is to identify the root cause BIS central bankers’ speeches of the challenges Japan’s economy faces and take the most appropriate action to address them, no matter how long this may take. On December 7, 2010, the Bank carried out the second new loan disbursement under the fund-provisioning measure to support strengthening the foundations for economic growth, so that the amount of loans disbursed now totals about 1.5 trillion yen. Individual investments and loans under the measure cover a broad range of fields, with financial institutions making a variety of efforts reflecting the particular customer base and/or region they serve. I feel these are extremely encouraging signs and that such efforts are a vital step toward overcoming the challenges the economy faces. The Bank, as the central bank, is determined to offer support as broadly as possible for the efforts that private financial institutions are making on their own initiative toward strengthening the foundations for economic growth. BIS central bankers’ speeches
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Symposium co-hosted by the University of Tokyo and the Development Bank of Japan, Tokyo, 10 December 2010.
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Hirohide Yamaguchi: Challenges for Japan’s financial system after the financial crisis Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Symposium co-hosted by the University of Tokyo and the Development Bank of Japan, Tokyo, 10 December 2010. * * * Introduction It is my great honor to have an opportunity to speak at a symposium co-hosted by the Center for Advanced Research in Finance, the University of Tokyo, and the Research Institute of Capital Formation, Development Bank of Japan. While the global financial crisis that erupted about two years ago, triggered by the failure of Lehman Brothers has not been completely over, the situation has significantly improved. Progress has also been made in establishing an international framework for preventing the recurrence of the recent global crisis in the future. Meanwhile, Japan’s Financial System has been relatively stable, compared with that in the United States and Europe, but some challenges have become clear as the effects of the crisis reached here in various forms. In those circumstances, it is indeed topical to discuss today how the future of Japan’s financial system should be, and I am looking forward to the discussions by the experts. For my part, I will briefly review the financial crisis and talk about the future of Japan’s financial system and challenges for Japanese financial institutions. I. Global financial crisis and Japan’s financial system A. The international financial system after the Lehman Shock These two years following the failure of Lehman Brothers have been indeed a tumultuous period for the global economy and the international financial system. Following the failure of Lehman Brothers, a financial crisis erupted on a global scale, and the global economy deteriorated simultaneously and rapidly. Subsequently, due to the effects of exhaustive policy responses by the governments and central banks, the global economy gradually started to recover around the spring of 2009 and profits and funding conditions of major U.S. and European financial institutions improved significantly. However, against a backdrop of European fiscal problems including those in Greece and Ireland as well as heightened uncertainty about the future of the U.S. economy, there have been phases in which financial markets have become unstable again since the spring of 2010. In the United States and Europe, amid continued balance sheet adjustments, bank lending has been sluggish and credit costs have been somewhat at high levels. The international financial system is still in a fragile state. B. Effects on Japan’s financial system Looking at the impact of the global financial crisis on Japan’s financial system, there was relatively a large decline in the functioning of CP and corporate bond markets. On the other hand, the direct impact on financial institutions central to Japan’s financial intermediation remained relatively small, compared with that on U.S. and European financial institutions, and the stability of the financial system as a whole was maintained. Three reasons can be pointed out. First, and probably the major reason, was that Japanese financial institutions had been generally cautious about taking risks based on the experience of the financial crisis since the BIS central bankers’ speeches 1990s. Specifically, their investments in complex financial products such as collateralized debt obligation had been low and they had not adopted, unlike major U.S. and European financial institutions, the originate-to-distribute business model in a full-fledged manner. Second, in terms of incentive, there was relatively low pressure from shareholders who pursued short-term returns and the remuneration system of financial institutions’ managers was also not conducive to short-term risk-taking activity. Third, as a result of the efforts by the public authorities to enhance the robustness of the financial system, including an establishment of a resolution framework for financial institutions, concern about the surfacing of systemic risk did not heighten among depositors and market participants. Nevertheless, the global financial crisis has also affected Japan’s economy in various forms such as a deterioration in economic activity, a fall in stock prices, and a decline in market functioning. Japanese financial institutions have also been hit accordingly in the form of impairment due to a decline in stock prices and of an increase in credit costs. In the meantime, the challenges Japanese financial institutions have been faced with, such as the weakness of core profitability and vulnerability against stock price fluctuations, have been highlighted again. I will come back to the details later. II. Prospects for Japan’s financial system A. Changing environment surrounding Japan’s financial system The topic of today’s panel discussion is “Whither the Financial System?” It is quite a difficult question, but in the hope of providing some reference to the discussion, I offer some consideration of how Japan’s financial system should be after the financial crisis both from macro and micro perspectives. As it might be useful to consider first what changes are expected in the environment surrounding Japan’s financial system in the future, let me start with the following three points. Strengthening of global regulation and supervision First, financial regulation and supervision will be strengthened on a global basis. On regulations, vigorous discussions are ongoing internationally, and the issues covered are quite wide, ranging from banks’ capital adequacy and liquidity, leverage, remuneration, and accounting. In terms of supervision, the scope will be widened mainly to cover those which have not been taken up sufficiently in the past, such as the so-called shadow banking system. Let me talk about some recent developments. For example, in terms of banks’ capital, an internationally common new regulatory framework, namely, Basel III, has recently been agreed on. Both the quality and the quantity of bank’s capital will be enhanced, albeit gradually, through increasing the ratios of common equities and Tier I that have a high loss absorbing capacity at the time of bankruptcy. Like the so-called “Volcker Rule” in the United States, there are also moves to directly regulate banks’ high risk businesses such as proprietary trading and investment in hedge funds. Through next year, the issue of moral hazard associated with systemically important financial institutions (SIFIs), namely, the “too-big-to-fail problem,” is expected to be discussed, including how to specify SIFIs and what responses will be necessary in preventing the failure of the specified SIFIs or in minimizing the impact once they fail. If I can offer my opinion on that issue, given the essence of the issue of avoiding moral hazard, it would be desirable to take a flexible approach. Namely, in accordance with the situation in each country, appropriate responses should be chosen from various options including not only a bank capital surcharge but also a liquidity surcharge and strengthening of supervision, and establishment of a resolution framework. BIS central bankers’ speeches Increase in new demand for funds Second, as the contents of demand for funds financial institutions are faced with at home and abroad change, there is a possibility that new demand for funds will increase. For example, emerging economies are expected to continue to be the driving force of the global economy, and thus fund demand for improving infrastructure and for firms’ business fixed investment as well as for asset management associated with an accumulation of personal financial assets in those economies, is expected to further increase. Turning to the domestic areas, in the process of firms exploring new growth strategies and rebuilding the supply system for goods and services, there could be new fund demand for research and development as well as business relocation. Moreover, as the industrial structure is expected to change further, there will be increased importance of fund demand associated with corporate rehabilitation and realignment such as M&A finance and DIP finance and of fund demand from emerging companies that challenge new areas. Moreover, needs for asset management mainly by elderly people are expected to diversify and increase. Changes in business models for globally active major financial institutions Third, business models of globally active major financial institutions might change. Specifically, the originate-to-distribute business model that had been actively used prior to the crisis will relatively decrease in number and the proportion of commercial banking business that put more emphasis on the relationship with customers is likely to increase: that is called “back to basics.” Moreover, as business regulations such as the Volcker Rule will be implemented and regulation and supervision will be reviewed in order to restrain “too-big-tofail,” it is likely that the moves toward mere scale expansion and toward excessive risk-taking will be restrained. In terms of funding, as awareness about liquidity risk heightened considerably through the experience of the financial crisis, more emphasis would be put on retail deposits, which have more stability than short-term wholesale funding such as repo transactions. Such changes in business models of globally active major financial institutions could have an impact on the business models and the competitiveness of Japanese financial institutions. B. Future of Japan’s financial system: macro perspective I will next touch on how Japan’s financial system should be in the future from a macro perspective, namely, a perspective of financial system structure. Needless to say again, Japan’s financial system has long been characterized by financial intermediation centering on banks. In this situation, from a perspective of improving the functioning and stability of the financial system, many have argued as follows. It is desirable to have not only bank-based financial intermediation but also financial intermediation through the capital market, inclusive of the so-called market-based financial intermediation. To that end, it will be necessary to increase the supply of risk money and eventually enhance the diversification of households’ asset investment. In fact, many policy measures have been taken to bolster such moves, including enhancement in market infrastructure, improvement in market transparency, and investor protection. If we revisit the discussions based on the experience of the recent crisis, it can be summarized as follows. First, the complementarity of functioning between banks and capital market is important. While the functioning of corporate bond and CP markets declined significantly in Japan during the crisis, bank lending substituted the financial intermediation function during such phase and underpinned the rapidly deteriorating firms’ funding. Subsequently, when the functioning of the capital market was restored, bank lending started to decline. Therefore, it became clear again that the existence of multiple financial intermediation channels is important for the availability of firms’ funding and the robustness of the financial system. BIS central bankers’ speeches Second, the existence of multiple financial intermediation channels alone would not be sufficient to ensure financial system stability. Former Federal Reserve Board Chairman Greenspan once pointed out that one reason for Japan’s protracted crisis was that its financial intermediation was concentrated on banks, and the financial system like that in the United States, which has a variety of financial intermediation channels, would be more robust against shocks to the financial system and the real economy. However, the fact that the crisis deepened in the United States implies that such view is not necessarily correct. What is important is that each financial system participant maintains business soundness and pursues solid risk management, and, at the same time, that the regulatory and supervisory authorities and central banks recognize where the risks lie in the financial system as a whole from a macro perspective and take proper responses. Namely, I believe it is critical for financial system stability to maintain not only the robustness of the financial system structure but also self discipline of financial system participants and the risk capturing capability of the authorities at a high level as a whole. C. Challenges for Japanese financial institutions: micro perspective I will next talk about two specific challenges for Japanese financial institutions. I will touch on the challenges for the authorities in the final part of my speech. Selecting business models and sustained improvement in profitability The first and the biggest challenge for Japanese financial institutions is to raise their profitability in a sustained manner. Looking at the recent business performance of Japanese financial institutions, core profitability has been trending down due partly to a narrowing profit margin and declining lending outstanding. For that reason, an increase in profitability is an imminent challenge. In doing so, while it applies to every industry, it is essential to choose the optimal business model that utilizes an institution’s respective realms of expertise. As I have mentioned earlier, competition in commercial banking business, in which Japanese financial institutions are mainly engaged, is expected to intensify at home and abroad. Japanese financial institutions that receive domestic stable personal deposits have an advantage, including funding for overseas activities, in terms of resilience against liquidity risk. Moreover, a characteristic of Japanese financial institutions that traditionally put emphasis on the customer relationship is an important element in terms of “information production,” which is a key to conducting lending business, and could serve positively for businesses not only in Japan but also in overseas including Asian countries. Furthermore, Japanese firms and households, which are the main customers of Japanese financial institutions, are not in need of balance sheet adjustments like those in the United States and Europe. Therefore, in terms of the competitiveness of Japanese financial institutions compared with that of the U.S. and European financial institutions, I believe there is nothing to be pessimistic. With that recognition, what is necessary for Japanese financial institutions is, at first, to hone their skills in identifying firms with growth potential and continue to strive to find new borrowers and also tap new fund demand from the existing borrowers. While a fundamental problem Japan’s economy is faced with is a decline in medium- to long-term growth expectations, to overcome such problem, it is important that private firms promote their innovative activities and pursue a new source of growth at home and abroad. It is essential that financial institutions also firmly support such moves. In that regard, looking at the recent efforts by Japanese financial institutions, there have been proactive developments to utilize their respective characteristics, which is quite assuring. The major banks have been further expanding their businesses in Asian and other emerging economies regardless of customers’ nationality, and the regional banks have been making efforts to tap growth areas in the regions, including distinct local firms. I hope that Japanese financial institutions will establish their respective business models and pursue proactive efforts including tapping new fund BIS central bankers’ speeches demand, while skillfully gauging various changes in the business environment at home and abroad. Second, it is also important to raise the core profitability of the existing borrowing firms through enhancing their governance. It has often been said in Japan that corporate governance that raises a firm’s profitability has been weak. There are many views that, one way to overcome such weakness is to use equity funds, which have a strong tendency to search for yields, as leverage to strengthen corporate governance from outside. Financial institutions can play a significant role in that regard by being involved in creating investment funds. Moreover, the role of a financial institution as a lender is also not insignificant. Many Japanese financial institutions appear to have been relying too much on real estate collateral and personal guarantees when providing loans especially to medium and small firms, and governance after loan provision has not necessarily been sufficient. Financial institutions are required to bolster firms’ growth constantly through deepening the ongoing relationship with them. In complementing such support, lending that uses movable assets, such as inventories, or accounts receivables as collateral – the so-called asset-based lending – or that utilizes covenants for medium and small firms can be useful options. Third, it is intrinsically important for financial institutions to play a role in encouraging metabolism, for example, corporate realignment. At the same time, it is also important that financial institutions also aim at metabolizing themselves through mergers, consolidation, or unbundling, in accordance with their own business models. For example, financial institutions that aim to be globally active could pursue the advantage of scale or scope through mergers and acquisitions. By contrast, for financial institutions that aspire to enhance their presence in niche markets, limiting functions and concentrating resources could be an important option. Those financial institutions’ behavior is expected to not only improve management efficiency of individual financial institutions through increased competitiveness but also lead to increased profitability of the financial sector as a whole through efficient resource reallocation. Proper risk management The second challenge for Japanese financial institutions is proper risk management. In that regard, there is an increasing awareness among financial institutions, including those overseas, of the importance of the following: to gauge risk comprehensively, for example, by way of stress testing, without relying too much on specific quantitative methods such as VaR, and to share the recognition of risks not only in the risk management section but also including top management. In addition to such general challenge, a reduction in market risk associated with stockholdings, in particular, would be a specific challenge for the future. As for market risk associated with stockholdings, many Japanese financial institutions have recognized the magnitude of price volatility associated with stockholdings and have been taking steps to reduce such risk as a management priority. Nevertheless, the pace of reduction in stockholdings has somewhat slowed recently due partly to sluggish stock prices and thus the due amount of market risk associated with stockholdings still remains. Of course, stockholdings could have implications as a part of corporate governance or could play a role as a tool to gain total profits including fee revenues. Even in those cases, however, it is important to firmly identify the risks and returns. On that basis, if it is judged that the risk is larger, financial institutions are required to steadily promote efforts toward the reduction of their stockholdings. Concluding remarks While I have been talking about the challenges for Japanese financial institutions, the recent crisis left various lessons for the regulatory and supervisory authorities as well as central banks. In relation to ensuring financial system stability, one lesson might be that “it is important to gauge with a sharp distinction between micro-level risks, such as risks of individual financial institutions, and risks of the financial system as a whole.” By taking that BIS central bankers’ speeches point into account, the importance of the so-called macroprudence – which aims at accurately gauging the risks of the financial system as a whole, with due recognition of the relationship between economic activity, financial markets, and financial institutions, and taking necessary policy responses – has been increasingly recognized on a global basis. In that regard, the Bank of Japan has been, from a standpoint of conducting monetary policy, monitoring a wide range of economic and financial developments at home and abroad and making in-depth research and analyses, as well as striving to improve infrastructure, including financial markets and the payment and settlement system. In addition, the Bank has been gauging business conditions of individual financial institutions through on-site bank examination and off-site monitoring, and information and perspectives obtained through such processes have been utilized in gauging the condition of the financial system as a whole and in risk analyses, and published in the Financial System Report. Also, the Bank took measures such as purchases of banks’ stockholdings and provision of subordinated loans aiming at ensuring the stability of the financial system as a whole. The Bank has thus been making various efforts on the macroprudence front. Nevertheless, such efforts are only half done. For example, gauging macro risks is still not sufficient. From a viewpoint of strengthening macroprudential analysis, the Bank has been trying in the Financial System Report to broaden analyses to businesses other than banks, for example, insurance companies, to gauge macro financial imbalances, and to expand stress testing, but those efforts still remain at a stage of trial and error. In addition, the Bank is aware that, even if the macro risk is properly gauged, it still remains as a future challenge to examine what specific policy measures would be desirable to address the risk. The Bank will, including the responses to the challenges I have mentioned, continue with the efforts to ensure stability of the financial system. BIS central bankers’ speeches
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the 2011 American Economic Association Annual Meeting, panel "The Future of Monetary Policy", Denver, 7 January 2011.
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Kiyohiko G Nishimura: This time may truly be different – balance sheet adjustment under population ageing Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the 2011 American Economic Association Annual Meeting, panel “The Future of Monetary Policy”, Denver, 7 January 2011. * 1. * * Introduction: population ageing This panel’s topic “The Future of Monetary Policy” is doubly opportune. Firstly, more than two years have past since the immediate fallout of the Lehman Brothers’ collapse, giving us time both to look back and to look forward. Secondly, we are not yet out of the woods and are still in the process of soul-searching; pursuing a better understanding of our economic environment and the appropriate monetary policy responses. In this presentation, I will give a perspective that may be different from other panelists: longer-run, more qualitative than quantitative. Specifically, to contemplate the future, I start from the fact that we are in the midst of a balance sheet adjustment process after the financial bubble burst, at a time when the population is ageing. This is not the simple balance sheet adjustment of the past, which took place with a growing young population. This is an acute balance sheet adjustment when the composition of the nation’s population is rapidly tilting toward the old. This is unprecedented in our modern history of economic growth. This ageing population is the result of people’s choices made many years ago when, after the Second World War, birth control became possible and substantial medical improvements were reducing child mortality and increasing longevity. These medical advances and the baby boom after the war, together with longer life expectancy, are true blessings for economic growth, bringing what are often called population dividends, with many young workers producing and few old people being supported. However, at some point in time, the trend had to be reversed. The significant point for us here is that the bubble we have experienced has coincided closely with the turning point in these demographic dynamics. Population ageing: inverse dependency ratio Let me show you some telling figures on the inverse dependency ratio, which indicates how many people of working age it takes to provide for one dependent person. The Japanese ratio peaked around 1990, and it was in the very next year, 1991, that the Japanese Bubble peaked. The peak of the US ratio was between 2005 and 2010, and the peak of the US Subprime Bubble was 2007 (Fig. 1.1). The economically troubled countries of the eurozone have a similar pattern to Japan and the United States. The ratios for Greece, Portugal and Spain have almost the same time profile, and all of them peaked around 2000–2005. The peak of the Spanish property boom was just after the ratio’s peak, and the Financial problems of Greece also started at the same time. A particularly interesting case is Ireland, which showed a sharp rise in the ratio until around 2005. The bust of the country’s property market bubble was just a few years around the corner (Fig. 1.2). Incidentally, for the sake of completeness, I have included the figures for China (Fig. 1.3), whose ratio seems still to be rising rapidly, but will peak a bit later than in Euro-American countries. The peak will be around 2010–15, after which it will go down as rapidly as it is now going up. The inverse dependency ratios of many other Asian countries have a quite similar time profile to that of China. I am not suggesting any causality here, but simply pointing out the balance sheet adjustments after the bubble burst in Japan, United States and the eurozone, whether private BIS central bankers’ speeches or public, must be carried out as the population is ageing. I believe this fact has an important bearing on the future of monetary policy, especially unconventional monetary policy. In Section 2, I first examine the process of balance sheet adjustment after the bursting of a bubble and when the population is ageing, juxtaposing Japan in the 1990s and the United States in the 2000s. Then, in Section 3, I summarize the consequences of severe, prolonged balance sheet adjustment, as seen in Japan in the 2000s. Finally in Section 4, I identify the multi-faceted challenges central banks may face as a consequence of carrying out balance sheet adjustments under population ageing, and I explain the Bank of Japan’s policies to tackle these problems. 2. Balance sheet adjustment and the breakdown of the transmission mechanism Who leveraged during the bubble period? Japan and the United Sates In order to find out the effect of balance sheet adjustments after the bursting of a bubble, let me first clarify who leveraged during the bubble periods. In Japan, it was the corporate sector, especially small to medium-sized firms, which for the first time gained access to large banks after the so-called financial liberalization (Fig. 2.1). The corporate sector’s loan-toGDP ratio increased by 29 percentage points in the ten years before the Bubble burst in 1991. In the United States, it was the household sector that leveraged, especially in housing. The household sector’s housing loans-to-disposable income ratio jumped by 39 percentage points in the ten years before the bubble burst in 2007. Breakdown of the monetary transmission mechanism These sectors were interest-sensitive and thus constituted the “transmission gears” of the ordinary monetary transmission mechanism in the periods before the bubbles burst. That is, these leveraged sectors had been sensitive to policy rate reduction in business cycles. However, after the bubbles burst, these leveraged sectors became insensitive to policy rate reduction, because of the acute balance sheet adjustments. Large legacy shortfalls must be compensated for by current profit or income, period by period, and this process is slow and painful. This leads to a breakdown in the ordinary monetary transmission mechanism of policy rate change. To see this, let me first consider corporate investment in Japan. Figure 3.1 depicts manufacturing investment by the corporate sector. The shaded areas indicate recession, the black line is manufacturing investment in real terms, and the blue line shows the time profile of the policy rate. This figure shows that the policy rate cut prevented investment from falling sizably in the three business cycles before the bubble. In contrast, after the bubble burst, a sharp decline in the policy rate clearly failed to prevent a sharp decline in investment. Basically, the same picture is found in the corporate sector’s non-manufacturing investment (Fig. 3.2). In the United States, the household sector is the leveraged sector. Its most interest-sensitive demand components are demand for new homes and new automobiles. In Figure 3.3, again, the shaded areas depict recession, the black line is new home sales, and the blue line is the federal fund target rate. This figure shows that policy rate cuts at least prevented new home sales from falling further, and that they helped sales to pick up in the three business cycles before the bubble. However, a sharp decline in the policy rate after the bubble burst failed to prevent a sharp decline in new home sales. Qualitatively quite similar observations apply to new automotive sales (Fig. 3.4). BIS central bankers’ speeches Ageing population and property prices As suggested in the Introduction, Japan was faced with a rapidly ageing population after the bubble burst of 1991, while the United States is about to face its own version with a somewhat milder population ageing. There are many consequences of population ageing, such as differences in consumer preferences and technological adaptability between the young and the old, but I will concentrate on one particular issue that is pertinent to balance sheet adjustments, namely, the possible effects of population ageing on property prices. In Figure 4.1, the real land price (national average, for all purposes) is juxtaposed with the inverse dependency ratio from 1955 to date. This figure shows, firstly, that the relative abundance of young people coincided with sharply higher property prices. Secondly, in contrast, the relative abundance of old people seems to be leading to lower property prices. It should be noted here that declining property prices greatly aggravated the balance sheet adjustments of Japanese corporations. The US case is illustrated in Figure 4.2. In the United States also, an increasing reverse dependency ratio seemed to coincide with the property bubble. After the bubble burst of 2007, property prices seem to have followed the long run movement of the inverse dependency ratio, although it would be premature to draw any conclusions from this at the moment. 3. Prolonged balance sheet adjustment under population ageing: consequences What then are the consequences of severe and prolonged balance sheet adjustment under population ageing? Three adverse consequences can be identified. Declining mobility First, mobility declines, or in other words, the economy becomes “inflexible”. Since de-leveraging firms or households have to pay back all their debts before “moving” from their current position, they are often stuck with an “underwater” property. Population ageing strengthens this tendency. In the case of Japan, de-leveraging took place in the corporate sector, and thus firms became less mobile between industries and regions. In the United States, the household sector is de-leveraging, and thus household mobility has been reduced. Figure 5.1 depicts declining entrepreneurial mobility in Japan. This figure shows the creation and destruction of enterprises between pre-bubble (1981–1986), Bubble (1987–1991), and post-bubble (1992–1996). It can be seen in this figure that, after the bubble burst of 1991, creation of enterprises was sharply reduced. In contrast, the increase in the rate of destruction was relatively mild. These two imply a “sticky industry structure,” a tendency to hang on to the past. Declining mobility is found in the household sector in the United States. Figure 5.2 shows changes in the householder mobility rate between 2005 and 2009. A sharp decline is found across all age groups. Since there is no such change in renters, this sharp decline suggests that the housing crash reduced householder mobility rates. Loss of non-tangible/human capital The second consequence of severe and prolonged balance sheet adjustment is the loss of non-tangible or human capital. De-leveraging firms and households suffering long underutilization or under-employment tend to lose their non-tangible or human capital. In Japan, this has been observed especially in small to medium-sized enterprises: loss of entrepreneurship, loss of human networks in skilled manufacturing, and loss of access to technological advances. In the United States, the long-term unemployed or underemployed risk losing their human capital.. BIS central bankers’ speeches Problems in financial intermediation The third consequence of severe and prolonged balance sheet adjustment is the deterioration in financial institutions’ efficient functioning as financial intermediaries. This was most acutely observed in Japan during the several years after the bubble burst: a pile-up of non-performing loans seemed to lead to a breakdown in the “market Selection mechanism” around 1997. Figure 6 shows the result of a large-scale panel analysis of Japanese firms, in which the total factor productivity of exiting and surviving firms is compared. Survival of the fittest is a basic premise of the natural selection mechanism. Thus, if the market Mechanism works well, the productivity of successful and surviving firms should be higher than that of failing and hence exiting firms, at least on the average. In this figure, the shaded areas show cases where the productivity of failing and thus exiting firms is higher than that of surviving firms, which is an anomaly. In fact, the shaded areas are rather exceptional most of the time. However, if we look at the period 1996–97, the period of the financial crisis, we see many shaded areas indicating that more productive firms were exiting in many industries. This strongly suggests a breakdown in the natural selection mechanism. Results of acute B/S adjustment under population ageing: Japan in the 2000s So, what are the end results of acute balance sheet adjustment under Population Ageing? Some of these consequences can be seen in the Japanese situation in the 2000s. First, growth prospects declined. The average real GDP growth fell from 5% to 4 % in the 70s and 80s to around 1% in the 90s and 2000s. This implies the expected rate of return on investment in the 2000s is low, especially for small to medium-sized firms depending on domestic demand. In contrast, money (bank deposits) becomes relatively attractive as a store of value, given the price-stability pledge of the central bank. Ironically, this leads to an apparent breakdown of the historically-proven quantity-theoretic relationship between real activity and money stock. Moreover, not only is the policy rate very low, but so too are longer risk-free rates, judged by historical standards. Conventional Monetary Policy through the overnight policy rate is not as effective as before, and this means the economy is more vulnerable to a downside shock. Second, there are signs of coordination failure. Banks’ lending is sluggish, partly because of their inadequate functioning as an expert relationship banker. Here a vicious circle seems to be working. To begin with, banks lack expertise to assess investment in new fields, suffering as they are from problems with non-performing loans and under-investment in their loan officers’ human capital. Consequently banks do not lend. This means that new investments and new enterprises cannot get funding, and thus new markets falter. Then, banks miss the opportunities to accumulate new expertise, bringing them right back to the starting point of this vicious circle. Another coordination failure is found in capital markets, in the form of “excessive” risk aversion. Fearing unknown unknowns, investors shun investing in riskier securities. Their market then becomes thin and vulnerable to non-fundamental shocks. This means they themselves become prone to turning into unknown unknowns, thus the original fear is selffulfilling. These two types of coordination failure in financial markets result in an apparent lack of “animal spirits”. Third, we see a piling-up of government debt. This is partly the result of the substitution of public debt for private debt in the process of balance sheet adjustment, and partly due to the substitution of public demand for private demand during this period of declining growth. According to the OECD’s Economic Outlook, Japan’s General Government Gross Financial Liability-to-GDP Ratio in 2010 was 198%, compared with 93% in the United States. However, BIS central bankers’ speeches it should also be noted that, because of low long-term rates, the Government Net Debt Interest Payments-to-GDP is 1.2% in Japan, compared with 1.7% in the United States. 4. Multi-faceted challenges and unconventional monetary policy The consequences of Japan’s prolonged balance sheet adjustment under Population Ageing described so far lead us to a number of multi-faceted challenges. The first challenge is that of cyclical-stabilization: ensuring a return to sustainable growth with price stability, when the policy rate is near zero and longer-term risk-free rates are also very low. In Japan’s case, this also means overcoming deflationary pressures. The second challenge is to enhance the growth trend, or strengthen the foundations for growth. In other words, the challenge is to raise long-term growth prospects, especially in domestically-oriented growth. This should be done by solving the coordination failure in banking and capital markets described above. The third challenge is to avoid causing problems in national debt management. We should design and execute carefully measures to cope with the first and the second challenge, taking appropriate account of the current national debt situation as explained before, as well as general economic conditions. To tackle the first and the second challenges, the Bank of Japan instituted its Growth Foundation Strengthening Facility (GFSF) in June of last year and adopted Comprehensive Monetary Easing (CME) in October. To meet the challenge of “cyclical-stabilization”, the first part of the CME changed the guidance for the policy rate from 0.1% to the range between 0 and 0.1%, making clear the Bank’s Virtually Zero-Interest Rate Policy (VZIRP). For the second part of the CME, the Bank clarified its policy duration commitment: the Bank will continue its VZIRP until it judges price stability to be in sight on the basis of the Policy Board members’ understanding of price stability. With Policy Board members’ announced forecasts for two years ahead, this is similar to “forecast targeting” though not specific in numbers. The third part of the CME is the Asset Purchase Program, which is also designed to meet the cyclical-stabilization challenge. Its aim is to influence downward longer-term rates. The outright purchase of JGBs with remaining maturity of 1–2 years and T-bills is to reduce the term-premiums of risk-free rates, and the purchase of CPs and Corporate Bonds is to reduce both term-premiums and riskpremiums. The scheme to provide 3-month funds at the overnight rate already instituted was aimed at lowering rates longer than the overnight rate, and has been continued and included in this program. Moreover, the Asset Purchase Program is aimed at breaking another vicious circle in capital markets, that caused by “excessive” risk aversion. In this Asset Purchase Program, the Bank purchases riskier assets than it bought before: BBB-rated corporate bonds, and a-2 CPs. It also purchases ETFs and J-REITs directly from the market. The purchase is designed to act as a catalyst to induce investment in riskier assets, and thus help solving the coordination failure. To tackle the second, “trend-enhancement” challenge, or strengthening growth potential, the Bank instituted its Growth Foundation Strengthening Facility (GFSF) in the form of preferential fund-provisioning to support financial institutions’ own initiatives in lending and investing in new growth areas. It should be made clear here that it is not the Bank of Japan but participating financial institutions that determine which investment projects should be funded using this GFSF. Thus, the GFSF is designed to be a catalyst to induce banks to find new firms or new investment projects in their perceived growth areas. In this way, the GFSF is targeted at breaking the vicious circle of no lending resulting in no new markets and thus no demand for lending to start with. BIS central bankers’ speeches When implementing these measures to cope with cyclical-stability and trend-enhancing challenges, it is very important to take appropriate account of the third challenge, that of avoiding causing problems in national debt management. Specifically, it is crucial to avoid creating an impression of the “monetization” of government debts. Otherwise, the large scale purchase of JGBs may lead to a substantial and lasting ratcheting up of long-term rates, which would pose a serious problem for economic recovery and the financial position of the government. Taking this point into consideration, the Bank of Japan has already purchased about 22 trillion yen in JGBs annually, beside the Asset Purchase Program. By the same token, we should be very careful about the possibility that asset purchases may lead to capital losses, which could tarnish the credibility of the central bank. In the bubble years, we often heard talk of this being the beginning of a new age of prosperity and that, as the title of the popular book says, “this time is different”. Since the bubble burst, people have tended to think the collapse was simply a fleeting nightmare and that we will eventually be back to the old normal, just as before. That may be true. However, if we recognize the problems arising from acute balance sheet adjustments when the population is ageing, there is the distinct possibility that this time may truly be different. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Summary of a speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Saitama, 9 December 2010.
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Yoshihisa Morimoto: Economic activity and prices in Japan and monetary policy Summary of a speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Saitama, 9 December 2010. * I. * * The global economy Economic activity in Japan is closely linked to global economic developments. Therefore, before discussing the Japanese economy, I will first take a look at trends in the world economy. From around 2005, the world economy grew at a rapid pace of around 5 percent annually, with China and other emerging economies gaining in prominence. The failure of Lehman Brothers in September 2008, however, brought this growth to a sudden halt, and the world economy marked negative growth in 2009 due to the severe contraction in the first half of the year. Causes of the sharp decline include the rapid deceleration in economic and financial activity due to the financial crisis triggered by the Lehman shock, and the corrections to the various excesses that had built up in the world economy since the mid-2000s. By “excesses,” I am referring to overborrowing by households, excess production capacity in the corporate sector, and the large amount of nonperforming loans held by financial institutions. Measures to address the financial crisis implemented by governments and central banks around the world started to show effects from the second half of 2009. With the contraction in economic and financial activity having come to a halt, policy measures to stimulate demand provided a further boost. It should be noted, however, that the pace of economic growth has been slowing somewhat since summer 2010, as restocking of inventories that took place during the recovery phase came to an end and the effects of demand-boosting measures in the United States and other countries waned. The slowdown is also due in part to the unwinding of accommodative policies in emerging countries in order to keep economies from overheating. A. Advanced economies Let us look at advanced economies in more detail. The U.S. economy remains on a moderate uptrend. Although the effects of fiscal stimulus measures have been waning, exports to emerging and commodity-exporting economies have continued to increase and private consumption and business fixed investment have been rising moderately. Housing starts have remained at a depressed level after dropping sharply due to the expiry of tax credits for homebuyers, but are unlikely to fall further. As for the outlook, the U.S. economy is likely to continue recovering on the back of increasing exports and accommodative monetary policy. It must be added, however, that in the labor market employment conditions have not improved greatly, with unemployment, for example, remaining at a high level. Consequently, balance-sheet adjustments in the household sector – that is, the restoration of financial health, including the repayment of household debt – are unlikely to gather pace, so that the pace of recovery is likely to remain moderate. Economic activity in the euro area as a whole has been recovering moderately, with some differences in growth by country: Germany has performed strongly while other countries have lagged behind. Although the pace has been slowing, exports and production have continued to increase, while domestic demand components, such as private consumption, have been rising from the previous quarter. For the present, the euro area is likely to continue recovering moderately. However, attention needs to be paid to the effects of fiscal BIS central bankers’ speeches consolidation, which from next year will start in earnest also in the major economies, and to volatility in financial markets due to concerns over the public and private debt problems in some of the peripheral countries. B. Emerging and commodity-exporting economies Although emerging and commodity-exporting economies are often grouped together, they are a diverse group. Here, I will focus on the major East Asian economies, since they are most relevant to Japan. First, the Chinese economy has continued to show high growth of around 10 percent. Although the pace of increase in exports has been slowing due to a deceleration in overseas economies such as the United States, domestic demand, as indicated by retail sales and investment in fixed assets, has continued to show high growth. Like China, South Korea, Taiwan, Thailand, and other NIEs and ASEAN countries also experienced continued economic growth driven by domestic demand, although inventory adjustments in IT-related goods are casting a shadow on the outlook for exports. Overall, it is very likely that emerging and commodity-exporting economies will continue to show relatively high growth due to robust domestic demand and capital inflows from overseas. The pace of growth of the Chinese economy is likely to decelerate somewhat due, among other things, to government measures to restrain the increase in real estate transactions. However, given the continuing increase in private consumption, growth is nevertheless likely to remain relatively high. Economic conditions in the NIEs and ASEAN countries are expected to follow a recovery trend due to the inflow of overseas capital and increases in private consumption and business fixed investment. II. The Japanese economy Based on the above assessment of the world economy, I will now talk about economic activity and prices in Japan. Semiannually, in April and October, the Bank of Japan releases the Outlook for Economic Activity and Prices, known as the Outlook Report, in which it makes public its forecasts for economic activity and prices for the next two to three years, the background for its forecasts, and the associated risk factors. My speech today will from time to time refer to this report, in particular the October 2010 Outlook Report. A. Economic activity Real GDP growth for the July–September quarter of 2010 was relatively strong. Recent developments in production, however, indicate that the economic recovery seems to be pausing. The pause in the recovery can be attributed to various factors, including a decrease in demand following the last-minute rise in demand ahead of the expiration of subsidies for purchasers of environmentally friendly cars and the boost from the extremely hot weather, the deceleration in overseas economies, and inventory adjustments in IT-related goods. Looking at the situation for each demand component, real exports as a whole have recently been more or less flat, reflecting the following factors: (1) the effects of inventory adjustments in IT-related goods such as semiconductors in South Korea and Taiwan; (2) the deceleration in the U.S. economy; (3) the unwinding of accommodative monetary policies in emerging economies; and (4) the effects of the strong yen on exports of cars and other goods. However, given the strong domestic demand in emerging economies, Japan’s exports are unlikely to fall precipitously and are likely to recover in the longer term, providing support to the economy overall. Furthermore, production, which is likely to remain lackluster for a while due to the reasons mentioned above, is expected to gradually return to a moderate upward trend along with the recovery in exports. The Bank maintained its assessment of business fixed investment as “showing signs of picking up.” This rather cautious assessment, despite the fact that business fixed investment BIS central bankers’ speeches this fiscal year is likely to turn out to be higher than in the previous year, reflects the following: (1) the fact that firms continue to feel that their capital stock is still excessive; (2) the shift of production to overseas locations; (3) the deceleration in overseas economies; and (4) the appreciation of the yen. Yet, I frequently hear that there is considerable pent-up need for replacement investment and investment in environmentally friendly equipment, given that firms have held back on such investment since the collapse of Lehman Brothers. Barring any extreme external shocks, the pick-up in business fixed investment is therefore expected to gradually become more pronounced as a result of the improvement in corporate profits. Turning to the household sector, private consumption in the July–September quarter of 2010 was supported by the last-minute rise in demand ahead of the expiration of subsidies for purchases of environmentally friendly cars and the increase in the tobacco tax, in addition to the boost from the extremely hot weather. There was a clear decrease in sales of cars, with the exception of small cars with engine sizes of 660 cc or less, which in October and November were sharply down, by approximately 30 percent, from the same period a year earlier. I earlier mentioned some factors behind the current “pause” in the economic recovery. Among them, I have been most concerned about the drop in car sales because of the wide range of firms and industries encompassed by the automotive sector. With the drop in car sales having become a reality, the question now is the depth and length of the decline. Demand for cars has been brought forward for a year and half since the introduction of subsidies in April 2009, so the decline in car sales is likely to continue. That being said, though, one would expect the negative impact on the economy to be greatest immediately after the expiration of subsidies and to subsequently ease gradually. Therefore, private consumption is expected to gradually recover. Obviously, the timing of a full-fledged recovery of private consumption is not clear, since the employment and income situation is expected to remain severe. Developments in this area, together with housing investment, which has been recovering gradually, warrant a close watch. Against this background, if overseas economies, led by emerging and commodity-exporting economies, were to register higher growth, this would increase the likelihood of Japan’s economy returning to a recovery path fueled by an increase in exports. The October 2010 Outlook Report paints such a scenario for fiscal 2011 onward. The report also said that in “fiscal 2012, Japan’s economy is expected to continue growing at a pace above its potential, as the transmission mechanism by which the strength in exports and production feeds through into income and spending will likely operate more effectively amid the continued relatively high growth in overseas economies, especially emerging and commodity-exporting economies.” Although this is subject to a considerable margin of error, the Bank estimates that Japan’s potential growth rate during the projection period is around 0.5 percent. B. Prices Domestic corporate goods prices are expected to remain on a moderate uptrend for the time being, mainly due to the uptick in international commodity prices. The decline in the consumer price index (CPI; excluding fresh food) on a year-on-year basis is decelerating and is expected to continue decelerating as a trend as the aggregate supply and demand balance gradually improves. As stated in the projection in the Outlook Report for the period ending in fiscal 2012, it will take considerable time for the supply and demand balance to improve because the drop in demand after the financial crisis was considerable and the pace of economic recovery has been moderate. Therefore, the deceleration in the decline in the CPI on a year-on-year basis is likely to remain moderate and it will likely take until sometime in fiscal 2011 for the year-onyear rate of change in the CPI to enter positive territory. Thereafter, the rate of increase is expected to start rising through fiscal 2012. BIS central bankers’ speeches III. Risks to the outlook The above outlook for economic activity and prices suggests that the Japanese economy will be able to overcome deflation and return to a sustainable growth path with price stability, although it will take time. However, there are various upside and downside risks to economic activity and prices. A. Risks to economic activity In the October 2010 Outlook Report, the Bank listed the following as risk factors concerning the outlook for economic activity: (1) developments in advanced economies; (2) developments in emerging and commodity-exporting countries; (3) developments in business and household sentiment; and (4) firms’ medium- to long-term growth expectations. Regarding the first risk, economies burdened with balance-sheet adjustments, such as the United States, are unlikely to achieve strong growth and will remain prone to weakness until the adjustments are completed. U.S. household debt relative to income remains high. In Europe, financial markets remain volatile, as indicated by the recent surge in yields on Irish government bonds. Furthermore, the amount outstanding of public debt has increased considerably due to the implementation of vigorous fiscal policies. The implementation of fiscal consolidation measures, which will proceed further, might exert greater-than-expected downward pressure on individual economies and the global economy. Emerging and commodity-exporting economies are likely to maintain relatively high growth led by domestic demand, and in this situation the continued large-scale monetary easing in advanced economies might accelerate capital inflows to emerging and commodity-exporting economies. Stock and housing prices in these economies have been rising already. If economic conditions in these economies are boosted further, Japan’s economy could realize stronger-than-expected growth through the increase in exports to these economies. On the other hand, if economic and financial activity in these economies becomes excessive, there is a risk that this could, in the longer term, lead to a sharp reversal. Therefore, whether emerging and commodity-exporting economies will be able to achieve a soft landing and return to a sustainable growth path is an issue that warrants careful attention. A domestic issue that warrants attention is the possibility that fluctuations in business and household sentiment might affect economic activity. For example, the appreciation of the yen may on the one hand encourage mergers and acquisitions abroad – a positive development – but on the other it is also likely to exert downward pressure on the profits of exporters and might damage economic activity if this were to hurt business confidence and lead firms to change their behavior. A final point concerns firms’ medium- to long-term growth expectations. If firms are able to capture infrastructure and consumption demand in emerging and commodity-exporting economies, this would increase the possibility that economic activity will be stronger than projected. On the other hand, if firms’ growth expectations continue to shift downward, there is a risk that business fixed investment and private consumption could decrease more than expected. I believe that the risks to either side are equally important and that at present the upside and downside risks are broadly balanced. However, I will continue to carefully monitor developments concerning these risks. B. Risks to prices Risks to prices, in addition to the above four risk factors affecting economic activity, include a possible decline in firms’ and households’ medium- to long-term inflation expectations. If the pace of recovery in resource utilization of labor and production capacity remains moderate, firms and households might expect prices to fall, which in turn could affect actual prices. BIS central bankers’ speeches Other risks to prices that require careful observation include the high uncertainty in gauging the aggregate supply and demand balance and its impact on prices, as well as price changes due to fluctuations in international commodity prices and foreign exchange rates. IV. Monetary policy Let me now turn to the Bank’s conduct of monetary policy. The Bank recognizes that Japan’s economy is faced with the extremely important challenge of emerging from deflation and returning to a sustainable growth path with price stability. Based on this recognition, the Bank has been doing its utmost as the central bank, using a three-pronged approach consisting of (1) strong monetary easing, (2) ensuring stability in financial markets, and (3) providing support to strengthen the foundations for economic growth. Today, I would like to explain the Bank’s pursuit of strong easing through comprehensive monetary easing and the support for strengthening the foundations for economic growth to address the medium- to long-term issues faced by the Japanese economy. A. Pursuing strong monetary easing: the comprehensive monetary easing policy With regard to its pursuit of strong monetary easing, the Bank has reduced its policy interest rate twice since the Lehman shock and, by increasing longer-term funds provision to financial institutions through new funds-supplying operations, the Bank has been influencing directly longer-term interest rates such as 3-month and 6-month rates. As a result, market interest rates have been stable at extremely low levels and firms’ funding costs have been declining. However, at the Monetary Policy Meeting held on October 4 and 5, 2010, it was judged that the economic growth rate was likely to be somewhat lower than the projection presented in the July 2010 interim assessment, reflecting the slowdown in the U.S. economy since summer 2010 and the effect of the appreciation of the yen on business sentiment. It was also agreed at the meeting that, in view of the downside risks to the economic outlook, it had become more likely that the return of Japan’s economy to a sustainable growth path would be delayed compared to what had been projected earlier. In this context, what particularly caught my attention was the results of the September 2010 Tankan (Short-Term Economic Survey of Enterprises in Japan) released by the Bank. Although I had anticipated that firms’ view of future business conditions had deteriorated to some extent due partly to the decrease in demand following the expiry of government measures to boost demand, the extent to which it had deteriorated was larger than I had expected. The Bank has repeatedly stated that it will continue to consistently make contributions as the central bank so that Japan’s economy will overcome deflation and return to a sustainable growth path with price stability. Therefore, the members of the Policy Board, myself included, thought that the time had come for the Bank to express this stance more clearly, examine concrete measures, and take drastic measures. Moreover, it was important to announce these measures as a package rather than piecemeal policies. The purpose of this package is to further enhance monetary easing, and I personally felt that first of all it was important for the Bank to announce a change in the guideline for money market operations and clarify the Bank’s commitment regarding the time horizon based on the “understanding of medium- to long-term price stability” (hereafter the “understanding”). Regarding the change in the guideline for money market operations, the Bank lowered the target for the uncollateralized overnight call rate – the shortest interbank rate – from “at around 0.1 percent” to “at around 0 to 0.1 percent,” thereby clearly indicating that it was pursuing a virtually zero interest rate policy. As for the clarification of its commitment regarding the time horizon based on the “understanding,” Policy Board members agreed that (1) the Bank would maintain the virtually zero interest rate policy until it judged that price stability was in sight, and (2) the “understanding” would be appropriate as the basis for that judgment. The “understanding” is the level of inflation that each of the nine Policy Board members understands as being consistent with price stability over the medium to long term. BIS central bankers’ speeches The “understanding” at present falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board members’ understanding are around 1 percent. In considering policy options the Bank could take, the Bank’s options within the conventional monetary policy framework were limited, given that short-term interest rates – ranging from overnight to longer-term rates – were already at levels that left little room for a further decline. In these circumstances, the Bank decided on the establishment of the Asset Purchase Program (hereafter the Program) as the third measure in the comprehensive monetary easing package. Like other Policy Board members, I felt that the Bank should consider a variety of policy options without precluding measures that are temporary or extraordinary for a central bank, such as directly influencing longer-term rates and expanding the type of financial assets eligible for the Bank’s purchases. The details of the Program are as follows. The Bank established a program on its balance sheet to conduct outright purchases of various financial assets, such as Japanese government bonds (JGBs), CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs), and the fixed-rate funds-supplying operation against pooled collateral. The total amount of the Program will be about 35 trillion yen, consisting of about 5 trillion yen for purchases of financial assets and about 30 trillion yen for the fixed-rate funds-supplying operation against pooled collateral. The Bank has already begun purchasing JGBs and corporate bonds, and the first auction for the purchase of CP is scheduled for tomorrow, December 10, 2010. The Bank also decided to start purchasing ETFs and J-REITs in the near future. As the Bank has been explaining, this is a temporary and extraordinary measure for a central bank. Moreover, the Bank did not adopt this measure lightly, since it entails the critical issue of making sure that the risks involved in holding various risk assets are properly managed in order to ensure the financial health of the central bank of Japan. B. The Bank’s measure to support strengthening the foundations for economic growth Lastly, I will move on to talk about the fund-provisioning measure to support strengthening the foundations for economic growth, which the Bank decided to introduce at the Monetary Policy Meeting held on June 14 and 15, 2010. The measure supplies long-term funds at a low interest rate against eligible collateral to financial institutions in accordance with their efforts in terms of lending and investment toward strengthening the foundations for economic growth. Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. To achieve this, the key, in my view, is to tap potential demand, and both economic entities in the private sector and the authorities need to continue to make steady efforts to this end. The main cause of the current deflation is the negative output gap, which largely reflects a long-term downtrend in the economic growth rate since the 1990s. However, looking again at major trends such as demographic developments and globalization, can we really say that Japan has nothing to gain from these trends? I do not think so. It all depends on one’s perspective. For example, demographic trends can be seen as a shrinking of the total and the working-age population, or they can be seen as an increase in the importance of the elderly. Similarly, global warming is an issue that requires an immediate response, but even more important is a medium- to long-term strategy covering the next 10 or 20 years. Regarding the fund-provisioning measure to support strengthening the foundations for economic growth, Bank of Japan Governor Masaaki Shirakawa has commented that, in addition to providing practical support through the provision of funds, he felt that it was more important to raise awareness of the challenges the economy faces. Having worked in the business world, I feel exactly the same. I believe what is needed is to identify the root cause BIS central bankers’ speeches of the challenges Japan’s economy faces and take the most appropriate action to address them, no matter how long this may take. On December 7, 2010, the Bank carried out the second new loan disbursement under the fund-provisioning measure to support strengthening the foundations for economic growth, so that the amount of loans disbursed now totals about 1.5 trillion yen. Individual investments and loans under the measure cover a broad range of fields, with financial institutions making a variety of efforts reflecting the particular customer base and/or region they serve. I feel these are extremely encouraging signs and that such efforts are a vital step toward overcoming the challenges the economy faces. The Bank, as the central bank, is determined to offer support as broadly as possible for the efforts that private financial institutions are making on their own initiative toward strengthening the foundations for economic growth. BIS central bankers’ speeches
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Speech by Mr Seiji Nakamura, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Fukushima, 25 November 2010.
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Seiji Nakamura: Japan’s monetary policy and developments in economic activity and prices Speech by Mr Seiji Nakamura, Member of the Policy Board of the Bank of Japan, at a meeting with Business Leaders, Fukushima, 25 November 2010. * * I. The outlook report for October 2010 1 A. The outline of the assessment * The Bank of Japan discusses economic activity and prices at the Monetary Policy Meetings (MPMs) held each month. Semiannually, in April and October, it releases the Outlook for Economic Activity and Prices, or the Outlook Report for short, in which the Bank makes public its forecasts for economic activity and prices for the next two to three years. At the MPMs held in July and January, three months after the release of the Outlook Reports, the Policy Board examines possible deviations from the scenario presented in the Outlook Reports. The Bank’s recent assessment of the Japanese economy was that it still showed signs of a moderate recovery, but the recovery seemed to be pausing. The Outlook Report released on October 29, 2010 projected that, in the second half of fiscal 2010, the pace of recovery was likely to slow owing to factors including the slowdown in overseas economies and the ending of the boost from policy measures targeted at durable consumer goods, as well as the recent appreciation of the yen. In fiscal 2011, albeit with some lingering effects of the yen’s appreciation, the economy was expected to return to a moderate recovery path, given that exports were projected to continue increasing as the growth rates of overseas economies were likely to rise again, and that firms’ sense of excessive capital stock and labor was likely to be dispelled gradually as corporate profits improved. In fiscal 2012, the Japanese economy was expected to continue growing at a pace above its potential growth rate, as the transmission mechanism by which the strength in exports and production fed through into income and spending would likely operate more effectively amid the continued relatively high growth in overseas economies, especially emerging and commodity-exporting economies. Forecasts made by the nine members of the Bank’s Policy Board in October were as follows. The median of the forecasts for Japan’s real GDP growth rate was 2.1 percent for fiscal 2010, 1.8 percent for fiscal 2011, and 2.1 percent for fiscal 2012. Figures for fiscal 2010 and fiscal 2011 were revised downward by 0.5 percentage point and 0.1 percentage point, respectively, from the forecasts in July. As for prices, the consumer price index (CPI) for all items excluding fresh food was projected to increase moderately due partly to the narrowing of the negative output gap as the economy picked up gradually and to a moderate rise in commodity prices on the back of the continued relatively strong growth in emerging and commodity-exporting economies. Meanwhile, attention should be paid to the possibility that the recent appreciation of the yen was likely to exert downward pressure on domestic prices by holding down import prices. The median of the forecasts for the year-on-year rate of change in the CPI was minus 0.4 percent for fiscal 2010, plus 0.1 percent for fiscal 2011, and plus 0.6 percent for fiscal 2012. Regarding the above forecasts for economic activity and prices presented in the Bank’s October 2010 Outlook Report, the following risks warrant attention. The fiscal year in Japan starts in April and ends in March. BIS central bankers’ speeches First, if the pace of already robust growth in emerging and commodity-exporting economies accelerates further as a result of strong domestic demand and the continued inflow of risk money from advanced economies pursuing prolonged monetary easing, this may push up economic activity in Japan and result in stronger-than-expected growth. However, such growth could be followed by the unwinding of risk exposure, which may result in larger adjustments in financial and economic activity, thus posing a downside risk to the Japanese economy from a longer-term perspective. Second, with regard to the advanced economies of Europe and the United States, the Bank feels that, overall, uncertainty remains high and risks are tilted to the downside. In the United States, the pace of recovery in the labor market is likely to be only moderate, and households in particular remain burdened by balance-sheet adjustments. Therefore, it will remain difficult for the self-sustaining virtuous circle of growth in production, income, and spending to operate properly. In Europe, there are concerns that, in 2011, the effects of economic stimulus measures could wane with the implementation of fiscal austerity programs. In addition, concerns over the sovereign risk of some European countries might have adverse effects on economic activity through a rise in long-term interest rates and a deterioration in market sentiment. Third, turning to the situation in Japan, if uncertainty about the outlook for overseas economies heightens further and the foreign exchange and stock markets become unstable, this might lower firms’ medium- to long-term growth expectations and lead to a deterioration in household sentiment, and economic activity in turn might be weaker than expected. And fourth, with regard to risks specific to prices, consumer prices in Japan could deviate upward from the projection through higher import prices as a result of a rise in commodity prices caused by booming of emerging and commodity-exporting economies and excessive inflows of risk money into these economies. Let me elaborate on these risks. B. Overseas economies Overseas economies as a whole have been on a moderate recovery trend, with the advanced economies continuing to recover moderately and emerging and commodityexporting economies, despite a slight slowdown, continuing to register relatively high growth. In its October 2010 World Economic Outlook, the International Monetary Fund (IMF) revised its projection for world GDP growth in 2010 to 4.8 percent, up 0.2 percentage point from the July 2010 forecast. For 2011, it expects growth to continue at a relatively high rate of 4.2 percent. Partly due to robust domestic demand and the inflow of risk money from other countries, emerging and commodity-exporting economies, particularly China, have continued to post relatively high growth, becoming the main growth engine for the world economy, accounting for about 70 percent of global GDP growth. However, the overall growth momentum of these economies has started to decelerate, due in part to the unwinding of accommodative monetary policies by authorities in these economies. The Chinese economy continues to show relatively high growth, with the year-on-year rate of GDP growth for the July– September quarter of 2010 marking 9.6 percent, but the rate has slowed from over 10 percent in the first half of 2010, mainly due to the introduction of government measures to rein in real estate transactions. Retail sales recorded high growth of more than 17 percent year on year in October for the ninth consecutive month, and car sales have also been strong. Meanwhile, with the rate of increase in the CPI accelerating for the fourth consecutive month to 4.4 percent in October, the People’s Bank of China has raised the policy interest rate and the reserve requirement ratio. Reflecting partly such policy responses, the Chinese economy may decelerate for the time being but – given the virtuous circle of growth in production, income, and spending – is still likely to continue registering a relatively high pace of growth. BIS central bankers’ speeches The U.S. economy has been recovering moderately and is likely to continue doing so. The real GDP growth rate for the July–September quarter of 2010 was 2.5 percent on an annualized, seasonally adjusted quarter-on-quarter basis, confirming this assessment. Steady growth in exports and private consumption, which accounts for about 70 percent of GDP, was the major factor behind the recovery. There has been other good news with regard to private consumption, such as the recovery in new car sales to a level exceeding 12 million cars on an annualized basis for the first time in 14 months. Nevertheless, activity in the housing market has been sluggish, and there has been little improvement in prices and sales or progress in inventory adjustments. Chairman Ben S. Bernanke of the Federal Reserve Board mentioned in his speech in late October that “now, more than 20 percent of borrowers owe more than their home is worth and an additional 33 percent have equity cushions of 10 percent or less, putting them at risk should house prices decline much further,” and that borrowers’ situation confirmed the severity of households’ balance-sheet adjustments. 2 As for the labor market situation, the unemployment rate remains high at 9.6 percent. Regarding prices, the rate of increase in the personal consumption expenditure (PCE) deflator has been around 1 percent. At the Federal Open Market Committee meeting held on November 3, 2010, the Federal Reserve decided on further monetary easing, announcing that it would purchase another 600 billion U.S. dollars of longer-term Treasury securities by the end of June 2011. Japan’s experience suggests that the ability of monetary policy to stimulate economic activity at a time of balance-sheet adjustments is limited. Therefore, close attention should be paid to the effects of the Federal Reserve’s recent monetary easing measures. European economies on the whole have been recovering moderately, although performances differ, with Germany and France registering robust growth, while others are showing only slow growth. The moderate recovery trend was confirmed by the recently released year-on-year real GDP growth rate of 1.9 percent for the July–September quarter of 2010 for the euro area as a whole. As for the outlook, the euro area economy is expected to continue to grow only moderately because the sovereign risk problem with regard to countries such as Greece and Ireland continues to lurk and fiscal austerity programs will be implemented in the area from 2011. C. The Japanese economy The Japanese economy has continued to show steady growth, particularly in private consumption, as evidenced by the fact that the real GDP growth rate for the July–September quarter of 2010 was 3.9 percent on an annualized, seasonally adjusted quarter-on-quarter basis. Looking back, until around spring 2010, exports and production continued to increase against the backdrop of strong growth in emerging and commodity-exporting economies, and private consumption had been recovering partly because of increased corporate profits. Economic activity in Japan subsequently strengthened temporarily until around the summer of 2010, due mainly to temporary factors such as the last-minute rise in demand upon the expiration of subsidies for purchasers of environmentally friendly cars and the boost from the extremely hot weather. However, from around the end of summer, the pace of recovery in the Japanese economy has been slowing, reflecting the ending of such temporary factors as well as a slowdown in export and production growth on the back of the deceleration in overseas economies. In global financial markets, there was increased demand for the yen as a safe haven amid heightened uncertainty about future developments in overseas economies, especially the U.S. economy. As a result, the yen appreciated to a level close to 80 yen against the U.S. dollar, leading to increased concerns about downside risks to the For details, see remarks by Chairman Bernanke made at “Mortgage Foreclosures and the Future of Housing Finance,” a Joint Conference Sponsored by the Federal Reserve System and the Federal Deposit Insurance Corporation, at Arlington, Virginia, on October 25, 2010. BIS central bankers’ speeches Japanese economy through a deterioration in business sentiment. In response to this situation, the Bank swiftly decided in early October 2010 to implement the “comprehensive monetary easing policy.” I will discuss the details of this policy later. Private banks’ lending rates, in terms of the average contracted interest rates on new loans and discounts, have been on a declining trend, reflecting monetary easing measures implemented by the Bank to date. Wages are showing signs of improving, albeit moderately, as evidenced by a year-on-year increase in overtime payments and a rise in special payments reflecting strong business performance. Although firms continue to regard their capital stock as excessive, business fixed investment is showing signs of picking up, partly reflecting replacement investment, which has been restrained in recent years. As for the outlook, private consumption is expected to be temporarily weak until around the end of fiscal 2010, as the boost from policy measures targeted at durable consumer goods and the effects of extremely hot weather come to an end. Export growth is likely to be only moderate because of the temporary slowdown in overseas economic growth and the effects from the earlier appreciation of the yen. Production is also projected to remain weak for the time being. A key factor is when production in the car industry, which has been sluggish following the sharp rise prior to the expiration of subsidies, will recover; this is expected to happen in early fiscal 2011. From the beginning of fiscal 2011, as the growth rates of overseas economies, particularly emerging and commodity-exporting economies, start to increase again, it is expected that exports will regain momentum, manufacturers’ production will return to an increasing trend, and their profits will continue to improve. Firms’ sense of excessive capital stock is likely to be dispelled gradually as exports and production pick up, and business fixed investment is consequently expected to generally continue to pick up. As for nonmanufacturing firms, the effects of the improvement in manufacturers’ business performance have started to spill over gradually, and therefore corporate profits and business fixed investment in these firms are expected to pick up moderately. Supported by these factors, private consumption is likely to return to a moderate recovery trend. II. Challenges facing the Japanese economy So far, I have been talking about the outlook for domestic and overseas economies; I would now like to move on to discuss the challenges facing the Japanese economy. These include the low birth rate and population aging, the prolonged period of low economic growth and deflation, and the large fiscal deficit. In 1968, Japan became the second-largest economy in the world, with its GDP surpassing that of West Germany. After holding onto second place for 42 years, however, Japan conceded that position to China in 2010. Looking back, in the 1960s the Japanese economy grew rapidly at an astounding pace, with the annual average growth rate reaching more than 10 percent, followed by a period of stable growth with an annual average rate of 4–5 percent from the 1970s to the 1980s. During that period, Japanese-style management was widely acclaimed. Since the 1990s, however, the economy has been growing at a slow pace on the whole, with the annual average growth rate hovering just above 1 percent, while Japanese government debt has increased sharply. The significant decline in the growth rate in the 1990s was triggered by a number of factors, particularly the bursting of the bubble economy and the malfunctioning of the financial system, but another major factor behind it seems to be structural changes that have affected the Japanese economy. These structural changes include the lower birth rate and population aging in Japan, and – triggered by the fall of the Berlin Wall in 1989 – the surge in the number of economies participating in the global market economy and the resulting intensification of global competition. Furthermore, the rapid expansion of the market economy, together with the progress in IT and the ample inflow of capital to emerging economies, led to a rapid catch-up in industrialization among emerging economies and an increase in their domestic demand. BIS central bankers’ speeches While these rapid global economic changes were occurring, Japan needed to devote substantial economic resources to dealing with the post-bubble adjustments. As a result, Japan was, in some respects, slow in adapting to these changes by, for example, achieving structural reforms and capturing demand from emerging economies, both of which bring about forward-looking investment. Following the collapse of the bubble economy, it seemed for a time that some firms had been successful in riding out the strength of the yen in 1995 and in ambitiously undertaking wide-ranging management reforms and restructuring to develop global business strategies. However, the changes in the global economy have been progressing even faster than such efforts, and for many firms the fruits of such endeavors have been limited. In view of the situation I have described, I will now talk about three issues that Japan faces. A. The low birth rate and population aging In 2005, Japan’s population for the first time in the postwar period registered a decline. The working-age population – that is, the population aged between 15 and 64 years old – in fact had already peaked in 1995 at 87 million and has been declining since then, due to the low birth rate and population aging. In the 15 years to 2010, the working-age population declined by 5.88 million. During the same period, the total population increased by about 1.61 million, with the population aging further. According to population projections made by the National Institute of Population and Social Security Research in 2006, the decline in the working-age population will continue to outpace that in the total population until the middle of the 21st century, and in 2055 the working-age population will have almost halved from the current level to 45.95 million in the medium variant projection. Unless the labor force participation rate and/or labor productivity increase, these trends will lower economic growth and exert downward pressure on the growth potential. The decline in the working-age population restrains economic growth not only from the supply side but also from the demand side, by reducing the number of consumers earning wages. Thus, the decline in the working-age population is likely to depress domestic demand. Looking at the labor force participation rate by sex and age group, that for men aged 25 to 59 years is more than 90 percent, decreasing to around 30 percent for men aged 65 years and above. The participation rate for women aged 20 to 55 years is 70 percent, but a closer look shows that the rate dips conspicuously to around 65 percent for women in their 30s. To address the continuing decline in the working-age population, it is important to raise the labor force participation rate by providing various measures for the overall population as well as for specific sex and age groups, namely the elderly of both sexes, and also women in their 30s who quit their job to look after their children. The increase in the elderly population will expand potential demand in the medical care and nursing care fields. Moreover, the advance in population aging shows that the elderly have emerged as a new consumer group, bringing about business opportunities for firms. However, it is also often said that the spending behavior of this new group is rather unpredictable because of the diversity of their needs. Therefore, tapping the potential demand of this consumer group requires greater efforts and an appropriate response by firms. B. Capturing emerging market demand According to the IMF, the share of emerging and commodity-exporting countries’ GDP in world GDP is currently about 50 percent. Their contribution to the year-on-year overall growth rate, however, amounts to about 70 percent. In view of the high rate of economic growth, emerging countries should not be considered merely as production bases for U.S. and European markets but as countries with great potential demand, the pace of expansion BIS central bankers’ speeches of which is beyond our imagination. Given the possible decline in demand in Japan due to the lower birth rate and further population aging, it is vital, for the growth of the Japanese economy, to devise measures in both the manufacturing and service sectors to capture emerging market demand. The following are some key considerations in this context. As highlighted in the White Paper on International Economy and Trade 2010 published by the Ministry of Economy, Trade and Industry, Asia’s middle-income population – households with disposable income of 5,000 U.S. dollars or more and less than 35,000 U.S. dollars – is forecast to expand in the next ten years. In 2000, Asia’s middle-income population stood at about 200 million, but by 2010 it was estimated to have grown to almost 1 billion, exceeding the aggregate population of Japan, the United States, and the euro area. Furthermore, this middle-income population is forecast to double by 2020. Combined with the high-income population – households with disposable income of 35,000 U.S. dollars or more – the market is expected to be enormous, with a population of more than 2.2 billion. In China, durable consumer goods such as color television sets, refrigerators, and washing machines have become quite common in urban areas, but are still not as widespread as in Japan. These goods are even less common in rural areas of China. As for personal computers, they are still rare even in urban areas. In urban areas of China, ownership of private cars is 10.9 cars per 100 households, one-eighth the level in Japan, and the gap is similar to the difference in the two countries’ per capita GDP. Thus, it could be said that China is only at the dawn of motorization and the market is poised for further expansion. With regard to the service sector, many Japanese firms have already ventured into emerging countries and have won high regard for the meticulous service they provide, but the market is expected to grow further reflecting improvements in living standards. On the other hand, an increasing number of Asian tourists have been visiting the Japanese hot spring town of Hakone near Tokyo recently, indicating that there is much scope for the domestic service sector to capture overseas demand through the provision of various high-quality services. C. The psychological challenge Recently the term “two lost decades” can be frequently heard, and it seems that this long period of low growth has shaken confidence in the future, possibly eroding managers’ determination to raise corporate value and people’s ambition to move up in the world. A survey by the Japan Youth Research Institute conducted in 2007 on the motivation of high school students in Japan, the United States, China, and South Korea reveals the inwardlooking attitude of Japanese youths. According to the survey, only 44.1 percent of Japanese respondents said they wanted to move up in the world, compared with 66.1 percent of respondents in the United States, 85.8 percent in China, and 72.3 percent in South Korea. Asked whether they would like a relaxed lifestyle earning an adequate salary, 42.9 percent of Japanese respondents said they would very much like such a life, a conspicuously high figure compared with the 13.8 percent for the United States, 17.8 percent for China, and 21.6 percent for South Korea. And consistent with these survey results, I have heard that at firms, too, the number of employees rejecting offers of promotion or overseas assignments is on the rise. But with economic globalization set to continue, for the Japanese economy to grow it is necessary to nurture personnel who can negotiate on an equal footing with ambitious overseas counterparts. Japan recovered from the devastation of World War II, tackled cases of environmental pollution, and overcame two oil crises as well as the sharp appreciation of the yen following the Plaza Accord. More recently, it went through the collapse of the bubble economy and financial crises. Each of these experiences enabled Japan to tackle the next challenge. Japan is close to the vast emerging markets of Asia and has a leading edge in areas such as environmental technology. Furthermore, the issue of a low birth rate and population aging is not limited to advanced countries; China and many other countries around the world face the same problem. If Japan can find a way to address this challenge, it could become a pioneer BIS central bankers’ speeches in this field. The government has presented its New Growth Strategy, which covers a wide range of areas. Even though the road to revitalizing Japan may be difficult, it can be achieved if all economic parties – aiming to raise the potential growth rate and productivity – face up to this reality and take bold measures in their respective roles, free from old habits and vested interests. III. Conduct of monetary policy Since the collapse of Lehman Brothers in autumn 2008, the so-called Lehman shock, the Bank has conducted aggressive monetary easing measures. These included the lowering of its target for the uncollateralized overnight call rate – the policy interest rate – from around 0.5 percent to around 0.1 percent and the continued provision of ample liquidity by increasing the annual amount of outright purchases of Japanese government bonds (JGBs) from 14.4 trillion yen to 21.6 trillion yen. As I mentioned earlier, with a view to overcoming deflation amid intense global competition and returning the Japanese economy to a sustainable growth path with price stability, the Bank has introduced new measures, which I will discuss in a moment. The Bank is determined to continue to carefully examine the outlook for economic activity and prices and take policy actions in an appropriate manner, as necessary, as the central bank. A. Fund-provisioning measure to support strengthening the foundations for economic growth The critical challenge facing the Japanese economy is to raise the potential economic growth rate and productivity. This can be achieved by exploring new areas of growth, and private firms, on their own initiative, should play the primary role in this regard to survive competition and attain growth. However, taking into account that the diminished growth potential of the economy is one of the fundamental problems underlying deflation in Japan, the Bank concluded that an effective way to use its functions as the central bank was to provide support to strengthen Japan’s future foundations for economic growth from the financial side. The Bank expects that this measure will act as a catalyst and provide support for the efforts made by private firms and financial institutions on their own initiative. Based on this thinking, the Bank decided in June 2010 to introduce the fund-provisioning measure to support strengthening the foundations for economic growth, through which it provides long-term funds at a low interest rate to financial institutions that are making efforts in terms of lending and investment toward strengthening the foundations for economic growth. This measure extends loans with maturities of up to four years at a low interest rate equivalent to the policy interest rate to financial institutions for their lending and investment in a broad range of areas and types of business that will eventually lead to the strengthening of the foundations for economic growth. The first new loan disbursement was carried out in September 2010, and loans totaling 462.5 billion yen were disbursed to 47 borrower financial institutions. The average amount per lending or investment project to be financed by such loans was 360 million yen, and the average duration of lending or investment projects was 8.2 years. Funds were provided to a broad range of areas such as “environment and energy business,” “development and upgrading of social infrastructure,” “medical care, nursing care, and other health-related business,” and “regional and urban revitalization business.” The second new loan disbursement will be conducted in the near future, and a significant number of financial institutions, about 140, have applied for the measure. Some financial institutions have already started actively exploring potential demand on their own initiative, bearing in mind their future utilization of the measure. The Bank therefore believes that the measure has made a rather good start, in that it has prompted financial institutions to explore new areas of growth in line with its intended purpose. BIS central bankers’ speeches B. Comprehensive monetary easing policy Next, I will talk about the “comprehensive monetary easing policy,” which the Bank – with a view to further enhancing monetary easing – decided to implement on October 5. This policy is an extraordinary measure for a central bank to implement in that, taking into account that there was little room for a further decline in short-term interest rates, it aims to encourage declines in longer-term interest rates and various risk premiums using a combination of a number of policy measures. The first measure was a clarification of the Bank’s pursuit of the virtually zero interest rate policy. The Bank changed the target for the uncollateralized overnight call rate from around 0.1 percent to around 0 to 0.1 percent, thereby clearly indicating that it was pursuing a virtually zero interest rate policy. If the interest rate were set at literally zero percent, financial institutions would lose the incentive to invest funds in the money market, incurring the risk of impeding the flow of funds in overall financial markets. Accordingly, the Bank decided to allow the overnight call rate to fluctuate in a range at or below 0.1 percent. For the same reason, the Federal Reserve set the target range for the federal funds rate, its policy rate, at 0 to 0.25 percent. The second measure was a clarification of the Bank’s commitment regarding the time horizon for maintaining the virtually zero interest rate policy. In terms of the future conduct of monetary policy, the Bank clearly stated that it would continue the virtually zero interest rate policy until it judged, on the basis of the “understanding of medium- to long-term price stability” – the so-called “understanding” – that price stability was in sight. 3,4 This measure aims to boost corporate activity and private consumption and stabilize the public’s medium- to long-term inflation expectations. On the other hand, a prolonged period of extremely accommodative financial conditions entails the risk of negative side effects such as an asset price bubble. Therefore, maintaining the virtually zero interest rate policy is subject to the condition that, upon careful examination, it does not give rise to the accumulation of financial imbalances, such as a surge in asset prices or excessive debt. The third measure was the establishment of the Asset Purchase Program (hereafter the Program). As I mentioned earlier, in order to achieve further monetary easing through the conduct of monetary policy, it is necessary to promote declines in risk-free, longer-term interest rates and in various risk premiums rather than in short-term interest rates, which have little room to fall further. Therefore, the Bank decided to purchase through the Program financial assets amounting to about 5 trillion yen – namely, Japanese government securities and risk assets such as CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) – and provide longer-term funds amounting to 30 trillion yen at a fixed rate of 0.1 percent through the fixed-rate funds-supplying operation against pooled collateral. The aim of the asset purchases through the Program is not to raise the prices of these assets by adjusting the supply and demand balance in the market. Rather, the Bank’s thinking behind the establishment of the Program is that the provision of funds through the Program will act as a catalyst in prompting a wider range of investors to purchase financial assets, reduce various risk premiums on these assets as a result of increased market transactions, and ultimately bring about positive effects on economic activity. The level of inflation that each Policy Board member understands, when conducting monetary policy, as being consistent with price stability over the medium to long term. The midpoints of most Policy Board members’ “understanding” are around 1 percent. BIS central bankers’ speeches The Bank has started purchasing assets for which necessary arrangements have been completed: on November 8, it purchased JGBs amounting to about 150 billion yen as its first purchase, and on November 9 it purchased treasury discount bills amounting to about 150 billion yen as its second purchase. BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Foreign Correspondents' Club of Japan, Tokyo, 7 February 2011.
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Masaaki Shirakawa: Toward a revitalization of Japan’s economy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Foreign Correspondents’ Club of Japan, Tokyo, 7 February 2011. * I. * * Introduction I am privileged to have the opportunity to speak before the distinguished Foreign Correspondents’ Club of Japan today. The topic I would like to talk about is the revitalization of Japan’s economy, focusing on the current state of the economy, the challenges it faces, and the efforts necessary to address such challenges. If one looks back at the history of any country’s economy, one will find times full of confidence and enthusiasm, and times where such confidence and enthusiasm were lacking. The 1980s were a time when the strength of Japan’s economy attracted attention from around the world. However, starting in the 1990s, and especially from the latter half of the 1990s onward, Japan’s economic conditions deteriorated due to the collapse of the bubble economy and the subsequent financial crisis. The expression that came to represent the state of Japan’s economy was the “lost decade,” which is commonly used both at home and abroad. I suppose that anyone might lose heart if hearing such an expression often enough. As you may know from experience in your own country, people tend to become overly optimistic or overly pessimistic, depending on the perceived economic performance relative to other countries. Assessing the economy of one’s own country through comparisons with other countries has both its advantages and disadvantages. An advantage is that it provides an opportunity to understand one’s own country in a more objective way. A disadvantage is that there are risks of becoming overly optimistic or overly pessimistic, depending on the economic situation at the time. If comparisons are made only superficially, this may lead to a wrong assessment and result in the wrong policy measures or the wrong corporate strategies. At any rate, even in a time when globalization is advancing in leaps and bounds, mutual understanding across borders is not easy. For that very reason, I imagine that the work of foreign correspondents such as yourselves is challenging and exciting. As a central bank governor, I myself have many opportunities to exchange views with the overseas media and policy authorities abroad. On these occasions, I get asked a great many questions about Japan’s economy. Here are the questions I am most frequently asked. First, why Japan’s economy has lost its vitality. This is in fact the starting point for the subsequent questions. The second question is why deflation has continued for a prolonged period. Discussions on the severe economic conditions then lead to the third question: are Japan’s public finances sustainable? In this context, I am often asked why, despite the deterioration in the fiscal balance, yields on Japanese government bonds (JGBs) have been stable at low levels. Finally, a fourth question I am often asked is whether Japan’s economy can really regain its vitality. It is an undeniable fact that Japan’s economy faces many challenges. However, I believe that Japan’s economy can most definitely regain its vitality. Needless to say, we have to work hard to achieve this. Obviously, the right prescriptions are also essential. To this end, it is necessary to have an accurate understanding of both the strengths and the weaknesses of Japan’s economy. I am looking forward to exchanging views with you on this point later. BIS central bankers’ speeches II. The current state of Japan’s economy I will start with short-term developments in economic activity in Japan. Japan’s Economy contracted severely following the failure of Lehman Brothers, but then started to improve around spring 2009. It continued doing so until the summer of 2010, mainly due to the increase in exports and production brought about by faster growth in emerging and commodity-exporting economies as well as policy measures to promote the sale of environment-friendly durable consumer goods. The improvement seems to have paused from the fall of 2010, but recent data suggest that Japan’s economy looks like it is about to emerge from that pause. If we compare these short-term developments in Japan’s economy with those in other advanced countries, Japan is not doing badly. 1 For example, according to the latest projections by the International Monetary Fund, Japan’s Economy was expected to grow by 4.3 percent in 2010, the highest rate of growth among the G-7 countries (Chart 1). Moreover, the unemployment rate in Japan, although higher than before the failure of Lehman Brothers, is at 4.9 percent, which is far below the roughly 10 percent in the United States and the euro area (Chart 2). Of course, the current level of economic activity is still below that before the global financial crisis and therefore not satisfactory. However, this is a problem common to many advanced economies. With regard to the degree of financial system stability, Japan is the most stable. Thus, as far as short-term economic and financial developments are concerned, Japan’s situation is by no means worse than that of other advanced economies. Despite all this, why are pessimistic views on Japan’s economy so widespread? Clearly, the main reason is the downward trend in Japan’s economic growth. Why Japan’s economy has lost its vitality Let me now explore the first question I mentioned earlier, that is, why Japan’s economy has lost its vitality. From around 1955 to 1970, Japan continued to achieve high-speed growth, registering annual rates of growth around 10 percent, which is similar to China’s growth since 1990. Subsequently, Japan’s economic growth rate declined gradually. Yet, in the 1980s, the average annual growth rate was still around 4.5 percent, greatly exceeding that of other advanced economies. However, in the 1990s, Japan’s annual growth rate fell substantially, dropping to around 1.5 percent, and in the 2000s, the economy grew at barely 1 percent per year on average, although the latter is partly due to the economic plunge triggered by the failure of Lehman Brothers (Chart 3). The long-term trend of the economic growth rate is determined by two factors: the rate of growth in the number of workers and the rate of growth in GDP per worker, or productivity (Chart 4). Among these, the main factor behind the decline in the growth rate in the 1990s was the decline in productivity growth. The first reason for this decline in productivity growth is the burst of the bubble economy. Many firms had to focus on resolving the so-called “three excesses” – in production capacity, employment, and debt – built up during the bubble period, and as a result, Japan’s growth rate declined. The second reason, overlapping with the first in some respects, is that Japanese firms were slow to respond to the significant changes in the global economic environment. Specifically, following the fall of the Berlin Wall in 1989, the globalization of the market economy proceeded at a rapid pace and the world entered an era of “mega competition.” However, Japanese firms were not able to sufficiently adapt to this changing environment. Looking back, during the high-speed growth era, Japanese firms were able to grow rapidly thanks to a favorable environment such as an For a comparison between Japan’s experience after the burst of the bubble and the U.S. and European experience in the recent financial crisis, see Shirakawa, Masaaki, “Uniqueness or Similarity? – Japan’s PostBubble Experience in Monetary Policy Studies – ,” Keynote Address at the Second IJCB Fall Conference hosted by the Institute for Monetary and Economic Studies, Bank of Japan, September 16, 2010 (available at http://www.boj.or.jp/en/announcements/press/koen_2010/ko1009c.htm). BIS central bankers’ speeches abundant supply of labor and the expansion of the domestic market as a result of population increases, as well as the absence of rivals from less industrialized countries. The business model developed in this environment at the time was based on long-term, stable business relationships and put emphasis on mass production and the sale of low-priced, high-quality products for the domestic market and advanced economies. The model was suitable for the business environment during the high-speed growth era, but because it had been so successful, many Japanese firms were slow to adapt the model when faced with the emergence of new markets and competitors in the 1990s. In the 2000s, partly because the effects of the burst of the bubble had gradually subsided, productivity growth stopped declining and Japan’s productivity growth rate today in fact remains among the highest among advanced countries (Chart 5). However, the rapid aging of the population, at a pace that has no precedence around the world, started to significantly affect economic growth. Specifically, the working-age population – which makes up the core group in production as well as consumption and the payment of taxes – peaked around 1995. It then started to decline, with the pace of decrease accelerating since the turn of the millennium (Chart 6). These trends reduce the growth in the labor force and weigh on economic growth from the supply side. At the same time, population aging also affects economic growth from the demand side. The shrinking of the working-age population, which accounts for the bulk of consumption, will decrease the size of the domestic market. Moreover, consumption by the working-age generation is likely to be further constrained by the growing burden of supporting the elderly. Of course, the growing number of elderly means that demand for such services as health care and nursing can be expected to rise. However, if the supply capacity to meet such growing demand remains constrained, domestic demand as a whole will likely be sluggish. Another subtle consequence of demographic trends that cannot be ignored is that the aging of the electorate may affect economic policy choices which in turn may have a negative impact on economic growth. Why deflation has continued for a prolonged period Next, I will discuss the second question, namely why deflation has continued for a prolonged period. Although Japan’s deflation is quite mild when compared with oft-quoted episodes of deflation such as that in the 1930s, this is a question that has attracted a lot of attention. The direct cause of deflation is the slack in the economy (Chart 7). I therefore attribute the most recent price declines to the global plunge in demand following the failure of Lehman Brothers. However, the prolonged, albeit moderate, deflation since the end of the 1990s cannot be explained only by short-term and cyclical factors. A more fundamental cause is the long-term downtrend in the growth potential of Japan’s economy. When the growth rate continues to decline for a protracted period, people’s expectations for future income growth are reduced and firms and households restrain their spending. As a result, downward pressure on prices continues (Chart 8). It is sometimes said that deflation will be solved only if the central bank provides liquidity more aggressively. Provision of ample liquidity is important, of course, but this alone does not solve the problem of deflation. In the United States, the Federal Reserve has expanded its balance sheet by a factor of 2.5 since the second half of 2008, but the inflation rate has continued to decline (Chart 9). Thus, to overcome deflation in Japan, two things – consistent monetary easing and efforts to strengthen the foundations for economic growth – are essential. Why yields on JGBs have been stable at low levels The third question in relation to the severe economic conditions in Japan is why yields on Japanese government bonds (JGBs) have been stable at low levels despite the deterioration in the fiscal balance (Chart 10). In fact, the average yield on 10-year JGBs since the beginning of 2000 has been around 1.4 percent, an extremely low level. BIS central bankers’ speeches Long-term interest rates are influenced by three factors: the expected growth rate, the expected inflation rate, and the risk premium associated with holding government bonds. Accordingly, one possible explanation for the low and stable long-term interest rates is that it reflects the market’s view that, for the time being, Japan’s economy will continue to grow slowly and have low inflation. However, this explanation alone is not sufficient. Given continued large fiscal deficits, if doubts about fiscal sustainability were to spread and investors were to become concerned about the risks associated with holding JGBs, long-term interest rates would rise. So far this has not happened, however. In this context, it is often pointed out that JGBs are largely absorbed by domestic private savings, which contributes to the low and stable long-term interest rates. However, as history shows, no country can continue to run fiscal deficits forever. Viewed from this perspective, it appears that the reason why interest rates in Japan have remained stable is that market participants believe that Japan ultimately has a strong will to work on mid- to long-term fiscal consolidation through, for example, reform of the tax and social security systems. And if I may add one more thing, I think another major reason is that the Bank of Japan’s conduct of monetary policy has been clearly focused on achieving sustainable growth with price stability. To put it the other way around, Japan should appreciate and make every effort to maintain the confidence shown by markets while working on mid- to long-term fiscal consolidation. III. Efforts needed to address Japan’s economic problems Next, let me turn to the fourth question, namely whether Japan’s economy can really regain its vitality. I mentioned earlier my belief that Japan’s economy can regain its vitality. At the same time, however, this of course cannot be achieved without any effort. The road toward Japan’s economic revitalization starts from a clear identification of the root cause of Japan’s economic problems. Understanding that this is the downtrend in the growth potential, it is necessary to work on specific solutions. In this context, some argue that the first thing to do is to overcome deflation. Needless to say, overcoming deflation is a major issue for Japan’s economy. In some instances, price increases may of course precede an acceleration in growth, but this is typically only the case when inflation is pushed up as a result of price increases in international commodities such as natural resources, fuel, and food. However, such developments would entail a worsening of the terms of trade and hence a fall in real purchasing power. People would not welcome such price rises. The relationship between economic activity and prices in the past shows that prices increase as growth accelerates and hence the output gap narrows. This is how the economy usually works. Thus, Japan’s moderate deflation is a manifestation of the fundamental problem of the long-term downtrend in the growth potential of the economy. I would now like to discuss efforts in three areas that I think are particularly important for raising the growth potential of Japan’s economy. The first concerns effort to tackle rapid population aging. Based on current demographic trends, the pace of decline in the working-age population will accelerate in the future. For this reason, society as a whole needs to create a working environment that promotes an increase in labor market participation, especially by the elderly and women. In this context, I would like to note that female labor market participation in Japan remains low in international comparison (Chart 11). Second, it is necessary to raise productivity growth in the economy as a whole. In this regard, Japanese firms have been diligent, of course. Typical examples are production and inventory management through just-in-time systems as well as kaizen (continuous improvement), a term that has made it into English. Following the burst of the bubble, Japanese firms have also been working on reducing labor costs. For individual firms, efforts to pursue operational efficiency are certainly important. However, in a world of increasingly BIS central bankers’ speeches fierce global competition, these efforts alone do not lead to an improvement in productivity. The reason why Japan’s walkman once dominated markets around the world is that, in addition to high product quality, it offered a new lifestyle, allowing users across all age groups to listen to music outside the home. Taking this as an example, Japanese firms need to make greater efforts not only to improve the functionality and quality of products from the perspective of monozukuri, a Japanese expression for “creating substance,” but also to provide new value from the perspective of shikake zukuri, or going beyond developing a product to create an environment that the product can thrive in. 2 Thus, what is needed is for firms to make greater efforts to tap latent consumer demand and create new added value. At the same time, in terms of improving productivity in the economy as a whole, efforts at the micro-level alone are not sufficient. What is also crucial is to enhance the metabolism of the economy as a whole, that is, not to impede the smooth transfer of production resources such as capital and labor from areas of shrinking demand to areas of growing demand. Moreover, it is vital to make efforts to actively capture demand in overseas markets that are enjoying high growth, and many firms have recently been striving for tapping such demand, especially in Asian markets (Chart 12). In these markets, and especially in China, demand for consumer goods is growing exponentially with the expansion of the middle class. At the same time, while enjoying high growth, these countries suffer from problems such as pollution and urban overpopulation, which Japan once experienced. In these areas, there also exist great opportunities for Japanese firms to take advantage of their skills and knowhow acquired over many years. In order to actually capture such overseas demand, it is necessary to arrange an open trade system. The Japanese government announced last year that it would accelerate the negotiation of free trade agreements and economic partnership agreements. Developments in discussions on these agreements are of key importance for increasing the productivity of Japan’s economy. The government needs to play its part – through deregulation, tax reform, and the opening of markets – to provide a business environment that helps to increase productivity. Third, efforts to improve the fiscal balance are also necessary. The deterioration in the fiscal situation reduces expectations for future income growth, especially among the working-age generation, and restrains spending by this generation. Moreover, as seen in the sovereign debt problems in European peripheral countries since last year, once confidence in fiscal sustainability erodes, this will result in an adverse feedback loop among fiscal conditions, the financial system, and the real economy, with negative consequences for economic activity. An improvement in the fiscal balance is not something that can be achieved through inflation. It is true that if prices rise, tax revenues may increase. At the same time, however, expenditures, such as those on social security and public works, would also increase. If future inflation is factored into long-term interest rates, the burden of interest payments on government bonds would also rise. It is therefore necessary to fully recognize that an improvement in the fiscal balance cannot be achieved without efforts to both reduce expenditures and increase revenues in real terms (Chart 13). IV. Recognizing the need for reform and Japan’s economic strengths I talked at length about efforts that are needed to raise the growth potential of Japan’s economy. Unfortunately, however, such efforts have not made sufficient progress. One of the reasons is that the need for reform cannot be immediately felt. This reflects the fact that although the growth potential is declining, Japan’s economy stands on relatively firm Ikujiro Nonaka and Akira Katsumi, in their book, The Art of Innovation (Innovation no sahou, 2007, available only in Japanese), argue that manufacturing today should not be a mere monozukuri that can be measured in terms of quantity, but kotozukuri, or event making, that is, the creation of products that tell a certain story with which purchasers can identify and in which they find value. BIS central bankers’ speeches foundations. For example, because Japan’s domestic market is relatively large, firms have been able to make some profit, even if their business focuses only on the domestic market. With regard to the fiscal problem, long-term interest rates have not been rising, the yen has not depreciated, and there has been no capital flight. In fact, even though the recession following the failure of Lehman Brothers was more severe in Japan than in the United States and Europe, in the foreign exchange markets, demand for the yen has actually increased, as it is viewed as a safe-haven currency. This is attributable to the fact that Japan has been running a large current account surplus and is the biggest creditor nation in the world, so that Japan is perceived as among the most robust countries in the world in terms of foreign currency funding. Be that as it may, given that the decline in the growth rate is a problem that has plagued Japan for a long period, a tremendous amount of human energy is needed to reverse this trend. What concerns me in this regard is that Japanese society is losing a healthy sense of optimism. Just as excessive optimism can generate an asset bubble, excessive pessimism can depress the economy. What is necessary is a strong will for reform and overcoming excessive pessimism. We should keep in mind that Japan’s economy and society still have many strengths. The first strength is that Japan is in Asia, which is the very center of global growth. For example, looking at trade developments with China, which is now Japan’s largest trading partner, Japan’s exports to China have grown 4.7-fold since 2000, while imports from China have grown 2.7-fold. Moreover, Japan’s direct investment position in China has expanded by a factor of more than 5 (Chart 14). Meanwhile, the number of visitors to Japan from Asian countries has doubled in the past 10 years, to about 7 million, accounting for nearly 80 percent of all visitors. In the future, visitors from Asia are likely to increase further as their living standards improve. This is also expected to provide a significant boost to the various regions in Japan. Japan’s second strength is its high level of technological capabilities. Japan’s technological capabilities are particularly high in environmental and energy-related fields, and the energy efficiency of Japan’s economy is second to none (Chart 15). Given global trends such as the substantial increase in demand for infrastructure in emerging economies, the shift to a lowcarbon society, and the growing role of environmental protection, the need for Japan’s advanced technologies in such areas is bound to rise in the future. In fact, there are a considerable number of Japanese firms that have gained a substantial global market share by making use of advanced technologies in electricity generation and storage or water purification and desalination. Moreover, in a recent new trend, electric power companies and local governments, exploiting their ability to provide efficient and reliable service, have shown great eagerness to enter overseas markets in the area of urban infrastructure development, such as the distribution of electricity and water. A third strength – although it is difficult to find the right word – is what may be called the “soft power” of Japanese society. 3 I am sure you yourself, as a foreign correspondent in Japan, have probably experienced how safe Japan is, as demonstrated by the great number of vending machines, how reliable business operations are, as epitomized by the bullet train, which is always on time, or how courteous the service is one receives in retail stores. It seems to me that soft power, such as safety and trust, is becoming an increasingly important asset in a globalized economy. Earlier, I mentioned that the rapid aging of the population is weighing on Japan’s economy. On the other hand, population aging, that is, an increase in longevity, should also generate an increase in demand in areas such as health care and nursing, tourism and leisure. For This term was first used by Joseph S. Nye, Jr., who focused on the role of the culture or values of a country in the area of international politics and calls this soft power as opposed to hard power such as military power. BIS central bankers’ speeches example, the turnover of fitness clubs has increased by nearly 40 percent in the past ten years, reflecting the increase in health consciousness due to population aging. At the same time, in areas that are regulated, such as health care and nursing care, supply capacity is insufficient and there is a mismatch of demand and supply. In these areas, there seems to be ample room for tapping potential demand in the domestic market. Japan is the country in the world where the problem of aging and population decline is the most acute, but other countries in Asia will face the same challenges in the not-so-distant future (Chart 16). Looking back, the rapid development of energy-efficient technology in Japan was triggered by major challenges, namely serious pollution and the rise in oil prices. The population aging Japan is now experiencing also represents a major challenge. At the same time, however, if Japan applies its technological capabilities, as epitomized by its robots, as well as its soft power, this challenge can give rise to new business models such as in the provision of personalized nursing care services and therefore also presents great business opportunities for Japanese firms. V. The Bank of Japan’s policy response Finally, I would like to briefly explain the policy responses the Bank of Japan has implemented in order for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability. To start with, the Bank is pursuing powerful monetary easing, so-called “comprehensive monetary easing.” The overnight call rate is virtually zero percent, the lowest in the world, and the Bank has committed itself to continuing the virtually zero interest rate policy until it judges, on the basis of the “understanding of medium- to long-term price stability,” that price stability is in sight. Moreover, although extraordinary for a central bank, the Bank last autumn started purchasing risk assets such as exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). In addition, to strengthen the growth potential, the Bank has also introduced a new program. Through this program, it provides long-term funds with JGBs and other assets as collateral at a low interest rate, to support financial institutions’ own initiatives in lending and investing in new growth areas. The Bank strongly hopes that the program, by acting as a “catalyst,” will prompt vigorous efforts by financial institutions and firms. In many respects, Japan has been the first among major economies to experience challenges such as balance sheet adjustments, a financial system crisis or rapid population aging. On the monetary policy front, many central banks in advanced countries have now adopted policy measures such as a zero-interest rate policy, quantitative easing, or credit easing. However, at the time, the Bank of Japan, the “forerunner” in implementing these policies, needed to devise such policies on its own. I feel that such creativity and innovativeness by the Bank deserves more recognition. Nonetheless, the Bank will continue to consistently make contributions as the central bank toward the crucial objective of achieving a revitalization of Japan’s economy. VI. Concluding remarks Today, I have talked about the challenges facing Japan’s economy and efforts needed for economic revitalization. Looking back at modern economic history, there are many countries that achieved economic revitalization once they earnestly addressed severe challenges that were initially seen as difficult to resolve. To give an example of another advanced economy, the United States, from the second half of the 1970s to the 1980s, faced the challenge of a decline in the international competitiveness of its manufacturing industries, which had enjoyed an overwhelming advantage. Another example is Korea. Its strong manufacturing sector is currently attracting attention, but only about a decade ago it found itself in distress in the face of a serious currency crisis. Korea took a hard look at the causes of the crisis and reformed its economic structures to prevent such a crisis from recurring. Such efforts have BIS central bankers’ speeches led today’s rapid progress. These examples suggest that history is a constant process of the rise and conquest of new challenges. Japan’s Economy is not an exception. Each time a new challenge arose, Japan overcame it through painstaking efforts and a strong sense of urgency. I think that once people share a will for reform, they can press ahead with tackling the critical issues Japan’s economy faces. In Japan, 2011 is the year of the rabbit. In our country, a rabbit running up a hill symbolizes a situation where things are progressing smoothly. And in the West, it is the rabbit that brings Easter eggs, which are a symbol of rebirth. For my part, I strongly hope that this year will be a year of revitalization for Japan’s economy. 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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Banque de France Financial Stability Launch Event, Paris, 18 February 2011.
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Masaaki Shirakawa: Global imbalances and current account imbalances Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Banque de France Financial Stability Launch Event, Paris, 18 February 2011. * * * The debate surrounding global imbalances gained increasing attention after the turn of the century as the United States’ current account deficit ballooned, while the current account surplus of some emerging market countries, notably China, increased dramatically. Some have argued that global imbalances were one of the key causes of the recent credit bubble in the United States and hence the global financial crisis. Thus, as the world economy recovers from the severe recession, the possible expansion of global imbalances is receiving renewed attention. If global imbalances were to become unsustainable, it could derail the nascent global economic recovery. Against this background, the G20 Leaders have made “external sustainability” a key item on the G20 agenda for 2011. The global imbalance debate contains a host of issues. How much emphasis should be put on adjusting current account imbalances per se? What are the causes of current account imbalances? Does the fact that the largest deficit country provides the key reserve currency delay the adjustment process, as the incentive to reduce deficits is weaker? How much does the fact that some current account surplus countries have fixed or relatively inflexible exchange rate systems influence current account imbalances? The introduction of new reserve assets would likely reduce the demand for US dollars, but would it reduce the precautionary demand for reserves, thereby reducing current account imbalances? These issues are closely linked to the broader discussions on the international monetary system and remind us of the original Bretton Woods debate between White and Keynes almost 70 years ago. Among the various topics, this paper will focus on the appropriateness of using current account surpluses and deficits as an indicator for assessing the sustainability of global imbalances. In the first section, I will review Japan’s own experience, especially during the 1980s when current account surpluses increased significantly and the country struggled to deal with external pressures to reduce current account surpluses, and in the second section look at experiences from the current global crisis. The third section will draw some lessons from the past and present. The fourth section will consider issues which need to be taken into consideration as we work to avoid the next global crisis, and the fifth and final section identifies some challenges for policymakers. 1. The Japanese experience Looking back at the developments of Japan’s current account balance over the last fifty years, with the rapid improvement in the competitiveness of the manufacturing sector, Japan began to continuously record trade surpluses and as a result current account surpluses starting from the mid-1960s (Chart 1). The only exceptions were the periods 1973–1975 and 1979–1980, when surging oil prices due to the first and second oil crises led to a fall in the trade surplus. BIS central bankers’ speeches Chart 1 Current account balance of Japan Ratio to nominal GDP Entering the 1980s, Japan’s trade and current account surplus increased sharply and this was accompanied by increased external pressure, both bilaterally and multilaterally, to reduce Japan’s surplus. In the first half of the 1980s, the focus was on constraining exports in specific sectors such as the voluntary restraints on automobile exports to the United States, and on “the opening up of Japan’s domestic markets” to overseas products and services. With regard to liberalisation of financial markets, Japan’s Ministry of Finance and the US Treasury set up the “Yen-Dollar Committee” in November 1983. The Committee released its report in May 1984, which provided a detailed plan to liberalise Japan’s financial and capital markets and to internationalise the yen. Meanwhile, the yen which had briefly reached 177 yen to the dollar in the late 1970s, generally moved in the range of 200 to 250 yen to the dollar during the first half of the 1980s, and the view that the yen should strengthen to reduce Japan’s trade and current account surplus mounted among its major trading partners. In September 1985, the G5 Ministers of Finance and Central Bank Governors announced in the “Plaza Accord”1 that “there are large imbalances in external positions which pose potential problems” and “agreed that exchange rates should play a role in adjusting external imbalances”. As is well acknowledged, based on this agreement the G5 began to intervene jointly in the foreign exchange markets to bring down the value of the dollar. The five countries also made individual commitments as a part of the Plaza Accord, and Japan, among various measures, committed to “further opening up of Japan’s domestic market to foreign goods and services” and noted that “efforts to stimulate demand will focus on increasing consumption and investment through measures to enlarge consumer and mortgage credit markets”. In the area of monetary policy, Japan agreed to “flexible management of monetary policy with due attention to the yen rate”. As a result of this agreement and ensuing intervention, the yen which had been around 240 yen to the dollar before the Plaza Accord appreciated sharply and touched 152 yen to the dollar in September 1986. The ratio-to-GDP of “Announcement of the Ministers of Finance and Central Bank Governors of France, Germany, Japan, the United Kingdom and the United States” (September 22, 1985). BIS central bankers’ speeches Japan’s current account surplus peaked at 4.2% in 1986 and began to decline thereafter.2 However, Japan’s trade surplus with its major trading partners remained at high levels, and the view gradually took hold that exchange rate adjustments alone cannot significantly reduce trade imbalances. External pressure on Japan to reduce its surplus began to focus more on the expansion of domestic demand. In February 1987, at a meeting in Paris, the G6 Finance Ministers and Central Bank Governors released the “Louvre Accord”.3 The Ministers and Governors “agreed that the substantial exchange rate changes since the Plaza Agreement will increasingly contribute to reducing external imbalances and have now brought their currencies within ranges broadly consistent with underlying economic fundamentals” and they also “agreed to cooperate closely to foster stability of exchange rates around current levels”. The Ministers and Governors also recognised “that the large trade and current account imbalances of some countries pose serious economic and political risks”. Each member once again made specific commitments and Japan agreed to “follow monetary and fiscal policies which will help to expand domestic demand and thereby contribute to reducing the external surplus”. Additionally, the Bank of Japan “announced that it will reduce its discount rate by one half percent” to 2.5%. Although the Japanese economy grew rapidly at an annual pace of 4.7% between 1986 and 1988, and asset prices showed double digit increases, the very low policy rate of 2.5% was maintained for over two years until May 1989, as inflation rates remained stable at low levels. 4 This period of a very low policy rate was much longer than in Germany which maintained its policy rate at 2.5% for less than a year. 5 In spite of repeated intervention by the major countries following the Louvre Accord, the yen continued to strengthen against the dollar reaching 121 yen to the dollar in November 1988, raising concerns about a slowdown in the domestic economy, mainly in the export-related sectors. In the meantime, bilateral pressure from the United States continued. The US Congress passed an omnibus trade bill 6 in 1988 and the following year Japan was identified by the US government as one of the countries conducting unfair trade practices. 7 In 1989, the Structural Impediments Initiative began between the US and Japanese governments. A joint report was finalised in June 1990 and the Japanese government committed to instituting a public investment program totaling as much as JPY 430 trillion (roughly 100% of nominal GDP) over a ten year period. 8 Japan’s current account surplus dropped to 1.4% of GDP in 1990, but as the bubble burst and economic growth slowed, the ratio of current account surplus to GDP rose once again and averaged 2.4% during the 1990s. More recently Japan’s current surplus has averaged 3.3% of GDP since 2000. However, its composition has changed significantly. In the past, Japan’s current account surplus was generally a reflection of its trade surplus (Chart 2). But during this decade, the share of the trade surplus has declined and in recent years three-quarters of the current account surplus is taken up by the income account surplus. The large income account surplus is to a large extent predetermined by Japan’s accumulation of external assets over the years through portfolio and direct investments. Due in part to the initial J-curve effect, there was a time lag before the surplus began to actually decrease. “Statement of the G6 Finance Ministers and Central Bank Governors” (February 22, 1987). The average year-on-year change in CPI between 1986 and 1988 was 0.5%. The Bundesbank reduced its discount rate from 3.0% to 2.5% in December 1987 and raised it again to 3.0% in July 1988. By the time the Bank of Japan raised its discount rate to 3.0% in May 1989, the policy rate in Germany was 4.5%. “Omnibus Foreign Trade and Competitiveness Act of 1988”. Brazil and India were also designated. According to the report (Japan Structural Impediments Initiatives Joint Report), public investment during the previous decade (Fiscal 1981 to 1990) was estimated at JPY 263 trillion. BIS central bankers’ speeches Chart 2 Trade balance of Japan Ratio to nominal GDP What does the Japanese experience tell us? First, how effective were exchange rate adjustments and other macroeconomic policies in reducing current account imbalances? They surely helped in bringing about a reduction in the trade surplus as part of cyclical dynamics, and thus a decrease of the current account surplus. However, aside from cyclical components, underlying current account trends were little changed. The attempt to make further adjustments through macroeconomic policies, especially through prolonged accommodative fiscal and monetary policy was unsuccessful. It rather had the detrimental side-effect of being one of the factors that fueled the expansion of the bubble and hence led afterwards to the serious predicament. Incidentally, depending on the structure of the current account balance, surpluses and deficits can be to a large extent predetermined. In Japan’s case, as mentioned above, the large income account surplus has driven the current account surplus in recent years. When we look across the G20 countries, this is not an isolated case. Australia’s current account deficit can to a large extent be explained by its income account deficit. The trade balance does have a large share of the current account in many countries, but other components such as the income account often have non-negligible and sometimes significant impact on the overall picture of the current account balance (Chart 3). This is a reflection of the structure of their economies and needs to be well understood when assessing the evolution of the current account. BIS central bankers’ speeches Chart 3 Current account balances of G20 members Ratios to nominal GDP – 2005–2009 average Second, was the current account surplus indicative of “imbalances”? The current account surplus may have been indicative of “imbalances”, but does not provide sufficiently granular information to make an effective assessment. The emergence of unsustainable imbalances seems to be better and more clearly captured through other indicators such as large jumps in asset prices and the rapid expansion in corporate sector debt (Charts 4 and 5). Japan’s continuously large current account surplus itself did not provide clear hints with regard to the bubbles that turned out to be the root cause of serious damage to economic stability. Chart 4 Major economic indicators of Japan (1980–1992) Exchange rate and official discount rate BIS central bankers’ speeches Asset prices and bank lending Real GDP and CPI BIS central bankers’ speeches Chart 5 Japan’s corporate sector debt Ratio to nominal GDP Third, how does exchange rate policy influence the overall economy? An excessive focus on preventing the appreciation of the currency and on easing the negative effects of exchange rate appreciation fostered expectations that a low interest rate environment would continue. This became one of the factors that led to the emergence of the bubble, thereby impairing the stability of the economy. The accommodative monetary policy following the Louvre Accord, reflected the external pressure to reduce the current account surplus as well as domestic concerns about the negative impact of the appreciation of the yen on the Japanese economy. 2. The recent global financial crisis In the run up to the recent global financial crisis in the mid-2000s, concerns were raised that a disorderly adjustment would occur through a sharp fall in the value of the dollar and a jump in long-term US interest rates. Such a view focused on the widening US current account deficit and the large increase in foreign exchange reserves in emerging market countries, and the possibility that such countries may at some point become reluctant to continue financing the US deficit. However, as we all know, what came to pass was quite different. At the outset of the financial crisis, as market participants became extremely risk averse, a global flight-to-quality occurred. US long-term rates fell substantially as demand for US Treasuries increased, and the dollar strengthened against most other currencies. This experience, similar to the Japanese experience, also highlights the need to look beyond current account balances and identify what constitutes underlying imbalances. Then the question becomes “How can we identify the imbalances or distortions which could lead to unsustainable global imbalances? What type of information do we need to focus our attention on which is not sufficiently captured in current account data?”. Taking into account the additional experiences from the current financial crisis, I would like to point out two areas where attention should be focused. BIS central bankers’ speeches 2.1 Build-up of excess leverage First, the build-up of excess leverage in the economy. When we look at long-term trends in ratio-to-GDP of the savings and investment balance which is equivalent to the current account balance (Chart 6), one can notice that the net negative savings in the United States widens in the 2000s. These changes in themselves do not tell us whether such changes are sustainable or not. However, when we additionally examine the developments in household debt, we can see large deviations from longer-term trends (Chart 7). Such developments are similar to the Japanese situation in the 1980s, only the sector where excess leverage materialised is different. In Japan, the build-up was in the corporate sector (Chart 5). Certainly, large deviations from longer-term trends in themselves are not definitive, but are a strong indication that unsustainable financial imbalances are likely to be accumulating. What is important is to have both an economy-wide assessment and assessment at a somewhat more disaggregated level, for example at the sector level. This would enable policymakers to obtain a better sense of where imbalances may be accumulating. Chart 6 Investment-savings balance of the United States Ratio to nominal GDP It is also important to understand the mechanism of how credit, which supports the build-up of leverage, is provided. Before the current crisis, special investment vehicles (SIVs) set up by US and European banks frequently purchased various structured products originated by the sponsoring bank. Once the subprime loan market collapsed, the credit and liquidity risks of the SIVs ended up with the sponsoring institutions, as reputational risks forced them to extend support. A similar situation had evolved in Japan during its bubble period in the late 1980s. Non-bank financial companies were used aggressively to expand residential and commercial real estate lending often to circumvent regulatory limits, especially after regulators introduced overall limits on bank lending growth to these sectors. Although such BIS central bankers’ speeches non-bank companies were structured so that they were not consolidated on to banks’ balance sheets, most of the losses ended up with the parent banks. Both the recent US and Japanese experience highlight the need to look beyond the banking system. The shadow banking system played a key role in both countries. Chart 7 United States’ household sector debt Ratio to nominal GDP 2.2 Gross capital flows and risk profile of financial institutions Second, gross capital flows. The net capital flows corresponding to current account balances do not provide us with sufficient information to locate possible sources of unsustainable imbalances. It will need to be supplemented with other sources of data. A case in point would be recent developments in the euro area. The current account of the euro area has been generally balanced during the past decade. But BIS banking statistics show that euro area banks actively intermediated US dollar funds from the international banking system to the non-banking sector in the United States (Chart 8). Although the netted amount was small, the accumulation of risks such as maturity mismatches, currency mismatches and credit risks, which increased on a gross basis was substantial. BIS central bankers’ speeches Chart 8 Euro area banks’ cross-border US dollar claims Chart 9 BIS reporting banks’ cross-border claims by currency BIS central bankers’ speeches BIS central bankers’ speeches Globally, banks, especially European banks, had been borrowing short-term dollar funds in the interbank market and investing in long-term assets. The dollar funding risk in the international banking system had been rapidly increasing in the mid-2000s, becoming substantially larger than the funding risk for other major currencies (Chart 9). As the crisis unfolded, counterparty credit concerns increased in global financial markets and banks began to hoard dollar liquidity. The US dollar interbank funding market froze up and many market participants struggled to obtain dollars. Serious tension continued in the financial markets until central banks including the Bank of Japan began to provide US dollars through bi-lateral swap lines arranged with the US Federal Reserve. BIS banking statistics and other sources of information help us fill the gaps in the current account data. There was a large inflow of funds from banks in advanced European countries before the crisis, which were rapidly withdrawn after the summer of 2007 (Chart 10). BIS reporting banks’ overall cross-border exposures to the Unites States have fallen more than 20% since reaching its peak in first quarter of 2008, and especially exposures to the private sector, which include investments in structured products, have fallen nearly 30% (Chart 11). Chart 10 Cross-border flows through the international banking system Chart 11 BIS reporting banks’ total foreign claims on the United States by sector BIS central bankers’ speeches By obtaining micro-level information on financial institutions, central banks and other supervisory and regulatory authorities can assess the true risk profile of individual institutions. It also provides the basis for grasping the distribution of risks at various levels of aggregation, including at the overall macro-level. It will be important to develop a macro-level understanding of where risks are concentrated in the financial system as well as the possible interlinkages among market participants. 3. Assessing global imbalances Current account balances provide us with helpful information on the state of the economy. At the same time, the current crisis as well as other past experience show the potential risks of simply using current account balances as an indicator of unsustainable global imbalances. Although not an exhaustive list, I would like to highlight three points as lessons from current and past experiences. First, surpluses and deficits emerge as a result of the voluntary choices of economic entities and thus should not be automatically deemed as problematic. Trends in current account surpluses and deficits are the reflection of longer-term trends in savings-investment activities which are strongly influenced by economic developments and demographics. Current account surpluses and deficits will only lead to problems when they become unsustainable, and thus a careful overall assessment is required. Second, distinguishing between the structural and cyclical components of the Current account balance is often a difficult task. Trying to adjust the structural component through macroeconomic policy and exchange rate policy entails the risk of causing the development of financial imbalances which may destabilise the economy. A narrow policy focus on current accounts per se can be counter-productive. Third, central banks and other authorities need to assess the possible emergence of unsustainable imbalances using a wide range of indicators such as asset prices, leverage, gross capital flows and information on risk pricing and risk profiles of financial institutions. Current account data only provide us with a partial picture. In the past, when the crossborder flow of goods and services dominated interrelationship among economies, assessing current account and trade balances would give us a relatively good picture of emerging external imbalances. But the size of global capital flows has dramatically increased and the speed with which capital moves to and from one country to another has accelerated as well. The growing use of derivatives adds another layer of complexity. The approach for assessing global imbalances needs to change accordingly. 4. Preparing for new types of crises Mankind has continuously searched for “monetary anchors” or “monetary benchmarks”. This endeavor has been a repetition of initial success followed by failure or outdatedness as a result of rapid changes in the economic and financial system. In the realm of monetary policy, money supply targeting was often used in the 1970s in many advanced economies. However, with rapid financial innovation, its relationship with inflation developments became unstable and was eventually abandoned. Inflation targeting emerged as a new monetary policy framework in the 1990s, but the challenges in its effective implementation have surfaced as bubbles developed in the run-up to the current financial crisis, especially in identifying imbalances when they appear in forms other than inflation of goods and services. With regard to the international monetary system, we have moved in the past from the gold standard to managed floating exchange rate systems. Currently, the major currencies are free floating, but many countries still have fixed or managed floating regimes. Current account imbalances can be one of many possible indicators. But there is no single indicator which can identify emerging imbalances, let alone unsustainable global imbalances. A sufficiently flexible policy framework which can adapt to rapidly changing economic and BIS central bankers’ speeches financial conditions is required. The process through which crises unfold is unique for each crisis. We must learn from past experience, but strategies for the last war do not assure success in future battles. Keeping an open mind is important. Chart 12 Financial account of emerging countries As policymakers work to develop a framework for identifying and dealing with unsustainable global imbalances in a rapidly evolving economic and financial environment, they need to be cognizant of three key elements: two longer-term trends and one element unique to the current environment. First, though needless to say, we are experiencing a further acceleration in economic and financial globalisation. In addition, due to technological advances, the interlinkages between financial markets and among market participants are becoming increasingly complex. Shocks in one part of the world will swiftly spillover to other parts and often through unexpected channels. The effects of the risk-taking channel of monetary policy can be larger and more widespread than in the past. Search-for-yield behaviour by global investors is one such example. Second, the share of emerging market countries in the world economy is increasing. Their share in the world economy which was 20% in 1990 and 2000 has increased to 31% in 2009 on a current price basis, and they are expected to account for seven-tenths of global economic growth in 2010. Emerging economies have become the drivers of global growth, and consequently their responsibilities as members of the global community have increased. For example, it needs to be recognised that the implications of inflexible exchange rates in major emerging economies on the global economy have become larger. The perspective of an orderly structural adjustment process for domestic industries may warrant a gradual shift from fixed exchange rates to a more flexible exchange rate system and a controlled appreciation of the home currency. But, at the same time, policymakers in emerging economies need to recognise that such a policy both hampers the flexible implementation of domestic macroeconomic policies including monetary policy, and exports the cost of the adjustment to other countries. If other countries follow and take similar measures to delay the appreciation of their currencies, the impact on economies which allow flexible exchange rate movements could be magnified. BIS central bankers’ speeches Third, we are now in the unique situation where some advanced economies are recovering from the aftermath of the bursting of the bubble, and as a result, the world is facing an uneven pace of recovery. On the one hand, emerging economies are continuing their robust growth. On the other hand, due in part to the balance-sheet adjustment process following the bursting of the bubble in some countries, recovery in advanced economies is slow. Central banks in advanced economies have introduced unconventional measures to implement extremely accommodative monetary policy. As advanced economies face the zero lower bound in interest rates and a weak transmission mechanism constrained by balance-sheet adjustment needs, monetary easing through the traditional interest rate or credit channel is not working to the extent normally expected. Instead, in an integrated global financial system and with the divergent pace of economic growth, capital is rapidly fl owing into high growth emerging economies which do not face such constraints (Chart 12). The risk-taking channel is working more effectively at the global level. Chart 13 Correlations among emerging market equity and commodity indexes Since the emerging economies are not hampered by the aftereffects of the bursting of the bubble, the stimulative effects of such capital inflows could be unexpectedly large. With short-term interest rates at very low levels in advanced economies, carry trade activity has picked up and correlation among emerging economy equity markets as well as between emerging equity markets and commodity markets is rising (Chart 13). If such capital flows lead to the development of bubbles and abrupt reversals in the future, the negative repercussions would not only be harmful for emerging economies, but also for the global economy. 5. Challenges for policymakers In order to prevent the emergence of unsustainable global imbalances, policymakers need to dig down beyond changes in the current account balance to capture underlying imbalances. A key sea change that we are witnessing is that through rapid globalisation the identification of harmful imbalances and implementing rebalancing measures can no longer be a purely domestic process. BIS central bankers’ speeches In formulating macroeconomic policy, the traditional emphasis was to ensure domestic stability or to put one’s house in order. However, with the deepening of globalisation, the simple sum of each country’s policy action may not necessarily achieve an optimal outcome at the global level. Policymakers in both advanced and emerging economies need to rethink the meaning of domestic stability. The direct impact of policy measures on the domestic economy does not provide a comprehensive view. It has become ever more important to review the spillover effects of their policies across borders which will also reverberate back to each country through economic and financial interlinkages. When considering possible financial imbalances stemming from large capital inflows or inflexible exchange rate regimes, there are no easy solutions which would satisfy each and every country’s needs both from an economic and political standpoint. But since we are all in the same boat, if we all start rowing in different directions, the risks of a fallacy of composition would increase. There are no mechanical or automatic mechanisms which can guide our economic policies. The complexity of how the current crisis unfolded across financial markets and economies as well as the new difficulties that continue to emerge as the global economy moves through the gradual recovery phase, are reconfirming this point. For policymakers, humbly learning from each other’s experiences and deliberate and constructive dialogue, though perhaps not fancy solutions, are essential, as our boat continues through uncharted waters. Bibliography Bank of Japan International Department (2010) “Japan’s balance of payment for 2009”, BOJ Reports & Research Papers. Bernanke (B.) “The global saving glut and the US current account deficit”, Remarks at the Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia. Blanchard (O.) and Milesi-Ferretti (G. M.) “Global imbalances: in midstream?”, IMF Staff Position Note SPN/09/29. Borio (C.) and Disyatat (P.) “Global imbalances and the financial crisis: reassessing the role of international finance”, Asian Economic Policy Review 5, No. 2: 198–216. Feldstein (M.) “Resolving the global imbalance: the dollar and the US saving rate”, Journal of Economic Perspectives 22, No. 3: 113–125. Fender (I.) and McGuire (P.) “Bank structure, funding risk and the transmission of shocks across countries: concepts and measurement”, BIS Quarterly Review, September. Kohn (D.) “Global imbalances”, Remarks at the High-Level Conference on the International Monetary System, Zurich, Switzerland. Obstfeld (M.) and Kenneth (R.) “Global imbalances and the financial crisis: products of common causes”, Paper prepared for the Federal Reserve Bank of San Francisco Asia Economic Policy Conference. Okina (K.), Shirakawa (M.) and Shiratsuka (S.) “The asset price bubble and monetary policy: Japan’s experience in the late 1980s and the lessons”, Monetary and Economic Studies 25, No. S–1: 395–450. Bank of Japan Institute for Monetary and Economic Studies. BIS central bankers’ speeches Shirakawa (M.) “Revisiting the philosophy behind central bank policy”, Speech at the Economic Club in New York. Shirakawa (M.) “Advanced and emerging economies – Two-speed recovery –”, Speech at the Bauhinia Distinguished Talk in Hong Kong SAR. BIS central bankers’ speeches
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Aomori, 23 February 2011.
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Hirohide Yamaguchi: Japan’s economy and monetary policy Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Aomori, 23 February 2011. * * * Introduction I am honored today to have this opportunity to speak and to exchange views with administrative and business leaders in Aomori Prefecture. And I express my gratitude for your cooperation in various business operations of the Bank of Japan’s Aomori branch. I have taken a Tohoku Shinkansen bullet train to come to the region. The full opening of the bullet train line was said to be eagerly awaited by you, and I imagine that you were especially thrilled by the opening. I have heard that you have been working to make the most of the bullet train line to stimulate the local economy, with enhancing the region’s rich tourism resources and public relations activity. As some of you may know, Mitsuru Yoshida, known also for his book Senkan Yamato no Saigo (The last days of the battleship Yamato), was the manager of the Aomori branch from 1965 to 1968. He also wrote a book titled Aomori Sanka (Praise of Aomori). In a chapter on the economy of Aomori Prefecture, he discussed the potential and challenges to the regional economy, and concluded that tapping the limitless potential of Aomori should be the most pleasant mission for people living here. The phrase still gets to our hearts after more than 40 years, and even if we rephrase “Aomori” to “Japan.” Just like your efforts to tap the potential of the Aomori economy, for Japan’s economy as a whole, it has become an important challenge of exploring its potential and paving the way for sustainable growth. Keeping in mind those issues, in my remarks today, I will talk about economic and financial developments at home and abroad and medium- to long-term challenges to Japan’s economy. Then, I will explain the Bank’s policy response. I. Global economic developments Current state and outlook for the global economy I will begin with the developments in the global economy. Looking back on the global economic developments in 2010, in the first half, the economy recovered from the plunge following the failure of Lehman Brothers. The pace of growth slowed from the summer to the autumn. That was because the sharp rise often seen in the early phase of economic recovery slowed down and the effects of various demand-boosting measures, such as subsidies for car purchases, implemented in many countries to address the financial crisis almost ran their course. Since the autumn of 2010, the global economy has gotten out of the temporary deceleration phase and its growth rate has started increasing again. Looking at the developments by region, the growth in emerging and commodity-exporting economies has started accelerating again since the autumn of 2010. Consumption has been buoyant associated partly with improved household income and growth in investment has been high in a broad range of areas including social infrastructures, such as roads and railways, and factory machines and equipment. In addition, on the back of large-scale monetary easing in advanced economies, funds that could not find profitable investment opportunities in their own economies have been flowing in. That has been stimulating BIS central bankers’ speeches economic activity through asset transactions and investment, which has also induced economic expansion in emerging and commodity-exporting economies. Looking at the developments in advanced economies, the U.S. economy has been recovering moderately. Exports, especially to emerging economies, have been increasing, and as for private consumption, Christmas sales in 2010 marked the highest growth since the mid-2000s. While pessimistic views on the prospects for the economy heightened in the summer of 2010, they have rapidly subsided and rather, optimistic views have become prominent, partly reflecting Federal Reserve’s large-scale accommodative monetary policy and fiscal measure of the extension of tax cuts. In that situation, stock prices have been rising. In Europe, countries called peripheral ones such as Greece and Ireland have confronted severe fiscal problems, which I will refer to later, and have been forced to make a difficult economic policy maneuver. By contrast, major economies such as Germany have been strong due mainly to the increase in exports to emerging economies. Economic activity in Europe as a whole has continued to recover moderately, with some differences in pace by country as I have just explained. My projection is that the global economy is likely to continue to record relatively high growth led by emerging and commodity-exporting economies that will continue growing rapidly. The International Monetary Fund projects that the global economy, following a 5 percent growth in 2010, will grow at a high rate of more than 4 percent in 2011 and 2012. The figures are comparable to those during the historical high growth period that had continued for several years prior to the 2008 financial crisis. Uncertainties over the outlook of the global economy The projection I have just noted entails various uncertainties. First, a risk of overheating in emerging and commodity-exporting economies. In those economies, China in particular, amid continuing high growth and capital inflow, economic overheating has become pronounced as seen in rising inflation and asset prices. Therefore, many of those economies have been shifting away from accommodative monetary policies, but concern about overheating of the economy and inflation is not fully dissipated. If overheating of those economies cannot be retrained successfully through somewhat tightened policy conduct, from a longer-term perspective, there is a risk that an unwinding activity from the excess will become large and those economies will be forced to make sharp and substantial adjustments. Second, developments in advanced economies. In the United States and Europe, through the mid-2000s while asset prices including real estate prices were rising, households made excessive borrowing and home purchases, and financial institutions increased lending to an extent that can be seen as excessive from now. It was the generation of the so-called credit bubble. The bursting of that bubble induced a financial crisis and an economic plunge following the failure of Lehman Brothers. Households have had to continue reducing borrowing to repair their balance sheets, which weakened due to a decline in home prices. Financial institutions have also been pressed to dispose of a large amount of impaired assets and become cautious about new lending. As Japan had experienced since the 1990s, once the economy is burdened by balance sheet adjustments, it is likely that economic activity will continue to be in a situation in which it is unlikely to turn upward and remains vulnerable to downward pressure. As I mentioned earlier, in the United States, the optimistic views for the future have recently become strong reflecting favorable economic indicators. However, one cannot deny a possibility that the optimistic views will change in the future. European peripheral countries, such as Greece and Ireland, have been faced with deteriorating fiscal conditions called as a sovereign risk problem. Amid the investment boom due to the credit bubble, the governments borrowed excessively from overseas and, in the process of crisis responses after the bursting of the bubble, the governments expanded their fiscal spending significantly to replace private financial institutions’ risks and debts. That can also be BIS central bankers’ speeches considered one kind of balance-sheet adjustment in the government sector. Since it takes considerable time to solve the problem of fiscal deterioration, due attention should be paid to how, during the process, a spread of concern about such public debt will affect international financial markets. The third uncertainty is developments in international commodity prices and their impact on developments in economic activity and prices in the world. International commodity prices have been on an uptrend since the beginning of 2009. The pace of increase has accelerated especially in food prices since the autumn of 2010, and prices of some nonferrous metals and grains have been around or surpassed their historical highs recorded around the summer of 2008. The factors behind that are the rise in demand due to high growth in emerging and commodity-exporting economies and the decrease in grain supply owing to the adverse weather. The rise in commodity prices seems to have been also boosted by the fact that, amid the large-scale monetary easing in advanced economies, some investment funds have flowed into commodity future markets. At any rate, amid uncertainty about the Middle East, attention should be paid to how international commodity prices will develop and how those developments will specifically affect economic activity and prices both in advanced and emerging economies. II. Developments in Japan’s economy Economic conditions and outlook Based on the developments in the global economy, I will next talk about the developments in Japan’s economy. To state the conclusion in advance, I am currently somewhat optimistic about a short-term economic outlook in the immediate future, but I have no choice but to have a cautious view on a medium- to long-term outlook. Let me first talk about the current state of the economy. Japan’s economy was picking up relatively clearly until around the autumn of 2010, but such improvement paused from the autumn to the end of 2010. As the growth in the global economy decelerated somewhat, exports became somewhat weak, especially of machinery and electronic parts to Korea and Taiwan, partly due to inventory adjustments in IT-related goods such as personal computers. In addition, the plunge following the last-minute increase in demand for energy-efficient cars ahead of the expiration of subsidies has also affected the economy significantly. According to the data released at the beginning of last week, the real GDP growth rate for the October–December quarter of 2010 is minus 0.3 percent on a quarter-on-quarter basis, the first negative growth in five quarters. The GDP data also proved that the improvement in Japan’s economy was in a pause. Economic indicators released after the turn of the year have suggested that Japan’s economy appears to be gradually getting out of the pause. Exports have started to resume an uptrend, as evidenced by high growth across almost all the regions and goods in December 2010. Production, partly reflecting such export developments, has been continuing to increase since November. As for private consumption, sales of electrical appliances such as flat panel televisions increased substantially, almost double the previous year’s level, in November immediately before the revisions in the eco-point system, but the sales suffered the reverse since then. On the other hand, sales of cars have been recovering gradually since bottoming out around October and November, when the sales plunged following the last-minute surge ahead of the expiration of subsidies. Firms’ fixed investment and households’ housing investment have started to pick up. According to the Bank’s quarterly branch managers’ meeting in January, upbeat views expressed by business managers were returning. Such views were that “demand for smart phones and tablet devices has been strong and there are prospects for inventory adjustments particularly of electronic parts to be completed,” or that “orders from emerging economies especially for machine tools have been increasing in number.” BIS central bankers’ speeches As for the outlook, it is projected that Japan’s economy will get out of the pause in the not so distant future and return to the moderate recovery path, on the back of high growth in overseas economies. Prices Let me turn to the price developments. The year-on-year rate of change in Japan’s consumer price index (CPI) excluding fresh food registered a substantial decline of 2.4 percent in the summer of 2009, but the rate of decline has steadily continued to slow since then as the economic slack gradually improved in line with the economic recovery. The latest December figure showed that, excluding a one-off factor of subsidies for high school tuition, the year-onyear rate of change in the CPI was plus 0.1 percent. Given that international commodity prices are on an uptrend while the economy is expected to return to the moderate recovery path, the year-on-year rate of growth in the CPI is likely to gradually increase toward fiscal 2012. However, the base year revision for the CPI, which is conducted regularly every five years, is scheduled for August 2011. In the past five years, goods for which prices declined substantially, such as flat panel televisions, have increased their share in consumption. Partly because that factor will be reflected in the base year revision, it is likely that the yearon-year rate of growth will be revised downward. Including that point, there will still be twists and turns until overcoming deflation is in sight. III. Toward a medium- to long-term revival of Japan’s economy A declining growth rate and its background I have explained that Japan’s economy appears to be getting out of the pause for the time being, and, on the price front, the deflationary situation is improving at any rate. However, there might be not a few people who think that such views do not feel real. One reason for that might be that the recovery is export-led and is mainly enjoyed by large manufacturers and needs some time to feed into domestic private demand and regional economies. However, the greatest concern might be that it is difficult to have prospects for future growth in Japan’s economy and for the industrial structure leading the growth. As a result, many might be feeling that it is difficult to imagine the prospects for the regional economy. I mentioned earlier that I have a cautious view on a medium- to long-term outlook for Japan’s economy. That view probably more or less coincides with your concern. With that, I will move on to discuss Japan’s medium- to long-term growth. The average annual growth rate of Japan’s economy declined significantly from around 5 percent in the 1970s, in the range of 4–5 percent in the 1980s, to around 1.5 percent in the 1990s, and below 1 percent in the 2000s. When the growth rate trends downward in that manner, firms’ and households’ expectations for future growth and future income growth will decline and therefore firms and households will become cautious about their investment and consumption. That has caused a protracted demand shortage in the economy and has become a fundamental cause for deflation. On the fiscal front, the decline in the growth rate has led to an increase in fiscal deficits through, for example, a decline in tax revenues. The fact that the decline in the growth rate is not temporary but prolonged suggests that the growth potential of Japan’s economy has decreased. Various factors have been cited as the reason why Japan’s growth potential has declined. Some have pointed out institutional factors including the delay in regulatory reform. Others have questioned Japan-style management and labor practice. The role of education has also been discussed. While it is true that those factors have been complexly intertwined, broadly speaking, the following can be pointed out. That is, Japan’s various systems, practices, and firms’ principle of behavior that were formed to adapt to the high-speed growth era might not BIS central bankers’ speeches be able to sufficiently adapt to the two significant changes in the environment that evolved since the 1990s. The two changes in the environment were, first the intensification of global competition and second, the demographic vortex. The first change, the intensification of global competition, started to advance from around the end of the 1980s. In the high-speed growth era, Japan had no formidable rivals among industrial countries except for the United States and European countries. Therefore, Japanese firms introduced advanced technologies in the United States and Europe and then implemented a competition strategy in which they increased exports of low-priced, highquality standardized industrial products with relatively inexpensive capital and labor. That was an optimal strategy at that time. However, amid the rapid progress in the globalization of a market economy, such as China’s and other emerging economies’ entry as peers of a market economy, and the striking development of the information and telecommunication technology, the global economy entered the era of so-called mega competition. The environment changed so that competition to reduce capital and labor costs became severe, and at the same time, firms around the world had to compete fiercely seeking for earning opportunities by utilizing IT technologies. It has become difficult for a firm to enjoy high profits unless it uncovered a new business area ahead of other firms around the world and allocated management resources such as personnel and capital promptly and intensively to such new business area. It exactly became an era when selecting and concentrating resources in key strategic areas have increasingly been required. The second change in the environment is the demographic vortex. Japan’s working-age population, namely, the population aged between 15 to 64, started to decline in the mid1990s, and the total population peaked in 2007. That exactly shows that population aging is rapidly progressing. The rate of the elderly population aged over 65 to the total population was 9 percent in 1980 and more than doubled in 2009 to 23 percent. If the trend continues, the ratio of the elderly population is projected to rise to nearly 40 percent in 2050. Population aging will hamper growth from the supply side of the economy in that it will bring a shortage of workers. To address that issue, it is necessary to make further efforts to increase female labor market participation and accept foreign workers. At the same time, population aging will have a large impact on the demand side of the economy; for example, it will bring a substantial shift in the components of consumer demand. Specifically, there is a possibility that demand for homes, cars, and eating out will decrease, while demand for health and nursing care, as well as businesses such as tours targeting the elderly will increase. A key to winning competition is how firms will be able to respond to such substantial shift in demand for goods and services. In sum, the two changes in the environment indicate that the source of economic growth would expand substantially from advanced economies such as Japan, the United States, and Europe, to a broader world including emerging economies, and in terms of domestic markets, from markets especially for young and middle-aged generation to broader markets for a wider range of generations including the elderly. The decline in Japan’s growth potential since the 1990s suggests that Japanese firms were not able to sufficiently adapt to such changes in the environment. Policy direction If we summarize such significant changes in the environment taking place in Japan and their impact in that way, we can see that addressing the change in the demand structure will be a key to increasing the growth potential of Japan’s economy. In that regard, it is critical to create an environment, in which firms can embark on new business areas with creative ideas, and smoothly transfer their management resources, such as personnel and capital, to those areas. If I point out some critical challenges, promoting deregulation remains to be one of those. There have been some areas, such as mobile phones and couriers whose markets have BIS central bankers’ speeches expanded due to deregulation. Those often pointed out as promising areas are health and nursing care as well as education. While it is true that the institutional design in those areas is required to take account of safety and fairness, it is also the fact that regulations have shrunk room for originality and ingenuity of private firms, as seen in the difficulty in integrating kindergartens and nursery schools. In addition, population aging can provide new business opportunities if new demand is tapped through the collaboration between different areas such as tourism and health and nursing care. Not to hamper the creation of a crossindustrial business model, efforts to constantly review the regulations are essential. Moreover, in promoting creative corporate activity, it is important to create an environment that will ensure the smooth transfer of resources both in terms of personnel and of capital and funds. As for personnel, while there are industries with excess employment on one hand, there are industries, including nursing, which are short on staff on the other hand. To resolve such mismatch, it is necessary to further enhance the flexibility of the labor market by, for example, making job changes easier. The weakness of Japan’s economy is that such lack of market flexibility is observed here and there. In addition, the expansion of a safety net including unemployment policy will be important in generating personnel who make challenges for new business areas. That is because without a framework for supporting those who have taken risks and make challenges by society as a whole, the transfer of personnel resources to new business areas will not make progress. As for capital and funds, it is critical to have an environment that will enable them to be allocated smoothly to growth areas. It is a fundamental function of financial markets to discover promising businesses and investment areas and allocate capital and funds to them. For firms that raise funds, a hurdle in embarking on new businesses will become lower by obtaining funds from financial institutions and markets. On the other hand, it is also possible to encourage firms’ efforts to increase profitability by attaching severe terms to businesses with low profitability accordingly. In that regard, financial institutions are particularly required to identify promising businesses and flexibly provide funds to them. In addition, it is essential to have the so-called risk money to foster new growth areas. In other words, it is important to improve various financial markets such as for stocks, corporate bonds, and asset-backed securities, which are underwritten using firms’ receivables and assets such as real estate as collateral. While the measures I have mentioned are not achieved easily, given that Japan’s economy continues to be stagnant for such a protracted period and is burdened by a serious challenge of further aging of the population in the future, there is no time to lose. I do not have time to go into details today, but fiscal consolidation is also an important topic that should be kept in mind. The deterioration in fiscal conditions would become a factor to restrain spending especially of working-age generations by reducing their expectations for future income growth. If firms’ and households’ sense of security about the outlook will be fostered through fiscal consolidation, it will stimulate spending and also contribute to increasing the growth potential of the economy. I recognize that, with a view to raising the growth potential of Japan’s economy, it is significant that various entities including the Bank work on addressing problems, with a widely shared sense of urgency. IV. The Bank of Japan’s policy response I will now explain the Bank’s policy response. The Bank has implemented various measures not only to address the challenge of ensuring economic recovery and overcoming deflation, but also the medium- to long-term structural challenge of increasing the growth potential of Japan’s economy. That is because the Bank considers that the decline in growth potential lies at the root of deflation. In October 2010, the Bank adopted a powerful monetary policy package of “comprehensive monetary easing.” Specifically, the uncollateralized overnight call rate, which is the policy BIS central bankers’ speeches interest rate, is encouraged to remain at around 0 to 0.1 percent. The Bank has also committed itself to continue the virtually zero percent interest rate level until it judges that price stability is in sight. That is considered to encourage longer-term interest rates to be low and stable. Moreover, the Bank has implemented an Asset Purchase Program to purchase not only safe assets as government securities but also purchase risk assets such as CP, corporate bonds, investment funds that link stock price indexes, and real estate investment trusts. The outstanding amount of total assets purchased, including those through the operation that provides funds at a fixed low rate, has set to be about 35 trillion yen by around the end of 2011. The measure aims at influencing longer-term interest rates and, from a viewpoint of enhancing economic growth potential, is also expected to activate the flow of risk money. In the measure, the purchase of risk assets in particular is extraordinary for a central bank. The Bank ventured to decide to implement it with a view to promptly overcoming deflation. Moreover, in 2010, the Bank introduced a new framework of lending called the “fundprovisioning measure to support strengthening the foundations for economic growth.” Through the measure, the Bank provides long-term funds at a low interest rate to private financial institutions that are making efforts in terms of lending and investment toward increasing the growth potential of Japan’s economy. The total amount of loans provided so far in two disbursement accounts for about 1.5 trillion yen, and the third disbursement is scheduled for the beginning of next month. In response to the Bank’s measure, financial institutions have been preparing a framework for actively supporting lending and investment by, for example, establishing special sections devoted to investment and lending to the new areas of growth or establishing new credit lines. There seems to be some firms that have taken a more active stance of fixed investment in new growth areas. With such new moves emerging, it seems that the recognition that increasing the growth potential of the economy is a pressing challenge has started to spread. Including such a change in the recognition, the fund-provisioning measure seems to start gradually producing expected positive effects as a catalyst. The Bank will continue to examine possible ways to strengthen the foundations for economic growth. Concluding remarks I have talked about the economic and financial developments at home and abroad, the medium- to long-term challenges to Japan’s economy, and the Bank’s monetary policy conduct. In closing, I will offer my view on the potential of Aomori’s economy based mainly on what has been reported from the Bank’s branch. In the Aomori Prefecture’s basic plan, “A Challenge for the Future,” which indicates the state of the region in 2030, three industries of food, energy, and tourism are identified as major industries. In the food industry, I hear that agriculture and fishery industries are aiming at increasing profitability by establishing an integrated production and sales system that contains from processing to distribution procedures. I also hear that efforts have been made to expand exports especially to emerging economies. For example, Aomori’s apples have established their brand recognition as high grade fruit, and further expansion of exports is expected. As for energy-related businesses, nuclear power generation has already been established as a key industry in the region and several nuclear reactors are under construction. In addition, a plant for nuclear fuel cycle, which is the only such plant in Japan and the fourth one in the world, has been preparing for its operation. The volume of wind power generation in Aomori Prefecture is number one in Japan. It is proved that Aomori is exactly in the front line of renewable energy. With regard to the tourism industry, Aomori Prefecture is blessed with attractive tourist spots such as Lake Towada and Mount Osore. It is also endowed with cultural events including the BIS central bankers’ speeches Nebuta Festival, as well as an abundance of seafood. It is projected that the full opening of the Tohoku Shinkansen Line will lead to a further increase in the number of tourists. Strengthening tourism is an effective tool for tapping demand not only in Japan but also in emerging economies especially in Asia. In the meantime, I understand that financial institutions in Aomori Prefecture have been active in supporting firms in such areas as nursing care and other health care and welfare services as well as food-related areas including agriculture by partly utilizing the Bank’s “fund-provisioning measure to support strengthening the foundations for economic growth.” With those various efforts, Aomori Prefecture has been demonstrating its potential while incorporating the vitality of rapidly growing Asian countries. I wish you the best of success. The Bank will continue to firmly support economic activity in various areas from the financial side and continue to consistently make contributions as the central bank in order for Japan’s economy to return to the sustainable growth path with price stability. BIS central bankers’ speeches
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Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the International Symposium of the Banque de France: Regulation in the Face of Global Imbalances, Paris, 4 March 2011.
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Kiyohiko G Nishimura: A central banker’s perspective on the international monetary system Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the International Symposium of the Banque de France: Regulation in the Face of Global Imbalances, Paris, 4 March 2011. * * * Introduction The theme of this panel, “Towards which international monetary system?” is a grand theme which cannot be easily captured in a ten minute intervention. So, I will focus on two issues. One is the over-arching issue of how to understand the role and limitations of the current international monetary system, or IMS. The other is the challenges for central bankers in fulfilling our responsibilities within the current IMS. The role and limitations of the current IMS First, the current IMS. The IMS provides a critical underpinning for the global economy. It enables the efficient and smooth allocation of goods and services as well as capital, both domestically and in a cross-border context. The central issue confronting the current IMS is how to introduce symmetrical adjustment between external surplus and deficit countries. The current IMS does not have a built-in mechanism which automatically fosters a balanced adjustment process. The United States as the main reserve currency country has little incentive to reduce its current account deficit, especially because once a currency is established as the main reserve currency, there is a strong inertia to continue its use. On the other hand, surplus emerging economies are expanding their foreign currency reserve holdings both from a precautionary motivation and from the perspective of maintaining their export competitiveness. To the extent domestic price developments are manageable, there are few constraints to this strategy. Past attempts to reduce imbalances have been conducted mostly on a bilateral basis and have, in some cases, turned into quite contentious discussions and negotiations. Another issue regarding the IMS is the extent of the adjustment that would be required among surplus and deficit countries. The distinction between longer-term trends in investment-savings balance, which are strongly influenced by the stage of economic development and demographics, and short-term cyclical trends, is not necessarily straightforward. For example, in the 1980s there was substantial pressure on Japan to reduce its trade and current account surplus. However, such pressure could easily turn into misdirected attempts. In the Japanese case, using macro-economic policies, especially accommodative fiscal and monetary policy, failed to achieve its goal and rather contributed to foster an environment where it became more difficult for authorities to act promptly when there were signs that the economy was overheating. We all know where this ended up. That is why the G20 mutual assessment process which aims to bring about strong, sustainable and balanced growth and reduce persistent large imbalances, and the G20 discussions on the IMS, such as dealing with global capital flows and global liquidity, are interlinked. Combined, they are expected to work to enhance the long-term stability of the global economy and financial system. What is important here is that the mutual assessment process will likely be, at least in its initial phase, a process through which countries better understand each others’ policies and the implications of their domestic policies on other countries. This will become the basis for constructive dialogue aimed at reaching an optimal combination of economic policies across multiple countries. The reform of the IMS will also be a long-term project. A caveat here in this global debate is that there will not be any single BIS central bankers’ speeches model or concept applicable to all countries and situations. A thorough analysis, taking into consideration each country’s unique situation, both cyclical and structural aspects, will be required. Even the IMF with its immense amount of expertise and resources has struggled to identify unsustainable imbalances over the years. In 1989, in the Article IV discussion for Japan, staff noted that inflation in Japan was not “a matter of concern” and therefore “no compelling reason” could be found to tighten monetary policy. In the 2007 Article IV Staff Report for Ireland, it explained that “economic performance remains impressive” and that “banks have large exposures to the property market, but stress tests suggest that cushions are adequate to cover a range of shocks.” The IMF Staff Report for the US in 2007 also presented “a soft landing” as the most likely scenario. It also noted that “financial innovation and stability have underpinned US economic success.” The limitations of IMF surveillance in the run-up to the current global crisis are detailed in the recently published IEO1 report. I am not trying to single out the IMF for criticism. Nobody was completely successful in recognizing beforehand the emergence of bubbles and the huge negative impact after its collapse. I simply wanted to highlight that when a single approach toward assessing an issue dominates the intellectual climate, it can cloud our judgment in finding emerging risks which could be seen when approached from a different angle. The challenges for central bankers in the current IMS Let me move on to the challenges for central bankers in the current IMS. I would like to raise three aspects. First, the implementation of macro-prudential policy. The recent global financial crisis has brought to the forefront the importance of macro-prudential policy. We have not been able to nail down its definition nor come up with a comprehensive toolkit. It may take some time before we can make it truly operational. But, we do need to recognize that it took a couple of decades before the importance of price stability for macro-economic stability was fully appreciated and became embedded in central banks’ monetary policy framework worldwide. Second, dealing with tail risks. Taking preemptive action to avoid the emergence of bubbles which can seriously harm the economy means implementing measures to prevent the build-up of tail risks or occurrence of low-frequency, high-severity events. The independence and the need for a clear mandate are often emphasized as an important basis for a macroprudential authority. However, I believe that is not enough. A fundamental change in the way economic policy is perceived is called for. A collective understanding within society that it would be acceptable and appropriate for the macro-prudential authority to take away the punch bowl when conditions still seem to be benign, is necessary. This is a large change from the current policy paradigm, where measures are typically introduced after specific negative shocks occur. Third, the cross-border spillover effects of policy actions. Due to continuing globalization and financial innovation, the interlinkages among economies and financial markets continue to strengthen. In this environment, regardless of whether it is monetary policy or macroprudential policy, policy-makers will have to inevitably be cognizant of the cross-border implications of their policy actions. It also needs to be recognized that there will be feedback effects from overseas economies and markets which will influence domestic economic and financial conditions. Forums such as the BIS have played critical roles in enhancing central bank communication and cooperation over the years. Their importance will increase further in such an environment. Independent Evaluation Office of the International Monetary Fund. The IEO released a report titled the “IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004–07” in January 2011. BIS central bankers’ speeches I will not go into details here, but issues such as strengthening the plumbing of the financial system though, for example, further improvements in foreign exchange settlement, and enhancing the framework for resolving cross-border failures of financial institutions must not be forgotten as well. Concluding remarks Already forty years ago, the Nobel Prize-winning economist Sir John R. Hicks predicted that in a globalized financial market “a national central bank will no longer be a true central bank,” but will become “single banks in a world-wide system.” Whether we like it or not, this is clearly the direction we are heading. BIS central bankers’ speeches
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Summary of a speech by Ms Miyako Suda, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Yamagata, 1 December 2010.
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Miyako Suda: The current situation of and outlook for Japan’s economy and the conduct of monetary policy Summary of a speech by Ms Miyako Suda, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Yamagata, 1 December 2010. * * * Introduction It is a great pleasure to address this meeting on economic and financial matters. The topic I would like to discuss today is the current situation of, and outlook for, Japan’s economy and the Bank of Japan’s conduct of monetary policy. Let me begin by looking at developments in economic activity and prices in Japan. I. Economic activity and prices in Japan A. The current situation Japan’s economy still shows signs of a moderate recovery, but the recovery seems to be pausing. Exports and production, which had been increasing reflecting the improvement in overseas economic conditions, have recently been decelerating as the pace of recovery in overseas economies is slowing down. Private consumption had continued to recover mainly due to the effects of various demand-boosting policy measures targeted at durable consumer goods, but more recently has been decreasing following the spike in demand before these policy measures expired. I will first look at developments in demand, economic activity, and prices overseas, and then make a more detailed examination of domestic demand in Japan. 1. Overseas demand, economies, and prices Breaking down Japan’s real exports by destination, East Asia accounted for more than 50 percent, the United States and the European Union for slightly less than 30 percent, and other countries for the remaining 20 percent. Until recently, Japan’s real exports had been on an upward trend, led by the increase in exports to emerging and commodity-exporting economies. However, growth in exports has recently been decelerating due to a number of factors, including measures by the Chinese government to prevent an overheating of the economy, the effects of which have materialized with a time lag; inventory adjustments in ITrelated goods, particularly with regard to those exported to the NIEs and ASEAN countries; and the appreciation of the yen. a. Overseas economies I will now move on to developments in overseas economies as a whole, which underlie the trends in Japan’s real exports. With inventory restocking – the driving force of the recovery after the Lehman shock – having run its course and the demand-boosting effects of fiscal policy measures waning, the pace of economic growth has been slowing since summer 2010. Looking at developments by region, the U.S. economy is continuing to recover moderately although the pace has slowed. However, the situation in the housing market remains uncertain, and with home sales, housing starts, and home prices all remaining at low levels, there are persisting concerns about home foreclosures and buybacks brought about by mortgage delinquencies. Many homeowners suffer from negative equity, and balance-sheet adjustment pressures continue to weigh heavily on households. As for the employment and income situation, neither the unemployment rate nor nominal wages have shown a notable recovery. In these circumstances, private consumption on the whole lacks momentum. BIS central bankers’ speeches Economic activity in the euro area as a whole is recovering moderately, with some differences in growth by country. Although the pace has recently slowed, exports have continued to increase, while private consumption has been rising gradually. However, market concerns regarding sovereign risk in some euro area countries have resurfaced amid uncertainty regarding the response of governments. Thus, financial markets in the United States and Europe partially show signs of instability and warrant continued attention. On the other hand, though the pace has slowed somewhat, emerging and commodityexporting economies continue to grow at a relatively rapid pace, led mainly by domestic demand. In China, economic growth has been accelerating again. The pace of increase in China’s exports has been slowing due to the deceleration in overseas economies, but growth in private consumption has been firm due to households’ higher income levels. Fixed investment continues to show high growth despite a slowdown partly due to government measures to rein in real estate transactions and energy consumption. With regard to economic conditions in the NIEs and the ASEAN countries, although growth in exports and production has slowed sharply due to the deceleration in overseas economies and adjustments with regard to IT-related goods, the recovery trend remains intact supported by firm domestic demand. As for the outlook, though the pace of growth in overseas economies will probably continue to slow for the time being, the recovery trend itself is likely to remain intact, and from 2011 the growth rate will start to increase again. Looking at developments by region, emerging and commodity-exporting economies, including China, despite a temporary slowdown, will continue to grow at a relatively rapid pace, supported mainly by robust domestic demand. Meanwhile, the effects of balance-sheet adjustments will continue in the U.S. economy, but growth there is expected to accelerate again from 2011 on the back of a rise in exports, mainly to emerging and commodity-exporting economies, and a moderate recovery in business fixed investment and private consumption. Economic activity in Europe on the whole is likely to continue to recover moderately, although the pace of recovery will differ by country. b. Overseas prices As for the price situation in overseas economies, a significant divergence can be observed between advanced economies and emerging and commodity-exporting economies. The U.S. and European economies continue to experience disinflationary tendencies due to the slack in supply and demand conditions in the goods and service markets as well as in the labor market. For example, in the United States, the rate of change in the core personal consumption expenditure (PCE) deflator fell to 0.9 percent on an annual basis in October, and the rate of increase in the consumer price index (CPI) is likely to remain low for the time being. In this situation, following the speech made by Federal Reserve Chairman Ben S. Bernanke on August 27,1 markets started to factor in possible additional monetary easing, and transactions based on the anticipation of a reversal in the disinflation trend increased – as evident from, for example, the rise in the breakeven inflation rate, which is a measure of medium- to long-term inflation expectations. Moreover, concerns about the risk of inflation have been raised following the Fed’s decision on November 3 to conduct large-scale purchases of longer-term Treasury securities totaling 600 billion U.S. dollars. As for emerging and commodity exporting economies, inflationary pressure has been increasing due to higher natural resource and food prices and greater utilization of production factors. In fact, in some countries, including China, inflation has already started to pick up. One reason is the acceleration of capital inflows to emerging economies caused by monetary See “The Economic Outlook and Monetary Policy,” a speech made by Chairman Bernanke at the Federal Reserve Bank of Kansas City Economic Symposium in Jackson Hole, Wyoming, on August 27, 2010. BIS central bankers’ speeches easing in advanced economies, especially the United States. This means that, given the socalled “trilemma of international finance” – the impossibility of simultaneously pursuing a stable exchange rate, free capital movements, and an autonomous monetary policy – in some countries, the conduct of monetary policy may be affected by interventions in the foreign exchange market to avoid a surge in the exchange rate, resulting in a delay of necessary adjustments in monetary policy. 2. Domestic demand in Japan Turning to domestic demand in Japan, business fixed investment is showing signs of picking up, supported mainly by the improvement in corporate profits. Specifically, the aggregate supply of capital goods, a coincident indicator of machinery investment, has registered a moderate increase, while there has been a substantial increase in machinery orders, a leading indicator of machinery investment. The employment and income situation, although remaining severe, has eased somewhat, with a slight rise in the number of employees and in wages, as well as a gradual improvement in the ratio of job offers to applicants. In this situation, growth in private consumption until September turned out stronger than expected, reflecting the last-minute rise in demand ahead of the expiration of subsidies for purchasers of environmentally friendly cars and the increase in the tobacco tax, in addition to the boost from the extremely hot weather. Since the beginning of October, however, private consumption has dropped following the earlier spike in demand. Meanwhile, housing investment has stopped declining, with the number of housing starts (a leading indicator of housing investment) – especially those for the sale of real estate lots – generally picking up and sales of apartments in the Tokyo metropolitan area increasing. On the other hand, public investment has been declining since the second half of 2009. Given this situation in domestic and overseas demand, domestic growth in production has lost momentum. Production dropped in September, mainly due to the decline in production of cars and semiconductor and related products reflecting the decrease in demand following the expiry of government measures. The drop was also seen on a quarterly basis.2 Consequently, inventories have been increasing somewhat, mainly in durable consumer goods and in electronic parts and devices. 3. Prices in Japan With regard to price developments in Japan, the CPI excluding fresh food is declining on a year-on-year basis due to the substantial slack in the economy as a whole, but the pace of decline has continued to slow. In October, the year-on-year pace of decline in the CPI slowed significantly due especially to the increase in the tobacco tax. B. The Outlook 1. The October 2010 Outlook Report As we have seen so far, Japan’s economy is still showing signs of a moderate recovery, although the pace of recovery seems to have temporarily slowed. The key issue is how to come out of this temporary slowdown. Let us therefore consider the outlook for economic activity and prices in Japan, which the Bank released in the October 2010 issue of the Outlook for Economic Activity and Prices (hereafter the Outlook Report). As a result of the revision to seasonal adjustments carried out in April 2010, it is likely that a portion of the significant drops in production in the October-December quarter of 2008 and the January-March quarter of 2009 is recognized as seasonal rather than actual movement. Such a seasonal adjustment method would push up future growth rates for the October-December and January-March quarters, but push down those for the April-June and July-September quarters. Therefore, it is necessary to assess actual terms for the AprilJune and July-September quarters by adjusting for such downward pressure. BIS central bankers’ speeches Starting with the outlook for the economy, the pace of recovery is likely to slow temporarily in the second half of fiscal 2010 due to factors such as the slowdown in overseas economies and the ending of the boost from policy measures targeted at durable consumer goods, as well as the recent appreciation of the yen. The growth rate of the economy for the October– December quarter of 2010, in particular, is highly likely to turn out negative following the higher-than-expected growth in the July–September quarter. However, although the effects of the appreciation of the yen may continue to linger, the economy is expected to return to a moderate recovery path once we enter fiscal 2011, given that – with growth in overseas economies expected to pick up again – exports are projected to continue increasing and firms’ sense of excessive capital stock and labor is likely to dissipate gradually. In fiscal 2012, Japan’s economy is expected to continue growing at a pace above its potential amid the continued relatively high growth in overseas economies, especially emerging and commodity-exporting economies. Although my view regarding the outlook is basically in line with the Bank’s projection, I am concerned about the extent to which Japan’s economy will be able to benefit from global economic growth. In fact, I have a growing sense that Japan has not yet enjoyed much success in this regard, given that the pace of growth in Japan’s exports has been more moderate than that of other countries since the mid-1990s and that Japan’s share in world exports has been declining since the mid-1990s despite trade liberalization in countries such as China. Moreover, Japan is likely to face an even tougher global competitive environment due not only to the recent rapid appreciation of the yen – in a situation where domestic capacity is yet underutilized – but also to factors unrelated to foreign exchange – such as the technological catch-up of emerging economies and the increase in free trade agreements concluded abroad – some of which I will discuss later. In addition, issues that directly affect the competitiveness of Japanese firms, such as various environmental constraints, the tax burden, and labor laws and regulations, still give cause for concern. Thus, attention should be paid to the growing possibility that the Japanese economy and Japanese firms will not be able to benefit from global demand to the extent commonly expected. As for the price outlook, the year-on-year pace of decline in the CPI excluding fresh food is expected to continue slowing as the aggregate supply and demand balance is projected to continue improving gradually in a situation where medium- to long-term inflation expectations are assumed to remain stable. In the Outlook Report, the Bank projected that the timing of the year-on-year rate of change in the CPI entering positive territory would likely be sometime in fiscal 2011, and that thereafter the rate of increase would start rising through fiscal 2012. However, I have a more cautious view of future developments in prices. Let me explain why this is the case. 2. Views on the expected rate of inflation When examining the outlook for price developments, key aspects to be considered are the size of the output gap, the expected rate of inflation, and import prices. In addition, empirical studies show that the current rate of inflation is also affected by past inflation. Thus, empirical analyses of inflation dynamics often use the following type of specification: Inflation rate for the current term = γ × (the expected rate of inflation for the next term) + (1 – γ) × (the inflation rate for the previous term) + β × (the output gap for the current term) + α × the rate of change in import prices, where α, β, and γ are parameters. A frequent criticism of this type of specification is that the inclusion of the inflation rate in the previous term lacks microfoundations and its role is therefore difficult to interpret. However, one possible interpretation is that the rate of inflation not only is determined by medium- to BIS central bankers’ speeches long-term inflation expectations but also may be affected by short- to medium-term inflation expectations that are influenced by actual inflation in the past. According to this interpretation, the key question for Japan at the moment is which of the two influences is stronger – positive medium- to long-term inflation expectations or negative inflation rates in the past.3 It goes without saying that for Japan it is important to enhance the influence of medium- to long-term inflation expectations on the actual rate of inflation. However, I believe it will not be easy to do this given the prolonged deflation Japan has been suffering. Furthermore, it seems that Japan is not the only country where the influence of medium- to long-term inflation expectations is weak. Though the context differs, in the United Kingdom – where the inflation rate has exceeded the ceiling of the target for almost a year – the possibility of a rise in medium-term inflation expectations driven by past rates of inflation is considered a serious risk.4 Furthermore, in the United States, concern has been voiced over the possibility of the current disinflation depressing medium-term inflation expectations.5 Moreover, given that inflation rates in the past were influenced by the output gap at the time, the fact that current inflation is affected by past inflation means that current inflation is determined not only by the output gap at present but also that in the past. Given that the utilization rate of Japan’s economy remains low and growth in the third quarter of fiscal 2010 is expected to be negative, little improvement is likely in the output gap. The effect of this output gap on future inflation cannot be ignored, and the influence of medium- to long-term inflation expectations on current inflation is not likely to be very strong. 3. Japan’s response to globalization Needless to say, Japan’s response to globalization is also an important factor when considering the outlook for price developments. The Japanese economy has stagnated for more than ten years and prices have been on a downward trend for much of that period, and it is clear that globalization – through the increase in low-priced imports and intensified competition – has played a role in this.6 The forecast for the medium- to long-term rate of inflation by economists has been stable at around 1 percent for the past few years. At a press conference in November 2010, Bank of England Governor Mervyn King stated, “And if the period of above-target outturns causes medium-term expectations to drift up, then the inflation outlook could be significantly higher” (Bank of England, Inflation Report Press Conference Opening Remarks by the Governor, 10th November 2010), and “If inflation expectations start to move away from target in a way that threatens the behaviour of inflation in the medium term, then we certainly would be concerned. And that is obviously the major upside risk and we talk about that at great length in the [Inflation] Report” (Bank of England, Quarterly Inflation Report Q&A, 10th November 2010). Moreover, at the Monetary Policy Committee meeting in November, it was stated that “some Committee members were concerned that recent inflation outturns and the higher near-term profile meant that the risk to inflation expectations was somewhat greater than previously thought” (Bank of England, “Minutes of the Monetary Policy Committee Meeting 3 and 4 November 2010”). See, for example, William C. Dudley’s speech entitled “The Outlook, Policy Choices and Our Mandate,” given at the Society of American Business Editors and Writers Fall Conference at the City University of New York on October 1, 2010. At the Federal Open Market Committee (FOMC) meeting held on June 22 and 23, 2010, it was stated that “some participants judged the risks to the outlook for inflation as tilted to the downside, particularly in the near term, in light of [. . .] the possibility that inflation expectations could begin to decline in response to low actual inflation.” Moreover, the minutes of the FOMC meeting held on November 2 and 3, 2010 stated that “participants citing downside risks noted concerns about the degree to which lingering resource slack in the economy was putting downward pressure on inflation, or about the possible effects that an extended period of low readings on actual inflation might have in reducing inflation expectations.” For details on structural issues in Japan that form the background to the prolonged deflation, see the speech I delivered at the University of Tokyo on December 1, 2010 entitled “Seichoukiban Kyouka no Juuyousei to Kin’yuseisaku (The Importance of Strengthening the Foundations for Economic Growth and Monetary Policy)” (available in Japanese only). BIS central bankers’ speeches With regard to globalization, one issue that I have recently been concerned about is the effect on Japan’s economy and prices of the rapid technological catch-up of emerging countries with Japan. In recent meetings with corporate managers, I increasingly hear that firms from emerging economies have, for example, been acquiring at low cost facilities made redundant at Japanese firms through restructuring and absorbing production know-how by employing expert technicians retired from Japanese firms, including from small and mediumsized firms, enabling emerging economies to catch up rapidly with Japanese firms with respect to production technology and skills. If the production technology of emerging countries were to improve rapidly, this would not only further intensify global competition but, from Japan’s perspective, also increase the impact of exchange rate fluctuations on exports due to the increased price elasticity of exports. In addition, the possibility of competitive disadvantages due to factors other than the exchange rate, such as tariffs, is increasing, so that exporting firms in particular will have no choice but to cut costs further in order to maintain their competitiveness. Traditionally, Japanese firms have tended to raise productivity through advances in labor-saving technology and cost cutting; however, given that there still remain significant wage differentials with emerging economies, it is possible that firms will seek to lower labor costs further by shifting more production bases overseas, replacing full-time employees with part-timers, and shortening working hours. For this reason, downward pressure on wages is likely to increase, in which case upward pressure on prices – including prices of services, which are affected by wages – will weaken. Considering the price-setting behavior of firms in a situation where competition with overseas firms is expected to increase, I cannot help but be cautious with regard to the outlook for prices. In view of what I have described, I believe that the probability that the year-on-year rate of change in the CPI will leave negative territory during fiscal 2011 is not high and that it will take some time to attain conditions necessary to overcome deflation. The probability is pushed down further by the scheduled change in fiscal 2011 of the base year for the CPI to 2010, as explained in the Bank’s Outlook Report.7 C. Risk factors As stated in the introduction of the October 2010 Outlook Report, a careful analysis of both upside and downside risks is of great importance due to the high level of uncertainty in the current economic situation and the considerable risk that the economy may deviate from the scenario considered most likely by the Bank. In the October 2010 Outlook Report, the following risk factors regarding economic activity were identified: (1) developments in advanced economies; (2) developments in emerging and commodity-exporting countries; (3) developments in business and household sentiment; and (4) firms’ medium- to long-term growth expectations. Risks regarding price developments included (1) the materialization of upside and downside risks regarding economic activity; (2) medium- to long-term inflation expectations of firms and households; (3) the uncertainty in gauging the aggregate supply and demand balance and its impact on prices; and (4) developments in import prices. I personally am also conscious of these risk factors. In what follows, I will consider them in greater detail. See Footnote 8 in “The Bank’s View” of the October 2010 Outlook Report, which stated, “This outlook for inflation is predicated on the 2005-base CPI. The statistics authority has announced that the base year for the CPI is scheduled to be changed to 2010 in August 2011, and year-on-year figures as far back as January 2011 are scheduled to be revised retroactively. This rebasing is likely to cause the year-on-year rate of increase in the CPI to be revised downward.” BIS central bankers’ speeches 1. Risks concerning overseas economic activity and prices I will first look at risks concerning overseas economies. In advanced economies, room for further fiscal stimulus measures is limited (and emphasis is in fact shifting to fiscal consolidation), and downside risks such as balance-sheet adjustments in the United States and Europe and a high level of uncertainty remain. On the other hand, in emerging and commodity-exporting economies, where governments have room for further policy actions, there are upside risks such as a further acceleration of the economy. Thus, at present, risks concerning overseas economies seem to be well balanced, although the level of uncertainty is high. However, as I mentioned earlier, considering the current economic situation and the level of asset prices in emerging and commodity-exporting economies, adjustments to the accommodative monetary policies there seem to be somewhat delayed. Against this background, upward pressure on prices, including those of commodities and food, is heightening. Thus, the risk of economic overheating and a subsequent rapid reversal appears to have grown slightly. Although I mentioned that emerging and commodity-exporting economies seem to have fallen somewhat behind in adjusting accommodative monetary policies, it would be inappropriate to focus on these countries alone. The sharp contrast in price developments between advanced economies and emerging and commodity-exporting economies – with the former facing disinflation and the latter inflation – combined with global external imbalances poses great difficulties for policymakers in countries around the world. At the same time, I am increasingly concerned that when policy actions are taken they might – contrary to intentions – widen fluctuations in real economic activity and prices around the world. This is because the economic size of emerging and commodity-exporting economies as a group is approaching that of advanced economies as a group, and the closer the size of the economies of the two groups, the more their policy actions affect each other. In terms of policy effects, this means that the feedback effects of policies also increase accordingly through this external economic impact. However, given the lack of adequate information on the domestic economy and overseas economies, and due to differences in exchange rate regimes and in capital mobility, it is difficult to accurately gauge the impact of such feedback effects and the spillover effects from policies undertaken by other countries.8 2. Risks concerning the domestic economy Next, I will talk about the risks concerning the Japanese economy. At present, financial markets cannot be described as stable due to the great uncertainty surrounding the economy and financial markets, and the volatility in the degree of risk tolerance in financial markets. Given the low capacity utilization in the economy, the recent appreciation of the yen, and the deterioration in corporate and consumer sentiment, there remains a high risk that the expected temporary weakness in the economy will persist. From a longer-term perspective, a downside risk of concern is that the expected growth rate may fall much further than expected. Following the bursting of the bubble economy, Japan was preoccupied with addressing the legacy of the bubble and failed to take sufficient measures to deal with major issues such as the large fiscal deficit and the aging and shrinking of the population. And this, I believe, is the fundamental reason why Japan has been unable to raise the expected growth rate. Another major reason is that Japan has not responded sufficiently, or has been slow to respond, to structural changes in the global economy, in particular the rise of emerging and commodity-exporting economies. Put Generally speaking, in a two-economy setting where one economy is large and the other small, the small economy will be affected by policy decisions of the large economy, while the policies of the small economy will not affect the large economy. However, if both economies are of a similar size, their policies will affect one another and it is therefore necessary to pay close attention to feedback effects. See, for example, chapter 18 of International Economics by Robert A. Mundell. BIS central bankers’ speeches differently, as I pointed out earlier, Japan has not been able to benefit fully from global economic growth.9 Against this background, many Japanese firms have recently been developing new products and expanding international sales networks in order to capture infrastructure and consumption demand in emerging and commodity-exporting economies. Among these firms, some are aiming to restructure their business strategies from a global viewpoint by acquiring overseas firms, making use of the strong yen. Such a constructive approach could increase corporate confidence and dispel the prevailing sense of gloom, leading possibly to an increase in the expected growth rate. If, however, firms that are developing business overseas place priority on strengthening overseas production by shifting production abroad and/or closing down domestic bases altogether, the impact on the Japanese economy – and especially the direct impact on subcontractors and sub-subcontractors – would be quite severe because of the large spillover effects from exporters.10 In fact, the Bank’s Regional Economic Report released in October 2010, based on information gathered from its Head Office and branches, highlighted the concern raised by some that increased overseas production was restraining new hiring in Japan.11 Thus, there is a risk that Japan’s expected growth rate will decline unless all economic players take forward-looking action in their respective fields. 3. Risks concerning prices The last issue is risks concerning prices. An increase in commodity prices brought about by high growth rates in emerging and commodity-exporting economies could cause prices in Japan to rise more than expected. At present, international commodity prices are on an upward trend, so it is necessary to carefully monitor the impact of import prices. However, the risk of a downturn in the rate of inflation cannot be ruled out because of factors such as a decline in medium- to long-term inflation expectations. Regarding the outlook for prices, the crucial point, as I mentioned earlier, is how well current inflation is anchored to stable medium- to long-term inflation expectations. I personally take a cautious view on this issue. I am also wary about the effectiveness of the comprehensive monetary easing policy that I will explain later, and therefore believe that, on balance, risks concerning prices are weighted on the upside. II. Conduct of monetary policy A. Background to the Bank’s decision to implement a comprehensive monetary easing policy Next, I will outline the Bank’s current conduct of monetary policy. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. To this end, it will continue to consistently make contributions as the central bank, namely, strive to pursue powerful monetary easing, ensure financial market stability, and support strengthening the foundations for economic growth. At the same time, it will carefully examine the outlook for economic activity and prices, and if According to the 43rd Opinion Survey on the General Public’s Views and Behavior conducted by the Bank in October 2010, the proportion of respondents who replied that they expected the Japanese economy to grow at about the current rate decreased to 33 percent, while the proportion of those who answered that they expected it to grow only at a lower rate increased to 64 percent. See Kozo Kiyota, “Nihon no Yushutsu to Koyou (Japan’s Exports and Employment),” RIETI Discussion Paper No. 10-J-29, Research Institute of Economy, Trade and Industry, April, 2010. See the summary of the Regional Economic Report released by the Bank in October 2010. BIS central bankers’ speeches judged necessary, take policy actions in a timely and appropriate manner.12 The Bank examined the outlook for economic activity and prices at the Monetary Policy Meeting on October 4 and 5, 2010, and judged that it had become more likely that the return of Japan’s economy to a sustainable growth path with price stability would be delayed. Based on this assessment, the Bank decided to implement comprehensive monetary easing as an additional policy measure to further enhance monetary easing.13 In recent months, following the Monetary Policy Meeting in July 2010, at which the Policy Board members conducted an interim assessment of the Bank’s view presented in the April 2010 Outlook Report, I have been thinking in more detail about the outlook for economic activity and prices through fiscal 2012. By September, I had become increasingly concerned about the downside risks to the economic outlook, especially for fiscal 2011 and thereafter, and concerned that the recovery in prices might be weaker than expected. Therefore, my view was that the Bank should take drastic policy action using unprecedented measures. Looking back, it seems that other Policy Board members, each from their own perspective, have had a similar or acute view. It is these concerns that prompted the decision to introduce the comprehensive monetary easing policy. B. Objectives of the comprehensive monetary easing policy The comprehensive monetary easing policy consists of three measures: a change in the guideline for money market operations; a clarification of the commitment regarding the time horizon for maintaining the virtually zero interest rate policy based on the “understanding of medium- to long-term price stability” (hereafter “understanding”); and the establishment of the Asset Purchase Program. Next, I will explain the objectives of these measures in detail. For clarity, I have classified the objectives into four categories, which are to achieve (1) lower interest rates, (2) quantitative easing, (3) qualitative easing, and (4) to affect market expectations. 1. Change in the guideline for money market operations The first measure was to change the guideline for money market operations. The Bank decided to change the target for the uncollateralized overnight call rate from previously “around 0.1 percent” to “around 0 to 0.1 percent.” The Bank has pursued a virtually zero interest rate policy since the policy change in December 2008, setting the target for the rate at around 0.1 percent. However, because it was not necessarily clear by how much the Bank would allow the rate to deviate from 0.1 percent in its daily market operations, it decided to clarify this point. While the Bank has been committed to providing ample funds since the Lehman shock, it will further enhance the provision of liquidity through measures such as the implementation of the Asset Purchase Program, which I will explain later. In addition, given that the transaction volume in the call market has declined as the ample provision of funds by the Bank increasingly replaced private interbank transactions, the uncollateralized overnight call rate may fall considerably below 0.1 percent. Since the Bank considered that explicitly allowing the overnight call rate to fall below 0.1 percent would enhance the effectiveness of its policy, it decided to adopt the change in the guideline for money market operations. However, while the aim of the change in the guideline for money market operations was to allow the overnight call rate to fall below 0.1 percent, the interest rate applied to the complementary deposit facility has been maintained at 0.1 percent. Some may feel that if the interest rate paid on financial institutions’ excess reserve balances were lowered, this would result in a decline in interest rates. However, since an excessively low call rate would deprive financial institutions of profit opportunities, it could result in a decline in interbank transactions See “Statement on Monetary Policy” released by the Bank on September 7, 2010. See “Comprehensive Monetary Easing” released by the Bank on October 5, 2010. BIS central bankers’ speeches and ultimately lead market participants to exit the market, as happened when the quantitative easing policy was implemented. Thus, the functioning of financial intermediation could be impaired, which would in turn hamper the effects of monetary easing. Therefore, weighing up the advantages and disadvantages I have mentioned, the disadvantages of further lowering the interest rate for the complementary deposit facility at this point in time would be greater. Chairman Bernanke made a similar point in his speech on August 27, 2010.14 2. Clarification of the duration of the virtually zero interest rate policy The second measure taken by the Bank was to clarify the duration of the virtually zero interest rate policy. Specifically, the Bank explicitly stated that it would continue the virtually zero interest rate policy until it judged that price stability on the basis of the “understanding” was in sight. However, the continuation of the virtually zero interest rate policy is subject to the condition that no problem will be identified in examining risk factors, including the accumulation of financial imbalances, because if monetary policy focused only on price developments, other risk factors might be overlooked. With regard to the four objectives I mentioned earlier, this measure meets the fourth and the first ones; that is, it aims at affecting market expectations and prompting a decline in interest rates. To explain this in more detail, the importance of trying to influence market expectations follows from what is called “expectations theory” with regard to long- and short-term interest rates. Specifically, this theory suggests that long-term interest rates are determined by the average rate of the expected series of overnight rates in the corresponding period. Thus, if the Bank announces to the markets that it will continue with its virtually zero interest rate policy until it judges that price stability is in sight and this is recognized by market participants, they will form the expectation that the overnight call rate will stay around zero percent as long as deflation is expected to continue, and term rates and medium- to longterm rates will stabilize at extremely low levels as a result. This effect of monetary easing is called the “duration effect.” When the Bank, in March 2006, terminated its quantitative easing policy, which was accompanied by such a duration effect, it introduced a new framework for the conduct of monetary policy and decided to conduct monetary policy based on its “understanding” – that is, the level of inflation that each Policy Board member understands, when conducting monetary policy, as being consistent with price stability over the medium to long term – expressed in the form of a numerical value. Moreover, in April 2007, the Bank presented in the Outlook Report its assessment of the outlook for price developments based on the “understanding,” and in December 2009 it provided further clarification with regard to the numerical value in the “understanding.”15 With regard to the current comprehensive monetary easing, the time horizon of the policy is clarified by making it explicit that the “understanding” is the basis for the judgment regarding the duration of the virtually zero interest rate policy. 3. Establishment of the Asset Purchase Program The third measure of the comprehensive monetary easing policy, the Asset Purchase Program, aims at encouraging a decline in longer-term interest rates and various risk premiums to further enhance monetary easing. Specifically, through the Program, the Bank will purchase a total of about 5 trillion yen of various financial assets, such as government securities, corporate bonds, commercial paper (CP), exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs), and will conduct fixed-rate funds-supplying See Chairman Bernanke’s speech cited in Footnote 1. The “understanding” in terms of the year-on-year rate of change in the CPI was made clearer by changing the expression from each Policy Board member’s “understanding” “falls in the range approximately between 0 and 2 percent, with most Policy Board members’ median figures at around 1 percent” to “falls in a positive range of 2 percent or lower and the midpoints of most Policy Board members’ “understanding” were around 1 percent.” BIS central bankers’ speeches operation against pooled collateral worth approximately 30 trillion yen. Taking on credit risks of individual firms is an extraordinary measure for a central bank, and the reason for establishing the Program was to make it easier for the Bank to grasp the risk profile of the assets purchased and to increase the transparency of the management of these assets by separating the assets purchased through the program from those purchased through regular money market operations. The Bank has already started purchasing some types of assets for which necessary arrangements have been completed. In addition, on November 8 it started to purchase Japanese government bonds (JGBs). Purchases of all other types of assets are planned to start by the middle of December. With regard to the four policy objectives, this measure mainly meets the third and the first ones, namely, to achieve a decline in risk premiums and in longer-term interest rates. Market participants have tended to focus on the size of the Program, but let me underline here that the direct objective has not been quantitative expansion; rather, the measure seeks to encourage a decline in longer-term interest rates and various risk premiums resulting in quantitative expansion. Efforts to achieve a decline in risk premiums under the Program do not mean that risk assets are purchased in substantial quantities to underpin prices. Rather, the aim is for the purchase of various risk assets by the Bank to act as a catalyst to increase the demand for and supply of riskier financial assets in the market and spur the effective use of the ample funds that have been already provided to the market so as to provide a boost to the economy. The Bank’s decision to encourage a decline in longer-term interest rates and various risk premiums through comprehensive monetary easing was based on its experience with the quantitative easing policy16 during the five years from March 2001 through March 2006. Since one of the ways in which quantitative easing worked was through the policy duration effect, it is difficult to clearly isolate the effects of quantitative expansion itself in assessing the overall effect of the policy. However, most subsequent empirical studies suggest that although quantitative easing contributed to stabilizing the financial system, the impact on economic activity and prices was limited.17 Moreover, preliminary assessment indicates that the extent to which the decline in interest rates resulting from the policy duration effect of the quantitative easing policy affected the yields of other financial assets – the so-called “portfolio rebalancing effect” – was limited. Given these results, the Bank judged that – in a situation where there was little room for a further decline in short-term interest rates – the most effective policy to achieve additional monetary easing would be to try to directly effect a decline in longer-term interest rates and various risks premiums, meaning that this policy pursues the first and the third of the objectives outlined earlier, that is, to lower interest rates and achieve qualitative easing. However, I did not concur with all the measures of the Bank’s comprehensive monetary easing policy. Specifically, I disagreed with the inclusion of government securities as assets to be purchased through the Program. The main reason is that I believe it would be more effective to strengthen efforts to effect a decline in risks premiums, which remain at a high level – that is, to focus on qualitative easing – than to focus on longer-term interest rates at a time when financial institutions were raising the weight of government securities in their The Bank’s quantitative easing policy consisted of four measures: (1) the main operating target for money market operations was changed from the uncollateralized overnight call rate to the outstanding balance of the current accounts at the Bank; (2) the new procedures for money market operations would remain in place until the rate of change in the CPI (excluding perishables, on a nationwide statistics) on a year-on-year basis was stable at or above zero percent; (3) the Bank raised the target for the balance outstanding at the Bank’s current accounts to around 5 trillion yen; and (4) the Bank would increase the amount of its outright purchase of long-term government bonds from the then 400 billion yen per month, if it considered this to be necessary for the smooth provision of liquidity. See Hiroshi Ugai, “Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses,” Monetary and Economic Studies, 25 (1), Institute for Monetary and Economic Studies, Bank of Japan, 2007. BIS central bankers’ speeches portfolios and both short- and long-term interest rates were declining anyway (the yield on 2-year instruments in the past month has been in the range of only 0.130–0.200 percent). In fact, I think that even before the implementation of comprehensive monetary easing, a lowering of longer-term interest rates had already been achieved to a substantial extent through the Bank’s lowering of the policy interest rate to 0.1 percent, through policy duration effects from previous policies, and through the provision of ample funds. Therefore, I felt that increasing the purchase of government securities to achieve a further decline in longer-term interest rates would only have limited positive effects18 and would increase the risk of overheating in the bond market; moreover, excessively low interest rates could deprive financial institutions of profit opportunities and instead hamper the effects of monetary easing, so that any positive effects might be outweighed by the potential negative side effects. Another reason why I disagreed with the purchase of long-term government bonds through the Program is that – in a situation where there is uncertainty over government finances in the medium to long term – making an exception to the principle that the outstanding amount of the Bank’s holdings of JGBs should be kept below the outstanding amount of banknotes in circulation could arouse suspicions in the market that the Bank had taken a step toward engaging in government debt financing, which in turn could adversely affect long-term interest rates. 4. Ensuring the Bank’s financial health Next, I would also like to mention the disadvantages of risk asset purchases by the Bank. Excessive intervention by the Bank may distort price formation in the market and deprive financial institutions of profit opportunities. Moreover, the Bank, too, may ultimately incur losses from the purchases. As you may know, any revenues the Bank makes derive from the issuance of currency based on having the sole right to do so, and this is referred to as seigniorage. As seigniorage revenue essentially belongs to the public, it is transferred to the government’s general account and the Bank has no right to use it at its own discretion. To put it differently, any losses the Bank incurs will ultimately have to be borne by the public. Moreover, any damage to the Bank’s financial health could undermine the independence of the Bank and prevent it from taking policy actions in a timely and appropriate manner, undermining confidence in the currency. This is why the Bank has sought the government’s understanding regarding the way in which the Bank would treat any losses incurred under the Program.19 I believe that particularly when the Bank pursues unconventional monetary policies that come close to fiscal policy, it is important to take the view of the public into account. C. The fund-provisioning measure to support strengthening the foundations for economic growth So far I have been talking about the Bank’s comprehensive monetary easing policy introduced on October 5, 2010, but it is of course also necessary to continue with medium- to long-term measures aimed at sustainably overcoming deflation. Based on various assumptions regarding trends in the overall population and the labor force participation rate (the number of persons willing and able to work divided by the number of persons aged 15 years and over), and using the recent rate of labor productivity growth per employee One of the reasons for my disagreeing with the policy change on August 30, 2010 (the introduction of a sixmonth term in the fixed-rate funds-supplying operation against pooled collateral and a substantial increase in the amount of funds to be provided through the operation) was that such policy action would produce only limited easing effects. Specifically, the Bank’s statement released after the Monetary Policy Meeting held on October 28, 2010 stated, “The Bank intends to ensure its financial soundness by managing risks stemming from the purchases of various financial assets under the Program and by properly recording loss provisions and appropriately treating losses if they are incurred. The Bank seeks the government’s understanding in this regard.” BIS central bankers’ speeches (around 1 percent for the past 20 years), the economy is estimated to grow at a rate of little more than 1 percent, even with a rise in the labor force participation rate of women and the elderly. As you can see from this, if things continue as they are, and unless the nation as a whole makes the utmost effort to raise labor productivity, Japan is unlikely to achieve a rise in the potential growth rate and a sustainable expansion in demand. By introducing the fundprovisioning measure to support strengthening the foundations for economic growth, the Bank has raised awareness of this issue and, in my view, should continue with the measure in the future.20 Although the measure has met with severe criticism that it has prompted a race among financial institutions to lower lending rates, financial institutions’ lending stance to firms – regardless of their size, from small ones to large ones – for investment in new growth areas fortunately appears to have turned more active. Moreover, I am informed that a growing number of firms have been approaching financial institutions to borrow funds through this measure. All this suggests that the measure is beginning to bear some fruit. Meanwhile, I am told that regional financial institutions, too, are supplying funds for business start-ups – a development that I find extremely encouraging. One factor underlying Japan’s prolonged deflation seems to be a growing tendency to avoid risks and a reduced willingness to take on new challenges. I therefore hope that this fund-provisioning measure to support strengthening the foundations for economic growth, together with the Bank’s purchase of various risk assets under the Asset Purchase Program, will be one step in resolving the structural problem of deflation. For details, see section 3 of the speech mentioned in Footnote 6. BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, in celebration of the 150th anniversary of German-Japanese diplomatic relations, Frankfurt am Main, 8 March 2011.
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Masaaki Shirakawa: 150 years of innovation and challenges in monetary control Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, in celebration of the 150th anniversary of German-Japanese diplomatic relations, Frankfurt am Main, 8 March 2011. * I. * * Introduction I am honored to have the opportunity today to speak at Goethe University (GoetheUniversität Frankfurt am Main) in celebration of the 150th anniversary of German-Japanese diplomatic relations. I would first like to express my thanks for the warm words of welcome from Dr. Hölscher, Permanent Undersecretary of the Ministry of Finance of Hessen, Dr. Raettig, Deputy Mayor of the City of Frankfurt, and Mr. Shigeeda, Consul-General of Japan. I also extend my sincere gratitude to Professor Gerlach of the Institute for Monetary and Financial Stability, who has made today’s speech possible. The Bank of Japan (Slide 1) stationed its representative in Berlin from 1919, just after World War I, and established its representative office here in Frankfurt in 1956. Frankfurt is a unique city in the world, with two central banks, the Deutsche Bundesbank and the European Central Bank (ECB) (Slide 2). The Bank of Japan has been developing very close ties with both of them. I would like to express my gratitude to the Bundesbank, the ECB, and everyone here in Germany for your support of the Bank of Japan’s Frankfurt representative office. BIS central bankers’ speeches About 150 years ago, in 1860, a Prussian expedition to East Asia visited Edo, now Tokyo, and in 1861 concluded a treaty of amity and commerce, which became the foundation of the subsequent close relationship between Germany and Japan. This was in fact quite an interesting period in Japan’s financial and economic history. In the 1850s, the price of gold relative to silver in Japan was set considerably lower than in international markets and as a result there were massive outflows of gold in a short period of time. In response, the Japanese government issued new gold coins with a much lower gold content. In the process, inflation rose rapidly due to the expansion of the money stock. There is a caricature drawn in Japan in 1861 that vividly illustrates the economic turmoil at the time (Slide 3). It shows the scene of a battle between two armies – a “currency army” with a gold coin as general, and a “commodities army” with a straw rice bag as general – with one shouting, “Prices, we will defeat you!” and the other replying, “No, we will not be defeated!” It could thus be said that Japan at the end of the premodern era found itself suddenly thrown into the currents of international financial markets, and I am sure that the Prussian expedition was able to observe the resultant turmoil Japan’s economy experienced. BIS central bankers’ speeches While there certainly has been some progress over the past 150 years in the area of monetary control, we probably have not made as much progress as we would like, as shown by the recent global financial crisis. Monetary control is critical for the stability of the economy. Thus, today I have chosen to talk about “150 Years of Innovation and Challenges in Monetary Control,” drawing on examples from Germany – and Europe more generally – as well as Japan, from the perspective of a central bank governor. II. Four innovations in monetary control In the history of economic activity, the invention of money itself of course represents an extremely important innovation. Since then, there have been numerous innovations in monetary control. In what follows, I would like to start with four innovations that I consider particularly important in modern times. The invention of central banks The first and greatest innovation was the invention of institutions called central banks. In Germany, the first central bank was set up with the establishment of the Reichsbank in 1876, while the Bank of Japan was established in 1882.1 At that time, there were still only about a dozen central banks in the world. Of course, most countries today have a central bank. The establishment of central banks meant that the supply of money was not necessarily influenced by gold discoveries and other vagaries anymore, and it became possible to actively control money in a systematic manner through transactions in financial markets. For a history of modern central banks, see Forrest Capie, Charles Goodhart, Stanley Fischer, and Norbert Schnadt, The Future of Central Banking: The Tercentenary Symposium of the Bank of England, 1994. BIS central bankers’ speeches The invention of a “lender of last resort” The second innovation is the idea of central banks as a “lender of last resort.” In 1861, the year that the treaty of amity and commerce between Germany and Japan was concluded, Walter Bagehot became editor-in-chief of The Economist magazine in England. As you probably know, he later wrote a famous book, Lombard Street, a treatise on the best central bank practices, providing the first-ever systematic analysis of the roles of a central bank. In the book, he formulated what came to be called Bagehot’s rule, namely that, to prevent disruption in the financial system in times of crisis, the central bank should act as a lender of last resort, providing unlimited funds at punitive rates.2 The practical application of Bagehot’s rule has been modified in line with changes in financial market structures, and in the recent global financial crisis, central banks – including the ECB and the Bank of Japan – aggressively provided funds to the markets as the lender of last resort, thereby preventing a collapse of the financial system. The establishment of the principle of the lender of last resort is of significant importance. The invention of monetary policy The third major innovation I would like to mention, although it may sound somewhat strange, is the “invention of monetary policy.” While I will touch later on the issue of how to define monetary policy, for the time being I will use the term in the conventional sense of “policy that aims at actively influencing the inflation rate or the economic growth rate by controlling the level of short-term interest rates.” Under the gold standard, the quantity of money was constrained by gold holdings and thus the central bank could not influence the price level and economic activity in an active manner. In this sense, central banks had limited room to deploy monetary policy. In fact, monetary policy was not discussed in Bagehot’s book. Monetary policy worthy of the name started only with the transition to a fiat money system. Nowadays, appropriate monetary policy conduct has become one of the key tools contributing to macroeconomic stability. The introduction of the concept of central bank independence Finally, the fourth innovation has been the idea of central bank independence. While it is only relatively recently that central bank independence has become firmly established in countries around the world, interestingly, in Europe active discussions on the enhancement of central bank independence already took place in the wake of World War I. For example, at the 1922 Genoa International Economic Conference, which aimed at restructuring the international economic and financial system in the post-World War I period, in the resolution concerning currency there was a proposal that “banks, and especially banks of issue, should be free from political pressure.”3 It goes without saying that, in subsequent decades, the German public and the Bundesbank played a significant role in establishing the concept of central bank independence at an early stage. Let me note that, when stationed in Berlin early in his career, Mr. Hisato Ichimada – who later became the Governor of the Bank of Japan for eight years immediately after the end of World War II – witnessed the so-called “miracle of the Rentenmark” (or “Wunder der Rentenmark”) that ended hyperinflation in Germany in the post-World War I period. It is said that he utilized this experience when he conducted monetary policy in Japan’s post-World War II period (Slide 4). See Walter Bagehot, Lombard Street: A Description of the Money Market, 1873. See Papers Relating to International Economic Conference, Genoa, April–May, 1922, 1922. BIS central bankers’ speeches The idea of central bank independence has begun to become firmly established in countries around the world since the early 1990s. For instance, the Maastricht Treaty signed in 1992 stipulated central bank independence as one of the conditions for joining the euro, while in Japan the Bank of Japan’s independence in the conduct of monetary policy was stated in law through the revision of the Bank of Japan Act in 1998. As central banks gained independence in their monetary policy, this made it legally possible for them to serve as a medium- to long-term anchor for money. There have been various other innovations in monetary control apart from the four I just mentioned. Money supply targeting is one of them. While the Bank of Japan did not adopt money supply targeting, many central banks in the advanced economies, including the Bundesbank, adopted it from the 1970s through the first half of the 1980s. However, subsequently, as the stable relationship between money supply on the one hand and the inflation rate and economic activity on the other broke down due to technological innovations in finance, money supply targeting became ineffective and was consequently abandoned. In this regard, the Bank of Canada Governor Gerald Bouey famously stated that “we did not abandon money supply targets, they abandoned us.” It could thus be said that the specific methods of monetary control have changed as a result of technological innovation. Since the latter half of the 1980s, many central banks have adopted inflation targeting – excluding, however, the Federal Reserve, the ECB, and the Bank of Japan. This approach has been effective in containing inflation or entrenching inflation levels that had already come down. However, it seems that this framework, or the focus on the stability of general prices underlying it, now faces new challenges. From the viewpoint of price stability, economic performance was benign for a prolonged period through the mid-2000s, giving no apparent cause for concern, but a large-scale credit bubble built up, culminating in the global financial crisis. As a result, numerous advanced economies are currently experiencing severe BIS central bankers’ speeches balance-sheet adjustments associated with the bursting of the bubble. These developments are having a subtle impact on how inflation targeting and, for that matter, monetary policies are managed. Having said that, I am by no means arguing that there is no point in money supply targeting or inflation targeting. In my view, history seems to suggest that – be it with regard to the lender of last resort function or monetary policy – it is necessary to constantly review measures of monetary control in light of changes in the environment. In other words, constant innovation is necessary. III. Central banks’ policy responses following the global financial crisis Next, from this perspective of constant review and innovation, I would like to move on to various unconventional policy measures that major central banks took in the course of the recent severe financial crisis. While the term “unconventional policies” can be understood by different people in a number of ways, in what follows I will talk about unconventional policies by dividing them into two categories: first, measures taken in the midst of the recent financial crisis as part of central banks’ lender of last resort function and aimed at ensuring the stability of the financial system, and second, measures taken in less difficult times, after the crisis had settled, that aim at stabilizing economic activity.4 As for the former, the measures were, in essence, in line with the lender of last resort principle emphasized by Bagehot. However, naturally, the financial system in the 21st century is not quite the same as that in the 19th century when Bagehot lived. Central banks around the world have faced new challenges he never imagined, and have worked with considerable ingenuity. Resolving the issue of stigma In the course of the recent financial crisis, the first challenge was to resolve the stigma attached to receiving emergency funds from the central bank. While aggressive liquidity provision is critical in a crisis, financial institutions might hesitate to borrow funds even in an emergency and try to raise funds in the market at all costs out of fear that their perceived creditworthiness will decline if it becomes known that they received emergency funds. As a result of such collective behavior, the liquidity shortage will accelerate further and interest rates will rise. Under the mechanism described by Bagehot, it is assumed that liquidity is provided based on negotiations with individual financial institutions, which, however, would stigmatize such institutions. To overcome this problem, major central banks have introduced new measures. For example, the Federal Reserve in 2007 introduced the Term Auction Facility (TAF), under which the range of financial institutions eligible for funds-supplying operations was substantially broadened, the duration of funds provided was significantly lengthened, and interest rates on funds were determined by auction. And the ECB in 2008 fixed the rate for its operations to the policy rate and initiated monetary control that provides unlimited funds upon request from financial institutions. For the policy responses taken by major central banks, see Monetary Affairs Department, Bank of Japan, “Major Central Banks’ Policy Conduct during the Current Financial Crisis,” 2009 (available only in Japanese); and Brian F. Madigan, “Bagehot’s Dictum in Practice: Formulating and Implementing Policies to Combat the Financial Crisis,” speech given at the Federal Reserve Bank of Kansas City’s Annual Economic Symposium in Jackson Hole, Wyoming on August 21, 2009. BIS central bankers’ speeches Responding to the evaporation of market liquidity The second challenge was to respond to the evaporation of market liquidity. When writing about declining liquidity, Bagehot also referred to liquidity in the government bond market in a crisis, but in his time there were neither the kind of complex financial products nor the derivatives transactions we see today. Therefore, in his day, systemic risk referred mainly to a contagious bank run on deposits. However, as a result of financial globalization and technological innovations, the forms in which systemic risk manifests itself have become more complex and diverse. If counterparty risk heightens, that is, market participants become concerned about the creditworthiness of counterparties, this can result in an “evaporation of market liquidity,” in which counterparties disappear from the market. If fire sales of assets spread and market prices start to plunge, the capital position of a large number of financial institutions may erode due to valuation losses on assets, which could develop into a solvency problem of financial institutions. To avoid such a situation, liquidity provision through traditional lender of last resort measures alone will not be sufficient. Instead, someone needs to serve as a trusted counterparty standing between market participants that no longer trust each other. During the crisis, it was central banks that played this role. In this situation, major central banks implemented measures that in essence directly provided liquidity to fund-raisers in markets where market functioning had deteriorated significantly. For example, in 2008, the Federal Reserve introduced a policy measure to lend to CP issuers and holders of asset-backed securities (ABSs). The Bank of Japan also purchased CP, asset-backed commercial paper (ABCP), and corporate bonds in order to cope with the rapid decline in liquidity in these markets, which were the main funding sources for large firms that were directly hit by the financial crisis. Provision of foreign currency liquidity The third challenge was the provision of foreign currency liquidity. In Bagehot’s day, liquidity meant liquidity in the home currency for domestic transactions and gold for international transactions. There is a reference in Bagehot’s book to a situation in which the Bank of England did not sufficiently carry out its lender of last resort function due to concerns over a shortage of gold. During the recent financial crisis, liquidity in the U.S. dollar funds market declined significantly and dollar funding became an extremely pressing issue, especially for private financial institutions whose home currency was not the dollar. In order to ensure that central banks could smoothly provide dollars to home financial institutions, financial institutions needed to have a sense of security that central banks themselves could provide unlimited amounts of dollars. To this end, major central banks, including the ECB and the Bank of Japan, secured dollar funds by making currency swap arrangements with the Federal Reserve and then introduced dollar funds-supplying operations domestically. The currency swap arrangements were made not only for the dollar but also for other currencies. For example, the ECB and the Swiss National Bank established a currency swap arrangement for Swiss franc funding, and the Bank of Japan and the Bank of Korea established a currency swap arrangement for yen funding, both of which contributed to restoring stability in foreign currency funding markets. Unconventional monetary policies Since the recent financial crisis, major central banks have also been implementing unconventional policies that aim at stabilizing economic activity. These are intended to deal with the challenge of achieving monetary easing effects to return the economy to a stable recovery path when nominal short-term interest rates are already near zero. One example is the increase in the government bond purchases decided by the Federal Reserve in the autumn of 2010, which aimed at absorbing interest risks in the private sector and lowering long-term interest rates. Another example is the comprehensive monetary easing decided on by the Bank of Japan in the autumn of 2010, which includes various unconventional BIS central bankers’ speeches measures. The measure is quite exceptional in that the eligible assets for monetary policy operations were expanded to include not only government bonds but also CP, corporate bonds, exchange-traded funds (ETFs), and real estate investment trusts (REITs). The Bank of Japan’s purchases aim at stimulating economic activity through a reduction in various risk premiums, as there is little room for a decline in short-term interest rates. IV. The Bank of Japan’s policy response after the 1990s: the bursting of Japan’s asset bubble Looking at the outcome, it can be said that the unconventional measures to deal with the global financial crisis have been effective. At the same time, though, the measures pose new challenges. Before discussing these new challenges in detail, let me digress slightly and talk about the unconventional policies that the Bank of Japan hammered out from the latter half of the 1990s in response to the bursting of the asset bubble. This experience meant that the Bank of Japan had to deal with the consequences of the bursting of a bubble and the ensuing economic and financial difficulties ahead of other countries. There is not sufficient time to elaborate today on this point, but let me note that the Bank of Japan has been a lonely forerunner in terms of the adoption of unconventional policies such as the introduction of quantitative easing and of a policy duration commitment in 2001. In the course of the current financial crisis, many other central banks have implemented measures that are in essence similar to the Bank of Japan’s, although they may differ in detail. This shows that what we are experiencing during the current global financial crisis is not a special case but reflects changes that are more or less universal. With this in mind, let me explain some of the unconventional policies pursued by the Bank of Japan, focusing on three measures in particular.5 Fund provisioning to Yamaichi Securities The first measure is the provision of loans as a lender of last resort to a securities company whose solvency could not be judged clearly. In the autumn of 1997, massive off-balancesheet liabilities were suddenly revealed at Yamaichi Securities, one of the biggest securities companies in Japan at the time, and it was decided to liquidate the company. However, the company had bank subsidiaries in Europe, and at that time other Japanese financial institutions held a large amount of impaired assets. Thus, it was judged that an immediate legal liquidation would very likely pose a systemic risk. The Bank of Japan, therefore, decided to provide Yamaichi with an unlimited amount of liquidity to support the orderly closure of its business operations. However, because the disclosure of off-balance-sheet liabilities occurred suddenly and financial markets were unstable, there remained uncertainty about the value of Yamaichi’s net assets. The premise of Bagehot’s rule is that the counterparty financial institutions are solvent so that they can submit good-quality collateral. Since this was not the case, it was all the more difficult for the Bank of Japan to decide the proper course. Regrettably, at Yamaichi’s subsequent legal bankruptcy proceedings, it was determined in 2005 that part of the loans by the Bank of Japan to Yamaichi were unrecoverable. However, it should be noted that a situation like the one after the failure of Lehman Brothers, when real quarterly GDP contracted at a double-digit rate on a year-onyear basis, was avoided. In other words, the measure prevented the worst-case scenario of having Japan’s financial crisis in the latter half of the 1990s trigger turmoil in the global financial system. The Bank of Japan implemented other innovative measures apart from the three measures mentioned here. For example, in 2001 the Bank of Japan introduced the bill purchasing operation conducted at all of its branches, providing longer-term funds to a wider range of counterparties including local financial institutions. This measure is similar to the Federal Reserve’s TAF. BIS central bankers’ speeches Operation twist to facilitate foreign currency funding The second policy measure pursued by the Bank of Japan concerns foreign currency liquidity. In the latter half of the 1990s, Japanese banks, amid serious concern about their soundness, faced difficulties in raising U.S. dollar funds, especially longer-term ones. In this situation, the Bank of Japan, as part of its funds-supplying operations, provided longer-term yen funds. Japanese banks exchanged these yen funds for dollar funds in the foreign currency swap market with foreign banks as their counterparties. Viewed from the foreign banks’ side, such transactions were dollar loans using yen funds as collateral. Therefore, even under the zero interest rate environment, they accepted the trades as long as yen funding rates were negative, despite the deteriorated creditworthiness of Japanese banks. However, foreign banks had to find safe investment opportunities for their yen funds. In this regard, interest-bearing bills issued by the Bank of Japan to absorb shorter-term yen funds became suitable investment opportunities. Bills sold were safe and had no default risk. This string of trading ultimately had the effect that the Bank of Japan became the counterparty of both Japanese and foreign banks, thereby promoting smooth dollar funding for Japanese financial institutions. The stock purchasing program The third measure, introduced in 2002, is the Bank of Japan’s purchase of stocks held by commercial banks. At that time, Japanese banks held large amounts of stocks on their balance sheets. Therefore, market risk associated with stock price volatility was a major risk for Japanese banks, and the adverse feedback loop of falling stock prices, restrained lending, and a deterioration in the real economy became a problem. In these circumstances, the Bank of Japan decided to purchase stocks held by commercial banks. This measure was very unorthodox, but was an effective tool in ensuring stability in the financial system and the real economy through the reduction of market risk associated with banks’ stockholdings. The credit easing and the large-scale asset purchase (LSAP) programs adopted by the Federal Reserve during the current financial crisis are very similar to the Bank of Japan’s stock purchasing program in that in both cases the central bank absorbs private-sector risks and thereby aims at improving financial conditions. V. New challenges As shown by the examples I have mentioned, central banks in the major economies – in their role as monetary policy authorities – have been implementing innovative policy measures, though they adopted the measures at different times: since the latter half of the 1990s in the case of the Bank of Japan and the current global financial crisis in the case of the Federal Reserve and the ECB. These policy measures have helped to prevent a depression as deep as the one that occurred in the 1930s. At the same time, however, as central banks stepped outside the framework of conventional behavior, they have been confronted with new associated challenges. The division of roles between the government and the central bank The first challenge is the division of roles between the government and the central bank. When acting as the lender of last resort in a crisis, the central bank must judge whether the problem it is dealing with is a liquidity problem or a problem concerning financial institutions’ solvency. If the problem is one of a shortage of liquidity, it is the central bank that should act, based on Bagehot’s rule. In contrast, if the problem concerns the solvency of one or more financial institutions, it is the government that needs to act by, for example, injecting public funds. However, in reality, and especially during a crisis, it is often difficult to distinguish between these two problems, as shown by the case of Yamaichi Securities mentioned earlier. Moreover, even if it is possible to tell the difference, the decision of injecting public BIS central bankers’ speeches funds tends to be delayed because it is politically unpopular. However, a financial crisis does not allow us to wait for such a political decision. The problem of the division of roles between the government and the central bank remains even after the acute symptoms have disappeared. At present, policy rates in major economies are virtually zero and these economies face balance-sheet constraints due to the bursting of the bubble. For example, in the United States, unemployment continues to be high on the back of balance-sheet adjustments in the household sector. In this situation, the Federal Reserve has announced that it would purchase 600 billion U.S. dollars in longer-term Treasury securities until June 2011. The Bank of Japan started comprehensive monetary easing in the autumn of 2010, and as part of this, has purchased corporate bonds, REITs, and ETFs. In a zero interest rate environment, if a central bank aims to stimulate economic activity through monetary policy, one option is to seek a reduction in risk premiums through purchases of assets with relatively high credit risk. So far, such policy measures have been relatively effective. At the same time, it cannot be ruled out that central banks eventually incur losses through these measures. Moreover, there is an increasing possibility that central banks will no longer be seen as neutral institutions, partly due to their stronger intervention in resource and capital allocation at the micro level. If this happens, public confidence in central banks – the very foundation for policy implementation – could be undermined. The reason why central banks are granted independence is fundamentally that their mission is to provide liquidity. The more policy measures become involved in the micro-allocation of resources and capital, the more these measures have the flavor of quasi-fiscal policy. However, in a democracy, fiscal policy is and should be decided by parliament. At the same time, however, central banks need to act flexibly in response to a crisis to maintain economic and financial stability. I do not think there is a universally applicable answer to the problem of the division of roles between the government and the central bank. The Bank of Japan has been addressing this problem by making tough decisions based on, for example, the severity of economic conditions, the legal framework for the central bank, and society’s tolerance of central bank involvement. What should the role of monetary policy be? As we consider these difficult issues, it is stating the obvious that the most important thing is to take preemptive measures to avoid falling into such a situation in the first place. In this regard, it is critical to take a deep look at the role monetary policy should play.6 It seems to me that in the past two decades, no other issue has been as frequently discussed as how monetary policy should respond to a bubble. The orthodox view prior to the recent global financial crisis, put simply, was that monetary policy should not respond to a bubble and that any resulting problems could be resolved if central banks took aggressive policy measures after the bubble had burst. In this context, Japan’s “lost decade” tended to be simply dismissed as mainly due to the delayed policy response of Japanese authorities. However, we are now entering the fifth year since the bursting of the housing bubble in the United States and real GDP there has hardly increased in the meantime. Thus, I think few today would support the optimistic view that any problems resulting from the burst of a bubble can be easily resolved through aggressive policy measures after the fact. The first lesson that could be drawn from the experience of the past two decades is that, while price stability is important, this alone does not guarantee that the economy is stable. Looking back at the causes of the recent financial crisis, we find that financial imbalances in various forms, such as the rise in asset prices, the increase in credit, the increase in leverage, and the increase in maturity mismatches, had built up to an extent that became See, for example, Masaaki Shirakawa, “Revisiting the Philosophy behind Central Bank Policy,” speech at the Economic Club of New York on April 22, 2010. BIS central bankers’ speeches unsustainable. The causes of these financial imbalances are complex, and although failures in financial institutions’ risk management and a delay in adequate regulation and supervision have no doubt played a role, this is not all. At the root of the financial imbalances was the expectation that interest rates would remain low. The subdued inflation seen in many advanced economies in the run-up to the global financial crisis gave rise to expectations that accommodative monetary conditions would continue for an extended period into the future. Of course, bubbles are not generated by expectations for protracted low interest rates alone, but it is also true that bubbles do not arise without such expectations. While price stability is important, paying too much attention to the near-term inflation outlook could impair the stability of the financial system, which is critical from the viewpoint of economic stability – the ultimate goal of price stability. The second lesson is the danger of monetary policy swinging too far in the direction of finetuning. Of course, it would be ideal if fine-tuning were possible, but in my view, monetary policy has a more important role to play, namely ensuring economic and financial stability in the medium to long term. In his famous presidential address to the American Economic Association in 1967, Milton Friedman stated that “the first and most important lesson that history teaches about what monetary policy can do – and it is a lesson of the most profound importance – is that monetary policy can prevent money itself from being a major source of economic disturbance.” Seeing the significant decline in the level of real GDP in advanced economies following the collapse of Lehman Brothers and continuing high unemployment, I keenly feel it is important to prevent money itself from becoming a major source of economic disturbance. While it is not easy to apply these lessons in practice, policy authorities must tackle the challenges I have mentioned, and in fact they are already making various efforts to do so. In this regard, in terms of the conduct of monetary policy, the ECB and the Bank of Japan seem to be taking similar approaches. The ECB has adopted a “two-pillar approach” – consisting of economic analysis that focuses on economic and financial developments and assesses the short- to medium-term determinants of price developments, and of monetary analysis that examines medium- to long-term price developments from a monetary perspective – and then cross-checks the results. Similarly, the Bank of Japan’s monetary policy conduct is based on a “two-perspective approach.” The first perspective focuses on economic and price conditions one to two years ahead and examines whether, in the Bank of Japan’s baseline scenario, the economy follows a sustainable growth path with price stability. The second perspective also includes a longer time horizon and, from the viewpoint of achieving sustainable economic growth with price stability, examines risk factors that have a low probability of materializing but that could have a large impact on economic activity and prices if they do materialize. In my view, what the monetary policy frameworks of the ECB and the Bank of Japan have in common is that they both deliberately incorporate the practice of examining financial imbalances using various types of information. Regardless of what framework central banks adopt in their monetary policy, preparing for so-called tail risks will be increasingly important. As shown by Japan’s experience and the recent global financial crisis, preparing for risks which have a low probability but could have a large impact if they materialize is crucial. The keyword in the debate currently in progress on this issue is “macro-prudential policy.” The first critical step in this direction is to accurately understand risk profiles at the macro level. In Europe, this will be the task of the European Systemic Risk Board, which was set up in January this year. Together with such steps on the analytical front, it will also be necessary for societies as a whole to consider whether or not to take preemptive measures for tail risks. In this regard, a major premise for the conduct of macro-prudential policy is the independence of, and a clear mandate for, the macroprudential authority. However, it is optimistic to think that this alone will lead to the implementation of the necessary policies. The key is whether a social consensus can be built that – because of the high costs involved in dealing with a bubble once it has arisen – the BIS central bankers’ speeches macro-prudential authority should “take away the punchbowl” even when economic conditions still seem benign. VI. Concluding remarks My speech today focused on the topic of “150 Years of Innovation and Challenges in Monetary Control.” The four innovations I mentioned have played an important role in monetary control and consequently in achieving economic stability. However, in the practical application of these innovations, constant adaptation to changes in the financial and economic environment is necessary. In this regard, I discussed the challenges we face regarding the lender of last resort function, central bank independence, and monetary policy. In terms of the existence of central banks, which I pointed out as the first of the four innovations, it is essential that central banks take policy actions in response to changes in the environment. If we think about the next 150 years ahead, financial and economic globalization are bound to advance further. Thus, for central banks to function as true “central banks” rather than as local banks in individual countries, cooperation among central banks is essential. International cooperation is necessary not only among central banks but also at various levels of government and in the private sector. Let me conclude my speech today by expressing my hope that the friendship and cooperation between Germany and Japan in this regard will continue to prosper in the future. Thank you for your attention. BIS central bankers’ speeches
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Summary of a speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Saga, 2 February 2011.
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Hidetoshi Kamezaki: Recent economic and financial developments in Japan Summary of a speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Saga, 2 February 2011. * I. The economy and prices A. The global economy * * Let me start by describing the situation in which the global economy currently finds itself. From 2000 onward, the global economy – after a period of stagnation in the wake of the bursting of the IT bubble – enjoyed sustained high growth led by improved productivity in many economies, owing to the advance of globalization and increased participation of emerging economies in the global market. In the United States, household consumption was buoyant, based on borrowing using increased home values as collateral. The hike in housing prices was due in part to increased demand from a growing population and the baby boomers, with funds made available by financial institutions. Through financial engineering, these institutions in turn raised low-cost funds from around the world in exchange for securitized products with a high credit rating backed by such housing loans. Furthermore, in the southern European and Baltic economies, growth accelerated because they were able to attract considerable foreign investment on the basis of a stable exchange rate and low interest rates due to the adoption of, or a peg to, the euro. China registered robust growth as its entry into the World Trade Organization (WTO) helped it to attract direct foreign investment. It was around this time that the emerging economies of Brazil, Russia, India, and China, which saw continued high growth driven by domestic demand, were collectively dubbed the BRICs. However, housing prices in the United States peaked around 2006 and started to decline, leading to an increase in defaults by households that had taken out mortgages based on the belief that housing prices would continue to rise. This resulted in an increase in defaults on mortgage-backed securities, and investors around the world that had purchased these products suffered losses. Investors increasingly withdrew funds from risk assets, causing turbulence in financial markets in Europe and the United States from around summer 2007, culminating in a full-blown financial crisis with the failure of Lehman Brothers in autumn 2008. Credit concerns gave rise to turmoil in financial markets and led to a deterioration in economic activity, which in turn affected financial institutions and markets, giving rise to a vicious circle that resulted in a severe global downturn. In addition, the fall in asset prices created a heavy debt burden for some financial institutions and households, forcing them to adjust their balance sheets and curtail spending, putting further downward pressure on the economy. Against this background, countries around the world introduced large-scale monetary and fiscal measures with the aim of bringing the deterioration in the economy to a halt. As a result of these measures, the global economy started to pick up around spring 2009, helped by the completion of inventory adjustments. Thereafter, emerging economies swiftly returned to a high growth path, while advanced economies recovered due to the strength of increased demand from emerging economies, monetary and fiscal measures, and the rebuilding of inventories. The United States, for example, is continuing to recover at a moderate pace, as is the euro area as a whole, although the pace of recovery there differs by country. Meanwhile, a number of developments have caused concerns, such as the Dubai debt crisis in autumn 2009, the Greek financial crisis in spring 2010, and the economic deceleration from summer to autumn 2010 after the completion of fiscal stimulus measures and inventory restocking, but these concerns have been overcome. It must be noted, however, that the BIS central bankers’ speeches pace of recovery in the advanced economies, particularly in Europe and the United States, is showing little sign of accelerating, since many economic entities are burdened with heavy debt repayments, and as a result, refrain from forward-looking spending and investment. In the United States, for instance, the sharp fall in housing prices means that many households have negative equity, making it also difficult for financial institutions to collect mortgage repayments. Furthermore, in some peripheral European countries, governments and financial institutions that borrowed a large amount of funds from overseas when their economies were strong are finding it difficult to repay loans due to the economic downturn. The global economy is expected to continue recovering, although the stark difference in the pace of growth – with high growth in the emerging economies and weak growth in the advanced economies, particularly in Europe and the United States – is set to persist. Yet, I think there are substantial downside risks with regard to the U.S. and European economies, since domestic demand remains vulnerable to shocks given the heavy debt burden in these countries. It is also necessary to be aware of the risk that problems in some peripheral European countries may trigger turmoil in international financial markets, exerting a negative shock on the global economy again. On the other hand, although emerging and commodity exporting economies – which are enjoying a virtuous cycle of growth in production, income, and spending – are in the process of tightening monetary policy, there is a risk that growth will accelerate further due to inflows of surplus funds from advanced economies, which are continuing to pursue loose monetary policies. From a longer-term perspective, however, this represents a downside risk, since it could lead to inflation or an overheating of asset markets, which would necessitate strong tightening measures. B. The Japanese economy The Japanese economy also got off to a weak start at the beginning of the 2000s, but then from 2002 to 2007 experienced the longest period of economic expansion since the end of World War II, owing mainly to robust external demand. Thereafter, the economy declined, falling steeply in response to the crisis triggered by the failure of Lehman Brothers in autumn 2008, but started to recover after leveling off around spring 2009. The driving force of the recovery in Japan was the recovery in overseas economies and government measures to stimulate sales of environmentally friendly goods, boosting exports and durable consumer goods sales. The increase in production then positively affected corporate profits, employment, and business fixed investment. The economy has been recovering moderately, but the recovery appears to have paused since autumn 2010 due to the deceleration in overseas economies, the phasing out of the various stimulus measures to increase demand for environmentally friendly goods, and the appreciation of the yen. At present, the economy is at a critical juncture and could either start to grow again or, if it fails to gain momentum, start shrinking. Fortunately, the deceleration of overseas economies appears to have ended and exports are thus expected to start recovering soon. Furthermore, it seems that the economy will not be weighed down long by the end of measures to stimulate demand for environmentally friendly goods, given that car production and sales have recovered somewhat due to efforts by automakers to launch new models after the expiration of subsidies. Moreover, the appreciation of the yen has also come to a halt for the time being. Therefore, the Japanese economy is highly likely to soon emerge from the present pause and resume its moderate recovery. Consequently, the general improvement in the employment and income situation and in business fixed investment is likely to continue. A strong recovery, however, is unlikely, as households and firms will be wary of undertaking forward-looking spending and investment due to persistent concerns about the future. Naturally, this outlook is subject to uncertainty. As mentioned, there are both upside and downside risks to overseas economic developments that are likely to influence exports and overall corporate activity in Japan. On the domestic front, a downside risk is that spending and investment by households and firms will be dampened further by weak growth BIS central bankers’ speeches expectations due to population decline as well as concerns regarding the pension system and the fiscal deficit. On the other hand, if, such concerns were to ease, this could lead to an increase in spending and investment. C. Recent price developments Next, I will move on to price developments. Prices in international commodity markets have recently been increasing, reflecting particularly the growth in emerging economies and inflows of surplus funds due to monetary easing in advanced economies. As a result, import prices in Japan have been rising, despite the considerable downward pressure from the ongoing appreciation of the yen. The domestic corporate goods price index (CGPI), which measures fluctuations in prices of goods traded between firms in Japan, has also been rising moderately. In contrast, the year-on-year rate of change in the consumer price index (CPI) excluding fresh food (the core CPI), which measures the price of goods and services purchased by households, has been in negative territory since March 2009, indicating that deflation is continuing. However, since reaching a year-on-year rate of decline of 2.4 percent in August 2009, the pace of decline in the core CPI has been moderating. Meanwhile, the pace of decline in the CPI excluding food and energy, or the core-core CPI, which is less susceptible to international commodity price fluctuations, has also been moderating after the year-onyear rate of decline reaching 1.6 percent in April and May 2010. Likely reasons are the increase in international commodity prices and the narrowing of the negative output gap as a result of the recovery of the Japanese economy. In terms of the outlook, the year-on-year pace of decline in the core CPI is expected to continue slowing, reflecting the rise in international commodity prices and the narrowing of the negative output gap, and I think that the rate of change in the CPI may even enter positive territory in fiscal 2011. However, needless to say, there are risks to the outlook for prices, just as there are risks to economic activity. First, there is the possibility of an upswing in international commodity prices caused by strong growth in emerging economies. On the other hand, if pessimism among the public spreads due to a slower-than-expected recovery of the economy, there could be a decline in the medium- to long-term inflation expectations – which are stable at the moment – possibly leading to a fall in the actual inflation rate. Lastly, a technical factor is the possible effects of the base year revision for the CPI, which is scheduled to take place in summer 2011. Taking into account the experience of past such revisions, it is highly likely that the year-on-year rate of change in the CPI on the basis of the new base year will be lower than that on the basis of the current base year. Of course, such statistical changes leave economic activity unaffected, and with medium- to long-term inflation expectations stable and prospects for a moderate improvement in the aggregate supply and demand balance, it seems certain that the Japanese economy is headed in the direction of overcoming deflation. D. Outlook for economic activity and prices The outlook I just presented is my own personal assessment. Let me now turn to the Outlook for Economic Activity and Prices, known as the Outlook Report, which the Bank of Japan releases semiannually, in April and October. The Outlook Report presents the Policy Board members’ assessments for economic activity and prices based on the forecasts in the form of numerical values. In addition to the semiannual Outlook Report, the Bank releases interim assessments in July and January, which present the Bank’s revised projections. In the most recent projection released in January 2011, Policy Board members considered it most likely that real GDP in fiscal 2010 would grow 3.3 percent on a year-on-year basis reflecting the rebound from the contraction in the preceding year. Following the relatively high rate of growth in fiscal 2010, real GDP is then projected to continue increasing moderately in the following years, at a rate of 1.6 percent in fiscal 2011, and 2.0 percent in BIS central bankers’ speeches fiscal 2012. The year-on-year change in the core CPI is projected to remain negative in fiscal 2010 at minus 0.3 percent – this excludes the effects of subsidies for high school tuition, which would cause a further decline of 0.5 percentage point – but is expected to turn moderately positive thereafter, to plus 0.3 percent in fiscal 2011 and plus 0.6 percent in fiscal 2012. It should be noted, however, that these figures do not incorporate possible effects of the base year revision for the CPI this summer. Policy Board members make their forecasts in terms of a range of values rather than a point estimate, and they then attach a probability of realization to each of the values. The collective view of the Policy Board has been that risks are balanced on the whole.1 II. Measures taken by the Bank Next, I will outline the policy measures taken by the Bank following the Lehman shock. A. Measures to address the financial crisis After the failure of Lehman Brothers in autumn 2008, financial market participants around the world became overly cautious about a possible chain reaction of bankruptcies and started to retain funds as on-hand liquidity rather than lend them to other participants, resulting in a sharp financial contraction. In order to address this situation, the Bank, as emergency measures to provide liquidity for financial markets, successively conducted same-day fundssupplying operations, introduced U.S. dollar funds-supplying operations, and accepted bonds issued by the governments of the United States, the United Kingdom, Germany, and France as eligible collateral. Furthermore, the Bank decided to introduce outright purchases of commercial paper (CP) and corporate bonds, based on the recognition that a significant decline in the functioning of markets, such as the serious shortage of liquidity in the CP and corporate bond markets, was causing a tightening of overall corporate financing conditions. In addition, the Bank introduced a series of temporary emergency measures to facilitate corporate financing, including the easing of the rating requirement for corporate debt to be accepted as eligible collateral and the special funds-supplying operation to facilitate corporate financing, through which the Bank provided 3-month funds for an unlimited amount against the value of corporate debt pledged as collateral at a fixed interest rate of 0.1 percent. Furthermore, in order to ensure an accommodative financial environment, the Bank reduced the target level of the policy interest rate (the uncollateralized overnight call rate) from 0.5 percent to 0.1 percent, which is the lowest level in the world. In order to provide ample liquidity by maintaining the policy interest rate at this low level, the Bank also introduced the complementary deposit facility, whereby interest is made payable on excess reserve balances held at the Bank by financial institutions. Moreover, the Bank introduced temporary measures to secure the stability of the financial system, given that the strains in global financial markets and the subsequent fall in stock prices and rise in credit costs had greatly affected financial institutions’ intermediary function and financial soundness. Such measures include the purchase of stocks held by financial institutions to help them reduce the market risk associated with stock holdings and the provision of subordinated loans to banks to help them maintain sufficient capital bases. The Bank gradually brought some of these temporary measures to an end as financial markets regained stability. For details, see Appendix 2 (Risk Balance Charts) of the “Statement on Monetary Policy” released on January 25, 2011. BIS central bankers’ speeches B. Recent conduct of monetary policy toward a sustainable growth path with price stability Financial markets have recently been stable and the economy has been showing signs of a moderate recovery, but the Bank recognizes that the Japanese economy is still experiencing deflation. With a view to overcoming deflation and returning the Japanese economy to a sustainable growth path with price stability, the Bank continues to consistently make contributions as the central bank and is currently utilizing a three-pronged approach of pursuing powerful monetary easing through comprehensive monetary easing, ensuring financial market stability, and providing support to strengthen the foundations for economic growth. 1. Pursuing powerful monetary easing The Bank aims to pursue powerful monetary easing through the implementation of the comprehensive monetary easing policy decided in October 2010. This policy consists of three measures: a change in the guideline for money market operations; a clarification of the policy time horizon; and the establishment of an Asset Purchase Program. Regarding the first measure, the change in the guideline for money market operations, the Bank lowered the uncollateralized overnight call rate target from previously “around 0.1 percent” to “around 0 to 0.1 percent.” Although the target rate of 0.1 percent was already extremely low, by allowing the target rate to fall below 0.1 percent, the Bank clarified that it is pursuing a virtually zero interest rate policy. As for the second measure, the clarification of the policy time horizon, the Bank made it clear that it will maintain the virtually zero interest rate policy until it judges that price stability is in sight, on condition that an examination of risk factors, including the accumulation of financial imbalances, reveals no problems. Price stability here is defined on the basis of the “understanding of medium- to long-term price stability” (hereinafter, the “understanding”) announced by the Bank and refers to the level of inflation that each Policy Board member understands, when conducting monetary policy, as being consistent with price stability over the medium to long term, with the midpoints of most Policy Board members’ “understanding” being around 1 percent. The Bank has made it clear that the Policy Board does not tolerate a year-on-year rate of change in the CPI equal to or below 0 percent. Usually, in an economic recovery phase, there are various forecasts as to when the policy rate will be changed and projections for longer-term interest rates consequently vary. The clarification of the policy time horizon – that is, the clarification of the conditions necessary for a change in the policy rate – should lead to a convergence in market expectations regarding future changes in policy and therefore help to stabilize longer-term interest rates. As the economic recovery progresses and corporate profits improve, this “policy duration effect” should exert significant further easing effects, since firms’ funding costs decline relative to their profits. As the third measure of the comprehensive monetary easing policy, the Bank established the Asset Purchase Program worth about 35 trillion yen to purchase various financial assets, such as government securities, CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs), as well as to conduct fixed-rate fundssupplying operations against pooled collateral whereby funds with a maturity of three or six months are provided at an interest rate of 0.1 percent. In the money market, where the Bank conducts daily operations as the central bank of Japan, most short-term interest rates are already close to zero, and there remains little room for further declines. Therefore, to achieve additional monetary easing, it is necessary to influence longer-term interest rates and prices of risk assets. It is for this reason that the Bank established the Asset Purchase Program, which aims at purchasing financial assets, including risk assets, thereby encouraging a decline in longer-term market interest rates and a reduction in various risk premiums. While the purchase of risk assets such as ETFs and J-REITs is an extraordinary measure for a central bank, the aim is that this will act as a catalyst for market participants to take a more BIS central bankers’ speeches active investment stance, thereby helping to smooth the intermediation of risk money and further improve firms’ funding conditions. 2. Ensuring financial market stability In order to fully ensure financial market stability, the Bank has been implementing a variety of measures including the utilization of various funds-supplying operations, even in the current situation where Japanese financial markets have been relatively stable. Specifically, the Bank has provided ample funds to financial markets, with the year-end outstanding balance of current accounts at the Bank last year exceeding 22 trillion yen, which was above the 20 trillion yen in 2009, and the 15 trillion yen in 2008, the year of the Lehman shock. However, measures include not only the amount of funds supplied but also steps to provide financial institutions with the confidence that they can obtain sufficient funds whenever necessary. For example, temporary measures introduced in response to the financial crisis that continue today include the complementary deposit facility, the acceptance of foreign government bonds as eligible collateral, and U.S. dollar funds-supplying operations. These measures aim to forestall a return of instability in financial markets. 3. Providing support to strengthen the foundations for economic growth Moreover, in order to strengthen the foundations for economic growth, the Bank has been implementing a measure through which it provides long-term funds at a low interest rate to private financial institutions in accordance with their efforts in terms of lending and investment. Currently, financial markets and financial institutions have abundant funds, firms have strong cash flows, and households hold an enormous amount of financial assets. Nevertheless, the Japanese economy has yet to show robust growth, indicating that the issue at stake is not a shortage of funds, but the unwillingness of economic entities to undertake forward-looking spending and investment. Underlying this situation is the fact that the decline in the growth trend of the economy has led to a decline in firms’ and households’ growth expectations, which in turn gives rise to insufficient domestic demand – the fundamental cause of the current deflation. In this situation, the Bank aimed to address the fundamental cause of the current deflation by making use of its function as the central bank and making more funds available to new areas of growth to raise growth expectations. While this fund-provisioning measure alone is unlikely to be enough to raise Japan’s growth potential, the Bank hopes that by acting as a catalyst it will prompt discussions on this issue as well as efforts to strengthen the foundations for economic growth. Looking at the outcome so far, I would say that most of the objectives of the fundprovisioning measure implemented in June 2010 have been achieved. Many financial institutions nationwide have shown an interest in the measure, and among the 140 financial institutions that applied, more than 100 financial institutions have been selected as counterparties. The total amount of loans provided through the two rounds of loan disbursements carried out by the Bank so far is about 1.5 trillion yen, which is already about half of the maximum amount of loans – 3 trillion yen – to be disbursed under the measure, with a year and a half still remaining until June 30, 2012, when the last disbursement of new loans is to take place. Areas eligible for loans or investment range, for example, from environment and energy business, development of social infrastructure, medical and nursing care business, and regional revitalization business to business deployment in Asian countries, and include efforts to support local industries. The measure is gradually producing positive effects as a catalyst – its intended purpose – since, although the maximum duration of loans provided under the measure is four years, more than 70 percent of actual individual loans or investments exceed this period. Moreover, following the introduction of the measure, financial institutions have been establishing new dedicated funds and lending schemes, and some of them in certain cases have set a higher ceiling on the total amount of lending or investment than the 150 billion yen ceiling for the total amount of loans that they could obtain from the Bank. BIS central bankers’ speeches III. Toward a sustainable growth path with price stability I will talk next about the structural problems facing the Japanese economy. As I have explained, the economy has been showing signs of a moderate recovery but is still experiencing deflation because the growth momentum remains weak. The “lost decade” following the bursting of the bubble economy has unfortunately turned into “two lost decades.” It is necessary to consider what can be done to avoid a third lost decade. A. Japan’s process of economic development Let us look back on Japan’s process of economic development in the past. Right after the end of World War II, Japan looked to the affluent advanced economies of Europe and the United States. At this point, Japan enjoyed a latecomer advantage and, with hard work, was in a position to aim at catching up and even overtaking these economies relatively quickly. Moreover, benefiting from a rise in the working-age population and the so-called population bonus – the increase in the share of the working-age population in the total population – it was easy to accelerate growth. Furthermore, with industrialization having already gotten underway before the war, Japan at the time was among the few countries that could produce high-quality manufactured goods at a low price and had few competitors in the international market. This favorable environment and Japan’s economic model – based on detailed government industrial policy, strong support for firms from the main bank system, and strong employee loyalty based on the seniority system and lifetime employment – helped form a positive cycle facilitating a high rate of growth. As a result, in 1968, Japan became the world’s second largest economy, and in the 1970s entered the ranks of the advanced economies, almost equal in terms of per capita GDP with the advanced economies of Europe and the United States. However, by joining the world’s leading economies, it lost its latecomer advantage. Moreover, around this time the population bonus also started to fade. Thus, the conditions that had propelled high-speed growth changed drastically, and with the outbreak of the oil crises and the appreciation of the yen, high-speed growth came to an end. Stable growth, however, was maintained thanks to the continued upward trend in the working-age population and the absence of competitors in the production of manufactured goods. In the 1980s, a large proportion of the population was able to enjoy a satisfactory standard of living. At the same time, however, the increased presence of the Japanese economy in international markets intensified trade friction, leading to a rising yen after the Plaza Accord. Foreign pressure rose for a wider opening of Japanese markets and for financial deregulation. It is against this background that the bubble economy emerged. The 1990s started with the tumbling of the Nikkei Stock Average, which had set a record high at the end of 1989. The bubble had burst, and Japan had to contend with the disposal of nonperforming loans (NPLs), slow growth, and the onset of deflation, marking the first lost decade. During this period, critical changes took place that affected Japan’s growth potential. The first is that the working-age population peaked in 1995 and then started to decline. The decade also saw the globalization of world markets following the end of the Cold War, the liberalization of international capital flows, and advances in information and communications technology, paving the way for the rise of emerging economies. Taken together, these developments clearly signaled the end of the favorable environment that had supported Japan’s economic growth. Consequently, growth in domestic demand remained weak in the 2000s, even after the disposal of NPLs had almost been completed. As a result, the lost decade turned into the two lost decades. B. Restrengthening Japan’s economic growth potential As illustrated by what I just described, the cause of the two lost decades appears to have been the vanishing of the favorable conditions that had propelled economic growth. In order to restrengthen Japan’s economic growth potential, efforts need to be made to create a favorable environment. For example, to reduce the negative effects of the fall in the BIS central bankers’ speeches working-age population on economic growth, measures should be taken to raise the labor force participation rate of women and the elderly. There is no question that the government, firms, and society as a whole need to work together, for example, to improve the environment for child rearing and actively promote employment policies that encourage the acquisition of new skills. Furthermore, to cope successfully with competition in global markets, Japan should improve its competitive environment by, for example, concluding more free trade agreements (FTAs) and economic partnership agreements (EPAs). Japan also needs to maintain and improve its model of growth based on benefiting from rapid growth in overseas economies, which has served it well so far. To this end, it is necessary to boost productivity in agriculture to strengthen the sector’s international competitiveness and ensure that it is not left behind in overall economic growth. In addition, we need to build a new growth model that reflects the changing economic environment. To stay in the forefront of global competition, it is necessary to devise and develop new areas of growth – simply following the example or copying the products of others will allow latecomers to catch up in no time. Firms need to take risks and pioneer new areas of business. It is also necessary to shift factors of production among industries to improve the efficiency of resource allocation. Areas where efforts should be strengthened without delay include environment-related sectors, where Japan has a technological edge, and areas linked with population aging, such as the nursing care and medical industry, since Japan has the fastest-aging society in the world. Successful implementation of efforts to this end should result in highly competitive new business models capable of capturing global demand. In order to strengthen economic growth potential, existing business structures must also be modified to suit the new environment. For example, it is important to proceed with further deregulation to encourage creativity and entrepreneurship by firms and individuals. Furthermore, some of the institutions that were devised on the assumption of high growth are becoming too costly to maintain in the current period of low growth; for the sake of efficiency, it is necessary to take measures to promote structural reform. In the past, deregulation has led to the birth of new areas of business such as mobile phones and door-to-door parcel delivery services and increased diversity in employment patterns, which has expanded employment opportunities. Moreover, increased efforts to correct high-cost structures have narrowed the differences between prices in domestic and foreign markets. Endeavors such as these will in due course inject vitality into the Japanese economy. At the same time, it is extremely important to reform the social security systems and to work on fiscal consolidation, since public concerns over the future of the pension system and public finances hamper economic growth by putting a brake on forward-looking spending and investment. Weak economic growth has made firms, individuals, and the government reluctant to take on new challenges and push ahead with painful reforms, and has made the economy heavily dependent on fiscal spending for a prolonged period. As a result, government debt has ballooned, and the combined long-term debt outstanding of the central and regional governments in Japan is forecast to reach 869 trillion yen at the end of March 2011, which is about 1.8 times Japan’s nominal GDP. Japan is thus in no position to merely sit back and observe the sovereign debt problems in Europe, which I touched upon earlier, and which were triggered by concerns about fiscal sustainability. A solution must be found before Japan suffers a serious loss of credibility in the markets. C. Measures taken by the Bank As I said earlier, the Bank continues to consistently make contributions as the central bank in order to overcome deflation and return the Japanese economy to a sustainable growth path with price stability. The Bank’s efforts through the conduct of monetary policy also aim to help strengthen Japan’s economic growth potential. The Bank must always be ready to proactively implement the necessary policies to achieve its objectives. Going forward, the Bank should continue to be proactive and do its utmost to bring the Japanese economy back to a sustainable growth path with price stability. BIS central bankers’ speeches
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Summary of a speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Oita, 23 March 2011.
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Ryuzo Miyao: Economic activity and prices in Japan and monetary policy Summary of a speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Oita, 23 March 2011. * * * Introduction It is my honor today to talk to Mr. Kugimiya, Mayor of Oita City, and business leaders in Oita Prefecture. And I express my gratitude for your understanding and cooperation in various business operations of the Bank of Japan’s Oita branch. First, I extend my deepest condolences to the people hit by the Tohoku-Pacific Ocean Earthquake, particularly those who have lost their loved ones. The earthquake was the biggest on record, and the damage has been geographically widespread. The quake has exerted various adverse effects on daily life and economic activity, as seen in the heightened problem of power supply shortages associated with the damage. Although the situation may be deemed a national crisis, it is important for us to have our determination to overcome the difficulties and rise from the disaster. In my remarks today, I will talk about the upheaval caused by the earthquake and the Bank’s responses, followed by an overview of Japan’s economic and financial developments as well as monetary policy. I will conclude by offering my impression of the regional economy of Oita Prefecture. I. Effects of the Tohoku-Pacific Ocean Earthquake and the Bank’s responses A. Settlement systems and financial markets Looking first at the settlement systems following the quake, there were incidents – mainly in the Pacific coastal areas in the Tohoku region – including the destruction of some branches and disruption of automated teller machines at financial institutions. Moreover, on the day the earthquake occurred, there were system troubles at some financial institutions. Financial institutions have been making strenuous efforts to combat the situation by utilizing their undamaged branches and/or making deposit withdrawals through operations on weekends and holidays. Some clearing houses in the quake-stricken areas continue to suspend their bill and check clearing (15 clearing houses as of March 18), but through the efforts I have just mentioned, the settlement systems, including the Bank of Japan Financial Network System (BOJ-NET), in other areas have been operating smoothly as a whole. The Bank has also been striving to ensure its own business continuity through, for example, setting up a disaster management team immediately after the quake occurred and making sure that the BOJ-NET is running as normal. The Bank has provided, through its branches and offices, cash to the quake-stricken areas on Saturdays and Sundays as well (the amount of cash provided through branches and offices in the Tohoku region was 55 billion yen for Saturday, March 12 and Sunday, March 13, and 256 billion yen during March 14–18). Also, in response to the subsequent planned power outage on concerns over power supply shortages, the Bank has been taking all possible measures to stem an interruption in the settlement of funds, partly by continuing its business using in-house power generation at some branches. The BOJ-NET has been provided with a stable power supply, as it is the cornerstone of Japan’s settlement system infrastructure. Since various financial needs are expected to arise in the quake-stricken areas, such as demand for cash and exchange of damaged banknotes and coins, the Bank will do its utmost to support these areas. Through such aggressive responses, the Bank will continue to ensure smooth BOJ-NET operation BIS central bankers’ speeches and cash supply and make every effort to ensure the stability of Japan’s settlement system as a whole. In the money market, fund providers have increasingly held back their fund provisions since the morning of Monday, March 14, and it has become difficult to make transactions in the call market. In response, the Bank conducted same-day operations, the first since May of 2010, and offered 82.4 trillion yen in one week (21.8 trillion yen on March 14, 20.0 trillion yen on March 15, 13.8 trillion yen on March 16, 15.6 trillion yen on March 17, and 11.15 trillion yen on March 18), of which 57.8 trillion yen was actually provided to the market. As a result, the overnight call market has been relatively stable in recent days. By contrast, in the CP and corporate bond markets, investors’ risk aversion has been strong and underwriting of CP and corporate bonds has declined, resulting in a significant rise in the issuing rates. The issuing rates have recently been somewhat high, which seems to be attributable in no small part to the protracted problem of the quake-stricken nuclear plant as well as the effects of the earthquake. In addition, in stock and bond markets, stock prices and long-term interest rates have fallen, reflecting investors’ risk aversion due to heightened uncertainty regarding the future. In particular, stock prices declined significantly, and on May 15, the Nikkei Stock Average plunged by 1,015 yen from the previous day. This rate of decline was the third largest in history, following only the declines recorded on Black Monday in 1987 and after the failure of Lehman Brothers in 2008. Moreover, in the foreign exchange market, while the yen depreciated immediately after the earthquake occurred, it then appreciated – reflecting the trend of risk aversion – and reached the range of 76.0–76.5 yen against the U.S. dollar in the early morning of March 17. Subsequently, due mainly to the concerted intervention by G-7 countries on Friday, March 18, the yen has been hovering around 80–81 yen against the U.S. dollar and stock prices have also recovered somewhat. B. Economic activity As for the effects of the earthquake on economic activity, the damage has been geographically widespread, with social infrastructure including ports and roads having been heavily damaged in the Tohoku region, and some large-scale factories being damaged in the Tokyo metropolitan areas. It is expected that a return to normal for the distribution system will take some time and that concerns regarding stable power supply, including in the metropolitan areas, will continue. In the meantime, restoration efforts have been made day by day. In this situation, the following could be pinpointed, albeit qualitatively, as three future effects. First, for some time, the effects of the damage will be seen substantially on the supply side, including production capacity, which will have an impact on economic activity, mainly in production and distribution. Since there are many parts manufacturers for automobiles and electronic devices in the quake-stricken areas, supply chains at home and abroad will be forced to be cut off, albeit temporarily. Second, uncertainty over the future could put downward pressure on economic activity through a deterioration in household and business sentiment. And third, while various forms of demand associated with restoration should emerge in the medium term, the timing and size of such demand is uncertain at present and quite difficult to envisage. While it is difficult to quantitatively gauge the effects of the earthquake at present, it is very much a situation in which the restoration of lifelines, utilities, and distribution has been slow, given that the earthquake was the biggest on record for Japan and accompanied by enormous tsunami. With that in mind, at least the extent to which economic activity will be pushed downward from the supply side could be larger and might be prolonged compared with, for example, the Great Hanshin-Awaji Earthquake of 16 years ago, and this warrants due attention. BIS central bankers’ speeches C. Policy responses With these things in mind, the Bank recognized that, in ensuring stability in public sentiment and in financial markets, it will be critical to examine the effects of the earthquake on Japan’s economic and financial conditions in the immediate future as well as promptly announce its guideline for money market operations. Therefore, the Bank shortened the duration of its Monetary Policy Meeting to one day from an initially scheduled two days and, upon examining the current situation, judged it necessary to further enhance monetary easing. In particular, given that preventing any deterioration in business sentiment or any increase in risk aversion in financial markets from adversely affecting economic activity was considered to be the most appropriate policy response at present, the Bank decided to increase the amount of the Asset Purchase Program, mainly of the purchases of risk assets, by about 5 trillion yen to about 40 trillion yen in total. Specifically, the 5 trillion yen increase in asset purchases will be made mainly in risk assets – namely, CP, corporate bonds, exchangetraded funds (ETFs), and Japan real estate investment trusts (J-REITs) – for about 3.5 trillion yen and in government securities for about 1.5 trillion yen. While there remains uncertainty over the future, the Bank will endeavor to gauge the effects of the earthquake on financial institutions and the financial system, as well as take all possible measures in order to secure stability in settlement systems and financial markets. II. Developments in economic activity and prices and monetary policy in Japan A. Overview The Bank has judged that Japan’s economy will get out of the soft patch and, from a longerterm perspective, continue to recover moderately. At the same time, the impact of the earthquake on Japan’s economy is projected to be by no means small, at least in the short run. It is necessary to examine with vigilance how the earthquake will affect the Bank’s previous outlook for economic activity and prices, together with the risk factors the Bank has highlighted. Next, I will examine those issues – although most are judgments made prior to the earthquake – starting with overseas economies. B. Overseas economies Let me first talk about the U.S. economy. The economy has continued to recover, coupled with additional stimulus measures both from the financial and fiscal sides. Business sentiment has improved among manufacturing and nonmanufacturing firms, and stock prices have been improving as a trend supported also by the good performance of global businesses. In this situation, business fixed investment has been on a recovery trend, albeit a moderate one, and private consumption has been recovering, exceeding the level before the Lehman crisis. On the other hand, balance sheet adjustments in the household sector are likely to take more time and housing investment has been at a low level, especially in terms of sales of newly constructed houses. The employment and income situation has improved somewhat, but the pace of improvement has remained moderate. In such circumstances, due attention should be paid to how the recent rise in commodity prices will affect the U.S. economy. Inflation expectations perceived by the market have been on an uptrend since the autumn of 2010. Household inflation expectations have risen since the turn of the year and the recent indicators of consumer sentiment have turned toward a decline. The pace of the rise in commodity prices has accelerated, due partly to speculative capital inflows and the unrest in the Middle East amid originally robust demand in emerging economies. While commodity prices have recently been soft as risk aversion has heightened globally, triggered by the earthquake in Japan, the trend of price rises and continuous high prices is likely to remain to some extent if the basis of such a trend is the real demand on the BIS central bankers’ speeches back of high growth in emerging economies. I will pay close attention to future developments in commodities prices and their effects on inflation expectations around the world, including the United States. Next, looking at East Asian emerging economies, especially China, those economies have exited the deceleration phase starting from the latter half of 2010 and have continued growing at a rapid pace. The structure of growth indicates the ongoing virtuous circle in which the continuing robust expansion of domestic demand in the Chinese economy is increasing exports to China from some peripheral Asian countries, which in turn is spreading to domestic demand in those countries. In this situation, within Asian emerging economies, concern over inflation has started to heighten partly because of the rise in commodity prices, as well as the robust domestic demand. Moreover, in terms of maintaining the domestic demand expansion, wage increases in tandem with price rises are inevitable. This might in turn increase upward pressure on inflation. Therefore, Asian emerging economies have proceeded with the gradual rise in policy rates to create an environment for sustaining high growth. If the previous accommodative policy conduct – referred to as “behind the curve” – prolongs and high inflation takes hold, this will have a negative impact on the economy. Thus, in order to prevent such negative impact, it is important to act ahead of time. As Asian emerging economies are the driving force behind global economic growth, attention is being paid to their potential future actions. Lastly, European economies are recovering moderately led by exports, driven in particular by Germany and other major economies. The rising inflation trend has become more pronounced and the European Central Bank has suggested a future policy rate rise. In some peripheral European countries that suffered fiscal problems, long-term interest rates have stayed high and uncertainty has remained elevated. C. Japan’s economy In light of such recovery in the U.S. economy and high growth in Asian emerging economies, the effects of inventory adjustments in IT-related goods have run their course around the world. Private consumption in Japan is showing signs of picking up after suffering the reverse following the sharp increase seen previously. Although this represents the judgment made prior to the earthquake, Japan’s economy is getting out of the soft patch, driven in particular by the recovery in exports and production. Looking at market developments prior to the earthquake, stock prices remained on an uptrend while the yen was in the range of 80–85 yen against the U.S. dollar. This is attributed to the fact that overseas stock prices, especially U.S. stock prices, rose in reflection of monetary easing in the United States, and that corporate profits and their cash flows improved substantially. On the other hand, the improvement seen in components related to domestic demand, such as business fixed investment and private consumption, and in the employment and income situation remained moderate. The pace of improvement in the output gap and price developments was generally moderate. Just like in the United States, the channel through which the favorable performance in the corporate sector fed into the household sector seemed to be somewhat weak. The likely underlying mechanism is as follows. Even if the economy were to achieve an export-led recovery, a rise in import costs due to the increase in commodity prices would cause the terms of trade to worsen and real income to be undermined. As a result, even if the GDP figure increased, gross domestic income (GDI) would not increase that much. For example, during the recovery phase in the 2000s – that is, during 2002–2007, before the Lehman crisis – the real GDP growth rate was 1.8 percent on average but the real GDI, excluding trading losses, remained 1.2 percent on average. During the same period, the increase in real GDP brought by net export expansion, accumulated over the six-year period, BIS central bankers’ speeches amounted to 23 trillion yen. The trading losses during the period amounted to 18.7 trillion yen, meaning that the real GDI only grew by 4.3 trillion yen. These figures suggest that some sectors in the economy have been burdened with these losses. During the recovery phase in the 2000s, firms contained total labor costs by constraining wages. The reduction in costs for wages represents firms’ strenuous efforts to achieve structural transformation and streamlining. The reduction in production costs plays a role in stimulating the economy from the supply side, thereby constraining price rises. On the other hand, the reduction in total labor costs and wages leads to a reduction in household income, which in turn undermines a transmission mechanism working on domestic demand. Thus, it can be said that the trading losses during the recovery phase in the 2000s burdened the household sector through the streamlining in the corporate sector. If such mechanism underlies the economic recovery led by exports and production, this trend seems to have continued even in the recovery phase after the Lehman crisis. It appears that, on the back of the global and increasingly competitive environment and the yen’s appreciation, firms have enhanced their efforts to proceed with structural transformation and to increase growth potential by accelerating their shifting of production sites overseas. It also seems that firms are maintaining their cautious stance in allocating corporate profits brought by the efforts just mentioned to domestic business fixed investment, or to employment and wages. There is a possibility that such mechanism has continued to operate while, until recently, the uptrend in commodity prices has constrained domestic income. I will closely examine whether such a trend will continue and how it would affect the outlook for Japan’s economic activity and prices. Let me repeat that the views I have presented so far were in consideration before the earthquake struck. Therefore, I will examine with vigilance the earthquake-triggered risk aversion around the world and its effects on the global economy, as well as Japan’s economy. D. Monetary policy In October of 2010, the Bank decided to implement comprehensive monetary easing to further pursue powerful monetary easing. Comprehensive monetary easing can be briefly summarized as follows. First, the Bank clarified its adoption of a virtually zero interest rate policy. Second, the Bank confirmed that it would maintain the virtually zero interest rate policy until it judged that price stability was in sight, and that the judgment would be based on the “understanding of medium- to long-term price stability.” Third, taking into account that there was little room for a further decline in short-term interest rates, the Bank established the Asset Purchase Program, which aimed at purchasing various financial assets – namely, government securities, corporate bonds, CP, ETFs, and J-REITs – with a view to encouraging a decline in longer-term market interest rates and various risk premiums. This is a quite extraordinary and unconventional monetary policy package that includes the Bank’s commitment to the continuation of the virtually zero interest rate policy, balance-sheet expansion, and purchases of risk assets. When the package was introduced, on the back of the slowdown in overseas economies and the sharp appreciation of the yen, business and household sentiment deteriorated and asset prices including stock prices were sluggish. Correcting the sentiment and risk-taking appetite that have excessively deteriorated in the markets is expected to produce sustained effects on lowering risk premiums. In fact, in the period after the introduction of comprehensive monetary easing until the earthquake, risk premiums generally declined, as seen in the rise in stock prices and REIT prices. It is also expected that the Bank’s bold measure to encourage risk taking will boost firms’ “animal spirits,” thereby leading to an increase in Japan’s growth potential and an improvement in productivity. Also, in the United States, in the period following the Lehman crisis until the introduction of a large-scale asset purchase program – the so-called “quantitative easing II” – in November of 2010, unconventional monetary easing measures were implemented four times. In particular, BIS central bankers’ speeches the decision to purchase 600 billion dollars of longer-term Treasury securities in November of 2010 has produced some effects through the decline in long-term interest rates and borrowing costs. It also appears to have had the effect of boosting stock prices through moderating overly pessimistic market views on the U.S. economy seen from the summer of 2010 and correcting the trend of excessive risk aversion, thereby continuing to affect risk premiums requested by market participants. As the dollar is the world’s key currency, monetary easing in the United States may have another global transmission channel. Specifically, as a result of the Federal Reserve’s commitment to the virtually zero interest rate policy as a policy action after the Lehman crisis, economies that have a strong linkage with the dollar, such as emerging economies and commodity-exporting economies, have ended up importing U.S. monetary easing, which in turn brings about economic expansion in countries other than the United States. U.S. global firms, both manufacturing and nonmanufacturing, are deeply involved in business operations widely around the world. Thus, economic expansion in areas with a strong linkage with the dollar would enhance the profits and growth expectations of U.S. businesses, which would in turn entail a rise in U.S. stock prices and lead to a recovery in private consumption. Therefore, it can be said that the powerful monetary easing policy that has continued for more than two years in the United States has been entailing “international spill-over effects” of stimulating its economy at home, due to the rise in U.S. stock prices through the expansion of overseas economies. It is important to note that the unconventional policy measures being implemented in Japan and the United States are not undisciplined, unlimited monetary easing. In the case of Japan’s comprehensive monetary easing, and to clarify that it is after all a temporary and extraordinary policy measure, the Asset Purchase Program has been established and managed on the Bank’s balance sheet. Similarly, in the case of the United States, Federal Reserve Chairman Ben S. Bernanke emphasized that the large-scale asset purchase program is a short-term policy measure and the Federal Reserve is committed to achieving medium- to long-term price stability. So far, I have examined monetary policy and its effects on Japan and the United States. What has been highlighted as a common factor is that, when market sentiment and confidence have swung excessively in the direction of pessimism, central banks’ aggressive actions and asset purchases were made to correct that situation and influence risk premiums in a sustained manner. As mentioned earlier, in response to the earthquake, at the Monetary Policy Meeting held at the beginning of last week, the Bank decided to increase the amount of the Asset Purchase Program, mainly of the purchases of risk assets, with a view to further enhancing monetary easing. This measure is expected to have an effect similar to the one mentioned above, in that, confronted with an unprecedented earthquake disaster, the measure aims at counteracting any deterioration in business sentiment or an excessive increase in risk aversion, thereby preventing economic activity from deteriorating. While uncertainty is likely to remain high, the measure taken by the Bank will exert powerful effects as various efforts toward normalization pay off. Concluding remarks: the economy of Oita Prefecture In conclusion, I will refer to the developments in this area. Oita Prefecture was designated as a new industrial city during the high-growth period, and it has been actively attracting growth-promising companies to the region, through cooperation between the public and private sectors, for a little less than the 50 years that have passed since the Oita coastal industrial zone was formed. Therefore, its industrial structure is quite well balanced and solid, with not only materials industries such as steel and oil having congregated in the area, but also processing industries such as precision machinery, BIS central bankers’ speeches semiconductors, and automobiles. Looking at the ratio of manufacturing to the prefectural gross product as of fiscal 2007, Oita posted a high 23.3 percent compared with the national average of 21.2 percent and the Kyushu average of 17.1 percent. There are many factories with extremely high production efficiency, as suggested by the value of manufactured goods shipments per establishment and per worker both being number one in Kyushu and number three in the nation. Since this region has a high share of manufacturers, it was significantly affected by the decline in exports and production caused by the failure of Lehman Brothers. Subsequently, in view of the many productive and efficient new factories, Oita’s exports and production have been recovering relatively steadily in tandem with the recovery in overseas economies. Moreover, I rediscovered that Oita is blessed with an abundance of resources with high brand recognition, ranging from fruits of the sea such as Seki aji, Seki saba, and Shiroshita karei, as well as dried shiitake mushroom and kabosu, for which production is the largest in Japan, to internationally popular hot springs resorts such as Yufuin and Beppu. Moreover, Oita has a geographical advantage of being located near rapidly growing East Asian economies, which gives the region a great advantage in terms of production and tourism. In addition, the improvement in traffic infrastructure, including the full opening of the Kyushu Shinkansen Line this month and ongoing extension work in the region for the Eastern Kyushu Expressway, is expected to intensify the interaction within the Kyushu region and with other areas including the Kansai region. Looking toward the future for Oita’s economy, I am paying close attention to the following two issues that could lead to future growth in Oita Prefecture. First, wide-ranging cooperation in the medical and welfare areas. Many medical equipment manufacturers have been congregating in Oita Prefecture and the prefecture’s total value of medical equipment production ranks fourth in Japan. In October of last year, Oita Prefecture formulated an “Initiative for Eastern Kyushu Local Medical Industrial Center (or Eastern Kyushu Medical Valley Initiative)” in cooperation with its neighbor Miyazaki Prefecture. The medical and welfare areas have been considered as growth areas in the nation’s growth strategy, and, given their characteristics of not being influenced substantially by a business cycle, are expected to contribute to the regional economy. I believe that cooperation among the government, industries, and the academia will be enhanced based on such wide-ranging cooperation, and that industrial congregation will advance in the future. The second issue is regional revitalization by utilizing natural energy. Oita Prefecture is the top in the nation in terms of the number of hot springs sources and the amount of hot water, and, supported by such geothermal energy, is an advanced prefecture in natural energy utilization, with the supply and self-sufficiency ratio of natural energy being ranked first among the prefectures in Japan. As for natural energy, there have recently been nationwide efforts by both the public and private sectors to enhance its utilization together with the beefed-up efforts toward solving environmental problems. Also in Oita Prefecture, there have been signs of promoting the use of natural energy sources other than geothermal power generation, including small hydroelectric generation and biomass generation. In perceiving the natural energy area as a business opportunity, some local firms appear to be crossing traditional business borders and entering the area through innovations, in which I expect future growth. With that, I will conclude my speech and move on to exchanging views with you. Thank you. BIS central bankers’ speeches
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Opening remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting hosted by the Institute of Regulation & Risk, North Asia, Tokyo, 11 April 2011.
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Masaaki Shirakawa: One month after the great East Japan earthquake – critical role of financial infrastructure Opening remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting hosted by the Institute of Regulation & Risk, North Asia, Tokyo, 11 April 2011. * I. * * Introduction I am honored to have been invited today to this meeting hosted by the Institute of Regulation & Risk, North Asia. It is now exactly one month since the March 11 earthquake. I would like to express my sincere condolences to the victims of the disaster and offer my heartfelt sympathies to those who are suffering. I am pleased to see many friends in attendance today, and my gratitude especially goes to Bill Dudley, president of the Federal Reserve Bank of New York, who is here despite these difficult times after the disaster triggered by the earthquake. I am told that the meeting focuses on financial regulation and supervision. The earthquake, which had a magnitude of 9.0 and was the largest on record in Japan, the tsunami, and the nuclear plant problems were a series of events that have raised many risk issues that go beyond the level of risk management by financial institutions. For that reason, it is critical to reconsider how society as a whole copes with such issues. Of course, it would be premature to attempt to provide comprehensive answers at this juncture, but one of the important aspects in this regard is the robustness of social infrastructures. In what follows, from such a perspective, I would like to make a modest contribution by sharing with you what has happened in terms of financial infrastructure, which is one of the critical social infrastructures, in the past month and my impressions over this period. II. Impact on financial infrastructure Let me first talk about how the disaster affected Japan’s financial infrastructure. The physical damage to financial institutions in the areas hit by the earthquake was enormous, including the destruction and flooding of some branches. Thanks to the dedicated efforts of those involved, financial institutions have been gradually starting to get their branches and offices in those areas back on their feet. There are 72 financial institutions with headquarters in one of the six prefectures of the Tohoku region or Ibaraki Prefecture. Of the 2,700 branches and offices of these financial institutions, those closed as of March 16 were about 310, or about 10 percent of the total, but as of today this has declined to about 150, or about 6 percent of the total. The other 94 percent are open for business as usual, providing various financial services. Looking at the impact on a nationwide level, Japan’s core payment and settlement systems, including the Bank of Japan Financial Network System, or BOJ-NET, have been consistently functioning as normal since the earthquake struck. In financial markets, the Tokyo Stock Exchange has been open for business as usual. Like electricity, water, gas, railways, and roads, the financial and settlement systems are critical infrastructure that supports people’s lives and economic activity. If the financial and settlement systems as a whole had ceased to function normally, the adverse effects on people’s lives and economic activity probably would have been even greater. The robustness of the financial system that we have seen this time was attributable to the hard work and solidarity of the people involved after the earthquake struck. I would also like to point out that the steady efforts of those involved in normal times, such as in developing business BIS central bankers’ speeches continuity plans and carrying out street-wide disaster exercises, greatly contributed to this robustness. III. Bank of Japan’s responses Next, I would like to explain how the Bank of Japan reacted to the disaster. Continued provision of financial services What the Bank of Japan did first was to continue providing financial services as usual. In that regard, it was vitally important to maintain the financial functions that serve as a lifeline in the affected areas. On the financial front, the first urgent need faced by people in the affected areas is to secure cash to purchase the necessities. The day the earthquake occurred, I promptly asked, jointly with the Minister for Financial Services, financial institutions to take appropriate measures to accommodate the needs of those affected by the disaster, such as permitting the withdrawal of deposits even in cases where depositors had lost certificates of deposits or passbooks. Moreover, the Bank of Japan strived to provide cash to the disaster areas in a prompt and sufficient manner day after day, including holidays, to meet the cash needs of people in those areas. In fact, the amount of cash provided to the affected areas was three times larger than in normal times. The Bank of Japan has also been taking all possible measures as the central bank to support affected areas by responding to various related financial needs such as exchanging banknotes and coins that were damaged by the earthquake and tsunami. The Bank of Japan’s operations in the Tohoku region, including our branches in Sendai and Fukushima and our office in Morioka, have been providing uninterrupted central banking services as usual, thanks to the efforts of the employees of these operations and the support provided by the Bank of Japan’s head office and other branches. In addition to maintaining retail payment functions, it is also vital to ensure that the wholesale payment systems for funds and securities continue to function in a stable manner. In this regard, as I mentioned earlier, the BOJ-NET continued to operate without interruption after the earthquake. Ensuring the stability of financial markets The Bank of Japan’s second response was to ensure financial market stability. When a huge risk manifests itself, such as a disaster triggered by an earthquake, and there is increased uncertainty over the future, market participants try to retain a large amount of funds at hand to prepare for the worst. If such an increase in precautionary demand for liquidity is left unaddressed, it could destabilize financial markets and eventually adversely affect economic activity. To prevent such a situation, the Bank of Japan has been providing ample liquidity since immediately after the earthquake, and has been striving to ensure financial market stability by maintaining a sense of security on the funding front. On March 14, the first business day after the disaster, the Bank of Japan provided a total of 21.8 trillion yen in liquidity. This was a daily record and four times larger than the largest daily liquidity provision after the Lehman crisis. The Bank of Japan has continued to provide ample liquidity every day and its outstanding current account balance also reached a record high of 42.6 trillion yen on March 24. Although the disaster had no impact on Japanese financial institutions’ foreign currency funding, in its U.S. dollar-funds supplying operation that has been in place since before the earthquake, the Bank of Japan started to offer one-week funds, as a safety valve, in addition to the existing three-month funds. Since Bill is here, I should not forget to mention that this operation is based on swap arrangements between major central banks and the Federal Reserve Bank of New York. I would also note that coordinated foreign exchange market BIS central bankers’ speeches intervention by G-7 countries played a critical role in not only stabilizing the foreign exchange market, but also helping to prevent negative spillovers into other markets, for example Japan’s stock market. With such ample liquidity provision and backup support, calm has been restored in Japan’s money markets and they are currently quite stable. Enhancement of monetary easing The third response was to take policy measures on the monetary policy front, by enhancing monetary easing. It so happened that the Monetary Policy Meeting was scheduled to be held over two days starting from the next business day after the earthquake. As the Bank of Japan deemed it desirable to examine the possible effects of the disaster on Japan’s economy and finances and promptly announce a guideline for money market operations, thereby ensuring stability in public sentiment and in the financial markets, it shortened the duration of the meeting to one day and decided on enhancement of monetary easing on March 14. What we feared most immediately after the disaster was a situation in which a deterioration in business sentiment or an increase in investors’ aversion to risk would lead to an increase in various risk premiums, thereby adversely affecting economic activity. Since the autumn of 2010, the Bank of Japan has started to purchase various assets, including risk assets such as CP, corporate bonds, exchange traded funds (ETFs), and Japan real estate investment trusts (J-REITs), under the comprehensive monetary easing framework. This time, the Bank of Japan decided to increase the amount of the Asset Purchase Program, by doubling the purchases of assets from about 5 to about 10 trillion yen. This measure appears to have helped to reassure financial markets. IV. Confidence in financial infrastructure That concludes my explanation of what we did in the month following the earthquake. As the situation is still evolving and we do not yet have sufficient information, it is too early to draw any lessons at this juncture. Nevertheless, it does seem worthwhile to share our impressions with one another while our memories are fresh, ahead of full-scale examination of the issue in the future. I myself have thought many things, but if I were to choose one, it would be the importance of ensuring that people retain confidence and trust that financial infrastructure will function normally. In the week following the earthquake, rumors spread mainly among some foreign financial institutions that Tokyo financial markets would close. While hard to believe, there was also a groundless rumor that the Bank of Japan would move its computer center to Osaka. Extreme anxiety can in itself induce self-propagating market reactions. Fortunately, such rumors gradually dissipated. Several factors contributed. The first of these was the strong commitment shown by those involved. For my part, I explained to overseas authorities, through an impromptu conference call with G-7 finance ministers and central bank governors and on other occasions, that the Bank of Japan had been taking all possible steps to maintain Japan’s financial intermediation function and ensure smooth fund settlement. Moreover, the International Bankers Association, which is a group of foreign financial institutions active in Japan, issued a press release on March 15, soon after the earthquake, stating that major foreign financial institutions in Japan were continuing to operate business as usual. Subsequently, senior executives of such institutions visited Japan one after another and expressed their commitment to continue to do business in Japan. Along with such communication, it is, as I mentioned earlier, of utmost importance that settlement systems and the financial markets physically continue to function as normal. Once financial infrastructure continues to function normally, unfounded rumors will disappear in due course. If, on the contrary, financial infrastructure does not function normally, the situation will BIS central bankers’ speeches deteriorate further. For that reason, even in times of disaster, it is important to make the necessary preparations to enable the normal functioning of financial infrastructure. In this regard, it has driven home to me the importance of the “logistics” of providing human and physical resources, and within this the importance of the location of backup centers. The foremost challenge for Japan today is responding to the acute emergency after the disaster. Financial infrastructure is vital not only in this emergency phase immediately after the disaster, but also in the process of economic rebuilding that will gradually become more and more center-stage. The financial markets have the most important role as the infrastructure for providing the financing necessary for this rebuilding. After the Great Kanto Earthquake of 1923, foreign currency-denominated government securities were issued to cover the rebuilding costs. At that time, the government was forced to issue securities at high interest rates. Since the recent earthquake, there have been 12 auctions for 35.0 trillion yen worth of newly-issued government securities including treasury discount bills. Despite the unprecedented major earthquake and subsequent disasters and despite the fact that Japan’s fiscal conditions remain severe, it was still possible to issue securities at low interest rates in a stable manner. This was possible partly because the markets have confidence that the aim of Japan’s monetary policy is to achieve sustainable growth with price stability and not to facilitate government financing. It is not easy to get a sense of the importance of the infrastructure at the heart of society, such as electricity supply and the road network, when it is functioning as normal. The recent disaster has made us recognize that, once such infrastructure is damaged and impaired, repairing it is not easy and the damage has a very large impact on people’s lives and economic activity. The same thing can be said of confidence in the nation’s currency. The Bank of Japan will continue, as the central bank, to steadfastly work to ensure that trust in Japan’s currency is maintained as well as to carefully examine the outlook for economic activity and prices, and take appropriate policy actions as necessary. Thank you for your attention. BIS central bankers’ speeches
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Speech by Mr Tadao Noda, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kumamoto, 3 March 2011.
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Tadao Noda: Recent economic and financial developments and the conduct of monetary policy Speech by Mr Tadao Noda, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kumamoto, 3 March 2011. * I. * * Overseas economies I will begin by outlining overseas economies. Overseas economies are continuing to recover from the downturn following the global financial crisis after the failure of Lehman Brothers in the autumn of 2008. Although there have been inventory adjustments in IT-related goods since summer 2010, this has not exerted much downward pressure on economic activity. Looking ahead, overseas economies are expected to continue to recover, but while emerging economies are likely to continue to show relatively high growth fueled by growth in domestic demand, the recovery in advanced economies is likely to lack strength. This divergence in growth trends has been referred to as the “two-speed recovery” or “two-track recovery.” A. Recovery in advanced economies lacks strength Let me first talk about advanced economies. The U.S. economy continues to recover. Led by increases in exports, corporate profits have been on a recovery trend, and business fixed investment has been rising moderately. In particular, private consumption, the main demand component, is growing quickly at present. Growth in consumption is currently outpacing increases in disposable income, and household saving rates, which rose after the failure of Lehman Brothers, have begun to decline. These developments can be attributed in part to the rise in stock prices fueled by additional stimulus measures, both from the monetary and fiscal sides. The recovery trend is expected to continue against the background of increasing exports, especially to emerging economies, and the accommodative financial environment. Firms, however, remain cautious about hiring new employees, and it will take time to resolve household balance-sheet problems, which were partly responsible for the financial crisis. While the recent rise in stock prices should accelerate the pace of balance-sheet adjustments, the resumption of the decline in home prices will act as a brake. As Japan’s experience after the bursting of the bubble economy shows, balance-sheet adjustments impede the virtuous circle of growth in production, income, and spending. Therefore, the pace of recovery in the U.S. economy is likely to remain moderate. Economic activity in the euro area as a whole has been recovering moderately, with some differences in pace by country. In particular, the German economy has been growing notably, with exports boosted by a weak euro. Going forward, Germany is expected to enjoy steady growth led mainly by buoyant exports. However, due to the effects of fiscal austerity, economic growth in some peripheral countries is likely to remain sluggish as both the public and private sectors are mired in excessive debt. B. Continued high growth in emerging economies Next, I will talk about emerging economies. On the whole, business fixed investment has been increasing reflecting higher capacity utilization rates, and private consumption has been boosted by the improvement in the employment and income situation resulting from increased production. Since emerging economies do not face the kind of structural problems weighing down on advanced economies such as balance-sheet adjustments and BIS central bankers’ speeches deteriorating fiscal conditions, the virtuous circle of growth in production, income, and spending operates normally and emerging economies are expected to continue to show relatively high growth. China, which takes center stage among emerging economies, continues to enjoy high yearon-year growth in excess of 9 percent. Growth in exports temporarily slowed in the middle of 2010 due to the completion of global inventory restocking following the recovery from the global financial crisis. At present, however, exports have regained their upward momentum. As for the outlook, the Chinese economy is expected to continue to grow at a rapid pace, with infrastructure-related investment remaining on an increasing trend, and private consumption continuing to expand due to increases in household incomes. II. Japan’s economy Next, I will outline the current situation of and outlook for Japan’s economy and prices. A. Economy emerging from a temporary pause Since the early autumn of 2010, there has been a temporary pause in Japan’s economic recovery, partly due to the slowdown in overseas economies and the decline in the demand for some types of consumer goods following the previous sharp increase. As a result of the recovery in overseas economies, however, the economy seems to have been emerging from its temporary pause. Exports have resumed their upward trend amid the reacceleration of growth in overseas economies and the progress in inventory adjustments in IT-related goods I just mentioned. Specifically, real exports declined in January from the previous month, partly reflecting the large increase in December – the first in five months – but are showing signs of resuming their uptrend. As for private consumption, while demand for some goods has fallen back following the sharp, last-minute increase in demand ahead of the expiration of subsidies for purchases of environmentally friendly cars and of the eco-point system for household electrical appliances, consumption of other goods and services has generally been firm. Under these circumstances, production has been showing signs of improvement since November. As for the outlook, exports are likely to continue to trend upward on the back of the improvement in overseas economies. Private consumption is likely to pick up gradually as the effects of the decline in demand following the previous sharp increase gradually dissipate. With corporate profits showing solid improvements, business fixed investment is also likely to start picking up. Thus, led by the recovery in exports, Japan’s economy is likely to return to a recovery path with clear signs of a self-sustaining recovery trend.1 That being said, however, private consumption is likely to remain subdued given that the employment and income situation – although easing somewhat – remains severe. Furthermore, the pace of improvement in business fixed investment is likely to remain moderate since it will take time until firms’ sense of excessive capital stock is dispelled, and the relative share of overseas investment has been increasing reflecting the widening gap between the economic growth potential at home and abroad. Every April and October, the Bank releases its Outlook for Economic Activity and Prices (the Outlook Report), and in the intervening January and July makes an interim assessment of the outlook laid out in the report. The Policy Board members’ forecasts for real GDP are presented as reference figures in the respective months. In January, the median of Policy Board members’ forecasts for GDP growth was 3.3 percent for fiscal 2010, 1.6 percent for fiscal 2011, and 2.0 percent for fiscal 2012. BIS central bankers’ speeches B. Weaker downward pressure on prices As for prices, the year-on-year pace of decline in the consumer price index (CPI), excluding fresh food and the effects of the special subsidies for high school tuition introduced in April 2010 as part of the government’s economic stimulus measures to reduce the cost of high school education, is slowing moderately due to the gradual improvement in the aggregate supply and demand balance in the economy as a whole.2 Regarding the outlook, this mechanism whereby the improvement in the aggregate supply and demand balance exerts upward pressure on prices is likely to continue as a trend. However, it is also likely that the year-on-year rate of growth in the CPI will be revised downward due to the base-year revision for the CPI scheduled for August 2011.3 Needless to say, regardless of the extent of the revision, prices themselves will remain unaffected and, in conducting monetary policy, such statistical artifacts need to be borne in mind. C. Upside and downside risks So far, I have talked about the scenario I consider to be the most likely. I will now consider both upside and downside risks that may impinge on the above outlook. 1. Emerging economies First, I will look at upside and downside risks to emerging economies. The rapid growth of emerging economies, which contrasts sharply with the weak momentum for recovery in advanced economies, continues to lure capital from investors seeking higher returns.4 The inflows appear to have been amplified by the continued large-scale monetary easing in advanced economies as well as the fixed or semi-fixed exchange rate regimes adopted by some emerging economies with the aim of keeping their currencies from appreciating. The further expansion of emerging economies will – for the time being – exert large positive effects on the economies of advanced countries, including Japan, through higher exports. However, if emerging economies continue with easy monetary policies, they may fall behind the curve.5 This could cause their economies to overheat, and any adjustment that follows could result in a rapid unwinding of excesses, leading to a contraction of economic activity. 2. Global commodity markets Next, I will talk about the rise in overall commodity prices. There is no doubt that the fundamental cause is a tighter supply and demand balance caused by robust demand from emerging economies and decreasing supply due to unseasonable weather in some The year-on-year rate of change in the CPI excluding fresh food – the core CPI – has remained negative (with a value of minus 0.4 percent in December 2010, and minus 0.2 percent in January 2011). However, when the effects of the special subsidies for high school tuition introduced in April 2010 are excluded to gauge the trend changes in consumer prices, the year-on-year rate of change in the core CPI has turned positive, registering 0.1 percent in December 2010 and 0.3 percent in January 2011. At present, calendar year 2005 is used as the base year for calculating the year-on-year rate of change in the CPI. In August, the base year will be changed to 2010 and year-on-year figures as far back as January 2011 will be revised retroactively. At present, the pace of capital inflows to emerging economies is decelerating due to concerns about rising inflationary pressures in emerging economies and heightened uncertainty regarding the situation in the Middle East. With regard to emerging economies with de facto fixed exchange rate systems, there appears to be a tendency for monetary tightening to fall behind. In open economies, it is said that three objectives are not attainable simultaneously: (1) independent monetary policy; (2) fixed exchange rate systems; and (3) free international movement of capital. Many advanced countries, including Japan, have adopted independent monetary policy and free movement of capital, while in principle the foreign exchange rate is determined by the market mechanism. BIS central bankers’ speeches commodity-exporting economies. In addition, the recent political unrest in North Africa and the Middle East, triggered by the riots in Tunisia, has been adding to the uncertainty over the supply of crude oil, sending prices sharply higher. Furthermore, the nature of commodity transactions has changed with the introduction of commodity futures trading. In the past, the price of each commodity moved independently of other commodities, reflecting the differing supply and demand structures. However, since around the mid-2000s, advances in the infrastructure for commodity futures trading have led to the creation of products such as commodity indexes and exchange-traded funds (ETFs) that combine exchange-traded futures on commodities and financial assets. The growing use of these products has resulted in the price movements of various commodities, as well as the prices of commodities and financial assets such as stocks, to be more closely linked. Against this background of “financialization” of commodities, it cannot be denied that accommodative monetary conditions around the world have fueled expectations of higher commodity prices and accelerated the rise in global commodity prices. Inflationary pressures have increased in emerging economies due to higher food and raw material prices reflecting the rise in global commodity prices, coupled with higher utilization rates of production factors such as labor and facilities.6 If global commodity prices continue to rise beyond what is warranted by fundamentals such as the increase in demand in emerging economies, resource-importing economies – both advanced and emerging – will see a decrease in consumption expenditure through a decline in real purchasing power. If the increases in costs cannot be passed on to prices of final products, corporate profits will be squeezed, resulting in a negative impact on consumption through a deterioration in the employment and wage environment.7 3. Industrialized economies The third risk concerns advanced economies. As I mentioned earlier, the U.S. economy is burdened with balance-sheet adjustments. Dealing with them will take time, and U.S. economic activity therefore still looks unlikely to accelerate and remains vulnerable to downside risks. I personally have remained cautious about the outlook for the U.S. economy throughout. However, forecasts by private-sector economists have fluctuated greatly since the beginning of 2010.8 The divergent views regarding the outlook have probably been caused by differing opinions regarding the time it will take to resolve the balance-sheet problems. A risk common to many advanced economies is the sharp growth in public debt. When the market’s confidence in fiscal sustainability declines, economic activity is negatively affected due to the adverse feedback loop between financial and economic activity. In some peripheral European countries, such a negative feedback loop has already materialized, creating persistent tensions in financial markets. However, this has not spread to other regions so far thanks to the establishment and expansion of support mechanisms to maintain stability in the region such as the European Financial Stability Facility. The political unrest in North Africa and the Middle East is believed to have been triggered by rising food prices, which meant that a growing part of the population was thrown into poverty. At the meeting of the Group of Twenty (G-20) Finance Ministers and Central Bank Governors held in February 2011, it was agreed to create a new study group charged with examining the impact of rising global commodity prices on global economic and financial conditions and reporting back to the G-20. Forecasts for U.S. economic growth for both 2010 and 2011 by private-sector economists as of the beginning of 2010 averaged between 3.0 and 3.5 percent. In the summer of 2010, the forecasts were revised downward to levels well below 3.0 percent, and were then revised upward again toward the end of 2010. These fluctuations in the forecasts caused swings in the sentiment of households, firms, and financial markets, and led to increased volatility in economic activity. BIS central bankers’ speeches III. Growth potential of the Japanese economy So far, I have talked about the outlook for the Japanese economy from a cyclical perspective. I would now like to discuss it from a longer-term perspective. Since 1990, following the bursting of the bubble economy, Japan’s average annual growth has hovered at a low level of around 1–2 percent. The sustained economic expansion from fiscal 2002 to 2007 was in reality supported by a global financial bubble. With the benefit of hindsight, I am afraid I have to say that it is clear the self-sustaining growth mechanism during that period was not sufficiently robust. In the high-growth era during the 1960s and the stable growth period from 1970 to the 1980s, the Japanese economy was blessed externally with an international competitive environment that was beneficial to Japan’s economic model designed to catch up with advanced economies, and internally, with an upward trend in the working-age population.9 From the 1990s onward, however, international competition intensified and the working-age population started to decrease. As a result, growth had to be based increasingly on a “pioneering spirit,” that is, the ability to discover hitherto unknown demand and create new markets. Thus, the main reason for Japan’s decline in productivity and in the economic growth trend has been an inability to cope with fundamental structural changes in the world economy. How should Japan address these challenges? It is clear that the expanding global economy provides ample potential demand, particularly in emerging economies. Though less obvious, it is also true that there are no limits to demand at home. Statistics show that there remains an output gap in Japan. This gap, however, only shows the size of the shortage in demand relative to the current supply capacity. Looked at from a different angle, this simply means there is a shortage of the kind of supply that meets the kind of latent demand which is there. Let me be more specific. Although the aging of society has generated wide-ranging potential demand for medical and nursing care as well as demand in other related areas, a regulatory framework that is rooted in Japan’s traditional economic system has hindered potential demand from materializing. Thus, it could be said that the ability to “pioneer” I mentioned earlier requires economic actors capable of tapping potential demand and a nation that provides an institutional environment encouraging the production of valuable goods and services through free market competition. With regard to overseas markets, it is important for Japan to open up and steer boldly toward the objective of integrating domestic and overseas markets. Needless to say, this challenge needs to be tackled immediately so as not to miss out on the enormous demand for goods and services in expanding global markets. At the same time, this greater integration with the global economy would allow the free movement not only of goods and services but also of human resources and capital, and would both require and promote deregulation. While it may sound a bit hyperbolic, such integration could further advance the international division of labor to an extent where the distinction between domestic and foreign demand becomes irrelevant except for statistical expedience. Another pressing issue is the improvement of the fiscal balance. Restoration of the fiscal balance is necessary not only from the perspective of fiscal sustainability but also from the perspective of restoring economic growth. The public debt being accumulated under the current social security system increases intergenerational differences in lifetime incomes, and the growing burden for future generations is weighing down income expectations and restraining consumption by the working-age population. Characteristic features of Japan’s economic model include (1) government intervention in a wide range of private-sector economic activities; (2) the importance of long-term business relationships as exemplified by cross-shareholdings, the main bank system, and lifetime employment; and (3) an income distribution mechanism that helps to prevent large disparities in income. BIS central bankers’ speeches IV. Conduct of monetary policy A. Policy responses by the Bank of Japan Next, I will explain the policy measures implemented by the Bank so far. 1. Pursuing powerful monetary easing In October 2010, the Bank introduced a policy of “comprehensive monetary easing” consisting of three measures. First, the Bank lowered the target for the uncollateralized overnight call rate to around 0 to 0.1 percent and clarified that it was pursuing a virtually zero interest rate policy. Second, the Bank announced its commitment to maintaining the virtually zero interest rate policy until it judged, on the basis of the “understanding of medium- to longterm price stability” (hereafter the “understanding”), that price stability was in sight. The “understanding” is the inflation rate level that each of the nine Policy Board members understands as being consistent with price stability over the medium to long term. On the basis of a year-on-year rate of change in the CPI, each Policy Board member’s “understanding” falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board members’ “understanding” are around 1 percent. In other words, the Bank provided clarification of the time horizon of the virtually zero interest rate policy. And third, given that there was little room for a further decline in short-term interest rates, the Bank established a program on its balance sheet to purchase various financial assets, such as government securities, ETFs, and Japan real estate investment trusts (J-REITs), to encourage a decline in longer-term interest rates and various risk premiums. Developments in financial markets since the implementation of the “comprehensive monetary easing policy” reveal that, in the money market, interest rates on term instruments have declined, spreads on corporate bonds have narrowed, and various risk premiums have generally been declining, as seen in the rise in prices of stocks and J-REITs. The environment for corporate financing has been favorable, with issuing conditions for CP and corporate bonds improving, as illustrated, for example, by the decline in lending rates and the increased variety of corporate bond issuers. Long-term interest rates, however, have risen somewhat. The reason is that although the Bank continues to steadily implement the comprehensive monetary easing policy and remains firmly committed to pursuing powerful monetary easing, it is fundamentally difficult for interest rate policy to directly influence longterm interest rates, and the rise in overseas interest rates seems to be affecting Japanese long-term interest rates to some extent.10 The outlook for Japan’s economy I presented earlier – the scenario considered to be the most likely – is based on the assumption that financial markets will fully factor in the Bank’s monetary policy measures taken so far. That is, I judge that, under the Bank’s monetary policy, Japan’s economy will likely continue to make steady progress toward overcoming deflation and returning to a sustainable growth path with price stability. 2. Providing support to strengthen the foundations for economic growth Following the implementation of the above measures, in June 2010 the Bank introduced a new fund-provisioning framework, the “Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth.” Given the decline in the economic growth trend mentioned earlier, the Bank established the new framework in order to play its part in Previously, it was widely thought that international bond markets were segmented, and therefore bond yields – at least in the short run – tended to follow idiosyncratic country factors. However, analysis by the Bank published in the February 2011 issue of the Financial Markets Report has shown that it is highly likely that government bond yields across countries are linked as a result of common risk perceptions among global bond investors. Please refer to pp. 36–42 of the February 2011 issue of the report, which is available on the Bank's web site at http://www.boj.or.jp/en/index.htm. BIS central bankers’ speeches addressing this challenge by making use of its central bank functions. The framework provides long-term funds at a low interest rate to financial institutions in accordance with their efforts in terms of lending and investment toward strengthening the foundations for economic growth. The outline of the fund-provisioning measure is as follows: (1) the total amount of loans shall not exceed 3 trillion yen; (2) the total amount of loans to each counterparty shall not exceed 150 billion yen; and (3) the last disbursement of new loans shall take place by June 30, 2012. The Bank is aware that it is not possible to raise Japan’s growth potential solely through this fund-provisioning measure. Rather, the aim is for the measure to act as a catalyst to bring about a shared awareness among financial institutions and firms on the need to raise Japan’s growth potential and to make various efforts of their own accord to raise the potential economic growth rate and productivity. On March 7, 2011, the Bank will carry out the third new loan disbursement under the fund-provisioning measure to support strengthening the foundations for economic growth, and the total outstanding balance is expected to exceed 2 trillion yen as of March 7. The number of borrower financial institutions11 has increased to 149 as of the end of February 2011, and the breakdown of these institutions reveals that loans will be provided to various types of institutions across wide regions. Individual investments and loans under the measure cover all of the 18 areas suggested by the Bank as possible investment areas, with investment in “environment and energy business” in the lead. In this context, what has particularly caught my attention is that a large number of financial institutions, on participating in the Bank’s disbursement of loans, started to actively make a range of efforts such as establishing new dedicated funds and lending schemes for investments and loans to support strengthening the foundations for economic growth. The Bank believes that this situation suggests that the Bank’s measure is producing positive effects as a catalyst, its intended purpose. B. Future monetary policy conduct and communication In order for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability, I believe it is important for the Bank to steadily continue to carry out the measures I mentioned earlier. In addition, the Bank will continue to carefully examine new economic data and information, so that appropriate policy measures can be taken flexibly if the probability rises of a significant deterioration in the outlook for economic activity and prices or it becomes uncertain that Japan is on the road to overcoming deflation. In order for these measures to be fully effective, it is vital that they are properly and widely understood by the public. To this end, the Bank holds meetings such as the present one between Policy Board members and business leaders and press conferences by the Governor after Monetary Policy Meetings, and promptly publishes the minutes of the Monetary Policy Meetings. In addition, the Bank makes use of various other communication channels such as its web site as a means of providing information to the public. I think that these efforts do not compare unfavorably with those of other central banks. Moreover, the Bank is doing its utmost to further improve the quality of such forms of communication.12 For example, as part of such efforts, the Bank launched a renewed web site in January.13 We This refers to the number of financial institutions that obtained the Bank’s confirmation for their plans to participate in the new loan disbursement. For information on the Bank's previous measures to enhance the transparency of monetary policy, please refer to “Transparency of Monetary Policy” on the Bank’s web site. As part of the renewal of the web site, the content structure was rearranged, the pages were redesigned, and the content was expanded, so that users can access more easily the information they need. For more details, please refer to “Renewal of the Bank of Japan Web Site,” released on January 14, 2011 on the Bank’s web site. BIS central bankers’ speeches would be delighted to hear your opinions and views regarding the Bank’s dissemination of information. 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Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Council on Foreign Relations, New York, 14 April 2011.
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Masaaki Shirakawa: Great East Japan Earthquake – resilience of society and determination to rebuild Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Council on Foreign Relations, New York, 14 April 2011. * I. * * Introduction I am privileged to have the opportunity to speak before the Council on Foreign Relations today. Before beginning my speech, I would like to extend my heartfelt gratitude to the government and people of the United States for the support and encouragement concerning the tragic Great East Japan Earthquake. The situation in the areas close to the earthquake epicenter, particularly coastal areas that were hit hard by the tsunami, is disastrous. The disaster claimed about 13 thousand lives and more than 15 thousand people are still missing. Residents of areas near the Fukushima Daiichi nuclear power plant have been directed to evacuate, and are forced to spend restless days and nights in shelters. In this way, Japan has faced a trying time since the earthquake struck. At the same time, however, Japanese society has shown resilience. The work of rebuilding has started to get under way, gradually but steadily. In my remarks today, I will talk about the situation in Japan in the month after the earthquake and the work being done to rebuild Japan’s economy. II. Experience in the month after the earthquake A good place to start is what happened in the financial markets, the area I am familiar with. The earthquake struck at 2:46 p.m. on Friday, March 11. At the time, I was being briefed by staff in preparation for the Monetary Policy Meeting scheduled to be held at the beginning of the following week. Even in Tokyo, about 250 miles away from the earthquake epicenter, the shaking from the earthquake was the strongest that I had ever experienced and continued for more than two minutes. The earthquake’s magnitude at the epicenter was 9.0, which makes it the largest on record in Japan, and the energy released was enormous (Chart 1). Based on previously formulated emergency procedure, the Bank of Japan immediately set up a disaster management team with me as head. This task was completed 14 minutes after the earthquake struck. The most important thing for a central bank during a crisis is to ensure the stability of settlement systems and financial markets. The Bank of Japan Financial Network System, or BOJ-NET – Japan’s core settlement system for funds and government securities – has been operating without any problems the entire time since the earthquake struck. The Bank of Japan’s Fukushima branch, which is about 40 miles away from the Fukushima Daiichi nuclear plant, has been conducting its business as usual, and has been providing cash, including on the weekend immediately after the earthquake. Financial market stability has been maintained. I would also note that trading on the Tokyo Stock Exchange has been perfectly normal. Looking beyond the world of settlement systems and financial markets, the people in the disaster areas have been calm and composed and full of a spirit of mutual cooperation, despite such a difficult living environment. In Tokyo, although electricity shortages are causing some inconvenience, people have accepted these new realities and adapted immediately. One of the visible changes is that people are increasingly deciding themselves to cancel parties or other events, as a mark of respect to the victims of the disaster and out of consideration for the feelings of the people affected. Another change is a substantial decline in visitors from overseas. BIS central bankers’ speeches III. Effects on Japan’s economy Next, let me turn to the effects on Japan’s economy of the disastrous events – namely, the earthquake, tsunami, and nuclear accident. Something that has not been recognized so much is that Japan’s economy in 2010 performed best among the G-7 economies in terms of both growth rate and unemployment rate (Chart 2). The disaster occurred at a time when Japan’s economy was gradually returning to a recovery path, albeit a moderate one. In the short run, it is inevitable that the earthquake will significantly affect production and other economic activity through its damage to supply capacity. The four prefectures most affected by the earthquake and tsunami in total account for about 6 percent of Japan’s GDP (Chart 3). In the case of the Kobe Earthquake, which occurred in January 1995, real GDP did not decline, even in the quarter when the earthquake occurred. In contrast, the March 11 earthquake will have a greater impact on production for the following reasons. First, this was not just an earthquake that was huge in magnitude and geographically widespread. It also triggered tsunami, which, together with the earthquake, caused a nuclear accident. Second, hard-to-replace parts and material produced in factories in the disaster areas are integral to supply chains. A typical example is electronic parts, the shortage of which has been having a severe impact on automobile production even in non-affected areas. The effects might go beyond the domestic sphere. The economies of Japan, China and the United States have become interdependent, in that Japan produces the parts, China assembles them, and the United States develops the finished consumer products. Therefore, the impact on supply chains could spread internationally (Chart 4). Third, Japan’s power generating facilities have been significantly impaired. The problems associated with nuclear power generation have been a subject of intense scrutiny due to the accident at the Fukushima Daiichi nuclear power plant, but it is worth noting that the earthquake also caused serious damage to thermal power plants (Charts 5 and 6). Measures are currently being taken to curtail demand through various efforts such as asking businesses and households to conserve electricity, and at the same time, steps are being taken to restore generating capacity. The power shortages will be temporarily eased due to seasonal factors, but electricity could run short again in Tokyo Electric Power Company’s service area when demand peaks in the summer. For historical reasons, Japan has two frequency domains and there is little room for surplus electricity to be delivered across domains. The impact of such supply constraints will be serious in the short term. But at the same time, we should remember that the impact of the disaster can be mitigated by human wisdom and determination. Let me give you two examples of how the impact is being and will be mitigated. First, top priority is now being placed on fixing the production and supply bottleneck of parts and materials, with the cooperation of the firms using them. At the same time, we are now seeing signs that alternate production has started in domestic factories located in places other than the affected areas. And on the electricity front, efforts are being made to devise effective measures for curtailing energy use during the high-demand period in summer when electricity could run short. Second, as time passes, demand will also emerge for restoring damaged capital stock such as roads, factories, and houses. While it is difficult to accurately forecast the amount and time path of rebuilding demand at present, the amount of damage to capital stock due to the earthquake and tsunami will be about 3 to 5 percent of nominal GDP and 1 to 2 percent of total capital stock, according to government estimates (Chart 7). Taking these factors into account, most private economists believe that Japan’s GDP growth rate will turn positive again from the third quarter of 2011 onward. Moreover, from a longerterm perspective, new demand is expected to emerge. For example, the recent experience of BIS central bankers’ speeches disruption to supply chains has made us aware of a concentration of risks in particular regions or with respect to particular firms. This new awareness, through a rethinking of business strategies, could generate new investment in, for example, computer centers and distribution depots. The accident at the Fukushima Daiichi nuclear plant has triggered active global discussion on nuclear power policy, which will highlight the importance of energy conservation and environmental technologies. And as Japanese firms have an edge in those areas, such as high-end batteries, there will be great room for them to make contributions. IV. Tasks ahead for Japan’s economic rebuilding Various challenges lie ahead on the road to overcoming the adverse effects of the earthquake and rebuilding Japan’s economy. The first challenge is ensuring the necessary financing for rebuilding. In this regard, Japan has continued to have a current account surplus. In other words, Japan has had an excess of savings over investment for a protracted period, which means that, from a macroeconomic perspective, this financing will not be difficult (Chart 8). Japan’s capacity for foreign currency funding is extremely strong, given that the country is the biggest creditor nation in the world, with net external assets of 2.9 trillion U.S. dollars, or 57 percent of nominal GDP. Private financial institutions are fully able to meet an increase in financing demand for rebuilding. Rumors have circulated that Japanese insurance companies would sell foreign currency assets due to an increase in payments of insurance claims relating to the earthquake and subsequent events. These companies have ample short-term liquid assets, so they do not need to sell their foreign currency assets in order to make the payments. Meanwhile, Japanese government bonds have been issued quite smoothly and long-term interest rates have remained stable at low levels compared with other countries. As long as Japan continues to work tirelessly toward rebuilding, it is unlikely financing problems will arise. The second challenge is raising Japan’s potential growth rate. Since 2000, Japan has had one of the highest GDP growth rates per worker among G-7 countries, although slightly lower than the United States (Chart 9). However, the decline in the working-age population in Japan is proceeding at a pace that has no precedent in modern economic history (Chart 10). As a result, Japan’s economic growth has been on a downtrend. Raising the potential growth rate was the biggest challenge for Japan’s economy even before the earthquake, but the efforts to do so by raising both the labor participation rate and productivity have now become all the more important. As Japan seeks to rebuild its economy, efforts to raise the potential growth rate have become even more important. These are certainly not easy challenges, but we have to take them on with great determination. V. The Bank of Japan’s response Finally, let me briefly touch on the Bank of Japan’s response after the earthquake struck. As was the case in the financial markets immediately after the failure of Lehman Brothers, when people’s lives and safety are at risk, they sometimes tend to become excessively risk averse, which makes things worse. Incidentally, while foreign nationals residing in Tokyo increasingly left Japan for fear of radiation risk, it has tended to be overlooked that the radiation levels in Tokyo are roughly the same as in other major cities around the world, such as Paris and Berlin, or they were exposed to more radiation on the airplane than they would have been exposed to in Tokyo. In the money markets, financial institutions’ precautionary demand for liquidity surged. Rumors have spread among the foreign financial community that the Tokyo financial markets would close due to fears of radiation risk. The Bank of Japan has been asked whether there was any truth to the rumors that the Bank of Japan was planning to retreat to a backup site in the western part of Japan. Of course, these rumors were and are groundless. As I said, the financial infrastructures are fully functional and there is no reason for us to relocate from Tokyo. BIS central bankers’ speeches In such times, the first priority is ensuring calm among market participants, and in this regard the Bank of Japan has provided ample liquidity on an unprecedented scale day after day. The very next business day after the earthquake, we decided to significantly increase the amount of its asset purchases, mainly of risk assets, with a view to preventing any deterioration in business sentiment or excessive increase in risk aversion from adversely affecting economic activity. As a result of these measures, financial markets, which became somewhat jittery in the period immediately after the earthquake occurred, have regained stability. Needless to say, the Bank of Japan’s mission is to ensure price and financial system stability, thereby contributing to the sustainable growth of Japan’s economy. We will continue to take appropriate measures as the central bank in order to achieve this mission. VI. Concluding remarks As I mentioned earlier, nothing is more heartening in a crisis than the encouragement and support of friends overseas. I would like to conclude by thanking you once again for your friendship. With the resilience of Japanese society and the determination to rebuild, I am absolutely convinced that Japan’s economy will overcome this trying time, successfully rebuild and become even better placed with greater growth potential. With that, I would like to conclude my remarks. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders in Kanagawa, Kanagawa, 21 April 2011.
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Kiyohiko G Nishimura: The current state of Japan’s economy and monetary policy stance Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders in Kanagawa, Kanagawa, 21 April 2011. * * * Introduction More than a month has now passed since the Great East Japan Earthquake. The disaster claimed many lives and many people are still missing. I would like to express my sincere condolences to the victims of the disaster. Moreover, many continue to face severe hardship, and I would like to offer my heartfelt sympathy to all of those who are suffering. Even in Kanagawa Prefecture, many people have been affected by the disaster, due, for example, to rolling blackouts. I appreciate being given this opportunity to speak and to exchange views with government and business leaders in the prefecture, despite these difficult times. And I would like to express my gratitude for your cooperation with the various business operations of the Bank of Japan’s Yokohama Branch. Before we start to exchange views, let me talk about developments in economic activity and prices in Japan, taking into account the effects of the disaster, and about the Bank of Japan’s response following the earthquake. I. Developments in the global economy Before outlining developments in Japan’s economy, let me first discuss developments in the global economy. In the first half of 2010, the global economy continued to recover from the sharp downturn caused by the financial crisis triggered by the failure of Lehman Brothers in the autumn of 2008. However, the pace of recovery slowed temporarily during the summer and autumn of 2010 and the recovery seemed to be pausing at one point. In the early phase of economic recovery following major downturns, we can often observe a sharp rebound as inventories, for example, are restored to previous levels. Thus the slowdown in 2010 was attributable to a tailing-off of this strong rebound, combined with the fact that the effects of various demandboosting measures, such as subsidies for car purchases, implemented in many countries as a means of addressing the financial crisis, had almost run their course. Nevertheless, from around the end of the autumn of 2010, the global economy exited this temporary deceleration phase and its growth rate has since been increasing again. Looking at developments by region, growth in emerging and commodity-exporting economies started accelerating in the autumn of 2010. At present, in addition to high growth in household consumption, there has been continued demand for investment in social infrastructures as well as factory construction and machinery facilities. It has been suggested that, on the back of large-scale monetary easing in advanced economies, funds that were not able to find promising investment opportunities in advanced economies have been flowing into some emerging and commodity-exporting economies, thereby stimulating economic activity there through asset transactions and investment, which has also been contributing to economic expansion in these economies. In advanced economies, the U.S. economy, which had been showing signs of deceleration from the summer to autumn of 2010 due to the waning effects of fiscal stimulus measures, appears to have returned to a moderate recovery path thereafter, partly due to effects of further monetary easing and fiscal stimulus measures including the extension of tax cuts. In BIS central bankers’ speeches Europe, economic conditions have differed by region. Germany and Scandinavian countries have been recovering strongly, supported in particular by buoyant exports to emerging economies. In contrast, peripheral European economies such as Greece, Ireland, and Portugal have been faced with severe fiscal problems, and have been experiencing difficulties conducting economic policy as a result. In the middle are France and other countries that continue to recover moderately. It could be said that the eurozone has become a “three-speed economy,” but our assessment is that economic activity in the region as a whole has been recovering moderately. As for the outlook, the global economy is expected to continue recovering, driven by strong growth in emerging and commodity-exporting economies. As in 2010, the growth rate of the overall global economy in 2011 and 2012 is likely to exceed the average rate recorded during the decade before the outbreak of the financial crisis triggered by the failure of Lehman Brothers. However, uncertainty remains high concerning the global economic and price environments. In advanced economies, for example, the United States faces a balance-sheet adjustment problem, and there are fiscal problems in Europe, as I have just mentioned. In addition, international commodity prices have been at high levels as emerging and commodity-exporting economies, which are less efficient in energy usage and distribution processes than advanced economies, continue to grow at a high rate. II. Developments in economic activity and prices in Japan Developments in Japan’s economy before the earthquake Amid these developments in the global economy, from the beginning of autumn to the end of 2010, the improvement in Japan’s economy weakened and there was a temporary pause in economic recovery. This was largely due to the fact that exports – particularly of automobiles and related items, capital goods and parts, and electronic components – were somewhat weak. This weakness in exports is attributed to a temporary slowdown in the pace of economic recovery overseas as well as the effects of the yen’s appreciation in the summer of 2010 and inventory adjustments in IT-related goods such as personal computers. From the beginning of 2011, however, exports and production were gradually returning to an upward trend, supported by a resumption of growth in overseas economies. Private consumption had been improving, with car sales resuming an uptrend after the fall following the expiration of subsidies for energy efficient cars, and business fixed investment and housing investment was also starting to pick up from the significant decline after the financial crisis. In other words, before the earthquake it appeared that economic activity in Japan was gradually emerging from its temporary pause. Developments in Japan’s economy after the earthquake The effects of the Great East Japan Earthquake on March 11 changed the situation considerably. According to Cabinet Office estimates, the amount of damage to capital stock will be about 16 to 25 trillion yen, or about 3 to 5 percent of Japan’s annual nominal GDP. The extent of the damage from this disaster will be significantly greater than that from the Kobe Earthquake, which caused about 10 trillion yen in damage to capital stock. Of all natural disasters in Japan since the start of the Meiji era in 1868, only the Great Kanto Earthquake of 1923 has caused more damage. More than 100,000 people lost their lives in that earthquake or remained unaccounted for thereafter, and the direct economic damage amounted to about 30 percent of nominal GNP at the time. Moving on to the economic situation after the March 11 earthquake, Japan’s economy is under strong downward pressure, mainly on the production side. The disaster has caused BIS central bankers’ speeches two types of supply constraints, which I will explain shortly. As a result of these constraints, production in some industries has declined substantially, which has had a severe impact on exports and domestic shipments. Business sentiment has also deteriorated and consumer appetite has waned. One of these supply constraints is the widespread damage to production facilities and associated malfunctioning of the supply chain networks that deliver parts. The Kobe Earthquake had a devastating impact on city functions in the part of southern Hyogo Prefecture that was directly hit, but the affected areas were not so widespread. In contrast, the March 11 earthquake caused devastating damage over a much wider area, destroying the production facilities of many industries, including the electrical and general machinery industries. I have heard that some firms in the Kanagawa Prefecture have production bases in the Tohoku region that have been affected. Production of electronic components and devices had been thriving in the affected areas, and there were more than a few parts manufacturers producing unique products with dominant global market share. Damage to the production facilities of these firms has meant that many other firms face difficulties procuring parts – typified by the automobile industry, which relies on computerized and customized parts produced under strict quality control. This is causing constraints on production throughout Japan. Another supply constraint is the constraints on power supply. More than 20 percent of generating capacity has been lost in the Tokyo Electric Power Company’s service area, due to damage not only to the Fukushima Daiichi nuclear power plant but also to several thermal power plants. The Tohoku Electric Power Company has also lost about 30 percent of its supply capacity. This has resulted in disruption to stable power supply, as rolling blackouts were at one point implemented in the Kanto and Tohoku regions to avoid unexpected largescale blackouts due to power supply constraints. There are some industries, such as the food and chemical industries, which need time to start up or shut down production facilities or need continuous power distribution to ensure the quality of their products. It has been pointed out that production levels have declined in these industries because of the absence of stable power supply, even though their production facilities were not significantly damaged by the earthquake. Meanwhile, on the demand side, while demand for necessities increased temporarily, a deterioration in firms’ appetite for investment and households’ appetite for consumption, due to rising uncertainty about the future, seems to be exerting overall downward pressure on business fixed investment and private consumption. For example, sales at electrical appliance stores and department stores declined significantly after the earthquake, as a result of a deterioration in households’ appetite for consumption coupled with shortened business hours due to power supply restrictions. Aspects to consider in the outlook for Japan’s economy Next, I will talk about the outlook for Japan’s economy. The Bank presents its outlook for economic activity and prices on a quarterly basis. At the Monetary Policy Meeting to be held on April 28, next week, the Bank will present its outlook until fiscal 2012. Today, I would like to discuss three key aspects to consider in projecting the outlook for economic activity and prices in Japan. The first aspect is when, how, and to what extent the current supply-side constraints that Japan’s economy is facing will be removed. The sharp downturn in Japan’s economy after the earthquake has been, simply put, triggered by supply-side shock from damage to production facilities, including damage to power supply capacity caused by the earthquake and tsunami. Therefore, the key for the outlook is when and how the supply-side constraints caused by the disaster will be removed. BIS central bankers’ speeches On this point, I must say that there is a great deal of uncertainty about when they will be removed. This is due to a high degree of uncertainty about the following three problems. The first problem is that it is very difficult to say with any certainty when the production capacity lost as a result of the disaster will be restored. Firms are making strenuous efforts to, for example, resume operations at affected production facilities and ensure substitute production by factories in non-affected areas. However, progress in these efforts has been slow due to various supply-side constraints including unstable power supply. Another factor that makes it difficult to remove such constraints is that some of the electronic components and high-end materials produced in the affected factories are hard to replace because of quality requirements and high levels of customization. The second problem, which is also related to the issue of restoring production capacity, is the question of when the disruptions to supply chains will be removed. At present, firms are working to repair or rebuild supply chains by, for example, seeking to secure alternative suppliers, including from overseas, and reviewing product specifications. However, as supply chains are complex and interconnected, if a bottleneck occurs in any one part of the chain, accurately gauging its impact and addressing the problem present various difficulties. Therefore, a considerable amount of time is considered necessary to reconstruct supply chains. The third problem is uncertainty as to when constraints on electric power supply will be removed. Electric power companies and other related parties are doing all that they can to, for example, resume operations of facilities to restore supply capacity. Firms are also taking various measures to address the situation. One such measure is changing working hours. For example, one firm in Kanagawa Prefecture has changed the working hours of some divisions. These divisions now start work two hours earlier in the morning to reduce the amount of electric power used. Another measure is operating at non-peak times, such as at nights or on holidays. And a third measure is using in-house power generators. Households have also been asked to conserve electricity and voluntary conservation has been ongoing. These efforts have recently eased constraints on economic activity due to power shortages. However, demand for electricity will surge in the summer due to the use of air conditioners, and therefore, the balance between electricity supply and demand will tighten again and a certain degree of supply constraint is likely to emerge. Taking these points into account, it is unlikely that the supply-side constraints will be removed anytime soon. I must say that Japan’s economy is likely to remain under strong downward pressure, mainly on the production side, for some time to come. However, looking ahead to the autumn and beyond, the supply-side constraints are likely to ease as the tightness in electricity supply and demand balance improves and progress is expected to be made in the reconfiguration of supply chains. If that is the case, as long as the global economy continues to record high growth led by emerging and commodity-exporting economies, which is likely, a recovery in production in Japan and ensuing increase in exports will probably serve as one driving force behind a recovery in Japan’s economy. The second aspect that I consider important for projecting the outlook for Japan’s economy after the earthquake is how to assess uncertainty regarding overseas economies. This aspect is important because one of the driving forces of future economic recovery in Japan will be growth in overseas economies. As pointed out prior to the earthquake, a factor that could lead overseas economies to deviate upward from projections is the possibility of a further acceleration of growth in emerging and commodity-exporting economies that have been enjoying robust domestic demand and receiving capital inflows from other countries. While many of these economies are in the process of adjusting their accommodative monetary policies, concerns about overheating and inflation have yet to be dispelled. For example, in China, rises in real estate prices and wages have become pronounced. On the other hand, factors that could lead overseas economies to deviate downward from projections include developments in global BIS central bankers’ speeches financial markets triggered by sovereign risk problems in peripheral European economies, and, uncertainties about the outlook for the U.S. and European economies, although these uncertainties have now diminished to some extent. The third aspect to consider when projecting the outlook for Japan’s economy after the earthquake is how efforts to restore capital stock damaged by the disaster will progress, as well as how indirect effects of the accident in the Fukushima Daiichi nuclear power plant will change with time. As I have explained, the significant short-term economic impact of the disaster is the impact of supply-side constraints. With time, however, these constraints will be eased, and at the same time, the efforts of the private and public sectors to restore capital stock damaged by the disaster – roads, ports and harbors, factories, commercial facilities, and houses – will become more pronounced. If such “rebuilding demand” emerges, it will contribute to Japan’s economic growth. However, I must say that there is considerable uncertainty with respect to the timing and scale of any such demand. From a longer-term perspective, the important point is how the disaster will affect the structure of Japan’s economy and the economy’s growth potential. I am not an expert in the accident at the nuclear power plant itself, but I think that, in terms of its effects on the economy, due attention should be paid to the risk that delays in resolving the problems at the Fukushima Daiichi nuclear power plant lead to continued power supply shortages, and that the spread of harmful rumors at home and abroad could have a significant impact on Japan’s exports and tourism industry. Moreover, as they seek to reconstruct their supply chains, some firms could consequently speed up the process of shifting their production bases to overseas locations. There is also a risk that the disaster and power plant accident might put a chill on corporate investment and households’ consumption, thereby reducing growth expectations for Japan’s economy. Developments in prices I will now move on to developments in prices. Recently, the year-on-year rate of decline in consumer prices (excluding fresh food) has continued to slow. In particular, if the effects of subsidies for high school tuition are excluded, the year-on-year rate of change has recently become slightly positive, mainly due to the effects of the rise in international commodity prices. As for the future price environment, short-term bottlenecks might emerge in individual markets for goods and services due to supply-side constraints caused by the earthquake. However, the short-term outlook for the aggregate supply and demand balance is unpredictable, because of the simultaneous occurrence of severe supply-side constraints due to the disaster, and a plunge in demand arising from the decline in firms’ appetite for investment and households’ appetite for consumption. However, over the longer term, the aggregate supply and demand balance is expected to improve gradually as economic activity returns to a moderate recovery path. There are also various uncertainties regarding the outlook for prices. First, if corporate and household medium- to long-term inflation expectations decline, actual prices could be lower than projected. On this point, I would like to draw attention to the possibility of the year-onyear rate of change in the consumer price index being revised downward with the base-year change scheduled for August 2011. We need to examine whether the revision affects corporate and household inflation expectations. On the other hand, if international commodity prices increase further, Japan’s prices could be higher than projected. Furthermore, foreign exchange rates, if they become volatile, will also affect consumer prices, not only by causing swings in economic activity but also through changes in import prices. BIS central bankers’ speeches III. Bank of Japan’s response after the earthquake As I have explained, the disaster has brought about significant changes to Japan’s economy. In addressing the disaster, the Bank, since immediately after the earthquake struck, has been taking a range of active measures, from the following three main perspectives: maintaining the functioning of financial and settlement systems; ensuring the stability of financial markets; and supporting economic activity. I would now like to explain the Bank’s response to the disaster. Maintaining the functioning of financial and settlement systems What the Bank did first after the earthquake was to do everything possible to ensure the safety and security of the financial infrastructures. When there is high uncertainty over the future of the economy, one of the most paramount challenges is to steadfastly maintain financial infrastructures to prevent rising concern among the people. With this in mind, the Bank has been doing its utmost to maintain the functioning of the financial and settlement systems, which are the critical infrastructures that support people’s lives, as well as striving to ensure financial market stability. In terms of maintaining the functioning of the financial and settlement systems, the Bank has been taking all possible measures to provide cash to the disaster areas the entire time, including holidays, since immediately after the earthquake, aiming to meet the cash needs of people in those areas. In such areas, many financial institutions, despite themselves being affected by the earthquake and tsunami, have been striving with a strong sense of mission to restore their operations, and open as many branches and offices1 as possible to smoothly enable individuals in need of cash to withdraw deposits and to meet firms’ growing needs for operating funds or on-hand cash. The Bank’s branches and offices in the Tohoku region, including those in the severely damaged areas of Sendai and Fukushima, started providing cash from the weekend immediately after the earthquake and provided a total of more than 310 billion yen in cash in that week. This is three times the amount usually provided in the same period in normal times. On March 11, the day the earthquake occurred, the Bank, jointly with the Financial Services Agency, asked financial institutions to take appropriate measures to accommodate the needs of those affected by the disaster, such as permitting the withdrawal of deposits even in cases where depositors had lost passbooks and seals. In addition, the Bank’s Head Office and other branches also continue to provide central bank services such as exchanging banknotes and coins that were damaged by the earthquake.2 As for wholesale payments and settlements for funds and securities, Japan’s major payment and settlement systems, including the Bank of Japan Financial Network System, or BOJ-NET – the core settlement system for funds and Japanese government bonds – have, thanks to According to the Financial Services Agency, 95 percent of financial institutions’ branches and offices in the disaster areas were open for business as of April 15. The Bank replaces banknotes and coins which are contaminated, damaged, or worn out and unfit for reuse, based on criteria specified by law. The Bank provides this service at its Head Office and branches. Those who live far away from the Bank’s Head Office and branches are asked to visit a neighboring financial institution, as the Bank has requested financial institutions to handle such exchange. The criteria are as follows: Provided that the banknote still has two sides, damaged, or burnt banknotes can be exchanged for new ones. (1) If two-thirds or more of a banknote’s original size remains, it can be exchanged for its full face value. (2) If less than two-thirds but two-fifths or more of a banknote’s original size remains, it can be exchanged for half of its face value. (3) If less than two-fifths of a banknote’s original size remains, it cannot be exchanged. BIS central bankers’ speeches the efforts of the related parties, been operating as usual for the entire time since the earthquake occurred, despite various difficulties in the aftermath. Ensuring the stability of financial markets To ensure financial market stability, the Bank has been providing ample liquidity after the earthquake. When the economy is faced with a major crisis and there is heightened uncertainty about the future, participants in the financial markets attempt to retain a large amount of funds at hand. If they fail to obtain sufficient funds, financial markets could destabilize due to heightened uncertainty, which could eventually adversely affect economic activity.3 To prevent such a situation, the Bank has been providing ample liquidity since immediately after the earthquake, striving to ensure financial market stability by maintaining a sense of security on the funding front, and trying to avoid adverse effects on corporate activity and people’s daily lives from the financial side. More specifically, on Monday, March 14, the first business day after the disaster, financial institutions’ precautionary demand for funds surged and tensions intensified in the money markets. To address the situation, the Bank provided a total of 21.8 trillion yen in funds, almost three times as much as the largest daily funds provision during the financial crisis after the failure of Lehman Brothers. Thereafter, the Bank continued to provide ample funds to sufficiently meet market demand. As a result, the outstanding current account balance of the Bank significantly exceeded the high of 36 trillion yen recorded during the period of Japan’s “quantitative easing” policy. The Bank went beyond simply providing a large quantity of funds. It also carefully devised types and timings of market operations according to market conditions. For instance, based on the fact that a slight weakness was seen in financial intermediation functions in the CP market due to uncertainties about the future following the earthquake, the Bank purchased CP under repurchase agreements on March 22 for the first time in a year. The Bank also conducted outright purchases of CP on March 25. As a result, issuance spreads on CP declined to just slightly above their levels prior to the earthquake4 and funding through CP continued without major problems. In coordination with the U.S. Federal Reserve System, on March 29, the Bank started to offer market participants in Japan one-week U.S. dollar funds, in addition to the existing threemonth funds, in its U.S. dollar-funds supplying operation. This measure was taken not because domestic financial institutions were having difficulties securing U.S. dollar funding at the time. Rather, it is taken because the establishment of convenient measures for providing U.S. dollar funding in advance is expected to contribute to preventing economic activity from being adversely affected by a widespread deterioration in business sentiment or an increase in investors’ risk aversion. Therefore, although there were no bids for the operation, its very existence is said to have given a great sense of security to the market. For instance, it is well known that the United States as a whole experienced considerable economic disruption in the aftermath of the San Francisco Earthquake of 1906 due to a shortage of liquidity (see, for example, Bruner, Robert F. and Sean D. Carr, “The Panic of 1907: Lessons Learned from the Market’s Perfect Storm,” August 2007, Wiley). Issuance spreads on an a-1 rated CP with a maturity of three months rose immediately after the earthquake to a range of 0.06 to 0.12 percent from 0.00 to 0.03 percent beforehand, but declined to the level of 0.03 percent in the period from March 28 through April 1, and they have recently been at more or less the same level as prior to the earthquake in terms of the average value of the issuance rates of CP issued by business companies (except electricity, gas, and other financial companies), as released by the Japan Securities Depository Center (JASDEC). BIS central bankers’ speeches Enhancing monetary easing to support economic activity The Bank also moved swiftly to support economic activity. Its Monetary Policy Meeting was scheduled to be held over two days starting from the next business day after the earthquake, which was also the beginning of the next week. As the Bank deemed it desirable to examine the possible effects of the disaster and promptly announce a monetary policy stance, thereby ensuring stability in the financial markets, it shortened the duration of the meeting to one day and decided on March 14, the first business day after the earthquake, to enhance monetary easing. What we feared most immediately after the disaster was a situation in which a deterioration in business sentiment or an increase in investors’ risk aversion in financial markets would lead to an increase in various risk premiums, thereby adversely affecting economic activity. Accordingly, the Bank decided to increase the amount of the Asset Purchase Program, by doubling its purchases of assets to about 10 trillion yen in total, mainly risk assets such as exchange traded funds (ETFs) and Japan real estate investment trusts (J-REITs). Financial system and financial conditions after the earthquake Thanks mainly to these measures, functioning of financial and settlement systems has been maintained in Japan and stability has been ensured in the financial markets. As for the effects of the disaster on the financial system, as I mentioned earlier, a significant number of financial institutions’ branches have been physically damaged. However, given that financial institutions have been striving to bolster their capital by raising additional capital and increasing internal reserves, and that financial institutions have not had any liquidity concerns thanks to the Bank’s ample liquidity provision, we believe that stability of Japan’s financial system is not threatened by the disaster. As for the financial environment surrounding Japanese firms and households, financial conditions have generally continued to ease, although weakness has been observed in the financial positions of firms, mainly small ones, since the earthquake. I have heard that, even here in Kanagawa Prefecture, some non-manufacturing firms whose ability to procure financing tends to be heavily dependent on their revenues have been concerned about their own financing conditions after the earthquake. Funds-supplying operation to support financial institutions in the disaster areas and broadening of the range of eligible collateral The Bank’s measures I have explained so far are those responses taken in the time of emergency immediately after the earthquake occurred. In addition, as a next step, the Bank decided at its latest Monetary Policy Meeting held on April 6 and 7 that it would be necessary to support the smooth financial functioning of financial institutions in disaster areas so that restoration and rebuilding in these areas could steadily progress. Specifically, the Bank decided to introduce a funds-supplying operation that provides financial institutions with offices in the disaster areas with a one-year loan of 1 trillion yen in total at a rate of 0.1 percent per annum in order to provide financial support for their initial response efforts to meet expected demand for funds for restoration and rebuilding. In line with this, the Bank also decided to broaden the range of collateral eligible for money market operations with a view to ensuring that financial institutions in the disaster areas have sufficient funding capacity. Let me explain briefly the background to this decision. The household sector and the corporate sector have ample funds, as they have maintained excess savings over a protracted period, and therefore, from a macroeconomic viewpoint, financial institutions would have no difficulty in financing. However, financial institutions in the disaster areas have to meet high demand for funds, ranging from the immediate demand from firms for cash for operating funds and cash on-hand, and from individuals for living expenses, as well as future BIS central bankers’ speeches demand for funds for restoration and rebuilding. Considering the damage caused to the affected areas, however, new deposits are unlikely to increase for the time being and an effect is likely to materialize from loans going into arrears. Given such circumstances, in addition to the current provision of ample funds, providing financial institutions in the affected areas with funds with even longer maturities will reassure them that they will be able to meet financing needs. Moreover, if financial institutions in the affected areas are able to fulfill their financial functions without problem, the people are likely to feel a greater sense of security as a result. So far, I have explained the Bank’s responses after the earthquake. The Bank will continue to carefully examine the outlook for economic activity and prices, including the effects of the disaster, and take appropriate policy actions as necessary. Concluding remarks In visiting Yokohama for today’s meeting, I am reminded of the story I heard from my grandmother about the remarkable way that this city was rebuilt after being utterly destroyed by the Great Kanto Earthquake. The Great Kanto Earthquake, which occurred on September 1, 1923, caused devastating damage to Yokohama. More than 20,000 residents of Yokohama, or about 5 percent of Yokohama’s population at the time, either died in the earthquake or remained unaccounted for thereafter. As a proportion of its total population, Yokohama’s loss was greater than that of Tokyo’s.5 Moreover, because a huge fire started immediately after the earthquake, about 80 percent of the city was burned down. It was so devastating a situation that, according to the then Mayor of Yokohama, rumors spread that Yokohama would never recover. Nevertheless, about 30,000 new houses were built in the year after the disaster, which corresponded to about 40 percent of the houses that had been lost, and bank deposits exceeded their levels prior to the disaster by the end of that year. Four years on, the population of Yokohama City had reached 530,000, significantly higher than the 450,000 before the earthquake. One characteristic of Yokohama’s rebuilding after the Great Kanto Earthquake was that it aimed not only to rebuild but also to reinvent itself as an industrial city rather than its preearthquake existence as a city dependent only on commercial trades. This had been a challenge facing Yokohama since before the earthquake. The rebuilding plan boldly included rezoning of land and improvements in the road network and parks. Moreover, in tandem with the rebuilding, a railroad network was developed that connected city areas with the suburbs, and progress was made in developing industrial and residential areas. As just described, Yokohama’s success in rebuilding seems to be down to the forwardlooking attitude and determination to rebuild of the people of the day, and the vision and enterprising spirit that they had to use the rebuilding as an opportunity to draw a blueprint for new growth. Mr. Sankei (Tomitaro) Hara, who led the rebuilding of Yokohama, said that while Yokohama had been burned to the ground, the fire was not able to touch the spirit of the people. If I may refer to his words again, he also said that Yokohama City had become a blank slate, and from a blank slate anything was possible. You can draw the latest picture by incorporating new culture. I would like to conclude by sincerely wishing that rebuilding in the affected area will make the same kind of steady progress that was made in Yokohama following the Great Kanto Earthquake, and that the economy in the affected areas ends up even better placed with greater growth potential. Thank you for your attention. The proportion of the population of Tokyo that died in the earthquake or remained unaccounted for thereafter was in the range of 2.0–3.0 percent. BIS central bankers’ speeches
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Remarks by Mr Masaaki Shirakwa, Governor of the Bank of Japan, at the Bank of Finland 200th Anniversary Conference, Helsinki, 5 May 2011.
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Masaaki Shirakawa: The transition from high growth to stable growth – Japan’s experience and implications for emerging economies Remarks by Mr Masaaki Shirakwa, Governor of the Bank of Japan, at the Bank of Finland 200th Anniversary Conference, Helsinki, 5 May 2011. * I. * * Introduction Thank you very much for inviting me to the Bank of Finland’s 200th Anniversary Conference1. It is an honor to take part in this panel session. After considering how I could contribute to the session “Global Shifts” as a discussant, I felt it would be best to compare the experience of the Japanese economy from its high-growth period onward, with that of the emerging economies which are currently growing at a very rapid pace. Although it is not well-known, Japan’s automobile industry first ventured into the European markets through Finland back in 1962. At that time, Japanese automakers had little name recognition, and one firm, in order to prove the safety of its car to Finnish consumers, had the car driven off a ski-jumping hill. I have been informed that the car landed safely and the driver was not harmed. The 1960s, when such episodes of Japanese firms were born, was the heyday of the Japanese economic miracle. Though needless to say, currently the emerging economies are the high-growth countries. In the past 10 years the global economy has grown at an annual rate of +3.6%. There is a large gap among countries. The BRIC countries have averaged +7.9% growth while non-BRIC countries have grown at +2.1% (Slide 1). If one simply extrapolates these numbers, by 2040 the BRIC countries would have more than an 80% share of the global economy, but we all know that is not realistic. As past economic history has shown, high-growth economies also begin to mature at some point in time. Japan was no exception. II. Japan’s patterns of economic growth High-growth period Japan’s post-war economic recovery began from a situation where capital stock equivalent to 86% of GDP had been lost due to World War II. It is usually understood that Japan’s period of high growth began in the mid-1950s and ended in the early part of the 1970s. During this 15 year period, the average rate of economic growth was nearly +10% (Slide 2). Let me highlight three factors which I believe enabled such rapid growth. First, favorable demographics (Slide 3). Total population increased at an annual rate of +1% during this period and the relative youth of the working-age population supported both production and consumption. At the beginning of the economic boom period, the farming population reached approximately 40% of the total population and the migration of surplus labor from the rural areas to the cities enabled the rapid growth of a high productivity manufacturing sector. Second, the use of competitive forces. It is sometimes pointed out that the government’s industrial policy or so-called “Japan Incorporated” was the key factor behind Japan’s economic miracle. I believe such public sector influence is overstated. When we look at the The Conference was held on May 5th and 6th under the theme, “Monetary Policy under Resource Mobility”. Please refer to, http://www.suomenpankki.fi/en/tutkimus/konferenssit/tulevat_konferenssit/Pages/BOF200_2011.aspx BIS central bankers’ speeches history of Japan’s leading firms, it is not rare to find cases where they entered into new areas dissenting against the government’s industrial policy or cases where they did not receive any favorable treatment. There are also examples where industries and firms which were wellprotected gradually lost their vibrancy. Strong competition supported Japan’s high-growth period by stimulating entrepreneurship and promoting technological innovation which enabled Japanese firms to catch-up with those in advanced economies. Third, the benefits of global free trade. When one looks at the contribution of individual components to GDP growth, domestic demand is by far the main factor (Slide 4). However, this does not refute the important role that the overseas economy played. Japan produced large amounts of producer and consumer goods for the expanding global market, such as steel, electronic appliances and automobiles. The foreign exchange obtained through exports was used to import raw materials necessary to support domestic economic development. The basic condition which made such a growth model possible was the continued growth of the world economy and the maintenance of the global free trade system. The bubble and its collapse Japan’s high-growth period ended in the early 1970s and the pace of growth gradually slowed. However, during the 70s and 80s, Japan still maintained a relatively high-growth rate when compared with other major advanced economies (Slide 5). Favorable demographics and strong global competitiveness were the basic components which continued to support economic growth. However, after the collapse of the bubble and the ensuing financial crisis in the 1990s, the pace of growth fell below that of major advanced economies. Three elements led to the prolonged period of economic weakness following the collapse of the bubble. First, of course, there was the direct effect of the collapse of the bubble. Balance sheet problems in the private sector constrained expenditures and the credit intermediation capabilities of the banking sector, saddled with non-performing loans, deteriorated. This led to weak growth during the 1990s, but was not the cause of the tepid growth during the past decade. Second, the business model which had supported the strong growth of Japanese firms was no longer compatible with the changed economic environment. The strength of Japanese firms was the pursuit of operational efficiency enabled by large scale production and sales. You all know the detailed management of production and inventories through the “just-in-time process” and the “Kaizen system” which has become a part of the English language. Such pursuit of efficiency gains is naturally important. But as other countries such as the Asian emerging economies rapidly catch-up with advanced economies through technological progress, global competition becomes more intense and increased profits cannot be generated simply through such efficiency gains. According to a study which analyzed the production costs of iPhones (Slide 6), of the 500 dollar sales price of the iPhone, component costs add up to 173 dollars and assembly costs account for only 6.5 dollars. Accordingly, gross profits reach 321 dollars. In other words, the added value for coming up with a product concept and developing it into a product is now quite significant. Third, demographics have changed (Slide 7). Our country’s working-age population, in other words population between the ages of 15 and 64, began to decrease in the mid-1990s. Our society is ageing at a very rapid pace. The share of people 65 and above went from 9% in 1980 to 23% in 2009. Such rapid ageing has never been seen in past economic history. Japan had experienced the “population bonus” based on working-age population during the high-growth period. But now it has entered the “population onus” stage2. There is no consensus on the definition of “population bonus period” and “population onus period”. Government reports and academic papers on demographic studies often focus on the level of the working age BIS central bankers’ speeches III. Comparison of high-growth periods: Japan and emerging economies Based on such an understanding of Japan’s growth pattern, I would next like to conduct a simple comparison of the high growth that China and India are currently undergoing with Japan’s past experience (Slide 8). China’s rapid growth started at the beginning of the 1990s and the pace of growth for the first 15 years is almost exactly the same as Japan. The difference is that China has continued to grow on average at a pace above +10%. With regard to India, the growth rate is slightly lower than that of current China, or Japan during its boom period. This is perhaps because India has yet to enter the population bonus stage (slide 9). During a high-growth period, the supply of labor from rural areas plays a key role. When we compare the urban population rate of Japan and China, China’s current level is roughly similar to Japan’s level in the 1960s. Looking at the car ownership rate as a reflection of a consumption boom due to strong household income growth, once again China’s level is similar to that of Japan in the 1960s. When seen from this simple comparison, I believe that the Chinese economy will continue its high growth for some time. With regard to India, the population bonus period will arrive around 2015, so its growth rate may accelerate further3. However, as Japan’s experience shows, when income levels increase together with strong economic growth, each society faces various new challenges. A smooth transition from high growth to stable growth is quite a challenge. From the perspective of a country which has been facing these challenges for some time, I would like to share with you some of the lessons we have learned. Preventing bubbles The first challenge is preventing the emergence of bubbles. When an economy experiences strong growth over an extended period, society often becomes over-confident. This seems to be human nature. Japan’s bubble during the latter half of the 1980s, was the result of a complex interaction among multiple factors. However, the fundamental reason was the overconfidence which cloaked the entire country and the ensuing dramatically aggressive economic behavior. At that time, Japan’s growth rate was higher than other advanced economies and the inflation rate was quite subdued. Japan was the perfect model student (Slide 10). It may sound ridiculous, but according to an estimate released at that time, the aggregate value of land in central Tokyo was equivalent to that of the entire United States. Financial supervision was also insufficient. Lending to real estate, construction and non-bank financial sectors increased sharply and lending conditions softened including the evaluation of collateral. The prolonged period of monetary accommodation also played a role. One reason why accommodative monetary conditions continued was the low inflation rate. The other reason was the serious concerns toward a stronger yen and the strong overseas pressure to reduce the current account surplus. A strong argument was put forward that accommodative monetary policy was crucial in order to prevent a stronger yen and to bring down the current account surplus. population ratio, and when it is above 65%, it is considered to be the bonus period and when it is below 65%, the onus period. On the other hand, economic literature often focuses on the change in the working age population ratio. When it is rising, it is considered to be the bonus period and when it is falling, the onus period. According to forecasts by the United Nations, India will overtake China to become the world’s most populated country in the middle of 2020s. BIS central bankers’ speeches Reviewing business models The second challenge is what we may call the review of business models. There is no universally optimal business model which is continuously applicable across time and borders. It is true that, during the economic boom period, the business model of Japanese firms matched the conditions of the world economy at that time. However, once a business model is successful, it is not easy for both the country and the firm to review it in line with changes in the environment. What is important is that regardless of whether it is a country or a firm, the ability to reinvent itself reflecting its stage of development plays a key role. Preparing for demographic change The third challenge is preparing for changes in demographics. Rapid ageing of the population would reduce labor supply and lead to a drop in the growth rate. A drop in domestic demand would be unavoidable. From a fiscal perspective, as long as the costs of public pensions, health care and nursing are covered by contributions from the working generation, and if the benefit levels for the elderly are not adjusted, ageing will lead to higher fiscal deficits. Concerns about demographic changes were already raised in the late 1980s, but at that time it was only considered vaguely as an issue for the distant future. However, as our experience shows, ageing has huge implications. It is evident that the vibrant emerging economies in Asia will age in the not-too-distant future (Slide 11). In the short run, demographics of the elderly are a given. Thus, reviewing the current social welfare framework in order to make it viable on a sustainable basis, taking into consideration the longer-term changes in demographics, is an enormous challenge. IV. Conclusion When one looks back into history, the “Global Shifts” examined by Professor Eichengreen are happening continuously. I believe Japan’s catching-up with the advanced economies through its post-war miracle and its ensuing transition to slow growth, as well as the current high growth of China and India, can be understood as examples of the “Global Shifts” (Slide 12). High growth cannot last forever. In concluding, I would like to emphasize that what is important here is to introduce a smooth transition from high growth to stable growth. Even emerging economies which are currently enjoying high growth will likely face, in the future, the same challenges that Japan is currently struggling with. For this, preventing bubbles, reviewing business models and preparing for changes in demographics are especially important. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 25 May 2011.
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Masaaki Shirakawa: Japan’s economy after the great earthquake – rebuilding, revival, and further growth Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 25 May 2011. * * * Introduction I am privileged to have the opportunity to speak before such a large audience today. Two and a half months have passed since the Great East Japan Earthquake, but many continue to face severe hardship, including those being forced to live at evacuation sites. I would like to offer my heartfelt sympathy to those who are suffering. At the same time, moves toward rebuilding life and infrastructure are under way in disaster areas, albeit gradually. At the beginning of May, the Diet approved the supplementary budget aimed at early rebuilding following the disaster. Discussions toward revival of the disaster areas are also under way. Moreover, discussions toward formulating growth strategies for Japan’s economy, which has been the great challenge since even before the earthquake, have also been regaining momentum. Those individual efforts and discussions are important and linked together. Today, I will first explain the current situation and near-term outlook for Japan’s economy. I will then share with you some of my ideas on the challenge Japan’s economy faces in each of the coming phases of rebuilding, revival, and further growth. I. The current situation and outlook for Japan’s economy Downward pressure on the economy by the earthquake disaster Let me start with the current state of Japan’s economy. From early 2011, Japan’s economy had emerged from the pause since autumn 2010. The earthquake disaster struck the economy when it was about to regain recovery momentum. The earthquake, tsunami, and accident at the nuclear power plant have changed the situation significantly, and Japan’s economy is currently facing strong downward pressure. Let me note that industrial production for March decreased by 15 percent on a month-on-month basis, the largest one-month drop on record. The recent sharp and substantial economic plunge is similar to that following the failure of Lehman Brothers but different in terms of its mechanism: the recent downward pressure is caused by a supply-side shock. The earthquake and tsunami caused considerable damage to social capital stock, such as roads and ports, as well as private capital stock, such as factories and commercial facilities, in a wide area from the Tohoku region to the northern Kanto area. The destruction of factories led to disruptions in the supply chains of parts and materials, which affected production not only in disaster-stricken areas but also a wide range of non-affected areas. The damage to power-generating facilities constrained electricity supply mainly in the Kanto and Tohoku regions. These factors have resulted in a decline in the capacity for supplying goods and services in Japan’s economy as a whole. As a result, exports have decreased substantially and domestic demand has been declining. It should be noted, however, that demand itself has not disappeared, but that it could not be realized due to supply constraints. In this regard, the current situation is significantly different in nature from that which followed the failure of Lehman Brothers, when demand both at home and abroad “evaporated” due to the rapid contraction of financial markets. There has been no significant change in the fundamental conditions that supported Japan’s economic recovery prior to the earthquake – namely, the expansion of markets for Japan’s exports on the back of robust growth in overseas economies. Therefore, the most vital near-term challenge for Japan’s economy is to resolve supply constraints as early as possible, and this should be addressed with utmost efforts. BIS central bankers’ speeches At the same time, however, the supply-side factor is not the sole cause of downward pressure on the economy. Additional downward pressure from the demand side, which is partly related to the supply-side shock, is also contributing. The accident at the nuclear power plant and power shortages have exerted downward pressure on economic activity through a deterioration in business and household sentiment, as well as a declining number of tourists from abroad. Voluntary restraint by consumers spread nationwide immediately after the earthquake, dampening spending particularly for services such as tourism and eating out, as well as for luxury goods. Even if the initial shock is brought about by supply constraints, if the sluggishness in production persists, there will be an increase in adverse effects on corporate profits and on employment and wages, thereby putting the brakes on business fixed investment and private consumption. In sum, the current downward pressure differs from the “evaporation” of demand following the failure of Lehman Brothers. Nevertheless, it is necessary to carefully examine whether or not demand-side factors will exert downward pressure on the economy. The baseline scenario for the outlook Next, I will talk about the outlook for Japan’s economic activity. The Bank of Japan judges that Japan’s economy for the time being is likely to continue facing strong downward pressure, mainly on the production side. But from the beginning of autumn 2011, supply-side constraints are likely to ease as the power shortage problem is mitigated amid the progress with reconfiguration of supply chains. In fact, in the past two and a half months since the earthquake, an increasing number of factories have made progress in restoration efforts and resumed production. Against this background, some firms have brought forward their originally targeted dates to resolve supply chain disruptions. As for consumer sentiment, which deteriorated sharply immediately after the earthquake, voluntary restraint has recently eased somewhat, and from April there have been signs of recovery in sales of electrical appliances as well as sales at department stores. During the Golden Week holidays – the period from late April to early May that includes four national holidays – more than just a few tourist sites were crowded compared with the pessimistic forecast made ahead of this period. These developments suggest that Japan’s economy has started to move toward recovery from the tumble immediately after the earthquake. Overseas economies have also continued to grow rapidly. According to the forecast by the International Monetary Fund, the growth rate of the global economy will be 4.4 percent in 2011 and 4.5 percent in 2012, surpassing the average rate of 4.0 percent for the ten years preceding the financial crisis. In this situation, Japan’s exports are likely to start recovering as supply-side constraints ease. The replenishment of inventories, which was significantly reduced due to the disaster, will act as a factor to boost production, and demand for restoring capital stock will gradually increase. Therefore, in the second half of fiscal 2011, the sense of recovery will be somewhat more noticeable, although it will fall short of a V-shaped recovery. In fiscal 2012, Japan’s economy is projected to continue to realize relatively high growth because we will see a more effective utilization of the transmission mechanism by which the strength in exports and production feeds through into income and spending, and because rebuilding demand will continue increasing. If expressed in numerical terms, the annual real GDP growth rate is projected to expand to 2.9 percent in fiscal 2012, after staying at a low 0.6 percent in fiscal 2011 due to the drop in the first half. Uncertainty regarding the outlook As I mentioned earlier, the Bank’s baseline scenario is that, in the second half of fiscal 2011, Japan’s economy will recover from the tumble caused by the earthquake and return to a moderate recovery path. However, the Bank fully recognizes that this outlook entails various uncertainties. BIS central bankers’ speeches First of all, there are uncertainties regarding developments in overseas economies and international commodity prices. There continues to be the two-speed pattern of overseas economies, with moderate recovery in advanced economies and very strong growth in emerging economies. In the United States, balance-sheet adjustment pressure following the bursting of the credit bubble – such as a decline in home prices and excess debt in the household sector – has continued to weigh on the economy. In Europe, concern about fiscal problems in some peripheral countries such as Greece has not been resolved. Meanwhile, in many fast-growing emerging economies, continued monetary tightening has not sufficiently calmed economic overheating and concern over inflation. This might cause another longerterm risk of more volatile fluctuations in economic activity, which could undermine sustainability in growth. Although our minds have been occupied with domestic events, we also need to pay careful attention to these developments in overseas economies. Having said that, the highest degree of uncertainty lies in the effects of the disaster on Japan’s economy. It is particularly important to consider when various supply constraints associated with the disaster will be removed. In terms of electricity, the supply and demand balance is expected to tighten in the summer, when demand peaks due to the use of air conditioners. Various measures have been taken to weather this difficult period: a strengthening of supply capacity by electric power companies; the use of in-house power generation; and firms and households’ efforts to conserve electricity and to level out demand. As for supply chains, the situation has been improving. However, we should not forget the difficulty in making precise projections at this point regarding the prospect of electricity supply shortages and supply chain disruptions. The summer demand for electricity depends significantly on the temperature. Concern over electric supply might be long-lived beyond summer 2011 depending on the rate of operation in nuclear power plants across Japan, which could be affected by the recent decision to shut down the Hamaoka nuclear power plant located in central Japan. Moreover, the pace of reconfiguration of supply chains will differ across industries and products. It might take time for consumer sentiment to fully recover depending on the aftermath of the accident at the nuclear power plant and on the employment and income situation. To put it the other way around, if problems regarding supply constraints start to be resolved at a faster pace than expected, the economy could deviate upward from the projection. While there is a high degree of uncertainty about the prospect of supply constraints, in conducting monetary policy, the Bank considers it appropriate to pay more attention to downside risks for the time being. What is certain is that the most important challenge to eliminating downside risks is to remove supply constraints as early as possible. On this point, many firms have been making their utmost efforts to restore affected facilities, carry out production at alternative sites, and secure alternative suppliers. Looking at worksites in the manufacturing industry, various continued efforts and attempts have involved putting aside the usual rivalries; for example, firms in the same industry temporarily covering the production of disaster-stricken firms and several manufacturers of final products cooperating in terms of sending staff to parts manufacturers to support their restoration efforts. The Japanese industry has proved its competitiveness in overcoming and addressing challenges in a flexible manner on many occasions. I hope that an early resolution of supply constraints will be enhanced by utilizing such “competitiveness at worksites,” or genbaryoku, in various areas. Needless to say, it is important to prevent any deterioration in sentiment and heightening of risk aversion with a view to avoiding any additional decline in demand until supply constraints will be resolved. In this regard, the Bank has been swiftly implementing various measures since immediately after the earthquake, which I will address later. Price developments Next, I will talk about price developments. I have just mentioned that the recent decline in economic activity is basically caused by the supply shock. Thus, there is a view that the decrease in supply capacity will cause a tightening of the supply and demand balance, BIS central bankers’ speeches thereby potentially increasing inflationary pressure. However, as I said earlier, the disaster has also resulted in a decline in demand. Therefore, the near-term prospect of the aggregate supply and demand balance is not so obvious. Still, in the longer run, the year-on-year rate of change in the consumer price index (CPI) is expected to remain slightly positive, as the economy returns to a moderate recovery path from the second half of fiscal 2011. For this projection to materialize, it is important that medium- to long-term expected rates of inflation for businesses and households remain stable. On this point, as far as the results of economists’ surveys are concerned, no significant change has emerged in medium to longterm expected rates of inflation. Another factor that affects prices is import costs. In this regard, developments in international commodity prices, such as prices of crude oil, grains, and nonferrous metals, are important. International commodity prices rose rapidly until spring 2011 and have experienced some adjustment since the end of April. It is difficult to forecast the short-term fluctuations of market-determined international commodity prices. Thus, in making its forecast, the Bank assumed that such prices are likely to continue a moderate uptrend given strong growth in emerging economies. Expressing the outlook in numerical terms, the year-on-year rate of change in the CPI is projected to be 0.7 percent both in fiscal 2011 and 2012. If this projection materializes, the CPI for fiscal 2011 will become positive on a year-on-year basis for the first time in three years, although this requires a supplemental explanation. In August 2011, the Ministry of Internal Affairs and Communications, which compiles the CPI, is scheduled to conduct the base-year change to the CPI, regularly conducted every five years. It has been pointed out that there is usually a technical upward bias in the CPI compilation – namely, a greater chance of having a somewhat higher inflation rate on a year-on-year basis in the period immediately before the revision because substantial price declines in goods such as personal computers and televisions are not sufficiently reflected. Thus, the rebasing is likely to cause the year-on-year rate of change in the CPI to be revised downward. Although there are some points that should be kept in mind, as described earlier, Japan’s economy is expected to return to a sustainable growth path with price stability in the longer run. Having said that, the question we must ask ourselves is: to what kind of growth path should Japan’s economy return? I would also like to stress the significant importance of serious efforts to raise Japan’s economic growth rate in the medium to long term – beyond the cyclical economic recovery. II. Efforts to address medium- to long-term challenges Even before the earthquake, the great challenge for Japan’s economy was to raise its growth potential amid a rapidly aging population that is unprecedented in other countries. Now, the task of rebuilding and revival following the disaster is added to the list of challenges. In the meantime, we cannot stop ongoing structural changes in the global economy, such as economic and financial globalization as well as emerging economies catching up. What I would like to emphasize today is that, even when doing our utmost to overcome the disaster, we should not retreat from efforts to address the medium- to long-term challenges that have been recognized for years. Rather, we need to change our way of thinking such that we regard the post-quake responses and measures, including the revival of the disaster areas, as a new starting point for the task of raising the growth potential of the economy. A. Efforts toward raising the growth potential of the economy The average growth rate of Japan’s economy fell substantially to around 1.5 percent in the 1990s. In the 2000s, the average fell to barely 1 percent, partly due to the economic plunge triggered by the failure of Lehman Brothers. This long-term downtrend in the growth rates reflects the slowdown in the productivity growth rate from the 1990s and the accelerated BIS central bankers’ speeches decline in the working-age population from the early 2000s. These problems need to be addressed in order to sustainably raise Japan’s economic growth rate. First, given that the decline in the working-age population is the result of demographic dynamics, it is not possible to immediately stop this long-term trend. Thus, in order to revitalize the economy based on the current demographic trends, efforts to raise the share of working people – namely, the labor force participation rate – are essential. In this regard, of key importance is how to raise the labor force participation rate of the elderly and women, especially women in their 30s, whose participation rate is low compared with abroad. With regard to the participation rate of the elderly, large firms typically used to have a retirement age of 55. Upon reaching that age, the remaining average life expectancy, which was 20 years for men and 24 years for women at the beginning of the 1970s – the last highgrowth era – has risen to 27 years for men and 33 years for women, an increase of around 10 years over the past 40 years. Although their working patterns are not exactly the same as those of younger generations, it is essential that the elderly join the workforce by making use of their experience. In order to raise the labor force participation rate, it is necessary to change the way of thinking within firms and society as a whole, such that workers are able to have more flexible working patterns depending on their lifestyles and sense of values. Second, it is also essential to raise the productivity growth rate. “Raising productivity” is often perceived as pursuing more efficient management through a reduction in personnel and equipment. It is true that, in the case of Japan, firms have a tendency to enhance productivity through intensive cost reductions. However, such “streamlining” alone in many cases does not lead to the enhancement of productivity for the economy; rather, it might end up in contracted equilibrium. Raising productivity that would contribute to economic growth is nothing more than raising individual persons’ capacities for generating value-added, thereby increasing the size of the economy as a whole. To this end, of importance are efforts to discover new demand and create new markets both at home and abroad – namely, embracing the role of innovation. In what follows, I will talk about these challenges in terms of both global and domestic demand, and then the demand directly related to the earthquake disaster. Capturing global demand In order to raise the productivity and growth potential of Japan’s economy, even in this tough situation after the earthquake, it is important to actively capture fast-growing demand in overseas markets by adjusting to accelerating globalization. Since the earthquake, mainly because of the effects of the accident at the nuclear power plant, Japan’s reputation for being “safe and secure” has been undermined; as a result, the number of visitors from abroad have fallen substantially across the country and exports of food have been adversely affected. This underscored the need to accurately and actively provide information on Japan’s situation, thereby dissuading from “passing on Japan,” which might otherwise occur on the basis of misunderstanding and rumors. At the same time, it is important to further increase the added value of Japanese goods and services by responding to the needs of foreign customers in a flexible manner. Before the earthquake, the number of tourists from Asia increased by three times in 10 years, in what could almost be called a “Japan Boom.” The disaster has ruined many factories but not Japan’s sophisticated technologies. The “soft power” that has supported Japanese society is still there, as epitomized by good public safety, reliable business operations, and personalized and courteous customer service. By making use of this strength, if efforts continue to be made to polish the attractiveness of Japan’s goods and services, Japanese brands will see a revival and be viewed as more attractive with resolution of the nuclear power plant problems and the passing of time since the earthquake. It is a cause for concern that the disaster might affect Japanese firms’ strategies for their overseas production network and foreign firms’ policies for procuring parts. Specifically, the possibility has been pointed out that disruptions to supply chains and power shortages may BIS central bankers’ speeches accelerate Japanese firms’ shift to overseas production. Some foreign firms have started to replace parts and materials obtained from Japan with products made abroad. There is a possibility that this will not be a temporary emergency measure and thus result in a permanent decline in the ratio of procurement from Japan. However, from a different point of view, the disaster has reconfirmed that Japan’s high-end parts and materials occupy irreplaceable positions within worldwide manufacturing, especially in the areas of automobiles and electronics. Japanese manufacturers have been increasing the ratio of overseas production in the long run while creating new technologies and products in Japan that other countries cannot easily imitate. This process is not the so-called hollowing-out of Japan’s manufacturing base, but rather product differentiation or a more advanced division of labor across the national border. Since emerging economies are becoming more competitive and sophisticated, the only way Japan can sustain itself in the global economy is by continuing to strengthen efforts to generate products and services that are always one step ahead. So long as Japanese firms maintain their fundamental strength, the global supply chains will be reconfigured, with manufacturing within Japan as the central core. Moreover, in order to provide a favorable environment in which Japanese firms and industries prosper together with the global economy, it is important to steadily expand the framework for free trade agreements and economic partnership agreements. Exploring new domestic markets Next, I would like to emphasize the need to explore new domestic markets. I mentioned the decline in the working-age population as one of the factors behind the decrease in Japan’s economic growth rate. At the same time, however, Japan’s economy has been faced with chronic excess employment, and developments in wages and prices have been weak for a protracted period. This fact suggests that simply blaming the decreasing workforce numbers due to the aging of the population as the cause of the slowdown in Japan’s growth rate misses the point. The structural cause of slow growth in Japan is that firms and industries have failed to recognize changes in the content of the potential demand driven by demographic dynamics. The other side of the coin is that, once the existing markets for goods and services mature and fall into excess supply, this situation tends to persist, and this has become a factor responsible for generating excess employment and deflationary pressure. The demographic dynamics of a declining working-age population itself is not a direct cause of a decline in the economic growth rate; rather, it is more attributable to economic and social systems that have failed to appropriately adapt to such demographic changes. The decline in the working-age population also represents the decline in the population that accounts for the bulk of consumption. This will act as a factor to shrink the domestic market, mainly the market targeting families, on the demand side. In this situation, without capturing new demand arising from the aging of the population, the domestic market would shrink as a whole. The desire to make life more comfortable is constant regardless of age. An increasingly aging population should be creating new potential demand across a wide range of areas such as health and nursing care, tourism, leisure, and cultural activity. The growth areas are not limited to global demand. If potential demand is carefully examined, there are also many seeds for growth in the domestic market. Of course, in order to explore new demand, it is essential to have a strongly motivated management and financial infrastructure that enables risk taking. In this regard, determination and efforts by the management of individual firms to take up such challenges is the starting point for everything. At the same time, it is important to have a business environment that supports such forward-looking corporate activity, and to this end, collaborated efforts by all the concerned parties in the country are needed. The aging population is not the only key area with regard to exploring new markets. Given the problems in electricity power supply after the earthquake, technological innovation in the energy area is promising as a way to increase the growth potential of Japan’s economy. Having nurtured sophisticated technologies for years, Japan is well placed to explore business opportunities by pursuing the following three goals together: BIS central bankers’ speeches “saving energy” to conserve energy through the wider use of LED lighting; “creating energy” through the use of solar power; and “storing energy” through the efficient storage of energy through improvements in battery storage. Constraints from natural resources and energy is the big challenge that the global economy faces in the long run, and becoming a forerunner in this area will be helpful in capturing global demand going forward. Innovations to rebuilding and disaster prevention In order to raise the growth potential of Japan’s economy, the strength to develop new markets by discovering potential demand is required. This also applies to the rebuilding process in the disaster areas, which will make further progress going forward. The Tohoku and northern Kanto areas are endowed with rich resources for agriculture and fishery as well as tourism. These areas also have a solid foundation in academic research and manufacturing, indicating considerable potential for responding to prospective demand. Rebuilding of the disaster areas involves the process of reconfiguring places for industries and employment in accordance with local peoples’ needs, by making use of the areas’ advantages and competitiveness. Needless to say, the first priority is to return the people in the affected areas to safe and comfortable lives as soon as possible. After completing such rebuilding of lives, even if it takes some time, the disaster areas will definitely move forward into the next phase, in which measures with new innovative ideas for regenerating the regional economy will be implemented. Moreover, the earthquake disaster has brought a renewed recognition that the Japanese Islands always hold the inherent risk of earthquakes and tsunami. Not only the disaster areas but also Japan as a whole need to make efforts to improve both physical and human infrastructures, in order to make the country more resistant to natural disasters. There are many kinds of potential demand, and in order to meet such demand, innovation again plays an important role. B. Efforts toward sustaining fiscal balance I have stressed the importance of addressing the challenge of raising the medium- to longterm growth potential of the economy, which is closely related to another challenge: efforts toward sustaining fiscal balance. As the aging of the population will advance further, pension payments and the costs of health and nursing care are projected to increase substantially. In this situation, allowing the fiscal deficit to perpetuate itself would result in the uncontrollable expansion of government debt outstanding, which is not sustainable. Once concern about fiscal sustainability heightens, this could impair the smooth issuance of government bonds. Moreover, if more people expect that a greater burden on the working-age population is inevitable, the economy could fall into a vicious circle in which more cautious spending by firms and households leads to a further economic downturn and a deterioration in fiscal conditions. As just described, the two challenges of raising the growth potential and fiscal consolidation are not independent but inextricably linked. One challenge should not be given priority over the other, but rather these must be addressed together. The large fiscal deficit has continued since the 1990s on the back of successive fiscal stimulus measures and the rise in social security costs, and addressing fiscal consolidation was an urgent task even before the earthquake. Fiscal measures for the rebuilding and revival of the disaster areas will definitely push up fiscal spending further even though it is still difficult to make an accurate estimate. The expected fiscal deterioration in the short run makes it all the more important for the government to present a more definite path toward medium- to long-term fiscal consolidation. Fortunately, long-term interest rates in Japan remain stable at a low level on an international comparison. With regard to the issuance market for government securities, these have been issued quite smoothly since the earthquake. There are two reasons why the market for government securities remains stable in this manner. The first is with regard to the aggregate BIS central bankers’ speeches savings and investment balance. That is, in view of the continuing net saving position in the household and corporate sectors, and given that financial institutions are maintaining a solid capital base, there is a sufficient amount of domestic funds to purchase government securities for the moment. The second reason concerns confidence in future policy management. As for fiscal policies, despite the significant deterioration in fiscal balance, market participants still expect that necessary steps will ultimately be taken to restore the balance. Regarding monetary policies, there is confidence that monetary policies are conducted with the objective to achieve sustainable economic growth with price stability. Considering the severity of fiscal conditions, none other than the confidence I just described is supporting the stability in the government securities market. People tend to believe without doubt that what has continued over a long period will stay as it is, but we should be mindful of the fact that confidence in the stability in the government securities market is only maintained by people’s will to adopt such a stance. Therefore, it is essential to take concrete steps toward raising the growth potential and fiscal consideration when stability in the government securities markets is maintained. Enhancement of market stability through these efforts is also likely to contribute to promoting a supportive environment for the rebuilding and revival following the disaster. Given the already enormous fiscal deficit, underwriting of government securities by the Bank of Japan is occasionally discussed as an option for funding new government spending. However, it should be noted that there is no magic wand that creates something from nothing. Whether government securities are underwritten by the central bank or purchased by private financial institutions in the market, there is no change to the big picture in which government securities are issued using firms and households’ savings as a resource. Rather, the central bank’s underwriting of government securities often comes with a serious side effect of weakening fiscal discipline. If the government depends on the central bank’s underwriting and ignores the market’s risk assessment function, the government debt could eventually expand to a level beyond the taxpayers’ funding capacity. After the earthquake, there has been increasing public interest in the historical episode of the Bank’s underwriting of government securities in the 1930s, when Mr. Takahashi was the Minister of Finance. This started as “temporal” but it soon became impossible to put a brake on the increase in the amount of underwriting and the associated expansion of currency issuance, which ultimately resulted in serious inflation. We need to reflect on this history. There are some counterarguments that, if underwriting creates such a problem, the Bank could purchase government securities from the market instead. The Bank currently purchases a large amount of government securities, but its purpose is to stably provide the markets with funds corresponding to increasing demand for banknotes, in association with economic growth. If the central bank’s purchases of government securities are considered to be conducted with the aim of facilitating government financing beyond its original purpose, this will cause the same problem as underwriting. III. The Bank of Japan’s response Lastly, let me explain the Bank’s response following the earthquake. A guiding principle for a central bank’s actions after a major disaster such as we suffered is very clear. That is, to maintain the functioning of payment and settlement systems as well as ensure the stability of financial markets. In other words, to prevent financial shock from developing into economic instability. The initial task the Bank worked on following the earthquake was to maintain the functioning of settlement and financial systems, which are the basis of people’s lives and economic activity. At the time of a crisis, the most important responsibility for a central bank is to firmly secure the financial infrastructures. Specifically, the Bank did its utmost to provide cash to meet the needs in the disaster areas through its branches and offices in Sendai, Fukushima, and Morioka. In the week after the earthquake, the Bank provided 310 billion yen in cash to the Tohoku region, about three times more than in the same period last year. Meanwhile, BIS central bankers’ speeches Japan’s major payment and settlement systems, including the Bank of Japan Financial Network System, or BOJ-NET, have maintained stable operations. Needless to say, the Bank’s actions alone could not secure the smooth operation of payment and settlement systems. Such a level of operation became possible because many of the parties involved, including private financial institutions, have made thorough preparations for business continuity risks in normal times. Despite devastating damage to their offices, financial institutions in the disaster areas have maintained or resumed business operations at teller windows through strenuous efforts, by utilizing temporary offices and also mobile ones. I have deep respect for and feel very reassured about such efforts by those involved. Second, the Bank worked to ensure stability in the financial markets. In the money market where financial institutions exchange funds, in order to avoid a heightening of anxiety, the Bank provided ample funds sufficient to meet demand over a period of successive days since the earthquake. In particular, on March 14, the first business day after the disaster, the Bank provided a total of 21.8 trillion yen in funds. This is almost three times as much as the 8.1 trillion yen that marked the largest daily funds provision, following the failure of Lehman Brothers. Third, the Bank further strengthened monetary easing. Specifically, on the next business day after the earthquake, the Bank decided to increase the amount of the Asset Purchase Program, mainly of purchases of risk assets – such as corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) – by about 5 trillion yen. Immediately after the earthquake, it was not possible to confirm an economic downturn from the macro data; nevertheless, the Bank decided to strengthen monetary easing because it was already fully aware at that time of downside risks to future developments in the economy and considered it necessary to respond to such risks in a forward-looking manner. At present, the Bank is steadily proceeding with the increase in asset purchases while also examining the effects of such increase. Fourth, the Bank started to conduct the funds-supplying operation to support financial institutions in disaster areas. The Bank found it necessary to financially support initial response efforts by financial institutions in the disaster areas even in the very early phase before demand for funds for the purpose of rebuilding and revival becomes full-fledged. Specifically, the Bank extends loans to financial institutions that have business offices in the disaster areas with one-year funds at the very low interest rate of 0.1 percent per annum. The total amount of loans is 1 trillion yen and new applications for loans can be accepted until the end of October 2011. For the first round of funds provisioning, about 74 billion yen in loans was applied, and the Bank extended these loans two days ago, on May 23. In June 2010, the Bank introduced the fund-provisioning measure to support strengthening the foundations for economic growth, and it has already conducted disbursements three times. As I mentioned earlier, the challenge of revival following the earthquake disaster partly overlaps with the longstanding challenge Japan’s economy faces – namely, of raising the growth potential. Going forward, as rebuilding efforts make further progress, the role expected of a central bank is to indirectly support financial institutions’ activities. The Bank will examine how to respond effectively as the central bank while monitoring how demand for rebuilding funds emerges and how such demand is met by private financial institutions and support from the government. Lastly, let me mention that the Bank has been working hard to exchange damaged banknotes and coins. If people in the disaster areas have banknotes and coins that are torn or soiled, they can be exchanged for new ones based on criteria specified by law. The Bank has been increasing the staff at teller windows at its branches, in the hopes that this will be of some help in restoring the economy in the disaster areas. BIS central bankers’ speeches Concluding remarks Today, I have explained the current situation and near-term outlook for Japan’s economy. I have also talked about the challenge Japan’s economy faces in each of the coming phases of rebuilding, revival, and further growth. The earthquake suddenly threw Japan into a crisis. Looking back, whenever faced with severe difficulties such as postwar hardship and oil shocks, the Japanese people have overcome them by tackling problems with a strong sense of urgency. History has proved that the Japanese people have an outstanding ability to overcome problems in the face of big shocks and associated crises. On the other hand, they do not seem to be particularly good at dealing with problems that gradually become worse over a protracted period, even though their effects on the economy are larger than the sudden shocks. This was the case with the non-performing loan problem in the 1990s. Even for the predictable problem of a change in demographic dynamics, Japan’s economy still faces many challenges, including the reform of social security systems. Due to the disaster, it is no longer possible to postpone the task of addressing the longstanding challenge of stopping the long-term downtrend in the growth potential of the economy and then revitalizing growth into the future. For the sake of our children and grandchildren, we have a great responsibility to pave the way for a bright future for Japan’s economy. Whether future generations will be able to look back at 2011 as a starting point for the renewed growth of Japan’s economy depends on our determination in the coming few years. The Bank, while firmly maintaining confidence in the currency, will continue to make its utmost contribution as the central bank. BIS central bankers’ speeches
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Keynote speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Bank of Korea International Conference 2011, Seoul, 26 May 2011.
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Kiyohiko G Nishimura: The importance of financial infrastructure in seeking a more resilient financial system – from an Asian regional perspective Keynote speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Bank of Korea International Conference 2011, Seoul, 26 May 2011. * 1. * * Introduction: resiliency of the financial system Governor Kim, distinguished guests, ladies and gentlemen, I am delighted and honored to have the opportunity to deliver this keynote speech at the Bank of Korea International Conference. The theme of this 2011 conference, “Future of the International Financial Architecture,” is timely and very important, because it points us directly to the lessons we should draw from the recent crises, including the collapse of Lehman Brothers, the sovereign debt problems in some European nations, and even the Great East Japan Earthquake and its massive tsunami in March this year. I am delighted to be able to participate in this conference, and hope to contribute to it, representing the Bank of Japan. Before proceeding with my speech, let me first express my sincere gratitude, on behalf of the Bank of Japan and the Japanese people, to all the people around the world who have given their generous support to the severely damaged area of East Japan. We are deeply grateful for all the prompt and compassionate physical assistance and financial donations we received from so many overseas jurisdictions. The disaster reminded me once again of the utmost importance of a resilient financial market and system, in which a central bank plays an essential part. In spite of the magnitude 9 earthquake, the Japanese financial system maintained its soundness, although some regional financial institutions were severely affected. Our payment and settlement systems have functioned effectively and without serious disruption in delivering necessary cash across the entire nation, including the disaster-hit areas. Although significant volatility was temporarily observed in the week following the disaster on March 11, the Japanese stock market has recovered its value since then, and the foreign exchange market has regained its stability. We must bear in mind, however, that such financial stability was not necessarily achieved in the case of past disasters. The San Francisco earthquake of 1906 is a case in point. That earthquake destroyed San Francisco, which was then the financial center of the West of the United States. Huge demand for cash was generated in the West for its reconstruction and insurance payments, at a time when the United States had no central bank system.1 Market participants then tried to address this urgent situation by transmitting money to the West from New York City, but ironically, their action resulted in a significant shortage of liquidity in the nation’s financial center. In consequence, short-term interest rates increased rapidly, and the New York money market lost its functionality. The contagious impact was also observed in overseas financial markets such as London.2 The Federal Reserve System, which serves as the U.S. central bank, was created by an act of Congress on December 23, 1913. For details see Robert F. Bruner and Sean D. Carr (2007), “The Panic of 1907: Lessons Learned from the Market’s Perfect Storm,” Wiley, John Wiley & Sons, Inc., Hoboken, New Jersey. BIS central bankers’ speeches In this speech, I will focus on the determinants of the resiliency of a financial system, and the role of regional cooperation in seeking a more stable and resilient system. Here, I argue that it is of utmost importance to build a liberalized, transparent, and deep financial market and system, without arbitrary intervention, whether formal or informal. In particular, from an Asian regional perspective, I would like to emphasize the need to improve the region’s financial infrastructure, including its payment and settlement systems, so that financial markets can maintain their functionality even during a crisis. In the following, I will first review a variety of policy efforts introduced in the region since the Asian currency crisis to address the risks related mainly to massive capital outflows. This is followed by my views on how to cope with harmful volatility in the financial market and system. Finally, I will conclude by emphasizing the importance of improving payment and settlements systems in the region. 2. Successful efforts since the Asian currency crisis: but don’t be too complacent The more than ten years since the Asian currency crisis has literally been a period of reform for Asian financial markets. Bearing the important lessons in mind, Asian authorities have made a variety of policy efforts to strengthen the resilience of their economies and financial markets, including the self-insurance of accumulating foreign reserves, multilateral swap agreements under the “Chiang Mai Initiative”,3 and reduction of their dependency on off-shore short-term funding. They have also endeavored to and succeeded in improving their fiscal positions. Coupled with the high growth potential of Asian economies, these policy efforts have proved effective in helping Asia steer through the global financial crisis, often called the “financial tsunami”, which followed the collapse of Lehman Brothers in September 2008. Such a success story would, however, be short-lived, if Asian economies were too complacent to address the challenges that capital flows and domestic inflation bring. Owing to their high growth potential, Asian economies have again experienced large capital inflows, creating an environment that is likely to increase volatility, particularly in asset prices (Slide 1). In addition, the recent surge and increasing volatility in commodity prices, which is in part explained by financial factors, may accelerate existing domestic inflation risks in emerging Asia (Slide 2). The challenge now is how to cope with the short-term, harmful volatility that disruptive capital flows may cause, while at the same time maintaining and enhancing the long-term welfare-improving efficiency that steady capital flows bring about. Capital flows are beneficial for the Asian region, where there is large potential demand for public and private infrastructure. Thus, they are absolutely necessary for the further development of Asian financial markets, as well as for further growth in Asian economies. Volatile capital flows are often said to be beyond the control of regional authorities. I believe this is true to a great extent because Asian financial markets are still lacking in depth and liberalization. Their ability to cope with large-scale external shocks through, for example, the modulation of capital flows, therefore remains far from sufficient. There are ongoing debates on, among other issues, the appropriateness of the current scale of 120 billion U.S. dollars relative to the total size of economy, and the manner of collaboration with the International Monetary Fund. These issues were addressed in the Joint Ministerial Statement of the 14th ASEAN+3 Finance Ministers’ Meeting on May 4, 2011 in Hanoi, Vietnam, coupled with the important issue of the participation of member central bank governors from its 15th meeting. The gathering will then become the “ASEAN+3 Finance Ministers’ and Central Bank Governors’ Meeting” from 2012. BIS central bankers’ speeches 3. Short-term measures to cope with financial instability: don’t forget their longterm consequences Recently, many Asian economies have again experienced a surge in capital inflows. Large-scale capital inflows are said to have brought three major problems. First, they have caused rapid currency appreciation in a short period of time, which is undermining the competitiveness of export industries and dampening corporate confidence. This is especially detrimental to Asian emerging economies with their relatively high dependence on exports. Second, these massive capital inflows, together with their favorable economic expansion, have pushed stock prices to historical peaks and brought about a rapid increase in property prices. Such developments, if continued for an extended period without appropriate policy actions, would increase the unwelcome risk of asset price bubbles. Third, increases in asset prices and bank lending are stimulating excessive consumer spending and business investment through wealth effects, leading to the risk of an overheating economy and accelerating inflation. Indeed, inflationary pressures and inflation expectations have been rising in many Asian emerging economies, fueled also by the recent surge in commodity prices. In response to these challenges, many Asian economies have adopted short-term policy responses, such as restrictions on capital inflows and macro-prudential policy measures, as well as foreign exchange market intervention. Since last year, they have introduced a variety of quantitative regulations and tax measures to mitigate the risks that excessive capital inflows may cause. Moreover, in an effort to curb overheated property investment, they have strengthened regulations and taxation on property transactions, lowered the required loan-to-value ratio for financial institutions, and imposed tighter limitations on bank loan volumes. These specifically targeted policy actions have indeed begun to take effect. For example, the upward pressure on property prices seems to have eased somewhat in several economies. However, such favorable effects may be the exception, and these policies may have unintended adverse effects on the economy if they are in place for longer than necessary, such as distorting optimal credit allocation and impeding necessary structural reforms. Moreover, temporary success in these short-term measures may tempt policy makers into postponing measures necessary to cope with real and fundamental problems. In particular, monetary and other macroeconomic policy actions must not fall behind the curve. Although the increase in interest rates may attract further capital inflows, we should not rely too much on the above-mentioned short-term regulatory and macro-prudential measures. As was evident from Japan’s experience of the past bubble, delayed monetary and macroeconomic policy responses may bring about an accumulation of “excesses” in employment, business capacity, and debt under an inflexible labor market or high investment irreversibility. Such accumulated excesses may persist for an extended period, and may hamper economic growth in the years following. After all, regulatory and macro-prudential measures are supplementary to, but not substitutive for traditional or conventional policy measures. Let me move on to the longer-term issues associated with vulnerability to unanticipated external shocks. As I mentioned earlier, steady capital inflows are beneficial in bringing about welfare-improving efficiency in the long run. In order to ensure their benefits, I would like to emphasize the importance, here in Asia, of long-term policy efforts to develop more liberalized, deep, and well-balanced financial markets, or I may say, a better financial infrastructure or architecture. Deep and well-balanced financial markets, side-by-side with free and stable capital flows, enhance the effectiveness of resource allocation. It should be emphasized that liberalized and deep financial markets also strengthen the effectiveness of macroeconomic policies, through improvements in the monetary transmission mechanism. The Asian authorities are together in having recognized this long-term perspective, and they have been making collaborative efforts over the past decade to develop their financial BIS central bankers’ speeches markets, particularly their bond markets. Examples of such efforts include the Asian Bond Fund (ABF) initiatives launched by the EMEAP,4 in which the Bank of Japan also takes part, and the Asian Bond Markets Initiative (ABMI) of the ASEAN+3 process.5 Asian financial markets have developed remarkably in recent years thanks to these policy efforts (Slide 3). Nevertheless, they are still much smaller and less liquid than their counterparts in advanced economies, magnifying the impact of short-term volatility of capital flows on their stock and bond prices, and accordingly on their foreign exchange rates. In particular, the secondary and repo markets as well as the primary markets for corporate bonds remain relatively underdeveloped in the region, compared with the expanding primary markets for government bonds. This situation needs to be addressed through more cooperative and collaborative efforts among Asian economies, including Japan. Moreover, in a broader sense of the infrastructure issue, there is still an excess of regulations on cross-border transactions, including those applied to foreign exchange, overseas remittances, and foreign inward investments, as well as an over-complex taxation system. The lack of transparency is often criticized, as well as the seeming arbitrariness found sometimes in the enforcement of such regulations. They remain an impediment to the promotion of transactions and to the development of liberalized and deep financial markets in this region. 4. Improving payment and settlement systems in Asia: respect free markets I would like to emphasize the utmost importance of improving the post-trade infrastructure of securities markets in Asia. This would enhance the resilience of the financial system as Asia’s financial markets continue to develop. As I mentioned earlier, Japan’s payment and settlement systems were not disrupted by the Great East Japan Earthquake, and have continued to function effectively, helping to ensure financial and social stability. The role of payment and settlement systems is to settle claims and obligations arising from transactions. While the infrastructure making financial contracts straightforward and smooth could be compared to arteries pumping out blood into the body of the economy, the payment and settlement system would then be the veins carrying the blood back to the heart (Slide 4). Both of them are absolutely necessary for the proper functioning of the financial system, especially for cross-border transactions. The international financial system would stall if the veins, or the payment and settlement system, became choked with blood clots. In this respect, it is extremely important to ensure the safety and efficiency of the payment and settlement system, as well as its stable operation, even in times of crisis. From the cross-border perspective, however, I recognize at least two problems in the post-trade infrastructure for cross-border securities trading in the Asian region.6 The EMEAP was established in 1991, and consists of eleven central banks and monetary authorities in the Asia and Pacific region, namely Australia, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, Philippines, Singapore, and Thailand. Under the ABF initiatives, EMEAP member central banks invest a portion of their foreign reserves in sovereign and quasi-sovereign bonds of eight EMEAP jurisdictions. The ABF initiatives have promoted the recognition of local currency-denominated bonds issued in Asia, and acted as a catalyst to accelerate and harmonize legal, regulatory, and tax reforms related to bond investments in the region. The ABMI has also made a variety of efforts and achievements, including providing technical assistances and credit guarantees, as well as enhancing information disclosure for investors, aiming at improving the issuance and investment environment on government and corporate bonds in the region. There have been relative improvements in domestic payment and settlement systems in Asia. Online securities payment and settlement systems have been constructed, and delivery-versus-payment settlement has been achieved. Many jurisdictions have also already realized settlement cycles of T+2 to T+3. Further improvements may still be needed in some jurisdictions to establish legislation on settlement finality. BIS central bankers’ speeches First, settlement risks associated with cross-border securities trading remain, and sufficient measures have not yet been introduced to manage them. For example, the U.S. dollar is usually employed as the intermediary for obtaining the investment currency. However, in many cases in Asia, the settlement between the local currency and the U.S. dollar is not made through payment-versus-payment settlement. In addition, since invested securities are held or settled through a multi-tiered system involving central securities depositories and sub- and global custodian banks, custody risks are inherent across the tiers. Second, as operational procedures often need to be adjusted individually in order to meet the regulatory and system requirements of each jurisdiction, operational costs are quite high for intermediaries between issuers and investors, such as central securities depositories, sub- and global custodians, and international central securities depositories. This in turn increases the costs for investors.7 In order to support strong and sustainable economic growth in Asia, it is important to develop deep and liquid bond markets, as well as to build the infrastructures supporting such markets. In this respect, the Asian economies must endeavor to rectify these and other problems, not only individually, but also on a collaborative basis by recognizing the whole Asian region as one single market. As for the direction of the action to be taken, we should in particular build an infrastructure for ensuring efficient and safe cross-border payment and settlements, and expand measures to maintain market liquidity even in times of crisis.8 There are two conceptual issues to be considered when designing Asia’s future cross-border payment and settlement system. One is to what extent the system should be integrated, while the other is to what extent the public sector should be involved in the function. As for the degree of integration desirable, the more integrated the infrastructure, the easier it becomes to adopt better functions. However, it would then be more costly and difficult to reach agreement on the location for its installation. As for public sector involvement, generally speaking, the more the public sector is involved, the safer the infrastructure becomes. However, it is then likely that the scope of the services would be limited, while raising private sector suspicion of possible state interference. Since the involvement of the public sector in payment and settlement systems is traditionally high in Asia, it might be realistic for us to consider the above-mentioned issue not as a choice between two mutually exclusive options, but as a decision on how to combine the efforts of both the public and the private sectors. In attempting to strike a better balance in such trade-offs, we should follow three basic principles. The first is to respect the choices of market participants using the payment and settlement systems and ensure good governance. The second is to enhance the use of central bank money in payments and settlements as a means of reducing settlement risks. The third is to adopt a gradual approach that takes into account the differences in the degree of market liberalization among Asian economies. The use of cross-border collateral arrangements by central banks could be one of the measures used to maintain market liquidity in times of crisis. If we have an infrastructure in which central banks can be flexible in providing their local currencies against highly liquid foreign assets as collateral, this would contribute to the smooth funding of locally active financial institutions, and thereby enhance the stability of domestic financial markets. In addition, a variety of identification codes and message formats are used in the payment and settlement systems, and they still fall short of the international standards. Discussions have been held at the ABMI of the ASEAN+3 process and other forums on ideas to build a cross-border payment and securities settlement system in the region. We should continue to make progress in these discussions and take measures to put the ideas into action in each field, ranging from removing transaction impediments to developing payment and settlement systems, and to test them in practice. BIS central bankers’ speeches Japan has made substantial improvements in the post-trade infrastructure for Japanese government bonds, which have the largest market volume in Asia. Improvements have been made, for example, in aspects of the payment and settlement system, the legislation governing securities settlement, and the tax system for non-residents. I believe that our experience will also be helpful in promoting the development and stability of financial markets across the Asian region. Working in close cooperation with the relevant institutions, the Bank of Japan hopes to be able to contribute to the development of financial infrastructures in both Japan and the Asian region by sharing the knowledge obtained from our experience. Now, let me wrap up. Motivated by the lessons of the Asian currency crisis, Asia is the most active region in terms of policy cooperation and coordination aimed at building robust financial markets and systems. However, to be honest, the policy goal has not yet been fully achieved, as the markets and systems are still under-developed. We Asian policymakers need to make more cooperative and coordinated efforts to construct better systems (both in terms of hard and soft aspects) that are sufficiently resilient against large unanticipated shocks, including sudden capital outflows and natural disasters, even though, realistically speaking, there may be no perfect design. Thank you for your kind attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Opening speech Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2011 Annual International Conference hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 1 June 2011.
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Masaaki Shirakawa: Bubbles, demographic change and natural disasters Opening speech Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2011 Annual International Conference hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 1 June 2011. * I. * * Introduction Good morning. I am very pleased to address the Bank of Japan Annual International Conference. On behalf of my colleagues at the Bank of Japan, I welcome all the participants from central banks, international organizations, and academia. Japan was hit by an unprecedented earthquake and tsunami on March 11th, the day that was etched into our memory. The scars are yet to heal in the quake-stricken regions. In the aftermath of the disaster, however, we Japanese were not in a hopeless situation. We have received lots of support and numerous warm messages from our friends abroad. I express my sincere gratitude to those whose hearts and thoughts have been with us since the day. The title of this year’s conference is “real and financial linkage and monetary policy.” Conventional macroeconomics has analyzed macroeconomic dynamics through the two lenses, trend growth and business cycles. While the two lenses remain important, over the past quarter century, the need to incorporate a third lens, rare but large events including financial crises, was increasingly recognized, by policy makers and academics alike. I myself already addressed the issue of bubbles and financial crises in the opening remark at the previous year’s conference. 1 This year, through this third lens, I find myself left with no choice but to refer to the repercussions of a natural disaster. At the other extreme compared with sharp, unanticipated shocks like financial crises and natural disasters, I also recognize the fully anticipated development, a demographic change, which Japanese economy is undergoing, as the paramount issue. Today, I will pick three issues, bubbles and resulting financial crises, demographic changes and natural disasters as the factors driving economic dynamics and call for further research on them. II. A retrospective view of the Japanese economy in the past quarter century and research agenda going forward The day after the great east Japan earthquake Before we move on, I will brief you on how matters stand in the Japanese economy. In the aftermath of the earthquake, production has declined very sharply due to supply constraints caused primarily by the destruction of capital stock, disruptions in supply chains and a shortage of electric power (Slide 1). As a result, exports have decreased substantially, and domestic private demand has also been weak, partly accentuated by deterioration in business and household sentiment. Those constraints are, however, being relaxed more quickly than expected initially as a result of strenuous efforts by firms. Looking ahead, for the time being, Japan’s economy is likely to continue to be under strong downward pressure, mainly on the production side. However, as supply-side constraints ease and production regains traction, the economy is expected to return to the moderate recovery path from the second half of fiscal 2011, backed by an increase in exports reflecting the high growth of the global economy and by a rise in demand for restoring capital stock. See Shirakawa (2010). BIS central bankers’ speeches The Japanese economy in the past quarter century Beyond the horizons of a short-term economic outlook, the paramount issue for the Japanese economy lies in the medium- to long-term growth prospects. In this regard, a review of the economy over the past quarter-century could benefit us. With this aim in mind, we need to underscore the following five facts. First, Japan’s real GDP growth rate has steadily decreased. Back in the 1980s, Japan was a front-runner in terms of GDP growth among G7 countries while it continued to lose momentum during the 1990s and remained in the most lackluster sub-group in the 2000s (Slide 2). Second, Japan’s per capita GDP continued to grow at a high pace comparable to other G7 economies in the 2000s, although significantly slowed compared with the 1980s. Japan’s per-worker GDP growth, in particular, remained in the top sub-group, and in fact it was only slightly less than that of the United States (Slide 3). Third, after the burst of the bubble, the Japanese economy took a long time to resume its expansion (Slide 4). The protracted period of economic underperformance is by now known as the lost decade. The Japanese economy resumed its expansion finally in 2004. Incidentally, it could be noted that after the burst of the bubble in the 1990s, the decline in Japan’s growth rate was relatively moderate compared with the declines experienced by the U.S. and European countries after the collapse of the global credit bubbles in the mid-2000s. Fourth, the Japanese economy was precipitated into a sharp contraction in the wake of instabilities in financial systems. One occasion was the failure of Yamaichi Securities in 1997 and the other was the Lehman shock. In the latter case, the contraction was more acute than the first case (Slide 5). Fifth, Japan is facing another sharp decline of economic activity triggered by the Great East Japan Earthquake. Research agenda going forward Admittedly, the global financial crisis in the late 2000s together with the aforementioned five facts left us with no choice but to realize how little we knew about macroeconomic dynamics. Against the backdrop, I put a bubble and a resultant financial crisis at the top of the research agenda. Beyond a variety of discussions prompted by the global financial crises, we need to make further progress on this front. The second issue is economic and social consequences of sizeable demographic changes, such as a declining population and ageing. The third issue is repercussions of natural disasters on economic activity. The second and third issues may look remote to financial systems and monetary policy, but it is a prima facie impression as I will flesh out later. A declining population gives rise to an outright reduction in the natural rate of interest and this could constrain monetary policy via the zero lower bound. If the guaranteed return of pension policies did not adequately reflect the anticipated decline in the natural rate of interest due to a decline in the population, the misalignment could spur the search-for-yield which would sow the seeds of a bubble. III. Bubbles and financial crises I will start with the first issue on the agenda, that is, bubbles and financial crises. We have commonly observed across countries that economic contractions following the burst of a bubble tend to be protracted and subsequently, the economies hobble at an early phase of recovery. 2 In the aftermath of the two bubbles, namely, one in the U.S. late 2000s and the See Reinhart and Reinhart (2010). BIS central bankers’ speeches other in the Japanese 1990s, both the GDP growth rate and inflation show similar trajectories across the two cases (Slide 6). The crippled balance sheets can be detected as the primary factors that impede the economic recoveries, while we also need underscore the linkage of low productivity growth and the inefficient resource allocations resultant from the malfunctioning credit intermediation. In fact, to promote economic growth, it is crucially important to maintain economic metabolism by smoothly reallocating economic resources toward the sectors with higher growth potential. In this regard, economists at the Bank of Japan estimated that the distortion in factor markets can account for one-seventh of the total 3.6 percent point decline in the GDP growth rate during the six years in the aftermath of the bubble burst. 3 More research would be called for in an attempt to further elaborate on the effects of the deterioration of banks’ balance sheets and the protracted zero interest rates on the efficiency of the resource allocations. In this context, I would highlight the subtle distinction between money and credit in a period of deflation. Professor Milton Friedman once noted that inflation is always and everywhere a monetary phenomenon, the well-known Friedman’s proposition on inflation. 4 With my respect for Friedman whose last class that I took at the University of Chicago, I would suggest asking whether the proposition holds if we replace the term, “inflation,” by “deflation” in the proposition. Elaborating on the validity of this seemingly symmetrical proposition would provide a clue to better understanding how a financial crisis interacts with deflation. You may argue that replacing inflation by deflation would simply flip a plus to a minus, but the issue is not as simple as it appears. Whether this deflation version of Friedman’s proposition holds or not would depend on how we interpret it. The proposition holds if the proposition means that destabilized financial systems shrink money stock noticeably, thereby resulting in deflation. In retrospect, we can reaffirm that severe deflation was accompanied by financial crises. 5 Friedman pointed out in his own writing, “A Monetary History of the United States,” that during the period of 1929–1933, money stock shrank by 31 percent and the price level declined by 25 percent primarily because the Fed failed to act as the lender of last resort. In sharp contrast to the U.S. experience in the 1930s, helped by such lessons from history, the Bank of Japan acted very aggressively as the lender of last resort. As a result, contraction of money stock was forestalled and the price level dipped by only 0.5 percent per annum at the maximum. It could also be noted that since 1998, the price level has dropped slightly larger than three percent, which is quite different from the U.S. experience in the 1930s (Slide 7). In sum, the experiences of the U.S. and Japan confirm that the proposition holds in line with the aforementioned interpretation. On the other hand, if we interpret the proposition in a way that central banks can raise the price level at will by flooding the economy with the monetary base, the proposition is, at least, not compatible with the recent experiences in Japan as well as in the U.S. In Japan, between 1997 and 2010, the monetary base soared by 90 percent while money stock increased by 30 percent. Likewise, the U.S. experience between 2008 and 2010 clearly shows that the monetary base soared by 140 percent while, by contrast, money stock increased by only 10 percent. Despite the flooding monetary base, Japan’s consumer price level dipped by 3.7 percent for the thirteen years by the end of 2010. The U.S. core CPI inflation rate has decreased by more than one percent point despite the increase in monetary base. To sum up, significant increases in the monetary base neither gave rise to an equally significant rise in money stock nor inflation, let alone proportional increases. Financial systems would See Nakakuki, Otani, and Shiratsuka (2004). See Friedman (1970). See Bordo and Filardo (2005). BIS central bankers’ speeches provide a key to better understanding the proposition. In light of the Japanese experiences, I agree with Chairman Bernanke on his remark in his scholarly work, saying, “I doubt that it [money] completely explains the financial sector-aggregate output connection.” 6 Without more in-depth understanding of the subtle intricacy underlying in financial systems and credit markets, we would remain less informed of macroeconomy and transmission channels of monetary policy. Against the backdrop, I am hoping for more research to proceed on this front. IV. Demographic changes and policy response Keynes’ Perspective We move on to the second issue on the agenda, demographic changes. In 1937, John Maynard Keynes gave a lecture titled “Some economic consequences of a declining population.” He noted that “in an era of a declining population, …demand tends to be below what was expected and a state of over-supply is less easily corrected. Thus a pessimistic atmosphere may ensue.” 7 By suggesting these views, he posed a question mark on the traditional Malthusian view that warns against a population explosion. Neoclassical growth theories tend to focus on per capita economic variables, such as per capita GDP and per capita capital stock. This means that the very challenges that Japan is currently faced with are left outside the scope of their analysis at the outset. Looking ahead, Japan is heading into a demographic vortex, by which, I mean, rapid ageing and a declining working-age population. To deal with the present and forthcoming challenges for Japan, we may need to rely more on the perspective offered by Keynes who tried to elaborate on the size of population itself and changes in its composition. It is fairly certain that not only advanced economies, but also a number of emerging economies are, sooner or later, expected to face the similar challenge as we proceed down the road (Slide 8). 8 Demography and aggregate demand Demographic changes affect economic growth through a variety of channels. To start with, in a country facing a diminishing population, like Japan, a declining working-age population would rein in growth momentum on the supply-side. Admittedly, because we need to take demographic factors as given for the time being, we should pursue higher labor force participation rates of female workers and the aged people. On top of this, attempts to enhance the quality of the labor force by improving education and vocational training systems are warranted as well. We may need to recognize the complex fallout of a demographic vortex on aggregate demand. A shrinking working-age population could be an outright factor that reduces aggregate consumption. On the other hand, the life-cycle model of consumption predicts that the ageing of society would spur the consumption of the elderly as they reduce their savings. In fact, a common observation across economies is that, as a general pattern, the elderly tend to cut their spending on durable goods while they increase demand for services to maintain their quality of life, such as medical and nursing services. We may need to bear in mind, however, that provision of these services tends to be subject to intensive government regulations. If the supply that can meet the demand of aged people would be hampered by misaligned regulations which do not reflect the changes in society and technology progress, potential consumption demand would not materialize. See Bernanke (1983). See Keynes (1937). See Shirakawa (2011). BIS central bankers’ speeches The foregoing argument reaffirms the importance of the flexibility of the social and economic systems that can ensure their own sustainability in the face of a demographic vortex. We could also bear in mind how the ageing of voters affects the social choices reflecting their preferences (Slide 9). Demography and business cycles As I mentioned at the outset, the third lens suggests that boom-bust cycles and demographic changes could interact with each other. For example, the spending wave hypothesis suggests a possible linkage between the two. This simple-looking hypothesis argues that peaks of business cycle and asset market booms tend to coincide with the years for baby boomers passing their peak spending years, presuming that their consumption reaches its highest for their ages in their late forties. As my colleague, Deputy Governor Nishimura, points out, the inverse dependency ratio, which indicates workers per non-working population, appears to be positively correlated with real estate market fluctuations both in the U.S. and in Japan 9 (Slide 10). Similar studies predict that real estate booms could be driven by increasing young generations when they come in markets as home buyers. 10 All those arguments suggest that demographic factors should not be taken lightly in analyzing bubbles and financial crises. V. Managing disaster risks Finally, I take up the last issue in the agenda, management of natural disaster risk in the context of economic activity. Natural disasters are universal risks against which human beings have been fighting since the dawn of history (Slide 11). The tangible capital stock lost in the Great East Japan Earthquake is estimated at five percent of GDP by the Japanese government. I will highlight, inter alia, specific aspects of the issue, that is, how much extra cost firms should bear to forestall a vast disruption in production. To this end, two issues immediately come to mind, inventory management and risk concentration. The Japanese manufacturing firms have been enhancing their competitiveness through constant efforts to minimize inventory of intermediate goods, by developing the sophisticated logistics network known as the just-in-time system. The efforts can be confirmed by the downward trend of the inventoryto-GDP ratio (Slide 12). Being faced with disruptions in the production process precipitated by the natural disaster, firms with a minimum level of intermediate goods inventory were left with no choice but to sharply scale back their production. In the wake of the earthquake, as discussed earlier, the ensuing disruption of the supply-chain revealed the risk of the reduced inventory, which may be described as a dilemma, namely, just-in-time versus just-in-case. While the level of inventory should remain as an important issue, the earthquake uncovered concentration risks as the linchpin for further assessment. The concentration risks that have been deeply buried under the complicated supply chain were due to overreliance on particular plants located in the particular regions. There is no free lunch: you need to bear some additional cost in either case, to raise inventory or to diversify procurement. In a related context, Professor Barro pointed out in his paper that the insurance premium that households need to bear at normal times to compensate for the disaster risks would be considerably high. 11 This question regarding the disaster risks needs to be considered at a national level as well as a firm level. For instance, See Nishimura (2011). See Sterling and Waite (1998). See Barro (2009). BIS central bankers’ speeches over-concentration of a nation’s business activities in particular plants located in a particular region would run a significant risk while its cost of such over-concentration could be hardly internalized by highly competitive markets. As a result, tail risks may be inadvertently elevated. In sum, economists, together with practitioners and policymakers, need to strive for a better design of broadly defined public risk-sharing systems against disaster risks. VI. Concluding remarks So far, I have discussed the challenges that the Japanese economy is faced with. I would call for further research on tail risks, such as financial crises and natural disasters, which have still relatively been given short shrift in the existing macroeconomics. The consequences of demographic changes are yet to be explored. We could make a stronger case to revamp the present social and economic systems. Those outdated systems, which are not in line with the ongoing demographic changes, could sow the seeds of another bubble because, for example, they could prompt search-for-yields under the low natural rate of interest. Now is the time to explore all these issues. With that perspective in mind, I am convinced that this year’s conference will catalyze dialogues between policymakers and academics. Thank you. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches References Barro, Robert J., “Rare Disasters, Asset Prices, and Welfare Costs,” American Economic Review, Vol. 99(1), pp. 243–264, 2009. Bernanke, Ben S., “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic Review, Vol. 73(3), pp. 257–276, 1983. Bordo, Michael and Andrew Filardo, “Deflation in a Historical Perspective,” BIS Working Papers, No 186, 2005. Friedman, Milton, “The Counter-Revolution in Monetary Theory: First Wincott Memorial Lecture, Delivered at Senate House, University of London, 16 September, 1970,” Institute of Economic Affairs Occasional Paper 33, 1970. Keynes, John M., “Some Economic Consequences of a Declining Population,” Eugenics Review, Vol.19, pp. 13–17, 1937. Nakakuki, Masayuki, Akira Otani, and Shigenori Shiratsuka, “Distortions in Factor Markets and Structural Adjustments in the Economy,” Monetary and Economic Studies, Vol. 22(2), pp. 71–99, 2004. Nishimura, Kiyohiko G., “This Time may be Truly Different: Balance Sheet Adjustment under Population Ageing,” Remarks at the 2011 American Economic Association Meeting, January 7, 2011. Reinhart, Carmen M. and Vincent R. Reinhart, “After the Fall,” Paper presented at the Federal Reserve Bank of Kansas City Economic Policy Symposium 2010, August 26–28, 2010. Shirakawa, Masaaki, “Future of Central Banks and Central Banking,” Monetary and Economic Studies, Vol. 28, pp. 17–26, 2010. ________, “The Transition from High Growth to Stable Growth: Japan's Experience and Implications for Emerging Economies,” Remarks at the Bank of Finland 200th Anniversary Conference, May 5, 2011. Sterling, William P. and Stephen R. Waite, Boomernomics, Ballantine Books, 1998. BIS central bankers’ speeches
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Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2011 Spring Meeting of The Japan Society of Monetary Economics, Tokyo, 28 May 2010.
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Masaaki Shirakawa: Money, government securities and a central bank Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2011 Spring Meeting of The Japan Society of Monetary Economics, Tokyo, 28 May 2011. * I. * * Introduction I am honored to be invited today to the Japan Society of Monetary Economics. It is of great significance to have discussions among academics, practitioners and policymakers in any academic field, and it is certainly true in the field of monetary economics. As I have worked at a central bank for a long time, and also placed myself in a university for a while, I sincerely hope to deepen intellectual interaction among academics, practitioners and policymakers. Today, from a viewpoint of a policymaker and a practitioner, I will offer my thoughts with the title of “Money, Government Securities and A Central Bank.” Since the 2000s, the global credit bubble and the ensuing financial crisis have marked the most striking events in the global finance. The course of the events during the bubble and the ensuing crisis periods shed new light on the interdependency of the confidence in the government, the financial system and the central bank. During the bubble period preceding the crisis, implicit government guarantee by the Government-Sponsored Enterprises (GSEs) such as Fannie Mae and Freddie Mac was one of the causes of the residential bubble in the United States. During the crisis period after the failure of Lehman Brothers, decisive actions backed by the confidence in the government were required in order to end the crisis. The U.S. and European governments were forced to make large-scale capital injections and guarantees to financial institutions to restore confidence in private financial institutions and the stability of the financial system. The governments also employed aggressive fiscal policies as decisive macroeconomic measures to escape from sharp and deep economic contractions. Even after the crisis, confidence in the government has remained an important issue. Since the mid-2009, the world economy has gradually recovered, thus preventing a deep depression, through a different path from the 1930s. However, confidence in sovereign debts has been eroded due to the deterioration in fiscal balance. At present, Greece and other European peripheral countries were hit most severely by the deterioration in fiscal balances and resulting sovereign debt problems. Those countries faced an adverse feedback loop among the sovereign risks, the financial system and the real economy. Although Japan has not confronted such a rise in yields on government securities, the deterioration in fiscal balance is also severe. The issue of confidence in a government has been relevant to a central bank. After the failure of Lehman Brothers, central banks in advanced countries, including Japan, took unconventional policy measures. Those measures were not pure monetary policies defined as liquidity provisioning. They included, more or less, quasi-fiscal policy elements. Debates are still going on regarding to what extent a central bank should pursue such monetary policy, namely, the relationship between a central bank and the government, or the relationship between monetary and fiscal policy. Looking back on those series of events, I hope you understand why I choose the topic of money, government securities and a central bank. BIS central bankers’ speeches II. Interdependency of Confidence Money and government securities I will start by talking about two financial assets, money and government securities (Slide 1). Money plays an important role as a means of payment, a unit of account and a store of value. The primary form of money is central bank money which consists of banknotes issued by a central bank and deposits in central bank current accounts. In Japan, the balance of central bank money is 122 trillion yen in March 2011. In addition, bank deposits, which are easily convertible to central bank money, also function as money. The outstanding balance of bank deposits is 1,024 trillion yen. The outstanding balance of Japanese government securities is 865 trillion yen. A government uses the securities as a means of funding; a central bank uses them as the instrument of monetary control; and investors including private financial institutions use them as one of the primary financial assets for investment. Since government securities are, in many cases, regarded as risk-free assets whose credit risks are negligible, yields on government securities are often used as benchmark rates for pricing various financial instruments. Both of money and government securities are merely pieces of paper which represent the liability of issuers, i.e., a central bank, private banks and a government. The debtor of central bank money is a central bank, the debtors of bank deposits are private banks, and the debtor of government securities is a government. Although those financial assets do not have intrinsic value as materials in themselves, they are regarded as valuable assets and fulfill their functions. That is ultimately because holders of money or government securities have confidence in the issuers of those debts. The importance of confidence is not a new topic; most textbooks on monetary economics emphasize its importance. Governments, central banks and private banks make their best efforts to maintain the confidence. Governments make their efforts to maintain the mediumto long-term fiscal balances. Central banks maintain the stability in prices and the financial systems through the conduct of monetary policy, through actions as the lender of last resort, through financial supervision, and others. Private banks maintain their capital base, manage various risks, and provide credit intermediation and payment services. My point here today is the interdependency of confidence. Confidence in each issuer is supported not only by the issuer’s own efforts but also by the fact that confidence in other issuers is maintained and that members in society understand the importance of confidence in each other. Now, I will elaborate on the interdependency of confidence. Determination by the government to underpin confidence in private financial institutions First, confidence in bank deposits of private banks, or in debts of financial institutions, is significantly affected by confidence in governments as well. The global financial crisis after the failure of Lehman Brothers demonstrated that. After the failure, financial institutions lost confidence in each other’s creditworthiness, and the interbank money markets almost stopped working. Under the circumstances, central banks acted as the lender of last resort and aggressively provided funds in order to deal with the liquidity shortage of financial institutions. Although the provision of liquidity by central banks was extremely important during the crisis after the failure of Lehman Brothers, it alone was not enough to restore the stability of the financial system. That was because the adverse feedback loop between the financial system and the real economy eroded capital positions of financial institutions and thereby confidence in their solvency significantly. As the central issue shifted from the liquidity shortage problem to the capital shortage problem, governments were required to inject public capital and to guarantee senior debts of the financial institutions in order to BIS central bankers’ speeches restore confidence in private financial institutions. The amount of public capital injected by the governments of the United States, United Kingdom, Germany and France during the recent global financial crisis reached an equivalent of 84 trillion yen.1 The experience above suggests that the stability of money and the financial system also depends on confidence in governments. Support by the public to underpin confidence in a government Second, having talked about the importance of confidence in a government, I would like to emphasize that confidence in a government is, in the end, underpinned by support by the public. After the global financial crisis, fiscal conditions in many countries deteriorated seriously as a result of decreases in fiscal revenues associated with the downturns in economic conditions, aggressive fiscal policy and capital injections to financial institutions. The International Monetary Fund (IMF) reported that fiscal deficits of advanced economies in G20 countries were 1.7 percent of GDP in 2007. The deficit rose to 9.4 percent in 2009 and are projected to be as high as 8.0 percent in 2011 (Slide 2). The report notes that about an half of the increase in outstanding public debts in G20 advanced economies is due to the decrease in fiscal revenues, while nearly 20 percent of the increase is due to fiscal stimulus measures and the authorities’ support to financial institutions.2 When fiscal conditions deteriorate, confidence in a government’s ability to repay its debts declines. As I mentioned earlier, confidence in private financial institutions is affected by confidence in a government as well. Therefore, when confidence in a government is undermined, confidence in private financial institutions is affected through various channels. The channels include a decline in the value of government securities they hold, erosion of their ability of funding due to the depreciation of values of collateral among others. Real economic activity suffers from rises in funding rates and difficulties in obtaining liquidity. As a result, tax revenue declines and confidence in a government’s ability to repay their debts is weakened. In other words, an adverse feedback loop emerges among sovereign risk, the financial system and real economic activities. Although the cause of sovereign debt problems in European peripheral countries varies from country to country, the common nature of the problem is such adverse feedback loop. When private financial institutions faced the financial crisis, governments succeeded in stabilizing the economy and the financial system by injecting public capital and conducting countercyclical fiscal policy. A prerequisite for such success is that a government is perceived to secure future revenue to cover the current expenditure. If a government is perceived as lacking sufficient future revenue to cover increased expenditure due to public capital injection or expansionary fiscal policy, the effect of the policy measures may lessen, or even worse, could be adverse. The key to success of various aggressive policy measures in an emergency is confidence in the government’s ability to maintain the sustainability of medium- to long-term fiscal balance. Various aggressive policies by a government in a crisis become effective only when a government has a “stock” of confidence in it. And the substance of the stock is, in the end, support by the public to maintain the sustainability of fiscal balance. A government is not able to pursue fiscal policy at will regardless of support by the public in such a way as to wave a magic wand. The figure is the total amount of public capital injections until March 2010 in the United States, United Kingdom, Germany and France. For details, see Bank of Japan, “Financial System Report” (March 2010). See IMF, “Fiscal Monitor” (May 2010). BIS central bankers’ speeches Determination by the government and support by the public to underpin confidence in a central bank Third, I would like to emphasize that confidence in a central bank is not maintained solely by the efforts of a central bank. Support and understanding by the government and the public about the importance of confidence in a central bank are also essential. Since the recent global financial crisis, central banks around the world have conducted unconventional monetary policies on a large scale.3 There is no universally-accepted definition of “unconventional monetary policy,” as “convention” varies from country to country. In the case of the Bank of England, unconventional monetary policy means a large-scale purchase of long-term government bonds under the Asset Purchase Programme. By contrast, the Bank of Japan has been conducting the purchase of long-term government bonds for nearly fifty years. In that respect, purchasing long-term government bonds is one of the “conventional monetary policy” measures. An unconventional monetary policy measure for the Bank of Japan after the Lehman shock is the purchase of corporate bonds, commercial papers (CPs), exchange-traded funds (ETFs), real estate investment trusts (REITs), etc. In the case of the Fed, the typical unconventional monetary policy measure is the purchase of CPs and mortgage-backed securities. As I mentioned above, central banks acted decisively to maintain the stability of the financial system in the wake of the recent financial crisis. In such a situation, confidence in a central bank is a prerequisite for a central bank to take those decisive actions. I will explain this point by taking the expansion of a central bank’s balance sheet as an example. When financial systems become unstable, demand for liquidity increases. Opportunity costs of holding central bank money could be negligible because of extremely low short-term interest rates. Under such condition, an increase in central bank money does not necessarily lead to a price hike. As a matter of fact, even though balances in central bank current accounts and the monetary base increased markedly in Japan and the United States in recent years, inflation rates in both countries did not rise (Slide 3). However, it is crucial for a central bank to have the capacity to take necessary action promptly when an increase in interest rates is required due to changes in economic conditions. If market participants and the public perceive that the central bank is unable to take prompt action “for some reasons” when needed, rampant inflation may follow because the amount of money is extremely large. “Some reasons” include these. One would oppose an increase in interest rates on the grounds of concern about capital losses of government securities held by private financial institutions or concern about an increase in interest payments on government securities. Although those arguments do exist at any time, the arguments tend to be heated more when the outstanding balance of government securities is larger and the period of low interest rates continues longer. Confidence in a central bank is formed in a complicated manner, and each country designs institutional arrangements deliberately and each central bank acts carefully when conducting their policies in order to maintain the confidence. I will come back to this point in more detail later. III. Issues related to fiscal balance Having talked about the interdependency of confidence, let me discuss the importance of confidence in light of Japan’s current fiscal condition. As for unconventional monetary policies taken by central banks after the failure of Lehman Brothers, see Monetary Affairs Department, Bank of Japan, “Major Central Banks’ Policy Operations in the Current Financial Crisis,” (July 2009, in Japanese). BIS central bankers’ speeches Japan’s current fiscal condition is very severe (Slide 4). The outstanding amount of gross financial liabilities of the government is as high as 198 percent of GDP. As the Japanese government, unlike other major countries’ governments, has a large amount of financial assets, some observers argue that net liabilities rather than gross liabilities may be a more adequate indicator for true indebtedness of the Japanese government. In terms of net financial liabilities of the government, Japan is still ranked as the worst among developed countries with its ratio of 114 percent, higher than that of Italy, which is 103 percent. In any event, so far Japan has experienced no currency crisis or financial crises triggered by the deterioration in fiscal balances that occurred in some other countries. Though the necessity of the sustainability of fiscal balance is generally well recognized in Japan, arguments which raise the alarm on risks associated with the deterioration in fiscal balance are sometimes regarded as crying wolf. That is because Japanese government securities have been issued smoothly for years and yields on long-term Japanese Government Bonds (JGBs) have been stable at low levels in spite of the deteriorated fiscal balance. No country can perpetuate fiscal deficit. Confidence in a government’s ability to repay its debts can change in a non-linear fashion. The European sovereign debt problem that started in Greece is a case in point. In the fall of 2009, widening spreads of government securities of the European peripheral countries against Germany became evident (Slide 5). In October 2009, spreads were below 2 percent, but suddenly widened dramatically and now remains at high levels currently such as 13.4 percent for Greece, 8.0 percent for Ireland and 6.6 percent for Portugal. Though macroeconomic conditions have not changed drastically since the fall of 2009 in those countries, market participants’ perception has changed substantially. Yields on JGBs have been stable at a low level of 1.15 percent on average in fiscal 2010 (Slide 6). One of the most frequent questions I have got at international meetings is why yields on JGBs have been stable at low levels despite the very severe fiscal condition. According to the economic theory, a quick answer is the expectations for a low growth rate and a low inflation rate. If we compare the past 10-years’ average nominal growth rates, which are the sum of Japan’s real GDP growth and inflation rate, with 10-year JGB yields, we will witness both have followed similar paths generally albeit with a small deviation (Slide 6). The low and stable JGB yields are explicable if many investors expect what prevailed in the past 10 years will continue into the next 10 years. However, the low growth and inflation rates are not sufficient to explain low yields on JGBs. Long-term interest rates are determined not only by the expected growth rate and the expected inflation rate, but also by the risk premium that compensates for their uncertainties. Thus, to fully explain the low yields on JGBs, we have to discuss why the risk premium is low. In that regard, I have to point to the following two. First, market participants believe that Japan ultimately has a will and an ability to work on fiscal consolidation despite a severe fiscal condition. Second, confidence is maintained in the Bank of Japan’s conduct of monetary policy focused on achieving sustainable economic growth with price stability. To put it differently, if confidence in those two points were to be undermined, the rise in risk premium would raise the yield on JGBs. That clearly underscores the responsibilities of the government and the parliament that formulate fiscal policy and those of the central bank that conducts monetary policy. As I mentioned earlier that confidence in one entity is underpinned by confidence in other entities, it is crucial for all the entities to recognize the importance of confidence in other entities. Ultimately, confidence in money and government securities is underpinned by the determination of people who recognize the importance of confidence. And, such support by the public is able to exist only with a comprehensive account by the government and the central bank, and with people’s understanding of the situation based on the account. The future is always full of uncertainties, and I see that there are two tendencies on how market participants and the public form expectations for a long-term future. First, they may BIS central bankers’ speeches tend to think that what has continued over a long period will stay as it is. In the context of the current Japanese economy, they may think that yields on long-term government bonds will continue to be stable at a low level in the future as the yields were for a long time. Second, once a change begins to occur with a trigger, this change reminds them of big events in the past and they may think that drastic changes will occur. Market participants and the public may drastically change their expectations triggered by an increase in fiscal deficit or an event which make market participants and the public think that the independence of the Bank of Japan is not respected. Then, they may expect that rampant inflation will occur in the end. Having mentioned those two contradictory tendencies, I have to add that it is quite difficult to predict when the former tendency will be replaced by the latter. What is certain is that expectations change in a non-linear fashion. That is why the principles of the authorities’ behavior have to be clear. It is vital for the fiscal authorities to work on the sustainability of fiscal balance in the midiumto long-run. The deterioration in fiscal balance lowers the increase in the expected future income by households, especially for the working-age population, and thus reduces current household expenditure. To make things worse, if confidence in fiscal sustainability is eroded, an adverse feedback loop among fiscal balance, the financial system and the real economy may exert a negative impact on economic activity, as shown in the sovereign debt problem in the European peripheral countries. IV. Role of a central bank and government securities Use of government securities in the money market operations Principles of a central bank’s behavior must be clear as well as those of the fiscal authorities. Let me now discuss the principles of a central bank’s behavior in association with government securities. First, let me show you some facts on the relationship between the Bank of Japan and the JGB market. The Bank of Japan uses JGBs to conduct money market operations (Slide 7). During a one-year period up to April this year, central bank money increased by 20.7 trillion yen on the liability side of the Bank of Japan’s balance sheet. Correspondingly, JGBs increased by 8.2 trillion yen on the asset side as a result of the outright purchases of JGBs. To deal with short-term fluctuations in financial institutions’ demand for reserves, the Bank conducts funds-supplying operations against pooled collateral. The operations are that the Bank extends loans to financial institutions against pooled collateral which they submitted beforehand. During a one-year period up to April this year, those loans increased by 20.1 trillion yen and JGBs account for 80 percent of the collateral. It is an example of how JGBs play an important role in the Bank’s money market operations.4 Apparently, the Bank is the most proactive among the central banks of major countries in using government securities in the money market operations. This way, the Bank of Japan uses JGBs on a large scale in conducting money market operations. In that context, I would like to stress that the goal of the central bank’s outright purchases of JGBs is to satisfy demand for secular growth in currency and to conduct monetary policy, but not to finance government debt or to stabilize yields of long-term government bonds. If market participants were to regard the central bank’s outright purchases of JGBs as a means of government financing or of stabilization of long-term JGB yields, the resultant hike in risk premium would raise yields on long-term government bonds. If the rise in the yields on long-term government bonds reflects improvements in economic For the details of the Bank’s use of JGBs in the conduct of money market operations, see Financial Markets Department, Bank of Japan, “Money Market Operations in Fiscal 2010.” (May 2011). BIS central bankers’ speeches conditions, the rise in the yields is natural and desirable. However, if the rise in the yields on long-term government bonds reflects the rise in risk premium, it exerts a negative impact on the real economy and the financial strength of financial institutions. The Bank has made the principle on the outright purchases of JGBs very clear. This principle, called “banknote principle,” has been working to prevent uncertainties of the Bank’s actions from raising a risk premium and thus from exerting a negative impact on the economy and finance. More specifically, the Bank keeps the total amount of its holding of government bonds below the outstanding amount of banknotes in circulation. Some criticize the Bank for establishing such a principle. However, if a central bank that holds such a large amount of government bonds were to purchase government bonds without making its fundamental principle of the purchases clear, increased uncertainties would create a risk premium and lead to a rise in yields on long-term government bonds. In addition to the ceiling of the total holding of government bonds, the Bank also makes public the amount of purchases in specific maturity segments as well as the frequency of the purchases in advance (Slide 8). In 2009, the Bank increased the amount of Bank’s outright purchases of JGBs to 1.8 trillion yen per month, that is, 21.6 trillion yen per year. Since then, the Bank has been keeping the ceiling. The average duration of the JGBs purchased by the Bank was about 4 years in 2010. If the Bank purchases JGBs at the current pace, it will lead the Bank to hold 82 trillion yen of JGBs, the amount calculated by multiplying the amount purchased per year by an average duration. The current outstanding amount of banknotes is around 81 trillion yen. At present, the outstanding amount of JGBs held by the Bank is 60 trillion yen and less than that of banknotes. However, if the Bank continues to purchase JGBs at this pace, the outstanding amount of JGBs will reach that of banknotes. The outstanding amount of banknotes in the future cannot be predicted with certainty because it depends on the income, the interest rate and the degree of stability of the financial system in the future. The Bank thinks it desirable for economic and financial stability that the Bank continues to purchase JGBs at a stable pace, based upon the best possible forecast of those economic developments. Underwriting of government securities by the Bank of Japan Now, I will talk about the idea of the underwriting of government securities by the Bank, which is occasionally advocated as a way for funding new government spending. In many countries, laws do not allow the central bank to directly underwrite government securities. In Europe, the underwriting is prohibited by law explicitly. In many other countries around the world, including emerging economies, it is not allowed, either. In Japan, Article 5 of Public Finance Act prohibits the Bank from underwriting government securities. The principle on prohibiting the central bank from underwriting government securities has been derived from historical lessons. History shows that once the underwriting by the central bank was introduced, it often led to an excess issuance of money and hence rampant inflation, even if it seemed to be under control at an initial phase. The excess issuance of money and resultant inflation destroy people’s lives and the national economy. Based upon this conventional wisdom, the introduction of the Bank’s underwriting of government securities would damage confidence in money. The damage would lead to higher long-term interest rates and instability in the financial market. Then, the government might not be able to issue its debts in the primary market. The current condition in the auction of Japanese government securities remains stable even after the recent Great East Japan Earthquake. Still, taking account of the deteriorated fiscal condition in Japan, it is of utmost importance to maintain the current stable condition in the primary government securities market. BIS central bankers’ speeches Confidence in money and the well-developed government securities markets are parts of the social infrastructure for the Japanese economy. Now, it is even more important to maintain confidence in money and government securities on both international and domestic grounds, given the severe fiscal condition and damage of the recent earthquake on the Japanese economy. Let me add a few words about the Bank’s bitter experience in oft-quoted underwriting of government bonds in the early 1930s when the veteran Finance Minister Korekiyo Takahashi initiated it. Though some commentators refer to this episode at times in their favor, they do not necessarily recognize a big difference between financial and economic conditions at that time and those at present (Slide 9). First, conditions in the financial market were tight on the eve of the Bank’s underwriting of government bonds in the early 1930s. The overnight call rate was 6.6 percent in December 1931, compared with the current level of 0.07 percent. The long-term interest rate was 5.9 percent in December 1931, compared with the current level of 1.14 percent. Second, fiscal conditions were much better in the early 1930s than in 2011. The outstanding amount of government securities was 47.6 percent of GNP at the end of December 1931, compared with 181.9 percent of GDP at the end of March 2011. Third, the Bank’s underwriting of government bonds in the early 1930s was associated with tighter capital controls in the early 1930s. By contrast, the financial market and other economic activities are much more globalized now. Under those circumstances, the misconduct of monetary and fiscal policy, which leads to a deterioration in confidence in money, would affect long-term interest rates immediately. Fourth, the relative size of a domestic financial market was smaller in the early 1930s than today, and the government securities markets were less developed. In the 1920s and in the early 1930s, the government issued its securities mainly through a syndicate of private financial institutions or through the Deposit Bureau of the Ministry of Finance. A large part of the fund of the Deposit Bureau came from postal savings. Under such condition, the government lacked effective measures to issue a large amount of its securities promptly and smoothly. During the first several years of Mr. Takahashi in office, the Bank was able to sell most of the underwritten government bonds in the secondary market promptly. The amount of the Bank’s holding of government securities did not grow significantly, hence the monetary base did not, either. By contrast, we now have well-developed primary government securities markets. Even after the recent earthquake, the government is able to issue its securities in the market smoothly, and the bid-to-cover ratios in the primary markets remain unchanged. Although some commentators mention a sharp depreciation of the Japanese exchange rate in the early 1930s, the exchange rate regime at that time was quite different. After the departure from the gold standard at the end of 1931, the yen depreciated from an overvalued level under the gold standard. By contrast, Japan is on the flexible exchange rate system today. As many of you know, Mr. Takahashi was assassinated in 1936 by militarists when he was trying to stop ever-growing demand for military spending, and the course of events led to the eventual rampant inflation. I would argue that the introduction of the scheme of the Bank’s underwriting of government securities itself paved the way for eventual ballooning of fiscal spending, precisely because the scheme lacked the checking process through the market mechanism. We often use the words of “entrance” and “exit” to discuss the conduct of monetary policy nowadays. In that terminology, we should interpret that the “entrance” of the introduction of BIS central bankers’ speeches the Bank’s underwriting of government bonds in the early 1930s led to the “exit” of the failure in containing growing demand for fiscal expenditure. In retrospect, we should note that the Bank’s underwriting of government bonds started as a “temporary measure.”5 Though Mr. Takahashi stated that he issued government bonds by a means of the Bank’s underwriting just temporarily in his address at a Diet session,6 history told us that it was not temporary. Today, central banks are not allowed to underwrite government securities in emerging economies as well as developed countries. Underwriting government securities by central banks may eventually lead to an excess issuance of money and rampant inflation, devastating people’s lives and economic activity, even though it may appear no problem at the beginning. Humans are prone to temptations, but at the same time, humans are aware of that and take a preventive measure by prohibiting central banks’ underwriting of government securities. We are not able to improve fiscal balance simply by creating inflation (Slide 10). Inflation may cause an increase in tax revenue, but as the data for the last twenty years in Japan shows, changes in fiscal revenue show no significant correlation with inflation. Rather, fiscal revenue increased as the economy grew in real terms. Expenditures such as social security and public works increase with inflation. Interest payments on the government debts also increase with inflation, since long-term interest rates also go up, reflecting inflation. In the interest of time, I do not get into more detail on fiscal issues. What is clear is that we need to review the overall structure of revenues and expenditures in order to improve fiscal balance. Also, higher economic growth is needed to improve fiscal balance. Here, we have to bear in mind that it is growth in real terms rather than in nominal terms that matters. It should be noted that the view that higher nominal growth is needed for the improvement in the fiscal balance is misleading. That view gives a false impression that economic growth in real terms and inflation would exert the same impact on fiscal balance. The truth is that inflation per se does not improve fiscal balance. The crucial element for improving fiscal balance is steady efforts toward higher economic growth in real terms. When higher economic growth is achieved, prices may rise as a result. V. Concluding remarks Now, it is time to conclude my speech. Let me first emphasize that money and the financial systems are essential for sustained economic growth, and that confidence in them is the most important foundation for money and the financial system to perform their roles. The starting point is obviously the efforts to maintain the confidence by the government, the central bank and private financial institutions, respectively. The government has to maintain fiscal balance in the medium- to long-run. The central bank has to maintain stability in prices and the financial system through the conduct of monetary policy and the lender-of-last-resort function. Private financial institutions have to provide payment and settlement services and the credit intermediation function properly. Those individual efforts are important, but they alone are not sufficient to achieve stability in money and the financial system. Confidence in private financial institutions depends on confidence in the government as well. To maintain confidence in the government, achieving the medium- to long-term fiscal balance is an important precondition. Support by the public is also essential in achieving the fiscal balance. Confidence in government securities is Fukai, Eigo, Reflections on Seventy Years, 1941 (in Japanese). “The Address on the Government Debt Policy in Fiscal 1933 Budget,” January 21, 1933, Plenary Meeting, the th 64 Diet, Ministry of Finance, Financial History of the Showa Era, vol.6 (1954, in Japanese). BIS central bankers’ speeches underpinned by confidence in the central bank. Confidence in the central bank may be enhanced if the government and people respect the central bank’s judgments, and it may be eroded if not. In other words, confidence in money and the financial system are interdependent on each other. Confidence is something like the air; nobody doubts about its existence at normal times. Confidence may wane in a discontinuous manner unless we make utmost efforts to maintain it. Once confidence is lost, the impact on the economy is enormous. Confidence is fragile. I have started this talk by mentioning the importance of dialogues among academics, practitioners and policymakers. Let me conclude by sincerely hoping that we, members of the Japan Society of Monetary Economics and the Bank of Japan, can cooperate further to promote understanding in society about the importance of maintaining confidence in money and the financial system. Thank you. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the 75th Anniversary Conference of Keynes' General Theory, University of Cambridge, Cambridge, 20 June 2011.
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Kiyohiko G Nishimura: Population ageing, macroeconomic crisis and policy challenges Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the 75th Anniversary Conference of Keynes’ General Theory, University of Cambridge, Cambridge, 20 June 2011. * 1. * * Introduction: macroeconomic crisis and long-run fundamentals I am honored and thrilled to participate in this conference commemorating the 75th anniversary of the publication of Keynes’ General Theory. In particular, being an academic-turned-central banker, the opportunity to participate in this panel on policy responses to macroeconomic crisis, is a great privilege. The task before me, as a central banker, is to describe the responses of central banks to the macroeconomic crisis of 2008, especially their “unconventional policies”. In addition, I hope to add some color to our discussion on the consequences of the financial crisis by drawing on the Japanese experience, which suggests a long and winding road in the post-crisis period. Having set the parameters of my presentation, I would like to start my presentation by expressing my uneasiness over the smugness that I sense among commentators on macro theory and policy. Very often, I hear that the worldwide asset market bubbles and resulting macroeconomic crisis of 2008 was due to financial excess, and therefore macroeconomic fundamentals have not changed, either before the crisis, or since. Financial excesses in the bubble years accumulate on the balance sheets of those who leverage heavily, and the prevalence of such problems may become a drag on economic recovery for some time, but eventually time will heal the wounds and everything will be back to normal. In other words, the issue at stake is maintaining financial stability, and all that is required of economic theory and policy is to supplement their theoretical and policy toolkits by adding measures to check financial excess before it builds up and to control systemic damage when bubbles burst. Lord Keynes, who laid the foundations of macro theory and policy three-quarters of a century ago would most certainly have challenged such a view, if he were attending this conference. In fact, just one year after the publication of the General Theory, in a speech whose theme still resonates today, he has alluded to the issue at the root of my uneasiness1. So let me stand on his shoulders and explain. There is a remarkable correlation between asset market bubbles that cause macroeconomic crisis and demographical changes. In Figures 1.1 and 1.2, I show Japan, the United States, Spain and Ireland as examples of countries affected by the financial crisis2. In these countries, the formation of bubbles in asset markets seems to coincide with a growing inverse dependency ratio, which is the ratio of the working population to the non-working (dependent) population. Meanwhile, busts in asset markets seem to happen when the inverse dependency ratio declines noticeably. Moreover, there also seems to exist a relation between asset market bubbles and demographical changes at the international level, which, borrowing from Lord Keynes, could be described as the demographic consequences of globalization. In the past decades, once Keynes, J. M., “Some Economic Consequences of Declining Population,” Eugenics Review, Vol.19, April 1937, pp.13–17. I presented this correlation elsewhere some time ago (see Nishimura, K. G., “This Time May Truly Be Different: Balance Sheet Adjustment under Population Ageing,” a speech presented at the 2011 AEA Annual Meeting, Denver, January 7, 2011). Appendix updates and expands the figures, showing this correlation using newly available data on world population prospects. BIS central bankers’ speeches non-market economies such as Russia and China were folded into the global market economy. As a consequence, the working population of the “market-economy world,” which once consisted largely of the so-called industrialized economies, has expanded dramatically, since the aggregate working population of China and others is much larger than that of the industrialized economies. Against this background, we witnessed a truly global asset market boom, synchronously involving many regions, and which culminated in the crisis of 2008. Real property prices across a wide area of the globe surged nearly threefold within a decade. The significant point for us here is that the bubble we have experienced coincided closely with the turning point in demographic trends. Such demographic perspective casts serious doubts on the view that little has changed in the fundamental character of the global economy even after the crisis of 2008. It will form the core of my argument in this presentation. The perspective directs us to recognize the fact that we are in the midst of a balance sheet adjustment process after the worldwide financial bubble burst, at a time when the population is ageing. This is not the balance sheet adjustment of the past, which took place when the population was young and growing. This is a balance sheet adjustment when the demography is rapidly tilting toward the old. With the change (though gradual) in demography, which is one of the long-run macroeconomic fundamentals, between the pre-crisis and the post-crisis era, macroeconomic policy challenges are also likely to have changed accordingly. In Section 2, I consider the acute impact of demography on asset prices. Assets such as residential property and company shares are stores of value enabling the transfer of purchasing power from one period to the next, as well as productive resources creating goods and services. I concentrate on the former characteristic of assets, namely, their role as stores of value. A simple, rather mechanical overlapping generation model suggests a correlation between residential property prices and the inverse dependency ratio, which is in fact found in many of the countries suffering financial crisis. When applied to the marketeconomy world as a whole, this simple model also suggests that globalization of the scale we have experienced over the past decades is likely to produce unprecedented increases in asset prices. Moreover, the example also suggests that the go-go age of asset booms has passed, and ageing populations imply that the rate of return on assets will be substantially smaller in the post-globalization era than in the globalization era. In fact, it will be even smaller than in the pre-globalization era. In Section 3, I begin by examining the process of balance sheet adjustment after the bursting of a bubble and when the population is ageing, juxtaposing Japan in the 1990s and the United States in the 2000s. Then, I summarize the consequences of severe, prolonged balance sheet adjustment under population ageing. I identify the multi-faceted challenges central banks may face as a consequence of carrying out balance sheet adjustments under population ageing. There I explain unconventional policies to tackle these problems, taking the Bank of Japan’s efforts as an example. In the final section, I will give some thoughts on the population issue in the tradition of Cambridge, especially with respect to technological innovation. 2. Background of financial crisis: population ageing and globalization Population growth and longevity after 1955 Let me first examine the changing characteristics of population dynamics. Table 2.1 shows population growth estimates for selected countries in selected years, based on the most recent United Nations population figures. As an illustration, I take the United States, United Kingdom, Germany, France, Italy and Japan to comprise the Developed area of the marketeconomy world. I take China and Russia to represent the former communist countries that have become incorporated into the market-economy world. In this table, they represent the BIS central bankers’ speeches Emerging area of the market-economy world. Table 2.2 depicts population longevity for the same countries. These tables illustrate three facts. First, looking at each country’s population growth and longevity, we see simultaneous declining population growth and increasing longevity. This implies that many countries face a sizable increase in working-age population up to a certain point in time, when the population then begins to age rapidly, with no exception, at least for the countries in this table. Second, if you compare the size of the Emerging population with that of the Developed, the huge impact of globalization is immediately apparent. In 2005, the Emerging area was more than twice as populous as the Developed. This table illustrates a big jump in the “marketeconomy world population” when the Emerging is incorporated into the market-economy world. As is apparent, it is the China factor that drives these dynamics. Third, however, the incorporation of the Emerging area through globalization does not help halt the population ageing of the market-economy world. Population growth in the Emerging area is actually expected to be lower than that in the Developed area. Conceptual framework: simple overlapping-generation model with pure store of value Although ageing populations may have a sizable effect on the economy, current sophisticated mainstream models are not particularly suited to examining the impact of the brute force of demographic factors, globalization and ageing, on asset prices as stores of value.3 To tackle demographic factors squarely, I take the other extreme of simplicity. Specifically, I use a skeleton form of an overlapping generation model, in which there is only one type of asset of no intrinsic value, and this serves as a pure store of value. As in familiar overlapping generation models in introductory economic theory, I assume people live in two periods, and that there are the Young and the Old at any point in time. The Young produce one unit of non-storable consumption goods, which are the sole goods in this world. There is only one type of asset, called Pure-Store-of-Value (PSV) assets. They yield nothing and thus have no intrinsic value, but they are the only stores of value in this world. That is, PSV assets are the only means to save, or to transfer purchasing power from one period to the next. The quantity of PSV assets is fixed and constant over time. People accumulate PSV assets in exchange for the consumption goods they produce when they are young, and trade them for consumption goods when they are old. To make the analysis even more transparent and mechanical, I make the extreme assumption that the Young are constrained not to consume but to save. Thus, unlike usual overlapping generation models, there is no utility maximization of the Young: the Young produce the consumption goods, trade them with the Old to get PSV assets, and save them for the next period. In this economy, there is only one market, in which the consumption goods produced by the Young are traded for PSV assets possessed by the Old. The supply of consumption goods is equal to the number of young people, since one young person produces one unit of the consumption goods and, by assumption, she does not consume it. The supply of PSV assets These sophisticated models (e.g., dynamic stochastic general equilibrium models), which are now the popular workhorses of macroeconomic analysis, typically assume life-long utility-maximizing representative agents who live infinitely (or in more sophisticated settings, decease probabilistically with a constant proportion) and are endowed with ability to form true-model-consistent own macro econometric models in an economy with the rest of the world as exogenously given. Because of these settings, it is not easy to analyze the effects of the unexpected incorporation into the market-economy world of former communist countries with huge populations, and the subsequent rapid ageing of the market-world population, that is, the increase in the Old as a proportion of the population. BIS central bankers’ speeches possessed by old people is fixed by definition. Thus, the purchasing power of PSV assets, or the price of PSV assets in terms of the consumption goods is: Price of the PSV Asset = (Number of the Young) divided by (Quantity of the Assets) Since the quantity of PSV assets is fixed, the change in the number of the Young determines the change in the price of PSV assets. Consequently, the PSV asset price inflation rate is: PSV Asset Price Inflation Rate = (Ratio of the Young to the Old Population) – 1 This model is admittedly simplistic: specifically, it is stripped of consumption and saving decisions (optimization), capital stocks (including human capital), and technological progress. More realistic models may bring smoother generational consumption/ rate-of-return paths through capital stock formation, and so on4. However, the demographic factors explained in this simple example are brute and forceful, and it seems unlikely that incorporation of intertemporal optimization and other adjustment processes would completely undermine the basic results. Closed economy: inverse dependency ratio and “boom and bust” in property markets Let me now apply this model to the real world. Assets such as residential and commercial property, equities and even art objects are essentially all “long-term stores of value,” that is, means of transferring purchasing power from the present to the immediate as well as distant future. And among these long-term stores of value, residential property is usually the most popular in many countries for various reasons including preferential tax treatment. So if the model has a reasonable explanatory power, we expect movement in real residential property prices5 to coincide with that of the inverse dependency ratio (i.e., ratio of working-age (15–60) population to the rest), which corresponds to the ratio of the young working population to the old non-working dependent population in the simple OLG model, abstracting from child-age population. Figure 2.1 shows real land prices in Japan (national average, for all purposes) juxtaposed with the inverse dependency ratio from 1955 to date. This figure shows, firstly, that the relative abundance of young people coincided with sharply higher property prices. Secondly, in contrast, the relative abundance of old people seems to be leading to lower property prices. It should be noted here that declining property prices greatly aggravated the balance sheet adjustments of Japanese corporations, as will be explained later. The US case is illustrated in Figure 2.2. In the United States also, an increasing inverse dependency ratio seems to have coincided with the property bubble. After the bubble burst of 2007, property prices seem to have followed the long run movement of the inverse dependency ratio, although it would be premature to draw any conclusions from this at the moment. How about the European experience? Figure 2.3 shows the situation in Ireland. A sharp ascent in property prices coincided with an increase in the inverse dependency ratio, and then we see a free fall. This free fall suggests a painful adjustment is coming. Spain is shown in Figure 2.4. Again, a sharp increase in property prices coincided with an increase in the inverse dependency ratio, and then prices declined. Germany, having no bubble in 2008, is If the Young are not constrained to save, they then face inter-temporal optimization of consumption allocation. Introductory economic theory tells us that in such a case there may be multiple equilibria. However, the thrust of the following argument is generic and likely to be carried over to each of these multiple equilibria. More precisely speaking, the model implies that generation-to-generation real asset price inflation is determined by the inverse dependency ratio. This means that current generation-period real asset prices are higher than previous if the inverse dependency ratio is increased from the previous generation-period. Typically, one generation-period is considered as 25 years or longer. Thus, in order for this relationship to hold within this long generation-period, we expect a positive correlation between real property prices and the slow-moving inverse dependency ratio. BIS central bankers’ speeches shown in Figure 2.5, where property price movement is depicted after 1995, when data are available. In contrast with Ireland and Spain, property prices in Germany had already begun to decline in 2010, coinciding with the population ageing that the country has experienced for some time. Recovery of property markets to the previous peak seems far away in an ageing society. Globalization: from exuberance to stagnation in global asset markets Let me now consider the effects on asset prices of globalization, in particular marketization6 of former communist countries into the market-economy world. To do this, we apply the simple overlapping generation model just described, as if the market-economy world were one big economy. Thus, I ignore productivity differences between regions, immigration and emigration, uncertainty, and in particular, exchange rate adjustments. I illustrate the possible impact of globalization by using the numerical example of Table 2.3, which is based on the United Nations population estimates of Table 2.1. To make the analysis as simple as possible, I take 25 years as a one-generation period postulated in the overlapping generation model described before. We will consider three periods: the Cold War (Period 1, represented by 1955), pre-globalization (Period 2, by 1980), and globalization (Period 3, by 2005). Also, to simplify the analysis but to add a realistic flavor, we take population numbers of respective years in Table 2.1 as those of the young population.7 These two assumptions lead to the figures in Table 2.3. I also assume that the quantity of PSV assets is fixed at, say, 100 million in the market-economy world. Suppose that in the Cold War and pre-globalization periods (Periods 1 and 2), the marketeconomy world consists solely of the Developed area of six industrialized economies, as shown in Table 2.1. Then, in Period 1, the market-economy-world Young population is the same as that of the Developed area, about 473 million. The Old population in the Cold War period is that of the Developed area, and as a whole they possess 100 million PSV assets. The Young population trades 473 million units of consumption goods for 100 million PSV assets that the Old population possesses. Consequently, the price of PSV assets is about 4.73 units of consumption goods in Period 1. A similar situation holds true in the pre-globalization period, where the price of PSV assets is about 5.90 units of consumption goods. Consequently, the asset price inflation rate in the pre-globalization period is 0.89% per annum. Then, consider globalization. The Emerging area (that is, Russia and China) is incorporated into the market-economy world in the globalization period (Period 3). I assume throughout a fixed exchange rate between the Developed area and the Emerging one. Thus, there is one free worldwide market of consumption goods traded for PSV assets. Like the Young in the Developed area, the Young in the Emerging area produce one unit of consumption goods, and sell it to the Old to obtain PSV assets for their retirement. The Old only exist in the Developed area in the worldwide consumption goods market, since the Old in the Emerging area have no PSV assets and cannot buy consumption goods in the worldwide market. The Old in the Emerging area are therefore ignored in the following analysis. (They are assumed to be outside of the market-economy world.) The Young population of the market-economy world is then the sum of that of the Developed and of the Emerging area, about 2.14 billion. The Young populations of both regions want to trade their consumption goods of about 2.14 billion units for 100 million of PSV assets. Merriam-Webster’s Online Dictionary defines marketization as “the act or process of entering into, participating in, or introducing a free market economy.” This simplifying assumption overstates the actual young population, but it does not qualitatively affect the following analysis. BIS central bankers’ speeches Consequently, the price of PSV assets is about 21.4 units of consumption goods in the globalization period (Period 3), a huge increase from 5.90 in the previous period. The price of PSV assets is nearly four times higher in the globalization period (Period 3) than in the pre-globalization period (Period 2), leading to asset price inflation of 5.28% per annum. The number of young people in the market-economy world, who are saving for future retirement, increases substantially in the period of globalization. Thus, we have a global “savings glut,” which leads to substantial asset price inflation globally. In the example of Table 2.3, the asset price inflation rate accelerated substantially, from 0.89% to 5.28% annually for twenty-five years. What will happen once the boom is over? Let me extend Table 2.3 to include the postglobalization period, in Table 2.4. Here the post-globalization period is represented by 2030, and all population figures are the United Nations population estimates given in Table 2.1. If we look at Period 4, the post-globalization period, we see that the market-economy world population will grow by only 0.28% annually from 2005 to 2030. Under my simplified assumption, the young population in the market-economy world will produce about 2.29 billion units of consumption goods, while there will be 100 million PSV assets. This means the price of the assets will be about 22.9 units of consumption goods in the postglobalization period, meaning that asset price inflation decelerates quite sharply. The asset price inflation of the post-globalization period is a mere 0.28%. In fact, the rate is lower even than the 0.89% of the pre-globalization period. Summing up So far, I have suggested that the brute force of compositional change in population might be in the background of asset market bubbles and their subsequent bust, especially those which caused the global macroeconomic crisis of 2008 and after. To close this section, I would like to draw two observations from this exercise. First, I am not suggesting this demographic factor is the cause of the crisis, but pointing out that this favorable demographic background (increasing inverse dependency ratio) might have been fertile ground for the excessive optimism that led many economic agents to take a highly leveraged position to multiply their returns. By the same token, the eventual sharp reversal of the ratio made resolution of accumulated financial excesses particularly difficult, resulting in the prolonged, severe balance-sheet adjustment that followed the crisis, and which is still under way. Second, the aftermath of globalization is likely to imply a substantial slowdown in asset price inflation, and ultimately in the rate of return on these assets. Moreover, the postglobalization-period rate of return is noticeably lower even than that in the pre-globalization period, because of increased population ageing. 3. Post-crisis world: multifaceted challenges and unconventional policy Severe and prolonged balance sheet adjustment under population ageing Let me now consider the post-crisis world. In order to determine the effect of balance sheet adjustments after the bursting of a bubble, I first clarify who leveraged during the bubble periods. In Japan, it was the corporate sector, especially small to medium-sized firms, which for the first time gained access to large banks after the so-called financial liberalization. The corporate sector’s loan-to-GDP ratio increased by 29 percentage points in the ten years before the bubble burst in 1991. In the United States, it was the household sector that leveraged, especially in housing. The household sector’s housing loans-to-disposable BIS central bankers’ speeches income ratio jumped by 39 percentage points in the ten years before the bubble burst in 2007.8 These sectors were interest-sensitive and thus constituted the “transmission gears” of the ordinary monetary transmission mechanism in the periods before the bubbles burst. That is, these leveraged sectors had been sensitive to policy rate reduction in business cycles. However, after the bubbles burst, these leveraged sectors became insensitive to policy rate reduction, because of the acute balance sheet adjustments. Large legacy shortfalls must be compensated for by current profit or income, period by period, and this process is slow and painful. This leads at least to a breakdown in the ordinary monetary transmission mechanism of policy rate change. What then are the long-term consequences of severe and prolonged balance sheet adjustment under population ageing? Three adverse consequences can be identified. Long-term consequence 1: declining mobility/flexibility First, mobility declines, or in other words, the economy becomes “inflexible”. Since de-leveraging firms or households have to pay back all their debts before “moving” from their current position, they are often stuck with an “underwater” property. Population ageing strengthens this tendency. In the case of Japan, de-leveraging took place in the corporate sector, and thus firms became less mobile between industries and regions. In the United States, the household sector is de-leveraging, and thus household mobility has been reduced. Figure 3.1 depicts declining entrepreneurial mobility in Japan. This figure shows the creation and destruction of enterprises between pre-bubble (1981–1986), bubble (1987–1991), and post-bubble (1992–1996). It can be seen in this figure that the creation of new enterprises was sharply reduced after the bubble burst of 1991. In contrast, the increase in the rate of destruction was relatively mild. These two imply a “sticky industry structure,” a tendency to hang on to the past. Declining mobility is found in the household sector in the United States. Figure 3.2 shows changes in the householder mobility rate between 2005 and 2009. A sharp decline is found across all age groups. Since there is no such change in renters, this sharp decline suggests that the housing crash reduced householder mobility rates.9 Long-term consequence 2: loss of non-tangible/human capital The second consequence of severe and prolonged balance sheet adjustment is the loss of non-tangible or human capital. De-leveraging firms and households suffering long underutilization or under-employment tend to lose their non-tangible or human capital. In Japan, this has been observed especially in small to medium-sized enterprises: loss of entrepreneurship, loss of human networks in skilled manufacturing, and loss of access to technological advances. In the United States, the long-term unemployed or underemployed risk losing their human capital. See Figures 2.1 and 2.2 in: Nishimura, K. G., “This Time May Truly Be Different: Balance Sheet Adjustment under Population Ageing,” a speech prepared for the Panel “The Future of Monetary Policy” at the 2011 American Economic Association Annual Meeting, Denver, January 7, 2011. It has been debated recently whether the negative equity of some homeowners significantly influences their mobility in the United States. (See, for example, Schulhofer-Wohl, S., “Negative Equity Does Not Reduce Homeowners’ Mobility,” Working Paper 682. December 2010, Federal Reserve Bank of Minneapolis.) However, the results based on past data are not yet conclusive, since in the past, negative equity was a relatively rare, idiosyncratic phenomenon. New data including the period after 2008 are needed to answer this question. BIS central bankers’ speeches Long-term consequence 3: problems in financial intermediation The third consequence of severe and prolonged balance sheet adjustment is the deterioration in financial institutions’ efficient functioning as financial intermediaries. This was most acutely observed in Japan during the several years after the bubble burst: a pile-up of non-performing loans seemed to lead to a breakdown in the “market selection mechanism” around 1997. Figure 3.3 shows the result of a large-scale panel analysis of Japanese firms, in which the total factor productivity of exiting and surviving firms is compared. Survival of the fittest is a basic premise of the natural selection mechanism. Thus, if the market mechanism works well, the productivity of successful and surviving firms should be higher than that of failing and hence exiting firms, at least on the average. In this figure, the shaded areas show cases where the productivity of failing and thus exiting firms is higher than that of surviving firms, which is an anomaly. In fact, the shaded areas are rather exceptional most of the time. However, if we look at the period 1996–97, the period of the financial crisis, we see many shaded areas indicating that more productive firms were exiting in many industries. This strongly suggests a breakdown in the natural selection mechanism. Post-crisis reality So, what will the post-crisis reality look like once the consequences of acute balance sheet adjustment under population ageing have taken effect? Some of the post-crisis reality can be seen in the Japanese situation in the 2000s. Decline in prospects for growth and investment returns First, growth prospects decline. Average real GDP growth in Japan fell from 5% to 4 % in the 70s and 80s, to around 1% in the 90s and 2000s. This implies the expected rate of return on investment in the 2000s is low, especially for those small to medium-sized firms that depend on domestic demand. In contrast, money (bank deposits) becomes relatively attractive as a store of value, given the price-stability pledge of the central bank. Ironically, this leads to an apparent breakdown of the historically-proven quantity-theoretic relationship between real activity and money stock.10 Moreover, not only is the policy rate very low, but so too are longer risk-free rates, judged by historical standards. Conventional monetary policy through the overnight policy rate is not as effective as before, and this means the economy is more vulnerable to a downside shock. The change is not only macroeconomic but also microeconomic and structural. The demand structure shifts from homogenous, mass markets for the young, to more segmented and heterogeneous markets for the old. Thus, continued focus on the young may entail everdeclining demand and overcapacity, and could miss the opportunity of exploiting the potential demand of the old. Here the microeconomic and structural failure of firms and banks to accommodate new demand may have macroeconomic consequence as well. In many discussions over the past two decades, this dramatic decline in growth and investment prospects has often be attributed to the supposedly unique nature of the Japanese economy, whatever that may be. However, if the demographic factors outlined in the previous section do indeed shape the future, then declining prospects for growth and investment returns may have more global relevance. The quantity-theoretic relationship presupposes that non-interest-bearing money is dominated by other positive rate-of-returns assets as a store of value. However, when price is stable and expected risk-adjusted return on investment is very low, the clear rate dominance of the other assets over money may no longer hold. BIS central bankers’ speeches Coordination failure in the financial system Second, there are signs of coordination failure. Banks’ lending is sluggish, partly because of their inadequate functioning as expert relationship bankers. Here a vicious circle seems to be working. To begin with, banks lack the expertise to assess investment in new fields, suffering as they are from problems with non-performing loans and under-investment in their loan officers’ human capital. Consequently banks do not lend. This means that new investments and new enterprises cannot get funding, and thus new markets falter. Then, banks miss the opportunities to accumulate new expertise, bringing them right back to the starting point of this vicious circle. Another coordination failure is found in capital markets, in the form of excessive risk aversion. Fearing unknown unknowns, investors shun investing in riskier securities. Their market then becomes thin and vulnerable to non-fundamental shocks. This means they themselves become prone to turning into unknown unknowns, thus the original fear is selffulfilling. These two types of coordination failure in financial markets result in an apparent lack of “animal spirits”. Piling-up of public debt Third, we see a piling-up of government debt. This is partly the result of the substitution of public debt for private debt in the process of balance sheet adjustment, and partly due to the substitution of public demand for private demand during this period of declining growth. According to the OECD’s Economic Outlook, Japan’s General Government Gross Financial Liability-to-GDP Ratio in 2010 was 198%, compared with 93% in the United States. However, it should also be noted that, because of low long-term rates, the Government Net Debt Interest Payments-to-GDP is 1.2% in Japan, compared with 1.7% in the United States. Three challenges and unconventional policy Let me now examine the challenges that central banks face in the post-crisis world. The first challenge is that of “cycle stabilization”: ensuring a return to sustainable growth with price stability, when the policy rate is near zero and longer-term risk-free rates are also very low compared with their historical average. The second challenge is to enhance the growth trend, or strengthen the foundations for growth. In other words, the challenge is to raise long-term growth prospects, especially in domestically-oriented growth. This should be done by solving the coordination failure in banking and capital markets described above. The third challenge is to avoid causing problems in national debt management. We should design and execute carefully measures to cope with the first and the second challenge, taking appropriate account of the current national debt situation as explained before, as well as general economic conditions. To tackle the first and second challenges, many central banks have introduced unconventional policies, which differ from region to region depending on the particular problems they face. Here as an example, I will explain the Bank of Japan’s recent attempts at unconventional policies, namely, the Comprehensive Monetary Easing (CME) in October 2010, and the Growth Foundation Strengthening Facility (GFSF) in June of the same year. To meet the challenge of cycle stabilization, the first part of the CME changed the guidance for the policy rate from 0.1% to the range between 0 and 0.1%, making clear the Bank’s Virtually Zero-Interest Rate Policy (VZIRP). For the second part of the CME, the Bank clarified its policy duration commitment: the Bank will continue its VZIRP until it judges price stability to be in sight on the basis of the Policy Board members’ understanding of price stability. With Policy Board members’ announced forecasts for two years ahead, this is similar to “forecast targeting” though not specific in numbers. BIS central bankers’ speeches The third part of the CME is the Asset Purchase Program, which is also designed to meet the cycle stabilization challenge. The first half of the Asset Purchase Program aims to influence downward longer-term risk-free rates. That is, the outright purchase of JGBs with remaining maturity of 1–2 years and T-bills is to reduce the term-premiums of risk-free rates. The scheme to provide 3- and 6-month funds at the overnight rate already instituted was aimed at lowering rates longer than the overnight rate, and has been continued and included in this program. These are unconventional, but can be considered as a natural extension of conventional monetary policy through policy rate changes. However, the second half of the Asset Purchase Program is truly unconventional, in that the Bank purchases riskier assets than it bought before: BBB-rated corporate bonds, and a-2 CPs. It also purchases ETFs and J-REITs directly from the market. The purchase is designed to act as a catalyst to induce investment in riskier assets, and thus help solve the coordination failure I described earlier. In other words, it is aimed at breaking another vicious circle in capital markets, that caused by excessive risk aversion. When there is grave anxiety about the future of the economy, as when there is so-called Knightian uncertainty, there is a tendency that aversion to risky assets such as stocks and real estate becomes “excessive” and demand for those assets declines, resulting in the risk premiums of those assets remaining high.11 This excessive “flight to quality” may greatly impede economic activity.12 Meanwhile, there is the possibility that as Knightian uncertainty increases, demand concentrates on assets whose risks are considered to be simple and small, thereby lowering the risk premiums of those assets. This is known as the “flight to simplicity,” which is different from the flight to quality. Whatever name it has, excessive flight to simplicity also distorts the market. In these cases, there is a possibility that the central bank’s purchase of risky assets will lead to it playing the role of “catalyst” to alleviate the tendency to excessive flight to quality and to simplicity. To tackle the second, “trend-enhancement” challenge, or to strengthen growth potential, the Bank of Japan instituted its Growth Foundation Strengthening Facility (GFSF) in the form of preferential fund-provisioning to support financial institutions’ own initiatives in lending and investing in new growth areas. It should be made clear here that it is not the Bank of Japan but participating financial institutions that determine which investment projects should be funded using this GFSF. Thus, the GFSF is designed to be a catalyst to induce banks to find new firms or new investment projects in their perceived growth areas. In this way, the GFSF is targeted at solving the coordination failure in the financial system mentioned earlier, by breaking the vicious circle of no lending resulting in no new markets and thus no demand for lending to start with. Recently the Bank of Japan expanded the GFSF to include the new function of promoting more effective lending methods. Banks in Japan play a central role in financial intermediation, and small companies in particular rely on banks for most of their funding. In the high growth era, Japanese banks responded to strong demand for funds, using their “expert eye” to monitor closely the business performance of companies and examine their ability to meet repayment obligations. However, through the hard process of disposing of Here, in order to facilitate understanding, I intentionally and informally use the term “excessive” risk aversion as representing “(Knightian) uncertainty aversion” or “ambiguity aversion” over and above conventional risk aversion. For a survey of this literature of Knightian uncertainty/ambiguity, see Gilboa, I., and M. Marinacci, “Ambiguity and the Bayesian Paradigm”, mimeo., April 12, 2011. For reference, please see (1) Nishimura, K.G., and H. Ozaki, “Search and Knightian Uncertainty”, Journal of Economic Theory, 119 (2004), 299–333.and (2) Nishimura, K.G., and H. Ozaki, “Irreversible Investment and Knightian Uncertainty,” Journal of Economic Theory, 136 (2007), 668–694. BIS central bankers’ speeches non-performing loans in the 1990s, banks began to rely more heavily on credit protection measures in the form of real estate collateral and personal guarantees. Unfortunately, this increased reliance on real estate collateral and personal guarantees weakened banks’ ability to monitor client firms. The value of real estate and personal assets pledged to banks as collateral bears no direct relation to changes in the client firm’s business cash flow. Thus, there is a risk that financial institutions may overlook changes in the cash flow of a borrower’s core business and suddenly be faced with its business failure. Moreover, too great an emphasis on protection by real estate or personal asset collateral makes loan officers focus on loans to companies with a long business history and abundant assets, rather than providing funds for new companies and new business areas. Taking these problems into consideration, the Bank of Japan decided to use this GFSF facility to promote lending methods that do not rely on real estate collateral and personal guarantees. When implementing these measures to cope with cycle stability and trend-enhancing challenges, it is very important to take appropriate account of the third challenge, that of avoiding causing problems in national debt management. Specifically, it is crucial to avoid creating an impression of the “monetization” of government debt. Otherwise, the large scale purchase of JGBs may lead to a substantial and lasting ratcheting up of long-term rates, which would pose a serious problem for economic recovery and the financial position of the government. Taking this point into consideration, the Bank of Japan has already purchased about 22 trillion yen in JGBs annually, beside the Asset Purchase Program. By the same token, we should be very careful about the possibility that asset purchases may lead to capital losses, which could tarnish the credibility of the central bank. 4. Concluding remarks: Keynes, population ageing and innovation Let me return to where I started this presentation. As I mentioned in the Introduction, it was Keynes who, in his Eugenics Review speech, placed population once again at center stage of macroeconomic policy in the framework of his General Theory. While in the Malthusian tradition, growing populations and inadequate food production to feed them are the major issue, Keynes was concerned with declining populations and inadequate capital investment for full employment. Life expectancy was not particularly long in the time of both Keynes and Malthus, and so population ageing was not an issue at all. Moreover, rapid technological innovation has at least partially solved the problems they had faced for some time. The problem we now face stems from population change, but with a different twist. Here composition of population has changed, inducing a large swing in asset prices as a store of value. With this in the background, we have witnessed asset prices bubble and then collapse spectacularly in some countries, leaving us with severe balance-sheet problems and diminished expectations on investment returns. One may then ask the question: Can our problems also be solved by technological innovation, as they were for Keynes and Malthus? If so, we need not be particularly worried about the present stagnation. I do not have an answer, but I would like to make three remarks about the possibilities presented by technological innovation. First, the ageing society might impose unique challenges on technological innovation. When the population is growing rapidly, as it was in the past, the demands of the young always dominate those of the old. Thus, successful technological progress has a tendency to be youth-oriented and quantity-oriented. In contrast, when the population is ageing rapidly, the demands of the old dominate the market. The characteristics of technology demanded by the old may differ substantially from those demanded by the young, and current youth-oriented technological progress may prove to be not as value creating as before. BIS central bankers’ speeches Second, if the ageing world implies a substantial fall in asset returns, it would induce curtailment of new investment, leading to a worsening of economic conditions. To prevent investment shrinking further, we might need a new source of investment, which is not based on high private returns. It should be noted that there are many socially desirable projects that carry a low private rate of return, such as urban renewal projects, which might have been crowded out in the age of high private returns. To counter possible shortfalls in private investment, we might be obliged to adopt some form of public-private partnership to mobilize these innovation-based projects.13 Third, in an ageing world, the financial needs of an older population are often very different from the risk and return profiles of existing assets. We would then need financial innovation, as one form of technological innovation. Specifically, securitization might be helpful in tailoring financial products to the particular needs of an older population. However, recent experience in securitized products markets has shown the need for care in the design of such securitization, to ensure the necessary regulations and adequate oversight for prospective practitioners of these schemes. Now it is time for me to stop here. Thank you for your kind attention. Some years ago, I proposed a scheme elsewhere for this purpose called Socially-Oriented Investment Trusts. See: Nishimura, K. G., and M. Saito, “On Alternatives to Aggregate Demand Policy to Revitalize the Japanese Economy”, Asian Economic Papers 2:2 (2003), 87–126. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches Appendix: Financial crisis and inverse dependency ratio – an update In a speech in January 2011,14 I presented some telling figures on the correlation of financial crisis, or so-called bubbles, and the inverse dependency ratio in Japan, United States, Greece, Portugal, Spain, Ireland and China. The figures were based on the 2008 revision of the United Nations World Population Prospects. Since then, the United Nations has published its 2010 revision. This appendix updates these figures and expands on them by including more European and Asian countries. The Japanese inverse dependency ratio peaked around 1990, and it was in the very next year, 1991, that the Japanese Bubble peaked. The peak of the US ratio was between 2005 and 2010, and the peak of the US Subprime Bubble was 2007 (Figure A.1 [same as Figure 1.1]). The economically troubled countries of the eurozone present a similar pattern to Japan and the United States. The ratios for Greece, Portugal and Spain have almost the same time profile, and all of them peaked around 2000–2005. The peak of the Spanish property boom was just after the ratio’s peak, and the financial problems of Greece also started at the same time. A particularly interesting case is Ireland, which showed a sharp rise in the ratio until around 2005. The bursting of the country’s property market bubble was just a few years around the corner (Figure A.2). How about other European countries? The so-called Core Europe, Germany, France and Italy, passed the peak 10+ years ago, and seemingly, did not have any particularly alarming property bubbles around 2010 (Figure A.3). However, new and potential members of the eurozone show similar patterns to Greece, Spain, Portugal, and Ireland (Figure A.4). Their ratios peaked around 2005–2010, and some have their own problems. In contrast to advanced countries, emerging Asia has shown remarkable resilience against the financial crisis of 2008. In fact, their inverse dependency ratio is still rising, as exemplified by China’s ratio (Figure A.5). The inverse dependency ratios of many other Asian countries have a quite similar time profile to that of China (Figure A.6). However, their ascent will be checked in a relatively short period, and the peak will be around 2010–15 in many of these countries. After that, the ratio will fall as rapidly as it is now rising. See footnote 2. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Annual General Meeting 2011 of the Foreign Bankers' Association in the Netherlands, Amsterdam, 27 June 2011.
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Masaaki Shirakawa: How to address tail risks Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Annual General Meeting 2011 of the Foreign Bankers’ Association in the Netherlands, Amsterdam, 27 June 2011. * * * I. Introduction Today I am privileged to have the opportunity to speak before the Foreign Bankers’ Association in the Netherlands, a respected association with a rich history and tradition. I would like to express my gratitude to Chairman Freddy Boom for the warm introduction. Since I believe this marks the first time for a governor of Japan’s central bank to address the association, let me begin my remarks by briefly reviewing the historical relationships between the Netherlands and Japan. As many of you may know, the two countries have nurtured close ties for centuries. The first contact between them dates back to 1600, when a Dutch trading ship named De Liefde drifted to the land called Bungo. I happened to have worked at our branch located near the point of landing and have long been interested in this episode. A Dutch national named Jan Joosten became a diplomatic adviser to the first Shogun of the Tokugawa government, which maintained a national isolation policy for some two hundred years from the early 17th century to the mid-19th century. Nevertheless, as an exception, the Netherlands continued to be a trading partner with Japan during this period. For Japan, the Netherlands was not merely a provider of foreign merchandise but also a window on advanced western science and technology, such as medical science, physics, and chemistry. The intellectual class in Japan referred to such subjects as rangaku, or “Dutch studies.” Let me also note that the Enlightenment thinker Yukichi Fukuzawa, whose portrait is on the ten thousand yen bill, made strenuous efforts in his younger days to master Dutch and learned about western civilization from Dutch literature. When I was given this chance to make remarks in the Netherlands, the first thing that came to my mind was the fact that both the Netherlands and Japan have devoted significant energy to dealing with the war against nature. With a quarter of its land below sea level, the Netherlands is well known for its history of repeated hardships caused by great floods. Historically, Japan has lived with earthquakes. Floods and earthquakes do not happen frequently but do cause significant damage when they occur. In this regard, within the short period of the past three years, Japan experienced not only the recent Great East Japan Earthquake but also another significant event. Needless to say, this was the global financial crisis, or the Lehman shock. The two differ from each other in that one was an economic shock and the other a natural disaster, but they share a common feature in that both have had enormous impact on the economy and society. How to address such events is definitely a big challenge for the authorities in many countries and for the management of financial institutions including the members of this association. When describing these events, we often use the term “tail events” (Slide 1) and refer to risks arising from such events as “tail risks” (Slide 2). The word “tail” implies that such events rarely happen and rest within the tail of a probability distribution. To be more precise, tail events or tail risks involve two types of events. One would be along the lines of the recent earthquake in Japan. This had a magnitude of 9.0, and was followed by an enormous tsunami that hit a wide area of east coast of Japan. The last time in recorded history that a comparably sized tsunami hit eastern Japan was in the year 869. This type of event is therefore extremely rare and rests far beyond the end of the tail (Slide 3). Another type of tail event is a financial shock, like the Lehman shock. The financial crisis with the most comparable seriousness and geographical scale as the Lehman shock was the Great Depression of the 1930s. Such events therefore occur with low probability but not as rarely as once in a thousand years. Looking back at the past twenty years, however, financial BIS central bankers’ speeches crises have occurred more frequently than would be assumed in a normal probability distribution. In any case, both types of tail events have a devastating impact on the financial markets, the economy, and society (Slides 4, 5, and 6). In cases where extremely rare events far beyond the end of the tail occur and where rare events within the tail happen more frequently than anticipated, the common feature is that such unanticipated events invite devastating turmoil. The global financial crisis triggered by the subprime loan problem in 2007 was attributable to the formation and bursting of the credit bubble at a scale that had not been anticipated in the preceding period. Natural disasters such as earthquakes, tsunami, hurricanes, and floods as well as diseases including the pandemics of highly virulent new types of influenza could develop into tail events once their magnitude and the scope of damage surpass expectations. The same could be said for large-scale computer disruptions, acts of terrorism, and wars. Responses to risks related to tail events are important not only as part of national economic policy but also in terms of management of the financial institutions for which many of today’s participants are responsible. Today, I will talk about how to address tail risks while focusing on the recent financial crisis and the March 11 earthquake in Japan. II. The great east Japan earthquake The damage With regard to significant tail events that have materialized in recent years, many that are related to the global financial crisis have already been discussed. Therefore, I would like to share with you some factual information about what exactly happened following the Great East Japan Earthquake. This time Japan suffered the interrelated tragic events of an earthquake, a tsunami, and an accident at a nuclear power plant. The toll of dead and missing persons was less than the 105 thousand recorded at the time of the Great Kanto Earthquake of 1923 but still reached nearly 23 thousand. The amount of damage to capital stock from the recent earthquake has been placed at about 3 to 5 percent of Japan’s GDP, according to government estimates (Slide 7). In the disaster areas, the infrastructures of electricity, gas, water, and communications services were interrupted across a wide area. Transportation networks such as roads, railways, and ports became dysfunctional all at once. To make matters worse, a serious fuel supply shortage followed due to problems at oil refineries and the disruption of transportation services. The tsunami seriously damaged the nuclear power plant, causing an electric power shortage problem. Most of the key infrastructures and fuel supplies have already been restored in disaster areas. But the situation at the nuclear power plant has not yet reached the stable stage of a cold shutdown. The estimated amount of damage I have just mentioned covers only capital stock and does not include damage to human resources or the economic impact of the nuclear power plant accident. Overall, this was truly the materialization of tail risk. The effects on economic activity I will now briefly describe the impact of the earthquake on Japan’s economy, focusing on the points relevant to considering how we should address tail events. First, needless to say, production has declined sharply and significantly (Slide 8). Although the March 11 earthquake clearly had no impact on the initial ten days of the month, a reading for the industrial production index in March showed that this fell by 16 percent on a month-tomonth basis, the largest one-month decline on record. This is attributable to the devastating damage to the production facilities in the disaster areas as well as electricity supply constraints and supply-chain disruptions experienced across wider areas. The pronounced BIS central bankers’ speeches production decline led to an export decline. As a result of the production decline, exports registered an almost 15 percent cumulative drop from February in the subsequent two months combined. Second, the earthquake also affected the sentiment of economic entities. Private consumption declined as voluntary restraint by consumers dampened spending, particularly for services such as tourism and eating out. Moreover, the impact of the disaster went beyond just the sentiment of the Japanese people to affect the global perception of Japan being safe and secure. Although the current radiation levels in Tokyo are roughly the same as in Amsterdam, Berlin, or Paris, the number of visitors from abroad for business purposes or as tourists fell sharply below the level registered a year before, declining by 50 to 60 percent after the recent earthquake (Slide 9). Third, despite such a sharp and significant drop in production, the economy is returning to a gradual recovery path with the easing of the supply-side constraints. The current downward pressure on the economy following the disaster is basically arising from the abrupt supplyside shock. The fundamental conditions for growth – namely, expansion of overseas economies – remain intact. In this regard, the current situation differs from the period following the Lehman shock when demand evaporated both at home and abroad due to financial contraction. In fact, the restoration of supply-chain disruptions has been making steady progress, thanks to strenuous efforts by private firms. Regarding the electric power shortage problem, although uncertainty and concerns remain in the medium and long run depending on the outcome of the ongoing discussion about future nuclear power policy, we are seeing better prospects for surviving the summer, when demand peaks due to the use of air conditioners. We have seen more thermal power plants resume operations, more firms install in-house power generation facilities, and firms and households make various efforts to conserve electricity. Manufacturing production is gradually recovering from the bottom in March and is expected to be restored to the pre-disaster level sometime in the third quarter of this year. Fourth, with regard to the global implications of the recent earthquake, its negative impact spread to overseas economies through supply chains with a certain time lag. Production in the auto and electronic products industries dropped in Europe, the United States, and Asia (Slide 10). The impact of supply-chain disruptions As I will explain shortly, the recent earthquake taught us various lessons. In terms of how to address tail events, the following facts require special attention. First, I would draw attention to the importance of supply-chain disruptions. More specifically, the magnitude of the economic downturn was much larger than implied by the share of disaster areas in terms of economic size and population (Slide 11). The share of disaster areas was 6 percent in terms of GDP and 7 percent in terms of population. As I have said, however, the rate of decline in production was as high as 16 percent. The negative impact was amplified by the supply-chain disruptions. In disaster areas, there are many firms producing hard-to-replace parts for automobiles and electronics, including a producer of microcontrollers for automobiles with a global share of 40 percent. As automakers have relied on highly customized parts, a stoppage of production in disaster areas significantly affected production in other areas, including overseas firms dependent on imported parts from Japan. The significance of the impact of such complicated supply chains had not been fully recognized before the recent earthquake. There are two important reasons for the greater-than-expected impact of the recent supplychain disruptions. The first is the low level of parts inventory. In normal times, a lower level of inventory contributes to increased efficiency and higher profits. Once hit by an enormous shock, however, firms are forced to curtail production sharply within a short period of time, and this creates a chain reaction to other firms. The second reason is the concentration risk BIS central bankers’ speeches in procurement. Tracing back to the most upstream stage of the complicated supply-chain network, it turned out that procurement greatly relied on specific firms in specific areas. As a result, the termination of production at a certain firm had a serious impact on the production activity of many firms, including those abroad. While supply chains increase production efficiency, our experience of the recent earthquake called attention to the problem of concentration risk in inventory management and procurement for the purpose of strengthening resiliency against shocks. The importance of maintaining stability in the financial system Now I would like to call your attention to the second factual observation deemed crucial when considering how to address tail events. This is the importance of maintaining stability in the financial system. Production started to recover from a plunge caused by the earthquake at a relatively fast pace, which is in a stark contrast to the situation in the period following the Lehman shock. One of the reasons for this early recovery is the fact that stability has been maintained in financial markets and the financial system. Both private financial institutions and the Bank of Japan have been doing their utmost to preserve stability on the financial front since immediately after the earthquake. In terms of payment and settlement systems, although some clearing houses in the quakestricken areas had to suspend their operations, major payment and settlement systems including the BOJ-NET – the settlement system for funds and government bonds – continued to operate smoothly. The buildings that store the computer center for the main payment and settlement systems sufficiently proved their resilience to the magnitude 5-plus earthquake in the Metropolitan Tokyo area. Moreover, at the time of the rolling blackouts that were temporarily implemented with a short notice soon after the earthquake, financial institutions’ branch networks and computer centers maintained their operations by resorting to backup measures such as the use of in-house power generation facilities. Over a period of successive days following the earthquake, the Bank of Japan provided financial markets with ample liquidity that significantly exceeded the amount provided at the time of the Lehman shock. Furthermore, on the first business day after the earthquake, the Bank decided to expand the size of its program to purchase risk assets including commercial paper (CP), corporate bonds, exchange-traded funds (ETFs), and Japanese real estate investment trusts (J-REITs). This decision was made in a forward-looking manner to prevent any deterioration in business sentiment and heightening of risk aversion in financial markets from adversely affecting economic activity. If the financial system had lost its stability this time, the extent of the economic downturn would have been much larger. Therefore, it is quite important to secure stability in the financial system. Although we have managed to maintain overall financial stability, as I have just described, we have also learned some lessons. First, a combination of various factors could lead to unexpected trouble. In disaster areas, key social infrastructures such as electricity, gas, communications, and transportation services simultaneously stopped functioning. Although the offices of financial institutions were equipped with in-house power generators to cope with blackouts, the sustainability of such backup measures was threatened as disruptions to transportation made it difficult to procure fuel. Disruptions to transportation and associated fuel shortages also made the delivery of cash difficult. Second, various rumors spread after the earthquake. For instance, when the yen appreciated sharply immediately following the earthquake, there was a baseless rumor that Japanese insurance companies would sell foreign currency assets due to an increase in insurance claim payments. However, these companies actually had no need to conduct such sales in order to make the payments, as they held a considerable amount of liquid assets in yen. In the week after the earthquake, rumors had spread among some foreign financial institutions that the Tokyo financial market would close. To our surprise, there was also a groundless BIS central bankers’ speeches rumor that the Bank of Japan was planning to resort to a backup computer center in Osaka, which is located more than 500 kilometers away from Tokyo. Clearly, extreme anxiety in itself can proliferate sensitive market reactions. III. Addressing tail risks: measures by financial institutions While specific measures to address tails risks differ depending on the pertinent risk factors, conceptually, they could be categorized into ex-ante and ex-post efforts. Before tail events take place, efforts should be made to measure tail risks as accurately as possible to make the internalization of expected losses possible and take actions accordingly. If tail risks unfortunately materialize, efforts should be made to prevent the impact of tail events from spreading. Such ex-ante and ex-post efforts should be made by individual financial institutions and firms as well as by the government and the central bank. Needless to say, there are no perfect solutions to the conundrum of addressing tail risks. At the same time, however, we are not allowed the luxury of being fatalists. We must keep thinking about how to make things better. Holding sufficient amount of capital and liquidity Let me start with ex-ante measures by financial institutions to address tail risks. As completely avoiding tail events is not possible, it is indispensable to secure resiliency against shocks, namely a sufficient amount of capital and liquidity. Firms that are part of supply chains consider how much inventory they should retain by striking a balance between efficiency in normal times and stability in an emergency. In other words, the balance between “just in time” and “just in case.” Financial institutions also face an issue of a similar nature. They are confronted by the difficult question of choosing the right balance between efficiency and stability. The starting point for making a proper judgment is to grasp the significance of tail risks to which they are exposed. Given that tail events occur with very little probability but entail gigantic losses once they occur, it is extremely difficult to quantify potential losses using statistical methods. In addition, as was the case both with the global financial crisis and the supply-chain disruptions, losses from tail risks could change significantly depending on how the concerned parties respond to the initial shock; for example, in terms of whether a central bank appropriately plays the role as a lender of last resort. The widely used Value-atRisk (VaR) model is useful for managing risks but its shortcomings should also be properly recognized. The VaR model has certain limitations in capturing tail risks because it assumes a specific probability distribution and relies on data about past events. Moreover, even when the VaR model shows that there is a 0.1 percent probability of realizing a certain amount of losses, it tells nothing about the more detailed probability distribution of losses within the realm of 0.1 percent probability. Given such constraints, in order to capture the impact of tail risks consistent with a unique risk profile of individual financial institutions, it is useful to conduct a stress test based on various risk scenarios instead of solely relying on risk measurement techniques based on assumed probability. Taking the example of an earthquake, financial institutions’ stress scenarios could include the loss of business function in some branches, widespread credit default, and the collapse of market functioning. In the process of constructing stress scenarios and assessing the results of a stress test, the active involvement of management is indispensable. For private financial institutions, the extent to which they should prepare for tail events is a crucial management decision that will affect their capital plans and investment in key infrastructures. Avoiding the concentration of risk exposures Second, financial institutions need to make efforts to avoid concentration of risk exposures. Similar to the problem of concentration risk in supply chains I mentioned earlier, in the BIS central bankers’ speeches context of financial institutions, the concentration of credit risk and liquidity risk has particular importance. Of course, prudent financial institutions do not intentionally concentrate risk. What is worrisome is the situation where financial institutions concentrate risks without knowing they have actually done so. The subprime loans and related securitized products in the United States were believed to be safe, protected by sufficient risk diversification. With respect to mortgage loans, risk was geographically well diversified based on the assumption that housing prices would not fall on a national scale. Also, in Japan, the myth that land prices would never fall was widely believed during the bubble period in the late 1980s. Stable business continuity Third, on the operational front, financial institutions need to make sufficient preparations for possible physical damage, including that caused by natural disasters. In other words, preparations are required to ensure stable business continuity. To strengthen the resiliency of a business continuity plan, it is desirable not to rely solely on the first line of defense, but rather to have multilayered safety measures. For example, it is not enough to simply secure the sufficient strength of major buildings such as a headquarters and a computer center, nor is it enough to just have backup facilities. You also need to have in-house power generators to prepare for blackouts and always maintain a sufficient amount of fuel for them. When diversifying risks, it is important to check the extent of concentration risk on the operational front by giving consideration to changes in the environment surrounding financial institutions; for example, proliferation in the scope of financial business and leanings toward business outsourcing. Based on a thorough examination, financial institutions should take necessary measures to avoid concentration risk of business operations by diversifying essential facilities and functions geographically, securing alternative energy sources, and maintaining multiple counterparties for business outsourcing. Furthermore, of crucial importance to business continuity at a time of crisis are measures to strengthen the human infrastructure by regularly reviewing the effectiveness of the existing business continuity plan and providing staff with sufficient training. The other day I had a chance to read a magazine article on an interview with the Dutch Ambassador to Japan, and was impressed by how calmly the Dutch Embassy had responded to the recent earthquake. I learned that the Embassy had conducted training under the guidance of a crisis management consultant in November last year. The training was quite detailed and covered how to evacuate, how to communicate with concerned parties, how to check the safety of Dutch nationals living in Japan, and how to respond to media inquiries. This is exactly what the famous slogan “Be Prepared” tells us to do. Global risk sharing Fourth, it is important to make efforts to share risk, especially on a global scale. We are not able to avoid the materialization of the risk of natural disasters. However, it is possible to mitigate casualties and losses to some extent by signing in advance a contingent losssharing contract between insurance companies and investors. In the case of the Great East Japan Earthquake, physical and human losses were covered not only by Japanese insurance companies but also reinsurance companies abroad. Moreover, as significant natural disasters occurred one after another recently, we have seen an increase in the issuance of catastrophe bonds as a means of diversifying the risks. Needless to say, to make such risk transfer effective, it is necessary to further promote the sound development of markets for products with a risk transfer function. Calm and orderly response I have discussed ex-ante measures to address tail risks by financial institutions. How about ex-post measures? In this regard, there is not much I can offer in terms of generalities. The most important thing is to effect a calm and orderly response. Coming back to the interview BIS central bankers’ speeches with the Dutch Ambassador to Japan, the article reported that he was surprised by the fact that the earthquake did not cause panic among the Japanese people. Although I cannot make an objective assessment of the calmness exhibited by my fellow Japanese people, I can say that being calm is crucial to preventing the proliferation of damage caused by an initial shock. Another important factor is cooperation within the private sector. As I have mentioned, the restoration of supply chains has been making swift progress. Looking at worksites in the manufacturing industry, various efforts and attempts involved putting aside the usual rivalries; for example, firms in the same industry temporarily covered the production of disaster-stricken rivals and several manufacturers of final products cooperated in terms of sending staff to parts manufacturers to support their restoration efforts. Private financial institutions cooperated in various ways. For example, to help people who evacuated to places somewhat distant from the disaster areas, financial institutions in the non-affected areas allowed for the withdrawal of deposits at affected financial institutions through a simplified procedure. In the face of fuel shortages, neighboring financial institutions jointly operated cash delivery cars together, so as not to interrupt cash delivery. IV. Addressing tail risks: measures by the authorities Next I would like to consider the case of the authorities, especially the central bank as well as the regulatory and supervisory authorities. To address tail risks, while appropriate efforts by individual private business firms and financial institutions are undoubtedly necessary, the role of the authorities is also crucial. First, the involvement of the authorities is indispensable because addressing tail risks entails significant costs and placing all of the burden on the private sector could hamper economic growth. This is especially the case when dealing with catastrophic natural disasters. The second reason why public sector involvement is required relates to the concentration of risk. When completely relying on market competition in the private sector, it is difficult to expect the complete internalization of extreme tail risk. In that situation, some kind of public sector involvement is necessary. Even in that case, however, if the authorities make a commitment in advance or are perceived as making an advance commitment, the private sector would stop making efforts to address tail risks. This is a typical moral hazard problem. It is difficult to set concrete criteria with regard to how much the private sector should shoulder the burden and to what extent the authorities should intervene as a last resort. In any case, to address tail risks, it is very important to properly design and put in place a society-wide risk management framework. Resilient payment systems In this regard, I would like to highlight the importance of building resilient payment systems with the cooperation of private financial institutions and central banks. Major payment systems should be designed to have sufficient resiliency against tail events including natural disasters. Taking the example of the BOJ-NET, the large-value settlement system for funds and government bonds, the main computer center is proud of its strong resistance to earthquakes and a backup center is located in Osaka. At the same time, on the operational side, in order to lessen payment risk at a time of crisis, major payment systems need to adopt safe settlement features such as Real Time Gross Settlement, Delivery-versusPayment, and Payment-versus-Payment. Financial regulation and supervision Second, financial regulation and supervision is an important component of a society-wide risk management framework. In the wake of the Lehman shock and with the aim of preventing another financial crisis, an agreement was reached on the Basel III framework, which includes a higher capital requirement, a strengthening of liquidity regulation, and the BIS central bankers’ speeches introduction of regulation on leveraging. The new framework requires the internalization of tail risks by financial institutions and provides the institutions with more incentives to lessen risks. In this context, there are discussions about the issue of “too big to fail.” These cover additional loss absorption capacity to reduce the likelihood of the failure of global SIFIs, or Systemically Important Financial Institutions, and measures to remove obstacles to the resolvability of global SIFIs, which would enable orderly restructuring and resolution. These measures aim at controlling the negative externality of global SIFIs. When designing the overall framework, it is important to choose a balance between those measures to promote the internalization of risks, such as additional loss absorption capacity, and those measures to lessen the externality itself, such as improving resolvability. Appropriately conducting monetary policy Third, I would like to discuss the appropriate conduct of monetary policy. Before the Lehman shock, the prevailing view among academics and the authorities was that aggressive easing after the bursting of bubbles could prevent a serious economic downturn. I myself had felt uncomfortable with such a view based on my experience following the bursting of bubbles in Japan. In the end, the Lehman shock crushed this optimistic view. One important issue is the possibility that an accommodative monetary policy itself might heighten tail risks endogenously. In the process of lowering interest rates, financial institutions and institutional investors enjoy an increase in profits due to capital gains, as well as widened yield spreads between short-term and long-term interest rates. However, if a low interest rate environment continues for a long time, financial institutions and institutional investors can no longer enjoy such a profit increase because of narrower credit and yield spreads. As a result, they tend to bet on further declines in long-term interest rates or further squeezes in credit spreads, and attempts to profit from leveraging become more evident. In other words, financial institutions start to pursue profits by bearing the cost of tail risks by themselves. One of the factors supporting such actions is the perception that a low interest rate environment will be maintained and a situation of abundant liquidity will continue. In retrospect, during the periods of credit bubbles preceding financial crises, various financial imbalances were widely observed in the economy, such as asset price inflation, credit expansion, increasing leveraging, and a widening of term mismatch. A low interest rate environment is not the sole cause of these phenomena. But it is also true that these could not take place without the expectation that a low interest rate environment would continue for long time. The goal of monetary policy is to achieve sustainable growth with price stability. But if a central bank maintains a low interest rate environment with too much focus on the near-term inflation outlook, this could consequently encourage the formation of financial bubbles. In that sense, a central bank should pursue price stability through the conduct of monetary policy with a sufficiently long time horizon. Macroprudential perspective Fourth, I would like to highlight the importance of a macroprudential perspective. Maintaining the soundness of individual financial institutions is important but not sufficient to secure the stability of the financial system. For example, the global financial crisis underlined the need to enhance the cross-sectional assessment of risk concentration in the financial system. This is very similar to the case of supply-chain disruptions in which efficient supply-chain management from the perspective of individual firms did not guarantee the risk management of the economy as a whole. As these examples demonstrate, a risk assessment from a macro perspective is very important. Someone has to present analysis from such a perspective, which I call a macroprudential perspective. In this regard, central banks use their unique institutional culture of looking at the system as a whole when analyzing the economy and financial markets through the conduct of monetary policy and various operations. In fact, many central banks including De Nederlandsche Bank and the Bank of Japan have made their macroprudential assessment public and have devoted significant BIS central bankers’ speeches resources to assessment of the risk within the financial system as a whole. I am aware that such analysis alone cannot effect the internalization of tail risks. But I expect that it could help many economic entities to recognize tail risks. Lender of last resort Fifth, I would like to touch upon the lender of last resort function of a central bank, which is related to ex-post measures to address tail risks. Once tail risks materialize, it is extremely important to secure stability in the financial system in order to avoid systemic risk. In this regard, central banks are required to act properly as a lender of last resort through fund provisioning and market operations. This is exactly what the Bank of Japan did after the earthquake. Effective communication Sixth, as an ex-post measure, effective communication is essential. As we experienced after the recent earthquake, groundless rumors often spread at the time of tail events. To make matters worse, in the absence of accurate information, economic entities tend to become too cautious. Therefore, it is essential for the government and the central bank to provide effective communication so that the public understands what is happening as well as the basic principles of the authorities’ response to the ongoing events. V. Concluding remarks Today I have shared with you my own thinking on the challenging topic of addressing tail risks, drawing lessons from the Lehman shock and the Great East Japan Earthquake. Specific causes of tail events have differed according to country and timing. In that sense, we should always be humble by recognizing that our knowledge with regard to tail risks is limited. It is not my intention, however, to finish my remarks on tail risks in a pessimistic tone. The materialization of tail risks itself is unfortunate but people are learning from such events. Currently, various discussions are taking place to review financial regulation and supervision, monetary policy conduct, and macroprudential measures. These efforts will certainly bear fruit in the future. Such a learning process is ongoing not only in terms of policy making but also in terms of operations at worksites. In the case of the Bank of Japan, our experience of a serious financial crisis in the late 1990s has created an institutional memory and the Bank staff have acquired know-how. The specific impacts of earthquakes and financial crises differ but they have something in common. As crises always arrive in a different guise, the role that humans play is very important. In this sense, it is crucial to promote cooperation among private financial institutions, between the authorities and private financial institutions, and among authorities all over the world. I look forward to exchanging views with participants today in the following Q&A session. Thank you for your kind attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Statement by Mr Masaaki Shirakawa, Governor of the Bank of Japan, concerning the Bank's Semiannual Report on Currency and Monetary Control, before the Committee on Financial Affairs, House of Representatives, Tokyo, 13 July 2011.
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Masaaki Shirakawa: Semiannual Report on Currency and Monetary Control Statement by Mr Masaaki Shirakawa, Governor of the Bank of Japan, concerning the Bank’s Semiannual Report on Currency and Monetary Control, before the Committee on Financial Affairs, House of Representatives, Tokyo, 13 July 2011. * * * Introduction The Bank of Japan submits to the Diet its Semiannual Report on Currency and Monetary Control in June and December. Most recently, the Bank submitted the report for the second half of fiscal 2010 on June 10, 2011. I am pleased to have this opportunity to talk about recent developments in Japan’s economy and present an overall review of the Bank’s conduct of monetary policy. I. Economic and financial developments in Japan I will first explain economic and financial developments in Japan. Japan’s economy faced strong downward pressure, mainly on the production side, due to the effects of the Great East Japan Earthquake that occurred on March 11. The earthquake disaster caused damage to production facilities in a wide range of areas and consequent constraints on the supply of parts and materials led to supply-chain disruptions. Moreover, serious damage to power generating facilities resulted in constraints on electric power supply. Production declined sharply mainly due to these supply-side constraints and consequently exports fell. Domestic private demand also suffered to a considerable degree, affected in part by a deterioration in business and household sentiment. Four months after the earthquake, Japan’s economic activity is picking up with a gradual easing of the supply-side constraints caused by the earthquake disaster. Production has recently shown clear signs of picking up as the restoration of supply-chain disruptions has progressed steadily at a faster-than-expected pace. At least for this summer, the electric power shortages are apparently not constraining economic activity as significantly as initially concerned, due to a strengthening of supply capacity by electric power companies and firms and households’ efforts to conserve electricity and level out demand. In response to the pick-up in production, exports have started to increase. Domestic private demand has also begun to pick up, with some improvement in household and business sentiment. Meanwhile, the June Tankan (Short-Term Economic Survey of Enterprises in Japan), released by the Bank at the beginning of this month, showed that business sentiment deteriorated compared with the March Tankan, which appeared to have hardly reflected the effects of the disaster. As for the outlook, however, many firms, especially in the manufacturing sector, expected improvements. The June Tankan also showed that private firms’ fixed investment was starting to pick up as evidenced by reasonably upbeat business fixed investment plans, which were revised upward from the March Tankan, particularly in the manufacturing sector. With supply-side constraints easing further and production regaining traction, Japan’s economy is expected to return to a moderate recovery path from the second half of fiscal 2011, backed by an increase in exports reflecting the improvement in overseas economic conditions and by a rise in demand for rebuilding. As for financial conditions, the overnight call rate has remained at an extremely low level, and the levels of firms’ funding costs have also continued to be low. Firms have continued to see financial institutions’ lending attitudes as being on an improving trend. Issuing conditions BIS central bankers’ speeches for CP have continued to be favorable. In the corporate bond market, although the views of issuers and investors continue to diverge on the terms of issuance of electric power company bonds, issuing conditions have been favorable as a whole, leading to an increased variety of corporate bond issuers. In these circumstances, firms have retained their recovered financial positions on the whole, albeit with the observed weakness at some firms, mainly small ones. On the price front, the year-on-year rate of change in the CPI (excluding fresh food) marked 0.6 percent in April and May. The rate turned positive in April for the first time in two years and four months since December 2008. As for the outlook, the year-on-year rate of change in the CPI is expected to remain slightly positive. However, the Bank recognizes that the yearon-year rate of increase in the CPI is likely to be revised downward with the base-year change scheduled for August 2011. Based on these assessments, Japan’s economy is expected to return to a sustainable growth path with price stability in the longer run. Let me turn to risks to the outlook I have mentioned. Regarding risks to the economic outlook, although concern over supply chains has subsided, the impact of the earthquake disaster on Japan’s economy, especially through changes in household sentiment, still requires due attention. Moreover, uncertainty has increased somewhat with regard to the longer-term outlook for electricity supply constraints beyond this summer. With regard to risks to overseas economies, the effects of balance-sheet adjustments on the U.S. economy and the possible consequences of the sovereign risk problems in Europe continue to warrant attention. As for emerging and commodity-exporting economies, although many economies continue monetary tightening, inflationary pressure has not been reduced as they maintain strong growth. Therefore, there is a high degree of uncertainty about whether these economies will be able to make a soft landing by achieving price stability and economic growth at the same time. Regarding risks to the price outlook, inflation could rise more than expected if international commodity prices increase further. There is also a possibility that the rate of inflation will deviate downward from the Bank’s baseline scenario due, for example, to a decline in medium- to long-term inflation expectations. II. Conduct of monetary policy Lastly, let me explain the Bank’s conduct of monetary policy. In order for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability, the Bank has continued to consistently make contributions as the central bank through the three-pronged approach of pursuing powerful monetary easing consisting of comprehensive monetary easing, ensuring financial market stability, and providing support to strengthen the foundations for economic growth. With regard to pursuing powerful monetary easing, the Bank has encouraged the overnight call rate to remain at virtually zero, namely, around 0 to 0.1 percent. Moreover, the Bank has committed itself to continue the virtually zero interest rate policy until it judges that price stability is in sight. In order to further enhance monetary easing despite the limited room left for a further decline in short-term interest rates, the Bank has implemented measures to encourage a decline in longer-term market interest rates and a reduction in various risk premiums. Specifically, the Bank has established a new framework called the Asset Purchase Program through which it conducts the fixed-rate funds-supplying operation against pooled collateral and purchases various financial assets. The assets to be purchased range from long-term government bonds and treasury discount bills to risk assets such as CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). Immediately after the earthquake, the Bank increased the amount of its asset purchases, mainly of risk assets, with a view to preventing any deterioration in BIS central bankers’ speeches business sentiment or excessive increase in risk aversion from adversely affecting economic activity. As a result, the size of the Asset Purchase Program increased to about 40 trillion yen from the initial size of about 35 trillion yen. In addition to such pursuit of powerful monetary easing, the Bank has been implementing the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth. Even before the earthquake, Japan’s economy was faced with the challenge of a long-term downtrend in the growth potential. This has led to a protracted demand shortage in the economy and has become a fundamental cause of deflation. After the recent earthquake, meeting the challenge of strengthening the growth potential of the economy has become all the more important. Based on these assessments, through the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth, the Bank has been providing funds to private financial institutions that are making efforts in terms of lending and investment to increase the growth potential of Japan’s economy. The funds are provided with maturities of up to four years, against collateral such as government securities, at a very low interest rate. Moreover, at the Monetary Policy Meeting held in June, the Bank decided to establish a new line of credit for the measure, through which the Bank will extend loans to financial institutions for their investments and loans with equity-like features and loans without conventional collateral or guarantees. The latter includes lending that takes movable property, such as inventories and machinery, or accounts receivables as collateral – the socalled asset-based lending (ABL). The Bank expects that this new initiative will further enhance financial institutions’ efforts to strengthen the foundations for economic growth through the use of a wider range of financial techniques. Furthermore, after the earthquake, in order to maintain the financial intermediation functioning and secure smooth funds settlement, the Bank, in cooperation with private financial institutions, provided cash in the disaster areas and ensured the stable operation of Japan’s core payment and settlement systems, including the Bank of Japan Financial Network System (BOJ-NET). With a view to ensuring stability in financial markets, the Bank also provided ample funds sufficient to meet demand in the markets over a period of successive days. Moreover, in April, it introduced the funds-supplying operation that provides financial institutions in disaster areas with a one-year loan of 1 trillion yen in total at a rate of 0.1 percent per annum, with the aim of supporting these institutions’ initial efforts to meet demand for funds for restoration and rebuilding. At the same time, the Bank broadened the range of collateral that financial institutions in disaster areas can pledge to the Bank to borrow funds to ensure these institutions’ funding capacity. The Bank will continue to carefully examine the outlook for economic activity and prices, including the effects of the disaster, and take appropriate policy actions as necessary. BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Kisaragi-kai Meeting, Tokyo, 25 July 2011.
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Masaaki Shirakawa: Japan’s economy and monetary policy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Kisaragi-kai Meeting, Tokyo, 25 July 2011. * * * Introduction I am privileged to have this opportunity to speak before such a large audience today. Four and a half months have passed since the Great East Japan Earthquake, an unprecedented tragic event. Immediately after the earthquake, production plunged mainly due to the destruction of capital equipment, supply-chain disruptions, and electric power shortages. After passing through the worst period, however, production activity has been recovering at a faster-than-expected pace with a gradual easing of various supply-side constraints. At the same time, there is also the harsh reality that many still bear hardships that cause them restless days. The conduct of monetary policy is by nature mainly based on a macroeconomic analysis. However, we recognize that the damage from the earthquake disaster varies by area and industry. I myself visited the disaster areas and now have a greater recognition that macroeconomic perspectives are not enough to fully describe the true state of our economy. Even from a macroeconomic perspective, although downside risk has been receding with respect to the supply-side constraints that emerged immediately after the earthquake, Japan’s economy is starting to confront another new problem of uncertainty regarding electric power supply in the long run. Even before the earthquake, our economy had faced various pressing structural problems, including the rapid aging of the population. So, this brings us to the end of a somewhat lengthy introduction. Today I will first describe the current state of Japan’s economy and its outlook. After illustrating the challenges confronting our economy, I will explain the Bank of Japan’s conduct of monetary policy. In my remarks, I would like to pay due attention to the time horizon by clearly delineating short-term and medium- to long-term periods. I. Developments in overseas economies I will begin with developments in overseas economies, which form the basis for analyzing those in Japan’s economy. The impact of the recent earthquake has been enormous, and recent economic debate tends to focus on the effects of the disaster. Needless to say, the global economy and financial markets keep changing while we deal with the aftermath of the disaster. After all, when the supply-side constraints are resolved, developments in overseas economies will be the most significant driver of Japan’s economic activity in the short run. The U.S. economy has been growing at a slower pace since this spring. This is partly because households’ real purchasing power has declined due to the rise in gasoline prices seen until around spring, and there have been difficulties in procuring automobile parts due to the disaster in Japan. It should be noted, however, that gasoline prices have fallen back somewhat since May and Japan-led supply-chain disruptions have started to be resolved. Therefore, the view held by the U.S. authorities and economists is that the recent economic slowdown is generally transitory, and their baseline scenario is that the pace of growth will resume a recovery supported by the accommodative financial environment. Of course, such an outlook entails uncertainties. The focal point is on how to assess balance-sheet adjustment pressure. Recent data on household debt and housing prices indicate that balance-sheet adjustment in the household sector is ongoing. The recovery in employment has also been disappointing. Just as in the case for Japan in the 1990s, after the bursting of the large credit bubble, the economy often continues to face a low growth rate for a BIS central bankers’ speeches protracted period, although there are some short-term boosts reflecting the implementation of fiscal stimulus packages or accommodative monetary policies. Having said that, it might not be appropriate to conclude that the U.S. economy will follow a path similar to the one Japan once experienced, taking into account the U.S. economy’s distinctive flexibility and the fact that it is a commodity-exporting country. Careful attention should be paid to how strongly balance-sheet adjustment pressure continues to constrain growth in the U.S. economy. The European economy as a whole continues to recover moderately, although there are large differences in the economic growth rates between the euro area’s major countries, such as Germany, and its peripheral countries, including Greece. The German economy maintains its robustness; for example, the latest unemployment rate is 7.0 percent, the lowest level since the reunification of West and East Germany. On the other hand, peripheral countries are experiencing a tough time, as witnessed by the recent Greek growth data, which showed an 8.1 percent decline on a year-on-year basis. Regarding prospects for the European economy, the focal point clearly is developments in the sovereign debt problem in peripheral countries. The essence of the problem is an adverse feedback loop among fiscal conditions, the financial system, and the real economy. This feedback loop works as follows. If confidence in the government declines due to the expansion of fiscal deficits, the government bond rate increases and the creditworthiness of financial institutions deteriorates. An overall increase in interest rates could cause further fiscal deterioration because an associated economic downturn reduces tax revenue. As a result, interest rates, including those on government bonds, could increase further. Such an adverse feedback loop among fiscal conditions, the financial system, and the real economy is the inherent nature of the sovereign debt problem. If the sovereign debt problem in Europe triggers instability in global financial markets, it will exert an adverse impact on the global economy as a whole. To address the problem, further efforts in the following two areas are indispensable. One is strenuous efforts by Greece and other problem-stricken countries to reduce their fiscal deficits and to advance a structural reform to strengthen competitiveness. The other is to “buy time.” The European Union (EU) and the International Monetary Fund (IMF) need to work together to provide financial support to the problem-stricken countries until those countries’ efforts produce noticeable outcomes. In this regard, Greece, the EU, and the IMF have been taking necessary steps. The Bank has been monitoring the situation carefully. The growth rates in emerging and commodity-exporting economies are still at high levels, but these have recently been slowing somewhat mainly due to the heightened inflationary pressures and associated monetary tightening. In China, the year-on-year rate of increase in the consumer price index (CPI) was 6.4 percent in June 2011, up substantially from the 2.9 percent exhibited a year ago. In response, the People’s Bank of China has raised the renminbi benchmark rates five times since October 2010. Other emerging economies have also raised interest rates, but in many cases the real short-term interest rate, which subtracts the inflation rate from the nominal interest rate, is significantly below the long-term trend of the economic growth rate. In any case, deceleration in growth is inevitable and necessary for emerging and commodity-exporting economies to achieve sustainable growth. Yet, there is a considerable degree of uncertainty as to whether these economies will be able to make a soft landing by achieving price stability and economic growth at the same time. I have explained the current state of the economy, the baseline scenario of the outlook, and associated risks by region – namely, the United States, Europe, and emerging economies. The Bank projects that the global economy as a whole is likely to continue realizing relatively high growth led by growth in emerging and commodity-exporting economies. The forecasts by the IMF released in June represent an upbeat projection for the growth rate of the global economy, with growth of 4.3 percent in 2011 and 4.5 percent in 2012. For reference, the average annual growth rate of the global economy over the 30 years since 1980 was 3.3 percent and that over the 10 years to 2007, which includes the period of the global credit bubble, was 4.0 percent. This suggests that the projected growth rates this year and next BIS central bankers’ speeches year are at a historically high level. Therefore, the global economy as a whole is likely to continue realizing relatively high growth; however, as I mentioned earlier, when considered by region, such an outlook entails uncertainties and various risks warrant sustained attention. II. The current situation of Japan’s economy and the bank’s baseline scenario Based on the outlook for overseas economies, now I would like to explain the current state of and outlook for Japan’s economy. As I mentioned at the beginning, production plunged immediately after the earthquake as the economy abruptly faced supply-side constraints. Although the initial problem was supply-side constraints, private consumption also weakened because the combination of increased uncertainties about the future and voluntary restraint by consumers led to a deterioration in household sentiment. As a result, in March, industrial production registered the largest month-to-month drop on record, surpassing the decline following the Lehman shock. It should be noted, however, that the economic plunge after the earthquake was different from the one following the Lehman shock. The recent plunge was mainly caused by the supply shock, while it was the “evaporation of demand” after the Lehman shock that took corporate activity into a downward spiral of contraction. Therefore, unlike the time after the Lehman shock, we were able to make a reasonable projection at an early stage that production would recover once the supply-side constraints eased. In fact, production is recovering quickly as progress in the restoration of supply-chain disruptions has been made at a faster-than-expected pace. This recovery is led by the automobile industry, which experienced an especially sharp downturn. At least for this summer, it seems the electric power shortages are not constraining economic activity as significantly as projected immediately after the earthquake, reflecting a strengthening of supply capacity by electric power companies and successful efforts to conserve energy and level out demand. Based on an overall judgment, taking into account the information from our business contacts, production is expected to recover to the pre-earthquake level sometime during July to September. Household sentiment is also improving somewhat. With regard to business sentiment, we are carefully monitoring business fixed investment plans. In this regard, business sentiment is becoming firm, as evidenced by the June Tankan (Short-Term Economic Survey of Enterprises in Japan), in which business fixed investment plans were revised upward from the March Tankan. After overcoming the supply-side constraints, which has been the most serious cause of concern, the short-term prospects for Japan’s economy will rely on demand-side developments. In this regard, there are two important factors. First, it seems that the economy can count on exports, which are likely to continue increasing on the back of strong growth in overseas economies. Second, demand arising from the rebuilding of capital stock that was damaged by the earthquake, or the so-called “rebuilding demand,” is expected to increase gradually. Although we have seen only a limited amount of rebuilding demand so far, such demand will become more noticeable as we get a clear overall picture of rebuilding in the coming period. Furthermore, although it might be slightly different from the rebuilding demand, private consumption data in the Tohoku region shows that there has been a large increase in the so-called “rebuilding-related consumption” – namely, consumption for the purpose of rebuilding daily lives, including the purchase of new durable consumer goods such as cars and electrical appliances. Based on the various information as I just described, Japan’s economy is expected to return to a moderate recovery path from the second half of fiscal 2011. The Bank published the Outlook for Economic Activity and Prices (hereafter the Outlook Report) in late April and made an interim assessment in July. Looking at the median of individual Policy Board members’ forecasts in the interim assessment, the year-on-year rate of increase in real GDP for fiscal 2011 is 0.4 percent. The figure is somewhat of a downward revision from the April 2011 Outlook Report. This is mainly attributable to a smaller carry-over effect from fiscal BIS central bankers’ speeches 2010 on GDP growth for fiscal 2011, reflecting the fact that the earthquake disaster resulted in significant negative growth in the January-March quarter of 2011. The forecast for the year-on-year rate of increase in real GDP for fiscal 2012 is 2.9 percent, broadly unchanged from the relatively high growth projected in the April 2011 Outlook Report. Let me turn to price developments. The pace of decline in the CPI has moderated steadily reflecting the improvement in the aggregate supply and demand balance. In April 2011, the year-on-year rate of change in the CPI turned positive for the first time in two years and four months since December 2008, and in May of this year it marked an increase of 0.6 percent. With regard to the outlook for price developments, the projection of international commodity prices is one key factor. The Bank projects that international commodity prices will continue to increase moderately along with strong growth in emerging economies. Another key factor is medium- to long-term expected rates of inflation. Based on forecasts made by economists, such rates remain stable at around 1 percent. The Bank has released the “understanding of medium- to long-term price stability” (hereafter the “understanding”) – that is, the level of inflation that each Policy Board member understands, when conducting monetary policy, as being consistent with price stability over the medium to long term. Members’ “understanding” centers at around 1 percent, which is the same as the medium- to long-term expected rates of inflation forecasted by economists. We expect that medium- to long-term expected rates of inflation are likely to remain stable going forward. In this situation, the year-on-year rate of change in the CPI is expected to remain slightly positive with the aggregate supply and demand balance improving as a trend amid economic recovery. In the July interim assessment of the April 2011 Outlook Report, the median of Policy Board members’ CPI forecasts was an increase of 0.7 percent both for fiscal 2011 and 2012. It should be noted, however, that the base year of the CPI is revised every five years in Japan. As the Bank has explained on various occasions, there will be a downward revision to the year-on-year rate of increase in the CPI to be released in mid-August this year, based on the new base year. While rather technical, based on the methodology currently employed to compile the CPI in Japan, the CPI basket that comprises the goods the consumers would purchase is fixed. Therefore, as a longer period of time has elapsed since the base year, it becomes increasingly difficult for the CPI to fully reflect the impact of substantial price declines for some goods for which the volume of purchases has increased due to a price decline. This is the so-called “Laspeyres bias.” Typical examples of such bias are found in the prices of goods such as personal computers and televisions. As a result, after almost five years from the previous base-year revision, the recent figures for the year-on-year rate of increase in the CPI have a somewhat large upward bias, and therefore are likely to be revised downward all at once in the scheduled base-year revision. Although some economists make public their estimates, it is difficult to accurately project the specific degree of downward revision in advance. This is because, in addition to the easy-to-estimate Laspeyres bias, the revision will be affected by the composition of a new basket and the methodology of measuring prices of individual items. Firms and households make their day-to-day decisions on production and spending on the basis of the observed prices of individual goods. Therefore, the underlying trend of prices and people’s economic activity will not be affected by the base-year change of the price index, which is a technical revision in statistics. Nevertheless, the Bank will examine how this revision will be made, as well as its implications. III. Risk factors for the outlook I have explained the baseline scenario of the outlook for economic activity and prices that the Bank considers most likely. As the outlook is always subject to uncertainties, we should acknowledge the risk that the economy will deviate from the baseline scenario. BIS central bankers’ speeches Risks regarding overseas economies The first risk factor concerns prospects for overseas economies. I will not go into detail on this point, as I already covered this earlier, but I emphasize that there are respective risks in the United States, Europe, and emerging and commodity-exporting economies. In relation to the risk regarding overseas economies, attention should also be paid to developments in the foreign exchange markets. If uncertainties about the prospects for the global economy heighten, investors increasingly become risk averse and upward pressures tend to be exerted to those currencies perceived as relatively safe. In terms of changes in the nominal effective exchange rate of advanced economies after the earthquake, the Swiss franc has appreciated most followed by the Japanese yen. Although the appreciation of the yen has some benefit of reducing the cost of imported energy and raw materials, it could have adverse effects on the economy as a whole through a decline in exports and corporate profits, as well as a deterioration in business sentiment, when the appreciation is caused by increased uncertainties about overseas economies. Careful monitoring is warranted in this regard. Risks regarding the effects of the earthquake disaster The second risk factor regarding the outlook for economic activity and prices concerns the medium- to long-term effects stemming from the recent earthquake disaster. The focal point of the effects of the disaster keeps changing as time passes. The risks that became apparent immediately after the earthquake – such as a delay in the restoration of supply-chain disruptions and electric power shortages in this summer – have receded. However, I must say that the somewhat improved household sentiment is still weak compared with the pre-earthquake level, and recovery in some components of private consumption such as eating out and travel expenses has been slow. Therefore, developments in private consumption for the time being warrant careful examination. Recently, uncertainty has increased with regard to electricity supply constraints, which will occur when more nuclear power plants fail to resume operations following their regular inspections. In that case, it will probably be difficult for some time to completely cover a reduction in electricity supply by other measures. Even if various efforts are made, the economy will likely continue to suffer from electric power shortages, mainly in summer and winter, in the coming years. Moreover, we are likely to bear higher costs anyway, either when some of the electricity generated through nuclear power is replaced by thermal power, or when the use of nuclear power plants is maintained after strengthening safety measures. In either case, a rise in electricity costs will oppress corporate profits and households’ real purchasing power, which could in turn restrain business fixed investment and private consumption. Furthermore, from a longer-term perspective, we should recognize the risk that the electricity supply problem will dampen the medium- to long-term growth potential of Japan’s economy. The recent experience of supply-chain disruptions has renewed awareness that domestic production is exposed to the risk of earthquake disasters. In addition, if high uncertainties continue with regard to electric power supply, both in terms of stability and costs, we cannot ignore the risk that the shift to overseas production will be accelerated. IV. The strengthening of medium- to long-term growth potential of Japan’s economy I have discussed the outlook for Japan’s economy with emphasis on the impact of the earthquake and developments in overseas economies. After long deliberation on the issue of rebuilding the economy after the earthquake disaster, I am increasingly convinced that we need to make renewed decisive efforts to tackle the challenge of strengthening medium- to long-term growth potential, which Japan’s economy had faced even before the disaster. I will now describe measures to strengthen Japan’s growth potential. BIS central bankers’ speeches Need to strengthen the growth potential In order to ascertain a specific prescription, we need to make an accurate assessment of the confronting problems. Although political and social difficulties are often pointed to as obstacles, I think that implementation of the correct prescription is also hampered by insufficient recognition of the bottom line for Japan’s economic problems and the causes of declines in the growth rate. In the long run, Japan’s economic growth rate has been on a declining trend: the average annual growth rate was 5 percent in the 1970s, around 4.5 percent in the 1980s, around 1.5 percent in the 1990s, and less than 1 percent in the 2000s. After making a successful take-off to high growth, every economy will sooner or later shift into stable growth. Japan was no exception, but abruptly got trapped in the financial bubble that was formed in the process of shifting to stable growth. After declining sharply in the 1990s on the impact of the bursting of the bubble, we have not managed to change the declining trend of Japan’s growth rate. In the time horizon of two to three years, a growth rate is dominated by changes in demand, except in periods following supply-side shocks such as earthquakes. However, in terms of an average growth rate in the time horizon of 10 to 20 years – namely, the medium- to long-term growth potential – it is natural to consider that key determinants are supply-side factors. Real GDP can be expressed as a product of “the number of workers” and “real GDP per worker.” As a corollary, the real GDP growth rate can be understood as the sum of the rate of increase in the number of workers and the labor productivity growth rate. Using these simple figures, I would like to highlight the following facts. The first is that the impact of declines in the number of workers on Japan’s growth rate has been gradually increasing in the 1990s and the 2000s. After peaking around 1995, the working-age population started to decline and the pace of decline accelerated in the 2000s. The working-age population plays a core role in production activity, and such a decline will constrain economic growth from the supply side through a reduction in the number of workers. The working-age population is also a major driver of private consumption and significantly contributes to tax revenue. Therefore, even from the demand side, a decline in the working-age population will lower growth potential unless necessary measures are taken. Such measures include deregulation in the areas of health care and nursing care services for the elderly to meet rising demand from the aging population, as well as measures to offset a rising fiscal burden on the working-age population. The second fact is that, despite some declines in recent years, Japan is still in the group of advanced countries with the highest labor productivity growth rate, along with the United States. The labor productivity growth rate is an important determinant of growth potential of the economy. As I will explain later, I think it is necessary to continue making efforts to raise the labor productivity growth rate, and there are good prospects for such efforts to bear fruit. At the same time, it is not realistic to expect that the labor productivity growth rate, which has been at around 1 percent on average, will rise by 1 or 2 percentage points at once. There is no significant difference in the productivity growth rate among countries that have already gone through a high growth period. While we must make the utmost efforts, we also need to be cool-headed and recognize that the already matured economy cannot expect to see a dramatic increase in its growth potential. So, what is the bottom line for Japan’s economic problems? In my view, the most serious problem is that, if we maintain the current situation, it becomes difficult for Japanese people to sustain the current relatively high level of living standards on an international comparison. Speaking of which, the level of real GDP per capita in Japan is still high on an international basis. In addition, the fact that the average lifespan of Japanese people is extremely long indicates that the country has achieved a significantly high standard of health on an international comparison. Health is an important condition for people’s happiness and cannot be measured by GDP statistics. The question is whether our children and grandchildren can sustain such a high standard of living, and I am afraid it is not possible if we choose to keep BIS central bankers’ speeches the status quo. The key word is “sustainability.” We can make a simple interpretation of a country’s economic activity as follows. The working-age population earns income through production activity and raises their children, the future workforce. The elderly, who once earned income as part of the workforce, now make their living by relying on their accumulated savings and the social security system, which is supported by the working-age population. In this way, human society continues to raise the standard of living through generational change. What is important here is a smooth transition to the next generations. In this regard, unless measures are taken to review existing institutions and customs to adjust to objective changes in the environment such as a rapidly aging and declining population, the sustainability of the economy will be threatened. In the following, I will explain the necessary measures to ensure sustainability. Encouraging labor participation First, we should make efforts not to reduce but rather increase the number of workers by raising the labor participation rate of women. By age group, this rate displays an M-shaped curve, with a dip in the age group of those aged in their 30s. This feature makes Japan different from other advanced countries, indicating that Japan is not a friendly society for working women raising children. Efforts to improve the environment for women, such that they can handle both a career and raising children, are meaningful not only for economic growth but for the society. Moreover, we should not overlook the fact that Japanese people are living longer and the number of the elderly blessed with good health and physical strength is increasing. There is research showing that the physical conditions of elderly people have improved and those who can work vigorously have increased. Building a society where elderly people who have the will and capability to work are able to actually do so, depending on their situation, will not only have a positive impact on economic growth but also lead to enriching people’s lives. Raising labor productivity Second, efforts are needed to raise labor productivity. The phrase “raising productivity” is often used to mean improving efficiency and streamlining. But I would like to emphasize the other aspect of higher productivity, which is that it leads to an expanded equilibrium, in that individual workers can generate higher added value. Added value is a source of funds that ultimately will be allocated as corporate profits and wages. Therefore, increasing added value is the same as saying that firms boost profits while expanding wages to be paid. To this end, firms need to increase their profits by exploring new markets, not solely relying on cost reductions. In what follows, I will highlight three strategies for exploring new markets. First of all, it is all the more important to actively capture global demand amid the world economy’s continuing strong growth. In this regard, the expansion of firms’ overseas bases would likely have a positive impact on Japan’s economy if it is motivated by the aspiration for growth to strengthen their global strategies, instead of the passive choice of giving up on Japan. The share of Japanese firms’ overseas production, which is currently a little less than 20 percent, has been increasing in inverse proportion to the gradual decline in Japan’s share in global GDP. In other words, as emerging economies have grown and Japan’s relative share in global GDP has declined, overseas production by Japanese firms has expanded to capture the demand for the increasing consumption of locally made products. In the process of continuous expansion of overseas production, domestic offices and factories have always constituted an integral part of international division of labor by changing their role. Specifically, they have started to assume the function of a global headquarters and to focus on advanced research and development while increasing exports of intermediate goods to overseas bases. For Japanese firms to be winners in the rapidly changing global markets, mergers and acquisitions have acquired increasing importance. In this regard, although Japan is BIS central bankers’ speeches experiencing declining growth potential in terms of flow, it still has strengths in terms of economic stock, such as abundant financial assets and technological competitiveness. In fact, an increasing number of firms, taking advantage of their ample funds, have recently concluded vigorous investment deals to purchase overseas firms with growth potential. Capturing global demand is not limited to the areas of monozukuri, or manufacturing. Efforts to further enhance Japan’s attractiveness as a tourist destination will generate a significant outcome in the medium to long run. As I have illustrated, Japan should pursue global strategies in a wide range of areas and in a variety of ways. In order to make the best use of Japan’s potential, it is extremely important to steadily enhance the framework of free trade agreements and economic partnership agreements. To raise labor productivity, it is also important to promote technological innovation and explore potential demand in areas related to the natural environment and energy. The earthquake disaster is expected to further heighten the need for technological innovation in these areas. Having nurtured sophisticated technologies for years, Japan is well placed to raise its growth potential by pursuing the following three strategies together: “saving energy,” to conserve energy through the wider use of LED lighting; “creating energy,” through the use of solar power; and “storing energy,” through the improvement of batteries in terms of efficiency and capacity. Furthermore, efforts are needed to further explore domestic markets and thereby generate added value by discovering potential demand. I often hear the pessimistic view that domestic markets will shrink steadily because of the declining and aging population. However, even in an aging society, people’s potential needs are diverse and unlimited, and continuously exploring such needs is a significant source of added value. V. Efforts toward fiscal consolidation I have talked about efforts to encourage labor participation and raise labor productivity as necessary measures to ensure the sustainability of the economy. In this regard, there is another policy goal of extreme importance that requires further efforts – namely, fiscal consolidation. As government debt outstanding has already reached a tremendous level in Japan, an increasingly aging population will act to exert pressure to further deteriorate fiscal balance. Deterioration in fiscal balance has adverse effects on economic activity through two channels. First, an increased burden on the part of the working-age population would constrain consumer spending. Second, as I explained earlier by taking the example of the sovereign debt problem in Europe, if confidence in the government’s debt repayment ability is undermined, there would be an adverse feedback loop among fiscal conditions, the financial system, and the real economy. Of course, the strengthening of growth potential is necessary in terms of improving fiscal balance, but the associated natural increase of tax revenue alone is not enough to ensure fiscal sustainability. Overcoming deflation is also important, but this has a limited effect on improving fiscal balance because past experience shows that rising inflation not only boosted revenues but also increased expenditures. This suggests that restructuring of revenues and expenditures is indeed necessary for fiscal consolidation. Although fiscal balance in Japan is deteriorating, yields on the Japanese long-term government bonds have maintained stability at the lowest level in the world. One possible interpretation of this phenomenon is the market participants’ view that the current fiscal conditions will not remain unaddressed and the specific measures to achieve fiscal consolidation will be implemented in due course. Another possible interpretation is the market participants’ vague expectation that the stability in interest rates that has continued to date will stay as it is for the time being. What is important is that, in either case, if any of the specific measures toward fiscal consolidation are not actually taken, market participants might suddenly change their views at some point. BIS central bankers’ speeches Fiscal consolidation is currently a common challenge to many advanced countries. This is because these countries made use of large-scale fiscal spending following the Lehman shock to maintain financial system stability and mitigate the adverse effects on the macro economy. In Europe, fiscal balance is deteriorating not only in those countries with clear symptoms of the sovereign debt problem but also in many other countries. Also, in the United States, the situation remains tense as the government debt has almost reached the ceiling. In these circumstances, we need to recognize the possibility that some events could trigger a worldwide rise in government bond rates, which would have a significant impact particularly on those countries with poor fiscal management. With regard to fiscal management, the often-heard policy suggestions after the earthquake were that the Bank should underwrite government securities or conduct outright purchases of government securities to fund expenses for rebuilding. However, if the view is taken that the central bank conducts monetary policy with the aim of supporting government financing, interest rates will rise, putting adverse effects on Japan’s economy. Since the earthquake, there have been active discussions as to whether various risks were beyond expectations. The problem arising from the central bank’s underwriting, or outright purchases representing a virtual underwriting of government securities, is not beyond expectations. The prospective risks involved are sufficiently predictable at the moment. In order to reduce the risk arising from fiscal deterioration, it is necessary to clearly present the path for achieving fiscal consolidation and implement specific measures. VI. The bank’s conduct of monetary policy Let me turn finally to the Bank’s conduct of monetary policy, based on the outlook and medium- to long-term challenges for Japan’s economy. I have had many occasions to talk about the Bank’s response immediately after the earthquake, so I will not go into detail on this today. It can be summarized as follows. The Bank, with a view to preventing financial shocks from developing into economic instability, worked to provide ample funds to the markets and ensure the functioning of settlement systems, which are the basis of people’s lives and economic activity. The Bank also decided to further enhance monetary easing. Let me explain the Bank’s basic policy stance in more detail. It has continued to consistently make contributions as the central bank through the three-pronged approach of pursuing powerful monetary easing consisting of comprehensive monetary easing, ensuring financial market stability, and providing support to strengthen the foundations for economic growth. Comprehensive monetary easing, which was introduced in October 2010, has three components. First, the Bank has encouraged the policy interest rate – namely, the uncollateralized overnight call rate – to remain at the very low level of around 0 to 0.1 percent. Second, the Bank has made clear that it will continue this virtually zero policy interest rate level until it judges that price stability is in sight, with confirmation that the accumulation of financial imbalances is not identified. The Bank expresses its idea of price stability in the form of the “understanding,” and each Policy Board member’s “understanding” falls in a positive range of 2 percent or lower, centering around 1 percent. The third component of comprehensive monetary easing is the Bank’s establishment of the Asset Purchase Program (hereafter the Program) through which it provides longer-term funds at a fixed rate and purchases various financial assets – namely, government bonds, CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). The Program aims at enhancing monetary easing effects by directly influencing longer-term market interest rates and various risk premiums in order to reinforce the indirect easing effects on those variables from the policy interest rate. The Program started with a size of about 35 trillion yen in October 2010. At the Monetary Policy Meeting (MPM) immediately after the earthquake, when an economic downturn was concerned, the decision was made to increase the amount of asset purchases, mainly of risk assets, which BIS central bankers’ speeches brought the total size of the Program to about 40 trillion yen. Following the decision on the total size of the Program, the Bank is steadily conducting asset purchases. The purpose of comprehensive monetary easing, which consists of the three components I have mentioned, is to support economic activity such that Japan’s economy will be able to achieve sustainable growth with price stability. As I noted earlier, the most fundamental challenge Japan’s economy faces is the decline in growth potential, and the so-called “deflation issue” is a manifestation of this fundamental problem. Deflation can be metaphorically expressed as a decline in body temperature, and it should be addressed by the strengthening of growth potential, or basic physical fitness. In this regard, the Bank has been implementing the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth. Through the measure, the Bank provides long-term funds at a low interest rate to financial institutions that are making efforts in terms of investment and lending to increase the growth potential of Japan’s economy. The funds amount to 3 trillion yen in total and are provided against collateral deemed eligible by the Bank, such as government bonds. At the June MPM this year, the Bank decided to establish a 500 billion yen new line of credit for the measure. With regard to the new line of credit, the Bank decided to support financial institutions’ efforts, focusing on loans with equity-like features to firms with growth potential and lending without conventional collateral or guarantees. For the latter, the lending method that is considered most likely is asset-based lending (ABL). ABL takes firms’ assets that are closely tied to their businesses – such as their inventories, equipment, and machines, as well as accounts receivables – as collateral. ABL currently plays a limited role in Japan but is a quite popular lending method in the United States. The greatest merit of ABL is that it enables firms that do not have sufficient real estate collateral or corporate managers’ personal assets to raise financial resources. For example, start-up firms tend to have a high ratio of accounts receivables to total assets. They will be able to raise funds for business expansion more smoothly if they can make use of their accounts receivables as collateral. ABL is said to be more time-consuming compared with lending against real estate collateral. Viewed in another way, however, the process of utilizing ABL allows a borrower firm and a financial institution to take more time and have closer communications regarding the characteristics and future vision of firms’ businesses. This will encourage a borrower firm to make business decisions based on more accurate analysis of its growth potential and profitability. Furthermore, the Bank has taken various measures in terms of supporting the disaster areas. One example is the funds-supplying operation that provides financial institutions in disaster areas with longer-term funds at a low interest rate, with the aim of supporting these institutions’ initial efforts to meet demand for funds for restoration and rebuilding. Going forward, in the phase when demand for funds for the purpose of restoration and rebuilding becomes full-fledged, the Bank will examine how to provide additional support appropriately as the central bank, based on the specifics of such demand, measures by private financial institutions, and support from the government. In this manner, the Bank has continued to make various efforts on the monetary policy front, taking into account the time horizon of short-term and medium- to long-term periods. The Bank will continue to carefully examine the outlook for economic activity and prices, and take appropriate actions as necessary. Concluding remarks I see I am running out of time, so I would like to conclude my remarks. The earthquake has posed additional challenges to Japan’s economy, which had already faced significant problems to tackle. It is true that Japan’s economy is facing very difficult challenges. However, we should avoid falling into pessimism unnecessarily. In the past, for example, at the time of oil shocks, Japan became an energy-saving society through acceleration of BIS central bankers’ speeches technological innovations. Moreover, the Japanese people’s outstanding ability to overcome problems is evident from the early restoration of supply chains following the disaster. In the process of such restoration, “competitiveness at worksites,” or genbaryoku, and “knowledge at worksites,” or genbachi, both demonstrated by Japanese firms, have been in full play. Japan also has a certain “soft power” that elicits confidence and empathy from around the world, as exemplified by its reputation for hospitality, its skill at generating intellectual property with originality, and the orderly and mutual cooperative behavior of its people seen immediately after the earthquake. In the face of the global financial crisis and the recent earthquake disaster, Japan’s financial system has maintained stability. Japan also has a geographical advantage in that it is located in East Asia, which is currently the most dynamic region in the world. As I have illustrated, at present, Japan has many factors that could lead to a bright future. A sense of urgency is necessary, but pessimism is not. We should face up to the real problem and work on reforms with confidence in our potential. BIS central bankers’ speeches
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Nagano, 20 July 2011.
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Hirohide Yamaguchi: Challenges to Japan’s economy and monetary policy after the Great Earthquake – preparations for uncertainties and strengthening of growth potential Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Nagano, 20 July 2011. * * * Introduction I am honored today to have this opportunity to speak and to exchange views with administrative and business leaders in Nagano Prefecture. And I express my gratitude for your cooperation in various business operations of the Bank of Japan’s Matsumoto branch and the local office in Nagano. On a personal note, Nagano Prefecture is a place full of memories. I started my career at the Bank in 1974, and worked at the Matsumoto branch for two years from 1975. I frequently visited corporate managers and learned about the details of the conditions of the regional economy and finance. Speaking of 1975, Japan was in the face of adversity due to the oil shock, and was faced with a shift from a high growth era to a stable growth era. Against such a backdrop, firms in this region made tremendous efforts and honed their technical skills, which still strongly impresses me. Japan’s economy is also faced with a major turning point due to a demographic vortex. In addition, the Great East Japan earthquake occurred, and Japan’s economy is faced with yet another challenge. Today, bearing in mind the medium- to long-term challenges Japan is faced with, I will talk about economic developments at home and abroad and the Bank’s policy responses. I. Outlook and risks for overseas economies I will begin with the developments in overseas economies. While the pace of growth in overseas economies has recently been slowing somewhat, growth rates remain high and those economies are expected to continue to achieve relatively high growth. In the following, I will talk about the recent developments, outlook, and risk factors associated with the outlook, by region. A. The U.S. economy The recent deceleration is temporary The U.S. economy, while repeating somewhat strong and weak phases back and forth after the Lehman shock in the autumn of 2008, has been recovering moderately on average. Its recent deceleration is basically said to be attributable to the following two factors. First, the rapid rise in gasoline prices up to this spring. By that, households could not afford to make other spending, and private consumption weakened. Second, the effects of the earthquake disaster in Japan. In industries, particularly automobile, parts procurement from Japan delayed and a reduction in production spread. Those two factors were only temporary. Oil prices have been somewhat stable, and parts procurement from Japan has been returning to normal. It is widely viewed that the U.S. economy will gradually regain its pace of growth. BIS central bankers’ speeches Balance-sheet adjustment pressure will be a headwind in the medium to long term There are, to begin with, structural factors at play in the current U.S. economy, which makes it difficult to achieve a steady recovery. It is the after-effects of the collapse of the bubble. The Lehman shock resulted in a global financial crisis that involved countries including Japan. The reason for such a massive crisis is that the housing and financial bubbles that had bloated in the United States were extremely big. In the United States, even low-income families increasingly borrowed mortgages until after the mid-2000s. Financial products that assembled and securitized such subprime mortgages were sold as attractive investment products to investors around the world. In that process, financial institutions gained massive profits. The reason that everybody could enjoy such a banquet was the assumption that U.S. housing prices would continue to rise. Once that assumption collapsed, everything was reversed. As a result, delinquent mortgages piled up, which plagued U.S. households and financial institutions. Since it is a problem that asset prices declined and liabilities became a heavy burden, or capital ran short, it is called “the balance-sheet problem.” Japan’s economy also experienced a similar problem in the 1990s. As one can tell from that experience, in the economy after the bursting of a huge bubble, the average economic growth rate will be contained over a protracted period. Since the U.S. economy is recovering against such a headwind, it is likely that weak resilience as witnessed recently might occur from time to time in the future. B. European economy Recover moderately with difference among countries In Europe, major countries including Germany have been basically buoyant albeit exports somewhat decelerating recently. Business fixed investment and private consumption have been increasing. Some countries including Southern European countries are weak in international competitiveness to begin with, and have to take fiscal austerity to address fiscal problems, which has been dragging the economies. While conditions in European countries vary substantially from country to country, the European economy has been recovering moderately as a whole. Sovereign debt problem continues to be a destabilizing factor for the international financial markets The European economy as a whole is expected to continue to recover moderately in the future. However, the concern about the creditworthiness of government bonds issued by countries including Greece and Portugal – the so-called sovereign debt problem – is likely to be a destabilizing factor for some time not only within Europe but also in the global economy. The total economic scale of Greece and Portugal I have just referred to is less than 1 percent of the global economy. However, European financial institutions have a substantial amount of exposure to those countries. If the government bonds of those countries face default, anxiety about the soundness of European financial institutions might rise. In addition, some relatively large economies face similar fiscal problems, albeit lesser in magnitude than the countries including Greece. If there is a situation in which the creditworthiness of government bonds of large economies also declines significantly, the effects on financial institutions will also become far-reaching. As financial transactions have recently become extensive and complex, if anxiety is generated in some part of financial markets, anxiety could spread over the entire international financial markets. Investors might become increasingly risk averse and stock prices and foreign exchange markets might fluctuate substantially. We should be careful in that once any disruption occurs in Europe, Japan’s economy, seemingly distant, might also be involved in turmoil through a plunge in stock prices and appreciation of the yen. BIS central bankers’ speeches The difficulty of the sovereign debt problem is that a country whose problem once becomes serious will be mired in the problem. Fiscal austerity leads to a decline in economic activity and tax revenue will increasingly decline. In addition, if financial institutions incur massive losses due to a decline in government bond prices, the real economy will be adversely affected and it will become necessary to augment capital of financial institutions by way of fiscal funds. As illustrated, three factors – deterioration in fiscal conditions, economic downturn, and the weakening of the financial system – are subject to an adverse feedback loop that mutually affects each other, and that delays the resolution of the problem. Given such characteristic of the European sovereign debt problem, that is likely to continue to be a destabilizing factor in the global economy over a protracted period. C. Emerging economies Emerging economies are leading the global economy Despite advanced economies being burdened with respective problems, according to the World Economic Outlook of the International Monetary Fund (IMF), the growth rate of the global economy is forecasted to register growth of around 4.5 percent both in 2011 and 2012. While I have mentioned that there had been a credit bubble for a protracted period before the Lehman shock, the average annual growth rate of the global economy for 10 years until 2007, which includes the bubble period, was 4.0 percent. Therefore, the forecast of “around 4.5 percent” for this year and next year can be considered to be rather robust growth. That is attributable to high growth in emerging economies including China. For instance, China’s growth rate in 2010 was 10.3 percent and it is expected to be 9.6 percent in 2011 according to the IMF outlook. China has been growing at a high rate comparable to that of the high-growth era in Japan. As for the contents of growth, China had been called a “factory of the world” up to a little while ago, but as people’s income levels improved, it has also become a “world consuming market.” For reference, the number of new cars sold in China last year was 18 million, which exceeds the sum of those in the United States and Japan. Such high economic growth is occurring not just in China, but also in India, Brazil and many other emerging countries. Naturally, they need a tremendous amount of energy and raw materials. As a consequence, buoyant demand for mineral resources including crude oil, ironstone, and nonferrous metals has been generated. In addition, as living standards of emerging countries rose, dietary habits have changed and people have come to eat more meat than before, so that demand for grains including those used to feed cattle and pigs has increased globally. An increase in global demand for various kinds of natural resources and food has brought about high growth in the so-called commodity-exporting countries, such as Canada, Australia, and Russia that produce primary commodities. A pattern that the global economy continues to grow led by emerging and commodity-exporting economies is likely to remain intact for some time. The challenge is to overcome inflationary pressure Emerging economies do have a blind spot. It is inflation. Even emerging economies have recently been decelerating basically because of the tightening of monetary policy against the rise in the inflation rate. But it is not yet known whether the tightening to date can sufficiently reduce inflationary pressure. Whether an increase in demand will be properly controlled and emerging economies will make a soft landing, in a manner that price stability successfully goes together with economic growth, is likely to remain highly uncertain for some time. The inflationary pressure in emerging economies is partly induced by a rise in international prices of mineral resources and foods. In order for emerging economies, and eventually the global economy, to achieve high growth in the medium to long term without increasing BIS central bankers’ speeches inflationary pressure, I believe it so important to make efforts on a worldwide basis in innovation of resource and energy saving as well as in improvement in food productivity. Based on overseas economic developments, let me now turn to Japan’s economy. II. Economic activity and prices in Japan A. Current state and outlook for economic activity and prices Return to the moderate recovery path in the latter half of fiscal 2011 After the Great East Japan Earthquake on March 11, Japan’s economy once plunged. While, in many cases, an economic downturn is induced by a decline in demand, the plunge after the earthquake has basically been due to constraints on the supply side, including a shortage in parts and power. First, factories and distribution infrastructure have been damaged or destroyed by the earthquake and tsunami, and procurement of raw materials and parts necessary for production has been disrupted. A complicated network of the supply chain has been cut off and nationwide production, particularly automobiles that require many parts, has been greatly affected. Second, due to the nuclear power plant accident, the power generating capacity of Tokyo Electric Power Company and Tohoku Electric Power Company has once declined by 20 to 30 percent. The effects have spread over to various activities other than manufacturing: Events including concerts have been cancelled and department stores have shortened their business hours. Of course, not everything is due to the supply constraints, and the voluntary restraint associated with the earthquake disaster and the problem of radiation due to the nuclear plant accident have also adversely affected consumer sentiment. Thereafter, supply constraints have been rapidly alleviated and production and exports have been recovering at a faster pace than expected by the concerned parties immediately after the earthquake. Firms’ production activity is expected to return approximately to the level prior to the earthquake in the near future. Such rapid recovery is, after all, attributable to the firms’ strenuous efforts. There have been moves of solidarity that go beyond the individual corporate framework, such as firms taking over the production on behalf of other firms in the same industry, and firms lending factories or machinery to the disaster-stricken small firms. A power shortage this summer is also not likely to constrain economic activity to the extent expected earlier. Taking the recent developments into account, Japan’s economy is expected to return to the moderate recovery path in the second half of fiscal 2011 onward amid the continued improvement in overseas economies. In the outlook the Bank released last week, Japan’s economic growth will stay at a low rate of 0.4 percent in fiscal 2011 due to the effects of the plunge after the earthquake, but is forecasted to accelerate to 2.9 percent in fiscal 2012. Inflation is expected to remain slightly positive Now, let me turn to prices. The year-on-year rate of change in the typical price indicator, the consumer price index (CPI), had been negative since shortly after the Lehman shock. As the effects of the shock subsided, the degree of negative had become gradually small, and the rate of change turned positive for the first time in 28 months in April and registered plus 0.6 percent in May. Since the economy is expected to return to the moderate recovery path, the year-on-year rate of change in the CPI is also expected to remain slightly positive. More specifically, the outlook the Bank released last week forecasted a rise of 0.7 percent for both fiscal 2011 and 2012. BIS central bankers’ speeches B. Uncertainties associated with future economic activity and prices Overseas financial and economic developments require caution I emphasize that the outlook for economic activity and prices that I have mentioned is associated with various uncertainties. After the earthquake up to now, there has been high uncertainty concerning what extent the supply chain will recover promptly. Such risk has, as I mentioned earlier, been subsided considerably. Rather, from now on, economic activity will depend on whether demand itself continues to increase steadily. In that regard, consumer sentiment, which recovered considerably compared with that immediately after the earthquake, has yet to recover completely. In addition, the most important assumption for Japan’s economic recovery is a mechanism that overseas economies, particularly emerging economies, will continue to grow at a high rate, under which Japan’s exports increase and positive effects spread to business fixed investment and employment. However, as I have mentioned earlier in detail, the outlook for the United States, Europe, and emerging economies is associated with high uncertainty. Increasingly uncertain power situation In the domestic area, uncertainty has rather increased about the somewhat longer term electricity supply beyond this summer. That is because nuclear power plants across Japan are not resuming operation smoothly after their regular inspections. Even if nuclear power is to be substituted by thermal power, the electricity costs are expected to rise. After the earthquake, an earthquake risk in Japan has been recognized again, and firms at home and abroad have been increasingly diversifying their parts procurement from Japan’s domestic suppliers to overseas suppliers. Partly due to the effects of the nuclear plant accident, the number of foreign tourists has plunged. On top of those, with the addition of anxiety against stable power supply and increase in costs, whether the hollowing out of industry, which is sometime called as “passing on Japan” or “avoiding Japan,” might intensify or not warrants vigilance. Risk of delay in achieving price stability If economic activity becomes weaker than the aforementioned outlook due to various uncertainties, prices might be lower than expected. In addition, prices are associated with statistical uncertainty. The CPI is subject to revision every five years, and there will be a revision this year. The current index will be replaced in August by a new index, and the recent data will also be revised retroactively. While I have mentioned earlier that the year-onyear rate of increase in the CPI was 0.6 percent in May, it is likely to be revised downward to around zero percent by the index revision. As the recent data will be revised, the outlook for the year-on-year rate of increase in the CPI, which was 0.7 percent for both fiscal 2011 and 2012, has to be read slightly lower. The Bank considers that a state in which the year-on-year rate of change in CPI hovers in a positive range of 2 percent or lower, centering around 1 percent, is closest to “price stability.” The current outlook for prices suggests that it might take some more time to achieve such “price stability,” and we need to monitor carefully how future economic developments and the index revision might affect the timing of price stability achievement. III. Medium- to long-term challenges to Japan’s economy Long-term downward trend in economic growth is one cause of deep-rooted deflation Japan’s deflationary trend has been continuing for a protracted period. That suggests that there might be a structural problem as well as cyclical weakness in economic activity on the back of deflation. Looking back at Japan’s economic growth rate over time, the average BIS central bankers’ speeches annual growth rate of Japan’s economy declined from around 5 percent in the 1970s, to around 1.5 percent in the 1990s, and below 1 percent in the 2000s. When the economic growth rate follows a long-term downward trend, firms and households inevitably tend to consider that future growth will continue to be low anyway. Such decline in firms’ and households’ expectations for future growth have restrained actual demand, such as business fixed investment and private consumption, and thus might have been one cause of a deeprooted deflation. Deflation is not desirable, and, if the current low growth rate continues, it will become difficult to maintain fiscal conditions and social security in the future. Therefore, strengthening medium- to long-term growth potential was a major challenge to Japan’s economy since before the earthquake. To tackle that challenge will lead to avoiding the after-effects of the earthquake disaster including the hollowing out of industry. Source of economic growth is each person’s power to generate added value The demographic vortex might have had a substantial influence on the long-term downward trend in the economic growth rate. If that is the case, one natural solution to strengthen the growth potential is to correct the demographic vortex. Some examples include creating better conditions to support childbearing and rearing to reverse the downward trend in the birth rate or more actively accepting immigrants and labor force from abroad. However, even if we boost the birth rate now, it takes about 20 years before it leads to an increase in labor force. As strengthening the growth potential is a more urgent challenge to tackle, we cannot afford to wait for demographic changes to take place. Let us go back to a simple mathematical formula. GDP, which is used to measure economic growth, is a multiplication of the number of workers and GDP per worker. Given that the number of workers will be to a large extent determined by demographics that cannot be changed easily, there is no way but to increase GDP per worker in order to increase GDP. GDP is, in other words, added value and is distributed in the form of corporate profits and household income. Therefore, creating added value is nothing more or less than firms increasing their own profit while raising employment and wages. In order to do so, it is necessary to tap potential demand of the field that is considered to have a good chance of success and create new markets. As specific directions, I mark four points that are deemed critical. Further tapping global demand First, drastic globalization. Incidentally, while the export share in GDP is about 50 percent in Germany and Korea and about 30 percent in China, it remains at about 15 percent in Japan. Moreover, the number of foreign tourists visiting Japan is only 10 percent compared with that visiting France, the United States, and China, and it ranks around 30th in the world, which is lower than Korea and Singapore. Depending on the ambition and creativity to open up the country, Japan seems to have room for capturing global demand and growing. Innovation in the areas of resources and energy Second, to make a leap in technology and know-how to enhance resource and energy efficiency. As I mentioned earlier, it seems to be tight supply and demand condition of resources, energy and food that may become a major constraint for the global economy to continue to grow strongly, especially in emerging countries, while avoiding inflation. Innovations including energy saving will contribute not only to a near-term domestic electricity shortage but also to medium- to long-term global economic growth. BIS central bankers’ speeches Tapping domestic potential demand Third, there appears to be plenty of unexplored need in the domestic markets where the demographic vortex and maturation are progressing, such as medical and nursing care as well as other areas. It is said more than often that Japan is already affluent and consumers do not want anything more. Arguably, if we look only at the existing goods and services, not a few of them might have already reached saturation point. Even so, in terms of people’s potential desire, a desire to enjoy life more or to live a more comfortable life will not disappear. It is the real entrepreneurship to strategically tap potential demand that even consumers themselves are not aware of. Incidentally, the generation which is in the prime will peak out within 10 years in some Asian countries such as China and Korea, and aging will progress following the path of Japan. If Japan, as a country that faces the challenge ahead of other countries, is able to build a vigorous economy under aging, it could serve as a good role-model for other countries that will be faced with aging at a later stage. Strengthening financial power to provide risk money Fourth, roles which finance plays. Firms’ aspiring approaches in tapping new demand do not necessarily succeed. To put it another way, challenging things that might fail will lead to exploring a chance of growth. Namely, a certain amount of risk is associated with growth and it is a role of finance to provide risk money to support the growth. Therefore, in order to enhance the medium- to long-term growth potential of the economy, it is necessary to reinforce the role of finance. In sum, Japan’s economy is faced with two challenges which have different time horizons. First, achieve a cyclical recovery in the economy that has plunged due to the earthquake disaster amid significant various uncertainties including the future of overseas economies. Second, tackle the strengthening of growth potential from a medium- to long-term perspective. The second challenge will further ensure the first challenge of achieving an economic recovery and contribute to bringing forward the escape from deflation. Based on the summarization, let me explain how the Bank’s monetary policy is responding to the challenges. IV. The Bank’s monetary policy Pursuing powerful monetary easing In order to support the cyclical economic recovery and achieve price stability as promptly as possible, the Bank is pursuing powerful monetary easing measures as follows. First, the Bank set its policy interest rate at extremely low level of around 0 to 0.1 percent, and made a commitment that it would basically continue with the low policy interest rate until it judged that price stability was in sight. Moreover, since October 2010, the Bank has established a new framework called Asset Purchase Program and, through that program, it has been purchasing not only government bonds but also a wide range of risk assets – namely, CP, corporate bonds, exchange traded funds (ETFs), and Japan real estate investment trusts (J-REITs). By way of that, the Bank has been encouraging a decline in longer-term interest rates, and, at the same time, acting as a catalyst for risk money flowing into financial markets, thereby trying to generate favorable effects on the economy. The Program started at about 35 trillion yen in total, and was increased to about 40 trillion yen immediately after the earthquake in March, trying to minimize the deterioration of economic conditions. Providing support to strengthen the foundations for economic growth In relation to Japan’s economy’s other challenge of strengthening medium- to long-term growth potential, the Bank has been conducting the Fund-Provisioning Measure to Support BIS central bankers’ speeches Strengthening the Foundations for Economic Growth since June 2010. This is a measure for the Bank to provide long-term funds with maturities of initially one year and maximum four years if rolled over at a low interest rate of 0.1 percent to financial institutions that tapped projects that would lead to strengthening medium- to long-term growth potential and made equity investment or lending. Since the introduction of the new measure, many financial institutions have been taking positive approaches such as establishing special sections devoted to devising and developing new areas of growth. The scheduled total amount of loans – 3 trillion yen – had mostly been disbursed. Therefore, the Bank created a 500 billion yen new line of credit in June 2011. The new line of credit provides funds at a low interest rate of 0.1 percent for initially two years and maximum four years to financial institutions that make equity investment and conduct lending against accounts receivable and inventories as collateral. Lending that takes accounts receivables and inventories as collateral is called asset-based lending (ABL) and is utilized widely in the United States. Compared with real estate collateral lending, the ABL is more difficult in terms of making collateral assessment. The value of assets that have been generated in the process of business cannot be assessed unless a borrowing firm and a financial institution share the thorough understanding of the business contents and developments in the industry. Nevertheless, aggressively putting such extra efforts will have a great merit in that it enables firms which do not own enough real estate collateral or personal guarantees to raise financial resources. To take advantage of such merit, the Bank expects that corporate managers and financial institutions will jointly make efforts to explore profit opportunities, and the hidden seeds for growth to sprout in Japan as a whole. Respond flexibly and decisively when risks manifest themselves As explained, the Bank has been pursuing powerful monetary easing and providing support to strengthen the foundations for economic growth, while stepping into an extraordinary territory for a central bank. However, as I have repeatedly mentioned today, the Bank is aware that uncertainties at home and abroad are significant. Upon carefully examining future economic and price developments, including the effects of the recent foreign exchange rate fluctuation, the Bank will, if judged necessary, take appropriate policy actions in a flexible and decisive manner. Concluding remarks In conclusion, I will refer to Nagano Prefecture’s economy. The development of Japan’s economy depends on what extent it can incorporate globalization and aging into its advantage. In that regard, Nagano’s economy has been developing by always paying attention to global markets, from the prewar era of the silk industry to the postwar era of electric and precision machinery. Nagano’s export share in manufactured goods shipments has been consistently above the national average most of the time since the 1990s. Also in terms of responses to aging, Nagano Prefecture is one step ahead of other regions. Nagano is not only one of the leading longevity prefectures in Japan and but also known for its high employment rate of elderly people. While the national average of the percentage of people aged 65 or older at work is about 20 percent, it is more than 30 percent in Nagano and ranks top in the nation. Also here in Matsumoto City, a project is underway to enhance health and create a comfortable place to live under the initiative called “the city of long and healthful lives.” Such efforts to create an environment that makes it easy for elderly people to work will also serve as a good reference for Japan as a whole. I will offer my heartfelt support so that your wisdom and actions that go ahead of the times will further develop the region and pave the way for Japan’s future. BIS central bankers’ speeches
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Statement by Mr Masaaki Shirakawa, Governor of the Bank of Japan, concerning the Bank's Semiannual Report on Currency and Monetary Control, before the Committee on Financial Affairs, House of Councillors, Tokyo, 9 August 2011.
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Masaaki Shirakawa: Recent developments in Japan’s economy and the conduct of monetary policy Statement by Mr Masaaki Shirakawa, Governor of the Bank of Japan, concerning the Bank’s Semiannual Report on Currency and Monetary Control, before the Committee on Financial Affairs, House of Councillors, Tokyo, 9 August 2011. * * * Introduction The Bank of Japan submitted to the Diet its Semiannual Report on Currency and Monetary Control for the second half of fiscal 2010 in June 2011. I am pleased to have this opportunity to talk about recent developments in Japan’s economy and present an overall review of the Bank’s conduct of monetary policy. I. Economic and financial developments in Japan I will first explain economic and financial developments in Japan. Japan’s economic activity has been picking up steadily as the supply-side constraints caused by the earthquake disaster have eased due to efforts from concerned parties. As for the outlook, Japan’s economy is expected to return to a moderate recovery path with production regaining traction, backed by an increase in exports and a rise in demand for restoring capital stock. However, the Bank recognizes that the economic outlook entails considerable uncertainty and judges that recent developments call for closer attention to downside risks. In the United States, concern over fiscal consolidation has not dissipated in financial markets even though the debt ceiling problem has settled for the present, and views on the economic outlook have become more cautious. The sovereign debt problem in peripheral European countries still warrants attention and emerging economies face the challenge of achieving price stability and economic growth at the same time. As such, the prospect of overseas economies entails a high degree of uncertainty. There is a possibility that these developments in overseas economies and the ensuing fluctuations in the foreign exchange and financial markets will have adverse effects on business sentiment, and consequently on economic activity in Japan. On the price front, the year-on-year rate of change in the CPI has been slightly positive. The Bank recognizes that the year-on-year rate of change in the CPI is likely to be revised downward with the base-year change scheduled this month. Taking the scheduled revision also into consideration, it appears that it will still take some time to achieve price stability. Meanwhile, the finance ministers and central bank governors of the G-7 made clear yesterday that, in response to the recent strains on global financial markets, they would remain in close contact and cooperate as appropriate, ready to take action to ensure stability and liquidity in financial markets. II. Conduct of monetary policy Next, let me explain the Bank’s conduct of monetary policy. First, the Bank has been pursuing powerful monetary easing through comprehensive monetary easing. Under the comprehensive monetary easing framework, the Bank encourages a decline in longer-term market interest rates and a reduction in various risk premiums through the Asset Purchase Program. At the Monetary Policy Meeting held last week, the Bank, with a view to responding to the downside risks to the economy that I BIS central bankers’ speeches described earlier, decided to increase the total size of the Program by about 10 trillion yen, to about 50 trillion yen. Second, the Bank has been making efforts to ensure financial market stability. Third, in order to meet the biggest challenge for Japan’s economy, which is the strengthening of the foundations for economic growth, the Bank has been providing funds to private financial institutions that make lending and investment consistent with the policy goal. The funds are provided against collateral such as government securities, at a very low interest rate. With a view to making this framework more effective, in June 2011 the Bank decided to establish a 500 billion yen new line of credit, through which it extends loans to financial institutions for their equity investments and the so-called asset-based lending (ABL). The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. Based on such strong recognition, the Bank will continue to consistently make contributions as the central bank through the three-pronged approach that I have explained. BIS central bankers’ speeches
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Speech by Mr Seiji Nakamura, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Nara, 2 June 2011.
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Seiji Nakamura: Japan’s monetary policy and developments in economic activity and prices Speech by Mr Seiji Nakamura, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Nara, 2 June 2011. * I. * * The Bank of Japan’s business operations Let me start my speech today by briefly explaining the business operations and functions of the Bank. The Bank conducts monetary policy with the aim of achieving price stability and thereby contributing to the sound development of the national economy, pursuant to the Bank of Japan Act. In the mind of the public, the Bank is most strongly associated with its role as the authority in charge of monetary policy, in order to achieve price stability and – as another of its objectives – financial system stability, but the Bank in fact carries out a wide range of business operations. Examples of the Bank’s business operations include the following. First, as part of its role as the sole issuer of banknotes, the Bank ensures the smooth circulation of clean banknotes across Japan. As of the end of May, there were about 13.1 billion banknotes in circulation with a total value of around 78.84 trillion yen. Second, to maintain financial system stability, it acts as the “bank of banks” by ensuring the smooth settlement of funds and monitoring financial institutions’ business conditions. Third, it acts as the “bank of the government,” receiving and disbursing treasury funds and conducting services relating to Japanese government securities (JGSs). Fourth, the Bank conducts surveys and research on developments in economic activity and prices at home and abroad, such as the Tankan (Short-Term Economic Survey of Enterprises in Japan), which requires the support of survey respondents nationwide. And fifth, in cooperation with overseas central banks, the Bank executes business operations in the field of international finance. These various business operations are carried out by the roughly 5,000 employees at the Head Office, 44 branches and local offices in Japan, and seven overseas representative offices. The flow of money in an economy is often compared to the circulation of blood in the human body in that, once it stops or slows, the whole system can fail. Maintaining the functioning of the nation’s payment and settlement system is, therefore, an important element of the central bank’s role in supporting economic activity. To this end, the Bank is continually improving its business continuity arrangements by preparing for emergency situations – natural disasters such as earthquakes, terrorist attacks, computer system failures, and the spread of epidemics such as influenza – including ensuring that essential staff necessary for the conduct of business operations are always available. On Friday, March 11, the Great East Japan Earthquake occurred during normal business hours at 2:46 p.m., and the Bank immediately set up a disaster management team headed by the Governor. The Bank of Japan Financial Network System (BOJ-NET) – the core system for the interbank settlement of funds and securities – continued to operate as usual following the earthquake. To prevent a shortage of cash in the disaster areas, the Bank’s branches in the Tohoku region provided a total of 55 billion yen during the weekend immediately after the earthquake. Also, to ease liquidity concerns, the Bank provided ample funds to the money market, totalling 82.4 trillion yen, in the week starting March 14, the first business day after the earthquake, thus preventing any turmoil in the market. Power outages at some of the Bank’s branch premises were dealt with by the use of stand-by in-house power generation systems. To exchange damaged or soiled banknotes and coins for clean ones, the Bank increased the number of staff at branches in the disaster areas and opened a temporary cash exchange counter in Iwate Prefecture, where the Bank does not have a branch. As of the end of May, the amount outstanding of cash exchanged at the branches in BIS central bankers’ speeches the Tohoku region, including Sendai, Fukushima, Akita, and Aomori, and the temporary counter in Morioka in Iwate Prefecture, was 1.883 billion yen. These business operations may seem distant from the conduct of monetary policy at first glance; however, public confidence in the currency and the Bank could be undermined, which in turn could hamper the Bank’s conduct of monetary policy, should the Bank fail to provide central banking services in a stable manner. II. Recent developments in economic activity A. Overseas economies Next, I will discuss developments in economic activity at home and abroad, starting with the situation overseas. With advanced economies continuing to recover at a modest pace, the global economy has continued to recover moderately, driven mainly by strong growth in emerging and commodity-exporting economies. According to the International Monetary Fund (IMF) World Economic Outlook released in April, the global economy is projected to grow 4.4 percent in 2011 and 4.5 percent in 2012, indicating that global economic growth is likely to remain firm. The impact of the earthquake on overseas economies generally appears to be limited. Led mainly by robust domestic demand, emerging and commodity-exporting economies have continued relatively high growth and are driving global growth. However, in many of these economies, concerns about inflation have been mounting due to the earlier rise in international commodity prices, prompting their central banks to lean toward monetary tightening by, for example, raising policy rates and reserve requirement ratios. China’s economy currently continues to grow at a rate of around 9.0–10.0 percent, while inflation runs at a rate of about 5.0–6.0 percent, exceeding the government’s inflation target of 4 percent. Against this background, the People’s Bank of China recently implemented the fifth increase so far this year of the reserve requirement ratio and strengthened liquidity controls, including setting a ceiling on aggregate credit newly extended by banks, and is strengthening its stance to curb inflation. These measures may dampen economic growth to some extent, but given that China is enjoying a virtuous cycle of growth in exports, production, income, and spending, the economy, on the whole, is likely to continue to grow at a relatively high rate. The U.S. economy has been recovering and is likely to remain on a recovery trend. The seasonally adjusted annualized quarter-on-quarter growth rate of real GDP in the January– March quarter of 2011 was 1.8 percent. Although this is lower than the 3.1 percent recorded in the preceding quarter, it confirms that, mainly thanks to exports and private consumption, the U.S. economy continues to recover. However, balance-sheet adjustments in the heavily indebted household sector remain a major drag on the economy, the prolonged sluggishness in the housing market persists, and the unemployment rate, which stood at 9.0 percent in April, is still high. Although private-sector employment has continued to trend up, the improvement still lacks the momentum to make up for the approximately 8 million jobs lost since the Lehman shock. While the Federal Reserve has announced that it will end purchases of an additional 600 billion U.S. dollars of Treasury securities by the end of June 2011, as scheduled, it also emphasized that it will continue to maintain an accommodative monetary policy stance for an extended period in a situation where the U.S. economy lacks vigor as a whole. European economies as a whole have been recovering moderately, albeit with some differences in growth by country. While peripheral countries in the euro area are registering low growth, large core economies, such as Germany and France, are enjoying steady growth supported by increases in exports, particularly to the emerging economies, and private consumption. As for the outlook, the pace of economic growth in Europe as a whole is likely to remain moderate, given that countries in the euro area are implementing austerity BIS central bankers’ speeches programs as part of their fiscal consolidation measures and because of the uncertainties regarding how the debt problems in countries such as Greece will develop. In this environment, the European Central Bank (ECB) in April raised its policy rates for the first time since the Lehman shock owing mainly to increases in international commodity prices. However, given the major risk factor presented by problems involving the credit risk of government bonds issued by peripheral countries in the euro area, the outlook for European economies, particularly Greece, remains highly uncertain. While the issue of fiscal consolidation in Europe and the United States has been gaining attention, let me touch upon the fiscal status of Japan. Although Japan has the highest ratio of public debt to GDP among major industrialized countries, yields on Japanese government bonds (JGBs) have remained stable at low levels. One likely explanation is that JGBs continue to command market confidence, despite Japan’s grave fiscal situation. Fiscal consolidation is not a task that can be achieved over a short period of time. It is therefore important for Japan to steadily work on measures aimed at fiscal consolidation while market confidence regarding the creditworthiness of JGBs remains in place. B. Japan’s economy Following a V-shaped recovery after the Lehman shock, Japan’s economy had been on a moderate recovery trend, but the situation changed completely with the earthquake on March 11. The economy is currently facing strong downward pressure, mainly on the production side. Although the preliminary results for the industrial production index for April show a small increase of 1.0 percent from March – mainly due to progress in the restoration of supply chains – the level of production remains at only around 85 percent of that in February, that is, just before the earthquake. Automobile production in particular dropped sharply, and the number of passenger cars produced in April marked a year-on-year decline of 60.2 percent. In these circumstances, real exports have continued to decline, registering a 6.9 percent fall in April from the previous month, due largely to the substantial decline in automobile exports caused by production constraints. However, production is likely to improve, with the production forecast index for May suggesting a month-on-month increase of 8.0 percent and that for June suggesting an increase of 7.7 percent. Moreover, in the automobile industry, production activity is gradually returning to normal. Parts makers announced that they would resume production of core components in June and hoped to achieve pre-quake production levels by the end of October. Major automakers also announced that they would raise production so that, from early autumn, production levels would gradually return to close to normal. Thus, although at present production continues to be well below normal levels, firms in the Japanese auto and parts industries seem to have become more confident about the restoration of production sites in coming months, which significantly contrasts with the early post-quake stage, when they found it difficult to specify the timing of such restoration. These developments, I think, can be interpreted as a positive development. Private consumption has also been weak, caused by sluggish sales due to supply constraints and restraint in consumption due to a deterioration in consumer sentiment. That being said, looking at retail sales indicators for April, although sales at convenience stores slowed, they still showed a year-on-year increase of 3.0 percent, while the year-on-year rate of decrease in sales at department stores decelerated considerably to 1.8 percent in April from 15.0 percent in March. A similar trend can be observed for sales in the food service industry. According to the Economy Watchers Survey for April, conducted between April 25 and 30, the diffusion index (DI) for current economic conditions remained at a deeply depressed level, but that for future economic conditions marked an increase of 11.8 percentage points, suggesting an improvement in business sentiment. Although consumers continue to restrain consumption of nonessential items, reports in the media as well as anecdotal evidence suggest that consumption has been gradually increasing since May, which included a string of holidays known as “Golden Week,” as voluntary restraint and supply constraints on goods BIS central bankers’ speeches and electricity have eased. That being said, substantial differences across regions and industries remain. The number of foreign visitors to Japan continued to fall substantially, registering a year-onyear decrease of 62.5 percent in April, following a drop of 50.3 percent in March. Partly as a result, the occupancy rates of major hotels in Tokyo (19 respondents) and Osaka (15 respondents) dropped sharply in April, according to a survey by Nikkei Inc. C. Baseline scenario of the outlook for the economy and prices Next, I will talk about the outlook. The main reason behind the current drop in economic activity is the supply-side shock caused by the earthquake and, as highlighted in the Outlook for Economic Activity and Prices (Outlook Report) released at the end of April 2011, the prospects for Japan’s economy crucially hinge on a recovery in production and exports. For the time being, Japan’s economy is likely to continue facing downward pressure, mainly on the production side, since it is likely to take some time to reconfigure supply chains and electricity supply constraints are likely to occur at peak times in the summer. However, from early autumn onward, with further progress in the reconfiguration of supply chains – which have been seriously disrupted, particularly in the automobile industry – and easing in electricity supply constraints, production and exports are likely to increase again against the backdrop of steady growth in overseas economies. In this situation, private consumption is likely to pick up again gradually and, together with a rise in demand for reconstruction, this is likely to accelerate the pace of recovery in the second half of fiscal 2011. In fiscal 2012, demand for reconstruction is likely to remain high, while overseas economies, especially emerging and commodity-exporting economies, are likely to continue growing steadily. The transmission mechanism by which increases in exports and production feed through into income and spending is likely to strengthen, and Japan’s economy is projected to grow at a pace above its potential in fiscal 2012 due in part to a rebound from the significant deceleration in fiscal 2011. The Bank’s forecast for real GDP growth released for reference in the Outlook Report is 0.6 percent for fiscal 2011 and 2.9 percent for fiscal 2012. As for price developments, the year-on-year rate of change in the consumer price index (CPI) for all items excluding fresh food in fiscal 2011 is likely to be slightly higher than in the previous year due to the falling off of the effects of subsidies for high school tuition introduced in fiscal 2010 and to the rise in international commodity prices. The Bank’s forecast for the average annual rate of increase in the CPI is around 0.7 percent for both fiscal 2011 and 2012. However, it needs to be noted that in August the Ministry of Internal Affairs and Communications, which is in charge of compiling the CPI, will announce revised CPI figures based on a change of the base year from 2005 to 2010, and that as a result the year-on-year rate of change in the CPI may be revised downward. D. Upside and downside risks to the baseline scenario of the outlook The baseline scenario I just presented is subject to various upside and downside risks, which warrant attention. First, there is a high degree of uncertainty – both on the upside and on the downside – about the effects of the earthquake on Japan’s economy. In addition, if firms and households were to maintain an overly pessimistic view regarding the outlook for Japan’s economy, domestic demand – such as business fixed investment and private consumption – could be restrained over the medium to long term, posing the risk of a decline in the expected growth rate of the economy. Further, economic activity might turn out weaker than in the baseline scenario presented in the Outlook Report if – due to delays in the reconstruction of supply chains, for example – firms accelerate the shift of production and/or parts procurement overseas or the share of Japanese products in overseas markets falls, or if the tense situation at the nuclear power plant and electricity supply constraints continue to linger. On the other hand, economic BIS central bankers’ speeches activity in Japan might turn out stronger than projected if, due to the damage caused by the earthquake, firms strengthen efforts to establish new production sites in Japan and reconfigure supply chains to diversify risks, make new investments aimed at promoting more efficient use of energy, or create new demand by developing new products in response to changes in lifestyles. Furthermore, the earthquake has brought into focus a wide range of issues that have been left unaddressed for years. If this can be grasped as a chance to carry out fundamental reforms, then – I would like to think – it may present an opportunity for Japan’s economy to emerge from its prolonged stagnation. The next risk factor concerns developments in overseas economies. For the U.S. and European economies, downside risks prevail: the U.S. economy is burdened by balancesheet adjustments in the household sector, while in Europe sovereign risk problems are lingering in some peripheral countries such as Greece, and these problems may act to reduce economic activity through disturbances in financial markets. On the other hand, emerging and commodity-exporting economies for the time being are likely to maintain relatively high growth led mainly by robust domestic demand. However, with concern increasing over overheating or inflation, there is also a risk that due to monetary tightening to address such concerns, activity in these economies might fall below expectations, which would pose a downside risk to Japan’s economy. Lastly, attention needs to be paid to the risk that private demand might be pushed down in Japan due to a deterioration in corporate profits triggered by a rise in raw material prices in international commodity markets, reflecting geopolitical risks such as increased tension in North Africa and the Middle East. E. Japan’s economy and the automobile industry As I mentioned, automobile production has continued to drop sharply: the number of passenger cars produced in April marked a year-on-year decline of 60.2 percent and automobile-related real exports a decline of 46.0 percent for the same month. This significant drop in production and exports in the automobile industry has played a large part in the recent substantial downturn in Japan’s economy. Industrial production in March fell 15.5 percent from the previous month. This was mainly attributable to a significant decline of 49.7 percent on a month-on-month basis in the production of transport equipment excluding ships and rolling stock (i.e., the production of two- and four-wheeled vehicles and related parts), which in 2005 accounted for 15.7 percent of Japan’s total industrial production. A key characteristic of automobile production is that, with its various sub-sectors, it involves a wide range of other industries, generating substantial production spillovers. For example, according to the Ministry of Internal Affairs and Communications’ Input-Output Tables for 2005, the transport equipment industry (here including ships and rolling stock due to statistical constraints) generated production spillovers of a factor of 2.82. In other words, each unit of demand that arose in the transport equipment industry both directly and indirectly generated domestic demand that was 2.82 times that amount. This figure illustrates the breadth and magnitude of the transport equipment industry, given that the average production spillover effect for all industries only has a factor of 1.93. Together with the fact that in fiscal 2010 exports in this sector accounted for 21.6 percent of Japan’s total exports on a customs clearance basis, this implies that automobile-related industries are indeed the main engine of Japan’s economy. As is well known, in order to maximize efficiency, supply chains in the Japanese automobile industry form a complex system in which the production and supply of parts – of which there are said to be more than 30,000 – and final assembly are synchronized across corporate boundaries to shorten lead times and minimize inventories. Moreover, corporate groups in the industry are in fact structured like multi-layered pyramids with broad bases, each comprising a large auto assembler and its subcontractor parts makers. However, irrespective of this multi-layered nature of the supply system, there had been a consolidation and BIS central bankers’ speeches concentration of production bases and lines, aimed at enhancing cost-competitiveness and production efficiency, which led to a concentration of production lines for core components at certain parts makers and resulted in large assemblers relying heavily on a very small number of parts makers. This was a source of risk to which large auto assemblers paid little attention. It was this defect in the supply system that led to bottlenecks in the aftermath of the earthquake and affected automobile production worldwide. Given the large role the automobile industry plays in Japan’s economy, as highlighted earlier, it can be said that the speed and breadth of the economic recovery following the earthquake will greatly depend on the reconstruction of parts makers’ production sites and the recovery in production and exports of the automobile industry overall. As the earthquake unexpectedly revealed, Japan’s economy is highly dependent on certain industries. This entails the risk that when these industries contract sharply, so does Japan’s economy as a whole. Such an industrial structure also carries risks in the case of intensified competition when emerging economies rapidly catch up with Japan in these industries, or in the case of the emergence of powerful innovative products that replace those produced by Japanese firms. The “Industrial Structure Vision 2010” introduced by the government advocates a shift from an industrial structure heavily dependent on a small number of competitive industries, including the automobile industry, to a more diversified structure in which multiple industries play the role of growth driver. Adopting such a structure is vital to build a nation that can withstand changes in the economic environment. III. Conduct of monetary policy I will now move on to the conduct of monetary policy. With a view to overcoming deflation amid intense global competition and returning the Japanese economy to a sustainable growth path with price stability, the Bank, even prior to the earthquake, conducted aggressive monetary easing through its comprehensive monetary easing policy while implementing measures such as the fund-provisioning measure to support strengthening the foundations for economic growth. In this situation, in response to the earthquake, the Bank further enhanced monetary easing through its comprehensive monetary easing policy and introduced measures to support financial institutions in disaster areas. I will discuss each of these measures in turn. A. Further enhanced monetary easing under the comprehensive monetary easing policy On October 5, 2010, the Bank decided to implement comprehensive monetary easing based on the recognition that it was highly likely that the return of Japan’s economy to a sustainable growth path with price stability would be delayed compared to what had been projected earlier, partly due to the slowdown in overseas economies and the effects of the yen’s appreciation on business sentiment. In a situation where there was little room for a further decline in short-term interest rates due to the virtually zero interest rate policy pursued by the Bank, the policy I just mentioned consisted of three measures aimed at further enhancing monetary easing: first, changing the target for the uncollateralized overnight call rate from “around 0.1 percent” to “around 0 to 0.1 percent” in order to further clarify the Bank’s adoption of a virtually zero interest rate policy; second, clearly stating that the Bank would continue the virtually zero interest rate policy until it judged that price stability was in sight; and third, establishing an Asset Purchase Program with a total size of about 35 trillion yen. After the earthquake, there were concerns that, amid expectations of unprecedented damage from the disaster, any deterioration in business and household sentiment and heightening of risk aversion in financial markets would adversely affect economic activity. In view of this, the Bank, at the Monetary Policy Meeting on March 14, 2011, immediately following the BIS central bankers’ speeches earthquake, increased the amount of purchases of assets, mainly of risk assets, from about 5 trillion yen to about 10 trillion yen, bringing the total amount of the Asset Purchase Program to about 40 trillion yen. In addition, given that the market faced severe stress following the earthquake, the Bank provided liquidity in a timely and flexible manner. Through these measures, the Bank helped markets to regain stability at an early stage. B. Introduction of measures to support financial institutions in disaster areas In order to support financial institutions in disaster areas in their initial efforts to meet the need for funds among firms and individuals for restoration and rebuilding, the Bank introduced a funds-supplying operation for the provision of loans totalling 1 trillion yen with a loan duration of one year and a loan rate of 0.1 percent. On May 23, the Bank conducted the first loan disbursement through the measure, providing financial institutions with a total of 74.1 billion yen, and on June 1 announced that it would conduct its second loan disbursement on June 28. It plans to continue disbursing loans generally once a month. In addition to implementing this operation, the Bank relaxed the eligibility standards for collateral submitted by financial institutions in disaster areas for the provision of funds. I sincerely hope that such efforts by the Bank will support rebuilding efforts in the disaster areas. BIS central bankers’ speeches
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Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Nagasaki, 23 June 2011.
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Yoshihisa Morimoto: Economic activity and prices in Japan and monetary policy Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Nagasaki, 23 June 2011. * I. * * The current situation of and outlook for the world economy The Bank of Japan released its latest Outlook for Economic Activity and Prices (hereafter the Outlook Report) on April 29. The report presents the scenario for Japan’s economy considered to be the most likely by the Bank. The Bank projects that the economy will return to a moderate recovery path in the second half of fiscal 2011. Although supply-side constraints – due to the damage to production facilities and the disruption of supply chains for parts and components caused by the Great East Japan Earthquake in March – as well as constraints on electric power supply are expected to weigh down the economy for a while, these downward pressures are expected to gradually ease, paving the way for a moderate recovery in production. Of course, this recovery in production will not be long-lived unless it is accompanied by a rise in sales. A key element in this scenario of a return to a moderate recovery, therefore, is the expectation that exports will increase based on an improvement in overseas economies. Consequently, before talking about the domestic economy, let me take a closer look at the world economy. Following the recovery from the Lehman shock in the autumn of 2008, growth in the world economy temporarily slowed in the summer of 2010. From the end of autumn, economic growth then regained momentum, driven by strong growth in emerging and commodityexporting economies. At present, the pace has slowed somewhat due partly to the effects of soaring crude oil prices. As for the outlook, a number of issues require careful attention, but basically it is expected that – fueled by rapid growth in emerging and commodity-exporting economies – the pace of global growth will soon pick up again and the global economy will continue to expand. The International Monetary Fund (IMF) in its World Economic Outlook released in April 2011 forecasts that the global economy will grow by around 4.5 percent in both 2011 and 2012. A. Advanced economies Looking at developments in the global economy in greater detail, it is useful to focus on advanced economies and on emerging and commodity-exporting economies separately. Let me start by considering advanced economies. In the United States, from the autumn of 2010 onward, various stimulus measures, such as monetary easing by the Federal Reserve and the extension of tax cuts introduced by the Bush administration, led to optimism regarding the U.S. economy. Caution, however, has returned as personal consumption has been curtailed by higher prices for gasoline and other daily necessities, leading to a slight decline in the growth rate of the economy overall. Moreover, job market data for May showed that nonfarm payroll employment was well below market forecasts, indicating that the recovery in the job market remains shaky. With balance-sheet adjustments continuing to be a burden and the path for addressing the fiscal deficit unclear, the need to pay attention to downward risks is increasing. Even though upward momentum is currently weak, however, the Bank’s main scenario, which expects the U.S. economy to recover moderately, remains unchanged. While developments up to the present are somewhat on the low side, they are within the range of expectations. As for the outlook, exports – mainly to emerging and commodity-exporting economies – are expected to follow an upward trend. Furthermore, the U.S. stock market, which has been in an adjustment phase for the past few weeks, remains firm from a longer- BIS central bankers’ speeches term perspective. In this environment, private consumption and business fixed investment are unlikely to deteriorate to any serious extent. In short, we should be aware of the downside risks without being unduly pessimistic. Economic activity in the euro area is recovering moderately as a whole, although the contrast has been increasing further between the strong performance of Germany and the performance of peripheral countries with serious fiscal problems such as Greece and Portugal. As for the outlook, the situation as a whole is likely to remain unchanged, with the moderate recovery continuing. However, since around April 2011, doubts have emerged regarding the credibility of Greece’s plans for fiscal reconstruction and funds procurement, leading to a surge in the yield on 10-year Greek government bonds to record levels of more than 15 percent. The surge triggered a rise in the yields on government bonds issued by other peripheral countries. Damage could spread from financial markets to economic activity. Therefore, it is necessary to closely watch fiscal developments in Greece and other peripheral countries, as well as the response of the European Union (EU) as a whole. B. Emerging and commodity-exporting economies Emerging and commodity-exporting economies are expanding steadily, led by firm domestic demand. Moreover, although these economies are likely to continue tightening their monetary policies in response to heightened concerns over inflation, they are expected to maintain relatively high growth, albeit at a slightly reduced pace. In China, for instance, consumer prices are rising at a rate of more than 5 percent and authorities are tightening monetary policy. The Chinese economy is expected to continue showing high growth, though at a somewhat slower pace, due to the continued increase in private consumption, housing investment, and investment in various infrastructures, reflecting higher household incomes and continuing urbanization. Economic activity in the NIEs and ASEAN countries is also likely to follow a recovery trend. It has been suggested that production is being affected by sluggish shipments of parts from Japan, but domestic demand – such as business fixed investment and private consumption – is expected to remain firm, and exports are expected to continue increasing. On the other hand, there is concern that growth in commodityexporting economies may slow if international commodity prices drop. Any deceleration, however, is unlikely to be prolonged. II. The Japanese economy Keeping in mind the present situation of and outlook for overseas economies I just outlined, let me now talk about the Japanese economy and prices. A. Economic activity The pace of improvement in the economy slowed temporarily from the autumn of 2010, partly due to the expiration of subsidies for purchases of environmentally friendly cars. Thereafter, from the beginning of 2011, the economy started to gradually return to a moderate recovery path. The devastating earthquake that struck northeastern Japan in March, however, destroyed many production facilities, disrupted supply chains, and caused electric power shortages. Production of cars and other products came to a standstill even though demand was clearly present. The index of industrial production for March showed a decline of 15.5 percent from the previous month, the steepest fall ever for a single month since data started to be compiled. The cause of the decline in production differed from that after the collapse of Lehman Brothers, when demand simply evaporated. This meant that immediately after the earthquake, the usual mechanism for economic recovery – in which a recovery is preceded by an improvement in overseas economies that boosts Japanese exports and production – was partially paralyzed. BIS central bankers’ speeches Supply-side constraints are still in evidence and downward pressure on production will remain for the time being, although there are also signs of recovery. Supply chains are likely to be restored earlier than previously anticipated due to the close cooperation among firms, especially in the car industry, and the wholehearted and coordinated efforts of workers on the ground. Another bright factor is that electricity demand in the Kanto and Tohoku regions this summer is expected to be lower than forecast earlier, although of course much depends on the weather. Initially, it was expected that supply constraints would ease from the beginning of autumn 2011, but now it appears that production will return to pre-earthquake levels in the July–September quarter and that supply constraints will be largely resolved by early autumn. From a somewhat longer-term perspective, uncertainties persist with regard to the supply of electricity. However, as the supply constraints ease, Japan’s economy should continue to recover, driven by the increase in exports and production that the expected improvement in the global economy should bring with it. Moreover, by that time, restoration and rebuilding of infrastructure, buildings, and other facilities damaged by the earthquake should be in full swing, pushing the economy forward. Looking at each demand component, exports, particularly of cars and car parts, declined as a result of supply chain disruptions. However, overseas demand in general is expected to continue to expand. Furthermore, exporters, particularly automobile makers, are working hard to resume shipments as quickly as possible. Therefore, although much depends on developments in the foreign exchange market, it looks increasingly likely that shipments will return to pre-earthquake levels sometime in the July–September quarter, which is earlier than previously expected. Exports are expected to follow an upward trend thereafter. Business fixed investment bottomed out and started to recover moderately during the second half of fiscal 2009, reflecting increased production and a recovery in corporate profits. Although business sentiment deteriorated due to the impact of the earthquake, various indicators suggest that business fixed investment has remained surprisingly resilient. This shows that firms’ growth expectations have remained stable. On this basis, business fixed investment, despite some fluctuations, is likely to remain firm against the backdrop of strong profits in fiscal 2010. It is likely to start to clearly turn upward from around the autumn of 2011, supported by the expected recovery in exports and production as well as rebuilding efforts in areas hit by the earthquake. Turning to private consumption, the mood of restraint seen immediately after the devastation resulting from the earthquake has gradually eased, with department stores and retailers of electrical appliances voicing, albeit cautiously, the view that consumption is returning to more normal levels. Furthermore, various indicators point to a slight improvement in consumer sentiment. Therefore, private consumption is expected to head toward a gradual recovery. Needless to say, it is important to keep an eye on the effect, particularly in the service sector, of the supply and demand balance of electricity during the summer. In addition, consumer sentiment is likely to be dampened by the ongoing problems at the nuclear power plant and awareness of the need to save electricity. What is more, the employment and income situation, particularly the wage situation, is becoming more severe. The expected recovery in consumption is, therefore, bound to be modest. B. Prices The three key factors likely to shape the direction of prices for the time being are (1) the aggregate supply and demand balance; (2) medium- to long-term inflation expectations; and (3) international commodity prices. In the short term, the net impact on the aggregate supply and demand balance is unclear, since on the one hand supply capacity has declined as a result of the earthquake, while on the other demand has also fallen due to a deterioration in consumer sentiment. Nevertheless, in the longer run, the supply and demand balance is likely to follow an improving trend as the economy returns to a moderate recovery path. According to various surveys, medium- to long-term inflation expectations have been stable at around 1 percent in recent years. Prices of international commodities, such as crude oil, BIS central bankers’ speeches have been undergoing adjustments recently. However, there has been little change in the factors that have fueled the rise in commodity prices so far, such as the strong growth of emerging economies and the increased “financialization” of primary commodities. Under these circumstances, with the aggregate supply and demand balance remaining on an improving trend in the longer run, and assuming that international commodity prices will increase moderately, domestic corporate goods prices are expected to rise. For the same reasons, the rate of increase in the consumer price index (CPI; excluding fresh food) is expected to remain slightly positive. The CPI, however, is very likely to be revised downward somewhat as a result of the planned change in August of the CPI base year to 2010. III. Risks to the outlook I would now like to turn to risks affecting the outlook for economic activity and prices. A. Risks to economic activity In the April 2011 Outlook Report, the Bank listed the following as risk factors concerning the outlook for economic activity: (1) uncertainty about the possible effects of the earthquake disaster on Japan’s economy; (2) firms’ and households’ medium- to long-term growth expectations; (3) developments in overseas economies; and (4) the effects brought about by a possible further rise in international commodity prices. As for the first risk factor, there is great uncertainty regarding the timing when supply-side constraints will be resolved, the timing and scale of the restoration of damaged capital stock, and the impact on the economy of possible changes in consumer and business sentiment caused by the disaster. The degree of the impact varies depending on future developments in the situation at the nuclear power plant, as well as on the outlook for corporate profits and the compensation of employees. In addition, if concern about the growth potential of the economy increases due to the effects of the disaster, and firms’ and households’ medium- to long-term growth expectations decline as a result, this could depress firms’ and households’ appetite for spending and act to reduce economic activity for a protracted period. On the other hand, medium- to long-term growth expectations by firms and households could rise if firms take the disaster as an opportunity to bolster efforts to implement growth strategies. Risk factors regarding overseas economies, as I explained earlier, are increasing to some degree. In emerging economies, there are upside risks due to economic expansion, and although monetary tightening has continued in these economies, this has not sufficiently calmed concern over overheating or inflation. Therefore, there is concern that from a longerterm perspective sustainable growth may be undermined due to increased fluctuations in economic activity. In addition, if international commodity prices rise further, this could lead to a decline in the purchasing power of households and a deterioration in corporate profits, which could depress private domestic demand in Japan. I believe that all of these risk factors are equally important. Although there is a possibility that the economy will grow faster than expected if supply-side constraints ease earlier than anticipated, it seems to me that the downside risks stemming from uncertainties regarding the effects of the disaster require the most attention, simply because the disaster involved an unprecedented tsunami and a nuclear power plant accident. Moreover, firms, particularly small firms, are concerned about whether the shift to overseas production will accelerate and the hollowing out of domestic industry will continue. This is an issue that I also feel requires attention. B. Risks to prices Next, turning to the risks to prices, these involve the materialization of the risks to economic activity that I have just described. Developments in the aggregate supply and demand BIS central bankers’ speeches balance play an important role in determining the outlook for prices, but because of the impact of the earthquake, these developments in the short term are not yet clear. Even if supply-side constraints cause supply shortages, firms will avoid making hasty decisions – such as raising prices of their products – that may result in losing customers, if firms judge the supply shortages to be temporary. On the other hand, if downside risks to the economy materialize, leading to a prolonged economic downturn, prices will be affected accordingly. Other risk factors to prices include firms’ and households’ medium- to long-term inflation expectations, as well as developments in import prices, which are affected by fluctuations in international commodity prices and foreign exchange rates. IV. Monetary policy A. The bank’s thinking behind the conduct of monetary policy So far, I have talked about economic activity and prices in Japan. I would now like to turn to the Bank’s conduct of monetary policy. The Bank recognizes that Japan’s economy is faced with the extremely important challenge of emerging from deflation and returning to a sustainable growth path with price stability. Based on this recognition, the Bank has been doing – and is determined to continue to do – its utmost as the central bank, using a threepronged approach consisting of (1) pursuing powerful monetary easing under the comprehensive monetary easing policy, (2) ensuring stability in financial markets, and (3) providing support to strengthen the foundations for economic growth. Furthermore, with a view to ensuring stability in financial markets, the Bank introduced a number of measures in the wake of the earthquake to address its impact on the economy and associated risks. 1. Pursuing powerful monetary easing under the comprehensive monetary easing policy “Comprehensive monetary easing” is a policy package that the Bank introduced in October 2010, consisting of three measures. First, the Bank lowered its policy interest rate, that is, the target for the uncollateralized overnight call rate – the shortest interbank rate – to “at 0 to 0.1 percent”, thereby indicating that it was pursuing a virtually zero interest rate policy. Second, the Bank clarified its commitment regarding the time horizon based on the “understanding of medium- to long-term price stability” (hereafter the “understanding”). The “understanding” is the level of inflation that each Policy Board member understands as being consistent with price stability over the medium to long term. The “understanding” at present falls in a positive range of 2 percent or lower, and the midpoints of most Policy Board members’ understanding are around 1 percent. The Bank has made clear that it will maintain the virtually zero interest rate policy until it judges, on the basis of the “understanding”, that price stability is in sight, on condition that no problem is identified in examining risk factors, including the accumulation of financial imbalances. And third, the Bank decided to establish the Asset Purchase Program. The Bank decided on this temporary easing measure to conduct outright purchases of various financial assets, such as Japanese government bonds (JGBs), and risk assets such as CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). The Bank has been steadily conducting outright purchases of such financial assets, which are registered on its balance sheet, through the Asset Purchase Program. 2. Providing support to strengthen the foundations for economic growth The fund-provisioning measure to support strengthening the foundations for economic growth supplies long-term funds at a low interest rate to private financial institutions in accordance with their efforts in terms of lending and investment to strengthen the foundations for economic growth. The Bank has provided 18 examples, including “environment and energy business”, “medical, nursing care, and other health-related business”, and “tourism business”, as areas for which financial institutions’ lending or BIS central bankers’ speeches investment would be funded by the measure, and in addition to these areas, a large amount of funds has been invested in the area categorized as “others”, such as lending or investment to support local industries. The Bank decided to implement this measure based on the recognition that the decline in the economic growth trend since the 1990s has been the fundamental cause of deflation and that it was important to support various growth areas to overcome deflation. In other words, it is important not only for Japan’s economy to achieve a cyclical recovery, but also to make efforts to raise Japan’s economic growth in the long term. While the government, for its part, also has been implementing measures to support economic growth, such as its “New Growth Strategy” aimed at achieving renewed economic vigor, I believe that the Bank’s measure to support the economy from the financial side – that is, to provide funds to support strengthening the foundations for economic growth – not only produces effects through the provision of funds, but also sends a strong message and raises awareness about the issues faced by Japan’s economy. The fund-provisioning measure to support strengthening the foundations for economic growth was decided at the Monetary Policy Meeting (MPM) held on June 14 and 15, 2010. On June 8, 2011, the Bank carried out the fourth loan disbursement under the measure, and the total amount of loans disbursed has reached nearly 3 trillion yen – the amount set as the ceiling for the measure. Therefore, given that the maximum amount of loans had almost been disbursed, Policy Board members at the MPM held on June 13 and 14, 2011 discussed how to proceed with the measure. If we assess the loan disbursements carried out so far, it could be said the measure has played its intended role as a catalyst in prompting financial institutions to develop their own initiatives to strengthen the foundations for economic growth. A wide range of financial institutions have been actively making a number of efforts targeting their specific customer base or the region they serve, such as establishing new dedicated funds that will support economic growth, so that the amount of lending and investment greatly exceeds the amount of loans disbursed by the Bank. However, the effects of the measure on equity investment and in terms of encouraging financial institutions to cultivate new business models have been insufficient, and it has been pointed out that a side effect of the measure is to intensify competition among financial institutions to lower lending rates. Against this background, my view with regard to the future of this scheme was that it should continue to firmly support as broadly as possible the efforts of private financial institutions to build on their specific experience and expertise and devise their own ways to meet demand in the areas and regions they serve. This view was shared by other members of the Policy Board, and at the MPM held on June 13 and 14, 2011 the Bank decided that it would firmly maintain its stance of supporting financial institutions’ efforts to strengthen the foundations for economic growth and take measures that would focus on boosting Japan’s growth potential even further. Specifically, the Bank decided to establish a new line of credit for equity investments and asset-backed lending (ABL) aimed at encouraging smooth financing of firms that lack sufficient collateral or equity investment, and/or who so far have received very little financing from the existing fund-provisioning measure. In introducing this measure, the Bank decided to set long loan periods to make them easier for financial institutions to administer, and to lower the minimum amount per investment or loan to meet even small requests and sow the seeds for growth in even the smallest “nooks and crannies.” B. The bank’s responses after the earthquake Since immediately after the earthquake disaster, the Bank has been taking a range of measures in a timely manner, from three main perspectives: (1) maintaining the functioning of financial and settlement systems; (2) ensuring the stability of financial markets; and (3) supporting the economy. I would now like to discuss the Bank’s response to the disaster. BIS central bankers’ speeches 1. Maintaining the functioning of financial and settlement systems and ensuring the stability of financial markets In terms of maintaining the functioning of the financial and settlement systems, the Bank has been taking all possible measures to provide cash to the disaster areas and to operate Japan’s major payment and settlement systems as usual, including the Bank of Japan Financial Network System, or BOJ-NET – the core settlement system for funds and Japanese government securities. In addition, to respond to the increase in precautionary demand for funds, the Bank provided ample funds to sufficiently meet market demand. More specifically, on Monday, March 14, the first business day after the disaster, the Bank provided a total of 21.8 trillion yen in funds, almost three times the largest daily funds provision during the financial crisis after the failure of Lehman Brothers. Thereafter, the Bank continued its ample provision of funds. As a result, the outstanding balance of financial institutions’ current accounts at the Bank marked a historical high of 42.6 trillion yen as of March 24. Comparing this amount to the level before the earthquake of around 17 trillion yen illustrates well the amount of funds provided by the Bank after the disaster. Due to these measures taken by the Bank, financial markets remained stable following the earthquake. 2. Further enhancing monetary easing by increasing the amount of the Asset Purchase Program At the MPM held immediately after the earthquake, on March 14, 2011, the Bank decided to take measures to further enhance monetary easing, with a view to preempting a deterioration in business sentiment and an increase in risk aversion in financial markets from adversely affecting economic activity. Specifically, the Bank decided to double the amount of asset purchases – mainly of risk assets, such as CP, corporate bonds, and ETFs – through the Bank’s Asset Purchase Program from about 5 trillion yen to about 10 trillion yen. I also shared the view that it was extremely important for the Bank to decide on drastic further monetary easing to fully reassure market participants. I believe that the measure was effective in reassuring market participants in that it prevented a deterioration in business sentiment and an increase in risk aversion in financial markets: for example, issuance spreads on CP, which had expanded immediately after the earthquake, declined to more or less the same level as prior to the earthquake and issuing conditions for CP continue to be favorable. I should note, however, that there are signs that since the earthquake small firms have been facing some difficulties in obtaining funding, and I will pay close attention to this issue when assessing the financial environment. 3. Supporting financial institutions in disaster areas In addition to the measures mentioned thus far, the Bank decided to conduct long-term funds-supplying operations to financially support initial response efforts by financial institutions in the disaster areas even before demand for the purpose of rebuilding and revival becomes full-fledged. Furthermore, with a view to securing sufficient financing capacity of financial institutions in disaster areas, the Bank decided to broaden the range of eligible collateral for money market operations. I believe the Bank’s bold measures, including the decision to quickly provide long-term funds to financial institutions in disaster areas to support firms in distress – particularly small and medium-sized firms – were timely and most appropriate. The damage caused by the recent earthquake has been much larger than that of the Great Hanshin-Awaji Earthquake in 1995, but the Bank has taken full advantage of the lessons learned at the time. The first funds-supplying operation to support financial institutions in disaster areas took place in May, and the second such operation took place on June 21. The amount disbursed so far totals some 200 billion yen at a rate of 0.1 percent. In principle, the operations, whose expected maximum amount is 1 trillion yen in total, will continue every month until October this year. BIS central bankers’ speeches These measures were put in place as an initial response to meet the demand for funds expected to emerge for rebuilding and revival. The Bank will continue to study further measures to help disaster areas recover, reconstruct, and move forward as quickly as possible. BIS central bankers’ speeches
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Speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Mie, 27 July 2011.
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Hidetoshi Kamezaki: Recent economic and financial developments in Japan Speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Mie, 27 July 2011. * I. * * The Bank of Japan’s measures following the Great East Japan Earthquake Let me start by introducing the measures implemented by the Bank thus far following the Great East Japan Earthquake, whose magnitude and effects were unprecedented. At 3:00 p.m. on March 11, 2011, right after the earthquake struck at 2:46 p.m., the Bank set up a disaster management team at its Head Office in Tokyo, headed by Governor Masaaki Shirakawa, and implemented the following measures. First, immediately after the earthquake, the Bank worked to maintain the financial intermediation function and secure the smooth settlement of funds. Specifically, to cope with demand for cash in disaster areas to the maximum degree, it provided cash to financial institutions in disaster areas as necessary, not only on business days but also on weekends and holidays. Moreover, on March 11, the Governor of the Bank, jointly with the Minister of State for Financial Services, released a document regarding financial measures to respond to the disaster triggered by the earthquake, requesting that financial institutions take appropriate measures to accommodate the needs of those affected by the disaster – for example, by permitting the withdrawal of deposits in cases where depositors had lost passbooks or seals. Furthermore, the Bank, in cooperation with relevant parties, maintained the stable functioning of Japan’s core payment and settlement systems, such as the Bank of Japan Financial Network System, or the BOJ-NET, even after the earthquake. It also worked hard to provide cash to the disaster areas by taking actions such as establishing a temporary teller window in Morioka City, Iwate Prefecture, for the exchange of damaged banknotes and coins. The total amount of cash exchanged since the earthquake at the Bank’s windows in the affected Tohoku region, including the temporary one in Morioka City, amounted to 3.06 billion yen, through July 22. This greatly exceeds the amount exchanged at the Bank’s Kobe Branch during the six months following the Great Hanshin-Awaji Earthquake, which was about 0.8 billion yen. Second, the Bank sought to prevent an excessive increase in risk aversion from emerging in financial markets or other areas of financial and economic activity. To this end, it provided ample funds to meet demand in financial markets for several successive days after the earthquake, and worked to ensure stability in the markets by maintaining confidence on the funding front. As a result, the outstanding balance of financial institutions’ current accounts at the Bank temporarily marked a historical high of 42.6 trillion yen, far exceeding that observed during the periods following the Lehman shock and when the Bank implemented quantitative easing. In addition, the Bank shortened to one day the two-day Monetary Policy Meeting that was initially scheduled to be held on March 14 and 15, completing it on March 14. At this meeting, with a view to preventing any deterioration in business sentiment or heightening of risk aversion in financial markets from adversely affecting economic activity, the Bank further enhanced monetary easing by increasing the amount of the Asset Purchase Program, mainly of the purchases of risk assets by about 5 trillion yen, under the comprehensive monetary easing framework. I will discuss the details of this framework later. Third, the Bank worked to ensure calm in markets at home and abroad by providing accurate information. Specifically, immediately after the earthquake, it expanded the communications offered on its web site, setting up a section in both Japanese and English devoted to the earthquake and releasing a continuous stream of information regarding its business BIS central bankers’ speeches continuity situation. In addition, on various occasions such as at international conferences, in speeches given at home and abroad, and at press conferences, the Bank emphasized the continuing robustness of Japan’s financial markets as well as its financial and settlement systems. And fourth, the Bank introduced the funds-supplying operation to support financial institutions in disaster areas, with a view to supporting their initial efforts to meet demand for funds for restoration and rebuilding. Through this operation, the Bank extends loans to financial institutions with business offices in the disaster areas – even to small local financial cooperatives that do not hold current accounts at the Bank through the central organization of each type of financial cooperatives – at the low interest rate of 0.1 percent per annum. The total amount of loans is 1 trillion yen with the maximum amount of loans to each counterparty set at 150 billion yen, and the deadline for eligible counterparties’ new loan applications is October 31, 2011. With a view to securing sufficient financing capacity at financial institutions in disaster areas, the Bank also expanded the range of eligible collateral to include BBBrated corporate bonds as well as bills and loans on deeds where debtor companies are classified as “normal” borrowers in the self-assessment by financial institutions in disaster areas. It conducted the funds-supplying operation three times, with the total amount of loans to date reaching 332 billion yen. II. Economic activity and prices A. Overseas economies Next, I will talk about the current economic situation. Overseas economies achieved robust growth from around 2005 onward, led by improved productivity in many economies, owing to the advance of globalization and increased participation of emerging economies in the global market. During this time, however, various countries experienced economic imbalances, such as the housing bubble in the United States and the investment bubble in some peripheral European countries that resulted from the stable currencies and lower interest rates following the European monetary unification. These imbalances gradually emerged as the financial market turmoil in the United States and Europe, triggered by the drop in U.S. housing prices. The turmoil grew into a global financial crisis after the Lehman shock in the autumn of 2008. The interaction between the financial market turmoil and economic deterioration led to the crisis of a sharp downturn in the global economy. In response, countries around the world adopted large-scale monetary and fiscal measures, and as a result, the global economy started to pick up around spring 2009. Consequently, the global economy as a whole is on a recovery path, although there is a divergence between the performance of slowly recovering industrialized countries and rapidly growing emerging and commodity-exporting economies. At present, the pace of recovery is slowing. The U.S. economy is being weighed down by damaged balance sheets among households in particular, due to the bursting of the housing bubble, and also by the effects of the disaster in Japan and high crude oil prices. In Europe as a whole, the pace of recovery remains moderate: while the German economy is robust, the economies of some peripheral countries with troubled fiscal conditions, such as Greece, are faltering. In contrast, rapid growth continues in emerging and commodity-exporting economies such as China and Brazil. In some countries, however, there are signs of economic slowdowns due to monetary tightening aimed to counter inflationary pressures, and production has been sluggish due to supply shortages of parts following the earthquake in Japan. As for the outlook, the global economy is expected to stay on a recovery trend; however, the degree of uncertainty remains high because of risk factors such as a further deterioration in the fiscal conditions in some peripheral European countries, an overheating of emerging and commodity-exporting economies, and a surge in international commodity prices. BIS central bankers’ speeches B. The Japanese economy The growth in the Japanese economy also declined, falling steeply in response to the Lehman shock, after experiencing the longest period of economic expansion since the end of World War II. Thereafter, the economy continued to recover, after leveling out around spring 2009, due to the recovery in overseas economies and government measures such as the subsidies for purchasers of environmentally friendly cars and the eco-point system for electrical appliances. However, when the earthquake struck Japan, the economy again suffered a steep decline. The economic downturn observed after the failure of Lehman Brothers was due to the sudden drop in domestic and external demand, reflecting a sharp financial contraction: triggered by the failure, the financial system and economic activity faced a spiral of deterioration, mainly in the United States and Europe, as a result of stagnant economic activity that reflected the difficulty in issuing CP and corporate bonds as well as the cautious lending attitudes of banks, which led to public concern over financial markets and financial institutions in general. The effects of the financial crisis in the United States and Europe spread to markets all over the world, including Japan. In such a situation, production and inventory adjustments took place worldwide, and the level of production dropped particularly sharply in Japan due to the fact that the high-tech manufacturing industries – including automobiles, electrical machinery, and general machinery, which were particularly affected by the downturn in worldwide demand – had a large share in its production. The economic downturn following the earthquake, on the other hand, was due to (1) direct physical damage in the disaster areas, (2) indirect damage due to a shortage of parts, (3) supply-side constraints such as the difficulty in producing and selling goods due to electricity shortages, and (4) a deterioration in household and business sentiment caused by concern about the future and voluntary restraint in consumer spending. It should be noted that, unlike the economic downturn observed after the Lehman shock, external demand was not much affected. Therefore, the economy picked up sooner than expected with the easing of the supply-side constraints due to the progress in the restoration of facilities and efforts to conserve electricity. At present, exports have started to increase. Domestic private demand has also begun to pick up, with some improvement in household and business sentiment. The Japanese economy is expected to return to a moderate recovery path from the latter half of this fiscal year as production regains traction with further easing of supply-side constraints, backed by an increase in exports reflecting the recovery in overseas economies and by a rise in rebuilding demand. In the longer run, however, attention should be paid to the downside risks to economic activity. In the short run, the restoration of supply chains is making steady progress and there is an increasing probability that the degree of constraints on economic activity due to electricity shortages this summer will be less significant than anticipated, although some concerns remain. On the other hand, uncertainty is also increasing somewhat regarding overseas economies, and therefore the current risks to the Japanese economy are shifting from the supply side to the demand side. In addition, from a relatively long-term perspective, uncertainty about electric power supply is increasing somewhat, reflecting the issues regarding the resumption of operations at nuclear power plants following regular inspections. Considering factors such as the appreciation of the yen, high corporate tax rates, and delays in the negotiation of free trade agreements (FTAs) and economic partnership agreements (EPAs), manufacturers already regard Japan as a somewhat unfavorable place to locate their production sites. It is my great concern that the shift of Japanese firms’ production sites to overseas might accelerate if anxiety about electric power supply lingers. C. Price developments Next, I will move on to price developments. International commodity prices had been increasing on the back of high growth in emerging economies. They have declined slightly of BIS central bankers’ speeches late due to the instability in global financial markets, but are still hovering at high levels. As a result, import prices in Japan and the domestic corporate goods price index (CGPI), which measures fluctuations in prices of goods traded between firms in Japan, have also been at high levels. Meanwhile, the year-on-year rate of change in the consumer price index (CPI) for all items excluding fresh food, or the core CPI – which measures the prices of goods and services purchased by households – had been in negative territory for about two years since March 2009 but turned positive in April 2011 against the background of the increase in international commodity prices and the narrowing of the negative output gap. In sum, the Japanese economy continues to be headed in the direction of overcoming deflation. As for the outlook, the year-on-year rate of change in the core CPI is expected to be slightly positive, reflecting the rise in international commodity prices and the narrowing of the negative output gap. However, this outlook is attended by a range of risks, examples of which include a substantial rise in international commodity prices, a delay in the narrowing of the negative output gap due to slower-than-expected growth of the Japanese economy, and a decline in the public’s medium- to long-term inflation expectations reflecting their pessimistic outlook for the economy. As you may know, the base year for the CPI will be revised in August 2011, and it is highly likely that the year-on-year rate of change in the CPI on the basis of the new base year will be lower than that on the basis of the current base year. Of course, such statistical revisions leave economic activity unaffected, and it seems certain that the Japanese economy is headed in the direction of overcoming deflation. D. Outlook for economic activity and prices The outlook I just presented is my own personal assessment. Let me now turn to the Outlook for Economic Activity and Prices, known as the Outlook Report, which the Bank releases semiannually in April and October. The Outlook Report presents the Policy Board members’ assessments of economic activity and prices based on the forecasts. In addition to the semiannual Outlook Report, the Bank releases interim assessments in July and January that present the Bank’s revised forecasts. In the most recent forecasts, released on July 12, 2011, Policy Board members considered it most likely that real GDP in fiscal 2011 would grow by only 0.4 percent on a year-on-year basis, reflecting the effects of the disaster, but by 2.9 percent in fiscal 2012 due to an expected increase in demand for rebuilding. The year-on-year change in the core CPI is projected to be 0.7 percent in both fiscal 2011 and fiscal 2012, reflecting an increase in materials prices and the narrowing of the negative output gap. It should be noted, however, that these figures do not incorporate possible effects of the base year revision for the CPI in August 2011.1 Policy Board members make their forecasts in terms of a range of values rather than a point estimate, and they then attach a probability of realization to each of the values. The collective view of the Policy Board has been that risks are tilted to the downside for real GDP on a year-on-year basis, whereas those for the year-on-year rate of change in the CPI are balanced on the whole. III. Measures taken by the bank Next, I will outline the policy measures taken by the Bank. The figures referred to in this paragraph are the median of the Policy Board members’ forecasts. BIS central bankers’ speeches A. Measures to address the Lehman shock The Lehman shock in autumn 2008 had caused a sharp contraction in the financial markets around the world. In order to address this situation, the Bank, just after the crisis occurred, successively conducted same-day funds-supplying operations and introduced U.S. dollar funds-supplying operations. In addition to reducing the target level of the policy interest rate, the Bank introduced a series of measures such as the complementary deposit facility, outright purchases of CP and corporate bonds, the easing of the rating requirement for corporate debt to be accepted as eligible collateral, the special funds-supplying operation to facilitate corporate financing, and acceptance of bonds issued by foreign governments as eligible collateral, based on the recognition that market conditions had deteriorated further and a negative feedback loop between financial and economic activity had emerged with a tightening of overall corporate financing conditions. Moreover, the Bank introduced temporary measures to secure the stability of the financial system, including the purchase of stocks held by financial institutions to help them reduce the market risk associated with stock holdings and the provision of subordinated loans to banks to help them maintain sufficient capital bases. The Bank gradually brought some of these temporary measures to an end as financial markets regained stability. B. Recent conduct of monetary policy toward a sustainable growth path with price stability Although financial markets regained their stability, the Bank, with a view to overcoming deflation and returning the Japanese economy to a sustainable growth path with price stability, continues to conduct various measures. 1. Pursuing powerful monetary easing First, the Bank aims to pursue powerful monetary easing through the implementation of the comprehensive monetary easing policy decided in October 2010. As the first measure for this policy, the Bank set the uncollateralized overnight call rate target at “around 0 to 0.1 percent.” It clarified that the policy interest rate is virtually zero. As for the second measure, the Bank clarified the policy time horizon of the virtually zero interest rate policy – specifically, it will maintain the virtually zero interest rate policy until it judges that price stability is in sight, on condition that an examination of risk factors, including the accumulation of financial imbalances, reveals no problems – and it has been working to help stabilize longer-term interest rates. Price stability here is defined on the basis of the “understanding of medium- to long-term price stability” (hereinafter, the “understanding”) announced by the Bank and refers to the level of inflation that each Policy Board member understands, when conducting monetary policy, as being consistent with price stability over the medium to long term, with each Policy Board member’s “understanding” falling in a positive range of 2 percent or lower, and the midpoints of most Policy Board members’ “understanding” being around 1 percent. As the third measure of the comprehensive monetary easing policy, the Bank established the Asset Purchase Program to purchase various financial assets, such as government securities, CP, corporate bonds, exchangetraded funds (ETFs), and Japan real estate investment trusts (J-REITs), as well as to conduct fixed-rate funds-supplying operations against pooled collateral whereby funds with a maturity of three or six months are provided at an interest rate of 0.1 percent. The aim of this measure is to create additional monetary easing effects by encouraging a decline in longerterm interest rates and a reduction in various risk premiums, while in the money market, where the Bank conducts daily operations as the central bank of Japan, there remains little room for further declines in most short-term interest rates. The Bank’s purchase of ETFs and J-REITs, which are assets with relatively high risks, will act as a catalyst for market participants to take a more active investment stance, thereby helping to smooth the intermediation of risk money and further improve firms’ funding conditions. At its establishment, the Asset Purchase Program was to be worth about 35 trillion yen, but as I BIS central bankers’ speeches stated earlier, the Bank increased the amount to about 40 trillion yen just after the earthquake. 2. Ensuring financial market stability In order to fully ensure financial market stability, the Bank has been implementing a variety of measures including the utilization of various funds-supplying operations. As I stated earlier, when uncertainty began to spread in the financial markets just after the earthquake, the Bank provided ample funds to the markets, the total amount of which represented a historical high. The Bank has also taken measures to provide financial institutions with the confidence that they can obtain sufficient funds whenever necessary. For example, temporary measures introduced in response to the financial crisis that continue today include the complementary deposit facility, the acceptance of foreign government bonds as eligible collateral, and U.S. dollar funds-supplying operations. These measures aim to forestall a return of instability in financial markets. 3. Providing support to strengthen the foundations for economic growth Moreover, in order to strengthen the foundations for economic growth, the Bank has been implementing a measure through which it provides long-term funds at a low interest rate to financial institutions in accordance with their efforts in terms of lending and investment. Currently, financial markets have abundant funds, but recent growth is sluggish and deflationary pressure remains strong as economic entities such as firms and households are skeptical about future growth and unwilling to undertake forward-looking spending. To address this problem, the Bank has made more funds available for financial institutions to utilize in new areas of growth, in order to raise growth expectations. Many financial institutions nationwide have shown an interest in the measure since it was implemented in June 2010. There were 153 financial institutions granted approval to participate in the new loan disbursement in June 2011, and loans were actually disbursed to 126 of them. Areas eligible for investments and loans range, for example, from environment and energy business, medical and nursing care business, development of social infrastructure, and regional revitalization business to business deployment in Asian countries. The measure has been producing positive effects as a catalyst – its intended purpose – since, although the maximum duration of loans provided under the measure is four years, more than 70 percent of actual individual investments and loans exceed this period. Moreover, following the introduction of the measure, financial institutions have been establishing new dedicated funds and lending schemes, and some of them in certain cases have set a higher ceiling on the total amount of investments and loans than the 150 billion yen ceiling for the total amount of loans that they could obtain from the Bank. The total amount of loans disbursed through the four loan disbursements conducted so far has almost reached the maximum amount of loans allowed under this measure (3 trillion yen), with a year left before the deadline for new applications for loans. The Bank decided to enhance the measure with a view to supporting financial institutions’ efforts to strengthen the foundations for economic growth through the use of a wider range of financial techniques. More specifically, in order to support emerging and small firms in their efforts to solve the problems they face – risk money and a lack of real estate collateral – the Bank provides funds to financial institutions that undertake equity investments and offer the so-called asset-based lending, or ABL, to firms with growth opportunities. The Bank hopes that this enhancement will stimulate further use of financial techniques that have yet to achieve a sufficient level of familiarity, and thereby lead to the nurturing of firms with growth opportunities. If this is accomplished, the Bank believes that Japan’s growth potential will increase and the ability of financial institutions to find and support promising firms will be improved. BIS central bankers’ speeches IV. Revitalizing the Japanese economy I will now take a look at the Japanese economy from a longer-term perspective. Although Japan has undergone various phases of economic cycles since the bursting of the economic bubble in the early 1990s, growth on average has been poor. The past 20 years or so of weak growth and deflation have been dubbed the “two lost decades.” The devastating earthquake that hit Japan on March 11 this year has further aggravated the situation. In order for the economy to emerge from the current slow growth and regain its strength, it is necessary to introduce drastic measures designed not only for the reconstruction of disasterstricken northeastern regions but also for revitalization of the Japanese economy as a whole. A. Causes of the low growth in the Japanese economy Before moving on to the topic of revitalizing the Japanese economy, I will first touch upon the causes of the high growth experienced after World War II and ensuing period of low growth. Three factors combined to create a favorable environment for the postwar rapid growth. First, Japan was in a position to take advantage of being a latecomer, learning from the growth process of advanced economies such as the United States and Europe. Second, the rise in the working-age population meant an increase in the population bonus, that is, the high share of the working-age population in the total population. And third, Japanese manufactured goods enjoyed a superior competitive edge in the absence of rivals outside the United States and Europe. During this period of soaring growth, Japan’s economic model – based on government industrial policy, the main bank system, the seniority system, and lifetime employment – functioned successfully. By about 1970, however, Japan had more or less caught up with the United States and Europe. Around this period, the population bonus started to fade. Furthermore, the outbreak of the oil crisis and rapid appreciation of the yen put a brake on the high-speed economic growth. The continued upward trend in the working-age population and the absence of competitors in the production of manufactured goods enabled the Japanese economy to grow steadily. However, downward pressure on the economy intensified as the increased presence of Japan in international markets gave rise to heated trade friction while the Plaza Accord in 1985 led to an appreciating yen. In order to counter the downward pressure, measures were taken to expand domestic demand, which eventually led to the emergence of the economic bubble in the second half of the 1980s. The bubble burst in the early 1990s. Low growth and deflation continues to this day in spite of repeated measures and monetary easing to stimulate the economy. A recovery appeared to be hampered by adjustments involving the “legacies of the past” – that is, the excessive level of debt, production capacity, and employment coupled with the large housing loans held by households and the massive amount of nonperforming loans held by financial institutions. The situation, however, remained unchanged even though the balance-sheet problems had more or less been resolved by around 2000. The reasons for the low growth must lie elsewhere, and I believe that it must be the critical changes that occurred during this period – namely, the decrease in the working-age population, which peaked in 1995, and the rise of emerging countries as rival producers of manufactured goods. B. Overcoming low growth and deflation I have already pointed to the gradual loss of the favorable environment as the cause of the downward trend in the growth potential of the Japanese economy since the end of the highgrowth period. The favorable environment consisted of three factors: the easily attained latecomer advantage; the increase in the working-age population; and the absence of competitors in the production of manufactured goods. Regaining this environment might put Japan back on a fast growth path. Such an attempt would be impossible, however, as the world has changed profoundly and the need has arisen to build a new growth model suitable for the new environment. BIS central bankers’ speeches Japan had long gained from the latecomer advantage in acquiring manufacturing technologies, and it became one of the world’s major exporting countries; however, there is still much more to learn from other countries, particularly regarding enhancement of the standard of living. The United Kingdom, Germany, and Australia have overcome long-term economic stagnation by implementing a range of social and economic reforms, while Scandinavian countries have achieved a high level of satisfaction among their citizens as a result of their comprehensive welfare systems, supported by high taxes. The Asian NIEs have improved their standards of living by achieving high economic growth through market competition. There is no shortage of lessons to learn from abroad to establish a new growth model and improve the standard of living. Institutional reforms and revisions are required in order to increase the working-age population, to raise the birth rate and put a brake on the population decrease. This undoubtedly is the correct approach, but it takes time to produce results. The measures to expand the working-age population in the short term and boost Japan’s growth potential should include: raising the labor force participation rate of women and the elderly by establishing incentives as well as providing job training; and introducing an orderly system for foreign workforce employment. In the meantime, given that the aging of society is bound to progress for some time, it is necessary to deregulate the medical and nursing care sectors and proceed with reforms, to facilitate their development into sizable industries led by domestic demand. In order to emerge victorious from the fierce competition in global markets, Japan needs to further enhance the added value of products with a high competitive advantage. However, it is equally important to venture into new areas by making use of existing technologies. For example, as indicated by the classic adage that says necessity is the mother of invention, the electricity shortages facing Japan have provided a good opportunity in that they have heightened the need to further improve the efficient use of electricity – an area in which Japan already excels out of sheer necessity. In addition, the experience gained by dealing with the aftermath of the accident at the nuclear power plant in Fukushima Prefecture indicates that robotics technology, in which Japan enjoys a high degree of competitiveness, could be developed further for more practical use. In order to encourage firms to carry out such undertakings, outdated regulations must be eased. Furthermore, as preconditions for global competition on an equal footing, Japan needs to improve its competitive environment by, for example, concluding more FTAs and EPAs. To this end, it is necessary to improve the competitiveness of primary industry by increasing productivity to achieve both the development of that industry and growth of the overall economy. In this context, the March earthquake has provided an occasion for primary industry and local governments to review their management strategies and decide whether to expand or streamline them in accordance with the situation in each region. I would also like to say that it is important to reform the social security systems and to work on fiscal consolidation, since public concerns over the future of the pension system and public finances hamper economic growth by creating a strong incentive to save, rather than spend. Weak economic growth has made firms, individuals, and the government reluctant to take on new, risky challenges and push ahead with painful reforms, and has made the economy heavily dependent on fiscal spending for a prolonged period. As a result, government debt has ballooned, and Japan is thus in no position to merely sit back and observe the sovereign debt problems in some peripheral European countries. Although trust in the government’s conduct of fiscal policy has been maintained so far, it could crumble without warning and when least expected. Therefore, the burning issue to be tackled is the creation and implementation of a roadmap for fiscal consolidation in an effort to maintain trust both at home and abroad. BIS central bankers’ speeches C. Measures taken by the bank The Bank continues to consistently make contributions as the central bank in order to overcome deflation and return the Japanese economy to a sustainable growth path with price stability. The Bank’s efforts through the conduct of monetary policy also aim to facilitate economic revitalization. The Bank must always be ready to proactively implement the necessary policies to achieve its objectives. Going forward, the Bank should continue to be proactive and do its utmost to bring the Japanese economy back to a sustainable growth path with price stability. BIS central bankers’ speeches
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Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hakodate, 14 September 2011.
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Ryuzo Miyao: Economic activity and prices in Japan and monetary policy Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hakodate, 14 September 2011. * * * Introduction Thank you for giving me this opportunity to exchange views with people representing southern Hokkaido, particularly the area around Hakodate. And I would like to express my gratitude to everyone for your cooperation in the various business operations of the Bank of Japan’s Hakodate Branch. Japan’s economy temporarily suffered a steep decline after the Great East Japan Earthquake occurred on March 11. I am aware that the Hakodate area was no exception and was likewise affected by the disaster. Nevertheless, the efforts of all parties concerned to work toward economic recovery are paying off in a number of ways. The challenge will continue for the time being, and the Bank will do its utmost to support the efforts being made. Today, I will present an overview of economic activity and prices in Japan, which is in the process of recovery, followed by remarks on monetary policy. In my conclusion, I will touch on the economy of southern Hokkaido, particularly the area around Hakodate. I. Economic activity and prices in Japan A. Overview Japan’s economic activity has been picking up steadily while the supply-side constraints caused by the disaster have been mostly resolved and, in particular, production and exports have recently been on an increasing trend. On the demand side, business fixed investment, housing investment, and public investment are expected to increase, on the way to restoring capital stock. Private consumption is picking up as household sentiment has improved. Japan’s economy is expected to return to a moderate recovery path as production activity increases with the resolution of supply-side constraints. While the current solid recovery, mainly in production, is welcome if it continues this autumn onward, there are also some concerns. These include a slowdown in overseas economies, prolonged appreciation of the yen, a rise in electricity costs, and possible protraction of deflationary expectations. In the following, I will give an overview of overseas economies and then Japan’s economy, which is in the process of recovery, and discuss points to note in the current and future situations. B. Overseas economies Let me first talk about the U.S. economy. Although the economy is recovering, the pace is slowing remarkably. Since the Lehman shock, the United States has been suffering balancesheet adjustments in the household sector, a problem in which households incur excessive debts and a protracted period is required for resolution. In addition, since April 2011, a bottleneck in supply chains associated with the Great East Japan Earthquake has surfaced in the form of disruption of supply in automobiles and automobile-related parts, and gasoline prices have surged reflecting a hike in international commodity prices. Moreover, a cutback in local government spending has proceeded. As a result, consumption has been contained due to a slowdown in real income, production has slowed, and employment has grown at a sluggish pace. Of course, positive developments have also occurred. Exports, corporate profits, and business fixed investment have been firm, benefiting from emerging economies BIS central bankers’ speeches whose domestic demand is robust as well as the U.S. dollar’s depreciation, and stock prices have been at a relatively high level. However, real GDP for the April-June quarter on an annualized quarter-on-quarter basis, announced at the end of July, was 1.3 percent (later revised downward to 1.0 percent) and real GDP for the January-March quarter was 0.4 percent, reflecting a rapid slowdown in private consumption. An annual revision conducted at the same time showed that real GDP has yet to recover to the level prior to the Lehman shock. Particularly since late July, markets have become highly volatile, as seen in a plunge in stock prices, and household and business sentiment has declined due to various events such as political turmoil over the federal debt ceiling, a series of deteriorating economic indicators such as ISM manufacturing and nonmanufacturing indexes and consumer spending, and a downgrading of U.S. Treasuries by Standard and Poor’s from triple A to double A plus. Longterm interest rates have also been declining. In response to this situation, at the Federal Open Market Committee (FOMC) meeting held on August 9, the Federal Reserve Board stated that the current economic conditions were likely to warrant exceptionally low levels of 0–0.25 percent for the federal funds rate at least through mid-2013. While volatility in the financial markets has been contained to some extent, many of the economic indicators of consumer and business confidence have remained weak. In addition, in a situation where concern over the European sovereign debt problem has been reignited, it seems that the trend of risk aversion in the financial markets is continuing. Meanwhile, one after another, private research institutes have revised downward their real GDP outlook for the second half of 2011 and for 2012. Judging from employment statistics and a manufacturing survey for August 2011, the pace of economic recovery is likely to remain very moderate. At the FOMC meeting in late September, it is expected that the Fed will deepen discussions on additional easing by extending the duration of the meeting from one day to two, and the Fed’s potential actions have been drawing attention. The European economy grew strongly at 3.4 percent on an annualized quarter-on-quarter basis in the first quarter of 2011, but slowed to 0.6 percent in the second quarter. As in the United States, the European economy was affected by the surge in international commodity prices and partly by the disaster in Japan, but the main reason for the decline was the economic slowdown in Germany and France, which had been driving growth in the euro area. In the second quarter, Germany’s growth was 0.5 percent on an annualized quarter-onquarter basis, versus 5.5 percent in the first quarter, and France’s growth was minus 0.0 percent, compared to 3.6 percent in the first quarter. The slowdown seems to reflect a drop in exports to the United States and Asian countries, and therefore it is a matter of concern whether growth in both countries will recover in the third quarter, given that European peripheral countries have been subject to low or negative growth due to fiscal austerity. Since July, economic activity in the euro area has been lacking signs of resilience, as confirmed by various economic indicators such as business confidence indexes, industrial output, and the unemployment rate. As for the European sovereign debt problem, additional support for Greece was decided at the European Union leaders’ summit on July 21 and sovereign bonds spreads against German government bonds and the credit default swap (CDS) rate temporarily narrowed significantly; however, since the root cause of the debt problem was not addressed, tensions spilled over to Italy and Spain, resulting in a spike in government bond yields in both countries, and financial markets became destabilized. Against this backdrop, the European Central Bank decided on August 4 to reinstate a liquidity-providing supplementary longer-term refinancing operation with a maturity of approximately six months, and to restart bond purchases under the Securities Markets Programme. Some countries – France, Italy, Spain, and Belgium – started to restrict speculative moves, and on August 11 they decided to ban short selling of financial stocks, with Italian and Spanish government bond yields declining as a result. European financial markets have remained unstable, however, with a rise again in Greek government bond BIS central bankers’ speeches yields and a decline in stock prices, mainly of financial institutions. Since the outbreak of the Greek crisis in May 2010, the number of countries targeted by the markets has increased. While support by the monetary and fiscal authorities has expanded during this time, tensions have spread even to Italy and Spain, and thus risks associated with the European sovereign debt problem seem to be on the rise. Concern from now on is the spillover of the European sovereign debt problem to the financial/banking sector and economic activity. As this spillover appears to have partly surfaced in the form of a rise in financial institution CDSs and a widening in corporate bond spreads, further developments should be monitored carefully. Asian emerging economies have been growing at a high rate, led by China, and medium- to long-term growth expectations appear to have remained high. However, due partly to monetary tightening conducted with a view to containing inflation, recent economic indicators have been showing signs of a slowdown. This can be seen, for example, in the declining trend in China’s manufacturing purchasing managers index. In addition, Japan’s disaster adversely affected ASEAN countries in the April-June quarter. While the effects of the disaster appear to have almost run their course as of July, external demand might slow down from now on reflecting a slowdown in the recovery in the United States and Europe. Domestic demand is robust, but, given continued concern over inflation, further monetary tightening is necessary. For example, while China has been intermittently raising bank lending and deposit rates as well as the reserve requirement ratio since the beginning of 2011, year-on-year growth in the consumer price index (CPI) has remained high, at 5.5 percent in May, 6.4 percent in June, 6.5 percent in July, and 6.2 percent in August. Whether the Chinese economy can make a soft landing will be critical in ensuring the sound development of the global economy, and therefore, developments in China continue to warrant close attention. Besides the problem of inflation, it should be noted that there is a risk in China that part of the large-scale investment made through local government investment vehicles might become nonperforming. In other words, considering China’s economic outlook from a somewhat longer-term perspective, the high-growth track led by investment is likely to continue for the time being. However, if such large-scale investment continues for a long time, some of it might become excessive in inefficient areas and financial institutions’ massive loans might become nonperforming. I will pay close attention to whether China can maintain a balance between price stability and economic growth from a somewhat longerterm perspective. C. Japan’s economy Japan’s economy is on the path to recovery following a plunge in growth due to the effects of the March 11 disaster. The real GDP growth rate in the second quarter on an annualized quarter-on-quarter basis, was minus 2.1 percent, marking three consecutive quarters of negative growth – that is, minus 2.5 percent in the fourth quarter of 2010, minus 3.6 percent in the first quarter of 2011, and minus 2.1 percent in the second quarter of 2011. After the earthquake, firms’ production activity plunged, consumer sentiment worsened, and labor and income conditions deteriorated, due mainly to the constraints of supply chains and the nuclear accident. As a result of strenuous efforts by the parties concerned, the economy has recently been recovering, mainly in production, at a high pace. Production and exports have nearly returned to their levels prior to the earthquake, and private consumption has been gradually recovering due partly to demand stemming from the transition to digital terrestrial transmission and power saving. Business fixed investment has also been picking up, and household and business sentiment has been generally improving. In the meantime, the Bank enhanced monetary easing on March 14 following the earthquake, and on April 7 decided to introduce the funds-supplying operation to support financial institutions in the disaster areas. BIS central bankers’ speeches The real GDP growth rate on an annualized quarter-on-quarter basis in the third quarter is likely to turn positive, according to private surveys. Production, mainly that of automobiles, continues to be at full capacity, and recovery demand is likely to gradually increase. Following the removal of the supply constraints, moderate economic recovery, generated by production and exports, is likely to continue. Having said that, the future scenario for economic recovery is associated with the following concerns and thus warrants vigilance. First, as already stated, there is a possibility that overseas demand will be weaker than initially envisaged amid the slowdown in the economic recovery in the United States and European advanced economies, and this might make Japan’s economic recovery weaker than expected. Second, the prolonged appreciation of the yen. If the appreciation of the yen continues in response to the events such as downgrading of U.S. Treasuries, conditional maintenance of the U.S. zero interest rate policy until mid-2013, and the renewed European sovereign debt problem, concern will grow regarding the hollowing out of domestic industries. There are both positive and adverse effects of the yen’s appreciation on economic activity, and the basic response to it should be to maximize the positive benefits and mitigate the adverse effects as much as possible. In this regard, one can point to such positive effects as providing firms and consumers with imported raw materials, products, and commercial goods at lower prices, as well as facilitating domestic firms’ equity investment and acquisitions of overseas firms and projects, thereby raising the domestic firms’ productivity. On the other hand, the adverse effects, needless to say, include exposing domestic automakers and electrical machinery manufacturers to severe price competition with overseas firms and thus lowering profitability. The important point here is that, while the prices of various goods and services have been steadily rising in the markets to which Japanese firms export – including Asian emerging economies and the United States – automobiles and electrical machinery products have been competing severely with overseas products and their prices have been declining markedly in these markets. Therefore, Japanese exporters of these products will be forced to fiercely compete without being able to mitigate the impact of the yen’s appreciation through inflation in the export destinations. As developments in exports are linked with domestic production and thus have a substantial impact on Japan’s economy, downward pressure from the yen’s appreciation tends to become strong. In addition, if the yen’s appreciation leads to a relocation of key factories as well as research and development (R&D) bases, the adverse effects on the economy’s potential growth are a concern. Based on this consideration, I believe it is meaningful that the government is considering support for R&D in the manufacturing sector and small and medium-sized subcontractor firms, to alleviate the pain associated with the yen’s appreciation and prevent the hollowing out of domestic industries. Third, a rise in electricity costs. This summer, the shortage of electricity did not substantially affect the production level, thanks to firms’ creativity and endurance as well as individuals’ efforts to save electricity. As a shift from nuclear power to alternative energy sources is likely from a long-term perspective, corporate profits could come under persistent pressure and some firms might have to shift their businesses overseas if electricity costs – including the imports of alternative energy sources – increase. Fourth, protracted deflationary expectations. In August 2011, the base year for calculating the CPI was switched from 2005 to 2010, and as a result the year-on-year rate of change in the CPI components (all items less fresh food) was revised downward by 0.5 to 0.8 percentage point. The year-on-year rate of change in the new 2010-base CPI (all items less fresh food) was minus 0.2 percent in April, minus 0.1 percent in May, minus 0.2 percent in June, and 0.1 percent in July. Private research institutes had originally forecasted that the year-on-year rate of change in the CPI (all items less fresh food), because of the change in BIS central bankers’ speeches the base year, would decline from the recent level of around 0.6 percent to around 0 percent. The Bank’s forecasts were almost within the same range, and it has been confirmed that it will still take some time to achieve price stability. If expectations for the continuation of the zero interest rate become protracted in a situation where more time is needed to achieve price stability, there is a risk that people’s deflationary expectations will intensify in a self-fulfilling manner. If by any chance deflationary expectations prevail, it will become difficult to change the behavior of people who are reluctant to take risks; people might postpone spending, and growth expectations would be unlikely to increase. There is a risk that the economy will be unable to escape from such a situation, which might be called a “deflation and low-growth trap.” At present, even following the change in the base year, it is still the case that the economy is emerging from deflation amid the narrowing output gap, and careful attention should be paid to any possible changes in people’s inflation expectations. In this regard, there are factors, including an incremental rise in commodity prices, that will push up the actual price trend with a lag. From October 2011 onward, the effects stemming from a rise in tobacco tax and an increase in non-life insurance rates will disappear. Due attention should be paid to whether these factors will again put downward pressure on the CPI. In the meantime, at the Monetary Policy Meeting held on August 4, the Bank decided to enhance monetary easing by increasing the total size of the Asset Purchase Program by about 10 trillion yen: 5 trillion yen for the fixed-rate funds-supplying operation against pooled collateral and 5 trillion yen for asset purchases. While Japan’s economic activity is picking up steadily mainly in production, its economic outlook entails various downside risks. Taking into account such downside risks, including uncertainty about overseas economies and effects stemming from the base-year change in the CPI, the Bank decided to further enhance monetary easing, thereby ensuring a successful transition from the recovery phase following the earthquake disaster to a sustainable growth path with price stability. The Bank will continue to take proper measures if necessary. II. Monetary policy A. Monetary policy at the zero interest rate Now let me summarize the efforts taken to enhance monetary easing in a general context. If the conduct of monetary policy, which controls the ordinary policy interest rate (the uncollateralized overnight call rate in the case of Japan) is defined as “traditional monetary policy,” monetary policy that is pursued while the policy interest rate approaches the zero bound is often called “unconventional monetary policy.” When the policy interest rate is lowered to around 0 percent, it becomes difficult to further enhance monetary easing. Instead, there are other policy measures to further exert powerful monetary easing effects, such as committing to continue the zero interest rate policy into the future or increasing the size of a central bank’s assets, or changing the composition of its asset portfolio. The “comprehensive monetary easing” implemented in Japan from October 2010 can be interpreted precisely as an “unconventional monetary policy package” that includes all the elements just mentioned. Namely, the Bank has confirmed that it will maintain the virtually zero interest policy until it judges that price stability is in sight, and it has been purchasing various financial assets such as government securities, corporate bonds, CP, exchangetraded funds (ETFs), and Japan real estate investment trusts (J-REITs). Successive monetary policy measures in the United States conducted following the Lehman shock were similar in that they included large-scale asset purchases such as mortgage-backed securities and government securities, changes in the composition of assets, and the continuance of the BIS central bankers’ speeches zero federal funds rate policy, at least through mid-2013 given the conditions of economic activity and prices. All these measures are expected to work on firms’ and households’ spending and investors’ portfolio selection by encouraging a decline in longer-term market interest rates and various risk premiums, and to ultimately influence economic and price conditions. Regarding the effects of comprehensive monetary easing, as far as financial market developments are concerned, we at the Bank believe that it has had certain positive effects. Credit spreads on CP and corporate bonds have declined, and stock and J-REIT prices have been firm on the whole. We consider these effects have played a role in underpinning economic activity and prices. With regard to the unconventional policy measures in the United States, particularly the large-scale government bond purchase program – the so-called “quantitative easing II,” implemented from November 2010 to June 2011 – there has been controversy about the effects of the policy measures. Supporters of the effects have pointed out that the measures have dispelled deflationary concern, raised stock prices, improved consumer confidence, promoted exports due to the U.S. dollar depreciation, and enabled prompt repayment of injected public capital through a rise in stock prices. On the other hand, critics of the effects have indicated that economic indicators including employment have not improved markedly, a mini-bubble in stock prices has formed and burst, a surge has been induced in international commodity prices such as crude oil and gasoline, real income of low-income families (who are unlikely to benefit from the surge in asset prices) has been reduced, and inflation has been exported to emerging countries. Assessments of the policy measures are diverse, in that some emphasize the positive effects of the measures while others cast doubt on the policy effects or claim that unexpected side effects were far too large. The controversy seems to suggest that it is difficult to grasp and foresee the size and channels of the policy effects in advance. B. Effects of monetary policy measures: a comparison of traditional and unconventional policies Is there a substantial difference between traditional and unconventional policies concerning monetary policy effects and their transmission channels? In traditional monetary policy, an expected transmission mechanism is to work on borrowing costs, various asset prices including stock prices and foreign exchange rates, and bank credits both through the interest rate channel and the portfolio adjustment channel. These, in turn, influence firms’ and households’ spending behavior and ultimately economic activity and prices. Such a transmission mechanism of traditional monetary policy, in theory, also holds true for unconventional policy. Influencing longer-term interest rates and various risk premiums is nothing more than the interest rate channel and the channel through portfolio adjustments and asset prices, both of which I have mentioned above. Almost all of the aforementioned controversy over the policy effects in the United States can be explained in terms of the traditional transmission channels. On the other hand, some arguments remain to be specifically pointed out about transmission mechanisms in unconventional policy, even though the qualitative mechanism in traditional and unconventional policies is the same. The first is about the effect of stabilizing financial systems and financial markets. This is the effect of soothing anxiety about financial systems by supplying ample liquidity to financial institutions, or the effect of stabilizing financial markets by central bank interventions when the markets become excessively risk averse and the market mechanism deteriorates, resulting in a surge in risk premiums. By preventing financial anxiety and preventing the markets from plunging, adverse effects on economic activity can be prevented. BIS central bankers’ speeches The second is about the effect of international spillover. With expectations for a protracted zero interest rate, global investors will search for yield or become active in the carry trade and risk taking, and capital will flow into high-interest-rate and commodity-exporting countries. This will then expand economic activity and raise stock prices in overseas emerging economies. As a result, there will be an effect that spills over to domestic economic activity and prices through an increase in exports to the emerging economies and an improvement in profits of global firms. The third is about the effect through the expected rate of inflation. This is the effect that, in addition to the existing channel of influencing demand, by attaching an expectation that a central bank’s balance sheet will expand for a protracted period, the expected rate of inflation will rise and real interest rates will decline, thereby affecting economic activity and prices. While these transmission mechanisms of monetary policy effects can be considered, the side effects will be a source of concern if monetary easing becomes excessive. As for the first effect I mentioned, if a central bank excessively intervenes in the markets and suppresses risk premiums too much, this might ruin the intrinsic function of the markets of making prices according to risks. In addition, financial institutions’ profits might be compressed. By encouraging excessive risk taking, the second effect could induce economic overheating or a credit bubble in the countries receiving the capital inflows and subsequently cause a serious economic downturn. As for the third effect, if excessive balance-sheet expansion continues, the expected rate of inflation might rise unexpectedly or the markets might realize that the balance-sheet expansion is an undisciplined monetary increase or the monetization of government debts, leading to a surge in government bond yields. It is necessary to take due account of the possibility that unconventional monetary easing will be associated with such unique side effects. C. Points to keep in mind Based on the summary I have just given, there are several points to keep in mind. First, as the transmission channels of the monetary policy effects overlap or are mutually related, it is quite difficult, if not impossible, to recognize each transmission channel separately or measure its quantitative effects. In particular, policymakers lack experience with respect to the effects and side effects of unconventional policy. And an economic situation that requires such a policy often occurs in the midst of severe and protracted economic stagnation following a financial crisis, in which firms and households have shouldered excessive debts. Therefore, it could indeed be an economic environment in which a normal transmission mechanism cannot function properly. Taking into account that there is limited experience with unconventional policy and such a policy is bound to face a difficult economic environment, it becomes crucial to make a comprehensive and deliberate judgment that requires vigilance for unexpected side effects, while referring to prior policy experience. Second, in a financial and economic environment after the effects of unconventional monetary policy spread in a desirable way, interest rates will rise in a positive sense. When somewhat longer-term interest rates decline or risk premiums fall by way of accommodative monetary policy, funds’ borrowers – for example, firms – can increase borrowing based on low interest rates, or can purchase many more capital goods by issuing new shares thanks to a rise in stock prices, thereby increase business fixed investment. As a result, economic activity and prices will rise. In the aggregate, stock prices will rise, and bond prices will fall and the interest rate will increase. As for investors, they feel discouraged by a decline in profitability due to the initial decline in interest rates, and they will try to sell low yield bonds and purchase other assets including stocks. As a result, asset prices including stock prices will increase and bonds will be sold and interest rates will rise. BIS central bankers’ speeches Consequently, at the transmission channel in which monetary policy effects surface gradually and the economy grows steadily, it is natural that longer-term interest rates initially will fall and then rise in due course. On the contrary, if longer-term interest rates remain low, this would imply prolonged low growth, given that inflation expectations are unchanged. As a footnote, let me point out that one needs to be careful in discussing the effects on an economy of a case in which interest rates are increasing in a desirable way. For example, in case of fiscal consolidation, if the assumed interest rate level rises, it will increase the interest burden in public finance. On the other hand, an increase in revenue can be expected from a rise in economic growth. Thus, it is important to discuss fiscal consolidation by taking account of these two effects. Third, desirable strengthening of growth potential cannot be achieved by monetary policy alone. To begin with, it is understood that strengthening of an economy’s growth potential will be promoted primarily by structural reform efforts in the private sector and the government’s growth strategy to support such efforts. Having said that, monetary policy might have medium- to long-term effects on the economy, in addition to an effect of containing shortterm and cyclical swings in economic activity. In an ideal case, monetary easing might contribute to strengthening productivity and growth potential by promoting quality business fixed investment as well as R&D investment. In an undesirable case, there is a risk that monetary easing will amplify swings in the economy in the medium to long term by encouraging excessive risk taking and excessive business fixed investment, or that undisciplined monetary easing will induce the erosion of confidence in the currency with an unexpected timing and induce a surge in interest rates. Therefore, it is important to recognize that potential effects of monetary policy could have both positive and negative effects on medium- to long-term economic growth. In relation to strengthening the medium- to long-term growth potential, the Bank has been conducting the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth since June 2010. With this measure, the Bank supplies long-term funds – with an initial duration of one year and a maximum duration of four years – at a low interest rate of 0.1 percent to qualifying financial institutions. The measure has already reached the initial total amount of 3 trillion yen and has been playing the role of a catalyst. In addition, in June 2011 the Bank decided to introduce a new line of credit of 500 billion yen. Through this, the Bank provides long-term funds, with an initial duration of two years and a maximum duration of four years, at a low interest rate of 0.1 percent to financial institutions that undertake equity investments and asset-based lending. The Bank expects that the new measure will further enhance financial institutions’ efforts to strengthen the foundations for economic growth through the use of a wider range of financial techniques including assetbased lending. I have talked about the transmission channel of monetary policy effects and some points that should be kept in mind. As I mentioned earlier, when conducting actual monetary policy, deliberate and decisive actions are required while considering carefully various conditions and possibilities and identifying the timing and measures that will produce maximum positive effects and keep side effects to a minimum overall. In a highly uncertain economic environment, the Bank will continue to consistently make contributions as the central bank, by pursuing powerful monetary easing consisting of comprehensive monetary easing, ensuring financial market stability, and providing support to strengthen the foundations for economic growth. Concluding remarks In my concluding remarks, I would like to say a few words about the economic potential of southern Hokkaido, particularly the area around Hakodate. BIS central bankers’ speeches There has been downward pressure on economic activity in the region, mainly in the key industry of tourism, due to the effects of the Great East Japan Earthquake. Recently, as pressure stemming from the disaster decreases, there have been signs of improvement mainly in tourism, private consumption, and production. The region offers a number of tourist attractions, such as a superb night view from Mount Hakodate – which is considered to be among the top three such views in the world – historic and cultural heritage sites such as Fort Goryokaku, fresh seafood, and numerous hot springs. It is famous as one of Japan’s leading tourist destinations, attracting 10 million visitors each year from home and abroad. In the revised second Japanese-language edition of Michelin Green Guide Japon, released in May 2011, the region as a whole received a high rating, with the night view from Mount Hakodate awarded three stars (worth a journey) and six sites including Fort Goryokaku awarded two stars (worth a detour). There are also many other positive aspects related to tourism, including the opening of Shin-Hakodate station on the Hokkaido Shinkansen Line planned in fiscal 2015. I sincerely hope that people here will take advantage of such opportunities. The region is characterized by abundant marine resources and marine-related industries, such as seafood processing that utilizes such resources and the shipbuilding industry, and many related academic organizations. I have learned that efforts to take advantage of these characteristics and promote the concept of “International Fisheries and Ocean City Hakodate” have been underway through the collaboration between industry, academia, and government. I strongly hope that the efforts to vitalize the region, by utilizing its characteristics and advantages, will lead to the further development of southern Hokkaido. BIS central bankers’ speeches
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Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 18th Annual Conference of the International Association of Insurance Supervisors (IAIS), Seoul, 30 September 2011.
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Masaaki Shirakawa: Insurance companies and the financial system – a central bank perspective Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 18th Annual Conference of the International Association of Insurance Supervisors (IAIS), Seoul, 30 September 2011. * I. * * Introduction It is a great privilege to have the opportunity to speak here today. Before starting, I would like to express my deep respect for the countless contributions made by the International Association of Insurance Supervisors (IAIS) since its establishment in 1994. The Bank of Japan has consistently had a keen interest in developments in the insurance business, although it does not have the authority to supervise insurance companies in Japan. As you know, Japan experienced a financial crisis from the late 1990s through to the beginning of the 2000s, during which a few small and medium-sized insurance companies failed. In a country with a significant insurance sector, these failures were one of the factors that had a considerable impact on the macroeconomy. The causal relationship between insurance companies and the macroeconomy also holds true the other way around. Macroeconomic developments can have a significant effect on the financial system, including insurance companies. In fact, Japanese insurance business from the late 1990s onward cannot be discussed without reference to Japan’s declining population and the “negative spread problem” caused by continued low interest rates. I hope this gives you some background on why the Bank of Japan has such a strong interest in insurance business. The title of my speech today is “Insurance Companies and the Financial System: A Central Bank Perspective.” First, I will talk about the significance of a shared aspect of the remit of insurance companies and central banks: providing stability and security. Next, I will discuss the current state of the global economy, with particular reference to its effects on the business of insurance companies. Finally, I will offer my thoughts on regulation and supervision of insurance companies. II. Provision of stability and security Looking at the relationship between central banks and insurance companies, the two have in common their role as providers of stability and security. From the moment human beings began to engage in organized economic activity of some sort, there was a prevailing sense of awareness of the need to transfer risks that could not be borne by an individual economic entity to other economic entities and to diversify them. The Code of Hammurabi, a Babylonian law code dating back to around the 18th century B.C., apparently refers to a contract under which the owner of a trading vessel who, when applying for loans for procuring cargo, paid a special fee in advance and was thus exempted from repayment of the relevant loans in the case of loss or damage of the cargo procured. This early example of an insurance contract shows how important it is for an economy’s development to transfer and allocate risks that exceed the risk-taking capacity and appetite of individual economic entities. Compared to the history of the insurance business, central banking is a relatively new invention. Although the oldest central bank has a history of nearly 400 years, the central bank in a modern sense only appeared in the mid-19th century. As economies became more complex and networks of banks started to provide credit for economic activity in an organized manner, there was an increasing need for someone to play the role of ensuring the stability of the network, or in other words the financial system. The financial system is built on mutual BIS central bankers’ speeches trust among participating financial institutions. Once such confidence is undermined and participants become beset with doubts and fears, the financial system destroys itself in a self-fulfilling manner. In order to stop such a vicious cycle before it ended in catastrophe and to ensure the stability and security of the financial system, central banks started to function as the “lender of last resort.” Central banks also provide stability and security in another form. Under the gold standard, which was adopted until the 1930s, at least theoretically the outstanding amount of gold held by individual countries formed the basis of the value of their currency and economic activity. After the gold standard was abandoned, it became necessary to conduct active policy intervention, with central banks playing part of this role. Through the conduct of monetary policy, central banks began to work toward fostering an environment in which individual economic entities were not disturbed by macroeconomic uncertainties such as large fluctuations in prices. To sum up, both insurance companies and central banks provide economic entities with stability and security through their respective business. Such contribution facilitates risktaking by economic entities and, consequently, promotes economic growth. By the way, in addition to having the similarity of both working to achieve stability and security, insurance companies and central banks share some of the same difficulties. Insulation from significant risks that cannot be borne by individual economic entities will stimulate economic activity but it could also encourage excessive risk-taking. Taking the example of car insurance, drivers insulated from liability for compensation could drive at excessive speed and cause accidents. This, as you know, is a textbook example of the “moral hazard” problem. Central banks also face the problem of moral hazard. Instead of contributing to financial system stability, the “lender of last resort” function of central banks could end up threatening that very stability by encouraging excessive risk-taking by banks. Also, in terms of macroeconomic stability, it is sometimes pointed out that the recent financial crisis was partly attributable to what is sometimes referred to as the “Great Moderation” from the 1990s to the mid-2000s, a period characterized by a favorable combination of low inflation and high growth, and a time of too much confidence in central bank policy, which contributed significantly to the moderation. As moral hazard is one of the most important topics of discussion for monetary policy, financial system stability, and regulation and supervision, I will return to it toward the end of my speech. III. Current state of the global economy and financial markets Next, I would like to turn to the current state of the global economy, with particular reference to its effects on the business of insurance companies. Developments in the global economy following the failure of Lehman Brothers It is now three years since Lehman Brothers collapsed in September 2008, triggering the financial crisis. Developments in the global economy thereafter can be summarized into the following three points. First is the fact that the global economy has managed to prevent a depression that might well have been as severe as the one witnessed in the 1930s. This significant achievement can be attributed to the effective measures to stabilize the financial system and to the bold monetary and fiscal policy after the failure of Lehman Brothers. Second, the global economic recovery has been bifurcated so far. Emerging economies started recovering relatively soon after the crisis and have continued to post high growth. In contrast, given the significant downturns of advanced economies after the failure of Lehman Brothers, their pace of recovery thereafter has been slow. BIS central bankers’ speeches Third, the downward pressure exerted on advanced economies by the repair of balance sheets is a root cause of their sluggish recovery. The global credit bubble in the mid-2000s was incredibly large. When such a huge bubble bursts, balance sheets have to be repaired, or in other words, excesses in stock and corresponding debt have to be adjusted. Furthermore, economic activity is restrained for the duration of that process. The sectors requiring balance-sheet adjustment differ according to the country: in the United States, it has been needed in the household and government sectors; in Europe, the financial and government sectors. The recent fiscal deterioration is attributable to several developments. One is the aggressive measures implemented by governments and a decline in tax revenue associated with economic deterioration after the onset of the financial crisis. The other, which applies to some countries in the euro area, is the weakening of fiscal discipline amid favorable issuing conditions of government bonds brought about by the introduction of a common currency. In any case, the time required to complete the repair of balance sheets largely depends on the magnitude of the bubble and financial imbalances preceding the adjustments. To sum up, although we have managed to prevent another great depression, conditions are not exactly favorable for the global economy as a whole. This reflects the prolonged balancesheet repair taking place particularly in advanced economies, which is counteracting the growth momentum being maintained in emerging economies. A particular point to note in this regard is that, in advanced economies, deteriorations in fiscal balances, combined with historically low interest rates, are recognized as restraints on the implementation of additional policy stimuli, and this is further undermining the already fragile recovery process. Current state of global financial markets Amid the developments in the global economy that I have mentioned, we have observed various changes in global financial markets. First, long-term interest rates of advanced economies have reached historically low levels and the yield curve is generally flattening. Underlying this are increased market expectations that major central banks of advanced countries will continue with accommodative monetary policy given the increasingly cautious views about the economic outlook. Second, investors are becoming increasingly risk-averse. Especially after this summer, stock prices fell and credit spreads widened on corporate bonds as investors became more risk averse and entered what is often called “risk off” mode. In government bond markets, U.S. and German interest rates declined partly due to market participants’ preference for risk-free assets, while interest rates in peripheral euro-zone economies rose substantially. In foreign exchange markets, the Swiss franc and the Japanese yen appreciated as they were viewed as relatively safe-haven currencies. And third, there is rising concern about sovereign debt. As I have described, fiscal balances in many advanced economies deteriorated after the failure of Lehman Brothers. In Europe, Greece, Ireland, and Portugal successively had to receive financial support packages. The sovereign spreads of peripheral euro-zone countries have remained wide, reflecting heightening market concerns about sovereign debt. Implications for insurance companies The current state of the global economy and financial markets definitely has significant implications for the insurance business. First of all, with little room left for fiscal stimulus, central banks in advanced economies have strengthened so-called unconventional monetary policy. While those central banks, including the Bank of Japan, have tried a variety of unconventional monetary policies, one common feature is that a flattening of the yield curve has been observed in the process. If the repair of balance sheets takes a certain length of time, the flattening could also last for that period. For BIS central bankers’ speeches some insurance products that cover a long time period, a slight difference in a discount rate could result in a significant variation in asset value. Therefore, the management of insurance companies as well as the regulatory and supervisory authorities need to consider carefully whether the current low interest rate environment is an exceptional case or not. Next, increasing risk arising from sovereign debt could call for a review of the risk management practices that have been adopted by insurance companies. Insurance companies have made efforts to match the durations of their insurance payment liabilities and the products in which they invest their insurance premiums. They have invested in super long-term government bonds to address mismatch risk arising from long-term contracts such as life insurance. If the credit risk associated with sovereign debt is not negligible, these risk management practices will become less effective. Finally, with their long investment horizons, insurance companies are expected to take advantage of market distortions caused by risk aversion among investors with shorter horizons. If insurance companies are currently having difficulties doing this, we need to consider the background to the situation and what the authorities can do to address the issue. At this juncture, central banks in advanced economies, including the Bank of Japan, are deploying strong monetary easing measures to ensure the global economic recovery. Given that we are already in the uncharted territory of unconventional monetary policy, it is important to weigh the benefit of such policy against its cost by carefully considering the following matters: whether a given policy is having its intended effect; whether it is causing an unexpected distortion in financial markets; and whether there are any other policy options for achieving the same results. IV. Regulation and supervision of insurance companies Financial system stability Until now I have been describing the current state of the global economy. Now I would like to turn to my last topic for today: regulation and supervision of insurance companies. We can point out two reasons to regulate and supervise financial institutions including insurance companies: consumer protection and prevention of systemic risk. With regard to the latter, whether insurance companies could cause systemic risk has been frequently discussed. One camp argues that, compared to banks, insurance companies themselves are less likely to become the epicenter of a liquidity crisis or to cause systemic risk because their liabilities are mainly long-term ones based on insurance contracts. Although such an argument is valid in a comparative sense, the global financial crisis shows that we cannot safely say that the failure of insurance companies would not cause systemic risk. As financial markets become increasingly interconnected, we cannot deny the possibility that a deterioration in the business conditions of insurance companies, or their failure, could trigger cancellations of savings insurance products or a deterioration of market sentiment that would undermine the stability of the financial system as a whole. When insurance companies are also involved in a wide range of business operations through their subsidiaries, such operations could trigger systemic risk. During the financial crisis, the U.S. Federal Reserve provided a large amount of funds to AIG, based on the judgment that such risk was highly significant. When small and medium-sized insurance companies failed in Japan, the Insurance Policy-Holders Protection Corporation was established and the Bank of Japan established a temporary credit line to the corporation, although it was never activated. Designing regulatory and supervisory frameworks: finding the right balance Various international efforts have been made in the areas of regulation and supervision of financial institutions, including insurance companies, with the aim of preventing future financial crises. With regard to bank regulation, the introduction of the Basel III framework BIS central bankers’ speeches was internationally agreed in 2010. This summer, planned measures were announced for global systemically important financial institutions, or G-SIFIs, including an additional capital charge and the establishment of a smooth resolution framework for winding down such institutions. In parallel with such developments, active discussions have been taking place to change the regulations for insurance companies, including the Solvency II Directive in Europe. As financial transactions become more complex and globalized, reforming our frameworks for financial regulation and supervision is becoming an extremely challenging task. Although it is easy to point out problems with any reform proposals, it does not mean that current frameworks should remain unchanged. In order to prevent financial crises, the regulatory and supervisory authorities, central banks, and financial institutions need to do their utmost to successfully make the necessary reforms. Today I am not going to discuss specific reform measures given the time constraints. Instead, as a guiding principle for reforming the frameworks for international financial regulation and supervision, I would like to emphasize the importance of finding the right balance in various respects without relying too much on any specific methodology. This is based on the recognition that our knowledge is still quite limited with respect to the intrinsically complex mechanisms of the financial system, which continue to evolve in a dynamic manner. The need for humility is obvious when we look back on how bubbles have developed and burst in the past and how financial crises have followed thereafter. In terms of finding the right balance, it is first of all important to strike a balance between regulation and supervision on the one hand and the macroeconomy on the other. While regulation and supervision is, of course, important, the macroeconomic environment is also critical. Our experience of financial crises clearly shows that various risks can accumulate in a seemingly benign macroeconomic environment and the materialization of those risks in the form of a financial crisis could end up causing significant economic damage. This is the sort of moral hazard that I spoke of earlier in which perceptions that risks have declined invite excessive risk-taking. In this sense, when conducting monetary policy we need to pay due attention not only to price developments but also to the accumulation of financial imbalances such as asset price inflation, leveraging and increasing maturity mismatch. Second, the balance between regulation and supervision is important. Business models of financial institutions differ by country and institution. Against the backdrop of financial globalization and advances in information and communication technology, individual financial institutions need to flexibly adjust to changing business environments. Given this, enforcing “one-size-fits-all” regulations for various types of financial institutions could increase the likelihood of adverse side-effects. In order to avoid this, we should rely more on supervision than we do today. We must design a comprehensive framework that better combines regulation and supervision. Third, it is crucial to find the right balance by paying due attention to similarities and differences in the functions of various financial institutions. Insurance companies are important providers of long-term funds to banks and other sectors. They can play this role because their liabilities are mainly long-term. This makes them less vulnerable to interest risk arising from maturity transformation and liquidity risk in comparison to banks. On the other hand, insurance companies have inherent insurance risk on their liabilities. As such, insurance companies and other financial institutions including banks have different functions and risk profiles. Collectively and in complement to one another, these various types of financial institutions perform important financial intermediation functions in the economy. There is also a similarity. In the current global financial markets, various types of financial institutions perform socially beneficial financial functions using their various distinct products. For example, options, one type of derivative instrument, are very similar to insurance. Of course, we should not denounce overlaps between different financial products that provide the same economic function. If more competition lowers the cost of financial services, it could benefit society as a whole. However, significant risk could be created depending on the BIS central bankers’ speeches incentive structures in the overlapping areas. In that sense, due attention should be paid to both similarities and differences in the functions of insurance companies and other financial institutions. I know that the points I have made so far are typical examples of something being easier said than done. Still, I believe these points are absolutely critical and should be considered when designing regulatory and supervisory frameworks. V. Concluding remarks As I have already used up most of my time, I would now like to conclude my remarks. With some exceptions such as France, the Netherlands and Belgium, in many advanced countries a central bank is not directly in charge of the regulation and supervision of insurance companies. Nevertheless, central banks have a keen interest in the activities of insurance companies, as insurance companies are an important player in the financial system. It is important that central banks take part in the discussion about the design of regulatory and supervisory frameworks for insurance companies. Another potentially significant contribution by central banks is to analyze potential risks within the financial system as a whole, including insurance companies, and present the results to the public. This is what we call macroprudential analysis, an area that is increasingly seen as important in recent years. In Japan’s earlier financial crisis, its insurance sector was hampered by the “negative spread problem” and capital losses on equity holdings. Insurance companies’ business conditions are affected less by short-term economic and financial fluctuations and more by long-term developments. Put another way, as insurance companies have the unique characteristic of handling longterm funds, it is particularly important for them to manage risk from a long-term perspective with emphasis on the interaction between the real economy and the financial system. When we think about coming developments in the global economy and their impact on insurance business, there are many factors that underscore the importance of macro-prudence, including the likelihood of continued low interest rates, sovereign debt problems, and demographic changes. In that sense, let me close my remarks by stressing the importance of cooperation and exchanges of views among insurance companies, regulatory and supervisory authorities, and central banks. Thank you very much. BIS central bankers’ speeches
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the ADBI FSA Conference, Tokyo, 30 September 2011.
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Kiyohiko G Nishimura: Macro-prudential policy framework from an Asian perspective Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the ADBI FSA Conference, Tokyo, 30 September 2011. * * * Charts to the above speech can be found on the Bank of Japan website. Introduction In this presentation, I would like to take up several key issues relating to macroeconomic policy frameworks explicitly taking account of financial markets, or macroprudential policies, especially from an Asian perspective. In particular, I ask following two questions: (1) What methods should we employ to detect intolerable accumulation of risks in the financial system? and, (2) How should we maintain financial stability in the short run, while improving efficiency in credit intermediation functions to support long-term economic growth? I will be seeking practical “best practice” answers to these questions, rather than “optimum solutions” based on a particular theory.1 This practical and somewhat atheoretical approach is warranted since we are still very much short of having a satisfactory macroeconomic theory that deals adequately with complex and sometimes violent financial markets, although there has emerged a sizable literature on the relationship between macroeconomic activity and financial markets. Before trying to answer these inherently difficult questions, it is worth looking back to the evolution of the current financial crisis in the United States and Europe, and of that in Japan two decades ago. Although much attention has been focused on financial excess as typified by excessive leveraging in financial institutions, I would like to emphasize the importance of underlying changes in fundamentals, especially demographic factors such as population ageing. The latter has particularly important implications for the future in Asia. The basic message here is that many of Asia’s growing economies may face problems in the near future similar to those of developed countries, and it is thus of the utmost importance to implement appropriate macro-prudential policy now. Section 1. Asia in perspective: financial crisis, its aftermath and fundamentals Financial crisis and fundamentals: demographic factors Although three years have passed since the so-called Lehman Shock, we are still in the process of soul-searching; pursuing a better understanding of its causes and the appropriate policy response to it. Since Japan and a number of Asian economies already experienced their own financial crises in the 1990s, we Asians may be in a slightly better position to compare them and draw the necessary lessons. Indeed, there are many similarities between the recent crisis in the United States and the eurozone on the one hand, and Japan’s financial crisis since the 1990s on the other. In the case of both the US- Clark and Large (2011) present ten questions in framing appropriate macro-prudential policy, crystallizing its fundamental and practical problems. In this speech, I touch on only a few of them, which I think are most relevant from the Asian perspective. BIS central bankers’ speeches eurozone and the “Bubble Era” in Japan, risks were accumulated during the period of high growth and low inflation.2 Risks were accumulated particularly in real-estate related sectors. The recent literature on financial crises has focused mostly on explaining how bubbles develop and influence economic activity through leveraging in financial markets.3 Here the measures of economy-wide financial activity, such as deviation from the long-run trend of the credit-to-GDP ratio, are considered to be informative and possible guides for macroprudential policy. However, I would like to emphasize another important background factor, that is, demographic change in the form of population ageing. Indeed, the “bubble and burst” and subsequent financial crisis seemed to coincide roughly with the turning-point of population pyramids in Japan, the United States, and Europe. Let me show you some telling figures on the inverse dependency ratio, which indicates how many people of working age it takes to provide for one dependent person.4 The Japanese ratio peaked around 1990, and it was in the very next year, 1991, that the Japanese Bubble peaked. The peak of the US ratio was between 2005 and 2010, and the peak of the US subprime bubble was 2007 (Fig. 1). The economically troubled countries of the eurozone have a similar pattern to Japan and the United States. The ratios for Ireland and Spain have almost the same time profile; they peaked around 2005, which corresponds to the peak of their property bubbles (Fig. 2). The ratio for Greece and Portugal peaked around 2000. The significant point for us here is that the financial crisis we have experienced has coincided closely with the turning point in these demographic dynamics. Asset price bubbles: dancing over the tide of fundamentals The “life-cycle” theory, or more precisely speaking, overlapping generation models suggest that demographic change is one of the most forceful drivers of asset prices. After all, assets are a means of saving for the young and dissaving for the old, and thus the numbers of the young and the old determine the demand and supply for these assets.5 The recent history of crisis seems to confirm this line of reasoning. In Figure 3, the real land price in Japan (national average, for all purposes) is juxtaposed with the country’s inverse dependency ratio from 1955 to date. This figure shows, firstly, that the relative abundance of young people coincided with sharply higher property prices. Secondly, in contrast, the relative abundance of old people seems to be leading to lower property prices. In the United States also, an increasing reverse dependency ratio coincided with the property bubble (Fig. 4). After the bubble burst in 2007, property prices seem to have followed the long run movement of the inverse dependency ratio, although it would be premature to draw any conclusions from this at the moment. We see a similar pattern in the Irish and Spanish experience (Figs. 5 and 6). The period is known as the “Great Moderation” in the US case. European Central Bank (2010) and Basel Committee on Banking Supervision (2011) provide a concise survey of models with macro-financial linkage proliferating recently in this literature. Bianchi (2010), Jeanne and Korinek (2010a, 2010b), and Stein (2011) focus on the credit externalities and pave the way for exploring the effects of macro-prudential measures. In particular, Bianchi (2010) and Jeanne and Korinek (2010b) study financial crises in open economies, aiming to provide macro-prudential remedial measures. However, there is unfortunately relatively little from an Asian perspective. Exceptions include Hattori et al (2010), and Hahm et al (2011). I take these figures from Nishimura (2011b), which contains more figures about other European countries, both core and periphery. Empirical evidence suggests strongly that this is the case. See Takáts (2010) for property prices, and Liu and Spiegel (2011) for equity prices. The Economist (2011) carries a readable account of this issue. BIS central bankers’ speeches I am not suggesting that this demographic factor is the sole cause of the asset bubbles that led to the crisis. There may be other factors, as for example in the case of Greece and Portugal, who experienced “bubbles” in their public sectors rather than in asset prices, but still faced the crisis. Likewise, there are other countries that underwent similar demographic changes, and yet did not fall into crisis. I only want to point out that a favorable demographic background (increasing inverse dependency ratio) might be fertile ground for the excessive optimism6 that led economic agents in many countries to take a highly leveraged position to boost their returns. In other words, asset bubbles might dance over the long-run tide of demographic change.7 By the same token, the eventual sharp reversal of the ratio made resolution of accumulated financial excesses particularly difficult, resulting in the prolonged, severe balance-sheet adjustment that followed the crisis, and which is still under way. Aftermath: severe balance sheet adjustment under population ageing In order to determine the effect of balance sheet adjustments after the bursting of a bubble, let me first clarify who leveraged during the bubble periods. In Japan, it was the corporate sector, whose loans-to-GDP ratio increased by 29 percentage points in the ten years before the bubble burst in 1991. In the United States, it was the household sector, whose housing loans-to-disposable income ratio jumped by 39 percentage points in the ten years before the bubble burst in 2007. These sectors were interest-sensitive, and thus constituted the “transmission gears” of the ordinary monetary transmission mechanism in the periods before the bubbles burst. However, after the bubbles burst, these leveraged sectors became insensitive to policy rate reduction, because of the acute balance sheet adjustments. This led to a breakdown in the ordinary monetary transmission mechanism. It should be noted here that declining property prices greatly aggravated the balance sheet adjustments of Japanese corporations and US households.8 In looking to the future, I would like to emphasize that the balance sheet adjustments after the bubbles burst in Japan, the U.S. and the eurozone, whether private or public, must be carried out, at a time when the population is ageing. This acute balance sheet adjustment is unprecedented in our modern history of economic growth. Where does Asia stand? Asian economies and financial systems weathered the recent financial crisis relatively well. Their recovery since 2009 has been markedly rapid, and emerging Asia is now a growth engine of the global economy. The fiscal situation of emerging Asia is also far more favorable than that of many developed countries. Furthermore, with the exception of Japan, Asian economies have not yet faced serious problems with population ageing. Nonetheless, I would like to point out future potential issues and the absolute necessity of a prudent approach now. Let me draw your attention to the inverse dependency ratio figures for China (Fig. 7) juxtaposed with those for Japan and the United States. The Chinese ratio seems still to be rising rapidly, but will peak a bit later than in Euro-American countries. The peak will be around 2010–15, after which it will decline as rapidly as it is now Nishimura and Ozaki (2006, 2011) provide decision-theoretic foundation of excessive optimism and pessimism, showing that seemingly-irrational excessive optimism and pessimism can be analyzed in the framework of rationality. See also Bracha and Brown (2010). One possibility is to incorporate the “bubble”, as formulated in Martin and Ventura (2010), into the detailed overlapping generation framework of Braun et al (2009) extended to the multi-country framework, to calibrate the bubble-bust and subsequent balance sheet problems both national and international perspective. See also, Aoki and Nikolov (2011). See Nishimura (2011a) for more detail of this balance sheet adjustment. BIS central bankers’ speeches rising. The inverse dependency ratios of many other Asian countries have a quite similar time profile to that of China, and some are even more pronounced (Fig. 8). Section 2. Macro-prudential policy – two “dos” and one “don’t” The recent financial crisis, as well as the Great Moderation leading up to the crisis, brought to bitter recognition the gap between our macroeconomic and micro-prudential policies. Thus, macro-prudential policy has come into the spotlight as something that would fill this gap. However, we are still very much short of having a satisfactory macroeconomic theory that deals adequately with complex and sometimes violent financial markets. Consequently, the very definition of macro-prudential policy remains elusive, even three years after the crisis. How are we to draw the lines between macroeconomic, macroprudential and micro-prudential policies? What indicators are useful in detecting risks? What should be the tools of macro-prudential policy? Should capital controls also be considered as a part of macro-prudential policy tools? How are we to achieve the appropriate burdensharing among monetary, macro-prudential and micro-prudential policies in order to maintain financial stability? Since we do not yet have a satisfactory theory to give clear-cut answers to these questions, I will take a more pragmatic approach and propose two “dos” and one “don’t” for prospective macro-prudential policies. 2.1. “Do” detect risks in advance – information and intelligence In order to avoid another crisis and subsequent stagnation, it is critically important for policymakers to detect undue risk accumulation. It should be noted that information propagation always plays a critical role in the inception and transmission of systemic crisis. Thus, “information” and “intelligence”, or more precisely speaking, market intelligence, is of the utmost importance both for risk detection and for crisis management. Here both bottomup and top-down approaches are absolutely necessary. Bottom-up information: market intelligence The history of financial crises provides clear evidence that systemic crisis is often ignited by the bankruptcy not of large firms, but of relatively small firms such as Sanyo Securities in Japan (1997) and Northern Rock in the United Kingdom (2007) (Fig. 9). This reveals one crucial aspect of financial intermediation, that is, information. Since financial transactions are a collection of information flows, the failure of a small financial institution may cause an immediate market-wide liquidity crisis or a “run”, if the failure gives rise to widespread fear or uncertainty in the market. Thus, both in terms of risk detection and crisis prevention, market intelligence obtained through face-to-face contacts and dialogue with market participants is critically important. In this regard, most Asian central banks can boast of their grip on individual institutions’ activities and micro information in the market. Nonetheless, the increased sophistication and innovation of financial services makes risk detection increasingly difficult. In some cases, financial institutions themselves do not seem fully aware of the risks associated with their investments and transactions, especially those related to structured products and derivatives. Any complacency in terms of risk detection could itself be another source of risk, and authorities should encourage market participants to continuously improve their risk management skills. Painstaking information gathering, continuous updating and openminded risk assessment are all about market intelligence. In this regard, macro-prudential measures such as information exchange through the publication of the Financial System [Stability] Report (FSR) have the potential to provide new ways of utilizing information and market intelligence. Macro-prudential policies can be effective only if they facilitate dialogue and coordination between market participants and authorities, and also between macro- and micro-policies. BIS central bankers’ speeches Top-down information: indicators for detecting macro risks and excesses I would therefore like to turn now to macro risks and excesses and the indicators used to detect them. In most cases of “bubble and burst”, the large gyrations of financial markets and the economy are driven by psychological swings: Economic entities are likely to become excessively optimistic in bubble periods, and excessively pessimistic when those bubbles burst. In economic boom periods, such as Japan’s “Bubble Era” and during the “Great Moderation”, the co-existence of high growth and low inflation may lead to the illusion of productivity growth and an expectation of continued low interest rates. Such optimism is likely to induce a euphoric view of asset prices and an under-estimation of risks. One the other hand, in a prolonged downturn, economic entities become excessively pessimistic, leading to further deterioration of the economy, and thus their pessimism turns to be selffulfilling. In order to avoid excessive accumulation of these risks, it is critically important to detect any such extreme optimism or pessimism behind the developments indicated by various financial data. For such purposes, we should carefully avoid becoming a hostage to any particular form of reasoning or theory. Although some indicators such as credit-to-GDP ratio and the deviation of real estate prices from the trends may provide useful information, we do not have any decisive indicators in this respect. The theory I have perused earlier is valuable in explaining what has happened before, but is not so helpful in providing an indication of what will happen in the future. Every crisis may take a different form. Excessive reliance on specific indicators might cause us to miss important risks or misidentify nonexistent risks. Moreover, we should take into account a variant of Goodhart’s law:9 If a central bank announces its intention to focus on specific indicators in order to take action to discourage risk-taking, market participants might try to take risks without influencing these indicators, and these indicators might eventually lose their information value. This problem would be further intensified if we focused on a narrower range of indicators. Thus, it would be wise for policymakers to monitor impartially a variety of indicators. Moreover, we need to make full use of market intelligence in order to interpret various data comprehensively, since price data themselves may not indicate whether they are in line with fundamentals or driven by euphoria. Bank of Japan’s framework for detecting risks Let me now explain the various efforts made by the Bank of Japan in this field. The Bank executes both on-site examinations and off-site daily monitoring of a wide range of financial institutions, including securities firms. Through such activities, the Bank, making full use of market intelligence, tries to identify any signs of risk accumulation. The Bank also maintains close dialogue with market participants such as the counterparties of market operations. Moreover, the Bank of Japan makes a regular comprehensive risk assessment of the overall financial system, analyzing both macro data and micro information, and publishes its assessment on financial stability in its semi-annual “Financial System Report”. Moreover, the Bank’s assessments of the risks in the financial system are useful inputs to the decisionmaking of monetary policy in the “Two Perspectives Framework” (discussed later). The Bank of Japan is making efforts also in terms of exploiting wide-ranging data, macro stress-testing and establishing econometric models incorporating the financial sector, which is in line with the efforts of other central banks. In addition, two Bank of Japan economists, Koichiro Kamada and Kentaro Nasu, have recently devised an innovative See Goodhart (1975) for the original account, and also Goodhart and Tsomocos (2011) for its most recent application. BIS central bankers’ speeches system of Financial Cycle Indexes (FCIXs), which are designed to be early warning indicators.10 These FCIXs are not based on a particular theory, but on the age-old analytic tradition of economic trends and cycles. Although the jury is still out, the performance of FCIXs seems to be promising: they predicted Japan’s financial crisis, and warned of the recent financial crisis about a year in advance (Fig. 10). From my viewpoint, FCIXs would be useful tools for macro-prudential policies, since they could provide early warning signals of excessive optimism or pessimism. Indeed, one of the most difficult challenges for macro-prudential policy is how to spot excessive optimism or pessimism, especially because we do not yet have a credible theoretical framework that can be applied for such purposes. In this regard, the FCIX approach may be atheoretical in the sense that it does not depend on a particular economic theory, but this is an advantage in light of the unsatisfactory state of theory. Owing to such strengths as indicators, FCIXs would contribute to effective monitoring of the financial system as a whole from the macroprudential perspective. 2.2. “Do” avoid pro-cyclicality Lean against the wind of financial risks: coordination of monetary and macroprudential policy I would now like to refer to another aspect of macro-prudential policy; that is, macroprudential policy as a means to counter procyclicality. After detecting undue risk accumulation, policymakers would be required to check further accumulation of risks and to discourage risk-taking. On the other hand, if policymakers find that market participants have become excessively risk-averse, they would be called upon to restore confidence in the market. The basic principles are simple: Don’t be so lenient when things are booming, and don’t be so restrictive when things turn sour. Here, coordination of monetary and macro-prudential policy is necessary, and very effective. In this regard, the Bank of Japan is making use of a “Two Perspectives Framework” in its conduct of monetary policy. The framework involves a two-step policy consideration: policy should be guided by the most probable scenario for the future course of the economy (first perspective), but at the same time it should incorporate “remote risk factors” that might affect the economy adversely if they happen to materialize, even though they may not be in the main scenario (second perspective).11 The latter clearly includes systemic financial risks. Thus, when it contemplates monetary policy, the Bank examines a broad range of information, not only conventional indicators such as inflation, but also financial information and market intelligence about risk accumulation. The Bank assesses such information in a comprehensive manner, and communicates to the public its assessment of these tail risks. Needless to say, there can be other styles of communication, such as conveying central banks’ risk assessment in terms of changes in their inflation forecasts over a long horizon within their inflation-targeting frameworks. There is no clear-cut answer as to the most suitable communication strategy, since the appropriate style of communication depends upon the economic and financial structure of the particular jurisdiction. However, there is an apparent need for financial risk assessment and its communication to the general public, beyond conventional inflation assessment. See the Appendix for a detailed explanation of FCIXs. See Nishimura (2007) for clarification. BIS central bankers’ speeches New regulatory framework and pro-cyclicality issues Let me now take up the issue of the new regulatory framework and pro-cyclicality. Indeed, one of the regular agenda items of recent international debates is how to address pro-cyclicality in financial regulation. The Basel Committee has tried to address this issue in Basel III, which incorporates a “capital conservation buffer” and “counter-cyclical buffer”. Here implementation is the key. Should banks conceive of the capital conservation buffer as a part of the minimum capital requirement and maintain the buffer regardless of the phase of the cycle, the introduction of the buffer might result in the banking sector holding more capital than is optimal from the inter-temporal viewpoint.12 In order for Basel III to be an optimal regulatory framework, not only from a static but also a dynamic perspective, it should be implemented appropriately and accompanied by adequate supervision. This is all the more true for the counter-cyclical capital buffer. In a similar vein, we should be aware of the possible side-effects of a newly-introduced Systemically Important Financial Institutions (SIFI) framework. Capital surcharges for “additional loss absorbency” in the SIFI framework may lead to the risk that SIFIs keep more capital than optimal on an inter-temporal basis, which may cause more acute credit contraction in the midst of a recession. Moreover, there is the confounding factor of possible deposit concentration in SIFIs. In the midst of Japan’s financial crisis, we experienced a substantial shift of deposits from small banks to money center banks. If a SIFI framework and the capital surcharge make people believe that SIFIs are much safer than non-SIFIs, a SIFI framework might even accelerate the shift of deposits in a stressed situation, but the surcharge might discourage SIFIs from fully implementing the credit intermediation functions formerly performed by non-SIFIs. Thus, we should carefully examine whether or not newlyintroduced regulatory frameworks will actually counter procyclicality as expected. 2.3. “Don’t” harm long-term efficiency A new excuse for an old addiction? That having been said, let me elaborate one “don’t” of macro-prudential policy, especially from a long-term perspective. Since there is no clear definition of macro-prudential policies or of their policy tools, any policy tool could be justified as a part of that policy. Thus, we have to be careful of the danger of making macro-prudential policy “a new excuse for an old addiction”, which often leads to long-term inefficiency. Indeed, most of the tools often referred to as “macroprudential policy tools”, such as ceilings on loan-to-value (LTV) and debt-to-income (DTI) ratios in property markets and capital controls in foreign exchange markets, cannot be free from the risk of distorting asset allocation that leads to inefficiency in the long run. Thus, policymakers should be required to examine carefully the consequences of each macroprudential policy action from the long-run perspective. Long run consequences often develop in a relatively short period of time, when addiction continues. SIFI framework and long-term efficiency It is important to design the SIFI framework in a manner compatible with incentives. One of the root causes of the recent crisis was excessive risk-taking. If the SIFI framework encourages SIFIs to pursue further the yield-searching originate-to-distribute model due to This is exactly the reason Basel III differentiates the capital conservation buffer from the minimum capital requirement. The capital conservation buffer and accompanying regulations such as restraining dividends are designed to be utilized in a counter-cyclical way. Otherwise, there is no rationale to distinguish between the capital conservation buffer and the minimum capital requirement. BIS central bankers’ speeches the need to downsize balance sheets while maintaining their return on equity, the effect might rather be to destabilize the financial system. In this regard, I would like to reiterate that the SIFI framework should be a comprehensive package of effective regulation and supervision sustainable in the long run. Furthermore, the SIFI regulation will be counter-productive if it hinders SIFIs’ core financial intermediation. Since the demand for financial services is largely determined by the needs of the real economy, any additional regulation imposed on SIFIs will reduce their financial functions to some extent, or the financial intermediation performed by SIFIs will be replaced by similar services offered by other entities. Thus, should there be a significant difference between the regulatory burden imposed on SIFIs and that on non-SIFIs, financial transactions might shift to less regulated entities and the risk underlying the financial system as a whole might heighten. “Shadow banking” is a typical problem of this kind. Asia should be well aware of these problems. First, emerging Asia is now at the center of global economic growth. To sustain such growth, the need for fund intermediation is also likely to increase. Hence, should new financial regulations hinder the core financial function at a global level, the negative impact on the real economy could be all the more serious. Second, some emerging Asian economies, where asset price hikes threaten to create bubbles, have already adopted macro-prudential tools such as lowering the LTV and DTI ratios of real estate-related loans. Accordingly, these countries should examine the costs and benefits of their macro-prudential policy actions, and devise appropriate and timely exit policies to avoid long-term inefficiency. Section 3. Tail risks and false sense of security of macro-prudential measures The recent financial crisis (the “financial tsunami”), and the tragic great earthquake in Northern Japan (with its gigantic real tsunami), showed vividly that tail risks may materialize in our life time, and thus they are not really tail risks anymore. Policy frameworks anticipating only “ordinary” shocks within usual economic cycles may not be very effective in mitigating the impact of such tail events when they actually materialize. The recent financial crisis in particular has forced policymakers to review their own policy frameworks and to examine how they could identify tail risks and deal with tail events. Nonetheless, at this juncture we do not have fully reliable indicators for detecting tail risks nor panaceas against the maladies that accompany these tail events. We have to bear in mind that, no matter how intellectually-inspiring policy makers may find this new tool, macro-prudential policy can never be a substitute for appropriate macroeconomic policy or for effective financial supervision. Japan’s experience of its bubble economy is a good example. Japan learned just how difficult it is to control asset prices solely with macroprudential tools such as an administrative ceiling on bank loans to the real estate sector.13 Thus, in detecting tail risks and tackling tail events, we have to avoid any complacency or false sense of security in our macro-prudential policy framework. If we mistakenly believe that we could discover excessive risk accumulation through observing specific indicators, or that macro-prudential policies could be mightily effective in achieving financial stability, such complacency could itself become another source of instability. Let me illustrate the importance of avoiding a false sense of security, by telling you the story of the world’s deepest tsunami breakwater at Kamaishi port in northern Japan (Fig. 11). At 1,960 meters long and 63 meters deep, it was celebrated as the deepest breakwater in the world by Guinness World Records when it was completed in March 2009. Exactly I explained the inadequacy of macro-prudential policy in Japan in Nishimura (2011c). BIS central bankers’ speeches two years later, it was shattered by the force of a tsunami equivalent to the impact of 250 Jumbo jets flying at 1,000km/h; the very apotheosis of a real tail event. With hindsight, we cannot deny that this seemingly indestructible tsunami breakwater, and other facilities to ward off possible tsunami threats, gave us a sense of security. It might lead us to underestimate the magnitude of the tail risk event of tsunamis and thus to ignore the antique stone inscriptions warning of the devastation of tsunamis (Fig. 12). Hundreds of these so-called tsunami stones, some more than six centuries old, dot the coast of Japan. We now know the true cost of relying on this false sense of security. Thank you for your attention. BIS central bankers’ speeches Appendix: the financial cycle indexes The Financial Cycle Indexes (FCIXs) developed by Kamada and Nasu (2011), are used to monitor financial stability from the macro-prudential perspective. They are designed specifically as an alternative to the early warning indicator introduced by Kaminsky and Reinhart (1999). Kamada and Nasu focus on the Juglar cycle – a cycle with a duration of 7 to 11 years – included in financial time series, according to the result of analyzing the data compiled by Laeven and Valencia (2010). The Juglar cycle is extracted from the original time series by the HP-filter-based band pass filter,14 which consists of two HP filters with different smoothness parameters, specifically and as defined below: to extract cycles lasting longer than 7 years; to extract cycles lasting longer than 11 years. In both of the above, is the parameter used to adjust the formulae for the frequency of an original time series. The Juglar cycle lasting 7 to 11 years is given by the difference between the two HP trends obtained above. The two financial crises are used to categorize data into leading and lagging indicators. (a) January 1990: the triple sell-off in the yen, equity, and bond markets, which is considered the beginning of the bursting of the asset-price bubble; and (b) November 1997: the bankruptcy of Sanyo Securities, which is considered the start of a series of financial institution bankruptcies Data is called a leading indicator if the Juglar cycle extracted turns down before the above two crises, or a lagging indicator if the extracted Juglar cycle turns down after the two crises. FCIXs comprise leading and lagging indexes. Kamada and Nasu propose three different types of index: type D, C, and B. Here, we explain the type-D leading FCIX, which is a diffusion index and constructed as follows: , where denotes the Juglar cycle extracted from a leading indicator; the number of leading indicators; and positive and –1 if its first difference; the index function, which takes on +1 if is is negative. The type-D lagging FCIX is obtained in a similar fashion. The OECD (2008) has recently adopted the HP-based band pass filter in place of the phase average trend (PAT) method to construct its composite leading indicators. The PAT is a traditional method of trend detection originally developed by the NBER and is calculated as follows: Deviations from a 75-month centered moving average are first calculated; then, the obtained series is divided into expansion and contraction phases and the average is calculated for each phase; a three-phase centered moving average is calculated and these averages are interpolated. BIS central bankers’ speeches FCIXs may not be very sensitive to a revival of financial activity, because they are designed to detect signs of financial crisis. As the father of business cycle analysis, Arthur Spiethoff, pointed out, the timing of recoveries is often ambiguous, compared with that of crises. The Japanese FCIXs are constructed only from monthly, quarterly, and semi-annual financial data that can be traced back at least to the mid-1980s. Kamada and Nasu have found 8 leading indicators: stock prices of the banking, real estate, and construction sectors; the lending attitude of financial institutions; the financial positions of firms; current profit levels of firms; housing loans; and commodity prices. Some of the leading indicators are affected by global shocks and enable the leading FCIX to detect financial crises prevailing in overseas economies. In contrast, Kamada and Nasu have found 11 lagging indicators: corporate debt; household debt; lending interest rates; changes in interest rates on loans; the two monetary aggregates, M2 and M3; deposits; land prices nationwide and in large urban areas; as well as 3 and 9 year government bond yields. The leading indicators cover mainly balance-sheet information, so that the lagging FCIX reflects domestic financial conditions. In the scheme of Kamada and Nasu, a possible financial crisis is warned of when the leading FCIX falls to the zero point. This simple scheme successfully forecast the BNP Paribas shock about one year ahead of its occurrence in August 2007. However, this result should be interpreted with caution, since the index fails to take into consideration the uncertainty caused by real-time estimation problems.15 Fig. 10 plots the predicted type-D leading FCIX. It forecasts three financial crises successfully, falling to zero in May 1988 (19 months before the triple sell-off), in February 1997 (8 months before the bankruptcy of Sanyo Securities), and in June 2006 (14 months before the BNP Paribas shock). In Fig.10, the predicted leading FCIX takes positive values during November 1999– December 2001, reflecting the IT bubble. However, no crisis was observed in Japan during this period. To avoid a potential false alert, we have to be able to discern such an “economic lull”. The lagging index is useful for this purpose. The lagging index (not shown here) indicates that Japan remained in a contraction phase during November 1999–April 2004, suggesting that the revival of the leading index during November 1999–December 2001 might be indicative of an economic lull. Some caveats are in order here. First, although FCIXs make it possible to detect signs of impending financial crises, they do not enable one to identify the source, type, or size of the crisis. Second, FCIXs do not make obvious the optimal policy measures that should be undertaken. With the help of FCIXs, policymakers must monitor financial institutions carefully and devise policy measures appropriate for the economic and financial conditions. FCIXs are not immune to real-time estimation problems, such as the end-of-sample and lagged-datapublication problems, which may cause serious delay in warning signals. As a solution, Kamada and Nasu propose to predict the Juglar cycle’s turning point, where the growth rate falls to zero, by an inflection point, where acceleration falls to zero in real time data. This is an application of the well-known rule of thumb: acceleration drops before velocity does. BIS central bankers’ speeches Reference Aoki, K., and K. Nikolov. 2011. “Bubbles, Banks, and Financial Stability”, paper presented at the 2011 International Conference, Bank of Japan. Basel Committee on Banking Supervision. 2011. “The Transmission Channels between the Financial and Real Sectors: a Critical Survey of the Literature”, BCBS Working Papers No 18 Bianchi, J., 2010, “Credit Externalities: Macroeconomic Effects and Policy Implications”, American Economic Review, vol. 100(2), pages 398–402. Bracha, A., and D. J. Brown. 2010. “Affective Decision-Making: A Theory of Optimism-Bias”, Cowles Foundation Discussion Paper no.1759, Yale University. Braun, R. A., D. Ikeda and D. H. Joines. 2009. “The Saving Rate in Japan: Why It Has Fallen and Why It Will Remain Low”, International Economic Review, 50 (1), 291–321. Clark, A., and A. Large. 2011. “Macroprudential Policy: Addressing the Things We Don’t Know”, Occasional Paper no.83, Group of Thirty. The Economist. 2011. “Economics focus: Bringing down the house”, September 24th 2011, page 94. European Central Bank. 2010, Financial Stability Review, December 2010. Goodhart, C.A.E. 1975. “Monetary Relationships: A View from Threadneedle Street”, in Papers in Monetary Economics, Volume 1, Reserve Bank of Australia. Goodhart, C. A. E. and Tsomocos, D. P. 2011. “The Role of Default in Macroeconomics”, Discussion Paper Series 2011–E-23, Institute for Monetary and Economic Studies, Bank of Japan. Martin, A., and J. Ventura. 2010. “Theoretical Notes on Bubbles and the Current Crisis”, Working Paper, Centre de Recerca en Economia Internacional. Hattori, Masazumi, Hyun Song Shin, and W. Takahashi. 2010. “A Financial System Perspective on Japan’s Experience in the 1980s”, presented at the 2009 Bank of Japan International Conference, Revised, Princeton University. Hahm, J.-H., H. S. Shin, and K. Shin. 2011. “Non-Core Bank Liabilities and Financial Vulnerability”, Princeton University. Jeanne, O. and A. Korinek, 2010a. “Managing Credit Booms and Busts: A Pigouvian Taxation Approach”, NBER Working Papers 16377. Jeanne, O. and A. Korinek, 2010b. “Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach”, American Economic Review, vol. 100(2), pages 403–07. Kamada, K. and K. Nasu. 2011. “The Financial Cycle Indexes for Early Warning Exercise”, Working Paper11–E-1, Bank of Japan. Kaminsky, G. L., and C. M. Reinhart. 1999. “The Twin Crises: The Causes of Banking and Balance-Of-Payments Problems”, American Economic Review, Vol. 89, No. 3, pp. 473–500. Laeven, L., and F. Valencia. 2010. “Resolution of Banking Crises: The Good, the Bad, and the Ugly”, Working Paper, No. WP/10/146, International Monetary Fund. Liu, Z. and M. M. Spiegel. 2011. “Boomer Retirement: Headwinds for U.S. Equity Markets?” Economic Letter 2011–26, Federal Reserve Bank of San Francisco. Nishimura, K. G. 2007. “The New Policy Framework of the Bank of Japan: Central Banking in an Uncertain World”, Asian Economic Papers, 6(3), 132–143. Nishimura, K. G. 2011a. “This Time May Truly Be Different: Balance Sheet Adjustment under Population Ageing”, speech prepared for the Panel “The Future of Monetary Policy” at the 2011 American Economic Association Annual Meeting in Denver. BIS central bankers’ speeches Nishimura, K. G. 2011b. “Population Ageing, Macroeconomic Crisis and Policy Challenges”, speech presented at the at the 75th Anniversary Conference of Keynes’ General Theory, University of Cambridge. Nishimura, K. G. 2011c. “Macroprudential Lessons from the Financial Crises: A Practitioner’s View”, forthcoming in M. Kawai and E. Prasad eds., Asian Perspectives on Financial Sector Reforms and Regulation, Brookings Institution Press. Nishimura, K. G., and H. Ozaki. 2006. “An Axiomatic Approach to ε-contamination”, Economic Theory, Economic Theory 27, 333–340. Nishimura, K. G., and H. Ozaki. 2011. “ε-exuberance: An axiomatic approach”, mimeo., Keio University. OECD. 2008. OECD System of Composite Leading Indicators. Stein, J., 2011, “Monetary Policy as Financial-Stability Regulation”, forthcoming in Quarterly Journal of Economics. Takáts, Előd. 2010. “Ageing and Asset Prices”, BIS Working Papers No 318, Bank for International Settlements. BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 31 October 2011.
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Masaaki Shirakawa: The outlook and challenges for Japan’s economy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 31 October 2011. * * * Introduction Let me first express my heartfelt sympathy for those who have suffered from two typhoons that hit the Kansai region particularly hard last month. I am sure you are still worried about the situation as the business leaders from the region, and I appreciate this opportunity you have given me to speak and exchange views with you at a time like this. I would also like to use this occasion to express my deep gratitude for your cooperation with the Bank of Japan’s branches in Osaka, Kobe, and Kyoto. It is now just over one year since we last met. In the interim, Japan’s economy experienced a severe hardship – namely, the Great East Japan Earthquake. Although it is not quite appropriate to describe the effects of the earthquake disaster only in terms of economic aspects, as such effects have spread to various areas of people’s lives, I should note that economic activity has fortunately recovered faster than expected. This is attributed to the remarkable capability of Japanese firms and people to respond to the hardship, as seen in the restoration of supply chain disruptions and measures to address power shortages. Consequently, production and exports, which had plunged immediately after the earthquake, almost recovered to their pre-quake levels this past summer. The effects of the disaster clearly spread beyond the disaster areas across the country in various forms. One example of this is the decline in operating rates of nuclear power plants. I am aware that, especially in the Kansai region, electricity supply and demand conditions are likely to be tight in the coming winter. Looking at overseas economies, strains in European economies continue and close attention should be paid to future developments. Before we exchange views, I will first outline the outlook for Japan’s economy and developments in overseas economies that greatly affect its future course. I will then speak about the challenges it faces as well as the Bank’s conduct of monetary policy. I. Outlook for Japan’s economy I will start with the outlook for Japan’s economy. During the period between the time of the quake until summer, the pace of economic recovery had been determined by the speed at which supply-side constraints were being resolved. However, as they have now almost been resolved, the key is demand-side developments from now on. The outlook for Japan’s economy in this regard can be described as follows. For the time being, the pace of economic growth is likely to remain only moderate compared with the recovery phase following the disaster, reflecting an adverse effect from a slowdown in overseas economies and the appreciation of the yen. After that, Japan’s economy is expected to return to a moderate recovery path because the pace of recovery in overseas economies will subsequently pick up led by emerging and commodity-exporting economies, whose mechanism of domestic demand expansion is basically being maintained, and because demand related to reconstruction after the earthquake disaster will gradually materialize. According to the projection in the Outlook for Economic Activity and Prices (Outlook Report) that the Bank released last week, the real GDP growth rate is projected to remain relatively low in fiscal 2011, at 0.3 percent, due in part to the effects of the disaster (Chart 1). However, it is projected to be 2.2 percent in fiscal 2012, partly because of an increase in reconstruction-related demand, and 1.5 percent in fiscal 2013, continuing to register positive growth. BIS central bankers’ speeches Turning to prices, the year-on-year rate of decline in the consumer price index (CPI) has continued to slow consistently since the summer of 2009, and registered 0.2 percent in September this year. As for the outlook on the basis of such a broad trend, the year-on-year rate of change in the CPI will remain at around 0 percent for the time being. Expressing the outlook in numerical terms shown in the October 2011 Outlook Report, the year-on-year rate of change in the CPI is projected to be 0 percent in fiscal 2011, 0.1 percent in fiscal 2012, and 0.5 percent in fiscal 2013. As illustrated, in the longer run, Japan’s economy will eventually return to a sustainable growth path with price stability. At the same time, the Bank fully recognizes that such an outlook is attended by various uncertainties. There are two particularly salient points. One is financial and economic developments in overseas economies – in particular, future developments in the sovereign debt problem in Europe. Another is the medium- to long-term growth potential of Japan’s economy. II. Sovereign debt problem in Europe Mechanisms for transmission to economic activity I will now talk about the sovereign debt problem in Europe. The origin of the problem is that in October 2009, triggered by a change of government in Greece, the country’s fiscal deficits turned out to be much more serious than suggested by the data that were already released, and the country’s debt repayment became doubtful. Greece has subsequently implemented fiscal consolidation measures while receiving financial support by euro area countries and the International Monetary Fund, but has remained to face a tough situation with negative economic growth and slow progress in fiscal consolidation. At the same time, the decline in market confidence in fiscal sustainability has spilled over to Ireland and Portugal, as well as bigger economies such as Spain and Italy, although the degree varies. The prices of government bonds issued by countries whose fiscal conditions became the subject of concern have declined, and financial institutions that were considered to be holding a large amount of such government bonds have come under close scrutiny (Chart 2). As illustrated, the decline in confidence in fiscal conditions caused the financial system problem, which in turn has started to affect the global economy through the following two channels. The first channel works as follows. Many financial institutions in Europe continue to face difficulty in terms of raising funds in the markets. Therefore, they restrain lending and put priority on hoarding cash. As a result, borrowing costs and funding of firms that depend on European financial institutions are adversely affected. If such a situation continues, this could also affect project financing and trade financing in emerging economies. The second channel is as follows. Global investors have become increasingly risk averse, which affects the flow of funds and prices of various assets worldwide. This materialized in the form of the fall in global stock prices and the widening of credit spreads of corporate bonds – that is, additional interest rates charged on government bond rates – in Europe and the United States since this past summer. Correspondingly, assets considered relatively safe have invited investors’ purchases; for example, yields on government bonds issued by the United States, Germany, and the United Kingdom were at historically extreme low levels. As for currencies, the Swiss franc, Japanese yen, and U.S. dollar have been regarded as having low risks, and this has led to the rise in these currencies in the exchange market. As illustrated, it can be said that the recent appreciation of the yen is one example of the spillover effect of the sovereign debt problem in Europe into Japan through the increasing risk aversion by global investors. In this regard, the Ministry of Finance intervened to the foreign exchange market today. The Bank strongly expects that such an action will contribute to the stable price formation in the market. BIS central bankers’ speeches The sovereign debt problem in Europe was triggered by the fiscal deficits, but it has started to affect economic activity in Europe through the financial system. If the economy deteriorates, it becomes more difficult to make progress with fiscal consolidation, which is the starting point of the problem. It should be recognized that the problem entails the risk that the adverse feedback loop among the fiscal situation, the financial system, and economic activity will intensify further. Japan’s financial environment continues to ease Fortunately, so far in Japan, unlike in the United States and Europe, the markets from which banks and firms raise their funds remain in a stable condition, without strains (Charts 3 and 4). Looking at firms’ funding conditions, they have actually continued to ease. Bank lending rates have declined moderately and credit spreads on corporate bonds and CP have remained stable at low levels. Underlying such stability is the fact that Japanese financial institutions do not hold a large amount of government bonds issued by those European countries that are a source of concern. Moreover, Japanese financial institutions in recent years have strengthened their capital and restrained their total amount of risks within their capital. They face no significant difficulty in terms of funding in foreign currencies. In addition, firms hold ample on-hand liquidity. The Bank’s extremely accommodative monetary policy, including the purchase of such risk assets as corporate bonds and CP, which a central bank does not usually purchase – I will touch upon this later – also contributes to the stability in Japanese financial markets. Given the stronger correlation among increasingly globalized financial markets, Japanese financial markets cannot remain immune from negative developments overseas, as these further materialize. As I mentioned earlier, the problem in Europe has already spilled over to Japanese markets, in the form of the yen’s appreciation and weak stock prices since this past summer. Due attention should be paid to future developments in global financial markets. The response to the sovereign debt problem in Europe As I have mentioned, the sovereign debt problem in Europe poses a significant downside risk to the global economy at present. I would raise four challenges to be addressed to prevent the sovereign debt problem in Europe from developing into a crisis. First, what is most important in the immediate future is to fully ensure financial market stability and prevent the problem from developing into a global financial crisis akin to the one engendered by the Lehman shock. In this regard, the European Central Bank, which is the central bank at the epicenter, has continued to provide ample liquidity to financial markets. Central banks in major economies, including the Bank of Japan, have worked together to establish frameworks in U.S. dollar funding markets for providing funds, including those with longer maturities covering the year-end, which marks a great improvement from the time prior to the Lehman shock (Chart 5). On October 19, the Bank of Japan and the Bank of Korea agreed to substantially increase the size of the yen-won swap agreement. The Bank of Japan believes that this action will mitigate adverse influences of heightened uncertainty in the global financial markets on the two economies and contribute to enhancing stability in regional financial and exchange markets in East Asia. Second, euro area countries need to strengthen the implementation of specific measures to restore confidence in the financial system. On this point, there has been some progress in the past several weeks. The 17 countries in the euro area have given approval to expand the functions of the European Financial Stability Facility (EFSF) and discussions about financial institutions’ recapitalization have started. At a series of meetings on October 26, European leaders agreed on comprehensive measures including a new Greek bailout package. I strongly hope that each measure will be specified and then implemented promptly. BIS central bankers’ speeches Third, those euro area countries drawing strong market concern over their fiscal conditions should steadily work to reduce their fiscal deficits. This is a very difficult challenge, but without addressing it, the risk of the situation evolving into a crisis will persist. And fourth, it is necessary to strengthen the euro area’s growth potential through structural reform of the economy. The root of the European sovereign debt problem lies in the decline in international competitiveness. Therefore, the countries in trouble need to make efforts to regain such competitiveness through an increase in productivity and via cost reductions. Sovereign debt problem as a lesson to be learned from The sovereign debt problem has many aspects that Japan should learn from. One important lesson is that, as government bonds have a privileged position in financial transactions based on the assumption that they are absolutely safe, once doubt about government bonds’ safety emerges, this will exert a wide range of effects on the financial system and subsequently on economic activity. Although the ratio of government debt to GDP in Japan is the highest among advanced economies, yields on Japanese government bonds have remained stable at low levels. As for the background to this stability, it is often pointed out that government bond markets in Japan are basically dominated by domestic investors backed by ample excess funds in the household and corporate sectors within the country. However, it is not quite appropriate to discuss this issue only in terms of the supply and demand balance. Needless to say, there is no problem if market participants are convinced by evidence that the government will work toward fiscal consolidation in the medium term. If not, however, the possibility cannot be ruled out that, as in Europe, some events could cause market participants to become aware of risks to government bond holdings, which could in turn lead to a discontinuous rise in interest rates. Confidence in government bonds is also a significant issue in Japan given the large share on an international comparison of government bond holdings in the assets of financial institutions, which are the main suppliers of funds to firms. It is important to clearly present the medium-term roadmap for fiscal consolidation and implement specific measures to bring it to realization. III. Medium- to long-term growth potential of Japan’s economy So far, I have talked about the sovereign debt problem in Europe and related matters, which constitute one of the two main points concerning the outlook for Japan’s economy. I will now turn to the other point – namely, the medium- to long-term growth potential of Japan’s economy. Increasing importance of strengthening the growth potential Looking at the long-term developments of Japan’s real GDP growth rates, the average growth rate was 5 percent in the 1970s and maintained relatively high growth of around 4.5 percent in the 1980s (Charts 6 and 7). It dropped substantially to around 1.5 percent in the 1990s and further to less than 1 percent in the 2000s. As illustrated, since before the earthquake, Japan’s economy has faced a long-term downtrend in growth rates on the back of the rapid aging of the population and sluggishness of labor productivity growth. Postearthquake, Japan’s economy faces the new challenges of steadily promoting reconstruction from the disaster, securing a stable electricity supply, and recovering the reputation abroad for Japanese products. I have recently heard concern over whether the expansion of overseas production by Japanese firms could lead to a hollowing-out of domestic industries. These are all serious challenges, but in what follows I would like to discuss my observations about concern over the hollowing-out of domestic industries and thereby highlight the importance of strengthening the growth potential of Japan’s economy. BIS central bankers’ speeches Meeting expanding overseas demand Among many reasons behind Japanese firms’ recent expansion of their overseas production, surveys targeting firms show that the predominant one is to meet expanding local demand overseas. The working-age population in Japan has been declining since peaking in the middle of the 1990s, and GDP growth rates abroad began to exceed those in Japan from around that time. In line with such structural changes, the overseas production ratio of Japanese firms – that is, the ratio of production value of overseas bases to Japanese firms’ total production value – has been trending upward. The recent expansion of overseas bases can be understood in the context of this long-term trend of corporate strategies that correspond to expanding global demand (Chart 8). In recent years, firms not only in the manufacturing sector but also in the nonmanufacturing sector have accelerated their establishment of overseas bases. In emerging economies, there continues to be robust demand for social infrastructures. Furthermore, against the background of an ongoing shift in the growth model from dependence on exports to a selfsustaining expansion of domestic demand, those markets that are already mature in Japan are expanding rapidly in emerging economies, including markets for retail, distribution and logistics, food service, food and drink, and housewares. Amid expansion of global markets, firms in every country face an equal increase in business opportunities. However, an international comparison of the outstanding amount of outward foreign direct investment as a percentage of GDP as of 2010 shows that the ratio is 75 percent in the United Kingdom, 44 percent in Germany, and 31 percent in the United States, while the ratio in Japan is only 15 percent (Chart 9). These data suggest that Japanese firms’ overseas strategies are still lagging behind firms in other advanced economies. As a population decline has started in Japan ahead of other countries, actively capturing global demand is much more of a pressing challenge for Japan than for other countries. Dual strategy of expanding business globally and exploring domestic demand The question is whether the expansion of overseas production will induce a hollowing-out of domestic industries – specifically, a contraction of domestic production activity and a decline in employment – and thereby put downward pressure on growth rates of Japan’s economy in the medium to long run. Although the danger of a hollowing-out of domestic industries has been an issue many times since the Plaza Accord in 1985, experience dictates that the expansion of overseas production has not resulted in a long-lasting overall negative impact on the domestic economy. This is because the increase in overseas production has also generated some positive effects on the domestic economy, such as the rise in exports of parts to overseas factories and the increase in dividends received from overseas subsidiaries. How should we factor in the effects of the yen’s appreciation? While the overseas production ratio of Japanese firms continues to be on a fairly consistent uptrend, there are times when the pace of increase is relatively fast or relatively slow. The trend of expanding overseas businesses is greatly determined by the pace of expansion of overseas demand, but within this trend the specific timing of individual firms’ decisions to go international is influenced by foreign exchange rate developments. Let me touch on one example of recent developments. Toward the middle of the 2000s, the pace of increase in the overseas production ratio of Japanese firms temporarily paused when the yen depreciated substantially in the foreign exchange market, causing a shift back to domestic production in some ways. Although it is hard to evaluate the absolute level of foreign exchange rates, relatively speaking, the yen is without doubt getting much stronger in the exchange market than before the Lehman shock. At present, against the background of this swing in foreign exchange rates and the fundamental factor of the expansion of global markets, Japanese firms’ strategies for the location of operations are again shifting back from returning home to going overseas. Therefore, in the short run, Japanese firms’ shifting of production sites to overseas might accelerate at a faster rate than the past average. It is difficult to imagine that production BIS central bankers’ speeches bases would return home once they shift to overseas. Therefore, if core companies and factories move overseas, it will be difficult for Japan’s economy to regain the merits of business clusters even with a correction in the yen’s appreciation. In addition, if the yen’s rapid appreciation accelerates the pace of firms’ shifting of production to overseas, there will be an increased risk that the pace of fostering new businesses and industries at home cannot keep up with the accelerated pace of the production shift. At any rate, the medium- to long-term trend of expanding overseas bases is likely to continue given that the driving force behind global economic growth is shifting to emerging economies. In this regard, it is important for individual firms to review their domestic and overseas business operations from the perspective of enhancing corporate value. In a rapidly aging Japan, a potential serious problem in the long run is not excess employment but indeed the shortage of labor. Therefore, it is also important to transfer the work that can be done overseas and to focus on goods and services that can be generated most advantageously in Japan. For example, Japanese firms should sophisticate the functions of their domestic bases by shifting their precious management resources and personnel to the development and manufacture of new technologies and high value-added goods. They will also need to divide the functions of their business operations by allocating domestic human resources to meet diversifying consumer needs as well as develop businesses targeting the elderly in Japan. It is also necessary to create an environment that attracts overseas firms and personnel to Japan. Earlier, I mentioned the data for outward foreign direct investment, but I must say that Japan is lagging far behind other advanced economies in inward foreign direct investment, or in “globalization of domestic markets.” The outstanding amount of inward foreign direct investment as a percentage of GDP for 2010 shows that the ratio is 48 percent in the United Kingdom, 29 percent in Germany, and 18 percent in the United States, while the ratio in Japan is low at only 4 percent – literally, an order of magnitude difference (Chart 9). The low ratio of inward investment basically reflects that overseas firms consider investment in Japan as having low profitability. The other side of the coin is that Japanese firms are doing business in the market with such low profitability. At any rate, if firms in every country exert their strength and deepen the international division of labor across national borders, this will lead to the advancement of the global economy as a whole. It is important to enhance not only outflow to overseas but also inflow to Japan, as well as create a competitive environment that attracts overseas firms and personnel to Japan. With a view to strengthening the growth potential of its economy, Japan should implement a dual strategy of expanding business globally and exploring domestic demand. Need to explore frontiers by exerting Japan’s strength In a macroeconomic analysis of economic growth of the country as a whole, the concept of potential growth rate is often used. This corresponds to the ability of firms’ management to keep generating new added value at the microeconomic level. Seeing that the role and profitability of businesses change as time passes, firms are able to increase the added value per worker – in other words, to increase wages and shareholder returns – by creating highly profitable businesses and shifting their resources to those businesses, instead of fixing personnel and capital to businesses with low profits. Such improvement in economic metabolism illustrates the abstract concept of strengthening the growth potential of Japan’s economy. Needless to say, the process of exploring frontiers is very tough. However, we should note that Japan has an advantage in international competition in terms of geography, in that it is located in Asia, which is the driving force behind global economic growth. Japan also enjoys sophisticated “soft power,” as exemplified by the credibility of made-in-Japan products and courteous service. Moreover, as I mentioned earlier, the great advantage at present is that financial system stability is being maintained in Japan, unlike in the United States and Europe. The results of various surveys including the Bank’s Tankan (Short-Term Economic BIS central bankers’ speeches Survey of Enterprises in Japan) show that the lending attitude of Japanese financial institutions has recovered to a level exceeding the average since 2000, despite the strains in financial markets around the world. In the past, Japan alone suffered from the disposal of nonperforming loans, and the weakness in the financial sector dragged down economic activity. However, on the back of their sound balance sheets, I believe that Japanese financial institutions at present are able to effectively provide support to firms’ strategic efforts. This embodies the strength of Japan. If firms and financial institutions reconcile their growth strategies, they will discover ideas and methods for exploring new markets. IV. The bank’s conduct of monetary policy In my remarks today, I first mentioned the outlook for Japan’s economy and noted that it is likely to return to a moderate recovery path. In terms of points to be kept in mind concerning the outlook, I then talked about the sovereign debt problem in Europe and challenges regarding the medium- to long-term growth potential of Japan’s economy. The Bank, in recognition of such outlook and risks, has been pursuing powerful monetary easing under the framework of comprehensive monetary easing (Chart 10). This framework has the following three pillars. First, the Bank sets the policy rate at 0 to 0.1 percent, which can be deemed a virtually zero interest rate. Second, the Bank is publicly committed to continuing this virtually zero interest rate policy until it judges that price stability is in sight. And third, as an exceptional measure for a central bank, it purchases from the markets not only long- and short-term government bonds but also risk assets such as CP, corporate bonds, and exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). A program for purchasing financial assets, called the Asset Purchase Program, started at 35 trillion yen, but has been repeatedly expanded in size on a significant scale. Last week, on October 27, the Bank decided to increase the size by 5 trillion yen, to about 55 billion yen. This decision is based on the recognition that some more time will be needed to confirm that price stability is in sight and due attention is paid to the risk that the economic and price outlook will further deteriorate depending on developments in global financial markets and overseas economies. As I have noted earlier, such pursuit of powerful monetary easing has become one of the factors responsible for stability in the financial environment in Japan, despite continued strains in the U.S. and European financial markets. Although an accommodative financial environment has been maintained, as illustrated, demand has been declining for a protracted period and thus deflation has been continuing. This is because there exist fundamental factors – namely, a long-term downtrend in economic growth rates in Japan and the resultant reduction in growth expectations by firms and households. In this regard, the Bank has been supporting firms’ positive efforts since summer 2010 by providing funds to financial institutions under the new framework of the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth. Raising the medium- to long-term growth potential of Japan’s economy requires vigorous efforts from concerned parties in both the private and government sectors. In order for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability, the Bank for its part will continue to consistently make contributions as the central bank. Concluding remarks As I have already used up most of my time, I would now like to conclude my remarks. At present, all regions of the world face difficult challenges. I mentioned earlier that the sovereign debt problem in Europe was triggered by Greece, but the more fundamental factor is that the structural problem that was originally rooted in the present euro area framework was revealed by the Lehman shock. In the United States, debt in the household and BIS central bankers’ speeches government sectors – specifically, excess debt in the household sector that accumulated during the housing bubble period and government debt that ballooned in the course of addressing the financial crisis and economic downturn after the Lehman shock – have become factors in destabilizing financial markets and the economy. Emerging economies are likely to increase their presence as engines driving global economic growth. For the time being, however, there is a high degree of uncertainty as to whether they can ensure the sustainability of economic growth by containing inflationary pressure. In the medium to long run, not a few Asian countries will experience rapid aging of their societies, following the lead of Japan. There is also an issue of whether the global capacity to supply energy and food will manage to continue to meet the robust demand from emerging economies. As I have described, every country and every region in the world has its own challenges. Japan, for its part, needs to positively tackle its challenges without falling into pessimism. The biggest challenge for Japan is to raise its growth potential. As the working-age population is declining, future generations cannot maintain the current high standard of living unless labor productivity is improved. As you may know, labor productivity is added value, or the sum of wages and profits, divided by labor input. Based on this definition, productivity growth is made possible by providing goods and services for which people are willing to pay. Without such efforts, economic growth cannot be achieved. Japan can be called an “advanced country” in the sense that it has faced various challenges ahead of other countries. That is why Japan, if it explores visionary solutions to address natural environment problems, energy constraints, and the declining and aging population, will be able to contribute to the advancement of the global economy as well as determine new growth strategies for itself. In the Kansai region, there are many firms whose advanced technologies have a large global market share in various areas such as the natural environment and energy, medical and nursing care, high-tech manufacturing, and high-end materials. The region also offers a number of tourist attractions; for example, five World Heritage sites designated by the United Nations Educational, Scientific and Cultural Organization (UNESCO). In addition, the region is easily accessed from other Asian countries. There are new initiatives that convey the region’s abundant spirit in tackling challenges, such as the broad-based collaboration between industry and academia across prefectural boarders. The Bank places its hope in and will provide support for the region’s efforts so that innovations as well as business models created in the region will help activate Japan’s economy. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Netherlands Bank conference in honour of Mr Nout Wellink on "Welfare effects of financial innovation" (via videoconference) , Amsterdam, 11 November 2011.
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Masaaki Shirakawa: What is so special about financial innovation? Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Netherlands Bank conference in honour of Mr Nout Wellink on “Welfare effects of financial innovation” (via videoconference) , Amsterdam, 11 November 2011. * I. * * Introduction Today I am honored to have the opportunity to appear as the keynote speaker of this conference marking the retirement of Nout Wellink. I wish I could participate physically, but thanks to innovation, which is the very topic of today’s conference, I am now able to join you through videoconference from Tokyo, about 10,000 kilometers away from Amsterdam. There is, of course no need for me to remind you of Nout’s distinguished career, at the Netherlands Bank, the Basel Committee and the Bank for International Settlements, to name just a few. I would just like to thank him for his contributions on all the occasions I had the pleasure of working with him, and for his friendship outside the meeting rooms. Central bankers, or policymakers more generally, are quite fond of innovation. It is the catalyst for growth. Innovation is the key to increasing productivity, and without it, our economies can only grow linearly with the increase in input factors. Innovation is now all the more important, especially in the developed economies, because – as our population ages and the labor force stops growing rapidly – productivity growth underpinned by innovation is the only way for us to realize growth in the years ahead. In this sense, innovation is something we regard as inherently positive. Nevertheless, we are gathered here to examine the welfare effects of financial innovation. The fact that we can usefully discuss such things implies that not all developments described as financial innovation might be welfare enhancing. Why is it that we have to persuade other people – and perhaps even ourselves – of the merits of innovation, when we add the word “financial” in front of “innovation”? Today, I would like to explore why we are sometimes uncomfortable with certain developments in the finance industry that are labeled “innovation” by their promoters, and consider policy implications for central banks, with a view to encouraging innovation that would benefit the whole society. Fifteen minutes will not be enough to arrive at definitive conclusions, but let me give it a try. II. Drivers of innovations in the financial industry Innovation means changing the way business is conducted in order to better serve the clients of the business. It is a constant adaptive process, and the changes could be either incremental or discontinuous. The financial industry is no exception. In fact, the Netherlands was one of the earliest centers of innovation in finance as we know it. For example, Amsterdam was the location of the world’s first stock exchange, established in 1602. The province of Holland was the first sovereign to issue bonds in the modern sense, backed by the tax revenues of the sovereign. The development of finance through these innovations contributed enormously to the subsequent development of the Western world. Since then, innovation in finance has continued. Banks are pushing less paper around. Records are kept centrally in computer systems. ATMs have replaced most functions of bank tellers. In our wallets, plastic cards have become just as important as, or perhaps more important than, banknotes and coins. These changes, which provide the same or better service to clients at lower cost, are certainly innovations in the usual sense of the word, and we have little concern for their welfare effects. BIS central bankers’ speeches What we worry about are those changes that are more often associated with the so-called “rocket science” side of banking. Take derivatives for example. In the early 1990s, when central banks first began to take interest in them, experts told us that derivatives enabled risks to be unbundled and shifted at a low cost to those who were most willing and able to bear those risks.1 Given the diversity of risk preference among economic agents, the new distribution of risk after derivatives transactions was regarded as welfare enhancing. Furthermore, as a result of better distribution of risk, it was claimed that the whole financial system should become more resilient. Conceptually, this argument made sense, but in practice, there were spectacular mishaps. Our intuition, based on such experiences, tells us that not all financial innovations are created equal. Some may be embraced wholeheartedly, while others may have to be carefully monitored and perhaps regulated or even prohibited altogether. One possible approach is to look at the drivers of innovation. Innovation can be technology driven or modality driven. Technology-driven innovation crystallizes when the application of technology results in a better way of doing business. The ATM may be the best example in the business of banking. On the other hand, modalitydriven innovation aims at rearranging business processes for the better. Financial risks can be shifted around without derivatives, but derivatives make it more efficient to transfer risks. The two are not mutually exclusive, but are distinct enough to be the basis for sharpening our thinking. Generally speaking, we are more comfortable with technology-driven innovations than modality-driven ones. Nevertheless, modality-driven innovations are not necessarily inherently unwelcome. One could argue that modality-driven innovations are just as welfare enhancing as technology-driven ones, and any innovation, be it technology or modality driven, could be harmful if misused. Although we cannot deny such a risk, there should be many more satisfied clients of innovative products and services than dissatisfied ones. Another argument would be caveat emptor. Alternatively, even if the risk materializes, one could attribute that to just bad luck. Can we accept these views? If the answer is “Yes”, what we need is perhaps a little more policing effort or education. But in today’s forum, I do not think we could be satisfied with such a conclusion. Are there any issues with incentive structure in modern finance that encourages the misuse of financial technology? Even if there is no misuse, should we not be concerned with incentives to create more complex instruments that can only be understood by a handful of educated people, leading to obfuscation of risks under the guise of innovation? Are we not seeing too many “once-in-a-hundred-year” accidents? III. Who benefits from innovation? Up to now, I have deliberately remained vague on the objectives of innovation. Why do financial institutions innovate? Innovations are better ways of doing business, but better at what? Broadly speaking, the core function of financial institutions is intermediation. For example, if a business can obtain capital from the outside, it can invest and grow faster than when it can rely only on retained earnings. Financial institutions are ready to stand between savers who have the money and businesses that need the money. Another important function, especially for banks, is effecting payments. If a business knows that it can easily exchange foreign See Bank for International Settlements, Macroeconomic and Monetary Policy Issues Raised by the Growth of Derivatives Markets, 1994. BIS central bankers’ speeches currency to domestic currency, it can more conveniently sell its wares abroad for growth. Financial institutions are ready to facilitate the transfer of money between buyers and sellers of goods and services. By standing between economic agents, financial institutions help other economic agents overcome financial constraints in various ways, and through this process of effecting intermediation and payments, help create value and thus enhance welfare. When we focus on this fact, we can finally understand why we are uncomfortable with some past developments in the financial industry. Problems seem to have arisen when a product or service is insufficiently anchored in intermediation or facilitation of payments. Innovation is useless or even harmful, if financial institutions lose sight of the needs of their clients, or more broadly the society. Technology-driven innovations are more likely to be beneficial, because, when the innovator is deliberating on the application of technology, the client cannot usually be ignored. On the other hand, in the case of modality-driven innovations, one can easily lose sight of the client when cutting and dicing existing businesses. For example, securitization now has a bad name because of its perceived role in the financial crisis. Nevertheless, securitization is conceptually beneficial, because it aims to bridge the gap between the risk preferences of lenders and the actual risk profile of borrowers. The only condition is probably that the investment bank arranging the transaction must find takers for all the tranches. In this regard, some resecuritized products, which inflicted enormous pain during the recent financial crisis, are suspect because they include unsold tranches of original securitization vehicles, tranches that investment banks could not sell to willing buyers or found too unattractive for their own books. Considering that financial institutions enhance welfare through intermediation, relevance of any developments to intermediation should be a good starting point. This perspective is particularly important for modality-driven innovations. IV. Dealing with undesirable outcomes Unfortunately, the world of finance is complex. As a result, one or two simple tests cannot separate all the wheat from the chaff. In this regard, one of the most difficult issues involves the claim that certain instruments or practices provide a public good, namely the better functioning of markets through enhanced liquidity or more efficient price discovery. For example, in the case of high-frequency trading (HFT), one can argue that the increase in the speed and execution serves no socially useful purpose, because most of the HFT transactions are netted out and, therefore, very little intermediation actually takes place.2 On the other hand, one could argue equally persuasively that trial and error carried out by HFT facilitate price discovery, performing a useful function for market participants that wish to trade in cash instruments. After all, nobody has doubts on the usefulness of the stock market, even though the market itself does not perform any intermediation between savers and firms in need of capital. If there were only long-term buy-and-hold investors, market liquidity, or the supply of immediacy, would be constrained. The fact that stocks can easily change hands facilitates the capital-raising activities of firms. This is a difficult issue, but for policymakers, the fact that the “first-best” solution is elusive cannot be an excuse for not acting on potentially harmful activities. “Second-best” or “thirdbest” solutions will have to be pursued. Instead of focusing too heavily on the welfare effects of individual innovations, on which sensible people can disagree, we could consider incentive issues behind developments in the financial industry, especially purported innovations that While HFT in equity markets has been intensely debated, that in foreign exchange markets has been little discussed. For recent discussions on the latter, see Bank for International Settlements, High-Frequency Trading in the Foreign Exchange Market, 2011. BIS central bankers’ speeches are modality driven. Very often, modality-driven innovations are the result of efforts to circumvent regulations, taxes, and accounting rules imposed on the financial industry. One of the lessons learned from the recent financial crisis is that such innovations tend to mask the build-up of excessive risk in the economy with dire consequences. V. Concluding remarks As I said at the beginning, innovation is the key to growth. Financial innovation can also promote growth, so long as it facilitates the activities of other economic agents. The invisible hand may bring into line the interests of the financial industry and the broader society, but the recent financial turmoil has shown that too often, improperly aligned incentives in the financial industry can stand in the way. In this regard, senior management of financial institutions, each time their traders and bankers come up with innovative proposals, should at least reflect on how the new products or services could add value to activities in the broader economy and facilitate intermediation, before giving the go-ahead. Meanwhile, central banks must better understand the incentive structures in the financial industry, and ponder if their actions might be distorting incentives, giving rise to modalitydriven innovations that hardly benefit the society as a whole. Doing so should allow us to avoid those policy decisions – for example, maintaining excessively loose monetary policy for too long or offering too wide a safety net through the lender-of-last-resort function – that inadvertently add momentum to such developments. We have, undoubtedly, made important progress in the various international fora, including the Basel Committee, of which Nout Wellink held the chair until his retirement. Still, much work remains, for example the potential for the shadow banking sector to pick up those risks pushed out of the formal banking sector as a result of recent regulatory tightening. I hope that today’s discussions will give us fresh ideas on how to take on the many remaining challenges with regard to aligning incentives and practices of financial institutions with socially desirable outcomes. Thank you for your kind attention. BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 28 November 2011.
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Masaaki Shirakawa: Japan’s economy – current situation, outlook, and challenges Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 28 November 2011. * * * Introduction I am honored to be here today to speak and exchange views with business leaders from the Chubu region. I would like to take this opportunity to express my deep gratitude for your cooperation with the Bank of Japan’s Nagoya branch. This region currently faces a very severe economic situation, as the significant relative importance of the automobile industry to the regional economy has amplified the impact of negative events including supply-chain disruptions due to the Great East Japan Earthquake, the appreciation of the yen since this summer, and the floods in Thailand since last month. While the Bank has been fully aware of such economic conditions as a result of having obtained information from various sources including reports from the Nagoya branch, I came here today to learn of your concerns directly. Before we exchange views, I will first talk about the outlook for and risks facing Japan’s economy, followed by the Bank’s conduct of monetary policy. I will then offer my views on the most pressing issue for Japan’s economy – strengthening its medium- to long-term growth potential. I. The outlook for and risks facing Japan’s economy I will start with the outlook for Japan’s economy. Although the economy has faced very severe supply constraints since this March, including supply-chain disruptions and electricity shortages due to the earthquake and tsunami, economic activity has recovered faster than expected thereafter, which reflects the remarkable capability of Japanese firms and the Japanese people to respond to such adversity. As well as the expected gradual decline in the pace of growth that generally follows this kind of rapid recovery phase, new concerns have surfaced since this summer: I am talking, of course, about the slowdown in overseas economies and the rapid appreciation of the yen against the backdrop of the tensions in Europe. As a result of these factors, the tempo of Japan’s economic recovery has been moderate. Moreover, given the addition of new ones such as the floods in Thailand, Japan’s economy is expected to be impacted by the adverse effects of these negative events for the time being. Considering their high growth potential, however, emerging economies will start leading the global economy again, assuming that they achieve a soft landing through appropriate policy responses, and growth rates of overseas economies are likely to pick up. In Japan, reconstruction-related demand after the earthquake is expected to gradually materialize. In the Bank’s current baseline scenario, therefore, Japan’s economy is expected to return to a moderate recovery path after slowing for the time being. According to the Bank’s projections released at the end of last month, the real GDP growth rate will remain relatively low in fiscal 2011, at 0.3 percent, but will continue to register positive growth in fiscal 2012 and fiscal 2013 – of 2.2 percent and 1.5 percent, respectively. Meanwhile, the year-on-year rate of change in the consumer price index (CPI) is currently at around 0 percent following a gradual narrowing of the negative CPI growth rates since the summer of 2009. It is expected to gradually rise to around 0.5 percent as we approach fiscal 2013, with the improvement in the aggregate supply and demand balance (Chart 1). As illustrated, in the Bank’s baseline scenario, the slightly more long-term perspective is that Japan’s economy will eventually return to a sustainable growth path with price stability. At the same time, the Bank fully recognizes that such an outlook is subject to various uncertainties. BIS central bankers’ speeches The most significant risk factor is the sovereign debt problem in Europe, or in the words of European authorities in official documents, “the sovereign debt crisis”. How will this problem develop in the coming period and how will it affect global financial markets and the global economy? In Europe, interest rates on government bonds issued by countries whose fiscal situations have become subjects of concern have been rising significantly and, more recently, rates have started to rise even in Italy, the third-largest economy in the euro area (Chart 2). As a result, European financial institutions with large holdings of the government bonds in question have faced difficulties raising funds from the market due to rising concerns about their creditworthiness, thereby making it inevitable that they restrain lending in order to maintain liquidity. As illustrated, in Europe, an adverse feedback loop is operating with respect to the fiscal situation, the financial system, and economic activity, under which a decline in confidence in fiscal conditions has increased concerns about the stability of the financial system, which in turn has started to affect economic activity. Such economic and financial developments in Europe have been affecting economies in other regions around the world. The sovereign debt problem has also been an underlying cause of the yen’s appreciation since this summer. Global investors have become increasingly risk averse amid growing uncertainty regarding the global economy. When a global financial crisis materializes, it always does so in the form of a currency crisis. In this regard, although Japan faces a wide range of challenges in the medium to long term as I will point out later, the yen has been considered a relatively safe asset and is therefore an attractive buying option for investors, due in part to Japan’s current account surplus and the resultant significant amount of net external assets. II. The Bank’s conduct of monetary policy The three-pronged approach Amid the slowdown in overseas economies and appreciation of the yen, the Bank has recently taken measures to enhance monetary easing twice – in August and October this year – due to heightened concerns about the likelihood of a future slowdown in Japan’s economy (Chart 3). As the Bank has heard various opinions with regard to the Bank’s conduct of monetary policy, I would like to give a rather detailed explanation of the policy, starting from the current framework. As many of you may be aware, the Bank has taken the three-pronged approach of pursuing powerful monetary easing under the framework of the “comprehensive monetary easing” implemented in October 2010, ensuring financial market stability, and providing support to strengthen the foundations for economic growth. Through this approach, the Bank has continued to consistently make contributions as the central bank in order for Japan’s economy to overcome deflation and return to a sustainable growth path under price stability as soon as possible. Regarding the first of these three measures – powerful monetary easing under the comprehensive monetary easing framework – the Bank sets the policy rate at around 0 to 0.1 percent, which can be deemed a virtually zero interest rate policy, and is publicly committed to continuing this policy until it judges that price stability is in sight. Moreover, it has established on its balance sheet a program for purchasing financial assets, called the Asset Purchase Program, under which it purchases from the markets not only long- and short-term government bonds but also – in a highly extraordinary measure for a central bank – risk assets such as CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). Through this measure, the Bank aims to encourage a decline in longer-term interest rates and various risk premiums. The Program has increased to a total of 55 trillion yen after being repeatedly expanded in size, and the Bank is proceeding with its purchases of various financial assets amounting to approximately 15 trillion yen in the period until the end of next year. BIS central bankers’ speeches Second, the Bank has been ensuring financial market stability. This becomes especially important at a time like this given the increasing anxiety in global financial markets due to the sovereign debt problem in Europe. In this regard, the Bank has continued to provide ample yen funds, and has established frameworks for providing U.S. dollar funds, in cooperation with central banks in North America and Europe (Chart 4). While maintaining close contact with overseas central banks, the Bank will do its utmost to ensure market stability. Third, the Bank is providing support to strengthen the foundations for economic growth, which is another extraordinary measure for a central bank (Chart 5). Under this framework, the Bank supports the efforts of firms and financial institutions aimed at strengthening the growth potential of Japan’s economy by providing financial institutions with long-term funds at a low interest rate. The accommodative financial environment How, then, are effects of such powerful monetary easing transmitted to economic activity? Proceeding with this discussion requires consideration of the transmission mechanism of monetary policy in two stages (Chart 6). The first stage is the transmission of monetary easing effects from the realm of monetary policy to the financial environment; in other words, this refers to the extent to which borrowing and availability of funds for firms and households become more accommodative. The second stage is the transmission of effects from the financial environment to the real economy, or in other words the extent to which firms and households make use of the accommodative financial conditions to increase their investment and spending. Looking at the first stage, financial conditions in Japan have continued to ease steadily amid increased strains in global financial markets against the backdrop of the sovereign debt problem in Europe (Chart 7). More specifically, market interest rates including longer-term ones have been at extremely low levels, and corporate bond and CP yield spreads over Japanese government bonds (JGBs), or credit spreads on corporate bonds and CP, have remained stable at low levels. Moreover, bank lending rates have declined moderately. Various surveys of firms suggest clear improvement in both the lending stances of financial institutions as perceived by firms and in firms’ financial positions. This is in sharp contrast to the situation in Europe and the United States, where financial conditions have tightened since the summer against the backdrop of market anxiety due to the sovereign debt problem in Europe. The Bank assesses that the improvement in Japan’s financial conditions can be partly attributed to the Bank’s highly stimulative monetary policy, which I touched upon earlier. Shifting our focus to the second stage of the transmission of monetary policy, unfortunately even an extremely accommodative financial environment has not led to an active increase in investment and spending by private economic agents. This is in fact a prime source of concern for the Bank as well as Japan’s economy. As a response to this situation, some believe that economic activity would eventually be stimulated if the Bank took further drastic measures. In reality, however, interest rates in Japan, particularly actual funding rates for private economic agents, have continued to ease and are the lowest among advanced economies. As for quantitative indicators, the monetary base – funds provided by the central bank – and money stock – funds possessed by households and firms – relative to nominal GDP indicate that the amount of fund provision in Japan is the largest among advanced economies, far exceeding the amounts in the United States and the euro area (Chart 8). While the United States substantially increased its amount of fund provision after the Lehman shock, Japan conducted such aggressive fundprovisioning at an earlier stage given that it experienced a financial crisis at an earlier stage. This may explain why the Bank’s active efforts may not be so noticeable. Nonetheless, the hard fact based on data is that Japan’s monetary base relative to nominal GDP already BIS central bankers’ speeches attained in 2002 the level currently reached by that of the United States, and has been rising further over the past several years. Although the Bank continues to enhance monetary easing, given the accommodative financial environment surrounding Japan that I have described, it is more important to make efforts to take advantage of such conditions – namely, efforts aimed at strengthening the economy’s growth potential. I will discuss this in more detail later, but before that let me turn to the effect of and responses to the yen’s appreciation, which is closely connected to this issue and is considered a matter of grave concern among people in this region. III. Responses to the Yen’s appreciation Regardless of whether a currency is appreciating or depreciating, the impact of foreign exchange rate fluctuations is highly significant for business, for local economies where businesses cluster, and for the national economy as a whole. Looking back, the yen was on a significant depreciation trend toward the middle of the 2000s, which was followed by a period of significant appreciation. The current appreciation of the yen has both advantages and disadvantages, and how they each materialize differs depending on the phase and time horizon. After considering all these factors, the Bank has concluded that, in the current time of high uncertainty regarding the future prospects of overseas economies, due attention is necessary to the risk that the yen’s appreciation will dampen future growth through a decline in exports and corporate profits as well as a deterioration in business sentiment. This is the very reason that the Bank has embarked on monetary easing measures twice since this summer. The most debated issue at present with regard to the yen’s appreciation is the possibility that Japan’s firms will accelerate their shift to overseas production, which may result in a hollowing-out of domestic industries. The trend of a rising share of overseas production among Japanese firms can be basically understood as a part of firms’ growth strategy to place production sites near markets that are experiencing rising demand, against the backdrop of a global shift of growth centers toward emerging economies. Having said that, the timing of this global shift is also affected by foreign exchange rate developments. As you may recall, in the phase of significant yen depreciation toward the middle of the 2000s, the profitability of domestic production improved dramatically and firms started to refocus on domestic production while pausing their shift to overseas production. However, as the aftershocks of the collapse of Lehman Brothers and impact of the sovereign debt problem in Europe have persisted, the yen has stayed at a higher level than the period before these problems emerged. Given this development, firms are returning to the strategy of shifting production overseas that they had been pursuing in response to the expansion of global markets. Therefore, during this period of transition in business strategy, the pace at which production is shifted overseas will generally accelerate compared to the past average. During this period, if the pace of this shift increases excessively, it may be difficult to create replacement job opportunities at home at a similar pace. Moreover, if core companies and factories with long-term competitiveness move overseas, they are less likely to return home even with a correction in the yen’s appreciation. Therefore, as well as the risks that I have pointed out so far, the impact of the recent appreciation of the yen on Japan’s economy warrants due attention. At the same time, the appreciation of the yen also has advantages, including lower import costs for energy and materials, which increases the purchasing power of firms and households. After the earthquake, the trade balance turned negative due to the expansion of imports of crude oil and LNG against the backdrop of the suspension of operation of nuclear power plants and an associated increase in electricity generated from thermal power. The yen’s appreciation has also worked to offset the negative impact of such drain of income to overseas. Such advantages are not uniformly extended to all firms and industries. With regard to the impact on the national economy as a whole, it is also important to consider how BIS central bankers’ speeches to make use of such advantages to promote the development of new businesses and reform of the industrial structure. Unfortunately, however, we have rarely seen such positive initiatives so far. IV. Necessity to strengthen medium- to long-term growth potential Let me now move on to the topic of strengthening the growth potential of Japan’s economy, which I briefly touched upon earlier. I believe this is the most fundamental challenge currently facing Japan’s economy. The growth rate can be broken down into the rate of growth in the number of workers and the rate of growth in GDP per worker, or productivity. The long-term downtrend in Japan’s economic growth is determined by two factors: a decrease in the number of workers due to the rapid aging of the population and low productivity growth (Chart 9). With this in mind, what will happen in terms of the future growth rate? Assuming that labor market participation by the elderly and female population remains unchanged, based on long-term projections of demographic trends, the rate of decline in the number of workers will accelerate further to 0.6 percent in the 2010s and 1.3 percent in the 2030s (Chart 10). The rate of growth in the number of workers and the rate of growth in productivity together constitute the economic growth rate. Assuming that the productivity growth rate is around the average of the past 20 years, that is, around 1 percent, the annual rate of economic growth for the 2010s onward will ultimately remain between 0.0 and 0.5 percent on average and enter negative territory in the 2030s. Given that such a situation can be clearly foreseen, we must do our utmost to improve it, even if only slightly. This means that in order to strengthen the economy’s medium- to longterm growth potential and thereby prevent it from entering a period of stagnation, it is necessary to both prepare a working environment that encourages an increase in labor market participation by elderly people and women and make efforts to enhance productivity growth. Productivity growth is defined as the capacity of individuals to generate added value, or in other words, the ability to earn. Aside from being somewhat lucky, the ability to earn cannot be acquired without actual efforts to achieve it, and this applies to both individuals and firms. Active efforts to respond to a changing business environment are thus required. Taking the example of firms’ shifting of production overseas, in order to realize an expanded equilibrium of profits and employment, firms need to rebuild development and production systems at home, especially for goods and services enabled by high technology and with high brand value, and explore the domestic market with a focus on capturing diversifying needs while further expanding their overseas operations to carry out production and sales activities that can be shifted overseas. More than anything, it will be firms’ efforts and their spirit of willingness to take on challenges that will make such developments possible. At the same time, it is equally important for the government to support firms’ potential to make progress through, for example, reform of regulations and tax systems. The Bank also supports firms in their efforts by providing them with a stable financial environment. As the key to growth lies in adapting to changes, it becomes just as important for society as a whole to share a sense of values that regard the active metabolism of the economy in a positive way. Low growth over a protracted period tends to draw attention to aspects of Japan’s economy that are facing challenges. Taking a step back and looking at the state of the country objectively, however, Japan possesses countless qualities that reflect its uniqueness and strengths, including the following: its advantage in international competition in terms of geography, in that it is located in Asia; its genbaryoku, or “competitiveness at worksites”, which was demonstrated in the way that post-earthquake supply-side constraints were resolved; its adherence to high-quality manufacturing and courteous service; and its financial system stability. I believe that, if firms pursue a dual strategy of expanding business globally and exploring domestic demand while taking advantage of their strengths, it will become BIS central bankers’ speeches gradually evident that Japan’s economy as a whole is on course toward effectively capturing both external and domestic demand. Once such a virtuous circle begins to be formed, Japan’s growth potential will strengthen. The course future developments will take depends on whether we are capable of accurately identifying the true cause of the severity of the current situation and engaging in the necessary efforts to address these issues. Concluding remarks As I have already used up most of my time, I would now like to conclude my remarks. As I mentioned at the start, Japan’s economy is likely to continue to face a severe situation for the time being, especially with respect to exports. The Bank is determined to support Japan’s economy as it seeks to return to a sustainable growth path, by continuing to pursue powerful monetary easing with due recognition of the actual situation. In order for Japan’s economy to regain its strength in the medium to long term and thereby overcome its deflationary trend, it needs to make efforts to end the decline in its growth potential, the fundamental cause of the deflationary trend. The Bank hopes that various endeavors will be made so as to enable the economy to take full advantage of the extremely accommodative financial environment. In this regard, this region has long been known for its deep-rooted spirit of entrepreneurship. In a period of large-scale changes, the first step to opening the door to dramatic growth is to accept those changes and view such uncertainties as opportunities to be seized. The Bank will continue to support your efforts, so that regional innovation and new business models will inspire and motivate not only the region but Japan’s economy as a whole. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Paris EUROPLACE International Financial Forum, Tokyo, 28 November 2011.
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Kiyohiko G Nishimura: Financial factors in commodity markets Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Paris EUROPLACE International Financial Forum, Tokyo, 28 November 2011. * 1. * * Introduction I feel privileged to have the opportunity today to speak at this International Financial Forum organized by Paris EUROPLACE. This is my second time to stand before you, following my presentation last year. It is always a great pleasure to join this forum, since Paris EUROPLACE has been playing a pivotal role in providing opportunities for market participants to deepen mutual understanding. I salute the members of Paris EUROPLACE for their dedication. It is also a great pleasure to have our friend Christian NOYER, Governor of the Banque de France, among our distinguished participants. I would like to take this opportunity to extend my sincere gratitude to Christian and the Banque de France for their invaluable support under the French presidency, for the work of the G20 Study Group on Commodities, chaired by my colleague Hiroshi NAKASO.1 My presentation today, in which I would like to share with you some of the findings of the Study Group, has profited greatly from such cooperative work between the Banque de France and the Bank of Japan. However, the views expressed hereafter are my own, and do not necessarily represent the views of the Study Group. Last year, I discussed in some detail the nature and impact of electronic trading in financial markets, examining how the global expansion of electronic trading has affected market microstructure. Today, I will focus on another significant development: that is, the growing influence of financial factors on commodity markets. In fact, my presentation this year is in many ways a sequel to the one last year, not only because both presentations aim to shed light on financial innovations in the various markets, but also because electronic trading is an important issue per se in commodity markets. I will come back to this point later. 2. High and volatile commodity prices Commodity prices have been fluctuating considerably both in terms of speed and amplitude. A surge in commodity prices until 2008 was followed by a sharp downfall in the midst of the financial crisis. Prices rose again from early 2009 to levels comparable to the peaks reached in 2008, though they had again declined until recently (figure 1). These see-saw developments pose a serious challenge to policymakers when dealing with, for example, inflationary pressures. Consequently, intensive research has been conducted to discern the main drivers behind these price developments. At this juncture, three factors have been identified as important. The first, and the most fundamental driver, has been the tightening of demand and supply conditions (figure 2). On the one hand, the rapid growth of the global economy, notably in emerging economies, has been a major factor behind strong commodity demand. On the other hand, a long period of underinvestment, coupled with geopolitical and climate-related shocks, has severely constrained supply growth. Consequently, as inventories and spare capacity have declined, commodity markets have become increasingly vulnerable to various See Report of the G20 Study Group on Commodities under the chairmanship of Mr. Hiroshi Nakaso, November 2011. BIS central bankers’ speeches shocks in both demand and supply. The tariffs, export restrictions and other ad-hoc measures adopted by some countries may also have aggravated market imbalances. The second factor driving these fluctuations in commodity prices is global monetary conditions. Accommodative monetary conditions, especially in the aftermath of the global financial crisis, seem to have contributed to the rise in commodity prices in various ways (figure 3). In particular, monetary policy affects aggregate demand in general, which in turn influences the demand for commodities. On top of these two factors, the third driver is what might be described as “financialization” (figure 4). Partly influenced by globally accommodative monetary conditions, financial investors have entered the commodity markets and changed market participants’ behavior in important ways, especially with respect to appetite for portfolio rebalancing and carry trades. In fact, during the past several years, the rise in price levels and volatility in commodity markets has coincided interestingly with the growing rate of participation of financial investors in these markets. 3. Growing importance of financial investors Investment in commodity-related financial products has increased considerably both in quantity and scope in recent years. The estimated market value of commodity-related assets under management reached almost 450 billion USD by mid-2011, from only 260 billion USD in mid-2008. Both instruments and players have diversified considerably. In addition to the traditional commodity investors, such as commodity trading advisors (CTAs) and commodityspecialized hedge funds, index investors and ETF sponsors have become prominent players. Moreover, we now observe very active participation of various hedge funds, proprietary trading desks of banks, broker-dealers and trading units of large non-financial enterprises. Accordingly, investment and trading strategies have also become more diverse. In particular, let me focus on the changing nature of index investment. It is true that a significant proportion of investment is still tied to strategies which replicate major indices by investing in the front end of the curve and passively rolling into the next contract each month. However, some managers are adopting so-called “enhanced” index strategies, which may entail positions on various parts of the curve or allow investments in subsets of commodities.2 ETF sponsors have also diversified their investment strategies. ETF sponsors, especially in the case of ETFs linked to the price of precious metals, typically take long positions in commodity spot markets under so-called physical ETF schemes. However, we have seen the emergence of synthetic ETFs, that is, ETFs backed by derivatives. Under synthetic ETF schemes, ETF sponsors often engage in total return swaps or commodity futures to issue ETFs linked to major indices. They also use other types of derivatives to issue complex products such as short ETFs and leveraged ETFs, although their presence is still limited at this stage. Turning to other participants, hedge funds typically take both long and short positions for arbitrage purposes or based on macro-economic views. CTAs trade in futures markets and often employ technically-based trading strategies such as trend following strategies. More recently, some CTAs have become increasingly involved in algorithmic and high-frequency trading (HFT). This is often described as a response to changes in the shape of futures curves and/or a crowding out of investor activities in some part of the curves. BIS central bankers’ speeches The growing participation of financial investors in commodity futures markets may also affect spot markets. In particular, several leading commercial and investment banks have become increasingly active in some physical markets, providing liquidity to their clients through arbitrage between physical and financial markets. There seems to be a variety of motives behind the growing investment in commodities. Some investors view commodities as an effective tool in hedging against inflation. Institutional investors with a long-term investment horizon have been attracted by the diversification benefits for portfolio rebalancing and high convenience yields. Furthermore, some investors consider commodity investments as a proxy for investment in rapidly growing emerging market economies. Investable assets in these economies are still limited. Thus, in order to gain exposure to these rapidly growing emerging market economies, some investors turn to commodity investments correlated strongly with growth in these economies. Finally, for some investors, arbitrage opportunities may have been the main motive for investing in commodities. 4. Financial investors’ impact on commodity markets Greater participation by financial investors in commodity markets, which I have called financialization, brings important economic benefits by providing liquidity to the market. Enhanced market liquidity can reduce hedging costs for both producers and consumers. However, there may be costs as well. The growing importance of financial investors suggests that commodity prices may have become more sensitive to financial investors’ decisions and position-taking. This may lead to commodity prices deviating from values consistent with their “fundamentals”. Such deviation may occur, for example, when financial investors’ liquidity constraints outside commodity markets trigger substantial financial outflows, relative to the size of the commodity markets themselves. A similar situation may arise when financial investors’ risk appetite swings wildly.3 A particularly delicate subject in this regard is the role of algorithmic and high-frequency trading. Although still a matter of some debate, a general consensus seems to be emerging in the equity markets that such trading techniques enhance the proper functioning of the market in normal times by providing liquidity, but in contrast they tend to disappear suddenly from the market and thus contribute to market disruption when sharp price movements occur due to unexpected and unprecedented events. However, in commodity markets, the precise role of algorithmic and high-frequency trading is yet to be determined. To sum up, it is not easy to identify to what extent the growing presence of financial investors has actually moved commodity prices away from “fundamentals”. The current literature on this point is inconclusive. Although there is consensus that the tightening in physical supply and demand has been one of the main causes of large fluctuations in recent years, it is also plausible that financial investments have affected price dynamics, at least over short time horizons, as we have observed the same dynamics in other financial markets. 5. Toward resilient and well-functioning commodity markets In view of what I have described so far with respect to recent developments in commodity markets, let me now draw three policy implications relating to market functioning and macro prudential policy. The deviation may also happen when “herding behavior” is observed. Herding may occur, for instance, if market participants extrapolate a series of recent price increases as reflecting better “fundamentals”, and then choose to follow such price movements. BIS central bankers’ speeches To enhance transparency First, the transparency of both physical-products and commodity-derivatives markets needs to be enhanced. As I mentioned earlier, the expansion of financial investor participation in commodity markets can bring about benefits by reducing hedging costs for producers and consumers. At the same time, trend following strategies, especially when they are combined with algorithmic and high-frequency trading techniques, may move commodity prices away from values consistent with “fundamentals” over short time horizons. This deviation may persist depending on how quickly offsetting forces come into play. In this regard, it is important to enhance the transparency of physical and futures commodity markets in order to improve the market price discovery mechanism. In this context, improving the quality and timeliness of information in physical-products and commodity-derivatives markets is essential. Improving data availability on commodity market transactions is also a precondition to understanding the microstructure of these markets. To guard against financial vulnerability Second, it is important to assess and bear in mind the potential financial vulnerability arising from the increased exposure of financial investors. The exposure of financial investors to commodity markets appears to remain relatively small when compared to total assets under the management of institutional investors. However, increased diversity and complexity of both financial instruments and players in the commodity markets requires closer monitoring to assess their impact on the risk management of financial institutions, and ultimately, on the overall development of financial markets. For example, the increased correlation between commodity derivatives markets and other financial markets suggests a higher risk of spillover effects from one market to another. The active involvement of several leading commercial and investment banks in physical commodity markets may present challenges to the way they manage these risks and how they incorporate them into their integrated risk management systems. The increasing presence of algorithmic and high-frequency traders in the markets also highlights the need to deepen our analysis of their impact on market stability and integrity. Moreover, though their presence in commodity markets is as yet limited, increasingly complicated products such as short ETFs and leveraged ETFs may also pose substantial risks with respect to counterparty, liquidity, and collateral management when they become popular. To develop emerging economies’ financial markets Finally, I would like to highlight the urgent need to develop and expand financial markets in rapidly growing economies. As I mentioned earlier, commodity markets seem to be serving to some extent as a proxy for investments in rapidly growing emerging market economies. This tendency may be stronger when monetary conditions are globally accommodative and financial investors’ appetite for portfolio rebalancing and carry trades is growing. It would be helpful for financial stability to broaden and deepen local bond and equity markets in those economies, thereby allowing funds to be channeled more directly to investments, and hence reducing possible shocks to commodity markets. In addition, it is desirable that transparent and resilient commodity markets are developed in Asia, where strong demand for commodities is being generated. Developing such markets further would be beneficial for the area by enhancing the liquidity of commodities in the Asian BIS central bankers’ speeches time zone, as well as by developing tradable markets for those commodities such as rice, which are in great demand and produced in the region, but whose global market is yet to be developed. 6. Concluding remarks In my presentation today, I have highlighted recent developments in commodity markets and the implications of these developments. As I have pointed out, the growing participation of financial investors in commodity markets can bring important economic benefits by adding liquidity to the market and thereby improving market functioning. However, the diversity and complexity of financial instruments and players calls for closer monitoring of their impact on the overall development of commodity markets as well as for an assessment of the potential financial vulnerability arising from the increased exposure of financial investors. These developments should be thoroughly and regularly analyzed. In terms of the macro-prudential framework, the Bank of Japan will continue its efforts to enhance the stability, efficiency and integrity of the financial system as a whole. Thank you for your kind attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kyoto, 30 November 2011.
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Kiyohiko G Nishimura: Overseas economies under persistent stress, and the current situation and challenges for Japan’s economy Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kyoto, 30 November 2011. * * * Introduction I am privileged to be here today to exchange views with business leaders in Kyoto. Also I would like to express my sincere gratitude for your cooperation in interviews and surveys conducted by the Kyoto branch of the Bank of Japan. Information from these interviews and surveys is invaluable and utilized fully in assessing economic and financial developments and conducting monetary policy. Before we start to exchange views, let me talk about economic and financial developments both in Japan and abroad and about the Bank’s thinking on the conduct of monetary policy. I will then speak briefly about financial institutions’ efforts to strengthen the medium- to longterm growth potential of Japan’s economy. I. Overseas economies under persistent stress Let me start with overseas economic and financial developments that could affect Japan’s economy. Since this summer, an extremely nervous situation has continued in global financial markets due to developments in the sovereign debt problem in Europe – namely, investors have been busily shifting back and forth between optimism (“risk on” mode) and pessimism (“risk off” mode) within a short period of time. In Europe, government bond yields have risen considerably in countries experiencing serious fiscal concern, especially Greece, and this development has recently spread to major European countries such as Spain and Italy. As a result, European banks with significant exposure to such government bonds have faced difficulty in liquidity funding in markets due to a rising concern for creditworthiness, and they have been forced to restrain their lending to ensure their on-hand liquidity. As such, in Europe a feedback loop among fiscal balances, the financial system, and the real economy is now operating in an undesirable way: that is, a decline in confidence in public finances has caused a high degree of concern over stability in the financial system, and this has adversely affected economic activity, including sentiment. The increasingly critical sovereign debt problem in Europe is basically caused by the fact that having already enjoyed most of the benefits arising from European monetary unification, euro area countries are now being asked to pay the price. For some peripheral European countries such as Greece, the main benefit of unification was a dramatic decline in funding costs such as government bond yields. In exchange for the decline in funding costs, these countries were expected to enhance their growth potential and solvency through the conduct of reforms in the labor markets, as well as tax and administration systems. In other words, the euro area was supposed to become a sustainable system only after going through such a process. These peripheral countries, however, expanded government spending excessively relying on low funding costs, and as a result public debt increased considerably, going far beyond their capacity to repay. On the other hand, Germany has continued to steadily record current account surpluses by increasing exports to these peripheral European countries and to increase credit to such countries. Thus, the essence of the problem is imbalances between euro area countries that have developed since monetary unification. Therefore, it is necessary to fully understand that there is no immediate remedy to solve the sovereign debt problem and postponing the resolution of the problem will never bring back the pre-crisis BIS central bankers’ speeches situation. In short, some peripheral European countries need to seriously consider longlasting policy responses that would strengthen their medium-to long-term growth potential. How will the sovereign debt problem develop for the time being? Given the extremely high degree of uncertainty it is difficult to predict future developments. Many market participants seemingly hold the view that euro area countries will buy time and contain overreaction of the financial markets, which currently tend to be ruled by extreme pessimism, by gradually presenting a roadmap for fiscal transfer and fiscal integration and finding some way to compromise with one another to deal with individual domestic political problems. If the situation develops in accordance with this view, it is necessary to acknowledge that the high stress in global financial markets caused by the sovereign debt problem in Europe will persist for a long time. The risk of some kind of shock triggering the spread of credit contraction also warrants attention. Turning to the United States, an increasing number of recently released economic indicators have turned out to be better than market expectations and concern about a possible double dip or a negative spiral has receded compared with early spring and summer. However, improvement in the employment situation has remained slow and the pace of economic recovery has remained extremely moderate. In such a situation where the average growth rate has declined, various economic indicators have shown large fluctuations and differences among industries and firm size. Therefore, it has become difficult to capture the underlying trend. This difficulty has heightened uncertainty regarding the U.S. economy, and is one reason for the increasing short-term fluctuations of sentiment. In any case, the pace of growth in the U.S. economy is likely to remain modest reflecting the limited room for further fiscal and monetary stimulus and the lingering adjustment pressure on households’ and financial institutions’ excessive debts. It is important to bear in mind that, despite the deteriorating situation in Europe, the market’s view on the outlook for overseas economies has not yet become too pessimistic, reflecting the improved outlook for the U.S economy. Therefore, attention should be paid to the possibility that if the outlook for the U.S. economy becomes cautious again, disruptions in global financial markets could spread rapidly. As for emerging economies, the pace of growth has decelerated somewhat due to the effects of monetary tightening and the decline in exports reflecting the slowdown in advanced economies. In fact, in China, the driving force of the global economy, tax revenues, the amount of electric power, and imports – indicators that are considered to be fairly reliable – have continued to be weak from around the middle of this year compared with the previous trend of high growth. If European financial institutions reduce their assets more as the sovereign debt problem deteriorates further, lending to emerging countries could be restrained and trade financing affected. On the other hand, it is encouraging that the room left for monetary easing in emerging countries including China has increased, reflecting the recent pause in the rise in consumer prices, particularly food prices. As I have stated, there are both positive and negative factors for emerging economies. Attention should continue to be paid to whether the economies can make a soft-landing by realizing price stability and growth at the same time. Before I turn to the next topic, let me point out that recently two significant changes are proceeding, albeit gradually, in the global economy. The first change includes the aging of the population profile and a decrease in working population in advanced countries, and an increasing mismatch between job seekers and job offers. This increasing mismatch reflects not only the change in the skills required of workers due to the rising importance of information technology in economic activity. It also reflects the fact that inter-regional labor mobility has become less smooth than before as workers experience increasing difficulty in buying and selling their homes due to the sharp decline in housing prices after the collapse of the housing bubble. These changes in the labor markets could exert downward pressure on the growth potential of advanced countries, and therefore delay adjustments in the excessive debts of U.S. households and European governments. If BIS central bankers’ speeches the structural unemployment rate rises due to the increase in this mismatch, wages and prices become less likely to decline even if a high unemployment rate continues. In fact, I think that such trend has recently appeared in the United States and Europe. The second change is that emerging economies with currencies that are de facto pegged to the U.S. dollar have an increasing presence in the global economy, and such countries, the so-called “U.S. dollar-pegged bloc”, play a major role in the dynamics of the global economy. In such a situation, the effects of monetary easing in the United States have spread to the U.S. dollar-pegged bloc as a whole through fixed foreign exchange rates. As a result, prices of commodities such as crude oil tend to trend upward since commodities are traded in U.S. dollars and underlying demand from emerging economies tends to be strong. It is uncertain how long these two changes will persist. The mismatch in the labor markets is expected to ease as proper employment policy measures are implemented and post-bubble adjustments in excessive debts proceed. Some emerging countries are apparently making adjustments to their exchange rates, albeit slowly, in the awareness that importing easy monetary conditions from the United Sates by pegging to the U.S. dollar will further exacerbate inflationary pressure. If the situation does not change dramatically and promptly, however, it is highly likely that in advanced economies, where growth potential is declining and inflationary pressures are tending to rise, the pace of recovery will continue to be restrained even under expansionary policies to stimulate aggregate demand. II. Moderate pace of recovery in Japan’s economic activity and price developments Now I will talk about recent developments in Japan’s economic activity and prices. Japan’s economic activity plunged after the Great East Japan Earthquake in March, mainly on the production and export sides. As constraints on the supply side were resolved, economic activity recovered in the summer at a faster pace than originally anticipated. As the supply-side constraints are now almost fully resolved, demand-side developments are once more becoming increasingly important for Japan’s economic prospects. In these circumstances, Japan’s economic activity has continued picking up but at a more moderate pace, mainly due to the effects of a slowdown in overseas economies. As for domestic demand, business fixed investment has been increasing moderately as demand related to reconstruction after the earthquake disaster has been gradually materializing. In particular, orders for construction machinery have recently marked a large increase due to demand for restoration of disaster-stricken buildings. Private consumption has been firm. Although services consumption took somewhat longer to recover from the earthquake disaster, it is now picking up as evidenced by the fact that sales in the food service industry and outlays for travel have more or less returned to their pre-quake levels. Exports and production continue to increase partly due to the restoration of the level of overseas inventories, which declined after the earthquake. However, the pace of their increase has become moderate due to effects of the slowdown in overseas economies. The effects of the slowdown in overseas economies are particularly apparent in exports of ITrelated goods such as semiconductor manufacturing equipment. As for the outlook, for the time being, Japan’s economy will face an adverse effect from the slowdown in overseas economies and the appreciation of the yen, as well as from the flooding in Thailand. After that, the economy is expected to return to a moderate recovery path as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies that basically maintain their growth mechanism of domestic demand, and as reconstruction-related demand after the earthquake disaster gradually materializes. The year-on-year rate of change in the CPI (all items less fresh food) has recently been at around 0 percent. It will remain at around 0 percent for the time being but will gradually rise BIS central bankers’ speeches to around 0.5 percent toward fiscal 2013, along with an improvement in the aggregate supply and demand balance. The baseline scenario for Japan’s economy is that it will eventually return to a sustainable growth path with price stability in the longer run. There are, however, various risk factors to such a baseline scenario. Needless to say, the risk factor that should cause most concern is future developments in the sovereign debt problem in Europe and their effects on global financial markets and the global economy. As I have stated earlier, the debt problem has largely affected the global economy already, but it could result in weaker growth, not only in the European economy but also in the global economy, particularly through its effects on global financial markets. As global financial markets continue to be under stress, global investors have tended to be increasingly risk averse, and to purchase the yen, which is considered a relatively safe currency. While the U.S. dollar-pegged bloc expands, the yen is one of the major freefloating currencies with high liquidity. There is a risk that if investors are attracted by such characteristics of the yen this will lead to a sharp appreciation of the yen that diverges considerably from economic fundamentals. This may cause a sharp increase in the shift of production overseas by Japanese firms beyond a critical level. If not just a shift of a factory to abroad, but a shift of the entire manufacturing, or monozukuri, system – including suppliers – occurs, Japan’s manufacturing would find it hard to recover even if the yen depreciated in the future. The essence of monozukuri is not efficiently producing goods at the lowest cost. Rather, it is the repeatedly occurring innovation that generates value-added in various ways, in which all the parties concerned cooperate but compete with one another at the same time. Innovation can sometimes be the identification and avoidance of unnecessary procedures in production, or it can be an effort to adapt goods to customers’ changing needs. In order to continue to innovate in the monozukuri system, it is vital to maintain a system that can respond immediately and flexibly to changes in the situation. That said, we should continue to carefully monitor developments in foreign exchange and global financial markets from the standpoint of whether they will cause irreversible shifting of the monozukuri system to overseas locations. III. Bank’s conduct of monetary policy I would now like to talk about the Bank’s conduct of monetary policy, taking into account the financial and economic situation in Japan and abroad. The Bank has been pursuing powerful monetary easing under the new monetary policy framework introduced in October 2010 – “Comprehensive Monetary Easing”. This framework is composed of three measures. First, the Bank sets the policy rate at 0 to 0.1 percent, which can be deemed a virtually zero interest rate. Second, the Bank is publicly committed to continuing this virtually zero interest rate policy until it judges that price stability is in sight. And third, as an exceptional measure for a central bank, it purchases from the markets not only long- and short-term government bonds but also risk assets such as CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). The aim of the Bank’s purchases is to encourage a decline in longer-term interest rates and risk premiums. A program for purchasing financial assets, called the Asset Purchase Program started at 35 trillion yen, but has been repeatedly expanded in size on a significant scale. Recently, on October 27, the Bank decided to increase the size by a further 5 trillion yen, to about 55 trillion yen, and to designate this increase for the purchase of Japanese government bonds (JGBs). This decision was based on the recognition that considering the slowdown in overseas economies and the appreciation of the yen, some more time will be needed to confirm that price stability is in sight and due attention should be paid to the risk that the economic and price outlook will further deteriorate depending on developments in global BIS central bankers’ speeches financial markets and overseas economies. The outstanding amount of the Asset Purchase Program is slightly over 40 trillion yen, and the Bank will further accumulate another 15 trillion yen to reach the targeted amount of 55 trillion yen. Over a year has passed since the Bank started to conduct comprehensive monetary easing in October 2010. Meanwhile, Japan’s economy and financial conditions have continued to face strong headwinds, including the earthquake disaster and heightening uncertainty regarding the global economy triggered by the sovereign debt problem in Europe. In such a severe situation, the comprehensive monetary easing has encouraged a decline in firms’ funding costs and eased investors’ risk aversion. And therefore, I believe that the easing has been effective in realizing an accommodative financial environment. Now I will explain about the positive effects by referring to some indicators. First, interbank rates have been declining moderately in Japan, although they have been rising considerably in the United States and the euro area since this summer when tension regarding the sovereign debt problem in Europe heightened. Yields on treasury discount bills, including those with a one-year maturity, have remained at 0.1 percent, and those on longer-term government bonds, up to those with a two-year maturity, have been at an extremely low level of around 0.1 percent. Against the background of such developments in market rates, firms’ funding costs have shown a steady, though moderate, decline. The average contracted interest rates on new loans and discounts are on a declining trend. Various surveys show that firms consider financial institutions’ lending attitudes as being on an improving trend and that the financial positions of firms are on an improving trend. As for risk assets, credit spreads on CP and corporate bonds widened somewhat soon after the earthquake. However, they declined rather quickly encouraged by the Bank’s outright purchases. Issuing conditions for corporate bonds have remained favorable: credit spreads on corporate bonds have remained stable at low levels and the variety of corporate bond issuers has increased. New issuance of corporate bonds has recently been steady except for industries related to electric power, which have faced difficulties with new issuance due to uncertainty concerning their business environment. Japan’s situation is quite different from that in the United States and Europe where credit spreads have widened remarkably and new issuance has decreased sharply since summer. Although comprehensive monetary easing was introduced last fall, stock prices and J-REITs have not risen, partly due to a deterioration in the external environment. However, some market participants have observed that the Bank’s purchases of ETFs and J-REITs helped markets to support some confidence right after the earthquake and also during the period of high uncertainty since this summer. As I have stated, comprehensive monetary easing has been effective in that it has encouraged a decline in longer-term interest rates and helped market participants from becoming too pessimistic. I believe that this is one reason why Japan’s financial conditions have been stable compared to those in the United States and Europe. IV. Financial institutions’ efforts to strengthen the medium- to long-term growth potential of Japan’s economy Let me use the remaining time to talk about efforts made by financial institutions to strengthen the medium- to long-term growth potential of Japan’s economy. I will share with you some examples of regional financial institutions supporting firms’ movement toward renewed growth with the cooperation of research institutions. I brought up this topic because I think that firms’ positive efforts in high-growth business areas are necessary in order to strengthen the medium- to long-term growth potential of Japan’s economy. The decline in the medium- to long-term growth potential of Japan’s economy is also part of the background to a protracted period of stagnant demand and ensuing prolonged deflation, notwithstanding an extremely accommodative financial BIS central bankers’ speeches environment. Based on this recognition, since last summer, the Bank has been supporting the private sector’s efforts to strengthen the medium- to long-term growth potential of Japan’s economy through the provision of long-term funds at a low interest rate to financial institutions under the new framework of the Growth Foundation Strengthening Facility (FundProvisioning Measure to Support Strengthening the Foundations for Economic Growth). Financial institutions are now requested not only to meet demand for funds from existing mature firms, but also to actively identify efforts made by newer, growth-oriented firms, making use of the Bank’s framework. Let me share with you one example in which a new business in the lumber industry was established using a lending method called asset-based lending (ABL). It has been pointed out for a long time that one of the structural problems of the lumber industry was a shortage of funds. There seem to be many firms that have abundant inventories of lumber but have a limitation in the amount of lumber that they can process and the amount that they can ship due to cash flow constraints. To deal with this problem, a project team, consisting of a regional financial institution, a furniture manufacturing firm, and a university’s laboratory, came up with an idea to use ABL for establishing a new business. Under ABL, a financial institution will take receivables and movable properties that are closely tied to the firm’s business cash flow, such as accounts receivable and goods in stock, as collateral for a loan. This lending method, which finds value in corporate activities on their own terms, enables firms that do not own enough real or personal assets to raise the financial resources necessary to run their business. In order to raise funds through ABL, there is a hurdle to clear. Specifically, the financial institution that adopts this measure, in addition to making collateral assessment of say, accounts receivable and goods in stock upon extension of credit, needs to keep track of subsequent changes in their value in order to manage credit risk. The firm is required to provide this information regularly to the financial institution. In this way, both the financial institution and the firm incur costs in monitoring and providing information, and this is considered to be the crux of ABL. But in this example, the project team treated the cherry wood used for furniture manufacturing as movable property and reduced such costs by attaching an IC tag to the wood to ensure traceability. This attempt has just started but it deserves attention in that a structural problem of an industry was solved by financial efforts. So far ABL has tended to be perceived with a negative image as a lending facility for small firms with little real estate collateral and insufficient financial resources. As I have stated, however, ABL is a lending facility that can be used for starting up a new business and project financing. If such understanding is more widely shared, ABL has large potential to become a more popular facility without any negative image. The outstanding balance in the Japanese ABL market is still very limited compared to the total size of accounts receivable and goods in stocks of small firms in Japan and also small relative to the outstanding balance in other advanced countries such as the United States. Going forward, I expect this method to be utilized widely through active cooperation between financial institutions and firms. Next I would like to introduce an attempt made mainly by regional financial institutions to send monozukuri or manufacturing instructors to small firms. “Competitiveness at worksites”, or genbaryoku, of monozukuri proved effective in the process of rebuilding from the earthquake disaster. In order to boost the growth potential of Japan’s economy by utilizing this strength, it is necessary to spread to other worksites the know-how of people who worked in the front-runner firms that lead the industry. Also, it is important to pass on the advantages of genbaryoku to the next generation. With that in mind, some local governments and universities have been training as monozukuri instructors people in their 50’s and 60’s who have retired from manufacturing firms and sending those instructors to small firms to spread and pass on special techniques to others. In such a process, regional financial institutions play a major role. From the standpoint of small firms, some of them feel reluctant to accept instructors who have built up a long-term career in another firm. However, in cases BIS central bankers’ speeches where regional financial institutions match the right instructor and the right workplace using the trust between institutions and firms that they have been fostering every day, small firms tend to accept instructors much more easily. An example such as this has also been seen in Shiga, Kyoto’s neighboring prefecture. Due to limited time, I have only touched upon two examples today. But I want to emphasize that, in either of the examples, not only industry, government, and academia but also financial institutions are collaborating and making efforts in their respective roles to boost the productivity and competitiveness of the region. I hope that such steady efforts, together with the accommodative financial environment, will support the enhancement of regions and industries, and consequently spread to Japan’s economy as a whole. Concluding remarks Kyoto is a special place for me. I was born in Tokyo, but during my childhood I often visited my uncle’s house in Kamigamo, Kyoto. He was chief librarian of the Kyoto Prefectural Library at that time. The history and the culture that I saw and experienced at my visits have formed the basis of the way I look at things. Also, when I was in graduate school, I was able to study on the east coast of the United States thanks to a scholarship that had been newly established by a benevolent entrepreneur in Kyoto. It is not too much to say that I am now here today because I have been supported by the culture in Kyoto and the industries that developed in Kyoto. Culture, or the vernacular wisdom, and industry, or making one’s living assiduously, are actually the two most important factors in solving the problems Japan’s economy faces. To solve the pressing problem of enhancing Japan’s growth potential, which I have been talking about in this speech, it is important that research institutions, private firms, and governments, together with financial institutions, use the wisdom that they have developed from their daily work and make steady progress. In Kyoto, active collaboration between industry, academia, and government is fostered and firms, universities, and the government are closely tied together since firms with advanced techniques and leading universities are based in Kyoto. Financial institutions have also made various efforts to support firms’ activities. Kyoto Chamber of Commerce and Industry is proposing to create a “Wisdom Industry” so as to expand domestic demand by using Kyoto’s unique characteristics and strength. Kyoto Prefecture has been promoting the plan to make Kyoto a capital of the Wisdom Industry. The City of Kyoto has established the Center for Integrated Sensible Industry. Kyoto as a whole is promoting “City of Wisdom Industry – Kyoto”. Kyoto’s economic environment is not particularly favorable due to the appreciating yen and aging population profile. However, Kyoto is an attractive city with one of the highest potential abilities in the world as shown by the cutting-edge mentality that produced many venture firms in Kyoto, fine traditions and tourism resources, as well as advanced research institutions. I hope that the latent strengths of the Kyoto economy will become further activated as a center of the Wisdom Industry through the efforts of the people of Kyoto. Thank you for your kind attention. BIS central bankers’ speeches
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Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at the 2011 Asia Economic Policy Conference, San Francisco, 30 November 2011.
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Ryuzo Miyao: A macroprudential perspective in the conduct of monetary policy Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at the 2011 Asia Economic Policy Conference, San Francisco, 30 November 2011. * * * Introduction First of all, I would like to thank the organizer of this conference for inviting the Bank of Japan and allowing me to exchange views among such distinguished panelists and scholars. Today I would like to highlight one of the key issues regarding the conduct of monetary policy, namely a macroprudential perspective in monetary policy making. More specifically, I will discuss how to take into account the risk of accumulation of financial imbalances in the conduct of monetary policy, which could help prevent financial bubbles and subsequent crises. I would also like to introduce our experience and summarize what the Bank of Japan has done so far in this regard. You may find it somewhat premature to talk about how to prevent future crises given that the world is still struggling in the aftermath of the global financial crisis. However, in order for Asia to keep playing a leading role in the global economy, the issue must be of great importance, although I should immediately add that we have not observed excessive financial imbalances in the region. Looking back at the period after the Asian crisis, we have witnessed a series of incidents that can be deemed crises. It appears that the frequency of such incidents is rising and that efforts to deal with one crisis might have provided the seeds for a subsequent crisis. In the coming years, Asia will not be allowed the luxury of simply being pleased with the situation. I. The essence of the global financial crisis As background, let me briefly review the essence of the global financial crisis. Although a variety of economic and financial factors are involved, the essence of the global financial crisis is the formation and bursting of the credit bubble. In forming the bubble, the household sector in the United States expanded borrowing and consumption along with the boom in housing prices. On the financial front, new types of transactions such as securitized products and derivatives prevailed, and leverage also increased significantly. Such excess in real economic activity, asset prices, and financial markets had a shared influence among each of these components, and this led to further excess that spread beyond national borders, resulting in the global credit bubble. Balance-sheet adjustment has continued to constrain recovery in many countries, which is typical after the bursting of a large-scale credit bubble. Unlike the case of the IT bubble in the early 2000s, the global financial crisis has had such a prolonged and serious aftereffect because financial imbalances have been accumulated widely on a significant scale in the form of the credit bubble. This accumulation of financial imbalances took place during a long period of global monetary easing amid the combination of high growth and stable inflation – the so-called “Great Moderation”. Such an environment led to the prevalence of optimism about the future. There was also growing overconfidence in the sophistication of financial technologies. In those circumstances, imbalances accumulated in the form of expanding credit and leverage as well as the rise in asset prices on a worldwide basis. At this moment, the most pressing and immediate concern for the global economy is the sovereign debt problem in Europe. The problem could be described as a part of the BIS central bankers’ speeches prolonged balance-sheet adjustment process after the financial crisis. The introduction of a single currency may also have contributed to accommodative financial conditions and macroeconomic stability in the mid-2000s, resulting in the lack of fiscal and financial discipline during the period. II. Two views on how to deal with asset price bubbles On the monetary policy front, central bankers and economists have attempted to address the issue of what is a desirable response to the accumulation of financial imbalances, especially how a central bank should respond to asset price bubbles. Discussions on this issue may be categorized into two broad views. The first view emphasizes ex-post measures, arguing that “a central bank should not apply monetary policy to asset price fluctuations but should carry out aggressive monetary easing after the bursting of a bubble”. The second view stresses ex-ante responses, arguing that “considering the magnitude of the adverse impact following the bursting of a bubble, a central bank should conduct monetary policy to prevent it”. Monetary policy responses to asset price developments involve a variety of issues, and it may not be possible to simply conclude which is right or wrong. Having said that, the global financial crisis has shown that, when asset price inflation is associated with a credit bubble, the impact of its bursting is significant, and ex-post measures have certain limitations in terms of their effects, no matter how promptly and aggressively they are implemented. As a result, although there remains the challenge of implementation, as I will describe shortly, there is seemingly a growing consensus that monetary policy should be conducted by sufficiently taking into account asset price inflation associated with a credit bubble, and including ex-ante responses. III. Importance of a macroprudential perspective In other words, we could say that a macroprudential perspective in the conduct of monetary policy has become more widely recognized as of essential importance. When one says “macroprudential”, it is usually used in the context of how to ensure financial stability. In a macroprudential approach, risks are analyzed and evaluated from the viewpoint of the entire financial system, and institutional designs and policy responses are formed on these assessments. Such a macroprudential approach is also very useful in examining the risk of accumulation of financial imbalances when conducting monetary policy. In the preceding discussion, I mainly touched upon asset price bubbles, which are one aspect of financial imbalances that could threaten the stability of the entire financial system and adversely affect economic activity. Such imbalances can also take the form of excessive mismatching in terms of interest rates and foreign exchange rates at financial intermediaries. As we have witnessed in the current crisis, imbalances could also develop in an unprecedented manner as a result of new financial techniques and products. Although they may take different forms, one common feature is that imbalances accumulate through the interconnectedness of financial institutions, financial markets, and other components of the financial system, all of which are accompanied by an excessive expansion of credit and/or leverage. This feature is a key when examining the risk of financial imbalances in the conduct of monetary policy. IV. Challenges involved in implementation We now understand the importance of examining the risk of accumulating financial imbalances and evaluating where and how much risks lie in the conduct of monetary policy, at least conceptually. For actual implementation, however, difficult challenges remain. One BIS central bankers’ speeches such challenge is how to detect the accumulation of financial imbalances. To this end, efforts have been made globally, including by the Bank of Japan, to develop analytical tools. Another challenge is how to respond to the accumulation of financial imbalances when they are detected successfully. In the first place, monetary policy by itself is not meant to achieve financial system stability, and moreover it is not possible to fully ensure financial system stability through monetary policy alone. Taking the example of asset price bubbles again, suppose a central bank tries to accomplish a soft landing of asset price inflation through monetary tightening. Then the more market participants believe that such an attempt will be successful, the higher asset prices may increase further. If a central bank conducts monetary tightening aggressively enough to prick bubbles, this could end up with overkill and hurt the real economy. As such, in order to restrain systemic risks from a macroprudential perspective, it is not appropriate to simply assign monetary policy directly for that purpose. Greater importance should be placed on macroprudential tools such as a restriction on the loan-to-value (LTV) ratio for real estate loans and the countercyclical capital buffer in the Basel III capital adequacy requirements. It is also true that an accumulation of financial imbalances develops in a prolonged period of accommodative financial conditions, and therefore such a risk should be duly considered in the conduct of monetary policy. V. The case of BOJ Now I would like to explain the experience by the Bank of Japan and summarize efforts we have been making so far. Because we experienced the formation and bursting of a significant credit and asset price bubble in the late 1980s and early 1990s, the Bank of Japan placed importance on the risk of accumulating financial imbalances in the conduct of monetary policy. In 2006, when we exited from the quantitative easing policy, the Bank introduced a monetary policy framework in which economic and price developments are assessed from two perspectives. The first involves assessing the baseline scenario for economic activity and prices, examining whether the economy is on a sustainable growth path with price stability. The second perspective assesses the risks considered most relevant to the conduct of monetary policy, including risks that have a longer time horizon than the first perspective. In line with this second perspective, the Bank examines the accumulation of financial imbalances as one of the risk factors with a longer-term horizon. The Bank’s emphasis on the risk of financial imbalances can also be found in the policy commitment made in October last year in the context of the comprehensive monetary easing framework. The Bank has made it clear that it will continue the virtually zero interest policy until it judges that price stability is in sight on the basis of the “understanding of medium- to long-term price stability” – that is, the level of inflation that each Policy Board member understands as price stability. The current understanding is “a positive range of 2 percent or lower, centering around 1 percent”, on the basis of the year-on-year CPI inflation rate. The unique feature in the policy commitment last October is that an explicit macroprudential condition is attached to the commitment, that is to say, the bank will continue the virtually zero interest rate policy “on condition that no problem is identified in examining risk factors, including the accumulation of financial imbalances”. In practice, however, detecting the accumulation of financial imbalances is not an easy task. In searching for early warning indicators for financial crises, vigorous research has been done globally at various institutions such as the IMF and BIS as well as central banks, including us. The results of those efforts have shown that, for the purpose of detecting financial crises, it is useful to assess the degree of financial excesses by monitoring indicators such as asset prices, credit aggregate, total investment, and residential BIS central bankers’ speeches investment, most typically their deviation from a trend. The Bank has established a framework to regularly check such indicators in the conduct of monetary policy. While developing analytical tools devoted to the conduct of monetary policy, the Bank has also been making efforts to better analyze and assess risks across the entire financial system. Specifically, it has produced diversified stress scenarios as part of macro stress testing and developed the new Financial Macroeconometric Model to analyze the feedback process in which stress exerted on economic conditions and asset prices spreads to the real economy through the behavioral changes of financial institutions. The Bank has also been developing indicators useful in analyzing excessive credit expansion and the financial sector’s risk-taking, as well as in detecting signs of instability in the financial system. These new tools and assessments were incorporated in our Financial System Report published in October, which is available at our web site. The Bank also attempts to further promote concerted efforts between these assessments of financial system stability and monetary policy making. The recent economic outlook released in October and subsequent policy judgments reflect these new developments from macroprudential perspectives. Closing remarks Let me conclude. I have described the importance of a macroprudential perspective in the conduct of monetary policy and the Bank of Japan has been making certain efforts in this regard. However, I should admit that these are only partially completed and we should keep up our endeavor. In the aftermath of the global crisis, each country has implemented various policy reforms based on similar grounds. I would like to finish by expressing my sincere hope that a policy framework to prevent future crises will be further established worldwide in the coming period, through sharing experiences at various gatherings such as this conference. Thank you very much. BIS central bankers’ speeches
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the JCIF (Japan Center for International Finance) International Finance Seminar, Tokyo, 22 November 2011.
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Hirohide Yamaguchi: Recent financial and economic developments and challenge of revitalizing Japan’s economy Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the JCIF (Japan Center for International Finance) International Finance Seminar, Tokyo, 22 November 2011. * * * Introduction Thank you for having me at the JCIF International Finance Seminar. Today, I will talk about the financial and economic developments at home and abroad, followed by my thoughts, from a medium- to long-term perspective, against the background of a declining trend in the growth potential of Japan’s economy and challenges toward the future. I. Developments in the global economy Current situation and future of the global economy Let me start with the developments in the global economy. Looking back, the global economy continued to mark a high growth rate in the recovery process from the Lehman shock, led by emerging and commodity-exporting economies. The pace of growth has been slowing, mainly in advanced economies, since this spring. In the United States, which was the epicenter of the Lehman shock, balance sheet adjustment, mainly in households, has been weighing on the economy, and the pace of recovery remains quite moderate. In Europe, the economies were recovering moderately after the Lehman shock, but their growth rates have recently been clearly decelerating as the sovereign debt problem, which started from peripheral countries including Greece, have aggravated. The pace of growth in emerging and commodity-exporting economies, which have been achieving high growth, is somewhat slowing. That is because real purchasing power has declined due to a rise in energy and food prices, and monetary tightening, which was implemented to contain the overheating of the economies, have shown effects. In addition, there are the effects of the slowdown in advanced economies. While the slowdown in the pace of growth itself in emerging and commodity-exporting economies, which have been somewhat overheating, is desirable in achieving sustainable growth with price stability, inflationary pressure in those economies is yet to be contained. For the time being, the pace of growth in the global economy will remain decelerated, mainly in the advanced economies, amid lingering strains in international financial and capital markets. Thereafter, the growth rate of the global economy will rise again led by emerging and commodity-exporting economies, which have high growth potential. Such outlook is associated with great uncertainties. In particular, the consequences of the sovereign debt problem in Europe remain unforeseen. So I will now talk about the sovereign debt problem in Europe. European sovereign debt problem and accumulation of financial and economic imbalance The origin of the sovereign debt problem was Greece’s massive fiscal deficits that surfaced toward the end of 2009. In the spring of 2010, Greece faced difficulty in raising funds in the market and was driven into a corner which was said to be a Greek crisis. As a result, Greece received financial support by euro area countries and the International Monetary Fund. The Greek government subsequently announced various fiscal structural reforms including a BIS central bankers’ speeches reduction in public servants’ salaries and revisions in the tax system. However, amid negative economic growth, a fiscal deficit reduction was not achieved in a pace initially envisaged, and Greece faced a second round of crisis toward this summer. In the meantime, a decline in market confidence in fiscal sustainability, which started from Greece, has spilled over to peripheral countries including Ireland and Portugal, which was in a tough fiscal situation, as well as bigger economies such as Spain and Italy. The yields of government bonds in those countries have risen substantially and market prices have declined significantly. European financial institutions, mainly those which held a large amount of such government bonds, have faced deterioration in their balance sheets and difficulty in raising funds in the markets. They have started to strive to reduce the size of balance sheets through measures including tightening their lending stance. As a result, firms’ and households’ sentiment has deteriorated and economic activity has been slowing. At present, in Europe, a rapid adverse feedback loop seen during the Lehman shock has not been generated, but the adverse feedback loop of the fiscal situation, the financial system, and economic activity seems to have started to act. On the back of the sovereign debt problem in Europe, there are factors that are essentially common to the Lehman shock. Namely, against a backdrop of accommodative financial conditions in the mid-2000s, a rise in asset prices, and optimistic growth expectations, financial and economic imbalances have been accumulated. In the United States, on the back of “technological innovation in finance” as seen in an expansion of securitized products, financial institutions’ and investors’ risk awareness concerning financial products including subprime loans became lenient. That, together with accommodative financial conditions and a rise in housing prices, has led to a significant increase in home loans and an accumulation of imbalances, mainly in the household sector, and consequently induced the Lehman shock. In European peripheral and other countries, due to the ease of fiscal funding on the back of confidence in “a single currency euro” and excessive expectations for economic growth potential and an increase in tax revenue, fiscal discipline has tend to become loose. Of course, a major player in the expansion of imbalances in such a case is the government sector, but also in the private sector, there have been inefficient investment and excessive employment supported by accommodative financial conditions, and productivity and external competitiveness have declined. Intrinsically, the government sector and the private sector, just because the countries are the members of the Euro, cannot continue to raise funds at low interest rates, which are beyond those sectors’ real strength, and continue to increase spending. Once the funding environment for the governments and the private sector becomes severe, due to a decline in confidence in fiscal conditions and a surge in government bond yields, economic activity will decline and a reverse whirl will start. Toward problem resolution A quick fix for the problem unfortunately does not exist. The accumulation of imbalances is like a chronic disease induced by the neglect of health for many years. For a cure, it takes time to improve physical health. Namely, the road to normalization is, by restoring fiscal discipline and raising economic growth potential, to repay debt and not to accumulate debt again in the future. While it is important to take responses including funding support and debt restructuring, those are, so to speak, policy measures to “buy time” and, in order to gain market confidence, it becomes necessary to show the market that countries have the capability to repay debt in the future. BIS central bankers’ speeches If the road toward the resolution of the sovereign debt problem in Europe is understood as just described, economic activity and financial systems in Europe are likely to be unstable for the time being. In addition, while I do not go into detail today, it should be noted that the United States is faced with a similar problem in that it suffers from the legacy of the accumulation of financial and economic imbalances. II. Developments in Japan’s economy Japan’s economy after the great earthquake disaster I will next talk about Japan’s economy. In the wake of the Great East Japan Earthquake on March 11, economic activity plunged. Because of the damage to production facilities and a severe power shortage, the nationwide and worldwide supply chains were cut off, and production and exports declined substantially. Households’ and firms’ sentiment slumped and spending declined. Looking at the developments thereafter, supply-side constraints were removed at a pace faster than expected and, around the summer, economic activity almost recovered to the pre-quake level. Together with the restoration of damaged facilities, firms made various efforts and attempts, including producing in alternative facilities at home and abroad as well as ensuring parts procurement from alternative sources. As for a power shortage in the summer, severe constraints on economic activity were avoided due to the efforts to save electricity and to level electricity usage. In those ways, “strength in the field”, or genbaryoku, of Japan’s economy has been fully exerted in the experience of the recent earthquake disaster Outlook and risk factors for Japan’s economy Japan’s economy is in a situation in which supply-side constraints were almost removed and economic activity will be determined by demand-side developments. For the time being, the economy will be affected by a slowdown in overseas economies and the appreciation of the yen as well as flood damage in Thailand. After that, Japan’s economy is expected to return to the moderate recovery path because the pace of recovery in overseas economies will subsequently increase led by emerging and commodity-exporting economies and because demand related to reconstruction after the earthquake will gradually grow. According to the projection in the Outlook for Economic Activity and Prices (Outlook Report) that the Bank released recently, the real GDP growth rate is projected to remain relatively low in fiscal 2011 due in part to the effects of the disaster. The growth rate is projected to rise in fiscal 2012, partly because of an increase in reconstruction-related demand, and continue to register somewhat high growth in fiscal 2013. Turning to prices, the year-on-year rate of change in the CPI will remain at around 0 percent for the time being, and is projected to be around 0.5 percent toward fiscal 2013 on the back of an improvement in the supply-demand balance. Such an outlook is accompanied by high uncertainties. First, the source of the utmost uncertainty is the consequences of the aforementioned sovereign debt problem in Europe. Fortunately, as Japanese firms have been performing vigorous management since the burst of a bubble, they have sufficient management vitality at present. Japanese financial institutions have also been restoring soundness in their assets and striving to reinforce their capital. The robustness of the financial system has been maintained. Therefore, despite continued strains in European financial and capital markets, financial conditions in Japan remain accommodative, supporting economic activity from the financial side. As the US economy is not in its best condition, suffering the aftereffects of the Lehman shock, due vigilance is necessary against a possibility that a shock initiated in Europe will BIS central bankers’ speeches lead to intensify global investors’ risk aversion or to a lower-than expected growth in the global economy as a whole. In those cases, downward pressure could also be exerted on Japan’s economy through the financial channel of the appreciation of the yen and a plunge in stock prices, the real economic channel including a decline in exports, and the channel of sentiment of economic entities, including firms. Second, uncertainty about demand related to reconstruction after the earthquake disaster. In the disaster-stricken areas, various activities toward reconstruction that include the reconstruction of disaster-affected facilities have already been underway. Demand for reconstruction in the worst-hit areas, including the Tohoku coast areas, is likely to gradually gain momentum as reconstruction plans that include the overall picture of urban development become specific. However, full-scale reconstruction demand, including private investment, should be seen with a certain margin of error in terms of size and pace of implementation. Third, uncertainty about firms’ and households’ growth expectations. After the earthquake disaster, Japan’s economy is faced with new difficulties, including the problems of electricity supply, in addition to the problem of the downtrend in economic growth rate due to the demographic vortex. Depending on responses to those problems, firms’ and households’ growth expectations could change and induce unexpected effects on future developments in economic activity. In what follows, I will talk somewhat in detail about those problems, which relate to the topic of today’s seminar “Strategy for Revitalization of Japan’s Economy”. III. Japan’s medium- to long-term challenges and toward their resolution Downtrend in growth rates After the burst of a bubble, Japan’s economy has often been referred to as a “lost decade” or “lost twenty years”. Recently, in the United States and Europe, in which prolonged economic stagnation has started to be worried about, the phrase “Japanization” has also been used. Looking at Japan’s real GDP growth rate, the average growth rate was relatively high at above 4 percent in the 1980s, but fell substantially to around 1.5 percent in the 1990s and further to less than 1 percent in the 2000s. Given such downtrend in the economic growth rate, it is likely that the growth potential of Japan’s economy has recently been structurally weakening. The reasons for the weakening growth potential are complicated. Broadly speaking, it seems that the system and the business practice which were formed in the past higher growth period as well as firms’ behavioral principle could not sufficiently adapt to two large changes going on since the 1990s. The two changes in the business environment were the intensification of global competition and the domestic demographic vortex. The first change, global competition, accelerated in the 1990s. Globalization enabled various and quick combinations of advanced economies’ capital and technology and emerging economies’ labor force, and opened the door to emerging economies to high growth. Potential business opportunities expanded beyond borders, and, in that regard, globalization was a change that brought new growth opportunities for Japanese firms and, eventually, Japan’s economy. At the same time, globalization ushered in a “mega competition” era. Japanese firms were strongly required to gain strength to promote differentiation from many overseas rivals and become among the first to tap potential demand. While it is a fact that Japanese firms have been going in that direction, the speed has not necessarily fast enough, compared with the speed of changes in the business environment. The second change, the demographic vortex has also progressed markedly since the 1990s. The population of workers, namely, the working-age population, defined as the population between 15 and 65 years old, started to decline since the mid-1990s and the pace of decline has been accelerating. BIS central bankers’ speeches Such change in the demographic composition could induce a shortage of labor and becomes a factor in reducing growth potential from the supply side. At the same time, on the demand side, the change will prompt structural changes of the demand content because necessary goods and services will differ, according to each stage of life. Mass consumption markets, including housing and consumer durables, will shrink, while demand for various goods and services that raise the quality of life, such as medical and nursing care services, will increase, at least potentially. If changes on the supply side cannot catch up with the substantial changes in the demand structure, potential needs will not lead to actual spending and remain untapped, while excess supply will continue in markets for existing goods and services and economic activity will be under downward pressure. In Japan’s economy since the 1990s, it is likely that a supply and demand mismatch has chronically remained and continued to act as one of the reasons for inducing low economic growth. Background of delayed responses to changes in the business environment Why Japan’s economy failed to adapt to changes including globalization and the demographic vortex? I would like to point out the following three. First, external exclusiveness. Second, rigidity in resource allocation. Third, a lack of the financial function that supports firms’ challenges to new businesses. Let me elaborate on those. First, external exclusiveness. Japan’s economy has basically been maintaining high export competitiveness even since the 1990s. The share of exports in the nominal GDP or the sheer size of trade, which is the sum of exports and imports, is by no means large. In addition, while Japanese firms have been actively expanding overseas, if the ratio of foreign direct investment to the nominal GDP is compared with that in other major countries, Japan is at quite a low level. What is more pronounced is a small number of foreign firms’ advancement to Japan, namely, a low level of inward direct investment. Also in terms of people, the acceptance of foreign workers is overwhelmingly small and the number of foreign tourists who visit Japan is at a low level. As described, if one looks at the extent of internationalization in terms of people, goods, and capital, Japan is not necessarily a country opened externally. Since the 1990s, even though business opportunities across borders have substantially expanded, Japan’s economy has lacked openness to utilize such chances. Second, rigidity in resource allocation. In Japan’s economic system that was established before the 1980s, long-term stability was valued in the relationship between management and labor, firms and firms, and firms and financial institutions. Such system, which used to be beneficial, has become a factor in hampering economic growth recently, when globalization and the demographic vortex have progressed and speedy metabolism and business model conversion have been called for. In that regard, an old-style safety net also has an aspect of constraining the effectiveness of resource allocation in the economy as a whole. Third, a lack of the financial function that supports firms’ challenges to new businesses. Enhancing competitiveness by improving production efficiency and cost reduction has been techniques of Japanese firms since the high growth era, and I believe it is still the case even now. Since the 1990s, as emerging economies with low production costs have come to the forefront, it is not possible any more for Japanese firms to earn sufficient profits just by improving production efficiency. Firms’ strategies to open people’s eyes to new values and create new markets should be strengthened. The problem is that such efforts do not always work. If so, the supply of risk money that supports such efforts will become critical. In that regard, restructuring of the financial function that will replace the traditional main-bank system and mortgage-backed loans is only half done. BIS central bankers’ speeches Direction for strengthening growth potential Looking at the medium- to long-term future of Japan’s economy, the pace of decline in the working-age population is projected to further accelerate. The economic growth rate can be divided into the growth rate of workers and the rate of productivity growth per worker. The acceleration of a decline in the working-age population in the future implies that there will be greater declining pressure on the number of workers. To avoid a downtrend in the growth rate in such situation, it is necessary to stave off a decline in the number of workers. Given that an increase in population and immigration is difficult in the short run, realistically, it is necessary to make efforts to encourage the employment of potential labor force. In particular, it is critical to solve the so-called “M-shaped curve” problem that women’s labor participation rate declines after marriage and childbirth, and raise woman’s labor participation rate. It is also necessary to increase opportunities for healthy elderly people to work. Those measures alone have their limitations. Without an increase in productivity, a decline in the growth rate cannot be staved off. To raise women’s and elderly people’s labor participation rates, some measures, including the expansion of part-time workers and men’s childcare leave, which will rather result in reducing productivity per worker, will become necessary. To overcome such adversities and clearly increase the rate of productivity growth is no easy matter. To begin with, now that Japan is trying to fight against a headwind of a continued decline in population over several decades and aging, we need to have resolution to convert our sense of value and reconstructing an economic society. Those are daunting tasks, but, as I have explained, the directions of the tasks have become clear to some extent. Let me summarize again. First, in order to benefit from the positive effects of globalization, open our country as much as possible. We need to increase not only trade but also the inbound and outbound traffic of capital and people. In addition to tourism and medical care, it is important to enhance the openness in various areas including education, culture, arts, and research and development. Attracting people from overseas could stimulate economic activity in terms of demand and innovation. Second, enhance the latitude and flexibility of the economy as a whole through regulatory reform and improvement in flexibility in the labor market. In the aging society, there are areas, including medical and nursing care services, in which potential demand will indeed increase. Of course, public support will be essential for medical and nursing care services, through which the public should fairly enjoy the benefits. There is room for encouraging market-based growth through deregulation and other measures. In addition, the employment system need to be reconstructed into a further flexible system so that transferring of job, learning of new skills, and various ways of working could be chosen more freely. Third, the supply of risk money that nurtures entrepreneurship. For firms to venture into new markets and generate profits and employment, the role of finance that shoulders such risk will be inevitable. In that regard, financial institutions are required to refine their own knowledge, find firms’ business opportunities, and create demand for funds by themselves. In addition, without relying on mortgage collateral or borrowers’ guarantee capability, it is also effective to diversify the form of lending, including the utilization of asset based lending, through being heavily involved in the process of firms’ cash flow generation. Furthermore, the activation of equity capital through funds is a critical element in supporting venture firms and speedy business strategy. BIS central bankers’ speeches IV. Needs for fiscal restructuring While I have so far talked about the direction for strengthening growth potential of Japan’s economy, an important challenge that also relates to that is fiscal consolidation. Japan’s government debt outstanding is at an extremely high level, compared with other advanced countries. So far it has not yet led to a situation in which financial and capital markets are severely affected. As one can see from the sovereign debt problem in Europe, the market’s view on a country’s fiscal condition will change suddenly. It is not too much to say that there is always a risk that government bonds, which used to be regarded as “safe assets”, might change discontinuously to “risky assets”. Therefore, it is particularly a period like this when the markets are stable, when Japan needs to take steady steps toward fiscal consolidation. To raise the growth potential of Japan’s economy through the aforementioned efforts will lead to a decline in fiscal deficit through an increase in tax revenue. In addition, if Japan’s tax system and social security system change to sustainable ones, corresponding to the demographic vortex, it is likely to support the self-sustaining recovery power of the economy through reducing households’ future uncertainty, and lead to a rise in the medium- to longterm growth rate. It is critical to pursue the strengthening of growth potential and fiscal consolidation concurrently, and let a positive feedback loop work. V. Conduct of monetary policy Finally, let me talk about the Bank of Japan’s monetary policy. The Bank has been pursuing powerful monetary easing in the framework of comprehensive monetary easing. First, the Bank sets the policy rate at 0 to 0.1 percent, which can be deemed a virtually zero interest rate. Second, the Bank is publicly committed to continuing this virtually zero interest rate policy until it judges that price stability is in sight. And third, it purchases from the markets not only long- and short-term government bonds but also risk assets such as CP, corporate bonds, and exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). The program for purchasing financial assets, called the Asset Purchase Program, started at 35 trillion yen in October 2010, but has been repeatedly expanded in size on a significant scale to about 55 billion yen. Those measures aimed at encouraging a decline in longer-term risk-free interest rates and narrowing of various risk premiums. Such pursuit of powerful monetary easing has become one of the factors responsible for stability in the financial environment in Japan, despite continued strains in the U.S. and European financial markets. Apart from those measures, the Bank started in June 2010 the new lending framework of the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth. It is a measure through which the Bank supplies long-term and low interest rate funds to private financial institutions that lend or invest in the promising areas. The ceiling of the measure was initially set at 3 trillion yen and, taking it into account that the funds actually provided have come close to the ceiling, the Bank established a new line of credit of 500 billion yen to provide funds to financial institutions that undertake equity investments or asset-based lending. As I have talked today, strengthening medium- to long-term growth potential is a critical challenge Japan’s economy is faced with, and if that challenge is met, it could lead to overcoming deflation through raising firms’ and households’ growth expectations. Based on that recognition, the aforementioned measure aimed at supporting private financial institutions’ efforts from the financial front. The Bank will consistently make contributions as a central bank so that Japan’s economy will emerge from deflation and return to the sustainable growth path with price stability. BIS central bankers’ speeches Concluding remarks I have today talked such issues as medium- to long-term challenges to Japan’s economy. I strongly hope that Japan will meet those challenges in the near future and restore its luster. At that time, I believe that the word “Japanization” would be used in an exact opposite meaning. BIS central bankers’ speeches
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Speech by Mr Seiji Nakamura, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Okinawa, 9 November 2011.
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Seiji Nakamura: Japan’s monetary policy and developments in economic activity and prices Speech by Mr Seiji Nakamura, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Okinawa, 9 November 2011. * * * I. Recent economic developments at home and abroad A. Changes in Japan’s economy after the Great East Japan Earthquake Following the Great East Japan Earthquake on March 11, 2011, Japan’s economy faced two major supply constraints: supply chain disruptions and electric power shortages. As a result, production plunged, and exports dropped considerably, with those of cars and related goods, for example, falling by 50 percent from the level in February 2011. Uncertainty heightened further due to the electric power supply constraints following the nuclear power plant accident. In these circumstances, business and consumer sentiment deteriorated, and Japan’s economy came under strong downward pressure. The restoration of supply chains, however, progressed faster than expected thanks to the many different creative solutions found at the individual firm level – something at which Japanese manufacturers excel. Moreover, because of changes in the way production is organized as well as wide-ranging efforts to reduce the use of electric power, production levels were not considerably hampered even though electric power shortages during peak hours in the summer had been expected. In this manner, Japan’s economy has more or less resolved the supply-side constraints caused by the damage from the disaster, and is now in a phase where the level of demand at home and abroad – rather than the level of production – plays the key role in determining the outlook for the economy. Today, I will talk about recent economic developments at home and abroad, the outlook for Japan’s economy, uncertainties regarding the outlook, and the Bank of Japan’s monetary policy stance. B. Overseas economic developments Although the pace of growth in advanced economies has been decelerating, the global economy as a whole has been on a moderate recovery trend, led by emerging and commodity-exporting economies. In September 2011, the International Monetary Fund (IMF) projected that the year-on-year growth rate of the global economy would be 4.0 percent in both 2011 and 2012 and 4.5 percent in 2013. Although these projections are down from those in June, taking into account the fact that advanced economies are decelerating, they are not necessarily low given that they are at around the same level as the average annual growth rate of 4.1 percent observed in the period from 2000 until 2008, the year that Lehman Brothers failed. The contribution of emerging and commodity-exporting economies, particularly China, to overall global growth is more than 70 percent, highlighting the importance of these economies. Next, I would like to talk about the economy of each major area. Starting with the U.S. economy, it has been recovering at a moderate pace, although the pace of recovery has been slowing. The annualized quarter-on-quarter growth rate of real GDP on a seasonally adjusted basis for the July–September quarter of 2011 was 2.5 percent, up from 1.3 percent in the previous quarter. The growth rate increased slightly because private consumption, particularly car sales, was firm and business fixed investment rose against the background of favorable corporate earnings. Developments in the housing market, on the other hand, have remained sluggish, preventing meaningful progress in the adjustment of household balance sheets. According to Zillow, a firm that provides information on the U.S. real estate market, almost 30 percent of all single-family homes with mortgages in the United States are in BIS central bankers’ speeches negative equity, that is, the value of the real estate is below the outstanding amount of debt. This figure illustrates how seriously the balance sheets of U.S. households have been damaged. The unemployment rate has also remained high at around 9 percent, and the recovery in employment has been slow. Moreover, the European debt crisis has started to affect U.S. financial markets, and at the meeting of the Federal Open Market Committee (FOMC) on November 1 and 2 the members of the Federal Reserve Board revised downward their projections of real GDP growth in the United States. While the U.S. economy is likely to continue to recover, the pace of growth is likely to remain only moderate partly due to limited room for additional fiscal or monetary stimulus measures. In Europe, growth in exports has become sluggish owing to the deceleration in the pace of recovery of the world economy, and the pace of recovery of the euro area as a whole has also been slowing. The most critical issue in the European economy at present is the sovereign debt problems. These began in peripheral European economies such as Greece, but have rapidly grown into problems involving the whole of Europe. As these problems spread, investors quickly have grown increasingly risk averse and strains in financial markets have heightened. Business and consumer sentiment has also been under strong downward pressure. Moreover, financial institutions’ lending attitude has been tightening and their asset base been shrinking. Consequently, the sovereign debt problems are starting to have a negative impact on economic activity in Europe. As for the outlook, the pace of recovery of European economies is likely to remain slow in general, with some differences in pace by country, due to the continuation of downward pressure arising from the prolongation of the European debt crisis and to cuts in fiscal spending as part of fiscal consolidation measures in the euro area economies. Under these circumstances, the European Central Bank (ECB) decided to lower the key ECB interest rates at the meeting of the Governing Council held on November 3, 2011. There remains considerable uncertainty as to how the European debt crisis will unfold, and the timing of a recovery in market confidence is unclear. Emerging and commodity-exporting economies have continued to grow at a relatively rapid pace led mainly by vigorous domestic demand, although the pace of increase in exports has been slowing due to the deceleration in the U.S. and European economies. In some emerging and commodity-exporting economies, the policy stance toward monetary tightening has been eased due to concerns about instability in domestic financial markets and the negative effects on economic activity. However, in many other emerging and commodityexporting economies, inflationary pressure remains high. Meanwhile, in China, the year-onyear growth rate of real GDP in the July–September quarter was 9.1 percent. Although this is a slight decline from the previous quarter, the pace of economic growth remains relatively high. The year-on-year rate of increase in the consumer price index (CPI) in September was 6.1 percent, significantly above the Chinese government’s full-year target of 4 percent for 2011. As for the outlook, the Chinese economy on the whole is likely to maintain its relatively high rate of growth as the authorities work to contain inflation and curb upward pressure on real estate prices. C. Current conditions of and outlook for Japan’s economy Japan’s economic activity has continued to pick up thus far. The September 2011 Tankan (Short-Term Economic Survey of Enterprises in Japan) released by the Bank showed significant improvements in the diffusion index for business conditions, particularly in the motor vehicles industry, and confirmed the rising trend in business fixed investment reflecting upward revisions in plans for such investment for the second half of fiscal 2011. Although the rapid recovery in production appears to have paused, as indicated by the slight month-onmonth decline in the preliminary figure for the industrial production index in September, production is expected to resume its upward trend. It should be noted, however, that this assessment does not take full account of the effects of the flooding in Thailand and therefore needs to be treated with caution. Reflecting the pickup in production, real exports, particularly those of motor vehicles and related goods, have been increasing and have surpassed pre- BIS central bankers’ speeches quake levels. Corporate activity has been improving in general. With consumer sentiment heading toward a pick-up, private consumption has been showing signs of improvement in a wide range of areas, including retail sales, outlays for travel, and spending in restaurants and the like. While the number of foreign visitors to Japan in September was 25 percent below the previous year’s level due in part to rumors about radiation contamination and to the appreciation of the yen, the extent of the year-on-year decline has gradually been shrinking since April. As for the outlook, it is possible that the pace of increase in exports will level out because of the effects of the appreciation of the yen and because we are likely to see a waning of demand associated with inventory restocking and the recapturing of market share temporarily lost due to supply constraints. As for the domestic economy, however, there are signs of a rise in demand related to reconstruction after the disaster, and domestic demand as a whole is likely to grow at a moderate pace. Demand related to reconstruction is likely to increase further as a third supplementary budget for fiscal 2011 is currently being deliberated in the Diet. Semiannually, in April and October, the Bank releases the Outlook for Economic Activity and Prices, or the Outlook Report for short, in which it makes public its forecasts for economic activity and prices for the next two to three years. In the October Outlook Report released recently, the forecasts for the year-on-year growth rate of Japan’s real GDP were 0.3 percent for fiscal 2011, 2.2 percent for fiscal 2012, and 1.5 percent for fiscal 2013. Figures were revised slightly downward from the forecasts made in the interim assessment in July 2011, reflecting the effects of the appreciation of the yen as well as the deceleration of overseas economies. As for prices, against the background of the gradual improvement in the aggregate supply and demand balance, the forecasts for the year-on-year rate of change in the CPI for all items less fresh food were 0 percent for fiscal 2011, 0.1 percent for fiscal 2012, and 0.5 percent for fiscal 2013. Compared to the forecasts made in July, figures were revised downward, mainly because of the change in the base year for the CPI, which takes place every five years and was conducted in August 2011. The base year is changed to revise the composition of the CPI basket and the weight of individual items, so that the CPI reflects changes over time in the variety of goods consumed, in lifestyles, and in consumer behavior. As a result of the base-year change, the average year-on-year rate of change in the CPI for January–July 2011 was revised downward by 0.6 percentage point. D. Uncertainty regarding the outlook While uncertainty persists regarding the outlook for Japan’s economy both in terms of upside and downside risks, developments with respect to the following downside risks in particular require close attention. First, it remains highly uncertain how the European debt crisis will unfold. It will likely take a long time before the crisis is resolved. At the Euro Summit held on October 26, agreement was reached among the member states of the euro area on the reduction of Greek debt, the strengthening of European financial institutions’ capital bases, and the boosting of the lending capacity of the European Financial Stability Facility (EFSF) aimed at serving as a safety net at a time of crisis. The announcement of the agreement on these issues temporarily calmed international financial markets. However, as shown by the subsequent turmoil in the domestic political situation in Greece and the discussions at the Group of 20 (G-20) Leaders Summit in Cannes, the details and implementation of the comprehensive set of additional measures agreed at the Euro Summit as well as the austerity measures of the relevant countries remain extremely uncertain. Consequently, market participants remain wary with regard to the creditworthiness of European financial institutions. For example, interest markups, which serve as a risk premium, in interbank funds transactions in Europe remain elevated and the situation is still tense. This is because the European debt crisis is no BIS central bankers’ speeches longer confined to the problems of countries with excessive liabilities, such as Greece and Italy, but is spreading throughout the euro area, and – triggered by a fall in confidence in bonds issued by these heavily indebted countries – a negative feedback loop has started to operate in which the decline in creditworthiness of European financial institutions and growing downward pressure on economic activity reinforce each other. Under these circumstances, with the market extremely sensitive to any negative news, careful attention should be paid to “tail risks”, that is, risks with a low probability of materialization but a devastating impact if they do materialize. For the European economies to overcome the negative feedback loop, it is crucial that peripheral countries carry out fundamental reforms of their fiscal structures and that medium- to long-term economic growth is raised through the strengthening of productivity and competitiveness. However, it inevitably takes time to press ahead, through democratic processes, with decisions that will entail pain, and the discrepancy between the amount of time required and the time span the market can tolerate is a cause of concern. Moreover, the current European debt crisis has revealed problems in the governance of economic and fiscal affairs in the euro area. To avoid this type of crisis in the area from recurring, not only reforms of the fiscal structures of the heavily indebted countries but also fundamental reforms of institutions, including the issue of fiscal management of the euro area, will be necessary. Second, as for the U.S. economy, it is likely that balance-sheet adjustments in the household sector will continue to be a drag on economic growth, making it difficult for the economy to gain upward momentum and creating vulnerability to downside risks. Recovery in the housing market and the employment situation is likely to take some time. The risk of the U.S. economy registering low growth for longer than expected should be borne in mind, as room is limited for additional policy measures on both the fiscal and the monetary front. And third, the risk persists that business sentiment may deteriorate further. Many Japanese firms did their utmost to overcome supply constraints resulting from the damage caused by the Great East Japan Earthquake, and only recently have finally returned to full-scale production. They are now working to recover the market shares at home and abroad that had been lost due to the disaster. The deceleration of overseas economies and the continued appreciation of the yen at this crucial stage – just when Japanese firms are returning to fullscale operation – are depressing business sentiment, particularly among exporting firms, by, for example, causing downward revisions of their profits. In addition, there are concerns about electric power supply constraints resulting from uncertainties regarding the resumption of operations at currently idle nuclear power plants, and such concerns could have a negative impact on business fixed investment and consequently the employment situation. At the same time, as the devastating flooding in Thailand is likely to negatively affect production in Japan through a decline in exports from Japan to Thailand and damage to supply chains in Asia, including those in Thailand, the situation warrants careful monitoring. E. Efforts toward fiscal consolidation around the world Restoring the health of public finances is a policy priority common to all advanced countries. Even before the financial crisis, the fiscal balances of advanced countries were generally deteriorating against the background of a long-term trend of declining economic growth and expanding social security burdens due to population aging. Following the failure of Lehman Brothers in autumn 2008, the fiscal health of advanced countries deteriorated further as a result of economic stimulus and support measures on the fiscal front to combat the sharp economic downturn. With concerns intensifying over the European debt problem, market views are hardening regarding excessive public debts, as these could disrupt the global economy. Since the beginning of 2011, rating agencies have downgraded the government securities of the United States, Japan, Spain, and Italy, because these countries were seen to be taking insufficient measures to reduce their fiscal deficits. The G-20 Cannes Summit held on November 3 and 4, 2011 reaffirmed member countries’ commitment to achieve fiscal consolidation as agreed at the Toronto Summit on June 26 and 27, 2010, as part of the BIS central bankers’ speeches action plan to strengthen medium-term foundations for growth.1 Advanced countries have been working on fiscal consolidation as a policy priority with a high degree of urgency:2 In the United States, the Budget Control Act of 2011, in which deficit reductions of more than 2.1 trillion U.S. dollars in the period from fiscal 2012 to fiscal 2021 were agreed, was enacted by Congress in August. As for the euro area economies, the Maastricht Treaty states that, in order to maintain confidence in the single currency, the euro, the deficit-to-GDP ratio should not exceed 3 percent, and that the government debt-to-GDP ratio should not exceed 60 percent. In Germany, the deficit-to-GDP ratio was 3.3 percent in 2010, but in the Stability Programme submitted to the European Commission in April 2011, the government stated that the ratio would be reduced to below 3 percent in 2011. In France, the deficit-to-GDP ratio was 7.0 percent in 2010, but the government stated that it would reduce this ratio to no more than 3 percent by 2013 and achieve fiscal balance by 2016. In the United Kingdom, Prime Minister David Cameron’s government raised the rate of value-added tax in January 2011 and aims to halve the ratio of public-sector net borrowing (borrowing by the general government and public firms) to GDP by the end of fiscal 2013, and to substantially reduce the public-sector net debt-to-GDP ratio by the end of fiscal 2015. Meanwhile, in Japan, the ratio of general government gross financial liabilities to GDP stands at 199.7 percent, while the deficit-to-GDP ratio stands at 8.1 percent. The former is considerably higher than in other advanced countries, such as the 93.6 percent in the United States, 94.1 percent in France, 87.0 percent in Germany, and 82.4 percent in the United Kingdom. It is even far higher than that in Greece, which – at 147.3 percent – triggered the European debt problem, or the 126.8 percent in Italy, which is suffering from a loss in market confidence. Nevertheless, yields on 10-year Japanese government bonds (JGBs) have generally remained below 2 percent for more than ten years and have recently been fluctuating at around 1 percent. According to data from the Ministry of Finance, the outstanding amount of government bonds has increased by about 70 percent during the past ten years, from 392 trillion yen in fiscal 2001 to 667 trillion yen in fiscal 2011. During this period, however, interest payments on JGBs have remained more or less unchanged, rising only slightly from 9.4 trillion yen to 9.9 trillion yen. Despite this secular increase in the outstanding amount of government bonds, the Japanese government has been able to raise funds at low interest rates without difficulties. This fact seems to have dulled the sense of crisis in Japan and led to procrastination in addressing the problem. Demand for government bonds in Japan has been sustained by the accumulation of surplus funds at financial institutions, partly reflecting efforts by firms to strengthen their balance sheets and reduce borrowing amid low economic growth since the bursting of the bubble in the early 1990s. The sustained demand for JGBs, with yields of only around 1 percent, is attributable to the sense that – in a situation where the opportunities for Japanese financial The Toronto Summit Declaration stated that “advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016”. However, on Japan, it stated that “recognizing the circumstances of Japan, we welcome the Japanese government’s fiscal consolidation plan announced recently with their growth strategy”. The “Fiscal Management Strategy”, decided by the Japanese Cabinet before the Toronto Summit, set the target of reducing the ratio of the primary balance deficit relative to GDP to half its fiscal 2010 level by fiscal 2015, and to achieve a primary balance surplus by fiscal 2020. The government debt-to-GDP ratios for 2010 quoted below are the “general government gross financial liabilities” taken from OECD Economic Outlook, No. 89, released in May 2011, while the fiscal deficit-to-GDP ratios are the “general government financial balances” from the same publication. BIS central bankers’ speeches institutions to invest their funds are limited – JGBs are safe and liquid assets that will continue to command market confidence. This confidence in JGBs rests on the confidence that payments of interest and principal are backed by future government revenues and, moreover, that the government and the Bank have the will and ability to restore long-term fiscal health and maintain the value of the currency. In the case of Greece, even though there was no major change in the level of economic activity, yields on 10-year government bonds surged from around 4.5 percent in October 2009 to nearly 9 percent six months later in April 2010 and are hovering at around 28 percent at present. This increase was due to abrupt changes in market participants’ confidence in the Greek government’s will and ability to improve the fiscal balance in the medium to long term, which forms the basis for its capacity to redeem government securities. In Japan, more than 60 percent of the outstanding amount of JGBs is held by banks, insurance companies, and pension funds,3 which receive their funds in the form of bank deposits and insurance premiums. It could therefore be said that the public is the ultimate holder of JGBs, although the general public probably is not aware of this. It should be noted, however, that, amid the rapid aging of the population in Japan, there is no guarantee that in the future financial institutions will continue to channel personal savings into JGBs in a stable manner. When these points are taken into account, the possibility cannot be ruled out that long-term interest rates, which at present are hovering at around 1 percent, could start to rise for whatever reason and the consequent increase in the interest burden could exert inordinate pressure on public finances. The “Fiscal Management Strategy,” decided by the Japanese Cabinet in June 2010 sets a clear target of achieving a primary balance surplus by fiscal 2020, followed by a stable reduction in the amount of public debt relative to GDP. For the time being, it is possible for the government to raise funds at low interest rates and it is unlikely that there will be a major disruption in the supply and demand balance for JGBs. However, debts must be repaid and cannot be defaulted on. Reducing the real value of debt through inflation is also not a solution, given the enormous economic costs this would involve. There are no shortcuts to fundamental fiscal reform, and although it may entail a great deal of pain, it cannot wait much longer, since fiscal consolidation inevitably takes time. Thus, giving due consideration to developments in economic activity, Japan urgently needs to steadily implement concrete measures toward medium- to long-term fiscal consolidation while interest rates are low and JGBs still command the confidence of the market. II. Conduct of monetary policy I will now move on to the Bank’s conduct of monetary policy. The Bank has been consistently making its utmost contributions through the three-pronged approach of pursuing powerful monetary easing consisting of comprehensive monetary easing that was introduced in October 2010, ensuring financial market stability, and providing support to strengthen the foundations for economic growth. The Bank further enhanced monetary easing following the Great East Japan Earthquake in March 2011 due to increased concerns about the effects of the deceleration in domestic and overseas economies and instability in the foreign exchange and financial markets. See the Flow of Funds Accounts released by the Bank of Japan. The figure is the share of JGBs held by banks, insurance companies, and pension funds in the outstanding amount of JGBs and Fiscal Investment and Loan Program (FILP) agency bonds. BIS central bankers’ speeches Given the extremely limited room for a further decline in short-term interest rates, the Bank has been pursuing the comprehensive monetary easing policy introduced in October 2010 mainly through the purchase of financial assets under the Asset Purchase Program (hereafter the Program). The Program has been repeatedly expanded in size on a significant scale. In addition, the Bank has made it clear that it will continue the virtually zero interest policy until it judges that price stability on the basis of the “understanding of medium- to longterm price stability” – inflation of around 1 percent – is in sight, provided that no problem is identified in examining risk factors, including the accumulation of financial imbalances.4 More recently, in August 2011 the Bank significantly increased the total size of the Program by about 10 trillion yen, from about 40 trillion yen to about 50 trillion yen, in response to the rise in various risks. However, subsequently, downside risks to the economy materialized in the form of, for example, greater adverse effects on Japan’s economic activity from the deceleration in overseas economies and the appreciation of the yen. Consequently, in the October 2011 Outlook Report, the Bank’s forecasts were revised slightly downward from those made in July 2011. Moreover, the Bank judged that there was increased risk that the outlook for economic activity and prices could deteriorate further depending on developments in international financial markets and overseas economies. Therefore, even though purchases of financial assets under the Program were still approximately 10 trillion yen below the maximum amount decided in August, at the Monetary Policy Meeting held on October 27, 2011 the Bank decided to further enhance monetary easing by increasing the total size of the Program by about 5 trillion yen, to about 55 trillion yen, for additional purchases of JGBs. The Bank needs to do all it can – by vigorously implementing these monetary easing measures – to help Japan’s economy overcome deflation and return to a sustainable growth path with price stability. The “understanding” is the level of inflation that each Policy Board member understands as being consistent with price stability over the medium to long term. The current “understanding” shows that “on the basis of a year-on-year rate of change in the CPI, it falls in a positive range of 2 percent or lower, centering around 1 percent”. BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, to the Board of Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 22 December 2011.
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Masaaki Shirakawa: Globalization and population aging – challenges facing Japan Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, to the Board of Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 22 December 2011. * * * Introduction I am honored to have this opportunity to address the representatives of Japan’s economy gathered here today. We have just over a week left in a year in which the most notable event for our nation was definitely the Great East Japan Earthquake of March 11. Speaking only about the economic impact of this terrible event, Japan’s economy suddenly faced enormous downward pressures arising from damage to production facilities, disruptions in supply chains, and shortages in electricity supply. Thanks to tremendous efforts by company managers and by employees in the field, these supply-side problems were resolved by the summer, which was faster than expected. However, just as the prospects gradually began to look good for Japan’s economy to overcome the problems caused by the disaster, the sovereign debt crisis in Europe triggered new problems – a slowdown in overseas economies and the appreciation of the yen. As a result, after a sharp rebound, the pick-up in Japan’s economic activity has gradually slowed and is currently at a pause. According to the Tankan (Short-Term Economic Survey of Enterprises in Japan) released last week, business conditions deteriorated for large manufacturing enterprises, as has been extensively reported in the newspapers, but improved for large nonmanufacturing enterprises (Chart 1). As for SMEs, business conditions improved both for manufacturing and nonmanufacturing enterprises. As such, although overall business conditions have improved, the pace of improvement has slowed. As can be seen from the results of the Tankan, there are currently two opposing forces in operation: on one hand, exports and production remain more or less flat due to a slowdown in overseas economies and the appreciation of the yen; on the other, in terms of domestic demand, private consumption remains firm and postearthquake rebuilding and reconstruction demand is expected to materialize. The Bank of Japan judges that Japan’s economy will be more or less flat for the time being as the former force prevails. Beyond that phase, it is our judgment that the economy will gradually return to a moderate recovery path, reflecting a pick-up in growth of overseas economies, especially emerging economies. Having said that, we are fully aware that this outlook is attended by various uncertainties. The most significant risk is, of course, the impact of the European sovereign debt crisis on our economy through its effects on international financial markets and the global economy. Although the economic outlook is important, I have already discussed it on various occasions. Today, instead, I would like to give my thoughts on the challenges facing Japan’s economy and its central bank from a medium- to long-term perspective, as I believe the end of the year is good timing for doing so. I. Japan’s economy during the past 15 years Progress in globalization In order to understand the medium- to long-term challenges that lie ahead for Japan’s economy, I will first compare how it is today to how it was back in 1995. I have chosen that particular year as a comparison point because of its similarities with this year, as in 1995 BIS central bankers’ speeches Japan experienced the Great Hanshin-Awaji Earthquake (or Kobe Earthquake as it is also known) and an appreciation of the yen, which peaked that year at under 80 yen against the U.S. dollar. There have been many changes over the past 15 years. First, we saw further globalization of goods, capital, and people (Chart 2). For goods, global trade volume in real terms after excluding the effects of price fluctuations is expected to rise from an index level of 100 in 1995 to 253 by 2011. This implies that global trade volume continued to expand at an annualized rate of 6.0 percent, a pace much faster than the real GDP growth rate of 3.7 percent during the period. This increase was essentially caused by the end of the Cold War and subsequent transition of regions worldwide to market economies. This increased opportunities for an international division of labor, which led to more optimal production by combining the technology and capital of advanced economies with the ample labor forces of emerging economies. Emerging economies, particularly China, India, and Brazil, grew rapidly in this process (Chart 3). For capital, the average amount of daily transactions in foreign exchange markets worldwide was 1.5 trillion dollars as of 1998 – which is as far back as we can go in making such a comparison – and grew to 4 trillion dollars, corresponding to almost 20 times world GDP per day, in 2010 (Chart 2). For people, tourists traveling abroad have increased substantially from 530 million in 1995 to 940 million in 2011. The number of first-generation immigrants has also increased from 170 million in 1995 to 210 million in 2010 (Chart 2). Rapid population aging Second, Japan’s population has continued to age rapidly (Chart 4). The working-age population, or in other words the population aged from 15 to 64, has been declining after peaking in 1995. The working-age population in 2010 declined by 7 percent compared to 15 years previously in 1995, or by 0.5 percent on a yearly basis. Meanwhile, the percentage of people 65 or older accounted for about 15 percent of the total population in 1995, but rose to about 25 percent in 2010. This globally unprecedented rapid population aging has had far-reaching and various effects on Japan’s economy. The first of these effects is on the economy’s potential growth rate. The working-age population plays a central role in economic activity. Its decline has reduced labor supply and thus has pushed down economic growth. The second effect is on the fiscal balance. At a time when it has become difficult to increase tax revenues through labor income, pressure has been increasing to expand the fiscal deficit, given that social security expenses – including pension costs and medical and nursing care expenses – increase as the population ages as long as the current level of benefits are maintained. The third effect is the diversification of consumer needs and services. Given the diverse lives and lifestyles of the elderly population, individuals have a wide range of unique needs, not only in terms of medical and nursing care but also in wider contexts such as living fulfilling lives after retirement, which encompasses hobbies and continued learning. To put it another way, the continued population aging is, in a sense, a market expansion that cannot be considered in mass terms. Japan’s delayed response to change We can see that the environment has changed significantly over the past 15 years, with globalization and rapid population aging. Change at any point in time always provides a country with both difficulties and opportunities, and the capability of a society as a whole to adapt to this change largely affects its economic performance. On this point, both Japan’s government and its firms have responded in various ways. Unfortunately, however, the economic growth rate has continued to decline and prices have continued to fall moderately BIS central bankers’ speeches as a result. Furthermore, government debt has increased substantially during this period. Faced with these facts, we cannot deny that Japan’s economic system has not managed to respond swiftly and sufficiently to the big changes in the environment. One reason for the decline in the growth rate is the aftereffects of the unprecedented economic bubble in the late 1980s. The effects of that bubble were considerable. Prior to the Lehman shock, an optimistic view prevailed among economists and policy authorities in the United States – that a significant economic downturn following a bubble period could be avoided through implementation of powerful monetary and fiscal policies once the bubble burst. That optimistic view is no longer prevalent today. Economic activity remains stagnant until excesses in production capacity and debt that have been built up during a bubble period are resolved (Chart 5). Such balance-sheet adjustments, however, no longer acted as constraints on Japan’s economy at least by sometime between 2003 and 2004. The more essential reason for the subsequent downturn in Japan’s economy was Japan’s delayed response to the significant changes in the environment, namely, globalization and population aging. Going back to my earlier reference to 1995, Japan around that time was desperately looking for ways to recover from the collapse of the bubble economy. At that stage, I recall that not many of us understood the significance of globalization and population aging for Japan’s economy as well as we later came to realize. In other words, it is better to attribute the delay in responding to an inability to fully recognize the seriousness of the problem itself than to difficulties implementing solutions despite knowing what they were. I believe the same could happen in the next 15 years (Chart 6). For instance, how will Japan’s rapid population aging alter the course of Japan’s future economic growth and fiscal conditions? Will Japan’s economy be able to maintain its longstanding current account surplus? II. Setting the agenda for Japan’s economy Serious consequences of leaving situation unchanged Regarding the first question, even if we focus on demographics, which are relatively easy to predict going forward, we can confirm that the conditions that the underlying factors affecting Japan’s growth are going to change dramatically. The average growth rate has declined from 4.3 percent in the 1980s to 1.5 percent in the 1990s and further to less than 1 percent in the 2000s (Chart 7). The economic growth rate consists of two components: the rate of growth in the number of workers and the rate of growth in labor productivity, which represents an increase in the value added by each worker. We can project future growth rates by forecasting these two components. Of the two, the rate of growth in the number of workers started to decline in the 2000s, and decreased at an annual rate of 0.3 percent on average during that decade. Based on long-term projections of demographic trends and assuming that current labor participation rates by gender and by age group will not change, the rate of decline in the number of workers will increase further to 0.6 percent in the 2010s, 0.7 percent in the 2020s and 1.3 percent in the 2030s. The impact of such population decline is serious, especially in regional economies (Chart 8). As for the other component, labor productivity, the average growth rate over the past 20 years has been around 1.0 percent. Excluding the 1990s, during which the economy was significantly affected by the legacy of the bursting of the bubble, and choosing a period characterized by relatively favorable economic conditions, the labor productivity growth rate was 1.5 percent from 2000 to 2008. Given that there are no significant differences in productivity growth rates among advanced economies, we may be able to assume that the average productivity growth rate in Japan will stay between 1.0 percent and 1.5 percent. Assuming this and that the rate of decline in the number of workers will be as just described, the annual rate of economic growth in the 2010s will remain somewhere between 0.5 percent and 1.0 percent and become around zero percent in the 2030s. Medium- to long-term growth rates will have a significant impact on the fiscal BIS central bankers’ speeches situation. The sovereign debt crisis in Europe provides us with an important lesson – that fiscal credibility can change in a discontinuous manner (Chart 9). We must work seriously with strong determination to strengthen our growth potential. Need to work and create value added How can we strengthen our growth potential? I have just explained that the rate of growth in the number of workers and the rate of growth in labor productivity together constitute the economic growth rate. As for the number of workers, it is difficult to expect a dramatic improvement unless demographic trends change. However, it is still possible to slow the pace of the decline in the number of workers by making it easier for elderly people and women to participate in the workforce. As for the second variable, raising labor productivity growth means increasing the value added per worker. The key, therefore, is to continuously capture potential needs and to provide more goods and services that people will find worth purchasing. More specifically, there are three important aspects to be considered. First, it is important to make the best use of the major trend towards globalization. It goes without saying that it is important to aggressively capture demand overseas, especially in fast-growing emerging economies. At the same time, it is important to take active steps to open up markets and society. With more inflows and outflows of people, goods, and capital, there are more chances of coming up with new ideas and business opportunities. Second, efforts to cultivate new domestic demand are also critically important. Senses of values and lifestyles have been diversifying not only for the elderly, as explained earlier, but also for all generations. It is important that businesses expand domestic markets by working to capture such potential demand and measures such as deregulation are taken to prepare the environment for firms to take on these challenges. Third, in order to dynamically implement a dual strategy of expanding business globally and exploring domestic demand, it is necessary to shift labor and capital smoothly to businesses with high growth potential. This means more effective use of human resources and capital within firms and improvement in economic metabolism on a macroeconomic basis. To mobilize resources in such a way without causing social stresses, it will be necessary to strengthen outplacement support schemes, make it easier to start new businesses, and improve safety nets. More than anything, it will be important to share a sense of values within Japanese society, which should include acceptance of the need to improve the economic metabolism and support for people taking on new challenges. “Hollowing out of domestic industries”? I would like to briefly touch upon recent concerns about a hollowing out of domestic industries, which are also related to the economic metabolism. To start with, expansion of production overseas is not unique to the current phase but rather a trend that has played out over the past twenty years (Chart 10). Until the middle of the 1980s, Japan increased its global market share by expanding exports. Since the second half of the 1980s, Japanese firms have increased their overseas production partly as a response to intensifying trade friction. Thereafter, they have continuously reviewed their global production networks to optimize the division of work between home and abroad while taking into consideration changes in demand structure and cost structure as a consequence of globalization. As a result of such management decisions by firms, the pace of expanding production overseas increased and this trend continues today. This shift of production sites overseas has decreased domestic employment in the manufacturing sector. We need to create more employment opportunities in the economy as a whole by enhancing growth in domestic demand-related sectors, such as service sectors that create more employment than other sectors, by making use of the resultant idle labor BIS central bankers’ speeches force (Chart 11). Within the manufacturing sector, given the significant gap in labor costs between home and abroad, it is necessary to promote a division of labor, with production and assembly sites for mass production expanded overseas and domestic operations focusing on more profitable businesses as well as cutting-edge technologies and business ideas. We must, of course, pay due attention to the risk that the expansion of production overseas will adversely affect the domestic economy. For example, the shift could suddenly accelerate for certain reasons, including the appreciation of the yen, such that its pace surpasses a rate consistent with a trend increase in overseas demand. Another risk is that core firms and factories abandon domestic production sites. It is true that the appreciation of the yen creates a need for serious adjustments to export industries. At the same time, there are also benefits from the yen’s appreciation. For example, the appreciation has clearly caused a reduction in the cost of imports, which have increased significantly due to increased imports of crude oil and LNG after Japan’s nuclear plants stopped operations. We have also seen more Japanese firms availing of the yen’s appreciation to make strategic moves to expand business globally, as evidenced by an increase in outbound M&A activity (Chart 12). Credits of foreign direct investment income currently total 3.4 trillion yen per year, 0.7 percent of nominal GDP. Although such income has somewhat increased compared to the past, the amount of overseas investment and the rate of return are still small compared to other countries (Chart 13). When domestic investment opportunities are limited, it is vitally important to improve returns from overseas investment, particularly foreign direct investment. In any case, the negative impact of the yen’s appreciation tends to be noticed more than positive effects in Japan because domesticdemand related firms, which are natural beneficiaries of the yen’s appreciation, have failed to develop successful business plans to reap such benefits. In other words, in order to overcome concerns about a hollowing out of domestic industries, ultimately we must work to strengthen our medium- to long-term growth potential. Making accommodative financial environment lead to growth As is clear from what I have said so far, strengthening of growth potential will be achieved by substantive efforts to work and increase value added. In this regard, some argue that “stopping deflation comes first and that can be achieved easily through monetary easing.” However, a rise in inflation without a pick-up in real growth rates will not improve living standards or fiscal balances. The real issue is how to raise the real growth rate. Past experiences show that prices rise later, after economic growth picks up in real terms. To use the analogy of the human body, prices are like its temperature, while growth potential is its fundamental strength. Raising the temperature without improving the fundamental strength is not possible. Even if it were successfully done temporarily, there would be side-effects. In fact, in Japan, a strong correlation has been observed between the potential growth rate and the expected rate of inflation (Chart 14). In the past even some prominent academic economists in the United States have argued that “stagnant growth and deflation in Japan can be solved easily by implementing significant monetary easing.” After experiencing difficulty restoring U.S. economic growth after the Lehman shock, however, they revised their understanding on the issue considerably and even apologized and withdrew their past criticisms of Japan. In any case, Japan’s financial conditions are extremely accommodative. Nominal interest rates and even actual funding rates of firms, such as real interest rates on corporate bonds adjusted using inflation expectations, are lower in Japan compared to those in the United States and Europe (Chart 15). In a related context, some argue that “insufficient provision of money by the Bank of Japan is the cause of deflation and the yen’s appreciation,” citing the size of the monetary base, which is the total amount of currency provided by a central bank. As Chairman Bernanke of the U.S. Federal Reserve has also pointed out, I, too, do not consider the monetary base to be an appropriate indicator for monetary easing. Still, even BIS central bankers’ speeches the size of the monetary base as a proportion of nominal GDP is larger in Japan than in the United States and Europe (Chart 15). As all of you present today must sense through your business activities, we are not in a situation where business fixed-investment and purchases of foreign currency-denominated assets are constrained by the amount of cash and deposits or the level of interest rates. The bottom line when it comes to our problem is how to make use of the current extremely accommodative financial conditions in order to strengthen growth potential. III. The roles and challenges of central banks The Bank of Japan is not alone: other central banks of advanced economies are in a similar situation. Europe is dealing with the sovereign debt problem and the United States is in the process of balance sheet repair. In such circumstances, both Chairman Bernanke of the U.S. Federal Reserve and President Draghi of the European Central Bank have repeatedly pointed out that central bank measures are not a panacea. Having said that, I am not denying the importance of the role played by central banks. On the contrary, there are many things that only central banks can do. What is important is that the government, the private sector, and the central bank play their respective roles properly. What, then, are the roles of a central bank? Financial globalization and central banks In recent years, it is becoming increasingly important for a central bank to have a global perspective when seeking to conduct monetary policy appropriately to achieve price stability. Coming back to the basics of how monetary easing stimulates demand, one channel is to bring future demand forward by urging firms to make investments now while interest rates are low. Another channel, if lower interest rates result in the depreciation of the currency, is to capture overseas demand. Once interest rates fall to almost zero, however, it becomes difficult to increase the benefit of making investments now. Moreover, when interest rates in other advanced economies are also close to zero as in the current situation, there is limited room left to make use of overseas demand, at least among the advanced economies. In sum, the two channels of monetary policy both become less effective. Given that emerging economies have high growth rates and interest rates, monetary easing in advanced economies is expected to have stimulative effects through an increase in exports to emerging economies if the currencies of advanced economies depreciate against those of emerging economies on the whole. At the present time, however, many emerging countries adopt fixed foreign exchange rates with currencies pegged to the U.S. dollar and the United States faces balance-sheet repair problems. What actually happened was that monetary easing in the United States, instead of stimulating domestic economic activity, contributed to overheating in emerging economies and a rise in international commodity prices, which resulted in more inflationary pressures and adverse effects on private consumption in the U.S. economy. In this way, in an increasingly globalizing world, there is a possibility that a central bank will find that unintended effects of its monetary policy eventually come back on itself through their effects on overseas economies and financial markets. In the end central banks should conduct monetary policy based on their assessment of economic and price developments in their respective countries and regions. At the same time, it is also becoming more important than ever to make decisions after considering the complex interdependence of the different parts of the global economy. Against a backdrop of increasing globalization, the task of maintaining financial system stability is equally important as monetary policy for a central bank. As can be seen in foreign exchange trading volumes, massive capital flows are moving around the globe beyond national borders. Even without actual movements of capital, derivatives transactions transfer BIS central bankers’ speeches risks across borders. Although some see such financial transactions negatively, given the progress in globalization in terms of the real economy and associated needs to hedge various risks associated with economic transactions, such as interest rate risk, foreign exchange risk and credit risk, simply dismissing financial transactions will not help to improve the situation. In addition, as evidenced by the sovereign debt crisis in Europe, the very credibility of sovereign states is being questioned this year. In such circumstances, maintaining stability in the global financial system is becoming the most important prerequisite for global economic growth. On the topic of global financial system stability, while strong commitment by national governments is necessary, central banks have also been doing their utmost in this regard. One example is the coordinated actions by six central banks, including the Bank of Japan, regarding U.S. dollar liquidity, which were announced at the end of November. As a contingency measure, the central banks also agreed to establish bilateral swap arrangements so that liquidity in non-domestic currencies other than the U.S. dollar could also be provided in each jurisdiction. I should also add that central banks are contributing to the ongoing efforts to revise financial regulation and supervision frameworks to prevent recurrence of financial crises like the one in 2008, by preventing the accumulation of financial imbalances. The bank’s policy conduct Finally, I will explain the Bank’s recent conduct of monetary policy (Chart 16). First, the Bank has been pursuing powerful monetary easing under the comprehensive monetary easing framework implemented in the fall of last year. The Bank has also repeatedly expanded the size of the Asset Purchase Program and intends to proceed with additional purchases of approximately 13 trillion yen over the next year. Second, the Bank has been doing its utmost to ensure financial market stability. Its provision of ample funds immediately following the earthquake as well as the U.S. dollar fundssupplying operations I have just mentioned are good examples of such efforts. Third, in an extraordinary measure for a central bank, the Bank is proceeding with fund provision to provide support for strengthening the foundations for economic growth. This is aimed at encouraging firms to make use of the accommodative financial environment, by providing financial institutions with long-term funds at a low interest rate and taking advantage of their expertise in identifying business opportunities. Concluding remarks – importance of adapting to changes and strengthening growth potential I have almost used up my time. My message today can be summarized into the following five points. First, we need to recognize that Japan currently faces major changes – globalization and rapid population aging – which have a significant impact on its economy. Second, in order to maintain existing living standards in Japan for the next generations, our economy must strengthen its capacity to adapt to these major changes and strengthen its growth potential. Third, deflation will be overcome by strengthening growth potential. Fourth, in order to strengthen growth potential, firms’ willingness to take on challenges is vital and there is a need to prepare the environment to encourage firms to do so. Fifth, the Bank of Japan will also continue to consistently make contributions from the monetary side with the aim of achieving sustainable growth with price stability. Incidentally, in October next year, Japan will host the Annual Meetings of the World Bank Group and International Monetary Fund. This is a big event with more than ten thousand participants from the existing 187 member countries. Japan hosted these meetings in 1964 when the country was still an emerging economy filled with the energy associated with high growth. In that year there were a series of historic events in Japan which enhanced people’s confidence: becoming a member of the OECD on April 28; hosting the Annual Meetings of BIS central bankers’ speeches the World Bank Group and International Monetary Fund from September 7 to 11; launching the Tokaido Shinkansen on October 1; and holding the opening ceremony of the Tokyo Olympic Games on October 10. Almost half a century has passed since then and, in the fall of next year, Japan will again provide the venue for discussion among global leaders tackling various problems, this time as a mature advanced economy. Japan experienced the bursting of a bubble twenty years ago and currently faces rapid population aging ahead of other countries. In that sense, Japan is well positioned to present a new growth model to the rest of the world as a mature economy and the global frontrunner in terms of population aging. I sincerely hope that, in 2012, Japan will show the rest of the world its vision and determination to continue to shine as a mature economy and, more than anything else, the people of Japan will regain hope and courage. In this regard, the Bank of Japan will do its utmost in close cooperation with you. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Yamanashi, 2 November 2011.
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Sayuri Shirai: Recent gobal economic developments and monetary policy in Japan – growing uncertainty over the European sovereign debt issues Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Yamanashi, 2 November 2011. * I. * * Global economic and financial developments The world currently faces two pressing macroeconomic issues: one is a slowdown in global economic growth, and the other is increased instability in international financial markets triggered largely by fiscal and financial problems in Europe. A. Outlook for the global economy Let me start with the outlook for emerging economies. These economies continue to be the main engine for global economic growth, although the pace of growth has slowed somewhat in recent months. Their sources of economic strength arise mainly from (1) robust domestic demand reflecting rising incomes and employment generation – phenomena commonly observed in developing countries, (2) considerable leeway for expansionary fiscal policies thanks to their relatively sound public finances, (3) abundant labor forces, and (4) the potential for high labor productivity growth as part of the process of technological catch-up. At the same time, some emerging economies are experiencing inflationary pressures, which have been placing them in the dilemma of containing inflation or decelerating the pace of economic growth when making a monetary policy decision. By contrast, the pace of economic growth in advanced countries remains moderate. In the case of the United States, economic growth so far has been slower than originally expected, as exemplified by substantial downward revisions made by a number of international organizations and think tanks – including the International Monetary Fund (IMF) – to their projections for 2011 and 2012. U.S. economic growth declined sharply in the first half of 2011, due mainly to (a) a decline in automobile production caused by supply-chain disruptions following the Great East Japan Earthquake and (b) a drop in real household incomes reflecting the hike in gasoline prices. On the bright side, corporate profits have been substantially strong, and production, business fixed investment, and exports have continued to rise. Although some economic indicators suggest a deterioration in business sentiment in recent months, the pessimism suggested by sentiment indicators appears to be greater than actual corporate business conditions warrant. Overall, the pace of economic recovery in the United States has remained modest, because the deleveraging process or the adverse impact of the burst housing bubble on household balance sheets persists. As housing loans and other debts remain excessive, debt servicing exerts a huge burden on households, particularly since employment generation and income growth have been sluggish. Moreover, given that about 30 percent of household financial assets have been invested in stocks, the negative wealth effect caused by the recent downturn in stock prices is likely to be considerable. Against this background, President Obama in September 2011 proposed a jobs package worth 447 billion U.S. dollars – about 3 percent of GDP, although it is not clear whether the proposal will gain approval in Congress. If not, fiscal stimulus to the economy in the coming year may be limited. B. Instability in international financial markets Not only has the pace of global economic growth been decelerating, in international markets investors have been increasingly risk averse. This reflects growing concerns over the BIS central bankers’ speeches economic performance of the United States as well as the worsening fiscal and financial problems in Europe, which I will touch upon later. Strains in international financial markets have intensified since the middle of 2011, in part due to the prolonged debate in the U.S. Congress over the fiscal debt ceiling and deficit reduction, and the resulting downgrading of the credit rating for U.S. Treasuries. Moreover, high-level meetings of the European Union (EU), the Group of Seven (G-7) countries, and the Group of Twenty (G-20) countries all failed to come up with a decisive solution to the fiscal and financial problems in Europe. This series of events prompted global investors to become even more risk averse. As a result, international financial markets have become highly volatile: the prices of stocks – perceived as riskier assets – fell substantially around the globe, while the prices of government bonds of major advanced economies – perceived as safer assets – rose (or yields declined). Since October this year, however, stock prices have recovered somewhat and yields on government bonds have risen. Regarding corporate bond markets, credit spreads have widened, particularly in the United States and Europe, and issuing conditions for low-rated corporate bonds have continued to remain unfavorable. The number of initial public offerings (IPOs) also dropped sharply around the globe. What is more, since September the price of gold – generally perceived as a safe asset – as well as the prices of other commodities have declined as well. In the foreign exchange market, meanwhile, the yen, together with the U.S. dollar, has appreciated against a wide range of currencies of emerging and commodity-exporting economies on the basis of the perception that it is a relatively safe international currency. Moreover, in some emerging economies, cross-border capital flows have reversed, leading to a decline in stock and bond prices as well as foreign exchange rates. The main reason that instability in international financial markets has increased is a lack of confidence in measures undertaken by the EU to resolve the fiscal and financial problems in Europe. As I will explain in the next section, the problems in Europe are unlikely to be resolved in the short term. Therefore, international financial markets are expected to face continued strains for a while. II. The fiscal and financial problems in Europe So far, I have presented an overview of the outlook for global economic and financial developments. Now, I would like to take a closer look at the fiscal and financial problems in Europe, which have become the epicenter of the growing strains in international financial markets.1 Before I go into details, I would first like to make sure that the difference between the EU and the euro area is well understood. The EU is an economic partnership between 27 countries and constitutes the world’s largest economic zone. It has a population of about 500 million and accounts for more than 20 percent of global GDP. People and money can move without restrictions in the region. The euro area, on the other hand, is presently comprised of the 17 EU member states that have adopted the single currency called the euro. Countries with large economies, such as Germany, France, Italy, and Spain, are among the members of the euro area. The area has a population of about 330 million and accounts for about 15 percent of global GDP. It is an economic zone almost as large as the United States. I will follow the standard practice of distinguishing between “core countries” (such as Germany, France, the Netherlands, and Belgium) and “peripheral countries” (such as Greece, Ireland, Portugal, Spain, and Italy). This speech is based on information available as of October 31, 2011. BIS central bankers’ speeches A. The three problems faced by the euro area The fiscal problems in the euro area have now reached a critical stage. Looking back, the fiscal problems of Greece surfaced in spring 2010, followed by those of Ireland in fall 2010 and Portugal in early 2011. As these countries – with large fiscal deficits and/or government debts – faced a sharp increase in the cost of funding, they had no choice but to ask the EU and the IMF to provide them with financial support. With regard to Greece, it became clear from the middle of 2011 that its fiscal consolidation and economic reform program, to which it had internationally committed itself, was far behind schedule. As a result, the Greek debt crisis resurfaced. In addition, market concerns over the fiscal position of peripheral countries intensified. This, in turn, adversely affected the creditworthiness of European financial institutions with large holdings of government bonds of these countries. As a result, these institutions faced a sharp increase in their funding costs as well. In response, the EU announced a comprehensive set of measures to address the sovereign debt and financial problems at the end of October. This may be considered a step forward. The measures appear to have won some support from financial markets. Nevertheless, more time is needed to see whether they will help restore stability in international financial markets by reviving the risk-taking appetite of investors in general. The euro area is not only a large economic zone, but, like the United States, it is also home to the headquarters of many large, globally active financial institutions. Given Europe’s close economic and financial linkages with other regions, the possible effects of volatile developments in the euro area on the global economy and international financial markets are a matter of great concern. I would next like to talk about the three main problems confronting the euro area. 1. Fiscal consolidation and economic reform in Greece The first problem is the loss of market confidence in the ability of the Greek government to pursue the fiscal consolidation and economic reform program, which triggered the problems that the euro area is facing now. Greece had a high level of government debt even before joining the euro. Moreover, in the latter half of 2009 it emerged that the Greek government had understated the scale of its fiscal deficit by falsifying official statistics. The discovery of such an act has given rise to skepticism toward the Greek government’s capacity to properly manage its economic and fiscal affairs, resulting in the successive downgrading by rating agencies of its government bonds. The downgradings in turn brought about a hike in bond yields, making it difficult for the government to raise funds from the market, and forced it to ask the EU and the IMF for financial assistance in May 2010. The financial assistance has been provided in installments on condition that the program is monitored by the IMF and the EU through quarterly reviews and makes progress on schedule. The disbursement of the sixth tranche was due to be approved in September 2011; however, the approval was suspended following findings that Greece would be unable to achieve its budget deficit target for both 2011 and 2012. The Greek economy is in the middle of a severe recession, and there is a strong likelihood that after facing four successive years of contraction it will continue to shrink. As a result, tax revenues have not grown despite increases in tax rates, thus undermining the government’s fiscal reconstruction efforts. Additionally, it has been pointed out that, partly because of problems associated with the government’s capacity to collect taxes, it is difficult to devise effective measures to raise tax revenues. Against this background, financial markets are conscious of the possibility that the program of fiscal consolidation and economic reform could stall unless the government conducts more drastic expenditure cuts and takes decisive measures to raise revenues through, for example, the privatization of government enterprises. The sixth tranche is likely to be disbursed during the first half of November, following the passage in late October of a bill by the Greek Parliament that provides for further reductions in the fiscal deficit, including layoffs of public employees. Yet, how things develop remains to be seen. BIS central bankers’ speeches When it was agreed in May 2010 to provide financial assistance to Greece, it was expected that from 2012 Greece would be in a position to raise funds from the market on the assumption that steady progress would be made in fiscal consolidation and economic reform. This scenario looks increasingly unlikely now with Greek government bond yields remaining at prohibitively high levels. The EU, the IMF, and Greece, therefore, agreed on a second bailout package for Greece – separate from the financial assistance mentioned so far – to provide funds from 2012 onward. In addition, it was agreed that given the sheer size of the government debt, the provision of financial assistance alone was not enough to bring the Greek government debt position to a sustainable level. Therefore, through the intermediation of the Institute of International Finance (IIF), a global association of financial institutions, financial institutions – private-sector creditors – with large holdings of Greek government bonds were asked to bear a part of the burden on a voluntary basis. More specifically, holders of Greek government bonds due to mature by 2020 were asked to exchange most of their holdings into new bonds at a discount of some 20 percent of the present value; in other words, the debt was to be cut by roughly 20 percent. In turn, the principal of the new bonds would be guaranteed and it is reported that a large number of the bond holders represented by the IIF agreed. More recently, however, some EU member countries voiced the view that, with Greece’s fiscal situation deteriorating more rapidly than had been anticipated, a steeper write-down of Greek government bonds was necessary. In other words, it became increasingly clear that reducing Greek debt by some 20 percent of the present value would be insufficient to sustain the Greek government’s ability to repay its debts. In view of this, meetings were held at the end of October between the EU and the IIF, and it was agreed in principle that creditors would write off 50 percent of their Greek bonds. At the same time, it was agreed that Greece should implement further fiscal consolidation measures. In order to meet its international commitments, Greece, with the economy already in a prolonged recession, was thus required to introduce additional restrictive fiscal measures, which may intensify the vicious cycle of economic contraction. Policies for the reduction of national debt are unavoidable, but what the Greek economy needs more than anything else to break out of its vicious cycle is to press ahead with growth-generating economic reforms and build a path toward credible fiscal consolidation to regain market confidence. 2. Mechanisms to stop the Greek fiscal crisis from spreading The second problem concerns mechanisms to stop the crisis in Greece from spreading to other euro area member states. In response to the financial turmoil triggered by the collapse of Lehman Brothers in 2008, European countries introduced various measures to help boost the economy and rescue banks. Such measures inevitably led to increases in fiscal deficits and government debts. It is in this context that the crisis in Greece spread to some peripheral European countries, such as Ireland and Portugal, which were perceived to have relatively greater difficulties in proceeding with fiscal consolidation and/or economic reforms. In order to prevent the current fiscal and financial problems in the region from triggering a chain reaction, the EU created the European Financial Stability Facility (EFSF) in 2010. The EFSF can raise funds through the issuance of bonds, the proceeds of which can then be used to provide loans at below-market interest rates to financially troubled euro area countries. These bonds are effectively guaranteed by euro area member states that remain financially healthy. So far, loans in this form have been extended to Ireland and Portugal, which requested financial assistance, and the second bailout package for Greece is due to use funds from the EFSF. Subsequently, at the Meeting of Heads of State or Government of the Euro Area, it was agreed to increase the size of guarantees for EFSF bonds, thereby raising the ceiling of the facility’s lending capacity. The EFSF is now able to purchase government bonds from the market and to inject more funds into the banking system by, for example, recapitalizing financial institutions. The agreement was ratified in October 2011. BIS central bankers’ speeches In financial markets, however, concerns emerged about possible contagion of the crisis to other euro area member states such as Spain and Italy. These countries have much larger economies, and therefore the lending capacity of the facility already agreed at the Meeting of Heads of State or Government of the Euro Area was perceived to be insufficient to fend off a further spread of the crisis. However, an additional increase in the lending capacity was difficult due to strong opposition led by Germany. At the Euro Summit, a meeting of EU and euro area leaders held at the end of October, it was therefore agreed to leverage the resources of the EFSF to enhance its ability to deal with critical situations.2 It will probably take a while for the leverage plan to actually take effect, as details have to be worked out in November and then need to be approved by each member state. Needless to say, building mechanisms to prevent the fiscal crisis from spreading to the euro area as a whole is extremely important for the stability of international financial markets. What matters is whether the mechanism succeeds in gaining the confidence of the market.3 3. Fiscal problems leading to problems in the financial system The third problem is that the fiscal problems in Europe are threatening the stability of the financial system. What started out as a fiscal problem in Greece, coupled with concerns over its ability to consolidate its finances and carry out economic reforms, has spread to other European countries, with doubts arising regarding their creditworthiness. This, in turn, raised concerns about the balance sheets of European financial institutions holding large volumes of government bonds of peripheral countries. Consequently, European financial institutions, including financial institutions from France and Belgium – core countries – began to find it difficult to raise funds from markets. The fiscal problems in Europe have thus begun to seriously undermine the stability of the financial system in the region. In July 2011, the results of a stress test for financial institutions performed by the EU confirmed that progress was being made in strengthening their capital bases. However, the results did not mitigate investors’ concerns over the soundness of the financial system. In fact, the IMF has stressed the need for European financial institutions to make a substantial capital enhancement based on its estimate of potential losses of 200 billion euros that European financial institutions could suffer in the event of a collapse in the prices of government bonds of peripheral countries such as Greece. However, given the current weakness in stock markets, it is not easy for financial institutions to increase capital on their own. As a result, concerns about counterparty risk have increased, causing some financial institutions to reduce interbank market trading activities. In addition, uncollateralized interbank trading, particularly of term instruments, has been declining, leading to an increase in funding costs for European financial institutions, mainly for longer-term and U.S. dollardenominated funds. In a comprehensive set of additional measures agreed at the end of October, the EU decided to require European financial institutions to attain a Core Tier 1 capital ratio of 9 percent by end-June 2012, after accounting for market valuation of sovereign debt exposures. It was also decided that when financial institutions are unable to increase capital by themselves, national governments should provide support or, if they are unable to do so, the EFSF should do so. It would have been easier to come up with a solution if the problem had been contained to fiscal deficits, as was the case for Greece at the beginning. The appropriate response would Leverage here refers to, for example, “guarantees” to be provided by the EFSF, which could amount to many times over what the facility can directly lend. If approved, the EFSF could be given more flexibility over the measure to prevent a crisis from spreading to major euro area member states. In addition, it has already been decided to make the EFSF a permanent institution and set up in mid-2013 the European Stability Mechanism (ESM) with the aim of facilitating a smooth restructuring of government debt issued by countries in financial difficulties. It has also been reported that discussions are underway to bring forward the starting date of the ESM by a year. BIS central bankers’ speeches have been to increase government revenue and reduce expenditure in the short term, while pushing through a wide range of economic reforms in the medium to long term aiming to achieve sustainable growth. However, when it comes to measures to stabilize the financial system, things become much more difficult, because the impact on international financial markets cannot be ignored. A major factor currently destabilizing international markets lies in the daunting situation of having to deal with two crucial issues simultaneously – fiscal imbalances and instability in the financial system. B. Effects on economic activity in Europe The problems in Europe have started to affect activity in the real sector of the economy (such as production, business investment, and consumption), setting off a downward spiral among the economy, the fiscal situation, and the financial system. Keeping this in mind, I will now touch upon the current situation of and outlook for economic activity in Europe. At present, the recovery in the European economy seems to be stalling due to the slowdown in the domestic and global economies. Growth in exports, which had been the main engine of economic growth, has slowed sharply, while growth in production and consumption has also decelerated. Furthermore, corporate and consumer sentiment has worsened. Nevertheless, the economies of core countries, particularly Germany with a strong manufacturing sector, remain relatively robust on the back of firm business fixed investment. The employment and income situation in Germany has also been improving, with the unemployment rate declining to about 7 percent. In contrast, peripheral countries, such as Greece and Portugal, have been suffering from short-term downward pressure on the economy due to additional austerity measures following the downgrade of their sovereign debt ratings. Their international competitiveness has long been weak, so that it will be a challenge for them to achieve economic growth, and – as we have already seen – the market remains deeply concerned about the sustainability of government finances in these countries. With regard to the economic outlook for Europe, a very moderate recovery is expected on the whole. Although private consumption is unlikely to grow because household incomes remain under severe pressure, exports are expected to increase gradually based on steady growth in emerging economies. In addition, business fixed investment in core countries is expected to remain firm. Nevertheless, restoring fiscal health is a challenge faced by all euro area countries. The government-debt-to-GDP ratio for the euro area as a whole was 85.4 percent in 2010, well above the euro convergence criterion of 60 percent. This wide gap highlights the need for continued efforts to reduce fiscal deficits and the limited scope for expansionary fiscal measures for the euro area as a whole. As for monetary policy, the policy interest rate is already low at 1.5 percent, leaving little room for further reductions. In view of the limited room for fiscal and monetary policy, it is necessary to be aware of the possibility of economic instability continuing for a while. III. Japan’s economy and the Bank of Japan’s policy measures Based on the developments in the global economy and international financial markets described so far, I will now talk about the current situation of and outlook for Japan’s economy and measures taken by the Bank. For details, please refer to Outlook for Economic Activity and Prices released by the Bank on October 28, 2011. A. Japan’s economy Following the earthquake on March 11, 2011, Japan’s economy contracted sharply. This was due to the following factors: (1) production activity fell significantly nationwide due to the physical damage caused by the earthquake and tsunami to production facilities and the BIS central bankers’ speeches distribution infrastructure as well as the disruption of supply chains in the manufacturing sector, especially in the automobile industry; (2) the nuclear power plant accident led to electricity shortages, which affected both manufacturing and non-manufacturing industries; and (3) consumer sentiment weakened as a result of voluntary restraint following the disaster and the problem of radiation due to the nuclear power plant accident. 1. The current situation Japan’s economic activity has been picking up steadily as the supply-side constraints caused by the disaster have been gradually resolved. Supply-chain disruptions, for example, have been easing at a faster pace than expected thanks to the efforts made by those involved. Production and real exports have returned to their pre-quake levels, although their rates of growth have moderated recently. While exports, particularly of automobiles, have increased, those of iron and steel products as well as digital cameras have declined. Business fixed investment has been increasing moderately and the results of the September 2011 Tankan (Short-Term Economic Survey of Enterprises in Japan) showed that business fixed investment plans, including those of small firms, were relatively firm. While the overall damage caused by the flooding in Thailand is not clear at this stage, the impact on supply chains warrants careful attention, given that Japanese firms, especially in automobile-related industries, have expanded their overseas production facilities for finished goods and parts and components, including in Thailand, in recent years. Meanwhile, although private consumption has almost returned to its pre-quake level, weakness remains in some areas as indicated by, for example, the fact that restaurant sales have not returned to their pre-quake levels. Also, the number of foreigners visiting Japan has remained below pre-quake levels. 2. Outlook for economic activity and prices Although adverse effects from the slowdown in overseas economies and the appreciation of the yen may continue for the time being, Japan’s economy is expected to return to a moderate recovery path as reconstruction demand following the disaster gradually materializes. Business fixed investment is likely to expand, provided that corporate profits improve, domestic and overseas demand recovers, and government economic policies are effective. Private consumption is also expected to gradually become firmer against the backdrop of a gradual recovery in the employment and income environment. The year-on-year rate of change in the consumer price index (CPI) has recently been around 0 percent, partly due to the change in the base year for the CPI in August 2011. As for the outlook, the year-on-year rate of change in the CPI is expected to remain at around 0 percent for the time being, with a factor in addition to the base-year change being that the positive contribution from the rise in the tobacco tax and in charges for accident insurance has dissipated since October 2011. Surveys of households, firms, and economists suggest that medium- to long-term inflation expectations remain stable; however, future developments warrant continued attention. 3. Risks to the outlook While there are many uncertainties regarding the outlook for economic activity and prices, the three risks that I think warrant the most attention are the following: (1) the risk that if the fiscal and financial problems in Europe intensify they may affect Japan’s economy through various channels; (2) downside risks with regard to overseas economies other than those of Europe; and (3) the possibility that firms’ and households’ medium- to long-term growth expectations may decline in the longer run. As for the first risk, there are two main channels through which Japan’s economy could be affected: an international financial markets channel and an international trade channel. Let us start by considering the international financial markets channel. Japan’s financial markets have remained stable as a whole despite the instability in overseas markets. BIS central bankers’ speeches Moreover, so far Japanese financial institutions’ funding costs have not been affected by developments overseas, because their exposure to Greece, Portugal, and Ireland in the form of investment and lending is relatively limited. However, given the growing international linkages in financial markets, if global investors’ appetite for safe assets intensifies further, prices of riskier assets (such as stocks) could decline globally. With global financial markets being increasingly integrated, stock prices in Japan could fall as a result of developments in other markets, and the foreign exchange rate of the yen – which is seen as a relatively safe currency – against the U.S. dollar and the currencies of commodity-exporting and emerging countries might rise further. Thus, there is a risk that, as a result, business and consumer sentiment may deteriorate, pushing down economic growth. In fact, the diffusion index for overseas supply and demand conditions in the September 2011 Tankan suggests that there is a growing perception of excess supply. With regard to the export channel, as I have already stated, there is a possibility that Japan’s exports to Europe might be directly affected if economic activity in Europe decelerates as a result of the worsening of fiscal and financial problems in the area. It is important to bear in mind that in this case the impact could be substantial, since Europe accounts for about 10 percent of Japan’s exports. Moreover, there is the risk that Japan’s exports might be indirectly affected through a decrease in exports to Europe from Asian economies. As for the second risk, there is concern that the slowdown in the U.S. economy could continue given the weaker-than-expected employment situation and sluggish activity in the housing market due to the persistent downward pressure on housing prices as seen in the increasing number of home foreclosures. On the other hand, emerging and commodityexporting economies, despite declining demand from the United States and Europe, are likely to continue to grow thanks to potentially large domestic demand; however, with inflationary pressures remaining strong, whether they can achieve a soft landing, that is, achieve both price stability and economic growth at the same time, requires continued attention. Attention also needs to be paid to a possible economic slowdown in emerging and commodity-exporting economies as a result of capital outflows from these economies if investors’ risk aversion intensifies further due to contagion of the fiscal and financial problems in Europe. With regard to the third risk concerning firms’ and households’ medium- to long-term growth expectations, Japan’s economy has long been facing the challenge of a decline in the growth rate due, among other things, to the shrinking and aging of the population. In addition, Japan is now confronted with new challenges, such as uncertainty regarding the supply and demand of electric power and the reconstruction effort needed following the earthquake. I am of course anxious about the uncertainty regarding reconstruction-related demand, but what concerns me more is the uncertainty surrounding electricity supply. Electricity supply during this past summer, which was a cause of great concern, turned out not to impose considerable constraints on the economy, not only because this summer was cooler than the extremely hot summer last year, but also because of efforts by firms and households to save electricity. In the longer run, however, the resumption of operations at nuclear power plants that are or will be under regular inspection is still unclear. Given this and the possibility that we might have an extremely cold winter or a heat wave next summer, uncertainty regarding the supply of electricity therefore remains, and as long as this uncertainty lingers, corporate activity could be restrained. In addition, attention needs to be paid to the possibility that a further appreciation of the yen could exert downward pressure on corporate profits, employment, and income, or accelerate the shift to overseas production, which could in turn lead to a decline in firms’ and households’ medium- to long-term growth expectations and increase the downside risks to the economy. B. The bank’s conduct of monetary policy and responses to the earthquake Taking into account the situation mentioned above – economic conditions abroad and in Japan, the outlook for Japan’s economy, and the various risk factors – the Policy Board of BIS central bankers’ speeches the Bank, consisting of nine members including myself, at the Monetary Policy Meeting on October 27, 2011 decided to enhance monetary easing. I will now explain the policy measures currently implemented by the Bank as well as the background of the decision. 1. Enhancement of the comprehensive monetary easing policy The first of the measures is a strengthening of the comprehensive monetary easing policy that the Bank has been implementing in order to pursue powerful monetary easing and underpin Japan’s economy from the financial side. As part of the comprehensive monetary easing, the Bank has set its policy interest rate at an extremely low level of around 0 to 0.1 percent, and made a commitment that it would basically continue with the low policy interest rate until it judged that price stability was in sight. Moreover, in October 2010, the Bank established the Asset Purchase Program (hereafter the Program), a new framework through which the Bank purchases various risk assets, such as government securities, commercial paper (CP), corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) in order to encourage a decline in longer-term interest rates and various risk premiums. The Bank increased the total size of the Program by about 5 trillion yen to about 40 trillion yen in March 2011, immediately after the earthquake, and by about 10 trillion yen to about 50 trillion yen in total in August in light of various risks, such as the effects of uncertainty regarding overseas economies and of the rapid appreciation of the yen on business sentiment as well as on economic activity. In addition, at the end of October 2011, the Bank decided to increase the total size of the Program by about 5 trillion yen to about 55 trillion yen reflecting the fact that some more time would be needed to confirm that price stability was in sight and that due attention was needed to be paid to the risk that the economic and price outlook would further deteriorate depending on developments in global financial markets and in overseas economies. Such asset purchases will continue to be made through the end of 2012, and since further monetary easing is still in progress, the effects of monetary easing will continue to appear hereafter. 2. Ensuring stability in financial markets Second, the Bank has been making efforts to ensure stability in financial markets in order to maintain the smooth conduct of economic and financial activities in Japan. Immediately after the earthquake, the Bank provided ample funds to meet demand in financial markets for several successive days to preempt concerns about potential liquidity shortages in the interbank money market. Thus, on March 14 – the first business day after the earthquake – the Bank conducted funds-supplying operations totaling 21.8 trillion yen. As a result of measures such as this, money market rates, which had temporarily risen immediately after the earthquake, soon regained stability. Since then, with the Bank continuing to provide ample funds and Japan’s financial system relatively sound, financial markets in Japan have remained relatively stable despite the heightened strains in European financial markets. 3. Providing support to strengthen the foundations for economic growth Third, as part of the efforts to strengthen the foundations for economic growth – a more medium- to long-term challenge – the Bank has introduced the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth, which aims to act as a catalyst for firms and financial institutions working toward this end. Under this measure, the Bank provides loans at a low interest rate of 0.1 percent for, if rolled over, up to four years to financial institutions for financing of and investment in projects that help to strengthen the medium- to long-term growth potential of Japan’s economy. The Bank has been working on new initiatives such as the establishment in June 2011 of a new line of credit, which expanded the range of eligible investments and loans to encompass loans without real estate collateral or guarantees (including asset-based lending, or ABL). BIS central bankers’ speeches 4. Funds-supplying operation to support financial institutions in disaster areas Fourth, following the earthquake and tsunami, the Bank introduced the funds-supplying operation to support financial institutions in disaster areas in April 2011 with the aim of supporting financial institutions in these areas in their initial response efforts to meet the demand for funds for restoration and rebuilding. Although there has been some demand for credit for rebuilding in disaster areas, it is still subdued. However, as the six loan disbursements that have been carried out by the Bank show, there is sufficient credit demand and the operation is having some effect, since around 490 billion yen of the total of 1 trillion yen initially set by the Bank has been disbursed. The Bank has been closely monitoring the funding situation of financial institutions in disaster areas, which has made some progress reflecting the inflow of funds to support disaster areas and of insurance payments. The deadline for new applications for loans under this scheme had originally been set for the end of October 2011, but on October 7 the Bank announced the extension of the deadline to April 30, 2012 in order to continue to support financial institutions in disaster areas in their efforts to meet demand for funds for restoration and rebuilding. 5. U.S. dollar funds-supplying operations against pooled collateral Fifth and finally, given the turmoil in international financial markets, the Bank established a framework to supply U.S. dollar funds in emergency situations with the aim of providing reassurance to market participants and, in coordination with major central banks abroad, has been conducting U.S. dollar funds-supplying operations against pooled collateral on a regular basis, with one-week funds being supplied weekly and three-month funds, in principle, monthly. As I mentioned when discussing the fiscal and financial problems in Europe, European financial institutions have seen their U.S. dollar funding costs rise. However, U.S. dollar funding conditions for Japanese financial institutions do not appear to have tightened substantively when compared with their counterparts overseas. Nevertheless, given the growing interconnectedness among financial markets worldwide, there is a risk that volatility in global financial markets could spill over to Japan in a short period of time. From this perspective, the U.S. dollar funds-supplying operations against pooled collateral is also important in that it functions as a safety net for Japanese banks conducting business abroad. BIS central bankers’ speeches
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Lecture by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the London School of Economics and Political Science, co-hosted by the Asia Research Centre and STICERD, London School of Economics, London, 10 January 2011.
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Masaaki Shirakawa: Deleveraging and growth – is the developed world following Japan’s long and winding road? Lecture by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the London School of Economics and Political Science, co-hosted by the Asia Research Centre and STICERD, London School of Economics, London, 10 January 2011. * * * Introduction “It was the best of times, it was the worst of times...” Thus begins A Tale of Two Cities, by Charles Dickens, the bicentennial of whose birth we will celebrate next month. While this famous opening sentence of the novel refers to the year 1775, it also strikes a chord with us in 2012. On the one hand, with all due respect to the frustration vented by the Occupy protesters, the people of today’s developed nations enjoy a living standard far higher than the harsh realities of Dickensian England. One of the few luxuries available to young David Copperfield, the alter ego of Dickens, was to take a plunge in the cold spring water at the old Roman Bath just a few hundred yards from this hall. On the other hand, it is also true that people feel as if the economy is in the worst possible shape. Difficult issues in their own right, such as mounting government debts, aging of the population and challenges brought about by globalization, are exacerbated by stagnant growth. These days, when people discuss the grim economic outlook for developed countries, I find that Japan’s experience is often cited. In the past twenty years, Japan’s growth rate has been very low, at 1.0 percent annually in real terms and 0.4 percent in nominal terms (Chart 1). People ask whether their economies are going to experience a lost decade – or more recently two lost decades – like Japan. As the governor of Japan’s central bank, I have mixed feelings when I hear Japan’s experience referred to in such a negative context, and I should also note, for the reasons I explain later, that it is not appropriate to bunch the two decades together. Nevertheless, I cannot deny that this question also provides much food for thought for other developed countries. Therefore, with apologies to two talented Liverpudlians and a song that they wrote over 40 years ago, I would like to share with you some of my thoughts today on the theme “Is the Developed World Following Japan’s Long and Winding Road?” It will be my great pleasure if my speech can be of some benefit to you. I. Change in how Japan’s experience is discussed To me, the question of whether other developed countries will repeat Japan’s experiences is itself surprising and appears to indicate that a significant intellectual change is under way. At various international meetings I have attended in the past ten years or so, policy makers and academics often have not seriously discussed the issue of stagnant growth in Japan, simply dismissing it as “an idiosyncratic failure of Japan’s society and its policy makers to respond to problems in a swift and bold manner”. Even after U.S. housing prices started to decline in the spring of 2006 this tendency remained. The following is a comment made by a U.S. official in January 2007.1 “The financial instability that many countries experienced in the 1990s, including Japan, was caused by bad loans that resulted from declines in commercial property prices and not Mishkin, Frederic S., “The Role of House Prices in Formulating Monetary Policy”, Speech at the Forecasters Club of New York, January 17, 2007. BIS central bankers’ speeches declines in home prices. ... Many have learned the wrong lesson from the Japanese experience. The problem in Japan was not so much the bursting of the bubble but rather the policies that followed.” What I see behind this comment is a gross underestimation of the extent of the balance sheet repair – or deleveraging – required after a bubble bursts, as well as an overconfidence in the effectiveness of aggressive policy measures.2 However, comparing Japan’s experiences in the early 1990s after the bubble burst to what happened in the United States, the euro area, and the United Kingdom in the past few years, it is my impression that the similarities far outweigh the differences. What happened in Japan was not unique to Japan. The first similarity is economic performance. For example, the paths of real GDP since the peak of the respective bubbles, 1990 in Japan and 2006 in the United States, are similar (Chart 2).3 Some may say that the selection of the base year is somewhat arbitrary but the same conclusion can be drawn if we choose as a starting point the year in which the financial crisis occurred, 1997 for Japan and 2008 for the United States (Chart 3). Comparisons with experiences in the euro area and the United Kingdom also show similarities, despite some differences in degree (Chart 2 and 3 as cited above). Some interesting similarities can be also found in other bubble-related variables. For example, the pace of decline in real estate prices in the U.S. after its bubble burst was almost the same as in the Japanese case (Chart 4). Despite some differences among countries and regions, overall developments in longterm interest rates were similar (Chart 5). Cross-country similarity was also evident in developments in bank lending (Chart 6). The second similarity is initial responses from the authorities and economists. When a bubble is being formed or even soon after it bursts, they underestimate the problem or deny its very existence. In Japan, after real estate prices started to decline, people talked about a reversal and subsequent upturn. Even after property prices continued to fall for some time, society denied the possibility that the decline would lead to a financial crisis or stagnation of the macro economy. In the case of the bursting of the housing bubble in the United States and the sovereign debt crisis in Europe, the initial reaction was also underestimation of the problem. Even at a later stage, when experts agreed on the need for public support for financial institutions, such measures met with opposition from the general public, influenced by the lingering effects of the underestimation, which was also seen in the case of Japan. In particular, injecting public funds into financial institutions was universally unpopular across countries. Likewise, the provision of financial support from core countries to peripheral countries in the euro area is politically unpopular. The third similarity is the policies adopted by central banks (Chart 7). In developed countries, short-term interest rates declined to close to zero and central bank balance sheets expanded enormously. Since the second half of the 1990s, the Bank of Japan successively introduced various unorthodox policy measures including zero interest rates, a commitment to maintain zero interest rates, quantitative easing, and the purchase of risk assets, including stocks held by financial institutions. After the subprime loan problem materialized, the U.S. Federal Reserve adopted various policy measures that were often described as innovative, but in fact many of them are essentially similar to measures previously adopted by the Bank of Japan. This fact demonstrates the unsurprising truth that central banks act similarly when At the press conference in February 2009, President Obama said, “[I]f you delay acting on an economy of this severity, then you potentially create a negative spiral that becomes much more difficult for us to get out of. We saw this happen in Japan in the 1990s, where they did not act boldly and swiftly enough, and as a consequence they suffered what was called the ‘lost decade’ where essentially for the entire ’90s they did not see any significant economic growth…” In the case of Japan, stock prices peaked at the end of 1989 and real estate prices, based on “Published Price of Land”, peaked on Jan. 1, 1991. The peak of the U.S. housing prices, based on “Case-Shiller Index”, was the second quarter of 2006. BIS central bankers’ speeches confronting similar problems. If there was any major difference, it was that the Bank of Japan was a lonely forerunner and had to feel its way forward, making decisions in the uncharted territory of unorthodox policy. The fourth similarity is the decline of the effectiveness of monetary policy in an economy that is deleveraging, or in other words, that needs to address the problem of balance sheet repair. When it comes to the transmission mechanism of monetary policy, in Japan, lower interest rates had previously induced an increase in banks’ lending to small- and medium-sized firms. This in turn increased business fixed investment by such firms, which drove economic recovery. This mechanism did not work, however, after the bubble burst. Similarly, in the United States, a decline in long-term government bond yields has not been fully transmitted to a decline in the effective rates of mortgage loans because borrowers with low credit scores have not refinanced at lower interest rates. In Europe – Spain is a prime example – bank lending rates have risen due to higher interest rates for covered bonds, reflecting a deterioration in the quality of real estate collateral. I have gone through some similarities between the current state of the U.S. and European economies and Japan’s experiences. Needless to say, there are also differences. The first difference is the fact that Japan never became the epicenter of a global financial crisis. The most important reason for this is that the Japanese authorities did not allow the disorderly failure of financial institutions. In this regard, the most challenging time for Japan was 1997, when the brokerage Yamaichi Securities, with assets of 3.7 trillion yen or 19 billion pounds at that time, collapsed. Yamaichi Securities also had sizeable presence internationally, especially in the European capital markets. At that time, as was the case when Lehman Brothers failed, Japan did not have a bankruptcy law that enabled the orderly resolution of securities companies. Given such circumstances, the Bank of Japan decided to provide an unlimited amount of liquidity to Yamaichi Securities. This measure essentially enabled an orderly resolution by replacing all exposures to the securities company held by market participants both domestic and overseas with exposures to the Bank of Japan and so prevented the materialization of systemic risk. This was truly a tough decision for the Bank of Japan. It was made without knowing whether the institution was solvent or insolvent, and eventually resulted in some losses. I would say, however, that the benefit of preventing systemic risk from materializing far exceeded such costs. As a result, Japan did not experience a sharp and significant plunge in economic activity like the one that followed the collapse of Lehman Brothers, and negative impact from financial turmoil in Japan did not spread to the rest of the world (Chart 8). The second difference is the length of time before the economy was exposed to acute market pressure after the bubble burst (Chart 9). In the Japanese case, non-performing assets were mainly loan assets, which were not marked to market. For that reason, it took more time before unrealized losses were recognized and correspondingly it took longer for the financial institutions involved to be exposed to acute market pressure. On the other hand, in the recent cases of the United States and Europe, the problem started in the securitized products market, which enabled the recognition at a relatively early stage of losses based on mark-to-market valuation, and therefore market pressures intensified earlier than in the Japanese case. As a result, a financial crisis materialized at an early stage and financial system stability measures were introduced in a relatively prompt manner. Examining these differences further, however, the plunge in output might have been limited in the case of Japan simply because the scope of the crisis was confined within the country. Even if financial system measures are introduced at an earlier stage, these measures do not mark the end of deleveraging that characterizes an economy after a bubble bursts. What happened in Japan, the United States and Europe was basically the same: the paying down of excess debt, or deleveraging. For the purpose of considering policy responses after the bursting of a bubble, I believe that examining similarities and differences in this way shows BIS central bankers’ speeches that it is more constructive to focus on similarities instead of differences, and then consider factors peculiar to each country. II. Facts about low growth in Japan In order to explain these similarities and differences, I would like to comment on Japan’s economy in a little more detail. Specifically, I will explain some facts about economic growth in Japan by looking at three different time horizons. Economic growth in Japan: long-term, medium-term, and short-term First, examining the long-term growth trend, Japan is known as a country which once recorded surprisingly high growth rates, just like China has done in recent years. The peak period of Japan’s high-growth era was the 15 years from 1956 to 1970, during which real GDP grew at 9.7 percent annually (Chart 10). Incidentally, this growth rate is exactly the same as that recorded by China in the period starting in the early 1990s. However, the good times inevitably come to an end, sooner or later, for any country enjoying such high growth. This is because some of the conditions that support high growth, especially the labor supply from rural areas to cities and the high rate of increase in labor force, will eventually reach their peak.4 Second is the medium-term time horizon. Although Japan’s high-growth period ended in the 1970s, its rate of economic growth continued to be much higher than in other developed countries. Since the 1990s, however, Japan has ceased to be a high-growth economy, even in a relative sense. In the past twenty years, Japan’s growth rate has been very low, at 1.0 percent annually in real terms and 0.4 percent in nominal terms. That is why the past twenty years are sometimes called “Japan’s two lost decades” (Chart 1 as cited above).5 Third is very short-term growth developments. Japan’s economic activity plunged after the tragic earthquake and tsunami on March 11 last year, but recovery proceeded at a higherthan-expected pace thanks to the efforts made by companies, individuals, and the public sector. Although Japan’s economy is not immune to a slowdown in the global economy, compared to the United States and Europe, the stability of Japan’s financial system and financial markets is notable, as evidenced by the risk spreads observed in funding markets and corporate bond markets (Chart 11). Reasons for low growth over medium term Of the three time horizons that I have just explained, hereafter I will focus on medium-term economic developments. Although I have used the phrase “the two lost decades”, the causes of low growth in Japan in the 1990s and 2000s were different and it is somewhat misleading to discuss the two periods together. In the 1990s, low growth was mainly brought about by the deleveraging associated with the unprecedented bursting of the bubble. In the 2000s and thereafter, the major causes of low growth in Japan have been rapid population aging and population decline. For Japan’s high growth period including a comparison with the current state of the Chinese economy, see Masaaki Shirakawa, “The Transition from High Growth to Stable Growth: Japan’s Experience and Implications for Emerging Economies”, Remarks at the Bank of Finland 200th Anniversary Conference in Helsinki, May 5, 2011. http://www.boj.or.jp/en/announcements/press/koen_2011/ko110506a.htm For Japan’s experience after the bubble burst, see Masaaki Shirakawa, “Way Out of Economic and Financial Crisis: Lessons and Policy Actions”, Speech at Japan Society in New York, April 23, 2009. http://www.boj.or.jp/en/announcements/press/koen_2009/ko0904c.htm BIS central bankers’ speeches Regarding the impact of the bursting of the bubble in the first half of the two periods in question, I do not have much to add to what I have already explained. If I can point out one difference, the rise in the unemployment rate in Japan was relatively limited (Chart 12). Japan’s unemployment rate peaked at 5.4 percent, significantly lower than the double digit figures reached in the United States and major European countries. This is attributable to the fact that wage levels were adjusted in a reasonably flexible manner, reflecting society’s preference to prioritize employment. That people’s jobs were preserved was a positive in terms of social stability. At the same time, it also had a negative consequence. Wage levels were adjusted but not sufficiently for the magnitude of the shock to the economy, and a situation arose in which effectively unemployed people retained their jobs at companies. This delayed the necessary reallocation of resources to respond to demand and cost changes after the bubble burst. The decline in wage levels also contributed to deflation through a decline in the prices of services which are labor intensive. In fact, a significant portion of the inflation differential between Japan and the United States reflects changes in service prices rather than goods prices. As for the second of the two lost decades, low growth was mainly attributable to demographics, or more specifically, a rapid aging of the population. Japan’s real GDP growth rate has declined and growth has been subdued compared to other developed countries. However, comparing the average real GDP growth rate per capita over the past ten years, Japan’s growth rate is almost the same as other developed countries. Moreover, Japan is highest in terms of real GDP growth rate per working-age population (Chart 13). As indicated by these figures, the most significant challenge confronting Japan is how to adjust to a rapid demographic change that is unprecedented in developed countries (Chart 14). To a significant extent, the decline in growth rates and deterioration in fiscal conditions are attributable to a failure to adjust to the rapid change in demographics. Although forecasts by economists almost always involve a large margin of error, demographic trends are one of the few economic variables that can be projected with relatively high accuracy. The implications of population aging and decline are also very profound, as they contribute to a decline in growth potential, a deterioration in the fiscal balance, and a fall in housing prices. Given that other developed countries will face the same problems despite some differences in timing and magnitude, the economic effects of demographics deserve further study. III. Is the developed world following Japan’s long and winding road? Now I would like to focus on the key question which I posed at the start of my speech. Is the developed world following Japan’s long and winding road? Of course, this is not the kind of question that can be answered with a simple yes or no. Policy measures are shaped by not only economic factors but also the response of society and the political world. Every country has its own unique complexity, both in social and political terms, of which outside observers have only a limited knowledge. Therefore, instead of providing a direct answer to the question, I would like to list three factors that define the length of time necessary for adjustment. The first factor is the size of excess debt accumulated before a crisis. And if we simply look at rough estimates of excess debt, it appears that a lengthy period of adjustment is inevitably required. The scale of the global credit bubble formed toward the middle of the 2000s was indeed gigantic. The second factor is growth potential. In the end, whether the amount of debt assumed by an economy is excessive or not can be judged by considering it in proportion to the economy’s size. For two economies with the same amount of debt, the one with higher growth potential can lighten the burden of excess debt faster. Having said that, growth potential is not fixed and can change as a result of policy measures and the response of the society after a bubble bursts. In that sense, avoiding collateral damage from the bursting of a bubble becomes extremely important. BIS central bankers’ speeches Collateral damage could materialize in various ways. For example, in a low-growth economy that is in the process of deleveraging, social stress tends to intensify and is more likely to result in a rise in protectionism and excessive government intervention. When lending to nonviable firms continues for political or social reasons, the resultant decline in productivity growth will lower growth potential. Furthermore, monetary policy can also distort economic incentives. Low interest rates and abundant liquidity are necessary but if they continue for a long time, they may lower productivity by keeping inefficient firms alive. Necessary adjustment will also be delayed if low interest rates discourage the government from making efforts to restore fiscal balance. Population decline will also prolong the adjustment of excess debt by lowering growth potential. Although these are common problems for the developed world, the decline in population growth and aging of the population profile are most serious in Japan. The rate of population growth is lower in Japan than in the United States, the euro area, and the United Kingdom. More importantly, the fast pace of decline in the population growth rate has been placing burden on Japan’s economy and society. Also, compared to Japan, the contribution to population growth from immigration is significant in the United States and many European countries. However, this contribution from immigration could diminish if the stagnation of economic activity is prolonged (Charts 15 and 16). The third factor is the growth rate of the global economy. Since the early 2000s, Japan’s economy gradually overcame the post-bubble effects of deleveraging. However, Japan was also greatly helped by the high growth in the global economy at that time, growth that was almost unprecedented in the past several decades (Chart 17 and 18). In retrospect, during that period, the global economy was in the very process of creating a global credit bubble and also led by strong performance of emerging economies. Given that growth rates in developed countries are currently restrained by post-bubble deleveraging effects, it is now of prime importance that emerging economies continue growing without causing inflation or bubbles of their own. Of these three factors that define the length of time needed for deleveraging, the first one – the initial size of excess debt – is a given once a bubble bursts, but we can still influence the remaining two factors: the growth potential of individual economies and growth momentum in the global economy as a whole. After the bubble burst, the priority is to maintain the stability of the financial system. At the same time, it is also important to adapt the economy to a new environment and resist to pressures that would lead to collateral damage. This requires strong will and determination. IV. The role of Central Banks Given the limited time remaining, I would like to wind up my remarks by briefly explaining my thoughts on the role of central banks in this difficult period. In addition to the aforementioned four similarities, there is another similarity between Japan, the United States and European countries after the bursting of their respective bubbles. That is, opinions are sharply divided with regard to the roles central banks should play. In the United States, criticism of aggressive central bank measures seems to prevail, as evidenced by negative reactions by politicians to the QE2 measures. In other developed countries, however, central banks apparently face rising expectations and demands to deal with the situation against a background of sluggish growth. The recent discussion about the responses to the sovereign debt crisis in Europe confirms this point. Maintaining price stability and financial system stability are important goals of central banks, but central banks are not able to solve all problems, especially in an economy characterized by zero interest rates and deleveraging. Central bank governors including myself have made this point clear BIS central bankers’ speeches recently.6 I would like to concur with the assessment of my respected colleague, Sir Mervyn, who said that “There’s a limit to what monetary policy can hope to achieve”.7 What can be accomplished by central banks? Or, what are central banks expected to accomplish? Conversely, what cannot be accomplished by central banks? Looking back at the process of how bubbles form and burst, and the financial crises that ensue, I would like to make the following four points. My first point concerns the role of central banks in providing liquidity to banks as “a lender of last resort”, which is extremely important in maintaining financial system stability. If there is a sharp financial contraction, it becomes more likely that the economy will experience an abrupt and significant downturn in a short period of time. Given the current circumstances where the European sovereign debt crisis has been worsening, this lesson is particularly important to all of us. At the same time, we need to bear in mind that providing liquidity as “a lender of last resort” is, in essence, a policy to “buy time”. It is essential that the necessary structural reforms take place while time is being bought, as the time that we can buy becomes progressively more expensive. My second point concerns the conduct of monetary policy after a bubble bursts. Monetary easing can affect the economy either through bringing forward future demand or bringing in overseas demand. In the former case, available future demand gradually decreases as monetary easing is prolonged. In the latter case, when economic growth in developed countries is generally weak, monetary easing in individual countries aiming at bringing in overseas demand may increasingly lead to a zero-sum game, which is not desirable for the sustainable growth of the global economy as a whole. Such diminishing returns, however, do not release responsible central banks from the need to act. That is why, at the present time when short-term interest rates in major economies have declined to almost zero, central banks, including the Bank of Japan, have been making efforts to generate monetary easing effects by implementing various unorthodox measures to lower long-term interest rates and credit spreads. While central banks are buying time with these measures, it is still essential to pursue the necessary structural reforms. My third point concerns the paradox of success in the conduct of monetary policy. The goal of monetary policy is to achieve sustainable growth with price stability. This is a wellestablished principle that is shared in Japan, the United Kingdom and globally, regardless of whether an inflation targeting framework is adopted. The more successful the conduct of monetary policy is, however, the more stable prices become and the less volatility is seen in economic activity and financial markets. When the expectation prevails that a stable economic and financial environment will continue for a long period of time, it is likely to encourage leverage and maturity mismatches between the assets and liabilities of financial institutions. The greater the leverage and maturity mismatches are, the more exposed the economy is to a possible unwinding triggered by a given event, so the more fragile it becomes. The bursting of bubbles is the materialization of such fragility. Before the global financial crisis, there was a debate over how to deal with bubbles, with one camp stressing ex-ante prevention and another emphasizing the importance of ex-post measures to resolve the situation in the aftermath. Following the global financial crisis, however, all now appear to agree that the cost of a bubble bursting is unbearably enormous. Most past bubbles were formed while economies enjoyed low inflation rates. Focusing obsessively on the short-term stability of the consumer price index as a way to ensure economic stability will actually have See the following comments. Bernanke, Ben S., Testimony at the Joint Economic Committee, U.S. Congress, October 4, 2011: “Monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the U.S. economy”. Draghi, Mario, Interview with the Financial Times, December 14, 2011: “Monetary policy cannot do everything”. This comment was made at the press conference on November 16, 2011 after presenting the Inflation Report. BIS central bankers’ speeches the opposite effect of increasing instability. Needless to say, bubbles are not caused by low interest rates alone. However, when the expectation prevails that low interest rates will continue for a long period of time, it is likely to encourage leverage and maturity mismatching between the assets and liabilities of financial institutions. In that sense, I believe that in the conduct of monetary policy central banks also need to be attentive to the accumulation of financial imbalances. My final point concerns the regulatory and supervisory framework. Looking back at how bubbles are formed, the bottom line is that it comes down to aggressive activity by both borrowers and lenders. Financial institutions’ activities are influenced not only by the expectation that a stable environment will continue but also by incentives created by the regulatory and supervisory framework. As for the background to such aggressive activities by financial institutions, almost without exception regulation and supervision did not prevent them from getting involved in risky lending, which was, in retrospect, an attempt to improve their low profitability. This was the case in the Japanese bubble period and European financial institutions did the same thing during the formation of the global credit bubble in the middle of the 2000s. Central banks and the regulatory and supervisory authorities in individual jurisdictions are currently working to reform the regulatory and supervisory frameworks. One important issue in this regard is how to find the right balance between two important tasks: restraining excessive risk taking and securing the profitability of financial institutions. Closing words The recent financial crisis has certainly left not one, as the Beatles song said, but many a pool of tears. As a result, if I may return to the Dickens quote, it feels for many of us like the worst of times. It may be a bit of a stretch to say that we are in the best of times, but it is too early to despair. Our economies have the resources, not only money but also the intellectual and institutional capabilities, to resolve the issues we face. If we can adapt the economy to a new environment and resist pressures that would lead to collateral damage, even after the bursting of the bubble, we should still be able to find a path leading to renewed growth. What we need is the determination and will. Ultimately, if we have this determination and will, we can shorten the long and winding road. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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bank of japan
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kagawa, 2 February 2012.
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Hirohide Yamaguchi: The European debt problem, Japan’s economy, and monetary policy Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kagawa, 2 February 2012. * * * Introduction Thank you for giving me an opportunity to exchange views with administrative and business leaders in Kagawa Prefecture. Today marks the 70th anniversary of the establishment of the Bank of Japan’s Takamatsu branch. The branch has been operating steadily in this area for such a long time, thanks to your understanding and cooperation. I also express my gratitude. Kagawa Prefecture is a memorable place for me. I worked at the Bank’s Takamatsu branch as General Manager for about two years since May 1996. During my stint, I visited frequently many local business managers and learned about local economic and financial conditions in detail. Extraordinary managerial efforts I witnessed at that time still vividly remain in my memory. I will also never forget that I had delicious Sanuki udon here many times. Today, I will talk about the outlook for Japan’s economy and its medium- to long-term challenges, and viewpoints of the conduct of monetary policy, while focusing on the European debt problem which is the greatest concern for the global economy for the time being. I. Developments in overseas economies and the current situation of the European debt problem Overseas economies have been on a decelerating trend, and are expected to recover moderately in the future Let me start with the developments in overseas economies. Following the Lehman shock in 2008, the global economy was recovering, led by emerging economies, but the pace of recovery has been slowing since around the middle of last year. By region, the U.S. economy has been recovering moderately. Recently, there have been some bright signs in consumption and production, and the market’s view has become somewhat optimistic. The foundations for sustainable growth remain vulnerable with the housing market in the midst of a protracted slump and the unemployment rate hovering at a high level of more than 8 percent. Therefore, the pace of economic recovery is likely to remain moderate for the time being. The European economy has become increasingly stagnant as a whole on the back of the debt problem in Greece and other countries, which continues to be a great concern for the global economy. I will later talk about that problem in detail. While emerging and commodity-exporting countries have been maintaining somewhat high growth rates as a whole, the pace of growth has been slowing recently and the degree of a slowdown in growth and the decline in inflation rates have started to differ among countries. For example, in India and Brazil, the inflation rates remain high despite a pronounced slowdown in economic activity. In China, a slowdown in growth and a decline in inflationary pressure have been progressing moderately, showing signs that the economy is heading toward a successful soft-landing, albeit lingering uncertainty. According to the latest World Economic Outlook, which the International Monetary Fund (IMF) published last week, the global economic growth rate is projected to be 3.3 percent in 2012. While the projection has been revised downward, due mainly to the European debt BIS central bankers’ speeches problem, a view that the global economy will gradually recover led mainly by emerging and commodity-exporting economies has been basically maintained. The European debt problem that became increasingly serious toward the end of last year Let me turn to the European debt problem, which has been the focal question now. The problem started with the fiscal problem in Greece. In October 2009, as for Greece’s fiscal deficit, it became clear that the existing statistics did not reflect the actual conditions and the actual deficit was much larger. Therefore, skepticism spread about whether Greek government bonds could be orderly redeemed, and the prices of Greek government bonds fell substantially. In other words, yields soared and have recently been hovering above 30 percent. As Greece could not raise funds under such circumstances, it has been implementing various fiscal reconstruction measures while receiving financial assistance from other European countries and the IMF. There has been a vicious cycle in that those measures in turn put downward pressure on the economy, thereby make fiscal reconstruction itself a difficult one. Therefore, in Greece, to reduce the heavy debt burden itself, discussions on how to handle the debt in the future are going on, including partial debt cancellation by private investors concerning their exposure. The Greek problem spilled over to Portugal and Ireland which also had concern over fiscal conditions and those countries have also received financial assistance including that from the IMF. Market concern also heightened for fiscal conditions of larger countries such as Italy and Spain, the third and fourth largest economies in terms of GDP in the euro area. Italy faced a tough situation as the yield of Italian government bonds once surged to above 7 percent at around the end of last year. Thereafter, both in Italy and Spain, due partly to the announcement of fiscal reconstruction measures under new governments, the yield on government bonds has recently declined slightly. There is uncertainty whether the reconstruction measures will be surely implemented, and as massive past-issued government bonds will reach maturity through this spring, whether refunding will be smoothly made is drawing attention. With respect to Portugal, partly due to the notable downgrading of government bonds, concern over fiscal conditions has recently been increased and the yield of government bonds has been hovering at a high level exceeding 15 percent. As the yields of European government bonds soared, in other words, the prices declined substantially, European financial institutions, which held a huge amount of government bonds on the assumption that they were safe assets, incurred huge losses. As a result, those financial institutions lost market confidence, facing a rise in funding costs and difficulties in funding themselves. The situation got worse toward the end of last year, and there was growing concern that financial institutions’ behavior, including a credit crunch by institutions that struggle with funding, could further affect significantly the already stagnant real economy. Strains have somewhat mitigated since the turn of the year, and yet vigilance is required In such a situation, the European Central Bank (ECB) implemented a measure last December to massively provide extraordinarily long-term funds, a loan period of three years, to the financial market. Meanwhile, major six central banks in Japan, North America, and Europe have also made united efforts, including strengthening their supply of dollar funds, to stabilize international financial markets. As a result, market strains have somewhat mitigated since the turn of the year, such as a decline in interest rates of the dollar funds transactions. That is only slight mitigation of anxiety over funding for the time being, and European financial institutions are suspected of still being burdened with huge losses and, in relation to that, lacking capital. While they are required by the financial authorities to increase their capital ratios by the end of June, if they cannot secure sufficient capital, they have no choice but to reduce assets, which is the denominator in calculating the capital ratio, to raise their capital ratios. Such reduction of assets, the so-called deleveraging, has already started to BIS central bankers’ speeches occur, and attention should be paid to whether it further affects borrowers of funds, including firms, and emerging economies which have substantial borrowing from European financial institutions. In short, we should not lack vigilance about whether a vicious cycle – a problem which has originated on the fiscal front spreads over to the financial front and further to the real economy – will further expands globally. II. Fundamental character of the European debt problem Why is Europe burdened with the big problem? Broadly speaking, the problem has two aspects. One is a manifestation of a weakness that has said to be inherent in monetary union, in which 17 countries share the single currency “Euro”. The other is an aspect common to other advanced economies, that is, worsening of fiscal conditions as a result of the burst of a global bubble that had been created until after the mid-2000s. Discipline on public finance and competitiveness inevitable for monetary union did not function Let us start with the issue of “Euro”. In the euro area, which now consists of 17 countries, currency is unified under the single monetary policy, that is, the single policy rate, but, needless to say, countries remain separate. Therefore, if a difference in competitiveness between individual countries widens, trade surplus accumulates in countries with strong competiveness, while trade deficit accumulates in countries with weak competitiveness. If individual countries are using different currencies, through changes in the foreign exchange rate in which a currency of trade surplus country becomes strong and a currency of trade deficit country becomes weak, a difference in competitiveness will be narrowed, thereby might mitigate trade imbalances. As long as the single currency was adopted, one cannot expect such power of foreign exchange markets. In addition, individual countries cannot pursue different monetary policy according to the respective economic conditions. Of course, as those issues were understood from the outset, rules were made to encourage countries with weak competitiveness to increase competitiveness, so that there would be no significant difference in competitiveness. The “Stability and Growth Pact” that incorporated such obligations as containing fiscal deficit at 3 percent of GDP or lower, is one of such rules. It was considered that, if a limit on fiscal deficit was firmly set, it would become difficult to make up a decline in competitiveness with fiscal spending and countries had no choice but to strengthen their economic power. However, in reality, the rule was not applied stringently, partly due to policy responses on the fiscal front after the Lehman shock, and fiscal discipline gradually became loose. As a result, a difference between countries with strong competitiveness, including Germany, and those with weak competitiveness, including Greece, became increasingly large, and trade imbalance bloated. The trade deficit countries have to cover their deficit by borrowing from other countries, and financial institutions and investors in other countries continued to purchase government bonds of Greece and others with low yields, partly because they did not need to worry about the risk of foreign exchange fluctuations under the single currency euro. Consequently, trade deficit countries increased borrowing from other countries more than their potential, and could not put a brake at an earlier stage. Thus, in the case of Greece, it became difficult for excessively issued government bonds to be repaid in full after all, and such situation surfaced as this time’s debt problem. There is also a problem of ballooning fiscal deficit after the Lehman shock, which is common to Japan, the United States, and Europe Excessive government debt has been accumulated as there was a weakness in the mechanism of monetary union in the euro area. On the back of the European debt problem, BIS central bankers’ speeches there is also an aspect of deterioration in fiscal conditions due to the burst of a global credit bubble, which is common to other advanced countries. Looking back, due partly to the rise of emerging economies and financial innovation, the global economy had been enjoying high growth without inflation until after the mid-2000s. That situation was also referred to as “Great Moderation”, and especially the U.S. and European economies became increasingly confident in their future. In the United States, however, the subprime mortgage problem aggravated and eventually led to the Lehman shock and it became clear that no small part of the past high growth was nothing more than an unsustainable bubble. Also in Europe, during the phase of global growth, real estate investment surged, mainly in Ireland and Spain, and real estate prices plunged with the burst of a credit bubble. As a result, massive public funds were used for bailing out financial institutions and for an economic stimulus, and fiscal conditions deteriorated rapidly. Also in the United States, fiscal deficit surged after the Lehman shock, and there were moves that a rating agency downgraded the U.S. government bonds from the highest AAA last summer. In Japan, while fiscal deficit has always been a grave problem due partly to rapid aging, fiscal conditions also further aggravated due to a series of economic stimuli after the Lehman shock. In general, for fiscal reconstruction, namely, for reducing government debt, it is necessary not only to address the public finance itself on both the revenue and expenditure fronts, but also strengthen economic growth potential to secure tax revenue which is a resource to repay the debt. For example, in the cases of Portugal and Italy, the market is concerned about fiscal conditions and even more about weakness in growth potential. As the global economic growth prior to the Lehman shock had been inflated by a credit bubble to begin with, the global economy cannot return again to such inflated state at this point. To steadily promote fiscal reconstruction, it is necessary to create a new growth model corresponding to changes in economic structure after the Lehman shock and strengthening growth potential over the future. While I talk about Japan later, that point is existing as a daunting challenge common to Europe, the United States, and Japan. It will take time to solve the European debt problem Keeping in mind the aforementioned situation, I will address measures toward the solution of the European debt problem. As I have said earlier, market strains have been somewhat mitigated, due partly to massive funds provision of the ECB and others. That is only an arrest of bleeding for the moment. Given the basic character of the problem, the following more fundamental responses will be necessary. First, as I said before, problem countries should tackle restoring fiscal soundness and strengthening growth potential. Second, prepare a sufficient mechanism on the funds front to support such efforts by the problem countries and to rebuild the financial system. Third, to avoid a recurrence of the problem, strengthen a governance mechanism so as to exert sufficient discipline on public finance and competitiveness. And fourth, avoid a financial crisis like that at the time of the Lehman shock. While there have been some steps forward in the first through the third responses, given difficulties of the issues, it is likely to take a while to solve them. For example, to restore fiscal soundness, the government should make the public receptive to considerable patience. In addition, as measures to provide financial assistance to problem countries, the establishment of a new funds supplying framework called “the European Stability Mechanism (ESM)” and assistance measures from outside the region have been examined. As there is also a risk for fund providers, it is not going to be an easy examination. In terms of avoiding a recurrence of the problem, at the recent EU Summit, many member countries have moved forward in the direction of signing a new treaty that includes reinforcement of fiscal discipline, but there are issues, including specific steps to take from now on, that remain to be settled. Even that should eventually overcome the problem the euro area had from the outset, that is, to what extent one can intervene in each sovereign nation’s economic policy. BIS central bankers’ speeches Keeping in mind the history of the euro area, which was established by holding an ideal of creating peace, prosperity, and stability in Europe and being supported by strong political determination, it is likely that monetary union will further go again toward the evolution of monetary union by using the crisis as a springboard. In fact, the European authorities are continuing to make exceeding efforts. Given a bumpy road to the end, we could not completely rule out a possibility that strains in financial systems will increase extremely triggered by some events or, in the worst case, a possibility that market confidence in the maintenance of monetary union itself will decline. We should pay close attention to future developments while recognizing a risk that has extremely low probability to manifest itself but will have a grave impact once it manifests itself, the so-called tail risk. I have earlier said, as the fourth response, that a crisis like the Lehman shock should be avoided, and that was indeed based on the awareness mentioned above. I have so far described the current situation of the European debt problem and its fundamental character. Keeping those in mind, in the remaining time, I will refer to the developments in Japan’s economy and the Bank of Japan’s thinking of the conduct of monetary policy. III. Prospects for Japan’s economy and medium- to long-term challenges From a somewhat longer-term perspective, the economy will return to the sustainable growth path with price stability Japan’s economy declined significantly following the earthquake disaster in March last year and thereafter recovered at a pace faster than envisaged thanks to efforts by firms and people. Since early autumn, the slowdown in overseas economies, the appreciation of the yen, and the flooding in Thailand have been affecting the economy, and Japan’s recent economic activity has been more or less flat. In such situation, the Bank published last week its latest economic outlook through fiscal 2013. In terms of the median of the Policy Board members’ forecasts, the real GDP growth rate is projected to be at –0.4 percent in fiscal 2011 due mainly to the effects of the earthquake disaster and the slowdown in overseas economies. For fiscal 2012, the economy is expected to grow by 2.0 percent as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and reconstruction-related demand gradually materializes. The growth rate for fiscal 2013 is projected to be at 1.6 percent. Under such circumstances, the year-on-year rates of change in the consumer price index (CPI) for all items less fresh food are expected to remain at around 0 percent for the time being, but expected to gradually rise to 0.1 percent in fiscal 2012 and 0.5 percent in fiscal 2013. As just described, while it still takes some time to overcome deflation, from a somewhat longer-term perspective, Japan’s economy is expected to return to the sustainable growth path with price stability. However, there are high uncertainties, including the effects of the European debt problem The outlook is associated with various uncertainties. While the biggest risk is the aforementioned European debt problem, there are other risks we should be aware of. The aforementioned recovery scenario for Japan’s economy assumed that emerging and commodity-exporting economies would increase the pace of growth again, with a decline in inflationary pressure, thereby leading the global economy. Even for such basic assumption, we should monitor without prejudgment whether it will become a reality as assumed. Geopolitical risk concerning Iran is also a source of concern. If there is mounting tension and oil prices surge, it will be an upward pressure on prices in Japan, while economic activity will deviate downward from the baseline scenario through a deterioration in corporate profits. As BIS central bankers’ speeches a surge in oil prices could also lead to a slowdown in emerging economies, sufficient attention should be paid to future developments. As for domestic factors, there is a possibility that conditions surrounding electric power supply and demand will become increasingly severe toward this summer in a wide area including the Shikoku region. In addition, if the overseas transfer of Japanese firms’ production bases proceeds rapidly against a backdrop of the entrenched appreciation of the yen and a rise in electricity costs, medium- to long-term growth expectations could be lowered, which continues to require attention. Medium- to long-term challenges for Japan’s economy: strengthening growth potential and ensuring fiscal sustainability The risk that medium- to long-term growth expectations might be lowered is not a new problem. In fact, Japan’s economic growth rate has been on a downtrend and, especially since the 1990s, chronic low growth has been continuing. In my view, primary reason is that, despite rapid aging, Japan’s economy has not been sufficiently equipped with power to quickly gauge changes in the demand structure and foster new industries. Given further population aging in the future and high-level government debt, Japan’s economy is faced with an imminent challenge of becoming serious about strengthening medium- to long-term growth potential while promoting fiscal structural reform. Strengthen growth potential by a two-pronged strategy of external and domestic demand Strengthening medium- to long-term growth potential is not an easy task. Nevertheless, it should be achieved by all means while keeping in mind the following four. First, incorporate global demand as much as possible. To that end, it is vital for firms to, through exports, and further more through aggressive overseas expansion, accurately gauge local needs and tap the market. As for firms’ overseas expansion, unless the pace of expansion is too fast, it would not necessarily be a factor in causing the hollowing out of domestic employment. If a cycle will be established that firms increase profits overseas, pass them on domestically, and invest in research and development of new products and services, more high value-added jobs will be generated in Japan, thereby could contribute to strengthening foundations for economic growth. Efforts to increase foreigners who stay in Japan for the purpose of tourism and business and prepare an environment that attracts investment from overseas will also be an effective strategy in incorporating global demand and increasing domestic employment together. Second, tap potential domestic demand. An aging society will have its own new potential needs, and there will be plenty of room for coping thoroughly with the diversified concept of values and life styles. There is much potential in the domestic market, let alone healthcare, including services for firms and households based on information technology. While I have earlier referred to concern over electric supply and demand, on the other hand, efforts to overcome such challenge, including saving energy and developing new alternative energies, could lead to a generation of new added-value. Third, enhance the flexibility of the labor market. To lessen the likelihood of a labor shortage associated with aging being a binding factor for economic growth, it is necessary to promote employment of the elderly and women. Preparing an environment that facilitates job transfers and the start of new businesses will lead to the effective use of human resources or the activation of metabolism in the entire economy. Fostering global human resources will also be imperative. Fourth, strengthen the function of financial and capital markets. For the development of new markets, it is critical to take risks. To support that, accepting risks by investors and financial institutions, namely, a provision of risk money is necessary. Japan’s households have almost BIS central bankers’ speeches 1,500 trillion yen of financial assets, and there are ample deposits in financial institutions. It is important to steadily make efforts to transform even part of those deposits into risk money. I have so far explained how to strengthen the growth potential of Japan’s economy from several angles. While there might be more, a basic pillar to strengthen growth potential will be to tap new markets both in terms of external and domestic demand, as well as to promote activation of labor and capital markets that support such challenge. Fiscal sustainability should be ensured before market confidence is lost Together with strengthening growth potential, it is necessary to steadily make efforts to ensure fiscal sustainability. Japan’s government debt outstanding exceeds 200 percent of nominal GDP, which is the highest level among advanced economies. Nevertheless, yields on government bonds remain low and stable. In my view, the most fundamental reason is that the market trusts that the Japanese people have a strong will to achieve fiscal soundness and thus Japanese government bonds will continue to be safe assets in the future. Having said that, given that national debt is still increasing, one cannot rule out the possibility that confidence in the government bond market might collapse at once triggered by some cue. If that becomes a reality, there will be a significant impact on the financial system and the real economy, as the actual case of Europe proved. Given that increasing pressure on social security costs is likely to continue amid further aging, it is difficult to blaze a path for fiscal soundness just by strengthening growth potential. It is necessary to proceed with fiscal structural reform both in terms of expenditure and revenue before the market confidence is lost. IV. Conduct of monetary policy Pursuing powerful monetary easing toward overcoming deflation Based on the aforementioned outlook and medium- to long-term challenges for Japan’s economy, let me talk about the Bank of Japan’s monetary policy. The Bank recognizes that Japan’s economy is faced with a critical challenge of overcoming deflation and returning to the sustainable growth path with price stability. With such recognition, the Bank has been pursuing powerful monetary easing in the framework of “comprehensive monetary easing”. Specifically, first, the Bank lowered the policy rate to around 0 to 0.1 percent, which can be deemed a virtually zero interest rate. Second, the Bank is clearly committed to continuing with this virtually zero interest rate policy until it judges that price stability is in sight. With respect to the meaning of price stability, the Bank clearly stated in a specific expression that “on the basis of a year-on-year rate of change in the CPI, it falls in a positive range of 2 percent or lower, centering around 1 percent”. The Bank calls the expression “understanding of medium- to long-term price stability”. The central bank of the United States newly introduced last week a “longer-run goal” with respect to the inflation rate and drew attention from the market. As is the case with the Bank of Japan, it also aimed at numerically clarifying the meaning of medium- to longterm price stability. Third, the Bank established the “Asset Purchase Program”, and purchases government bonds and other various financial assets. It is a measure to facilitate monetary easing to steadily spread to firms’ funding costs through encouraging a decline in longer term market interest rates. The total size of the Program is about 55 trillion yen, which corresponds to more than 10 percent of Japan’s GDP. BIS central bankers’ speeches Tap external and domestic demand by utilizing extremely accommodative financial conditions With such pursuit of powerful monetary easing, at present, ample liquidity is provided to Japan’s financial markets and firms’ funding conditions are quite accommodative. It is quite a contrast to international financial markets which are under enormous stain due to the European debt problem. If such domestic accommodative financial conditions are utilized aggressively for tapping external and domestic demand, I believe Japan’s economy can emerge from deflation. In that regard, the Bank itself has been implementing a measure to supply long-term and low interest rate funds to financial institutions that made lending or investment which contributed to strengthening foundations for economic growth. Through the measure, the Bank has been supporting firms and financial institutions efforts to utilize the accommodative financial conditions. Constantly review monetary policy conduct and prepare a system for a rainy day Toward overcoming deflation and strengthen medium- to long-term growth potential, the Bank will consistently make utmost contributions as a central bank as well as strive to continue to take appropriate policy responses with due recognition that there is a high degree of uncertainty for the time being, including the effects of a slowdown in overseas economies and the appreciation of the yen. The Bank believes it is important to review its conduct of monetary policy constantly with composure and in an objective manner, including how communication with the market should be. Besides, as for the European debt problem, I have said that, while the possibility might be extremely low, we also need to prepare for a rainy day when financial markets become chaotic. In that regard, the Bank will continue to firmly monitor the financial system, payment system, and financial institution management, and, while closely working together with the government and central banks overseas, the Bank will cover all the bases so as to ensure financial market stability even in an emergency. Concluding remarks I am running out of time. Let me conclude today’s speech, touching on the economy of Kagawa Prefecture. There are many firms in this region that have the largest market share in the world in specific areas, and, during my visit this time, I was able to learn about the eagerness to further develop the growing markets from a global perspective. In addition, Kagawa Prefecture built a prefecture-wide medical records sharing system ahead of other prefectures in Japan, and, based on the system, “the Kagawa medical and welfare special zone” was established last December. I strongly expect that such joint efforts of the public and private sectors will tap potential demand from elders and others, and become a model case for the development of domestic demand. To wrap up my speech, I quote the word “dogan” which Mr. Haruo Maekawa, who had been General Manager of the Takamatsu branch for about one and a half years from 1954 and later became Governor of the Bank, fondly used. The word is originally quoted from a line in Mr. Yukichi Fukuzawa’s book and the meaning is “a goose who takes a role in paying attention to changes in the surroundings to protect neighbors from outside enemies”. Mr. Maekawa often compared a central bank to “dogan” and emphasized that it is important for a central bank “not to be influenced by the flavor of the time but appeal to the world by anticipating changing times and future directions always from an objective viewpoint”. In my view, the phrase holds true not only for a central bank but also for people who are in responsible positions in the region’s administration, finance, and the economy. Amid globalization, the demographic vortex, and various challenges the regional economy is faced with, everybody here has been anticipating changing times with composure and exerting BIS central bankers’ speeches strong leadership to guide regional neighbors to perfect answers. The Bank will also steadily continue with its contribution as the central bank and support your positive efforts. BIS central bankers’ speeches
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Keynote address by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the OECD-ADBI 12th Roundtable on "Capital market reform in Asia", Tokyo, 8 February 2012.
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Kiyohiko G Nishimura: Asian markets at the crossroads Keynote address by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the OECD-ADBI 12th Roundtable on “Capital market reform in Asia”, Tokyo, 8 February 2012. * 0. * * Introduction Good morning, Distinguished Guests, Ladies and Gentlemen. I am delighted and honored to have the opportunity to deliver this keynote address at the OECD-ADBI 12th Roundtable in Tokyo. This Roundtable was established in 1999 immediately after the Asian Financial Crisis. It aims at providing an opportunity for experts who have a wide range of backgrounds, including policymakers, and those working in financial industries and academia, to exchange frank and candid views on the development of Asian financial markets. Although it was unfortunately canceled last year owing to the Great East Japan Earthquake, it is my distinct pleasure to be invited this year once again. In this regard, I would like to convey my sincere appreciation to the relevant institutions, including the OECD and the ADBI, for their enthusiastic efforts to organize this valuable event. Moreover, I hope our most welcome guests, taking the opportunity to attend international conferences hosted in Japan, including this Roundtable, can experience firsthand the great progress Japan has made in recovering from the disaster. 1. Financial markets in Asia: resiliencies and vulnerabilities How should we evaluate the development of Asian financial markets over the recent past? To answer this question, let me begin by summarizing the resiliencies and vulnerabilities of Asian economies and financial markets at this moment. Resiliencies As for the resiliencies, we can first point out the fact that Asian economies have achieved higher growth in the past several years than other regions of the world. Current accounts have in general recorded stable surpluses during this period (Chart 1). We should also commend the region’s authorities for their efforts in maintaining the relative soundness of their fiscal positions. Given these favorable economic conditions, some Asian jurisdictions, such as China, introduced prompt and large-scale fiscal stimulus measures, and contributed successfully to the recovery not only of the regional economy but also of the global economy as a whole. Asian economies have also enhanced their resilience to various financial shocks through the flexible introduction and implementation of a number of macroprudential measures, including changes in the loan-to-value (LTV) ratio and the debt-to-income (DTI) ratio. These measures have contributed favorably to the stability of domestic financial systems, as well as the stability of prices of goods and services and financial assets. Moreover, they have introduced a number of regulatory measures, such as those relating to the foreign exchange positions held by financial institutions, the so-called financial levy, and the minimum holding period of bonds for nonresident investors. These measures have steadily taken effect since they were announced and introduced. Vulnerabilities On the other hand, there are also vulnerabilities in the region. First, there still remains the double-mismatch of currency and maturity in the banking sector (Chart 2). This problem was identified in the wake of the Asian Financial Crisis of 1997. When banks finance short-term BIS central bankers’ speeches money in foreign currencies, swap it to local currency, and invest in long-term domestic assets, they incur risks both in terms of currency and maturity. For some external reasons, if short-term foreign currency funding becomes difficult in the market, banks tend to face funding problems. Moreover, if their local currency depreciates significantly at the same time, they also encounter an increase in unhedged foreign currency liabilities in terms of local currency, and eventually have to deal with the deterioration of their balance sheets. In fact, when Lehman Brothers collapsed, such vulnerability emerged in some Asian economies. Second, in the Asian region including Japan to some extent, the financial intermediation function has traditionally been served by indirect financing, mostly through banks (Chart 3). Although it has gradually declined in some jurisdictions in recent years, the reliance of firms on indirect financing is still structurally high. Given this financing structure, when a large negative shock hits financial institutions, nonfinancial corporations are likely to find it hard to get smooth debt financing from these financial institutions, almost regardless of these nonfinancial corporations’ financial soundness. Third, from a wider perspective, there is still the issue of scant investment opportunities in Asian local currencies. Abundant savings in Asia have not been invested sufficiently within the region, and have thus eventually been invested outside the region, such as in bonds in the United States and developed Europe. To put it in a different perspective, the Asian financial sector remains insufficient both in terms of its variety and its depth, in contrast with the strength of its non-financial sectors, especially manufacturing. High reliance on bank finance implies the underdevelopment of regional bond markets. It is also often mentioned that the immature local derivatives market makes appropriate risk-taking transactions difficult, as risk-hedging instruments are limited. Moreover, owing to less-developed securitization markets in the region, Asian economies do not sufficiently enjoy the merits of the securitization schemes that attract a variety of investors depending on their risk-taking capacities (Charts 4 and 5). Fourth, meanwhile, there are some jurisdictions in Asia that rely significantly on so-called micro-finance. Micro-finance is indispensable particularly for the sustainable growth of emerging markets and developing economies, and as such has been a main agenda item of the G-20. However, there is one caveat. The main agents of micro-finance are nonbank financial institutions that, unlike banks, are not tightly supervised by the authorities, but which, like banks, take deposits and provide credit to customers. This means that it could become a risk factor in the financial system, if the market share of loans and deposits by micro-finance agents becomes non-negligible. 2. Policy responses by the Asian authorities Current regional initiatives How have the Asian authorities responded to these vulnerabilities? Among many, I would like to introduce the following two projects that have been particularly effective in the past ten years. The first is a project aimed at developing liquid bond markets to bridge abundant local savings and local investments. The Executives’ Meeting of East Asia and Pacific Central Banks, EMEAP, consisting of eleven central banks and monetary authorities in the region, established the Asian Bond Fund investment trust, and became the initial buyers by investing in sovereign and quasi-sovereign bonds in the eight member jurisdictions.1 Also, as part of When it was launched in 2003, the Asian Bond Fund was limited to investment only in U.S. dollardenominated bonds. However, since 2005, the Fund has begun to include those denominated in the local currencies of the eight members, with the aim of raising awareness among private investors. Each listed fund BIS central bankers’ speeches the process of ASEAN+3, the authorities have launched the Asian Bond Markets Initiative (ABMI). Under the current initiative, there are four main issues that were raised and have been implemented since 2008, namely i) the facilitation of demand for local currencydenominated bonds, ii) the promotion of their issuance, iii) the improvement of the regulatory framework, and iv) the improvement of the relevant infrastructure for the bond market.2 Owing in part to these projects initiated by the regional authorities, the Asian bond market has developed steadily, although still not deep enough and varying across jurisdictions. The second is a project aimed at building a mutual framework of foreign currency liquidity provision in times of crisis, called the Chiang Mai Initiative (CMI). The CMI started building a bilateral currency swap network in the region, which involves a contingent claim on foreign currency reserves held by each ASEAN+3 authority. The CMI has since enhanced its effectiveness by increasing its size and the number of participants.3 The authorities are discussing expansion of the scope to cover crisis prevention, as well as to assess the sufficiency of the size. To ensure the effective implementation of crisis prevention and liquidity support in times of crisis, it is essential for the authorities to monitor closely the regional economy and financial markets, and exchange their views on respective macroeconomic policies. The ASEAN+3 authorities thus established their own but independent surveillance unit, called the ASEAN+3 Macroeconomic Research Office (AMRO), in Singapore in April 2011. In addition, the toplevel Finance Ministers’ Meeting will be expanded from 2012 to include the region’s central bank governors in the Finance Ministers’ and Central Bank Governors’ Meeting. Remaining challenges However, challenges remain. Although there have been improvements in some areas, as I have mentioned, I would like to raise the following five points. (1) To Solve Double-Mismatch of Currency and Maturity The first is about the double-mismatch of currency and maturity. This structural issue has not changed fundamentally in the past ten years. According to BIS statistics, cross-border credit denominated in local currencies from foreign banks to local residents has grown rapidly in the 2000s (Chart 2). However, their reliance on foreign currencies is still large. Fundamental vulnerability continues to be found also with respect to maturity mismatch, although the mismatch has reportedly been improving to some extent.4 (2) To Change Bank-Centered Financial Structure and High Reliance on Foreign Institutions Second, the bank-centered structure of the financial intermediary function also remains basically unchanged. Moreover, Asian region’s funding relies heavily on foreign financial has steadily been recognized by investors, although the extent of this recognition varies across the markets. Moreover, the Fund has been functioning as a catalyst for improving market infrastructure, such as deregulation and exemption of withholding taxes for nonresident investors, through its reviewing process among the EMEAP members. The most notable recent achievement of the ABMI is the establishment in November 2010 of a trust fund in the ADB, called the Credit Guarantee and Investment Facility (CGIF). The CGIF plans to start its credit guarantee operations for local currency-denominated corporate bonds issued in the ASEAN+3 jurisdictions in the first half of 2012. In 2010, the authorities evolved the CMI framework from its original bilateral swap arrangements to the multilateral Chiang Mai Initiative Multilateralization (CMIM), which is a collective decision-making framework signed by all member jurisdictions in the single contract. In the BIS statistics on cross-border credit outstanding by maturity, it is not evident that borrowing of less than one-year maturity has been decreasing. However, the authorities report the considerable reduction in those of very short-term maturities. BIS central bankers’ speeches institutions. For example, in the areas of project finance and trade finance, the Asian region has continued to depend considerably on foreign financial institutions, particularly European banks. In fact, in the wake of the European sovereign debt problem, net capital outflows were observed from August to December last year, except in October. Recent data suggests that capital flows returned to the region in January. As such, Asian financial markets have suffered from high volatility caused by the development of global capital flows, which is more or less the same problem they experienced in the Asian Financial Crisis. The background to this is that the market infrastructures, such as those of bond markets, remain less developed. Although the Asian bond market has certainly been developing as I mentioned earlier, the corporate bond market, in particular, remains limited in its depth and liquidity.5 (3) To Develop Collateralized Transactions Markets Third, let me emphasize the importance of collateralized transactions markets, including the repurchase agreement of securities, in order to develop deep and resilient financial markets. Short of a full blown crisis, but still relatively strained conditions such as found in the current European debt problem, market participants tend to prefer collateralized to uncollateralized transactions, when counterparty risks are strongly recognized among them. This indicates the utmost importance of having a solid market foundation of eligible bond transactions in order to secure stable financial transactions, regardless of rain or shine in financial conditions. In this regard, the cross-border collateral arrangement (CBCA) made between the Bank of Japan and the Bank of Thailand in November last year has the potential to be expanded throughout Asia. In fact, at almost the same time, a CBCA was announced between the Bank Negara Malaysia and the Monetary Authority of Singapore. Meanwhile, the EMEAP formed an action group, and has been discussing the promotion of CBCAs within the region. (4) To Foster Financial Innovation The fourth challenge is to develop innovative financial products, appropriate for an aging population in the region. In Asia, the population is aging at a steady but faster pace, not only in Japan but also in other economies such as China, Korea, and Thailand (Chart 6). Financial innovation is therefore essential to offer a flexible variety of enhanced financial products appropriate to the particular stage in the life cycle of the population. In this regard, the development of securitization seems a key factor. I recognize that securitization, especially in its complex forms, has suffered from a negative image since the Lehman shock. However, simple, plain-vanilla type securitization products may contribute to the realization of appropriate risk-adjusted returns on financial transactions including lending, leading to more active operations of financial institutions. Moreover, as the credit intermediary channel becomes multi-layered to complement conventional lending, the risk tolerance of the financial system would be enhanced through risk diversification. Thus, it is important to “reinstall” useful securitization technologies into the system. In this regard, let me mention, for example, Asset-Based Lending (ABL), which is collateralized lending based on business assets held by firms. By utilizing effectively a variety of their assets, firms do not have to rely on conventional real estate collaterals and personal credit guarantees when borrowing. ABL is particularly useful in providing opportunities for firms at different stages in their life cycles, such as during start-up, business expansion, and business transformation, when it is difficult to obtain sufficient financing through conventional In Japan, although the amount outstanding of corporate bonds has been increasing, the market size continues to be limited compared to that of government bonds, and we have to admit that the market liquidity is low. There are also a limited number of issuances of corporate bonds with non-investment grades, which has long been an issue in Japan. Against this background, market participants established the “Forum on the Activation of Corporate Bond Market”, and have been discussing a number of ways in which the market may be improved. Moreover, as the issuance of securitized products has stagnated since its peak in fiscal year 2006, we need to revitalize the securitization market as well. BIS central bankers’ speeches bank borrowings. ABL may thus lead to the enhancement of the surveillance capacities of financial institutions through the necessity of continuous monitoring of such firms. The promotion of this kind of ABL could contribute to the enhancement of economic growth potential, and I believe it is a useful scheme also for Asia in the future. In this regard, the Bank of Japan established the “Special Rules for Equity Investments and Asset-Based Lending to Enhance the Fund-Provisioning Measure”, which has been in effect since summer 2010. The special rules were established with the aim of further enhancing financial institutions’ efforts to strengthen the foundations for economic growth through the use of a wider range of financial techniques. (5) To Enhance Financial Inclusion The fifth challenge is financial inclusion. From the perspective of developing deep financial markets, it is also important to improve infrastructures so that more of the world’s population has access to financial services. There are reportedly more than 2.5 billion adults who are excluded from accessing financial services, and also tens of millions of small enterprises that are facing serious financing problems. Financial inclusion is a project with the aim of resolving the problem of inaccessibility to fundamental financial services. The project is expected to improve the lives of underprivileged people, and provide fundamental financial support to small enterprises, leading to the realization of sustainable economic growth through the increase in personal consumption and the creation of job opportunities. As the European debt problem gets worse and uncertainties grow in the global economy, financial inclusion has an important role to play in improving the welfare of emerging markets and developing economies with high growth potentials, and thus in ensuring global economic stability (Chart 7). Financial inclusion has been discussed in the framework of international forums such as the G-20 and APEC. Meanwhile, in the area of financial education, closely related to financial inclusion, the OECD has introduced valuable initiatives to enhance global cooperation by, for example, publishing the report, “Recommendation on Principles and Good Practices for Financial Education and Awareness” in 2005, and also by establishing the International Network on Financial Education. I support wholeheartedly further development of these initiatives, as financial education, like financial inclusion, is essential for the stability of the global financial system, and thus for sustainable growth of the global economy. 3. Financial internationalization Next, I would also like to express my views on financial internationalization, especially, the recent development of “renminbi internationalization”, one of the agenda items of this Roundtable. Generally speaking, the internationalization of a currency indicates that its settlement, calculation, and value-storage functions have expanded beyond a certain jurisdiction. To maintain these functions, it is assumed that capital movements are liberalized, and international customs such as commercial contracts are adhered to. In other words, if these fundamental conditions are breached, or altered artificially or politically, true financial internationalization cannot be realized. New kid on the block – renminbi on the rise From this point of view, let me take a look at the recent development of so-called renminbi internationalization. In recent years, we have observed an increase in reminbi-denominated trade settlements, the establishment of an offshore renminbi market, and the expansion of renminbi-denominated financial products in Hong Kong. In addition, some central banks and monetary authorities in emerging markets and developing economies have recently announced the inclusion of the renminbi in their foreign currency reserves. As such, the BIS central bankers’ speeches renminbi has been used increasingly in cross-border financial transactions, attracting greater attention from all over the world. China began taking steps towards currency internationalization in order to improve the renminbi’s settlement function. The Chinese authorities intended to reduce Chinese firms’ excessive reliance on the U.S. dollar in their trade settlements, and to mitigate the foreign exchange risks of huge U.S. dollar holdings in the corporate and government sectors, as the impact of the Lehman shock spread throughout the global financial system. Cross-border trade settlements in renminbi first started in July 2009 as a trial across a limited region, namely between 365 designated firms in the city of Shanghai and four cities of Canton Prefecture and ASEAN, Hong Kong, and Macau. The amount has since expanded to record just under RMB 600 billion (about JPY 7 trillion) in the third quarter of 2011 (Chart 8). However, the development intended by China means simply that we can use renminbi for cross-border financial transactions that used to be settled only in foreign currencies. It should be kept in mind that the development has not contributed significantly to the mitigation of capital regulations. While the volume of renminbi has increased in offshore markets as it is employed in cross-border trade settlements, there remains very limited room for offshore renminbi to flow back to the mainland under the current strict capital regulations imposed by the Chinese authorities. For this reason, there has been a growing need for developing offshore renminbi markets to meet the demand of agents who hold renminbi outside the mainland and wish to invest them in the market. In fact, the Hong Kong offshore market has been playing a major role in absorbing such offshore renminbi liquidity. It would be implausible to assume that renminbi “internationalization” will be further developed without significant capital-flow deregulation. In fact, the current strict regulations on capital inflows to the mainland have gradually become an obstacle to the further development of offshore renminbi markets themselves. The need for issuance of renminbidenominated bonds, so-called dim-sum bonds, is after all limited. In the Hong Kong renminbi offshore market, the amount outstanding of issuance of dim-sum bonds is currently around RMB 70 billion, which is much smaller than renminbi-denominated deposits of about RMB 600 billion. If China wishes to promote further the internationalization of the renminbi, it may be necessary to address the issue of capital account liberalization. Future synergy between renminbi and yen Nevertheless, the renminbi has steadily and increasingly been used in settlements outside the mainland. Depending on developments in the liberalization of capital transactions, the presence of the renminbi is expected to increase in the Asian region. Against this background, what do we think about the status of the Japanese yen? The yen is used internationally as a currency that is always tradable and has a well-established settlement infrastructure, in line with the U.S. dollar, euro, and British pound. Meanwhile, the amount of trade between Japan and China, the two economic giants in Asia, has expanded by 2.5 times since 2001, reaching about JPY 26.5 trillion in 2010. During the same period, the number of firms that have extended their operations from Japan to China has increased by 1.5 times to about 22,000. However, the amount of trade settlements denominated in either yen or renminbi is very limited. Taking into consideration the long and profound ties between the two countries, as well as their importance to Asian regional trade, mitigating foreign exchange risks incurred by exporters and importers, and reducing their transaction costs, by promoting trade settlements denominated in both currencies would have considerable significance (Chart 9). Currently, the U.S. dollar is generally used as the intermediary currency when conducting currency transactions between yen and renminbi on foreign exchange markets. As a result, the price of the yen and renminbi is determined by the cross-currency rate of yen-U.S. dollar and renminbi-U.S. dollar, thereby requiring U.S. dollar settlements. If a direct exchange market between the yen and renminbi is developed and has a certain degree of liquidity, one BIS central bankers’ speeches benefit will be a reduction in transaction costs, as the price will be set directly without the U.S. dollar as intermediary. Moreover, without settlements in U.S. dollars, there is also the merit of a reduction in currency settlement risks for financial institutions. As such, the development of financial and foreign exchange markets denominated in yen and renminbi is an important issue for financial stability, not only for Japan and China but also for the rest of Asia (Chart 10).6 I believe the yen and Japanese government bonds have an important role to play in the process of developing financial and foreign exchange markets in Japan and China, and thus in the whole Asian region. For example, to develop highly-liquid and deep bond markets, price transparency in the market is indispensable, as is a stable risk-free yield curve as the basis for pricing. The improved market-based function of interest rates formation is also an essential factor for the development of risky product markets, including corporate bond markets, as well as for determining appropriate foreign exchange rates that reflect economic fundamentals. In Europe, German government bonds function as a benchmark not only for financial products in Germany but also for fixed income products traded in the rest of Europe. Currently in Asia, I believe Japanese government bonds are a leading candidate to act as such a benchmark, as they are always stably priced, and promptly traded and settled. Moreover, their issuance volume is large enough, and their credit rating is reasonably high. In Japan, we have strived to improve the financial infrastructure, including the payment and settlement system. As you know, the issuance of Japanese government bonds is the largest in the world, and there exists a well-developed local currency-denominated bond market. The Bank of Japan operates the payment and settlement system for Japanese government bonds, and has worked continuously over the past more than ten years to improve market functions. As a result, the Japanese government bond market has maintained its high liquidity. In this regard, please allow me to repeat the importance of promoting cross-border collateral arrangements between other Asian neighbors, with the use of such highly-liquid Japanese government bonds as an effective means. 4. Concluding remarks I have so far explained the current assessments on Asian economies and financial markets and the relevant developments in the region’s financial internationalization. Now, let me wrap up by summarizing my views once again on the points that are crucial for Asia’s future development. A balance between domestic and external demands The growth in Asian economies since the 1970s has been driven mainly by exports. As a dividend of successful economic growth, the increasing numbers of people in the middle income class have contributed significantly to the steady increase in domestic demand since the mid-2000s, thereby leading current global economic growth. Nevertheless, it is undeniable that the region remains vulnerable to external shocks through the trade channel, as evidenced by the Lehman shock. As population pyramids change and the region’s To support the growing economic ties between Japan and China, the leaders of Japan and China agreed on December 25 last year to enhance financial transactions between the two countries, specifically through promoting the use of the yen and renminbi in cross-border transactions between the two countries, and in support for the development of direct exchange markets between the two currencies. These agreed areas will be mutually promoted by establishing the “Joint Working Group for Development of Japan-China Financial Markets”. Meanwhile, the global community has also begun to pay attention to developments in “renminbi internationalization”. For example, on January 16 this year, the Hong Kong Monetary Authority and HM Treasury of the United Kingdom announced the establishment of a forum with the aim of mutually promoting offshore renminbi operations between Hong Kong and London. BIS central bankers’ speeches economies develop, Asia needs to be vigilant in isolating the potential contagious effects of external shocks, such as the deleveraging of assets by European banks, through a steady transition to an economy driven also by domestic demand. Further development in local bond markets To increase resilience against external shocks and reduce volatility in asset prices, it is important to develop deep local capital markets and enhance their functions and resistance to the influences of capital flows in the region as a whole. As I mentioned earlier, higher volatility in Asian stocks and bonds causes higher volatility in their currencies. Volatile asset price leads to an unstable financial system, and is thus an obstacle to sustainable economic growth. What is important in the region is to enhance the market capacity for receiving capital flows, or in other words, to dramatically improve the situation of being “a big fish in a small pond”. Regional financial cooperation and collaboration It is essential for each jurisdiction to harmonize its market regulations and practices with the global standards in promoting cross-border transactions. However, unilateral effort by a single jurisdiction has its limitations. Collective effort is also needed to build the investment foundations by actively utilizing regional forums, such as ASEAN+3 and EMEAP, to create a regional investment class. While respecting diversity across jurisdictions, we should not introduce arbitrary regulations or ignore global contractual practices. Needless to say, we cannot completely prevent financial crises. However, we can improve our resiliency in times of crisis by preparing multi-layered safety nets as backstops in the financial system. Such safety nets include the development of deep and liquid capital markets, the establishment of currency swap networks, and cross-border collateral arrangements that provide local currency liquidity by accepting foreign currency assets as eligible collateral. It is often said that Asia is the region with the widest variety of cultures, social structures, and developmental stages. As traditional financial theory tells us, the appropriate combination of these diversities offers welfare gains. In the process of deepening the mutual ties between Asian economies, improvements in market function through regional financial cooperation will provide better investment opportunities for households, firms, and financial institutions, and thus contribute to more effective resource allocation in the region. The activities of ASEAN+3 and EMEAP, particularly their resolute efforts since the Asian Financial Crisis, have proven that financial cooperation based on mutual understanding and respect will always enable us to find effective measures in any circumstances. The Bank of Japan would like to continue contributing to the development of Asian financial markets, through its active participation in the initiatives of regional financial cooperation and collaboration. Thank you for your kind attention. 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Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the dinner reception, hosted by the Japan Securities Dealers Association, preceding the International Conference, Tokyo, 9 February 2012.
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Masaaki Shirakawa: Finance in Asia – banking business and capital markets Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the dinner reception, hosted by the Japan Securities Dealers Association, preceding the International Conference, Tokyo, 9 February 2012. * I. * * Introduction Thank you very much. It is my pleasure to speak at this dinner reception hosted by the Japan Securities Dealers Association that precedes tomorrow’s international conference. The conference, entitled “Asian Market Integration and Financial Innovation”, brings together senior officials from such international forums as the International Organization of Securities Commissions (IOSCO) and the International Accounting Standards Board (IASB), as well as a number of capital market experts in Asia. I look forward to lively discussions tomorrow on the future evolution of Asian financial and capital markets, the direction of the strategic reshaping of financial infrastructures in Asia, and other important subjects. Since the Lehman crisis in 2008, major central banks have undertaken a variety of policy measures that transcend the conventional boundaries of central banking. In this process, central banks have become more closely involved in capital markets. For example, the Bank of Japan has been buying risk assets such as corporate bonds, exchange-traded funds (ETFs), and domestic real estate investment trusts (J-REITs). These purchase programs are truly extraordinary in central bank history. Given that the global financial landscape, including policy responses, is undergoing profound changes, today I would like to share my views on financial and capital markets in Asia, with a principal focus on the interplay between banking business and capital market development. II. Current economic conditions in Asia Let me start with the recent economic and financial developments in Asia. We are now entering the third year since the European sovereign debt problem surfaced in Greece. Without doubt, the way the debt problem in Europe will play out remains a key factor shaping the near-term outlook for the global economy. Concurrently, for the past several years emerging economies have been the propelling force behind global economic growth. Among them, Asian countries have displayed particularly robust growth, driven mainly by China and India. In its latest projections, the International Monetary Fund expects the global economy to grow by 3.3 percent this year, with the 27 countries of developing Asia contributing nearly 60 percent of that. Despite the concerns over the global economic outlook, there are reasons to believe that Asian economies are better placed to sustain solid growth. Most fundamental are their rich human resources, rapid urbanization, and a competitive technological base. In addition, various policy initiatives taken after the Asian financial crisis in the late 1990s have played an important part. In response to the Asian crisis, countries in this region carried out ambitious reforms on many fronts, including fiscal consolidation, monetary policy management aimed at price stability, improvement of financial supervision and regulation, and development of regional financial markets. In hindsight, the Asian crisis could be considered a blessing in disguise in the sense that it prompted tough reforms which in normal times might have been difficult. BIS central bankers’ speeches Yet, Asian economies are not immune to the sovereign debt problem in Europe. Three potential channels of contagion can be noted: first, trade links; second, financial market disturbances; and third, deleveraging by European financial institutions. Naturally, these three channels are not mutually exclusive. For instance, the longer the disturbance continues in European financial markets, the harder the hit to the balance sheets of European financial institutions, which causes European deleveraging in Asia. If this spreads to disrupt trade finance, Asian economies heavily reliant on exports would surely suffer. So far, the spillovers from Europe to Asia have been mild. Deleveraging by European financial institutions looks moderate for the most part, with Asian financial institutions filling the shoes of European banks in some cases. Given that European financial institutions have enjoyed a visible presence in Asian financial businesses – most notably in corporate syndicated loans, trade finance, and lease finance involving ships and aircraft – it is sensible, however, to pay careful attention to deleveraging by European financial institutions. III. Business model of Asian financial institutions With regard to the brisk growth of Asian countries, there is another factor we should keep in mind. This is the limited exposure of Asian financial institutions, in the run-up to the subprime crisis, to complex securitized products and risk transfer techniques. It seems that the subprime crisis has generated skepticism or soul-searching vis-à-vis cutting-edge financial innovations. In order to enhance social welfare, such innovations should be in line with the core functions of finance, that is, financial intermediation and payment and settlement services. Without this connection, financial innovations cannot help boost the productivity of the economy at large.1 We can see that some resecuritized products deviated from this basic tenet before the subprime crisis. Even in simple secured transactions such as repos, the same securities posted as collateral were used repeatedly for a chain of transactions, with liquidity multiplying in the process. Put differently, we saw a sharp increase in collateral velocity through the nexus of repo transactions. We now know that Asian financial institutions were not deeply involved in such financial daisy chains, which probably helped them navigate the post-Lehman turbulence. Asian banks have been known for their traditional or basic business models, in which loans are funded primarily by domestic deposits. In fact, the loan-to-deposit ratios are below 100 percent in many Asian countries (Chart 1). Business models built on such domestic deposits are less susceptible to an acute funding squeeze than models dependent on wholesale funding. I think this feature has also provided Asian banks with some advantages over their Western counterparts in weathering the current crisis. On the other hand, the economic ties among Asian countries have grown stronger on the back of continued economic growth in this region. In line with this, cross-border transactions have grown substantially and more sophisticated financial services are being called for. In this regard, the expansion of the so-called transaction banking services in Asia is noteworthy. Transaction banking makes it possible to provide cash management and trade finance services in an integrated fashion and beyond national borders. In a similar vein, supply chain finance seems to be gaining momentum in Asia as the need grows for cash flow management through the entire supply chain. For further discussion on this point, see Masaaki Shirakawa, “What Is So Special about Financial Innovation?” keynote address at the conference entitled “Welfare Effects of Financial Innovation” held by the De Netherlandsche Bank (via videoconference) on November 11, 2011 (available at http://www.boj.or.jp/en/ announcements/press/koen_2011/ko111114a.htm). BIS central bankers’ speeches IV. Challenges for Asian financial institutions These developments suggest that the business model of Asian banks is evolving, and is not immutable. In this connection, I would like to mention two challenges facing Asian banks. The first challenge concerns demographics. We all know that Japan is already feeling the pinch of this headwind. Asian countries now enjoy ample labor forces, but rapid aging coupled with low birth rates will inevitably present these countries with demographic adversities in the next decade or so. In fact, the ratios of working-age population to total population are nearing their peaks in many Asian countries, which means that the size of the labor force relative to population in these economies will start diminishing in several years (Chart 2). These demographic changes could constrain economic growth from both the supply and demand sides. For the banking industry, population aging could shrink the depositor base through dwindling savings. One way to mitigate this negative trend is to promote financial inclusion – that is, a provision of financial services to wider segments of society. In Asia, this can be done by taking advantage of the rapid expansion of the middle-income population and small enterprises. In this context, the prevalence of mobile banking in Asia is remarkable. Mobile banking aims to connect mobile phone users with basic financial services, giving them greater access to financial intermediation and payment and settlement services. Designed properly, mobile banking could offer great promise in terms of improving social welfare. The second challenge for Asian banks is to strengthen risk management amid the increasing demand for longer-term credit. Because of rapid urbanization and industrial agglomeration, Asian countries are in need of well-functioning infrastructure such as transportation, energy supplies, and telecommunication networks. According to the Asian Development Bank, estimates of infrastructure needed in Asia from 2010 through 2020 could reach roughly 8 trillion U.S. dollars.2 To satisfy this need, reliance on fiscal spending alone is not sufficient. Instead, it is necessary to effectively mobilize private-sector funds such as bank loans. Normally, infrastructure loans have maturities longer than ten years, exceeding the average deposit maturities by wide margins. Unless these maturity mismatches are managed appropriately, banks cannot involve themselves in long-term infrastructure projects. This problem also exists for long-term mortgage loans. For Asian banks, therefore, dealing with maturity mismatches poses a formidable challenge going forward. V. Development of capital markets in Asia In order to reduce maturity mismatches of banks as intermediaries, development of capital markets, especially corporate bond markets, will play a key role.3 In this regard, I would like to mention two points. First, if banks can diversify their funding sources by issuing bonds, they will be able to manage maturity mismatch risks more effectively. Second, development of corporate bond markets will facilitate direct funding of infrastructure investment. Infrastructure projects, because of their long-term nature, are prone to unexpected shocks. If both bond issuance and bank loans are available, the stability of funding for such projects will presumably be enhanced. Unfortunately, Asian corporate bond markets are far from fully developed. A number of projects are underway to nurture regional corporate bond markets, and the Bank of Japan has participated actively in some of these initiatives, including the successful launch of the For more details, see Asian Development Outlook 2010 Update: The Future of Growth in Asia, Asian Development Bank, 2010. For more details, see “Weathering Financial Crises: Bond Markets in Asia and the Pacific”, BIS Paper No. 63, Bank for International Settlements, 2012. BIS central bankers’ speeches Asian Bond Fund (ABF). But the saving-and-investment balance in Asia has remained lopsided since the Asian financial crisis. In other words, Asia has excess savings, with the region’s investment still below the levels seen prior to the Asian crisis. Development of corporate bond markets in Asia is one effective way to align savings with investment within the region. Also, given the aging trends in Asia, well-developed corporate bond markets would offer the additional merit of creating long-term investable assets for such institutional investors as pension funds and life insurance companies. With regard to capital markets, I would also like to touch briefly on the subject of Asian stock markets because stock markets, together with bond markets, are a vital part of capital markets. Asian stock markets have grown exponentially in recent years. According to statistics from the World Federation of Exchanges, equity finance in the Asia-Pacific region accounted for 46 percent of the world total last year. During the same period, half of all global initial public offerings took place in the Asia-Pacific region. Asia’s stock market capitalization accounts for 31 percent of the global total, indicating that the pace of recovery in stock markets following the Lehman crisis is fastest in this part of the world (Chart 3). It seems that a virtuous cycle is operating in Asian stock markets, in which larger trading volumes and higher market liquidity reinforce each other, prompting both regional and foreign firms to seek funding in Asia. Last year, for example, we saw Glencore, one of the world’s leading commodities traders, listed in both London and Hong Kong. This event points to the vitality of Asian stock markets. By making its stock markets more attractive as funding venues, Asia can open up its plentiful savings to globally active firms. The flip side of this is that Asian investors will have greater opportunities to invest abroad. To achieve further development of Asian capital markets based on their interactions with global firms, it seems necessary to harmonize market infrastructures and financial regulations at regional levels. In this respect, I think that Europe offers some insights for Asia in terms of its experience of financial market integration. To broaden the degree of financial market harmonization, market participants also need to play a prominent role. For instance, cross-national tie-ups between stock exchanges would not only create efficiency gains in systems terms but also have the potential to alter the entire dynamics of the regional capital markets. A notable example is the ASEAN Trading Link initiative, which aims to build a joint electronic platform for cross-border trading between the exchanges of some ASEAN countries. I look forward to seeing how this and other intraregional projects will reshape Asian capital markets in the years ahead. VI. Concluding remarks Today I presented my views on banking business and capital markets in Asia. Coexistence of robust banking systems and capital markets is conducive to financial system stability. But this is not a sufficient condition for such stability. In Asia – where a deepening of trade links has preceded that of cross-national financial ties – ample scope remains for regional financial cooperation. In collaboration with colleagues in this part of the world, the Bank of Japan remains committed to the salutary development of financial and capital markets in Asia, while placing a special focus on central bank expertise in payment and settlement infrastructures, cross-border collateral arrangements and so forth. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan National Press Club, Tokyo, 17 February 2012.
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Masaaki Shirakawa: The Bank of Japan’s efforts toward overcoming deflation Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan National Press Club, Tokyo, 17 February 2012. * * * Introduction It is a great honor for me to have the opportunity to speak to you today at the prestigious Japan National Press Club. This is my third time speaking here, having initially done so in May 2008 – my first public speech after becoming Governor of the Bank of Japan – and then again in May 2010, around the time when the European debt problem triggered by the crisis in Greece started to overshadow the global financial markets. Given that today happens to be just a few days after the Bank implemented measures to further enhance monetary easing, this is my first opportunity to provide a thorough explanation of this latest policy decision. The previous two speaking events before the Club were valuable opportunities for me, because they resulted in my being presented with many thought-provoking opinions and questions and provided the chance to put my own thoughts in order. With that in mind, I really look forward to exchanging views with you after delivering my speech. As I have just mentioned, the Bank decided the following three measures this week, at the Monetary Policy Meeting on the 14th, with a view toward clarifying its monetary policy stance and to further enhance monetary easing in order to overcome deflation and achieve sustainable growth with price stability (Chart 1). First, the Bank introduced a numerical expression of price stability in the form of “the price stability goal in the medium to long term.” Second, as for its conduct of monetary policy for the time being, the Bank stated that it will “continue pursuing powerful monetary easing with the aim of achieving the goal of 1 percent in terms of the year-on-year rate of increase in the consumer price index (CPI) until it judges that the 1 percent goal is in sight.” And third, the Bank increased the total size of the Asset Purchase Program introduced in the fall of 2010, from about 55 trillion yen to about 65 trillion yen, by adding another 10 trillion yen earmarked for the purchase of Japanese government bonds (JGBs). Today, I will first explain the aim of and thinking behind these decisions. In the second half of my speech, I will focus on the challenge of overcoming deflation, which is the goal of the aforementioned measures, and discuss the causes of deflation as well as our thinking on necessary policy actions. After short-term interest rates in major economies including Japan declined to virtually zero, the scope of the operational tools of monetary policy has expanded from a traditional way of “raising and cutting interest rates” to the area of unconventional policy tools such as the purchase of various financial assets. Therefore, please forgive me if some parts of my speech inevitably become somewhat technical. I. “The Price Stability Goal in the Medium to Long Term” Numerical Expression of Price Stability I will begin with “the price stability goal in the medium to long term.” This is the inflation rate that the Bank judges to be consistent with price stability sustainable in the medium to long term. The Bank judges it to be “in a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI” and, more specifically, has set “a goal at 1 percent for the time being.” BIS central bankers’ speeches The Bank conducts monetary policy based on the Principle of Currency and Monetary Control as clearly stipulated in the Bank of Japan Act; namely, that the policy shall be aimed at “achieving price stability, thereby contributing to the sound development of the national economy.” In doing so, the price stability must be of the sort that is sustainable in the medium to long term. Then, what kind of state does this “price stability” refer to? Conceptually, we can express it as “a state where economic agents such as households and firms may make decisions regarding economic activities without being concerned about the fluctuations in the general price level.” In the conduct of monetary policy, price stability needs to be expressed in numerical terms. Individual central banks express price stability in numerical terms within the context of each country’s situation and name the expression differently. Examples of such numerical expressions include the Bank of England’s “target,” “definition of price stability” adopted by the European Central Bank and the Swiss National Bank, and the U.S. Federal Reserve’s previously adopted “longer-run projection,” as well as the “longer-run goal” it introduced recently. “Understanding,” “Goal,” and “Target” Six years ago, in March 2006, the Bank introduced its own framework under which it expressed price stability in numerical terms, named “an understanding of medium- to long-term price stability.” After undergoing a series of changes in expression, the Bank’s recent “understanding” was “a positive range of 2 percent or lower, centering around 1 percent” on the basis of a year-on-year rate of change in the CPI. The word “understanding” was chosen for a definite reason. Back then, the Bank was approaching the exit from its quantitative easing policy, which had lasted for the five years since 2001, and the Policy Board members had a wide range of views with regard to price stability in the coming new phase. At the same time, all the members recognized the need to publish, as the Policy Board, the basic idea of price stability in numerical terms. As a result, the decision was made to ask individual Policy Board members to present their own understanding of price stability in specific inflation rates and issue numerical expressions in the form of a range covering the presented rates, and this was published as the “understanding.” 1 Over time, however, a growing number of voices began to be heard, pointing to the difficulties in understanding the Bank’s judgment from a collection of individual views held by each member. Others expressed the view that connotations of “understanding” did not allow for smooth interpretations of the Bank’s policy stance in its efforts toward achieving price stability, and in overcoming deflation in light of the current situation. The Bank’s decision to introduce “the price stability goal in the medium to long term” also took into account such various views. Let me summarize the differences between the “goal” and the former “understanding.” First, the “goal” introduced represented “a judgment by the Bank” and not “the views of individual Policy Board members.” Second, while judging that the “goal” was “in a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI,” the Bank clarified this by setting it at a more specific 1 percent for the time being (Chart 2). And third, in order to strengthen the so-called “policy duration effects,” the goal is more clearly linked to the Bank’s policy commitment on the duration of powerful monetary easing including the virtually zero interest rate policy, which I will explain in more detail later. Based on my explanation to this point, the question of why the Bank did not choose alternatives such as “target” might arise. The basic idea of the “goal” introduced is largely in line with the basic thinking held by some central banks abroad with regard to using the word “a target,” in that it expresses the inflation rate the Bank judges to be consistent with the For more details, please refer to "The Bank's Thinking on Price Stability" (March 10, 2006) and Minutes of the Monetary Policy Meeting on March 8 and 9, 2006. BIS central bankers’ speeches mission of a central bank and is one that the Bank aims to achieve in the medium to long term. In Japan, however, it is still often the case that “inflation targeting” is mistakenly considered equivalent to conducting monetary policy in an automatic manner in pursuit of a certain inflation rate. In reality, in many countries, including those adopting inflation targeting, monetary policy is conducted not in such an automatic manner but with an emphasis on price and economic stability in the medium to long term, as I will explain in more detail later. The Bank judged that the Japanese wording of “the price stability goal in the medium to long term” would be the most appropriate name for the actual conduct of monetary policy. In the case of Japan, while inflation rates have remained low over a protracted period, the sustainable levels of such rates could rise gradually in the future if efforts to strengthen the economy’s growth potential bear fruit. 2 In view of the high uncertainty surrounding future developments, including possible structural changes in Japan’s economy and the global economic environment, the Bank judged it appropriate to attach the term “goal” to the inflation rate that the Bank aims to achieve in the medium to long term, instead of the expression of “target” that gives a rigid impression, and to review it once a year in principle. II. Strengthening of Policy Duration Effects Clarification of Determination to Pursue Monetary Easing Next, I would like to explain the second step taken at the latest Monetary Policy Meeting – the strengthening of policy duration effects. In order to generate the policy duration effects, central banks make a commitment to the future course of monetary policy based on certain conditions. When short-term interest rates almost hit zero, leaving little room for a further decline, there is a need to introduce measures that influence the entire yield curve, including the longer end, in place of the traditional operation of controlling short-term interest rates. Long-term interest rates are formulated based on the expected future path of short-term interest rates and risk premiums. Therefore, if market participants believe that a central bank’s commitment to monetary easing will continue for a long period of time and that a short-term interest rate that is a policy rate will stay low for an extended period, then this will exert a downward force on long-term interest rates. The Bank has made the best use of the policy duration effects while engaging in maintaining the zero interest rate policy since 1999 and quantitative easing policy since 2001. More recently, based on the “understanding of medium- to long-term price stability” that I explained, the Bank made it clear that it would “continue the virtually zero interest rate policy until it judges that price stability is in sight.” Although this commitment had played a certain role in encouraging the stable formation of long-term interest rates, the Bank made two changes this time, with the aim of further clarifying its policy stance toward overcoming deflation. First, the condition for policy duration is now more clearly specified based on the 1 percent inflation rate that is set as a price stability goal for the time being. Second, the Bank judged that it was more appropriate to express the policy stance on the conduct of monetary policy in a more active manner; that is, not only acknowledging the continuation of the virtually zero interest rate policy but also pointing to other policy measures that have actually been taken. For this reason, it introduced a new policy commitment, which says “For In the "Economic and Fiscal Projections for Medium to Long Term Analysis" released by the Cabinet Office in January 2012, the following two figures are provided as estimates of the rate of increase in the CPI for the medium to long term: (1) around 1 percent (an average of 1.1 percent for the period until fiscal 2020) under the assumption that economic developments at home and abroad require vigilance, and (2) around 2 percent (an average of 1.7 percent for the period until fiscal 2020) if measures proposed in the "Basic Strategy for Revitalizing Japan" are steadily implemented amid robust economic developments at home and abroad and the average growth rates for the period until fiscal 2020 rise to about 2 percent. BIS central bankers’ speeches the time being, the Bank will continue pursuing powerful monetary easing by conducting its virtually zero interest policy and by implementing the Asset Purchase Program mainly through the purchase of financial assets, with the aim of achieving the goal of 1 percent in terms of the year-on-year rate of increase in the CPI until the goal is in sight.” At the same time, based on the experiences of the forming and bursting of a bubble in Japan and the global financial crisis following bubbles in recent years, a condition to the above commitment was set that, even when price stability is maintained, the Bank checks to see whether any significant risk is materializing, including the accumulation of financial imbalances, from the viewpoint of ensuring sustainable economic growth (Chart 2). 3 Commitment of Timing and Commitment of Conditions This kind of policy commitment aimed at generating policy duration effects is also adopted by central banks abroad. One way of doing this is to refer to a specific duration or timing of an exit, just like the U.S. Federal Reserve does. According to its statement, the U.S. Federal Reserve currently anticipates that economic conditions are likely to warrant an exceptionally low level of its policy rate “at least through late 2014,” but holds significant reservations with regard to such anticipation being subject to change depending on economic and price outlooks. On the other hand, the Bank of Japan makes its commitment on a “condition” based on the CPI inflation rate, instead of a specific “timing” of an exit from monetary easing. The Bank judged it better to present a condition in terms of an inflation goal, rather than specifying the timing of an exit from monetary easing to gain a greater “credibility of commitment,” and consequently more effectiveness of monetary policy, given the high uncertainty surrounding the economic and price outlooks in Japan at this juncture. As long as economic and price outlooks entail high uncertainty, it is impossible to specify the exact timing of an exit from monetary easing, but there is no uncertainty with regard to the Bank’s policy stance to pursue monetary easing until it sees the exit. Given the current state of Japan’s economy, the Bank believes that this type of policy commitment is more effective in showing its strong determination to pursue policy aiming at overcoming deflation. Relation to Inflation Targeting I have explained that the Bank recently introduced the combination of “the price stability goal in the medium to long term” and “strong policy commitment based on the CPI inflation rate.” How is this related to the so-called “inflation targeting?” I would like to note at the outset that, after going through a bubble in Japan and experiencing the recent financial crises, the monetary authorities around the world have made efforts to improve their frameworks for the conduct of monetary policy by learning from each other’s lessons in the wake of those crises, and consequently have converged to share the following three elements in such frameworks. First, they published specific inflation rates considered to be consistent with their responsibility. As I have already explained, although the wording differs, such as between the Bank of England’s “target,” “definition” used by the European Central Bank and the Swiss National Bank, the U.S. Federal Reserve’s “goal,” and the Bank’s “medo (in English, ‘goal’),” their characteristics are basically same. Second, and more importantly, they have placed increasing emphasis on economic and price stability in the medium to long term, instead of the short term, when using the numerical expression of price stability in their conduct of monetary policy. In many cases, bubbles are During the bubble period in Japan, the rate of increase in the CPI (all items less fresh food, after adjusting for the effect of a consumption tax hike) was 0.4 percent in fiscal 1987, 0.6 percent in fiscal 1988, and 1.6 percent in fiscal 1989. BIS central bankers’ speeches formed when the economy enjoys price stability and their bursting results in significant fluctuations in economic activity and prices later. Even if the authorities try to control the effect of supply shocks such as volatility in crude oil prices in the short run, economic activity suffers a significant burden and price stability ultimately is endangered in the long run. All these kinds of experiences in recent years underscore the importance of pursuing price stability sustainable in the medium to long term. Even in the United Kingdom, where the monetary policy framework is called inflation targeting, the actual conduct of monetary policy is increasingly aimed at achieving the inflation target in the medium to long term while paying attention to economic and financial stability, instead of achieving the target at all costs in the short term. Third, and related to the second element, major central banks have come to publish their economic and price outlooks covering a longer period. Having said that, the longer the period of forecasts, the greater their inevitable decline in terms of reliability. Therefore, these central banks increasingly emphasize the medium- to long-term perspectives in showing their basic thinking on the mechanism behind the outlook and assessing risks, instead of focusing too much on highlighting the forecast numbers themselves. Given that the monetary policy frameworks of major central banks have converged as described, I think it no longer important to play with the taxonomy of which one is inflation targeting or not. In fact, while Chairman Bernanke made it clear that the newly introduced longer-run goal does not mean the introduction of inflation targeting, some nevertheless do call it inflation targeting. If the new monetary policy framework adopted by the U.S. Federal Reserve can be called inflation targeting, a similar view could be taken in the case of the Bank’s new framework. III. Expansion of the Asset Purchase Program 10 Trillion Yen Increase in the Purchase of JGBs Now I would like to touch upon the third step taken at the latest Monetary Policy Meeting. That is, the expansion of the Asset Purchase Program (Chart 3). As part of the comprehensive monetary easing introduced in October 2010, the Bank has purchased various types of financial assets through the Program. Using the newly established segregated fund on its balance sheet, which is also used for the funds-supplying operations over the longer term, the Bank has purchased JGBs - both short-term and long-term – and, in an exceptionally unusual practice for a central bank, risk assets including commercial paper, corporate bonds, exchange-trade funds (ETFs), and Japan real estate investment trusts (J-REITs). The purpose of this operation is to encourage a decline in longer-term market interest rates and a reduction in various risk premiums so that financial conditions surrounding the ultimate borrowers of funds, such as firms and households, will become more accommodative. In the process of enhancing monetary easing, the total size of the Program had been increased repeatedly, from the initial 35 trillion yen in October 2010 to 55 trillion yen, and the Bank made a decision to further increase it to 65 trillion yen by earmarking another 10 trillion yen for the purchase of JGBs at the latest Monetary Policy Meeting. The cumulative increase in the total size of the Program is about 30 trillion yen. In addition to this Program, the Bank regularly purchases JGBs at the pace of 1.8 trillion yen per month, or 21.6 trillion yen per year, for the purpose of meeting the stable long-term demand for funds. Adding up the purchases through such operation and those through the Program, the Bank is going to purchase a large amount of JGBs until the end of this year at the pace of 3.3 trillion yen per month, or about 40 trillion yen per year. At the end of last year, the amount of JGBs held by the Bank was 66.1 trillion yen, representing 14.2 percent of nominal GDP. Although you may have the impression that the U.S. Federal Reserve has aggressively purchased government bonds, its holdings at the end of last year were BIS central bankers’ speeches 10.8 percent of nominal GDP. The holdings by the European Central Bank, which started making such purchases in 2010, represented 2.2 percent of nominal GDP. Such a significant scale of government bond purchases entails risk, to which more attention needs to be paid. More specifically, once the purchase of government bonds by a central bank is perceived as financing government debt and not conducted for the purpose of monetary policy, this could instead invite a hike in long-term interest rates and lead to financial market instability. The Bank has repeatedly cautioned about this risk and rigidly maintains its policy of not conducting purchases of JGBs for the purpose of financing government debt. Ensuring Accommodative Financial Conditions As a result of the comprehensive monetary easing consisting of the aggressive purchase of financial assets and the virtually zero interest rate policy, financial conditions in Japan have become extremely accommodative (Chart 4). More specifically, interest rates – including longer-term ones – in short-term money markets where financial institutions lend and borrow funds have stayed at very low levels, and credit spreads have been stable at low levels in corporate bond and commercial paper markets. Bank lending rates have already reached significantly low levels but continue to decline gradually. According to various surveys, firms see their financial position and financial institutions’ lending attitudes as being on a clear improving trend. On the other hand, in the period after the Lehman shock, an increase in quantitative indicators such as the size of the Bank’s balance sheet and the monetary base – money provided by a central bank – has been moderate compared to that in the United States and in Europe, sometimes inviting the misunderstanding that the Bank’s monetary easing is insufficient. When interest rates decline to extremely low levels, people tend to hang on to money. This situation is called a “liquidity trap.” Once caught in this, it is no longer possible to measure the degree of monetary easing by simply looking at quantitative financial indicators. In fact, when we ask business managers about confronting challenges, few complain about a shortage of on-hand liquidity and many point to a lack of demand or business. In any case, in such a situation, what is more important is the easiness of financial conditions in a broad sense, such as developments in short-term and long-term funding rates for firms and risk premiums as well as funding conditions of firms and households. In the case of the United States and Europe, a significant expansion of the central bank balance sheet was indispensable to restoring stability in financial markets that had suffered significant damage to their functioning after the Lehman shock. Once provided to financial markets, the funds remained piled up in deposits with central banks because of negligible opportunity costs amid extremely low interest rate levels. On the other hand, in the case of Japan, damage to the functioning of financial markets was relatively limited and financial system stability was maintained even at the time of the Lehman shock. Therefore, without having quantitative expansion on the scale seen in the United States and Europe, the Bank could realize more accommodative financial conditions. Although tensions in global financial markets heightened again last year due to the European debt problem, the Bank has managed to firmly maintain accommodative financial conditions in Japan. It is expected that the recent determined increase in the Asset Purchase Program earmarked for JGBs will further strengthen the easing effects by affecting the entire yield curve, including the longer end. IV. Our Thinking on Deflation and Needed Actions Cause of Deflation So far, I have explained the Bank’s new policy steps, which aim at overcoming deflation and bringing the economy back to a sustainable growth path with price stability. Conducting BIS central bankers’ speeches monetary policy in this way, how significant of an effect can be expected in terms of achieving the goal of overcoming deflation? Put differently, what kinds of measures are needed for Japan’s economy as a whole to ensure that this goal will be achieved? Using the time left for today’s remarks, I would like to share with you our thinking on deflation. A good starting point is to have an accurate understanding of the fundamental cause of deflation in Japan. The various causes of deflation in Japan have been provided and discussed for years. For example, for some time, downward pressures on prices came from deregulation and the streamlining of distribution systems, which were pursued under the policy initiatives to reduce international price differentials. In Japan, both employers and employees tend to make wage adjustments for the sake of securing employment. As a result, even under the severe economic conditions, the unemployment rate in Japan did not rise compared to that in the United States and in Europe, while the declining trend for wages became more evident. Such a declining trend of wages is one of the factors explaining deflation in Japan. In the meantime, there is an argument that deflation has continued because of an insufficient amount of money – in other words, insufficient monetary easing by the Bank. However, such an argument needs to be properly fact-checked (Chart 5). Let’s take the typical example of money stocks, which are cash and deposits held by firms and households. The Marshallian k is the ratio of money stocks to nominal GDP that is used to measure the size of money stocks in relation to economic activity. In Japan, the ratio had been about 1.1 until the mid-1990s, which means that money stocks and nominal GDP were almost same size. Since then, the ratio has continued to rise against the background of prolonged monetary easing and is now about 1.7 – in other words, the amount of money stocks is about 805 trillion yen while nominal GDP is about 467 trillion yen. This ratio of 1.7 is the highest among major economies. Conducting a similar exercise with the monetary base and the size of the central bank balance sheets results in the same conclusion that the ratio of Japan is the highest among major economies. As I have stated, the Bank has managed to maintain accommodative financial conditions despite the rising tensions in global financial markets against the background of the European debt problem. Viewed in this way, it appears that the problem of Japan’s economy is not a lack of money but rather a lack of business chances and growth opportunities to make the best use of money. Ultimately, deflation is a decline in the general price level, and therefore must be caused by a deterioration in the supply and demand balance of the macro economy – i.e., a shortage of demand against supply. An output gap – an indicator for supply and demand balance estimated on the basis of certain assumptions – has continued to indicate a shortage of demand since 2000 with the exception of a very short time period. Looking back at real GDP growth rates in Japan from a relatively long viewpoint, the rates have gradually declined from 4.4 percent in the 1980s, to 1.5 percent in the 1990s, and to 0.6 percent in the 2000s (Chart 6). There are several reasons for this decline. First, the negative legacy of the bubble bursting had continued to weigh on the economy since the beginning of the 1990s. To be more specific, while firms and financial institutions were tackling the challenge of balance-sheet repair, Japan’s economy as a whole failed to adjust to a changing environment, such as increasing globalization and a rapid aging of the population. In particular, the effects of the population aging at a much greater speed in Japan than in the rest of the world have become more evident since entering the 2000s. The aforementioned widening of an output gap certainly means a shortage of demand against supply capacity, but in the current conjuncture it is specifically a shortage of demand against the supply capacity of existing goods and services. Rather, it might be interpreted as a widening mismatch of demand and supply in a sense that the supply side fails to sufficiently meet new demand in the new environment, such as demand from seniors. BIS central bankers’ speeches In any case, when growth rates trend down in this way, households increasingly grow concerned about future income; this results in stagnant consumption and the corporate sector restrains investment in future business. If these events occur, this will lead to a vicious cycle in which contraction of expenditure by firms and households drags down actual growth rates and growth expectations. The relationship between economic activity and prices could be compared to that between fundamental physical strength and body temperature. In order to raise the body temperature to a normal level, it is necessary to improve the fundamental physical strength. Likewise, we need to face the reality that, in order to raise prices appropriately, it is indispensable to strengthen Japan’s growth potential and growth expectations, and deflation cannot be overcome without such efforts. Of course, there are some cases where only an increase in prices takes place without changes in growth. The two oil shocks in the 1970s and the 1980s are typical examples. However, it also should be noted that a temporary increase in prices will not improve the performance of firms or quality of people’s lives, as you can easily see in the case where crude oil price hikes are transmitted to general prices, and we certainly do not wish to see such a situation materialize. The bottom line is that it is important to realize desirable inflation rates in proper sequencing so that improvement in economic activity leads to a rise in prices in a natural manner. Efforts toward Strengthening Growth Potential Strengthening growth potential is an extremely difficult challenge for Japan, especially given the constraint it faces – namely, the rapid aging of the population. Let me provide you with a rough calculation. The economic growth rate consists of two components: the rate of growth in the number of workers and the GDP per worker – or the rate of growth in productivity (Chart 6). 4 Of these two components, the rate of growth in the number of workers started to decline in the 2000s and decreased at an annual rate of 0.3 percent on average during that decade. Based on long-term projections of demographic trends recently released by the National Institute of Population and Social Security Research, the rate of decline in the number of workers will increase further to 0.7 percent in the 2010s, 0.8 percent in the 2020s, and 1.2 percent in the 2030s. Meanwhile, although the rate of growth in productivity has fluctuated due to the effects of the Lehman shock, the recent trend is 1 percent on average in the past twenty years and about 1.5 percent on average for the period in the 2000s before the Lehman shock. The rate of growth in productivity in Japan itself is comparable to those of other G-7 economies and was highest in the period in the 2000s before the Lehman shock. However, adding this rate of growth in productivity to the rate of decline in the number of workers leaves us with a grim outlook; that is, not only will the annual rate of economic growth in the 2010s remain around 0.5 percent, but it may decline further in the longer run. How can we strengthen the economy’s growth potential? First, while it is difficult to induce a dramatic increase in the number of workers, it is still possible to slow the pace of decline in the number by making it easier for elderly people and women to participate in the workforce. Nevertheless, the key to strengthening growth potential lies in efforts to raise productivity growth. In doing so, firms’ efforts to capture global demand and cultivate new diversifying domestic demand become necessary. On the policy front, it is important to take measures such as deregulation in order to create an environment that encourages firms to take on these challenges. Financial institutions’ expertise in identifying good business opportunities and providing risk money also become important with regard to providing financial support to As for various measures for the rate of growth in productivity, see Chart 13 of Masaaki Shirakawa, "Deleveraging and Growth: Is the Developed World Following Japan's Long and Winding Road?," Lecture at the London School of Economics and Political Science (Co-hosted by the Asia Research Centre and STICERD, LSE), January 10, 2012. http://www.boj.or.jp/en/announcements/press/koen_2012 /data/ko120111a.pdf BIS central bankers’ speeches firms in the course of making such efforts. Above all, it will be vital for society as a whole to realize the harsh reality and critical issues facing Japan’s economy and share a sense of values, which should include acceptance of change as well as the need to improve the economic metabolism. The most significant contribution that a central bank could make in terms of strengthening growth potential is to maintain accommodative financial conditions and support firms from the financial side by creating an environment that makes it easier for them to explore new growth strategies. The Bank will continue to pursue powerful monetary easing, taking full account of “the price stability goal in the medium to long term” I have discussed today. It is also an essential role of the Bank to make efforts to minimize the effects on the financial market and the financial system in Japan, and do its utmost to ensure stability even in the event that some kind of destabilizing factor arises overseas amid high uncertainty surrounding global financial developments, including the European debt problem. Furthermore, in an extraordinary measure for a central bank, the Bank has been proceeding with a new fund-provisioning measure to provide support for strengthening the foundations for economic growth. This is aimed at encouraging firms to explore new growth strategies by taking advantage of financial institutions’ expertise in identifying good business opportunities. In any event, there is no magical wand that can be used to strengthen growth potential. It is important for business firms, financial institutions, the government, and the central bank to continue making efforts in their respective roles as they face changes in the environment surrounding Japan’s economy – such as globalization and the aging of the population. The goal of overcoming deflation will be achieved through such efforts to strengthen growth potential and support from the financial side. V. Economic and Price Developments and Outlooks Lastly, let me brief you on recent economic and price developments as well as the outlook for Japan’s economy, in order to show how much progress has been made in terms of overcoming deflation. Japan’s economic activity experienced a sharp rebound from a plunge caused by the earthquake disaster in the second half of last year. Recently, economic activity has been more or less flat, reflecting downward forces deriving from the effects of a slowdown in overseas economies and the appreciation of the yen as well as upward forces stemming from firm domestic demand, such as in terms of private consumption. Although this state of the economy is expected to continue for the time being – beyond early spring – the economy is expected to return to a moderate recovery path as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and as reconstruction-related demand after the earthquake disaster gradually strengthens. The year-on-year rate of change in the CPI is expected to remain at around 0 percent for the time being but gradually increase to around 0.5 percent in the next two years or so. According to the Bank’s projections released last month of the economic and price outlooks through fiscal 2013, the real GDP growth rate is expected to be –0.4 percent in fiscal 2011, 2 percent in fiscal 2012, and 1.6 percent in fiscal 2013. As for the CPI, the year-on-year rate of increase is expected to gradually rise, from –0.1 percent in fiscal 2011, to 0.1 percent in fiscal 2012, and 0.5 percent in fiscal 2013 (Chart 7). Looking back, the rate of decrease in the CPI (all items less fresh food) marked a low of –2.4 percent in mid-2009, recording the largest decline in recent years. Thereafter, amid the economic recovery trend, albeit a moderate one, and the narrowing of the negative output gap, the rate of decrease in the CPI has been slowing and finally reached almost zero percent on a year-on-year basis. In this sense, we have been making progress in our steps toward overcoming deflation. We admit, however, that the inflation rate still has a long way to go before it reaches the 1 percent goal that the Bank has set for the time being, as indicated in “the price stability goal in the medium to long term.” BIS central bankers’ speeches In addition, the environment surrounding Japan’s economy is attended by various uncertainties. We cannot rule out the possibility that future developments in the European debt problem will spill over to Japan’s economy through strains in the global financial market. In terms of domestic factors, there are still many uncertainties regarding the supply and demand balance of electricity and the effects of the yen’s appreciation, as well as the pace of strengthening in reconstruction-related demand. At the same time, however, we must not overlook the fact that positive signs have recently begun to appear among developments at home and abroad. Tensions in global financial markets regarding the European debt problem have abated somewhat since around the end of 2011. Some improvement has recently been observed in the U.S. economy, mainly in the employment situation, despite the burdens of balance-sheet repair. Shifting our focus to Japan’s economy, reconstruction-related demand has begun to materialize in both public works and private demand, and private consumption has recently been firm due in part to a recovery in demand that had been temporarily restrained after the earthquake disaster last year. The Bank has decided to further enhance monetary easing, through the measures I have discussed, with the aim of supporting the recent positive developments from the financial side. The Bank will continue making its utmost efforts in order to overcome deflation and achieve sustainable growth with price stability. At the same time, I would like to repeat that, in order to strengthen the foundation of Japan’s growth potential, there is a need to concentrate all the efforts made by concerned parties. Firms and financial institutions need to make efforts in an aggressive manner to make the best use of accommodative financial conditions, and government measures to support such initiatives in the private sector are required. In doing so, given that our economy is facing the frontline challenge of a rapid aging of the population, our responses in tackling this challenge must be at the cutting edge. We need to determinedly pave the way by ourselves, recognizing that it is not possible to find case studies for solutions and best practices in other countries. If we succeed in overcoming this challenge by ourselves, our country can provide the rest of the world with a new type of economic and social norm for the first time since we presented the high-growth economic model. I would like to finish my remarks by stressing the importance of solving problems through using our own wisdom and will. Thank you. BIS central bankers’ speeches Chart 1 Chart 2 BIS central bankers’ speeches Chart 3 Chart 4 BIS central bankers’ speeches Chart 5 Chart 6 BIS central bankers’ speeches Chart 7 BIS central bankers’ speeches
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Institute of International Bankers 2012 Annual Washington Conference, Washington DC, 7 March 2012.
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Kiyohiko G Nishimura: What should we learn from the Eurozone Crisis? A regulatory-reform perspective Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Institute of International Bankers 2012 Annual Washington Conference, Washington DC, 7 March 2012. * 1. * * Introduction: two “once-in-a-century” crises just three years apart Let me begin by thanking the Institute of International Bankers for inviting me to join the leading international bankers today. I am delighted and honored to have the opportunity to deliver this speech at the 2012 Annual Washington Conference. It is a great pleasure for me to return to Washington D.C. from Tokyo after 30 years of absence, especially as it is just two weeks before the Cherry Blossom Festival officially begins. I vividly remember the Festival on the Mall in 1982 when I lived here. In fact, this year is special not only for me but also for all Washingtonians and Tokyoites. This year marks the centennial anniversary of the gift of these 3,000 cherry trees from Tokyo to Washington D.C. in 1912. The Washington cherry trees have rooted strongly, survived the elements, and withstood the test of time. Their blossoms come into full bloom every spring so as to make us feel eternal peace and serenity, regardless of economic cycles, market swings, and in particular, financial crises. Alan Greenspan once described the “Lehman Crisis of 2008” as a “once-in-a-century type event”.1 And now we are facing the “Eurozone Crisis of 2011”. Some say the potential magnitude of the fallout from this latter crisis may approach that of the former unless appropriate measures are devised and implemented promptly. Thus, we have experienced two once-in-a-century events within three years. Indeed, this is quite extraordinary. However, if we look closer at these two crises, we find they are not necessarily isolated events (or in statistical terms, they are not independent.) Rather a certain factor was active behind both events: important regulatory changes in the United States around 2004. These regulatory changes are seen as having led to excessive leveraging in the United States, culminating in the collapse of Lehman Brothers. But what is relatively less well known is that these regulatory changes provided fertile ground for the excessive risk taking of European financial institutions as well, making these institutions vulnerable to potential shocks after the Lehman Crisis, when the sovereign risks of a small periphery country surfaced. This vulnerability is the source of the contagion fears we have observed. In this speech, I examine the current Eurozone Crisis from the perspective of how to devise and implement a regulatory framework appropriate for financial stability and economic activity. In particular, I have two issues in mind. The first issue is that regulatory changes often have unintended and sometimes large crossborder impacts in the increasingly integrated world of finance. One country’s deregulation may cause excessive risk taking not only by that country’s financial institutions, but also by those in other countries, and in some cases, the impact is larger for foreign institutions than domestic ones. The second issue I wish to raise is that the effectiveness of regulatory changes is crucially dependent on economic conditions at the time those changes are introduced. Thus, there is As reported by AFP, September 14, 2008. BIS central bankers’ speeches a non-trivial possibility of implementing the right policy, but at the wrong time. And by the same token, appropriate sequencing is also dependent on economic conditions. In Section 2, I first explain how the U.S. regulatory changes, most notably deregulation on the leverage of investment banks, affected the behavior of European financial institutions. It is not at all likely that regulators intended this effect, so this is a classic example of the unintended cross-border impact of regulation. I also argue that the timing of this regulatory change was not quite right: deregulation took place exactly when European financial institutions, as well as their U.S. counterparts, had begun to search for yield and to take risks, which turned out to be excessive. In Section 3, I examine what we should learn from the Eurozone Crisis, and examine the current issues of regulatory reform from this perspective. I argue that we should not indulge ourselves in the wishful thinking of a quick return to “normality”. In advanced countries, we are likely to face severe and prolonged balance sheet adjustment under the unfavorable conditions of population ageing. Bearing this in mind, I also argue that what is needed is appropriate sequencing of regulatory reform when banks are deleveraging, not leveraging. Finally, I will touch upon the cross-border issue raised by the Volcker Rule in the Dodd-Frank Act, which is another example of the unintended cross-border impact of financial regulation. There, appropriate implementation is the key to avoiding unintended side-effects that may be quite hazardous to some countries. 2. The Eurozone crisis and US regulatory change: unintended pull of “excessive” European risk taking 2.1. Genesis of the Eurozone crisis The euro currency is a “grand experiment”: centralizing monetary policy to one central bank, yet leaving fiscal sovereignty to individual member countries, of which there were originally 11, now expanded to 17. This experiment is itself a “process”: the euro was adopted not because the prerequisites of the optimal currency area had been met, but under the premise that continuing efforts, for example, increasing labor market mobility and flexibility, would eventually lead to the true “conversion” of economic conditions while maintaining the identity of member countries. Unfortunately however, various imbalances, especially in trade and finance, have been accumulated on the way. These imbalances have led to the current sovereign debt crisis, since the appropriate adjustment mechanism has been lacking, given that exchange rate adjustment is ruled out by definition. Nobody denies that the current Eurozone financial problems have been caused by the region’s sovereign debt crisis. And the sovereign debt crisis is the direct result of worsening public finances caused by massive fiscal stimulus programs to support the economy and capital injections to failing financial institutions after the Lehman Crisis of 2008. However, the current Eurozone crisis is at least partly due to excessive risk taking by many European financial institutions before the Lehman Crisis, especially in the U.S. financial markets, and in particular in those of structured products. Several years before the Lehman Crisis, notably after 2004, European financial institutions accelerated their search for yield and expanded their balance sheets. Chart 1 shows the total assets of the financial institutions of Germany, France, Italy and Spain, relative to their position in 2004. A notable acceleration of expanding balance sheets is found in European financial institutions, except for German ones. Here the grand experiment of the euro played a pivotal role. Based on the European Union’s financial services directives, a single market was being formed in terms of financial markets and financial business in general. Competition intensified among financial institutions, and this squeezed their profits. A remarkable convergence of sovereign interest rates highlighted declining risk premiums in financial markets (Chart 2), though in retrospect this proved BIS central bankers’ speeches unsustainable. Moreover, there were challenges from growing capital markets in Europe, where indirect financial intermediation had traditionally dominated. Fund business also accelerated in Europe as the net assets of asset management funds expanded after 2004 (Chart 3). European financial institutions expanded their claims not only to borrowers within Europe, including those in their own countries, but also to those outside the region. For example, Spain increased its claims on Latin American countries and France expanded those on the United States. According to the BIS International Consolidated Banking Statistics compiled by the Bank for International Settlements, European financial institutions, which traditionally had a major presence in cross-border claims, continued to boost volume and market share, especially after 2004 (Chart 4). A look at the statistics by country for non-Eurozone assets shows that both Spain and France experienced remarkable increases after 2004 (Chart 5). Even Germany showed a noticeable increase. 2.2. 2004: inflection point of the cross-atlantic financial markets Looking back at the history of European financial institutions’ risk taking behavior, the widespread acceleration around 2004 is remarkable. There seem to be no particular events or regulatory changes in the Eurozone that can fully explain this acceleration. So, what happened in 2004? In fact, 2004 is the inflection point of the U.S. financial markets as well. The size of U.S. investment banks’ balance sheets ballooned after 2004 (Chart 6). Likewise, the balance sheets of special purpose vehicles (SPVs), which are off the balance of, but virtually supported by their “parent” commercial banks, accelerated sharply to a degree that exceeded even those of the investment banks. SPVs increased their assets, including investment in securitized products, against a backdrop of favorable funding conditions, which I explain shortly. The massive expansion of the balance sheets of SPVs together with the “activism” of investment banks contributed significantly to the astonishing growth in the size of this so-called shadow banking system. One factor that explains this remarkable increase in risk taking activity is the seemingly benign financial conditions of the “Great Moderation” at that time. Massive capital inflows from emerging economies contributed to lowering interest rates in the United States during the period.2 After joining the WTO in 2001, China expanded its current account surplus, playing an increasingly important role in financing the U.S. current account deficit. A large portion of securities investment from China went to U.S. Treasuries and agency debt markets (Chart 7),3 contributing to the decline not only in interest rates but also in their volatility (Chart 8). The sustained volatility decline after 2004 was remarkable, and likely contributed to the perception of declining risk, thereby encouraging the risk taking that turned out to be excessive after all. However, this so-called “savings glut” argument cannot explain why risk taking accelerated exactly in 2004, since the savings glut emerged well before 2004. What happened exactly in 2004? This question leads us squarely to the regulatory changes in the United States in 2004. According to the “global savings glut” argument, capital inflows from countries with a current account surplus, such as China, brought about a decline in U.S. interest rates and thereby played a role in forming housing bubbles. Although the U.S. Federal Reserve raised policy rates in 2004 against a background of clear signs of an economic recovery, long-term interest rates remained stable at low levels, which the then Federal Reserve Chairman, Alan Greenspan, described as a “conundrum”. At the time, agency debt was under implicit government guarantee. BIS central bankers’ speeches In 2004, the net capital rules on U.S. investment banks were relaxed (the so-called Bear Sterns exemption).4 Specifically, investment banks with capital of US$5 billion and above were allowed to increase their leverage by applying for an exemption from the standard net capital rule. The relaxation partly reflected rising calls from the industry, which had faced severe business conditions in the early 2000s and was seeking to strengthen profitability through greater leverage. The increasingly sophisticated risk management of these institutions, as it was described at the time, was also cited as one rationale for this deregulation. Moreover, in 2004, regulatory changes with respect to Fannie Mae and Freddie Mac reduced federal mortgage pools and thus opened a large profit opportunity for private-label RMBS. Many commercial banks jumped at this opportunity to set up their own SPVs. These two regulatory changes, coupled with economic and financial conditions that turned much more favorable after 2004, induced aggressive risk taking, which in retrospect turned out to be grossly excessive, as shown in the previous charts (see again Chart 6). 2.3. Triple vulnerability of European institutions With profits being squeezed at home, European financial institutions tried to take advantage of these newly-opened and seemingly profitable opportunities in the U.S. markets. European investment in the U.S. securities market expanded. A clear difference was observed between European and Chinese securities investment: Europeans invested in credit products, while Chinese invested in safer assets, U.S. Treasuries in particular (Chart 9). This extraordinary expansion of European investment in risk assets is often argued as being at least partly responsible for the formation of the U.S. credit bubble. This is clearly an unintended effect of the 2004 regulatory changes. This excessive risk taking of European financial institutions in the U.S. markets led to their “triple” vulnerability to economic shocks. The first vulnerability is a sizable exposure to legacy assets. A large portion of lower-quality assets such as those related to subprime loans were held by European financial institutions, and even today these institutions face the challenge of dealing with these legacy assets. The second vulnerability is their heavy reliance on wholesale dollar funding. A distinctive feature of European financial institutions has been their relatively high loan-to-deposit ratio, compared with their Japanese and U.S. counterparts. Consequently, in expanding their balance sheets, European financial institutions have become increasingly reliant on marketfunded liquidity. Looking at the funding structure of French financial institutions, for example, the ratio of funding other than deposits by residents has been rising noticeably since 2004 (Chart 10). This caused a significant problem when U.S. institutional investors such as money market funds became increasingly nervous about counterparty risk in the Eurozone. The third vulnerability is sovereign risk. The Eurozone has many sovereigns within one currency area. It becomes increasingly difficult to treat all sovereigns equally in their risk weights once market participants recognize individual debts as being different in their creditworthiness. It should be noted that, although the U.S. and other countries’ institutions share the first vulnerability, the second and third are unique to the Eurozone. When their holding companies were placed under the umbrella of the Securities and Exchange Commission in 2004, U.S. investment banks were exempted from the standard SEC net capital rule. BIS central bankers’ speeches 3. Looking forward: what should we learn from this episode? 3.1. This time may truly be different: severe balance sheet adjustment under unfavorable conditions Now, I would like to examine what we should learn from the current Eurozone Crisis in terms of financial regulation, and examine the current issues of regulatory reform from this perspective. Global regulatory reform since the Lehman Crisis of 2008 has clearly been focused on the “prevention” of another crisis. Several advanced economies are to introduce new regulatory frameworks for the purpose of preventing financial institutions’ excessive risk-taking. A typical example is the Dodd-Frank Act in the United States. The tale of U.S. financial markets after 2004, which I have just described, shows how loose regulations went wrong and resulted in bitter consequences. In this regard I fully understand the rationale of such regulatory reforms. Having said that, I am afraid that the global debate on these reforms has sometimes been based on the “wishful thinking” of a quick return to normality, that is, on the assumption that the new regulatory frameworks would be implemented in the normal times that are supposed to prevail in the immediate wake of a brief crisis. The Bank of Japan repeatedly cautioned against such wishful thinking, having experienced prolonged problems after Japan’s financial crisis in the 1990s. The Bank warned that downward pressure stemming from financial crises is likely to be persistent, and any signs of recovery observed shortly after the crisis could be a “false dawn”. It also emphasized the risk of bank deleveraging and balance sheet adjustment, especially when the adverse impacts of the crisis remain. Indeed, what we had to tackle after the crisis was not leveraging and excessive risk-taking by the banking sector, but deleveraging and malfunctioning of credit intermediation. Moreover, we had to deal with these problems under severe constraints on macro-policies, with interest rates close to the zero-bound and fiscal balance deteriorating. Unfortunately, developments in the global economy after the Lehman Crisis seem almost to have confirmed our fears. Moreover, many advanced economies are now experiencing both the downward pressures associated with financial fragility and the structural adjustment pressures from population ageing. Suppose the contrary. When advanced economies were not under severe pressure from population ageing, counter-cyclical fiscal policies were broadly effective because market participants were able to believe that any deterioration in fiscal balance should be temporary and, consequently, a large-scale increase in sovereign risk premiums was avoided. However, the fundamental fiscal balance of many advanced economies is now broadly expected to worsen as a result of population ageing and reduced growth potential. In such an environment, the policy effects of fiscal easing are likely to be substantially reduced by an increase in sovereign risk premiums. Thus, I would say “this time may truly be different”, mainly because many advanced economies have to tackle widely ranging challenges, including population ageing and the consequent decline in potential growth rate, more intense constraints on fiscal policy and the persistent balance sheet adjustment pressures stemming from the financial crisis. Indeed, in “peripheral” Euro-zone countries, on which markets are now focusing, financial crises and population ageing have been taking place almost simultaneously (Chart 11). We should all be aware that, as a consequence, most of the new regulatory frameworks are to be introduced not in “a normal time after crisis” as expected, but in a stressed time. 3.2. Implementation of regulatory reform: crisis prevention versus crisis response Finding ourselves in such a difficult economic and financial environment, we should bear in mind that the best “prevention” may not be the best “response” to a crisis. Although public BIS central bankers’ speeches capital injections into banks or blanket guarantees of deposits might give rise to moral hazard, these measures are sometimes necessary in order to contain immediate spillover. Similarly, increasing capital buffers may contribute to maintaining a bank’s solvency over the medium term, but increasing banks’ capital burden in a stressful time might create an adverse feedback loop of intensified capital constraints, weak bank lending and economic slowdown, thus accelerating the bank deleveraging that could lead to a devastating credit crunch. Although we are intellectually tempted to consider what policy tools are available to help promote financial stability, it is practically more important to consider when to use these tools. Particularly, inappropriate sequencing of policy measures might intensify the risk of adverse feedback loops in stressed times, even though individual measures could be effective in normal times. Moreover, we should be extremely careful to avoid miscommunication through the inappropriate timing of policy announcements, especially when we introduce crisis prevention measures in an environment where emergency responses to the on-going crisis are still crucial. In view of the on-going Eurozone crisis, we have to monitor carefully how European banks react to the new regulatory environment in which tighter capital regulations are expected. Needless to say, after the substantial leveraging of European banks before the crisis as I explained, orderly and gradual deleveraging should be viewed as the “intended” consequences of tighter regulation. Nonetheless, in order to evaluate the impact of the Eurozone problem on the global economy, it is necessary to assess whether and to what extent European banks intensify their deleveraging overseas, given the various pressures they face within their home jurisdictions. I believe such assessment is what “macroprudence” is required to do. 3.3. The Volcker Rule and unintended cross-border impacts We are now tackling the difficult issue of implementing new regulations for crisis prevention while economic and financial conditions are still fragile. As a typical and familiar example of such difficulties, I would like to raise a couple of points concerning the Volcker Rule stipulated in the Dodd-Frank Act. First of all, I should make it clear that I fully agree with the fundamental reasoning behind the Volcker Rule. Indeed, speculative activities by some financial institutions under the “originate-to-distribute” type business model were the main driver of the recent crisis, as explained before. Based on such appropriate recognition, the Dodd-Frank Act asks financial industries to make a thorough assessment of their business models, and to modify them if necessary. At the same time, in view of the on-going Eurozone crisis, I would like to emphasize that policymakers should be extremely careful to avoid any unintended consequences when introducing new rules, especially in terms of possible negative impacts on overseas sovereign debt markets at this juncture. Moreover, central banks are required to be attentive to the liquidity of sovereign debt markets, which are the core of the monetary policy transmission mechanism. The Volcker Rule is intended to restrict proprietary trading by banking entities for the purpose of short-term gain. However, the Rule could have significant implications for important market-making activities as well as for market liquidity, depending on how related regulations are written and how they are actually implemented. According to the proposed regulations, U.S. government bonds and most other U.S. agency obligations are exempt from the Rule. Obviously, the U.S. authorities are keen to ensure smooth transactions for these securities, and are well aware of the importance of market-making activities for that purpose. Market liquidity is no less important for the securities of non-U.S. governments. However, the proposed regulations do not exempt government obligations of other countries, including BIS central bankers’ speeches Japan, Canada and European countries. Thus, if the Volcker Rule were to be strictly implemented as proposed, it could adversely affect the liquidity of overseas sovereign debt markets. Another issue is that short-term foreign exchange swaps could also be subject to the Volcker Rule under the proposed regulations. This means, dollar liquidity that has been provided through foreign exchange swaps could be curtailed, causing difficulties for the dollar funding of financial institutions. This could also be a concern for many financial institutions, especially when the global condition of foreign-currency funding is tightened. I understand that the proposed regulations take into consideration the possible implications for market-making and other important activities by way of several exemptions. But these exemptions seem to be applied under strict and complicated conditions, and often allow ambiguous interpretations. As a result, some market participants seem uncertain as to how the Volcker Rule would impact both sovereign debt markets as well as funding conditions. At a time when tension is heightening in European sovereign debt markets, a prudent assessment of the potential impact of the Dodd-Frank Act on other countries is crucial, especially in terms of the liquidity of sovereign debt markets and the short-term funding of financial institutions. Needless to say, we should not expect any law to be a perfect solution in this difficult environment, but well-articulated guidance by the authorities and wellbalanced implementation of the law is of the utmost importance. 4. Concluding remarks: prudent implementation of the prudential measures In this speech I have argued that regulatory changes often have unintended and sometimes considerable cross-border impacts in the increasingly integrated world of finance, as evidenced by the leveraging rule and other regulatory changes of 2004 on European financial institutions, and now possibly by the Volcker Rule on non-U.S. financial institutions. However, what is at stake goes beyond these cross-border effects: the effectiveness of regulatory changes is crucially dependent on underlying economic conditions when they are introduced. Financial regulations are in their very essence prudential measures. Even more importantly, we need prudent implementation of these prudential measures. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a conference sponsored by the Federal Reserve Board and the International Journal of Central Banking, Washington DC, 24 March 2012.
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Masaaki Shirakawa: Central banking – before, during, and after the crisis Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a conference sponsored by the Federal Reserve Board and the International Journal of Central Banking, Washington DC, 24 March 2012. * * * Introduction The global financial crisis and the bubbles preceding it pose mounting issues for a central bank. The Bank of Japan was the first central bank among advanced countries to confront those issues in the postwar period. Japan’s experience intellectually stimulated academics and policy makers overseas, which led to the Bank being flooded with policy proposals, including highly experimental ones. With the exception of just a few cases, however, the low growth in Japan following the bursting of a bubble was often simply interpreted as a unique episode caused by a failure to implement bold policy measures in a prompt manner. As many of you may recall, there was an oft-quoted paper coauthored by a number of Federal Reserve economists entitled “Preventing Deflation: Lessons from Japan’s Experience in the 1990s” that was released in 2002.1 This paper argued as follows (Chart 1). “our sense is that much of the failure of monetary loosening to support asset prices and to boost the economy owed to offsetting shocks rather than to a genuine breakdown of the monetary transmission mechanism. …… there is little evidence that the transmission channels of monetary policy were so diminished as to have obviated the benefits of faster and sharper monetary easing in the 1991–95 period.” At that time, I found that such a view on the effectiveness of monetary policy was too sanguine. Several years later, the housing and credit bubbles burst, this time in Europe and the United States, triggering a financial crisis. Developments in real GDP for the United States, after U.S. housing prices peaked and again after a large-scale financial crisis occurred in the form of the Lehman shock, reveal surprisingly similar trends shared with Japan (Charts 2 and 3).2 The same can be said of the two countries’ policy responses, including the virtually zero interest rate policy and the expansion of central banks’ balance sheets (Charts 4 and 5). When the Bank of Japan was striving to devise new policy measures, not to mention the zero interest rate policy, quantitative easing, a policy commitment regarding the future level of interest rates, and – as referred to today – credit easing, little did I imagine that the Federal Reserve would adopt similar measures within such a short span of years. I have become painfully aware of the need to more closely study each of the countries’ experiences over the past quarter-century, and to draw true lessons that could be applied to future policy conduct. Relevant topics for discussion range widely from monetary policy to regulation and supervision, payment and settlement systems, and so on. In my remarks today, I will raise For more details, see the following. Ahearne, Alan, Joseph Gagnon, Jane Haltmaier, Steve Kamin, and others, “Preventing Deflation: Lessons from Japan’s Experience in the 1990s,” International Finance Discussion Papers, No. 729, Board of Governors of the Federal Reserve System, June 2002. For the deleveraging process after the bursting of bubbles, see Masaaki Shirakawa, “Deleveraging and Growth: Is the Developed World Following Japan’s Long and Winding Road?,” Lecture at the London School of Economics and Political Science (Co-hosted by the Asia Research Centre and STICERD, LSE), January 10, 2012. BIS central bankers’ speeches several points with particular focus on the role of the central bank in maintaining macroeconomic stability at each of three phases: before, during, and after the financial crisis. I. Before the crisis: financial imbalances and monetary policy I would like to start from issues relevant in the periods preceding financial crises, focusing on the role of monetary policy. Conventional wisdom tells us that price developments serve as a trigger for changes in monetary policy. In fact, without exception, central banks pay attention to output gaps and inflation expectations, which have an impact on future inflation developments. In retrospect, however, when we look back at how bubbles were formed and then developed into financial crises, the most significant imbalance that destabilized the macroeconomy emerged on the financial front instead of the price front. The financial imbalances took the form of a sharp and significant rise in asset prices and credit expansion associated with increased leveraging and maturity mismatches. Financial imbalances ultimately created a tremendous shock to financial institutions and the financial system, and led to a sharp and significant contraction of economic activity. While such acute pains wore off as a result of aggressive policy measures taken by the governments and central banks after the crisis erupted, the chronic affliction of low growth associated with balance-sheet repair remains. This experience has revealed the fact that the economy was not able to avoid a prolonged period of stagnant growth even though aggressive monetary easing was adopted in a prompt manner after the bursting of bubbles. In this sense, policy priority should be placed on ex-ante measures to restrain a buildup of financial imbalances instead of ex-post measures to clean up the mess after a bubble bursts. Regarding ex-ante policy measures to address financial imbalances, some argue that, based on Tinbergen’s rule and Mundell’s assignment principle, the authorities should assign monetary policy to price stability while tasking regulatory and supervisory measures with the challenge of addressing financial imbalances. However, such a policy assignment can be effective only when the two policy objectives of price stability and financial system stability are independent from each other. A series of events in recent years have made it clear that the two policy objectives are not independent. When a macroeconomic environment including prices becomes stable, economic entities become more sanguine about risks and increase their appetite for risk-taking. Furthermore, with the growing expectation that a low interest rate environment will continue under price stability, financial institutions increasingly get involved in “search for yield” activity by increasing leverage and mismatches in their assets and liabilities with respect to maturities and currencies (Chart 6). When such imbalances grow beyond a certain threshold, they threaten the stability of the financial system and consequently that of the real economy and prices. Many central banks, including the Bank of Japan, were aware of the financial imbalances in the periods preceding financial crises. The most troublesome thing for central banks was the fact that inflation rates did not rise, or remained low, during the buildup of imbalances, which was ironic given their traditional emphasis on price stability (Chart 7). At least in the case of Japan, when inflation rates remained low amid high economic growth, those who tried to justify an interest rate hike needed to defeat the strong counterargument that was predicated on what later became known as “the arrival of the new economy.” The continuation of a low interest rate environment is one cause of financial imbalances. In particular, if the central bank commits itself to asymmetric conduct of monetary policy – more specifically, if it does not lean against a bubble so long as prices are stable but instead intervenes aggressively after the bursting of bubbles –, the situation could get worse through the following channels. First, this kind of put option-type monetary policy engenders more risk-taking by financial institutions. Second, if monetary policy focuses narrowly on price stability alone and successfully engenders an extended period of a stable macroeconomic environment, it will further boost various economic entities’ expenditure and risk taking. Even though monetary policy itself leads to a combination of high growth and low inflation, on the surface, it is difficult to distinguish such a case from the arrival of the new economy. If the central bank BIS central bankers’ speeches continues with monetary easing without a proper diagnosis, this boosts the economy and accelerates the accumulation of financial imbalances under seemingly continued price stability, resulting in a correspondingly larger shock after the bubble bursts. This could be referred to as “a paradox of price stability.” Needless to say, it is inappropriate to blame only monetary policy for an accumulation of financial imbalances that are in fact formed through a much more complicated mechanism. In this regard, nobody disagrees with the claim that regulations and supervision play important roles in addressing financial imbalances, and that macroprudential perspectives are crucial. So, what about the argument that the authorities should assign regulatory and supervisory measures to financial imbalances? My answer is simple: we need to employ appropriate monetary policy in tandem with regulations and supervision. It does not seem promising to address financial imbalances only through macroprudential measures and regulations without monetary policy responses. This is just like endlessly bailing out water that is overflowing from a bucket without turning off the tap. II. During the crisis: the importance of the lender of last resort role Now I would like to move on to the next phase: the midst of the crisis. In this phase, the essential role of the central bank is to act as the “lender of last resort.” The time-honored importance of the lender of last resort function has also been demonstrated by the aggressive measures taken by central banks in the midst of the recent crisis, which proved to be very effective in preventing a sharp drop in economic activity. Taking the examples of quantitative easing by the Bank of Japan, credit easing by the Federal Reserve, and the three-year LTRO by the European Central Bank, the effectiveness of all these measures essentially hinges on these central banks’ role as the lender of last resort. In association with the lender of last resort function, I would like to stress the importance of policies regarding payment and settlement systems (Chart 8). Only the central bank is able to issue currency that private economic agents can accept without conditions. Therefore, in a financial crisis where the credibility of counterparties is undermined, the role of the central bank becomes extremely important. In the midst of the crisis, it is crucial that financial institutions and investors manage the counterparty risk by controlling not only the amount of exposure at the end of the day but also that of intraday credit. In the past twenty years or so, it has been the role of the central bank, as a bank of banks, to make various efforts to improve the safety and efficiency of payment and settlement systems. Such efforts have led to the introduction of real-time gross settlement, delivery versus payment, and simultaneous settlement of foreign exchange (Chart 9). Without such efforts made by central banks, the Lehman shock could have induced a complete termination of financial transactions. If I am asked what the most significant contribution by central banks is in terms of securing economic and financial stability in the past quarter of a century, I could point to their unceasing efforts to improve payment and settlement systems. III. After the crisis: the effects and limits of aggressive monetary policy Lastly I would like to discuss the role of monetary policy in the aftermath of the financial crisis – specifically, when the economy has overcome acute pains but still suffers from chronic affliction of low growth associated with balance-sheet repair (Chart 10). When taking monetary easing steps, it is essential to conduct a careful analysis of their intended benefits as well as unintended costs. While aggressive monetary easing is definitely needed after the bursting of bubbles, its side effects and limits should also be taken into consideration. Although there is no universal conclusion to such cost and benefit analysis for monetary easing, as it depends on countries and phases, I would like to call attention to the following BIS central bankers’ speeches four aspects, which have not been paid sufficient attention in traditional arguments made before the recent crisis.3 The first is the burden of balance-sheet repair. Even with monetary easing, economic entities with excess debt neither increase expenditures nor embrace more risk taking until their debts are reduced to an appropriate level. Monetary easing only mitigates pains associated with balance-sheet repair. Moreover, employing this mitigator for a prolonged time comes with costs, as it reduces incentives to lessen excess debt and causes delays in balance-sheet repair, which ultimately is necessary for economic recovery. Needless to say, the effect of low interest rates is extended to those economic entities that have not suffered any damage to their balance sheets. If they bring forward future demand to the present by taking advantage of a low interest rate environment, this leads to an increase in aggregate demand. As balance-sheet adjustment continues for a long period of time, however, the amount of future demand that could be brought forward gradually diminishes even in a low interest rate environment. The above-mentioned cost of reducing incentives to lessen excess debt is not only an issue for private economic entities but also for the government. Once the increased level of government debt is perceived to be unsustainable, this threatens both price stability and financial system stability, as in the case of the European debt problem. The second aspect is the impact of low interest rates on the supply side of the economy. If low interest rates induce investment projects that are only profitable at such interest rate levels, this could have an adverse impact on productivity and growth potential of the economy by making resource allocation inefficient. While central banks have typically conducted monetary policy by treating a potential growth rate as exogenously given, when the economy is under prolonged shocks arising from balance-sheet repair, we may have to take into account the risk that a continuation of low interest rates will affect the productivity of the overall economy and lower the potential growth rate endogenously. The third aspect is the impact on financial intermediaries. The effect of monetary easing usually materializes when firms and households increase their expenditures, induced by low interest rates. Within that process, we should bear in mind that there are financial intermediaries and financial markets that connect monetary policy conducted by the central bank with firms and households. Once such intermediaries stop functioning properly, we can no longer expect to see a successful transmission of monetary easing. Maturity transformation is an important intermediation function of banks, which benefit from the spread between short- and long-term interest rates. Monetary easing widens this spread and increases the interest margins of financial intermediaries. This is one of the monetary transmission mechanisms that enhance the stimulative effect on the economy through the banking sector. Beyond a certain threshold, however, further monetary easing could instead squeeze the margins and discourage financial intermediation, resulting in lower efficiency in resource allocation and lower growth potential in the long run. A similar problem arises for institutional investors in the form of a negative spread – that is, investment returns on assets fall below the promised return on long-term liabilities. The fourth aspect is the international spillovers of monetary easing and the feedback effect on a country’s own economy. When the domestic economy is in the process of balancesheet repair, the effect of monetary easing tends to materialize in the form of a search for yield activities by global investors and the depreciation of foreign exchange rates, instead of increased expenditures by domestic private economic entities. If emerging economies become the destination of a search for yield activities by global investors, monetary easing in advanced economies, combined with an inflexible foreign exchange rate policy in emerging economies, is likely to lead to expansion in emerging economies and a rise in international As for quantitative analysis of the effect of various policy measures adopted during the period of quantitative easing in Japan, please see Hiroshi Ugai, “Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses,” Monetary and Economic Studies Vol. 25, No.1, March 2007. BIS central bankers’ speeches commodity prices.4 Even though such a rise in commodity prices is affected by globally accommodative monetary conditions, individual central banks recognize that the fluctuation in commodity prices is an exogenous supply shock and focus on core inflation rates which exclude the prices of energy-related items and foods. The resulting reluctance of individual central banks to counter rising commodity prices, when aggregated globally, could further boost these prices. From a global perspective, such a situation represents nothing more than a case where a hypothetical “World Central Bank” fails to satisfy the Taylor principle, which ensures the stability of global headline inflation (Chart 11). While it is understandable that central banks would pursue the stability of their own economies in the conduct of monetary policy, it is increasingly important to take into account the international spillovers and feedback effects on their own economies. Concluding remarks: monetary policy challenges for the future So far I have raised points relevant to discussing central banking in terms of three phases – before, during, and after the financial crisis. In closing, I would like to offer a change in perspective by pointing out future challenges for central banks as organizations. The first is the framework of monetary policy. In this regard, a consensus is already emerging. Most central banks of the advanced economies are now conducting policy with the aim of maintaining price stability in the medium to long term, regardless of the difference in the label attached to their monetary policy framework. Furthermore, it has also become apparent that an excessive focus on short-term inflation development may ultimately result in larger swings in the economy through the buildup and inevitable correction of financial imbalances. The Bank of Japan is probably not alone in trying to incorporate its view on financial imbalances – in other words, the macroprudential perspective – into the conduct of monetary policy. The remaining issue here is to weave such a desirable framework into the political foundations of central bank independence, which is the cornerstone of economic stability and prosperity. It is relatively straightforward to hold the central bank to account for hitting or missing a certain inflation number. In that sense, the spotlight accorded to specific levels of inflation has been a quid pro quo for entrusting an important slice of economic policy to a technocratic institution. In contrast to this, macroprudential considerations are much more nebulous – containing more elements of art rather than science – and will inevitably test the limits of democratic deference to the conduct of monetary policy. The second, and related, challenge is to strengthen the decision-making processes and economic analyses at central banks. Good decision making and research supporting a central bank are the real foundation of its independence. The recent crisis has revealed that we miss many important points when we look at the economy only from traditional macroeconomic perspectives. We need to make efforts to avoid falling into this trap and to break free from the habit of groupthink. It is essential to develop an institutional culture in which a variety of information vital to decision making in monetary policy – related to the macroeconomy, financial markets, and financial institutions – is fully utilized in a wellbalanced manner. As to the background of international commodity price developments and its policy implications, please see Report of the G20 Study Group on Commodities under the chairmanship of Mr. Hiroshi NAKASO, November 2011. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Summary of a speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Fukuoka, 29 February 2012.
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Hidetoshi Kamezaki: Recent economic and financial developments in Japan Summary of a speech by Mr Hidetoshi Kamezaki, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Fukuoka, 29 February 2012. * I. Economic activity and prices A. Overseas economies * * Tensions have heightened considerably in global financial markets since summer 2011 due to concerns about the European debt problem. Uncertainty about the fiscal discipline of peripheral European countries gave rise to doubts about the financial soundness of European financial institutions with large holdings of government bonds issued by these countries, making it difficult for these financial institutions to procure funds. In turn, the lending attitude of financial institutions to firms and households deteriorated, and this negative sentiment among economic entities had a detrimental effect on economic activity, giving rise to an adverse feedback loop among the fiscal situation, the financial system, and economic activity. Furthermore, the effects of increased risk aversion among investors as well as deleveraging by European banks are evident in neighboring Central and Eastern European countries and even in parts of Asia and other regions that have trade and financial ties with Europe. A key characteristic of the European debt problem is that the sovereign debt problems, which had been confined to some peripheral countries such as Greece and Portugal, have spread to major European countries such as Italy and Spain. Consequently, the stock prices of banks with large holdings of European government bonds fell. Recently, however, tensions in financial markets have abated somewhat due to the provision of ample funds through the 36-month longer-term refinancing operations conducted by the European Central Bank (ECB), the coordinated action being taken by six central banks – including the Bank of Japan – to provide U.S. dollar liquidity, and the recent agreement by euro area finance ministers on a second rescue package for Greece, worth 130 billion euros. These are, however, merely stop-gap measures to prevent further financial turmoil. Of more importance is prompt action in the following areas discussed by the European authorities: (1) fiscal reform in, and strengthening the competitiveness of, member states; (2) enhancing fiscal governance within the euro area; and (3) boosting the funds for a so-called firewall to contain disruptions in the financial system and financial markets. The objective of adopting the euro had been to create an economic zone free of currency rate fluctuations through the introduction of a unified single currency, with member states obliged to maintain fiscal discipline. In reality, however, taking advantage of a strong currency and low interest rate, peripheral countries such as Greece increased private consumption, resulting in greater external imbalances. Furthermore, wages rose faster than productivity due to rigid labor markets, resulting in a decline in competitiveness. At the same time, other countries such as Germany were able to raise productivity, mainly in the manufacturing sector, and succeeded in strengthening their export competitiveness. As a result, disparities in competitiveness and economic prosperity among member states increased. In theory, efforts should have been made to tighten fiscal discipline and raise competitiveness before the disparities could give rise to a financial crisis, but when the economy remained strong, the impetus for such efforts was lacking. Thus, the financial crisis arose, exposing the structural flaws of the euro area. As a result, in order to achieve its initial objective, Europe is now faced with the critical issue of restoring fiscal prudence and economic competitiveness, which need to complement the currency union. Given that BIS central bankers’ speeches political deliberations are shaped by public opinion in the member states, reaching decisions requires considerable time. However, because the crisis could potentially have a large negative impact on financial markets and economies around the world, it is essential that a sufficiently large firewall is erected quickly and countries implement fundamental fiscal and structural reforms. Against the background of the European debt problem, the pace of recovery of the world economy has been slowing. The annualized growth rate of overseas economies was 6.5 percent during the January-March quarter of 2011, but fell to 3.0 percent in the April-June quarter before rising to 3.8 percent in the July-September quarter and then slowing again to 0.9 percent in the October-December quarter. As for the outlook, it is likely to take a while for the European debt problem to be resolved, while in the United States the household balance-sheet problem is weighing down on private consumption, reducing the likelihood of any buoyant recovery. For the balance-sheet problem to be overcome, it is necessary either for housing prices to bottom out and start rising, which would resolve the negative equity situation – where mortgage balances exceed the market value of a home – or for households to regain their ability to repay debt through improvements in the employment and income situation. The correction of excess debt is a time-consuming process, however, as Japan’s post-bubble experience shows. While industrialized countries as a whole struggle to grow, emerging and commodity-exporting economies are likely to become the engines of global economic growth. Although expectations are high for emerging and commodity-exporting economies, it remains to be seen how strong an engine they can actually be given the various uncertainties. B. The Japanese economy The Japanese economy slowed temporarily following the Great East Japan Earthquake in March 2011. Subsequently, strenuous efforts were made by firms to rebuild supply chains, helping the economy to recover by around the summer of 2011 despite constraints to the supply of electricity. Since autumn 2011, exports and production have been under pressure from a further negative shock in the form of the flooding in Thailand, adding to the European debt problem and the effects of the appreciation of the yen. Private consumption remained firm, due in part to a recovery in demand that had been restrained after the earthquake, while business fixed investment has been on a moderate increasing trend, aided partly by the restoration of disaster-stricken facilities. As a result, the Japanese economy has been more or less flat, caught between both negative and positive factors. Real GDP growth in fiscal 2011 is likely to be slightly negative mainly due to the effects of the supply-side constraints caused by the disaster as well as the slowdown in overseas economies and the appreciation of the yen. Restoring the national finances is also one of the major issues Japan currently faces. The situation in Europe, where fiscal risks have materialized, cannot be considered merely a “fire on the other side of the river.” A look at Japan’s fiscal situation shows that its primary budget deficit is similar to those of Spain and Portugal, while its outstanding debt is extremely large, be it on a gross or a net basis, that is, offsetting financial assets held by the government. Some argue that there is little reason to worry as the share of Japanese government bonds (JGBs) held by foreign investors is low compared to the share of European and U.S. government bonds held by foreign investors. And in fact, government bond prices are not weak – long-term interest rates are not rising – at present. However, a lesson to be learned from the European debt problem is that once trust in a country’s fiscal management wanes, this can soon lead to a loss of confidence in government bonds as a safe asset. Although to date there has been little difficulty in finding buyers for JGBs, this may not hold true in the future. Confidence in JGBs could change in a non-linear fashion and government calculations suggest that the fiscal situation in Japan is likely to remain severe. To ensure that confidence in Japan’s public finances is maintained, it is necessary to embark on a path to fiscal sustainability that gives the public reasons to believe that the government can BIS central bankers’ speeches restore fiscal balance in the medium to long term. Steps in this direction include a growth strategy to lift the country’s growth rate as well as revisions to the social security and taxation systems. Turning to the balance of payments, Japan’s trade balance fell into a deficit of 1.6 trillion yen in 2011, marking the first deficit since 1963, that is, in 48 years. There are three main reasons for this. First, exports declined sharply due to the supply-side constraints caused by the disaster, while imports of intermediate goods increased to make up for shortages in domestic supplies. Second, shutdowns of nuclear power plants led to an increase in imports of crude oil, liquefied natural gas, and other fossil fuels used for thermal power generation. And third, the slowdown in overseas economies and the appreciation of the yen since autumn 2011, as well as the flooding in Thailand, weighed down exports. Thus, a combination of various factors was behind the trade deficit for 2011. The supply-side constraints and the flooding in Thailand are, however, temporary factors and are unlikely to affect exports and imports hereafter. The trade balance in January 2012 also marked a record deficit. According to preliminary data, the deficit was 1.5 trillion yen, the largest monthly deficit ever since the compilation of comparable data started in 1979. The deficit in large part also reflects a special factor – namely, the decline in exports due to the fact that in 2011 the Chinese New Year holidays took place in February. The current account balance, which consists of the balance of trade in goods and services, the balance of income, and current transfers, remained in surplus in 2011, although the surplus decreased substantially mainly due to the trade deficit. The services balance records the receipts and payments for international transactions in services, while the income balance records the international receipts and payments of interest and dividends, and current transfers record contributions to international organizations as well as the flow of government food and financial assistance. The current account was in surplus owing to a large surplus in the income balance, which in turn was brought about by increases in interest and dividend payments from direct and portfolio investments. It is very likely that the income balance will remain in surplus for the time being given external assets amounting to 250 trillion yen. Therefore, unless the trade deficit continues to expand rapidly, the current account is likely to remain in surplus. C. Recent price developments Next, I will move on to price developments. International commodity prices had been increasing from around spring 2009 on the back of high growth in emerging economies, but weakened slightly around summer 2011 due to the instability in global financial markets and subsequently remained more or less flat. However, most recently commodity prices have been rising again, mainly due to geopolitical risks. Import prices in Japan and the domestic corporate goods price index (CGPI) – which measures fluctuations in prices of goods traded between firms in Japan – have been more or less flat, reflecting movements in international commodity prices. Meanwhile, the year-on-year rate of decline in the consumer price index (CPI) for all items excluding fresh food, or the core CPI – which measures fluctuations in prices of goods and services purchased by households – has slowed consistently since around 2009 as the aggregate supply and demand balance gradually improved, and the year-on-year rate of change is currently around 0 percent, reflecting developments in import prices and the CGPI. As for the outlook, in light of recent developments in the output gap, the year-on-year rate of change in the core CPI is expected to remain at around 0 percent – potentially falling into slightly negative territory – for the time being, albeit with some fluctuations reflecting movements in international commodity prices. BIS central bankers’ speeches D. Outlook for economic activity and prices The outlook I just presented is my own personal assessment. Let me now turn to the Outlook for Economic Activity and Prices, known as the Outlook Report, which the Bank releases semiannually in April and October. The Outlook Report presents the Policy Board members’ assessments of economic activity and prices based on their forecasts. In addition to the semiannual Outlook Report, the Bank releases interim assessments in January and July that present the Bank’s revised forecasts. In the most recent forecasts, released on January 24, 2012, Policy Board members considered it most likely that Japan’s economic activity would remain more or less flat for the time being, but thereafter the economy was likely to return to a moderate recovery path as the pace of recovery in overseas economies picked up, led by emerging and commodity-exporting economies, and as reconstruction-related demand after the earthquake gradually materialized. On the price front, the year-on-year rate of change in the core CPI is expected to remain at around 0 percent for the time being, but thereafter is expected to record a clear year-on-year increase in fiscal 2013. This outlook, however, is subject to various uncertainties, among which future developments with regard to the European debt problem continue to represent the most significant risk to the economy. Its effects are already spreading to Japan’s exports and production, both directly and indirectly through international trade. Attention should therefore continue to be paid to the possibility that the European debt problem could lead to weaker growth in overseas economies – and consequently in Japan’s economy – mainly through its effects on global financial markets. In the United States, strains from balance-sheet repair, as mentioned earlier, continue to weigh on the economy despite some firmness observed in household sentiment on the back of improvements in the employment and income situation. With regard to emerging and commodity-exporting economies, which are expected to drive global economic growth, there remains a high degree of uncertainty about whether these economies – including China, where the inflation rate has been declining recently – can achieve price stability and economic growth at the same time. Regarding the outlook for prices, there is a possibility that the inflation rate will rise more than expected if international commodity prices increase due to geopolitical risks such as those associated with the situation surrounding Iran, while there is also a risk that the rate of inflation will deviate downward from the Bank’s baseline scenario due, for example, to a decline in medium- to long-term inflation expectations resulting from a slowdown in economic activity. II. Measures taken by the bank A. Recent conduct of monetary policy toward a sustainable growth path with price stability With a view to overcoming deflation and returning Japan’s economy to a sustainable growth path with price stability, the Bank continues to consistently make contributions as the central bank, through the three-pronged approach of pursuing powerful monetary easing consisting of comprehensive monetary easing, ensuring financial market stability, and providing support to strengthen the foundations for economic growth. 1. Pursuing powerful monetary easing The Bank decided the following three new measures at the Monetary Policy Meeting held on February 13 and 14, 2012. BIS central bankers’ speeches a. Introduction of “the price stability goal in the medium to long term” First, the Bank introduced “the price stability goal in the medium to long term,” which is the inflation rate that the Bank judges to be consistent with price stability sustainable over the medium to long term. Prior to the introduction of the goal, the Bank’s “understanding of medium- to long-term price stability” (hereafter “understanding”) showed the range of inflation rates that each Policy Board member understood as price stability from a medium- to long-term viewpoint. However, at the latest Monetary Policy Meeting, the Policy Board decided to replace the “understanding” with the inflation rate that the Bank, based on a consensus among all Policy Board members, judges to be consistent with price stability sustainable over the medium to long term and to refer to this as “the price stability goal in the medium to long term.” The Bank judges “the price stability goal in the medium to long term” to be in a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI and, more specifically, sets a goal of 1 percent for the time being. b. Clarification of determination to pursue monetary easing Second, the Bank showed its commitment to pursuing monetary easing through the so-called “policy duration effects.” For the time being, the Bank will aim to achieve the goal of 1 percent inflation in terms of the year-on-year rate of increase in the CPI through the pursuit of powerful monetary easing, conducting its virtually zero interest rate policy – that is, maintaining the target for the uncollateralized overnight call rate at “around 0 to 0.1 percent” – and implementing the Asset Purchase Program (hereafter the Program) mainly through the purchase of financial assets. The Bank will continue with this powerful easing until it judges the 1 percent goal to be in sight, on condition that it identifies no significant risk to the sustainability of economic growth, such as from the accumulation of financial imbalances. c. Expansion of the Program Third, the Bank increased the total size of the Program by about 10 trillion yen, from about 55 trillion yen to about 65 trillion yen. The increase in the Program is earmarked for the purchase of JGBs, as the Bank – in consideration of the generally smooth corporate financing conditions observed recently – judged it appropriate to further enhance the spread of monetary easing effects throughout financial markets through the purchase of JGBs. By fully implementing the Program, including the additional expansion decided at the latest Monetary Policy Meeting held on February 13 and 14 by the end of 2012, the amount outstanding of the Program will be increased by about 22 trillion yen from the current level of around 43 trillion yen. The Program has been established with the aim to create additional monetary easing effects by encouraging a decline in longer-term interest rates and a reduction in various risk premiums in a situation where there was little room for further declines in short-term interest rates. Through the Program, the Bank – in addition to the increased purchase of JGBs just mentioned – purchases various financial assets, such as CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs), and conducts fixed-rate funds-supplying operations against pooled collateral whereby funds with a maturity of three or six months are provided at an interest rate of 0.1 percent. As a result of the most recent increase in the Program, the Bank’s pace of purchasing JGBs will accelerate significantly from about 0.5 trillion yen per month to about 1.5 trillion yen. Adding up JGB purchases through the Program and the Bank’s regular JGB purchases to meet the trend increase in banknote demand, conducted at a pace of 1.8 trillion yen per month, the Bank will be purchasing a large amount of JGBs until the end of 2012 at the pace of 3.3 trillion yen per month, or about 40 trillion yen for the year. It should be emphasized, however, that the purpose of this significant scale of JGB purchases is to achieve sustainable growth with price stability, and that the Bank rigidly maintains its policy of not conducting purchases of JGBs for the purpose of financing government debt. BIS central bankers’ speeches 2. Ensuring financial market stability The Bank has been showing its commitment to fully ensure financial market stability through implementing a variety of measures including the utilization of various funds-supplying operations. When uncertainty began to spread in the financial markets just after the earthquake, the Bank provided ample funds to the markets, the total amount of which represented a historical high. The Bank has also taken measures to provide financial institutions with the confidence that they can obtain sufficient funds whenever necessary. In May 2010, in response to the reemergence of strains in U.S. dollar short-term funding markets, the Bank – in coordination with the Bank of Canada, the Bank of England, the ECB, the Federal Reserve, and the Swiss National Bank – reestablished the temporary U.S. dollar liquidity swap facility, which had expired, and reintroduced a scheme that would make it possible to conduct the U.S. dollar funds-supplying operation. Furthermore, in November 2011, the aforementioned six central banks decided to enhance this facility by lowering the interest rates on the U.S. dollar funds-supplying operations and extending the effective period of such operations through to February 1, 2013, as well as expanding the currency swap agreements to include Canadian dollars, pounds sterling, euros, Swiss francs, and yen in addition to U.S. dollars. 3. Providing support to strengthen the foundations for economic growth The Bank has also been encouraging initiatives by financial institutions and firms through the fund-provisioning measure to support strengthening the foundations for economic growth. Specifically, through this measure, the Bank provides long-term funds, with a maximum duration of four years at a low interest rate of 0.1 percent, to financial institutions up to the actual amount of lending and investment carried out by each financial institution, against pooled collateral such as JGBs. Many financial institutions nationwide have shown an interest in the measure since it was implemented in June 2010, and by mid-2011 the total amount of loans disbursed by the Bank had reached the ceiling of 3 trillion yen. Areas eligible for investments and loans range, for example, from environment and energy business, medical and nursing care business, and development of social infrastructure, to investment and business deployment in Asian countries. In addition, although the maximum duration of loans provided under the measure is four years, the average duration of actual individual investments and loans provided by financial institutions is more than six and a half years. Moreover, following the introduction of the measure, financial institutions have established new dedicated funds and lending schemes, and some of them in certain cases have set a higher ceiling on the total amount of investments and loans than the 150 billion yen ceiling for the total amount of loans that they could obtain from the Bank. As this shows, the measure has been fully serving its purpose to act as a catalyst. In June 2011, the Bank enhanced the measure with a view to supporting financial institutions’ efforts to strengthen the foundations for economic growth through the use of a wider range of financial techniques. More specifically, in order to support emerging and small firms in their efforts to solve the problems they face – risk money and a lack of real estate collateral – the Bank provides funds to financial institutions that undertake equity investments and offer the so-called asset-based lending, or ABL, to firms with growth opportunities up to the actual amount of investment and lending carried out by each financial institution. The Bank hopes that this enhancement will stimulate further use of such financial techniques that have yet to achieve a sufficient level of familiarity, and thereby lead to the nurturing of firms with growth potential. The Bank believes that this, in turn, should help to raise Japan’s growth potential as well as financial institutions’ ability to find and support promising firms. Through this new line of credit, the Bank provided 38.1 billion yen in the first new loan disbursement conducted in September 2011, and 17.5 billion yen in the second new loan disbursement conducted in December 2011. These loans were provided to financial institutions against collateral pledged to them, consisting mostly of equipment, accounts receivable, and products. With BIS central bankers’ speeches regard to equipment, there were cases in which ships, machine tools, and construction machinery were used as collateral. B. The bank’s measures following the great east Japan earthquake In less than two weeks, one year will have passed since the Great East Japan Earthquake that struck in March 2011. Following the earthquake, the Bank swiftly implemented various measures from three perspectives: (1) maintaining the functioning of financial and settlement systems; (2) ensuring the stability of financial markets; and (3) supporting economic activity. First, immediately after the earthquake, the Bank conducted measures including the provision of cash to financial institutions in disaster areas, the provision of ample funds in financial markets, and the further enhancement of monetary easing by, for example, increasing the total size of the Program. In addition to these measures, since April 2011, the Bank has been conducting funds-supplying operations with a view to supporting financial institutions in disaster areas in their initial efforts to meet demand for funds for restoration and rebuilding. In the same month, the Bank also decided to broaden the range of eligible collateral for money market operations with a view to securing sufficient financing capacity at the financial institutions in disaster areas, and this measure has been in place since then. III. Returning to a sustainable growth path with price stability I will now take a look at the Japanese economy from a longer-term perspective. While the Japanese economy has gone through a number of business cycles since the bursting of the bubble in the early 1990s, average growth has been poor and the economy has failed to extricate itself from deflation, resulting in the “two lost decades.” In order for the economy to escape from this long trend of low growth and deflation and regain its strength, it is necessary to introduce fundamental measures designed for the revitalization of the Japanese economy. A. Causes for low economic growth During the 1960s, the average annual growth rate of the Japanese economy was more than 10 percent, and even during the period of stable growth in the 1970s and 1980s, the economy grew at average annual rates of 4 to 5 percent. In the 1990s average annual growth fell sharply to around 1.5 percent, and in the 2000s the economy grew at only 0.6 percent per year on average, although the average rises to 1.5 percent when the two years of negative growth due to the Lehman shock are excluded. Thus, in the 20 years since the early 1990s, the Japanese economy on average has grown at a low rate of around 1.5 percent. How can this long-term downtrend in Japan’s growth be explained? In order to answer this question, if we examine the two factors that affect the growth trend – changes in the number of workers and changes in labor productivity per worker – we see that the decline in Japan’s economic growth rate was due to both of these factors. However, compared with other countries, labor productivity in Japan is not particularly low and is more or less in line with that in the United States and the United Kingdom. Therefore, in order to raise Japan’s growth rate, efforts to increase the number of workers are particularly important, together with efforts to raise productivity growth. B. Revitalizing the Japanese economy Given the decline in the number of workers and in productivity growth, what steps should be taken to revitalize the Japanese economy? According to the National Institute of Population and Social Security Research, Japan’s population peaked in 2010 and is forecast to decline to 91.93 million in 2055. The BIS central bankers’ speeches working-age population, that is, those aged between 15 and 64, has already started to decrease, peaking at 87.17 million in 1995, and is forecast to fall to 47.06 million by 2055. The share of the working-age population in the total population, which was 69 percent in 1995, is forecast to drop to 51 percent in 2055. By then, about 40 percent of the population is expected to be 65 and over. I believe that, to avoid further decreases in the number of workers, it is necessary to slow the aging of society by implementing measures to increase the birth rate, but unfortunately such measures do not produce immediate results. Therefore, it is essential to make efforts to raise the number of workers by increasing labor market flexibility so as to (1) reduce labor market mismatch, that is, situations where those wanting to work cannot find a job; (2) promote employment of those aged 65 and over that have left the workforce; and (3) promote employment of women who left the labor market when getting married or giving birth but want to work again. Although some deregulation and investment in infrastructure with the aim of improving labor market conditions has already been undertaken, I believe that more effective measures than those implemented to date are required. Next, what steps should be taken to improve labor productivity? Before the onset of the two lost decades, Japan enjoyed high growth in a favorable environment that, in addition to the increase in the labor force, included the following. First, Japan benefited from the latecomer advantage and was able to learn from the growth process of the advanced economies of the United States and Europe. And second, Japanese manufactured goods enjoyed a superior competitive edge in the absence of rivals other than the United States and Europe. However, since then, having caught up with the United States and Europe and finding itself pursued by emerging economies that have become rival producers of manufactured goods, Japan has been forced to transform its catch-up growth model. Going forward, Japan needs to adapt to changes in the environment and open up new growth markets in such a way as to enhance its own growth potential. On this basis, the question arises as to what kind of measures should be taken. The government’s “Strategy for Rebirth of Japan” states that, as part of its efforts to further strengthen economic growth, emphasis should be placed on the following areas: (1) promoting economic partnerships and harnessing global growth; (2) creating new industries and new markets in response to changes in the environment; (3) revitalizing financial markets through new capital flows; (4) revitalizing the food, agriculture, forestry, and fisheries industries; and (5) promoting tourism. As there is insufficient time today to cover all of these areas, I will focus on the following issues: (1) exploiting business opportunities arising from the aging of society; (2) adjusting the business environment to better adapt to globalization; and (3) increasing the number of foreign visitors to Japan. The first issue concerns business opportunities relating to the aging of society. Given the declining birthrate and rapid aging of the population, the market for products and services for the elderly is certain to expand, providing one of the most promising growth areas with great potential demand. For instance, it takes little to foresee a vast expansion in demand for medical and nursing care. In order to cater for such demand, it is necessary to increase the supply of medical and nursing care services. To this end, along with further deregulation, the following should be encouraged: (1) addressing the shortage and uneven geographical distribution of doctors and nurses; (2) providing a wider range of choices for patients with regard to their treatment, including highly advanced medical treatments not covered by health insurance; and (3) innovation with regard to new drugs and medical equipment. The second issue relates to providing the proper business environment in a globalized economy. While it is necessary to expand domestic demand, it is even more important to try to capture demand from rapidly growing overseas economies. Therefore, to fully benefit from globalization, it is essential to put in place the appropriate business environment. Yet, so far, Japan has entered only twelve Economic Partnership Agreements (EPAs) and Free Trade Agreements (FTAs) and none have been concluded with any of Japan’s major trading partners. It is extremely important to build a framework that will help integrate domestic and overseas markets through agreements such as EPAs and FTAs. BIS central bankers’ speeches The third issue concerns increasing the number of foreign visitors to Japan. Looking at the number of foreign tourists for 2010, Japan was well behind popular international tourist destinations. France was the most popular in the world, attracting 76.8 million foreign visitors, followed by the United States with 59.75 million. The number of tourists that visited Japan was 8.61 million, just above one-tenth that of France. Looking at other Asian destinations, Japan lagged far behind China, which received 55.67 million visitors, and was behind Hong Kong (20.09 million), Thailand (15.84 million), Singapore (9.16 million), and South Korea (8.8 million), which is just next door. Thus, the number of foreign visitors to Japan is not only extremely low compared to other advanced economies but is also lower compared to other Asian economies. Efforts should therefore be made to increase the number of foreign visitors, as this would raise derived demand for tourism-related industries. In addition, such efforts should not be confined to tourists; if Japan attracted more foreign visitors in the fields of health care, education, and culture and the arts, this not only would help to create new jobs but also could promote innovation through the fusion of skills that foreign workers would bring with them. C. Measures taken by the bank The Bank continues to consistently make contributions as the central bank in order to overcome deflation and return the Japanese economy to a sustainable growth path with price stability. The Bank should always be ready to proactively implement the necessary policies to achieve its objectives. Nevertheless, it should be kept in mind that the challenges the economy faces today cannot be overcome by the Bank’s efforts alone. The Bank will continue to do its utmost to provide support from the financial side. At the same time, however, it is extremely important for business firms, financial institutions, and the government each to continue exerting themselves in their respective roles. BIS central bankers’ speeches
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Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Chiba, 28 March 2012.
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Ryuzo Miyao: Economic activity, prices, and monetary policy Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Chiba, 28 March 2012. * * * Introduction Thank you for giving me this opportunity to exchange views with people representing Chiba Prefecture. Allow me to express also my gratitude for your cooperation with the activities of the Research and Statistics Department and other departments of the Bank of Japan. I have been told that the Bank’s meetings with business leaders have not been held in Chiba since October 2003, and thus I am looking forward to hearing your views. In my speech to you today, I will review economic activity and prices both overseas and in Japan – whose economy is heading toward recovery despite the effects of the global economic slowdown – and then present a few remarks on monetary policy. My concluding remarks will touch on the economy of Chiba Prefecture. I. Recent developments in economic activity and prices A. Overview Japan’s economy entered a soft patch around the turn of the year. While domestic demand has been firm, growth in external demand has been sluggish, reflecting the deceleration of the global economy – caused by the European economy’s stagnation due to the European debt problem, a slowdown in the Chinese economy due to monetary tightening, and the flooding in Thailand – as well as the continued appreciation of the yen. As a result, Japan’s economic activity as a whole has remained more or less flat. However, it is expected that the pace of recovery in overseas economies will pick up slowly, led by emerging economies, and reconstruction-related demand after the Great East Japan Earthquake in March 2011 will gradually increase. Supported by these factors, Japan’s economy is expected to gradually emerge from its soft patch and return to a moderate recovery path. In what follows, I will present an overview of developments in overseas economies, and then discuss the current situation and prospects for Japan’s economy. B. Overseas economies The European economy experienced severe strains in the financial markets and financial systems until around the end of 2011, because of the European debt problem. However, market conditions subsequently improved with the subsiding of tail risks such as the funding collapse at financial institutions. This positive development was partly the result of a reduction in the pricing on the existing temporary U.S. dollar funds-supplying operations by six central banks and 36-month longer-term refinancing operations (LTROs) with full allotment conducted twice by the European Central Bank. In particular, approximately 500 billion euros on a net basis were provided through each tranche of the LTROs, which facilitated the smooth redemption of corporate bonds and reduced the yields on government bonds through their purchase by financial institutions. With the recovery of stability in financial markets and financial systems, some financial institutions have begun issuing uncollateralized corporate bonds, and the situation has been steadily improving. In mid-March, debt restructuring with Greek government bondholders in the private sector was carried out successfully and the second tranche of financial assistance under the economic BIS central bankers’ speeches adjustment programme for Greece was agreed. The risk of anxiety sweeping through financial markets or rapid economic deterioration – which had been acknowledged in the phrase “Europe is the greatest risk” – thus appears to have been alleviated. Nevertheless, the European debt problem itself has not been resolved, and concern over deleveraging – whereby financial institutions reduce lending and adversely affect economic activity – has yet to be dispelled. European financial institutions appear to be reducing their foreign currency-denominated lending, such as syndicated loans, in North and South America and Asia. It has been reported that these institutions have also been gradually reducing euro-denominated lending, particularly in some European peripheral countries. In the background, it seems that two factors are at work, namely, sluggish demand for funds by firms and households due to the economic downturn, and the need of financial institutions to improve their capital ratios. Future developments in both factors continue to require attention. More fundamentally, Europe faces the critical challenge of pursuing both fiscal consolidation and structural reform at the same time and raising growth potential. The difficulty for the European countries is that they must pursue fiscal consolidation in the short run but at the same time boost private-sector vitality and enhance economic growth, while preventing fiscal consolidation from further harming economic activity. The European economy as a whole is likely to stagnate for the time being and subsequently return to a moderate recovery path. Given that disparities in competitiveness are becoming apparent among European countries, it is possible that the pace of recovery will be extremely slow. Due attention should continue to be paid to the risk that economic stagnation might become chronic or prolonged. As for the United States, several favorable economic indicators have been released recently and the economy is recovering moderately. The year-on-year rate of change in the consumer price index (CPI) for all items less food and energy has been stable at about 2 percent. The general picture of the economy is that households’ balance-sheet adjustments continue to weigh on economic activity, but the mechanism of economic recovery supported by the corporate sector is operating continuously and the momentum for a moderate improvement is being maintained. Let me elaborate on this point for a moment. In the United States, housing prices have been sluggish, but firms’ production, exports, and profits have been strong because they have succeeded in tapping global demand, and this has led to an improvement in employment and income conditions and steadily underpinned private consumption. Gradual materialization of pent-up demand, or potential demand, which had been contained after the Lehman shock and the Great East Japan Earthquake, seems to have also supported the economic recovery. Another advantage is the fact that spill-over effects of the European debt problem on economic activity have thus far been less serious than initially expected. As for the outlook for the U.S. economy, a number of private research agencies hold the view that moderate growth of 2.0–3.0 percent is achievable. Given that housing construction and house sales are showing signs of bottoming out against the background of a solid expansion in employment and a gradual reduction in the ratio of household debt to disposable income, it appears that the burden of households’ balance-sheet adjustments is gradually easing as a whole and the economy is gradually increasing in resilience to downside shocks. Having said that, as a current risk to the U.S. economy I would point to the surge in gasoline prices stemming from an increase in crude oil prices. Thus far, the rise in crude oil prices is considered to be largely attributable to supply-side factors, including the situation in Iran, and thus the price hike is likely to be temporary. As natural gas prices have been declining in the United States due partly to progress in shale gas development, we might not need to be overly concerned about the rise in crude oil prices. However, if gasoline prices – which at present are 3.8 U.S. dollars per gallon – exceed 4 U.S. dollars, this is likely to adversely affect economic activity, mainly in the form of its impact on medium- to low-income families, and thus the situation warrants attention. BIS central bankers’ speeches In the meantime, stock prices have recovered to their level prior to the Lehman shock and developments in U.S. financial markets have been favorable. Although long-term interest rates have not moved in tandem with the rise in stock prices and have been more or less flat for some time, they have started to rise recently, gradually reflecting the improvement in economic activity. Asian emerging economies, led by China, have been maintaining high growth rates, and medium- to long-term growth expectations also appear to be high. In China, however, exports and imports declined and the pace of increase in production slowed around the turn of the year, due to the effects of monetary tightening to contain the rise in prices as well as to stagnation in the European economies associated with the debt problem. Consequently, exports have declined and the economies of the NIEs and the ASEAN countries have decelerated somewhat as well. Asian emerging economies are leading the global economy, and the Bank’s baseline scenario is that these economies will gradually recover, supported by buoyant domestic demand. At the same time, attention should be paid to the possibility that European financial institutions’ credit contraction will spill over to trade credits and prolong the current economic slowdown. In terms of achieving sound development of the global economy in the longer term, a key factor will be how to maintain the balance between economic growth and price stability. In this regard, China’s announcement that lowered the economic growth target from 8.0 percent in 2011 to 7.5 percent in 2012 was a favorable step toward achieving a soft landing of the economy, despite the weakened economic stimulus effect in the short term. At any rate, in 2012 uncertainty and changes in economic policy associated with the transition of leadership in China should be carefully monitored. C. Economic activity and prices in Japan One year has passed since Japan’s economy experienced the Great East Japan Earthquake. Following the disaster, economic activity plunged due to the disruption of supply chains and constraints on electric power supply. Thereafter, as a result of strenuous efforts by the parties concerned, Japan’s economy began to recover in the July-September quarter of 2011. However, in the October-December quarter, the economy faced downward pressure as exports and production grew at a sluggish pace due to a slowdown in overseas economies – on the back of the European debt problem, monetary tightening in China, and the flooding in Thailand – as well as the appreciation of the yen. The annualized quarter-on-quarter growth rate of real GDP on a seasonally adjusted basis in 2011 was minus 6.9 percent in the January-March quarter, minus 1.2 percent in the April-June quarter, 7.1 percent in the July-September quarter, and minus 0.7 percent in the October-December quarter. In recent months, exports and production have remained more or less flat, but domestic demand has been solid. Business fixed investment has been on an increasing trend, albeit moderately, supported by the restoration of disaster-stricken facilities, and private consumption has firmed up due in part to the effects of measures to stimulate demand for automobiles. Housing investment has generally been picking up and public investment has stopped declining. Household and business sentiment appears to have stopped deteriorating in general. Thus, although the Bank judged that Japan’s economic activity has remained more or less flat, it has shown some signs of picking up. With regard to the outlook, the baseline scenario is that Japan’s economy is expected to gradually emerge from the current phase of flat growth and return to a moderate recovery path as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and reconstruction-related demand gradually increases. It is desirable for such improvement to be as sustainable as possible. From the viewpoint of achieving sustainable growth, it is desirable if, both in manufacturing and nonmanufacturing industries, high-quality capital that enhances value-added is BIS central bankers’ speeches accumulated domestically, investment increases, and the competitiveness of industries improves. It is important to maintain and enhance in the domestic economy the qualities necessary for manufacturing, while working to tap domestic demand that reflects the needs of the aging population. Looking at developments in domestic private business fixed investment, we can see that it declined substantially after the Lehman shock and the ensuing pace of its recovery has been quite modest. The slowdown in overseas economies and the appreciation of the yen in the second half of 2011 might have put additional downward pressure on business fixed investment in the manufacturing industry. According to the Cabinet Office’s “Annual Survey of Corporate Behavior in FY2011,” however, firms are forecasting an annual growth rate of about 1.5 percent in real GDP and about 4 percent in business fixed investment for the next three years, which suggests that as a whole firms’ medium- to long-term growth expectations have been maintained and their investment appetite has not declined. In the survey, firms’ overseas production ratio is currently about 18 percent and is forecast to reach approximately 22 percent in five years, which suggests that the balance between overseas and domestic production will be maintained. In addition, as investment was reduced to the level below depreciation following the Lehman shock, this in turn is currently encouraging replacement investment. It can also be expected that firms will add investment spending to restore and reconstruct disaster-stricken facilities as well as to strengthen their earthquake resistance. Given the situation I have described, it would be no surprise if domestic business fixed investment, compared with firms’ cash flows or depreciation costs, became more apparent, and thus potential demand for investment is likely to have accumulated accordingly. If actual investment has been contained even though firms’ investment appetite has not declined, this might mean that firms have been deferring investment decisions because of sluggish stock prices, the yen’s appreciation, the slowdown in the global economy stemming from the European debt problem, and related uncertainty about the future. Let me repeat that firms’ forward-looking investment in projects that would enhance value-added is a major driving force in order to increase the growth potential of the economy and improve productivity. It would also contribute to overcoming deflation. Whether firms’ investment spending will steadily increase – at a pace consistent with their growth expectations, both at home and abroad, in a balanced manner – is vital for Japan’s economy to achieve sustainable growth and overcome deflation. Turning to price developments, the year-on-year rate of decline in the CPI (all items less fresh food) slowed at a moderate pace in 2011, reflecting the improvement in the aggregate supply and demand balance, and has been hovering around 0 percent since the summer of 2011. The baseline scenario of the outlook for prices projects that the current situation is likely to continue for the time being, but the year-on-year rate of change in the CPI will gradually turn positive as the aggregate supply and demand balance improves. While crude oil prices have recently been surging due partly to the situation in Iran, the price levels of other commodities have not necessarily risen compared with 2011. As this seems to be consistent with the currently still-weak recovery of the global economy, upward pressure on crude oil prices might be temporary due to supply-side factors. Since crude oil prices might remain high depending on developments in geopolitical risk, careful monitoring is required. II. Monetary policy A. Conduct of monetary policy Let me now discuss the Bank’s enhancement of monetary easing decided in February 2012. At the Monetary Policy Meeting held on February 13 and 14, the Bank – amid the continued BIS central bankers’ speeches high uncertainty surrounding economic developments both at home and abroad – judged it necessary to further support the recent positive developments from the financial side and better ensure the economy’s return to a moderate recovery path. Accordingly, the Bank decided to introduce “the price stability goal in the medium to long term,” clarify its monetary easing stance, and increase the total size of the Asset Purchase Program (hereafter the Program). In this regard, let me mention three points. First, the introduction of “the price stability goal in the medium to long term.” Prior to the introduction, the Bank had shown the range of inflation rates that each of the nine Policy Board members understood as price stability in the form of the “understanding of medium- to long-term price stability.” At the Monetary Policy Meeting in February, the Bank replaced this to show the Bank’s own judgment. Namely, it judges “the price stability goal in the medium to long term” to be within a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI, and has set the goal at 1 percent for the time being. Second, the clarification of the Bank’s monetary easing stance. Based on the aforementioned goal, the Bank further clarified its powerful easing stance by clearly stating that, for the time being, it will continue to pursue powerful monetary easing by conducting its virtually zero interest rate policy and by purchasing financial assets, with the aim of achieving the goal of 1 percent in terms of the year-on-year rate of increase in the CPI, until it judges that the 1 percent goal is in sight. Third, the increase in the total size of the Program. The Bank increased the purchase of Japanese government bonds (JGBs) through the Program by about 10 trillion yen, thereby increasing the total size of the Program from 55 trillion yen to 65 trillion yen. This demonstrates the clarification of the Bank’s monetary easing stance in the form of action. B. Channels through which the enhancement of monetary easing should lead to the overcoming of deflation Based on the decisions I have just mentioned, let me now consider the channels through which deflation can be overcome. With regard to the transmission channels for the effects of unconventional monetary policy under the zero interest rate policy, enhancing monetary easing – by committing to continue the virtually zero interest rate policy into the future and by increasing asset purchases – would induce a decline in longer-term interest rates and risk premiums through both the interest rate channel and the portfolio channel. The declines would influence firms’ borrowing costs, a range of asset prices including stock prices and foreign exchange rates, and bank lending, thereby influencing households’ and firms’ spending and eventually have positive effects on economic activity and prices. Looking at the developments following the February decision based on this consideration – in the form of effects on longer-term interest rates and people’s risk-taking appetite brought about by prospects, that is, valid expectations for future aggressive monetary policy conduct – the 2-year government bond yield has declined, the yen has depreciated, and stock prices have risen. The depreciating trend of the yen and the rise in stock prices were already evident prior to the February decision, reflecting the mitigation of global risk aversion, improvement in the U.S. economy, and Japan’s trade deficit. The decision at the Monetary Policy Meeting in February also appears to have contributed to establishing the trend. The clarification of the Bank’s powerful monetary easing stance and decisive policy action seem to have exerted a strong commitment effect and a policy duration effect. These spilled over and lowered longer-term interest rates – including the 5-year government bond yield – enhanced people’s risk-taking appetite – lowering required risk premiums in turn – and thereby enhanced the effects to improve financial conditions. I pointed out earlier that firms’ investment spending might have been restrained due to sluggish stock prices, the appreciation of the yen, and the slowdown in the global economy. If the current improving trend in financial conditions continues in tandem with the improvement in overseas economies, these improvements could induce a favorable turn in BIS central bankers’ speeches corporate profits and business sentiment, increase forward-looking investment, and concurrently enhance growth potential and value creativity. The depreciation of the yen and the rise in stock prices might also lead to an improvement in consumer sentiment and an increase in tourists from abroad, thereby further stimulating domestic demand. Such developments would likely work to induce a sustainable economic recovery and a moderate rise in prices. As cautious views remain with regard to future uncertainties, the headwind Japan’s economy faces is likely to continue. Nevertheless, what I have just discussed suggests one channel through which powerful monetary easing could lead to overcoming deflation. If the path of improvement induced by powerful monetary easing can be forecast and grasped by market participants, the improvement in financial conditions thus far will not be short-lived but might reflect trends and sustainable movement consistent with economic fundamentals. The movements of financial indicators actually observed reflect a mixture of the effects of various short-term factors and underlying factors. While it is difficult to clearly distinguish between the two types of factors, we cannot rule out the possibility that further enhancement of monetary easing has been supporting the desirable trend. C. The need to strengthen growth potential In the policy decision made at the Monetary Policy Meeting held on February 13 and 14, 2012, the Bank clarified its commitment to aim at achieving 1 percent inflation and continue pursuing powerful monetary easing until it judged that the 1 percent goal was in sight. Further clarification of the commitment has the key merit of reducing forecasting uncertainties and further enhancing the credibility of monetary policy conduct. Having said that, however, if policy is conducted in a manner “only to achieve 1 percent inflation at any cost,” it would be too rigid and would not be desirable for the sound development of the national economy. Overcoming deflation is an overriding issue and needs to be supported from the financial front. To this end, it is necessary for policy conduct to combine credibility and flexibility. In pursing aggressive monetary easing going forward, one of the necessary flexibilities is proper attention to potential side effects. The Bank’s purchases of JGBs within the framework of the Program are monetary policy measures that have been judged necessary to overcome deflation, and are not conducted with the aim of financing the fiscal deficit. At the same time, Japan’s enormous fiscal deficit and government debt outstanding are significant concerns that could elevate fiscal risk. A rise in government bonds’ risk premiums and an increase in interest rates, in the absence of an economic recovery and a rise in stock prices, would indicate an unfavorable rise in interest rates. The manifestation of such fiscal risk must be avoided by all means. To this end, first of all, medium- to long-term fiscal discipline must be ensured. Even if a central bank implements aggressive asset purchases and government bond purchases to overcome deflation, this could increase the probability of “unintended consequences” from fiscal risk manifestation unless key fiscal discipline is ensured. Furthermore, I believe it is important for Japanese people to make efforts steadily to increase Japan’s growth potential. If firms and households rein in such efforts because uncertainties regarding the outlook are not dispelled, the crucial growth potential will not increase. Focusing on savings without carrying out forward-looking investment might induce a substantial decline in growth potential and, as a result, larger negative impact on public finance, including a decline in tax revenue. Confidence in government bonds is sometimes considered from the viewpoint of confidence in Japan’s economy as a whole, by focusing on the current account balance and net external assets. There is a view that, as long as the trend of current account surplus is maintained, Japan can continue to accumulate net external assets, which currently total about BIS central bankers’ speeches 250 trillion yen. Therefore, for Japan’s economy as a whole, including the corporate and household sectors, confidence has been maintained and net external assets will serve as a cushion against fiscal risk. In the sense that the current account surplus and net external assets might be factors inducing the yen’s appreciation, these might contain to some extent the risks of a one-sided depreciation of the yen and capital flight. However, there is no simple one-to-one relationship between confidence in fiscal sustainability and the current account balance or the external position. In order to maintain confidence in fiscal sustainability, therefore, I believe it is ultimately necessary to ensure fiscal discipline and increase Japan’s growth potential. In order to increase growth potential, a reasonable amount of time is required to implement measures, including economic and fiscal structural reforms. This should be obvious even without reference to the example of Europe. On the relation between monetary policy and fiscal reform, there are views on one hand that fiscal structural reform cannot be promoted unless deflation is first overcome and, on the other, that further monetary easing – particularly purchases of government bonds – should be restrained unless fiscal structural reform progresses. I support neither of these views. Aggressive efforts from the financial side to overcome deflation, fiscal structural reform, and efforts to increase growth potential should all be carried out at the same time by the public as a whole, from the respective standpoint of each individual. As for the Bank’s policy taken to strengthen growth potential, the Bank has been implementing the “fund-provisioning measure to support strengthening the foundations for economic growth,” and has been supporting financial institutions’ efforts in this regard. At the Monetary Policy Meeting held on March 12 and 13, 2012, with a view to enhance support by broadening the base for the efforts, the Bank decided on the following measures. First, the Bank extended the deadline for applications for new loans by two years, to March 31, 2014. Second, it established a new arrangement for loans of 500 billion yen for small-lot investments and loans (1 million yen or more but less than 10 million yen). Third, the Bank raised the ceiling for the outstanding balance of loans under the existing arrangement from 3 trillion yen to 3.5 trillion yen. And fourth, with a view to support financial institutions’ efforts also from the side of foreign currency funds provisioning, the Bank established a new arrangement for providing loans in U.S. dollars to the equivalent of 1 trillion yen, using the U.S. dollar reserves held by the Bank. Details of the measures will be examined at the next Monetary Policy Meeting to be held on April 9 and 10, 2012. As a result of the measures, the outstanding balance of loans under the arrangements will increase from 3.5 trillion yen to 5.5 trillion yen. Up to now, I have described the Bank’s efforts to overcome deflation and discussed things to keep in mind by focusing on the policy decisions made recently. In the actual conduct of monetary policy, based on the outlook for economic activity and prices, it is necessary to respond carefully and decisively by identifying the timing and measures while monitoring a range of conditions and possibilities. The Bank will continue to do its utmost as the central bank by pursuing powerful monetary easing to overcome deflation, ensure financial market stability, and provide support to strengthen the foundations for economic growth. Concluding remarks: the economy of Chiba prefecture In my conclusion, let me touch on the economy of Chiba Prefecture. The Great East Japan Earthquake in March 2011 caused tremendous damage to the region, including fires, tsunami, and soil liquefaction. One year has passed since the disaster occurred. Let me express once again my heartfelt condolences to the victims of the disaster and their families. I also salute the local citizens, firms, and governments for their efforts to achieve restoration and reconstruction. BIS central bankers’ speeches Chiba Prefecture is bounded by water on three sides, and it is blessed with mild weather and rich natural surroundings. It has a strong agricultural sector with an array of crops that rank first nationwide in terms of output, including peanuts, Japanese radishes, green soybeans, and Japanese pears, and its agricultural output as a whole ranks third in the nation. Chiba Prefecture also ranks high in terms of fisheries, with plenty of fishing ports, including the nation’s largest, in the city of Choshi. The coastal area contains the Keiyo industrial zone, which serves as the nation’s largest supply depot for raw materials and energy, such as chemical products, steel, and oil. More than six million people live in Chiba Prefecture, which also serves as a bedroom community in the Tokyo metropolitan area, and the many commercial and recreational facilities attract numerous visitors from other prefectures. Such diversity, offering something for everyone, is a key characteristic and strength of Chiba Prefecture. Chiba also contains historic tourism resources including Narita-san, a Buddhist temple that has been a popular tourist attraction since the Edo Period. A number of efforts have been made to promote Chiba’s attractions to people both within and outside the prefecture. The Chiba Aqualine Marathon, the first full marathon ever routed on an expressway over the sea, will be held this October, and a model cycling course has been set up to popularize cycling tourism. Other promising steps in the prefecture include an expansion of the number of annual departure and arrival slots as well as the introduction of low-cost air carrier service at Narita International Airport, which should boost exchanges with other regions. I trust that Chiba Prefecture will develop even further through people’s efforts to maximize the diverse strengths of their region. BIS central bankers’ speeches
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Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Okayama, 18 April 2012.
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Kiyohiko G Nishimura: Toward overcoming deflationary pressures in Japan Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Okayama, 18 April 2012. * * * Introduction I am privileged and honored to be here today to exchange views with administrative and business leaders in Okayama Prefecture. I deeply appreciate your continuing support and cooperation in taking part in interviews and surveys conducted by our Okayama branch. The quantitative and qualitative information from these interviews and surveys is invaluable to making timely assessments of economic conditions, and thus appropriate policy decisions. This can be especially true in the case of great uncertainty that follows events that profoundly alter economic and financial conditions, such as the Lehman Shock and the Great East Japan Earthquake. Although those events effectively render past statistical data uninformative or even utterly useless, the Bank cannot delay its policy responses just for the sake of waiting for new data to be released. Even in situations such as these, our regular contact with you provides us with valuable information about what is really happening in the real world in various respects. In fact, our colleagues at foreign central banks consider the Bank of Japan as fortunate and privileged in this regard. I would like to express my sincere gratitude and also ask for your continued cooperation. Let me start today by discussing the economic outlook at present and its risk factors. After that, I would like to share the Bank’s basic thinking on the necessary measures to overcome deflationary pressures. Furthermore, I will explain the Bank’s policy responses geared toward this aim – as put forth during the February and March Monetary Policy Meetings – by answering frequently asked questions. In closing, I would like to touch upon some relevant issues for the economy in Okayama Prefecture. I. Economic outlook at present and its risk factors A. Economic outlook at present Let me first describe the current domestic and overseas economic conditions and the outlook at present. First, I will start with developments overseas. Despite the recent nervousness seen in the foreign exchange and stock markets, the funding environment for financial institutions in global financial markets has been calm and stable against the background of ample liquidity provision by the European Central Bank and certain progress in efforts to support Greece. However, overseas economies as a whole have yet to emerge from a deceleration phase. In the United States, although some improvements have been observed in consumption and employment, such positive movements have not yet gained momentum, as evidenced by the recent weaker-than-expected employment statistics. Against such a background, Japan’s exports and production have not emerged from the phase of crawling growth, and thus the country’s economic activity remains more or less in a lull. However, domestic demand has recently shown some signs of improvement. Steps toward restoration and rebuilding following the Great East Japan Earthquake are progressing, most notably in business fixed investment. Private consumption has firmed up due in part to the effects of measures to stimulate demand for automobiles, such as the reintroduction of subsidies for purchasing energy efficient cars and the release of popular models of new cars. Industrial production has begun to show signs of a possible improvement. As for the outlook, Japan’s economy is BIS central bankers’ speeches expected to return to a moderate recovery path as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and as reconstruction-related demand after the earthquake disaster gradually strengthens. B. Risk factors Whether or not this projection is going to be realized depends on various risk factors. The one that the Bank is most concerned with is, in short, uncertainties regarding the global economy. Among them – including the prospects for the European debt problem, developments in international commodity prices, and the likelihood of emerging and commodity-exporting economies maintaining growth under price stability – I regard whether improvement in economic indicators in the United States can continue or not as particularly important and deserving of very careful monitoring, as this is attracting wide attention recently. The sustainability of the ongoing U.S. recovery requires careful examination, for two reasons. First, in the United States, there is rising bifurcation of the labor market into two groups: (1) those who have no concern about their employment and (2) those who do. The recent firm economic indicators reflect a recovery in consumption by the former group, which benefited from a decline in mortgage rates and rising stock prices. However, the distinguishing feature of the current business cycle has been a large increase in the number of the latter group – i.e., those who have concerns about their employment – and its size has not decreased notably even in the recovery phase. This could weigh on the U.S. economic recovery ahead. Second, there is a possibility that a seasonal adjustment method used for major U.S. economic data had created some distortions due to the effects of the Lehman Shock, causing the data for the period from winter to early spring to be overvalued and those for the period toward summer to fall to be underestimated. If this is the case, it means that the favorable data so far have exaggerated actual economic performance and the forthcoming data will be disappointing – showing a weaker picture than actual conditions. Attention should be paid to the risk that such distorted data could weaken expectations for recovery held by firms, households, and markets. As a longer-run risk for many economies, prolonged stagnant economic performance coupled with the aging of a population could reduce the flexibility of the economy such as in terms of the mobility of people across sectors and regions, thereby making it more difficult for the supply side to respond smoothly to changes in the demand structure. As a result, growth potential could decrease. Such a reduction in the flexibility of the economy amid a situation of an aging population has become a serious problem not only in Japan but also in other advanced countries, such as the United States and Europe. Even emerging economies, including those in Asia, are not immune to this problem because the aging population problem is set to intensify considerably within the next ten years and it is not unimaginable that early indications of the problem could emerge in the very near future. Bearing in mind that there are various risk factors, the Bank will conduct a thorough review of the outlook for economic activity and prices and will issue the results in our biannual outlook report, to be released at the end of this month. II. Toward overcoming deflationary pressures Next, I would like to turn to the challenge of overcoming deflationary pressures. In order for Japan’s economy to make steady progress toward overcoming deflationary pressures, it is necessary to make efforts on the following two fronts. The first one involves continual support of the recent momentum toward economic recovery to enhance the level of economic activity. In this regard, it is important to make steady BIS central bankers’ speeches progress in narrowing the negative output gap by firmly supporting positive developments at home and abroad. Second, it is necessary to make efforts to tackle the long-term structural problem that Japan’s economy has confronted of declining trend growth rates. It is no easy task to raise the growth potential of Japan’s economy when the working population decreases due to aging. In order to raise the growth potential of Japan’s economy by capturing new demand, it is crucial that business firms, financial institutions, the government, and the Bank each take decisive measures in their respective roles. One possible direction is for Japanese firms to tap global demand, mainly in emerging economies, by undertaking a reappraisal of their comparative advantages, such as the capacity to develop new materials, “integral-type technology”, production efficiency, and attentive customer service, in pursuit of a best mix of these advantages that fits with respective market demand. In this regard, manufacturers continue to expand their overseas business while reestablishing global production and sales networks. Recently, more firms in domestic demand-oriented industries have also started making efforts to capture global demand. What is important is to establish a favorable domestic business environment so that firms’ active movements to capture global demand lead to enhancing the growth potential of Japan’s economy rather than causing a hollowing-out of domestic industries. At the same time, efforts to stimulate domestic demand are also crucial. From the standpoint of enhancing the growth potential of Japan’s economy, it is an extremely important challenge to make steady progress in regulatory reform to promote growth industries and in supplying risk money to them, so that seeds for growth are produced, sprout, and evolve into flourishing domestic demand. III. The Bank of Japan’s policy measures Next, I would like to touch on the Bank’s policy measures. As I have stated so far, in order to overcome deflationary pressures and achieve sustainable growth with price stability, it is vital to make efforts both to firmly support the recently observed upward momentum toward economic recovery and to strengthen growth potential. Based on its recognition of this point, the Bank launched a policy package to overcome deflationary pressures at the Monetary Policy Meetings held in February and March. I will briefly describe the essence of the package. A. Policy measures in February: introduction of “The Price Stability Goal in the Medium to Long Term”, clarification of the Bank’s commitment regarding the policy time horizon, and expansion of the asset purchase program in size At the Monetary Policy Meeting held on February 12 and 13, 2012, the Bank decided three measures. First, it introduced “the price stability goal in the medium to long term”. This represents the price stability that the Bank should aim to achieve using the year-on-year rate of increase in the consumer price index (CPI). The Bank judges the “goal” to be within a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI, and it set a goal of 1 percent for the time being. In deciding a specific inflation rate, the Bank considered that (1) there is considerable uncertainty surrounding the prospects for Japan’s economy because it is in a process of transition to a normal growth path following long-term stagnation, and therefore (2) deliberations should fully take into account the perception of price developments held by the general public, which is used to long periods of low inflation rates, including even the period of the financial bubble prior to the 1990s. As a result, the Bank decided to set a specific goal of 1 percent for the time being, and from a longer-term perspective, to express the goal with a degree of latitude as “a positive range of 2 percent or BIS central bankers’ speeches lower” given the possibility that the inflation rate the Bank should aim to achieve could rise due to changes in the economic structure at home and abroad. Second, the Bank clarified its commitment regarding the time horizon for pursuing powerful monetary easing. By promising accommodative monetary policy in the future, based on certain conditions regarding the economic environment, the commitment aims to strengthen the immediate monetary easing effects by bringing forward future easing effects. In line with the introduction of “the price stability goal”, the Bank decided at the February meeting that it will aim to achieve the goal of 1 percent CPI inflation and will continue the pursuit of powerful monetary easing until the goal is in sight, conducting its virtually zero interest rate policy and implementing the Asset Purchase Program mainly through the purchase of financial assets. The Bank clarified its stance to actively take policy measures by expressing the specific inflation rate of 1 percent as a goal and using the phrase “aim to achieve” with respect to said goal. The Bank also stated specifically that it will continue to not only conduct its virtually zero interest rate policy, but also implement the Asset Purchase Program mainly through the purchase of financial assets until the conditions in the commitment are met. Third, the Bank made a decisive increase in the total size of the Asset Purchase Program, of 10 trillion yen. As a result, together with its regular purchases for the purpose of supplying currency consistent with underlying steady development in the economy, the Bank is going to purchase a large amount of JGBs until the end of this year, at the pace of about 40 trillion yen per year. The aforementioned three measures are aimed at strongly supporting recent positive momentum from the financial side through a clarification of the Bank’s policy stance to overcome deflationary pressures and an enhancement of its pursuit of powerful monetary easing. B. Policy measures in March: enhancement of fund-provisioning measure to support strengthening the foundations for economic growth At the subsequent Monetary Policy Meeting in March, the Bank decided to enhance the fundprovisioning measure to support strengthening the foundations for economic growth (hereafter referred to as “the Growth-Supporting Funding Facility”). The Growth-Supporting Funding Facility supplies long-term funds at a low interest rate to financial institutions in accordance with their efforts – in terms of lending and investment – toward strengthening the foundations for economic growth. Looking at the composition of the areas to which financial institutions have been lending and investing using this facility, “environment and energy business” and “medical and nursing care business” accounted for a large share. Let me share with you some examples of actual lending or investment based on information made public by financial institutions. For example, there was a project in which the manager of a nursing home for the elderly upgraded the air-conditioning system to an eco-friendly one that recovered waste heat. In another case, food manufacturers made investments for the purpose of expanding their production sites in emerging Asian economies, so as to respond to vigorous demand from such economies. Taking into account the lending and investment conducted under the facility, the Bank decided to establish special rules, first, for a new lending arrangement for small-lot investments and loans and, second, for a new U.S. dollar lending arrangement for foreign currency-denominated investments and loans. The Bank also decided to increase the maximum outstanding balance of loans under the main rules for the facility, which raised the overall outstanding balance of loans available through the facility by 2 trillion yen. The Bank also decided to extend the deadline for applications for new loans under the facility, by two years. Such measures are aimed at further enhancing the Bank’s efforts to strengthen growth potential, which is another pillar for overcoming deflationary pressures. BIS central bankers’ speeches IV. Has the Bank changed? The series of policy measures by the Bank – especially its decision in February to clarify its policy stance and further enhance monetary easing – took many market participants by surprise, since few had predicted such responses. Following the Bank’s decision, stock prices rose and the yen depreciated. These developments were of course significantly influenced by some new positive worldwide developments at that time, such as diminishing perceived risks from the European debt problem and relatively firm improvement in the U.S. economy. In addition, I believe that the Bank’s clarification of its policy stance, which was taken as a positive surprise, also had a considerable impact on those market developments. I am often asked whether the Bank’s policy objectives, basic thinking behind the conduct of monetary policy, and policy stance have changed since its decision in February. Next, I would like to outline my understanding of what has changed and what has stayed the same with regard to the Bank’s policy conduct. A. Question: has the aim of the Bank’s monetary policy changed? With regard to the introduction of “the price stability goal in the medium to long term” in February, a frequent interpretation is that the Bank has finally adopted the so-called “inflation targeting framework”. I would like to outline my reflections on this point by asking the following question: “has the aim of the Bank’s monetary policy changed?” The Bank’s basic thinking about the price stability that a central bank should aim to achieve includes the following three elements. First, “price stability” is a state where economic agents such as households and firms may make decisions regarding economic activities without being much concerned about the fluctuations in the general price level. Second, central banks should pursue “price stability” over the medium to long term that should not be judged by short-term developments in the recent period. Third, “price stability” should be expressed in numerical terms using indicators that cover goods and services consumed by households and represent the public’s true feelings regarding price developments. This basic thinking had been explained to the public before the introduction of “the price stability goal in the medium to long term”, and has not changed with this introduction. That being said, I believe that the introduction of “the price stability goal” in place of the old “understanding of medium- to long-term price stability” is significant as an effort to specifically express what the Bank pursues based on its basic thinking on price stability. When conducting monetary policy, each Policy Board member makes decisions based on their own thinking on price stability that should be pursued by the Bank. The old “understanding” showed the range of inflation rates that each Policy Board member understood as numerically expressing price stability over the medium to long term. There should be no confusion, since if inflation rates fail to be within this range, then it is obvious that price stability has not been achieved from any of the members’ perspectives. However, there was a criticism that the old “understanding”, which was a collection of individual Board members’ views, did not represent the “price stability” that is the basis of the policy decisions of the Bank as an institution. In addition, there was some difficulty with the word “understanding”, in that it failed to deliver the message that the Bank was making active moves toward price stability. Taking account of these problems, the Policy Board members have made a collective decision on how to express the price stability that the Bank should aim to achieve. They have also decided to use the word “goal”, so that the Bank’s policy stance can be understood clearly. I would like to point out that there is a notable feature in the introduction of the “goal”. That is, the “goal” for the time being is set differently from the “goal” from a longer-term perspective. The Bank has decided to set a specific inflation rate goal for the time being – a rate that it currently aims to achieve – even though there is considerable uncertainty surrounding the prospects for Japan’s economy, such as in terms of changes in economic structures. At the BIS central bankers’ speeches same time, from a longer-term perspective, if the efforts to strengthen growth potential successfully boost real growth rates to an adequate level in a sustainable manner, then the medium- to long-term sustainable inflation rate – and consequently, the nominal growth rate – will gradually rise. Bearing in mind such a possibility from a longer-term perspective, the Board has decided to express “the goal for price stability in the medium to long term” with a degree of latitude as “a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI” and to review the “goal” once a year in principle. As long as the Bank’s thinking behind the “the price stability goal in the medium to long term” is shared correctly, it is not essential to argue about what it should be called. I feel no discomfort in referring to the “goal” as a flexible inflation target. B. Question: was the policy change in February based on the assessment from the “Two Perspectives”? Next, let me take up the issue of how difficult it was to predict the February decision to enhance monetary easing. Since March 2006, in deciding the conduct of monetary policy, the Bank has been examining economic activity and prices from two perspectives. The first is in terms of whether the baseline scenario of the outlook for economic activity and prices follows a sustainable growth path with price stability. To put it another way, using the new framework, this is with regard to whether the economy is heading toward achieving the “price stability goal”. The second perspective is in terms of what kind of risk factors are considered relevant to the baseline scenario. I would like to examine the market comments that the policy change in February was difficult to predict because such a decision could not be derived from the monetary policy framework based on the assessment from the two perspectives. At the time of the February Monetary Policy Meeting, some positive developments were observed in domestic and overseas economies, such as receding tensions in global financial markets, some improvement observed in the U.S. economy, and the firm domestic demand due in part to reconstruction-related demand after the earthquake disaster. However, Japan’s economic conditions continued to be harsh with the level of economic activity not having recovered from the plunge after the Lehman Shock, due to the slowdown in the overseas economies and the appreciating yen. At the same time, as you can find in the Minutes of the Monetary Policy Meeting in January 2012, the following recognition had been gradually spreading among Policy Board members during the process of discussing prolonged deflationary pressures: the Bank’s intention in its conduct of monetary policy might not have been fully understood by firms, consumers, and markets since the Bank’s communication had not been effective enough, and consequently the effects of powerful monetary easing have been considerably diminished. In addition, market participants and the media renewed their attention on the central bank’s policy stance toward achieving price stability triggered by the U.S. Federal Reserve’s decision on January 25, 2012 to set the inflation rate of 2 percent as its “longer-run goal”. Thus, the Bank faced a situation where, from the perspective of achieving the “goal”, it needed to consider the risk that the effects of monetary easing that was designed to achieve the baseline scenario had been noticeably compromised. Taking into account such a situation, the Policy Board recognized that it was necessary to communicate the Bank’s policy stance clearly in order to ensure the realization of the baseline scenario so that the “goal” would be achieved, and if the Bank did not take such action, more time might be needed to achieve the “goal”. This led the Bank to make a policy decision at the February meeting. Also, to make its intention clear, the Bank decisively increased the total size of the Asset Purchase Program. It deemed that such a decision would strongly support the positive momentum observed at that time from the financial side, and that it would bring about visible effects of monetary easing. BIS central bankers’ speeches Even after replacing the “understanding” with the “goal”, the Bank continues to conduct monetary policy based on the assessment from the two perspectives. It had been quite unfortunate that, until last February, the Bank’s policy stance was not well communicated in an effective manner and thus not fully understood. The introduction of the “goal” was received with some surprise partly because of this communication problem. The Bank introduced the “goal” with the clear aim of solving this problem, and will continue to make further efforts to enhance its communication. C. Question: has the possibility of further monetary easing increased? I will now make my best effort to provide an answer to the following difficult question. Has the Bank’s monetary policy stance become more dovish after all? In other words, has the possibility of further monetary easing increased? As I have already stated, the Bank’s stance has not changed toward the conduct of monetary policy based on the “price stability goal” and the assessment from the “two perspectives”. Allow me to repeat the Bank’s current monetary policy stance: “[The Bank] will aim to achieve the goal of 1 percent CPI inflation and continue the pursuit of powerful monetary easing until the goal is in sight, conducting its virtually zero interest rate policy and implementing the Asset Purchase Program mainly through the purchase of financial assets.” As stated in the Minutes of the Monetary Policy Meeting in February 2012, the described policy stance shows that the Bank is committed to implementing additional easing measures, if deemed necessary. The clarification of the Bank’s determination to overcome deflationary pressures has been understood in financial markets more clearly and widely than before. I think this might have given the impression to some that the Bank has changed. After all, the Bank’s policy decision depends on the outlook for economic activity and prices and on the results of the assessment of risk factors in the context of achieving the “price stability goal”. An examination of policy effects is also important. It is often said that there is considerable uncertainty regarding when the effects of monetary policy will emerge, because they often come with a variable time lag (sometimes long). Unconventional policy measures taken recently are no exception. As I have stated, although positive momentum has been observed in Japan’s economy, there remains considerable uncertainty, mainly regarding the outlook for the global economy. There is also non-negligible uncertainty about how the policy changes in February and March will affect the public’s medium- to long-term expectations regarding economic activity and prices. The Bank would like to conduct appropriate monetary policy while taking fully into account such risk factors and examining the outlook for economic activity and prices. Concluding remarks Let me briefly touch upon some relevant issues for the economy in Okayama Prefecture. I stated a short while ago that, in order to overcome deflationary pressures, (1) efforts to strengthen growth potential are crucial and (2) business firms, financial institutions, the government, and the Bank should make such efforts within their respective roles. From this standpoint, let me take a look at the efforts being made in Okayama Prefecture. Several projects have been actively conducted to develop industries that have growth potential – such as aircraft-related and medical and nursing care industries – into key industries, with the government and the private sector working together. Firms in the chemicals and steel businesses – which have been the main industries in this region – have been making efforts to develop new products and business plans targeted at environment- and energy-related sectors using the skills they have acquired so far. Meanwhile, financial institutions have taken steps to develop a system to firmly support, from the financial side, firms’ efforts to strengthen growth potential while using the Bank’s Growth-Supporting Funding Facility. In addition, I have heard that academics have made unique proposals for urban development BIS central bankers’ speeches using technological knowledge acquired from universities and university hospitals. I am thrilled to hear that substantive efforts to strengthen growth potential have been made in various areas. I truly hope that these various efforts align further with each other and lead to strong economic growth, not only in Okayama but in Japan as a whole. Thank you for your kind attention. BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Foreign Policy Association, New York, 18 April 2012.
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Masaaki Shirakawa: Society, economy and the central bank Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Foreign Policy Association, New York, 18 April 2012. * * * Introduction Even as the world is practically getting smaller, with the remarkable advances in transportation and communications technologies, and with all the resulting increases in interaction among peoples and economies, foreign policy is, unfortunately, something that is all too often put on the back burner by people busy with their daily lives. This is why the activities of the Foreign Policy Association are so invaluable. Since its foundation in 1918, for nearly a century, the Association has served as a catalyst for developing awareness, understanding of, and providing informed opinions on global issues. I am honored, therefore, this evening, to receive the FPA Medal, whose past recipients include many people I respect very much. Today, I will offer my views on the recent Global Financial Crisis, which, from the viewpoint of central banks, was the most important international development of the past few years. In doing so, I will not comment on the Crisis itself, on which a lot of ink has been spilt already, but on the issues that the Crisis has raised concerning the role of central banks in relation to the well-being of the society at large. As the Crisis is bound to leave indelible marks on the global economy, it would probably affect how central banks would conduct their business in the future. In this Crisis, as I will later explain, central banks have succeeded in deflecting the destructive forces in the acute phase, by injecting unprecedented amounts of liquidity into the financial system and by rolling out massive monetary easing. Now, the Crisis has moved into the chronic phase, characterized by low growth and persistent unemployment. In this regard, many more challenges certainly lie ahead, before we can even take back the lost ground and make further advances from there. One reminder that prosperity is quite fragile can be found in The Economic Consequences of the Peace, by John Maynard Keynes.1 I believe it is rather fitting to quote his writing today, considering that FPA was founded to promote the “Just Peace,” advocated by President Wilson, who led the U.S. delegation to Versailles, and that the collective failure of the international community to achieve that goal at Versailles prompted Lord Keynes to write the book. Lord Keynes describes the world before the First World War as “economic Eldorado” or “economic Utopia,” where a middle-class Londoner could easily “order by telephone...the various product of the whole earth,” “adventure his wealth...in any quarter of the world,” and “secure...cheap and comfortable means of transit to any country.” Furthermore, this state of affairs was regarded “as normal, certain and permanent, except in the direction of further improvement.” Whenever I read this passage, I am always struck by the power of globalization in bringing about economic prosperity, the ephemeral quality of such achievement in the light of the two World Wars, and the parallel with our experiences leading to the Great Financial Crisis. Keynes, John Maynard, The Economic Consequences of the Peace, 1919. BIS central bankers’ speeches I. The changing economy and central banking In our current discourse on economic policy, or more broadly the whole economy, no one would doubt the critical stabilizing role played by central banks. Nevertheless, economic history after the Second World War reveals that such a view is quite a recent product. The enhanced role of central banks came into being on the back of three important changes. Firstly, there is now a clear division of labor between monetary and fiscal policies. To our eyes, such an arrangement seems too obvious, but during the War, in many countries including the United States and Japan, monetary policy was subordinated to fiscal policy. Central banks were doing all they could to finance the war effort, and there was no room for independent monetary policy. In fact, monetary policy continued to be constrained for some time after the War. For example, in the United States, the Fed was freed, in 1951, from the obligation to maintain long-term interest rates below a level set by the Treasury, after arriving at the so-called “Accord” between the Treasury and the Fed.2 Secondly, there is no longer any doubt about the role of monetary policy. It is widely accepted that monetary policy should be an important stabilizing force for the macroeconomy. During the 1960s and as late as the first half of 1970s, an influential school of thought, now more or less discredited, held that a slightly higher inflation was a necessary evil for achieving stronger growth and fuller employment. As monetary conditions were relaxed and tightened discretionarily with such a bias over a number of business cycles, inflation, both actual and expected, began to creep up quite noticeably. It became evident that higher inflation was not contributing to higher growth or employment. Furthermore, the distortions in the savings and investment decisions of economic agents and in resource allocation resulting from higher inflation became a drag on growth. This was how stagflation of the late 1970s came into being. This unpleasant experience taught us that economic growth could only be sustained with price stability, and price stability should be the goal of monetary policy. Finally, against the backdrop of the first two changes, central banks are nowadays granted formal independence. If central banks are to pursue price stability, they should be able to conduct monetary policy from a medium to long-term perspective, away from short-term concerns. This is legally secured by recognizing the independence of central banks in national laws. Looking back, there were not many central banks that had statutory independence in the 1980s. The situation changed markedly during the 1990s, when many countries, including Japan, revised their central bank laws. The new laws clearly stipulated the independence of the central banks in conducting monetary policy. These changes were the basis of the new institutional framework for the conduct of monetary policy, which emerged from the second half of 1980s and into 1990s. At the core of the new framework was the linkage between independence and the mandate to ensure price stability. In other words, central banks are held strongly accountable for achieving price stability, in return for being granted independence. The increasing adoption of inflation targeting from the second half of 1980s and into 1990s symbolizes this development. In the context of this transformation, there was also a slight shift in the traditional mandate granted to central banks regarding the regulation and supervision of financial institutions. Under the view that price stability and financial stability are two distinct objectives, and in order to avoid concentrating too much power in one institution, at some central banks, for example at the Bank of England, regulatory and supervisory functions were carved out and transferred to another organization, thereby letting central banks to focus solely on monetary policy. Bernanke, Ben S., “Lecture 2: The Federal Reserve after World War II,” The Federal Reserve and the Financial Crisis, Chairman Bernanke’s College Lecture Series, March 22, 2012, http://www.federalreserve.gov /newsevents/lectures/about.htm. BIS central bankers’ speeches As this new framework of monetary policy was being accepted over the 1990s, many developed economies experienced a prolonged period of both relatively high growth and stable prices. The age of Great Moderation had come. The phrase, which seemed to have appeared shortly after the turn of the century, quickly gained popularity, capturing the optimistic mood of the times, and central banks were praised for their substantial role in bringing about prosperity. In a sense, the 1990s and 2000s, up until the Crisis, were, in fact, the heyday of central banking. One exception, however, was Japan, which experienced a prolonged period of sub-par growth and modest but persistent deflation. Actually, Japan was experiencing profound changes in the economy ahead of other developed economies. While Japan had suffered severe stagflation at the time of the first Oil Crisis of the 1970s, its subsequent economic performance was superior compared with other developed economies, reflecting the restraint in wage increases and appropriate monetary policy. The bubble years of the second half of 1980s were, in this vein, the culmination of all that was good about the Japanese economy. The bubble burst in the 1990s, and Japan has since been suffering from its lingering effects. It is quite remarkable that economies in North America and Europe are now experiencing the same changes that Japan has experienced from the 1990s onwards. Since 2006, the United States has experienced a drawn-out period of declining house prices. This was only the beginning. Financial strains quickly spread around the world engulfing many venerable names both in the United States and Europe, and leading to, but not ending with the demise of Lehman Brothers. As governments and central banks intervened aggressively, the global financial system and the economy subsequently gained a respite, but it was short-lived. Beginning from the spring of 2010, cascading problems within the euro area weighed on global economic activity and heightened uncertainties. Consequently, output in the developed economies is only 4 percent above the pre-crisis peak, and average growth since 2007 is a paltry 0.8 percent. What went wrong? What can central banks do to prevent the development of another disruptive bubble? Policy makers are certainly in the midst of soul-searching, regarding the conduct of monetary policy and the regulation and supervision of financial institutions in the years leading to and during the crisis. Today, I will just stress one point, considering that I have already explained my thinking on another occasion.3 The key issue is that price stability and financial stability are intricately intertwined. In an environment of price stability, economic agents may come to expect ever more strongly that a prolonged period of low interest rates would be sustained. This could exacerbate financial imbalances, such as increasing asset prices or leverage. Taken too far, such imbalances would destabilize the financial system, which would then lead to unacceptably large fluctuations of real economic activity and ultimately prices. In this vein, monetary policy must take account not only of inflation but also of financial imbalances, and it must attempt to look beyond the conventionally accepted time horizon. At the same time, it has also become clear that it is not appropriate to purge nonmonetary policy functions from central banks, and that central banks must maintain at least some regulatory and supervisory functions over financial institutions. For lessons of asset bubbles and financial crisis, see the following. Masaaki Shirakawa, “Revisiting the Philosophy behind Central Bank Policy,” Speech at the Economic Club of New York, April 22, 2010, http://www.boj.or.jp/en/announcements/press/koen_2010/ko1004e.htm. Masaaki Shirakawa, “Deleveraging and Growth: Is the Developed World Following Japan’s Long and Winding Road?” Lecture at the London School of Economics and Political Science (Co-hosted by the Asia Research Centre and STICERD, LSE), January 10, 2012, http://www.boj.or.jp/en/announcements/press/koen_2012/ ko120111a.htm. Masaaki Shirakawa, “Central Banking: Before, During, and After the Crisis,” Remarks at A Conference Sponsored by the Federal Reserve Board and the International Journal of Central Banking, March 24, 2012, http://www.boj.or.jp/en/announcements/press/koen_2012/ko120326a.htm. BIS central bankers’ speeches Apart from these somewhat abstract challenges of tomorrow, today, central banks are still confronted with numerous challenges, resulting from the recent global economic and financial turmoil. What can central banks do in this difficult environment? The answers are inevitably unique to each central bank, but let me identify some common emerging themes. II. Central banking today Currently, many central banks are implementing measures that were unthinkable only a few years ago. As interest rates are cut to almost zero, there is no longer any room for conducting monetary policy in the traditional sense. Consequently, central banks are now conducting so-called unconventional monetary policy. This fact is reflected in the most significant increases in the size of central bank balance sheets. The composition of balance sheets has also changed considerably. In the case of the Bank of Japan, over the last ten years, it has purchased commercial paper (CPs), corporate bonds, equities, exchangetraded funds (ETFs), and real estate investment trusts (REITs). Looking at the Fed, it has purchased various risk assets, such as mortgage-backed securities. Meanwhile, at the end of last year and in February this year, the European Central Bank (ECB) supplied an unlimited amount of three-year loans to banks. Furthermore, on interest rate developments, the Bank of Japan has made clear its commitment and the Fed has announced its guidance. Unfortunately, notwithstanding these efforts, growth in the developed economies remains anemic, as I noted a few minutes ago. When conducting monetary policy in such an environment, central banks must be aware of three socioeconomic trends. Firstly, in many developed economies, there are heightened expectations on what central banks could deliver.4 In this regard, one of the most symbolic discussions touched upon the measures that could be unleashed by the ECB in the context of the euro-area financial crisis. As an analogy to the lender of the last resort function to banks, which is an important and established function of central banks, some have forcefully argued for increasing the Bank’s supply of liquidity through a novel and untested function – a lender of last resort to governments. There are probably several reasons for the elevated expectations. Probably, the most important one is the prolonged period of low growth and high unemployment. Another factor is the increasing constraints on the conduct of fiscal policy, reflecting the dire straits of government finances in most developed economies. In fact, the outstanding amount of government debt relative to the size of the economy in G7 countries is fast approaching levels not seen since the end of the Second World War.5 Furthermore, one could also point out that central banks can act quickly – they can put up a huge wall of money almost instantaneously. This could be most relevant given the differences in the speed demanded by markets for results and the amount of time that is necessary for the democratic process to agree on and implement fiscal and structural policies. However one interprets what is happening now, there is a potentially toxic mix of heightened expectations regarding central banks on the one hand and what central banks could actually deliver on the other. If central banks cannot deliver, public confidence in the institution will be eroded. This, to which I will come back later, will impact the efficacy of central bank policies. Turning to the second issue, I would like to draw your attention to the blurring of the line between monetary and fiscal policies. As I have just explained, unconventional monetary See Hannoun, H., “Monetary Policy in the Crisis: Testing the Limits of Monetary Policy,” Speech at the 47th SEACEN Governors’ Conference, 13–14 February 2012. See Haldane, Andrew G., “Risk Off,” August 18, 2011. BIS central bankers’ speeches policy of central banks involves the purchases of substantial amounts of long-term government bonds and/or risk assets. The value of these assets, in the long run, may fall, and when that happens, losses incurred by the central bank will have to be passed on to taxpayers in the form of reduced profit distribution from the central bank to the government. Additionally, these purchases will inevitably influence micro-level resource allocation. In these respects, unconventional monetary policy is getting closer to fiscal policy. Considering that, in a democracy, the delegation of the power to issue unlimited amounts of legal tender to an independent central bank can only be justified by the tacit understanding that it will not overstep into the realm of fiscal policy, the adoption of measures bordering on fiscal policy could ultimately undermine the legitimacy of central bank independence and public trust in the institution. The third and final issue is a corollary to the first two issues. Reflecting the fact that central banks are introducing heretofore untested measures, public opinion is beginning to diverge widely on the desirable course of action by central banks. One example is the policy proposal for ECB that I have noted a few minutes ago. In the United States, monetary easing by the Fed is criticized by those who fear the consequence of inflation, while there are many economists who believe additional easing is warranted in view of the slightly falling but still stubbornly high unemployment. Also in Japan, there is a heated discussion on monetary policy and fiscal consolidation. III. The capacity and limits of central banking Up till now, I have explained the significant economic and social changes evident in the operating environment for central banks. The role of central banks, whether it should or should not change, needs to be carefully deliberated in the context of these changes. If I may jump to the conclusions first, it is dangerous to both over- and underestimate what central banks could achieve. Central banks must act correctly. What central banks can do One thing that central banks can always do is to stamp out inflation. No matter how severe inflation is, conceptually, it can be contained by monetary tightening. In the history of mankind, severe inflation has never been defeated without tightening. Nevertheless, it should also be noted that conceptual possibility and practicality is not the same. Statutory independence is not sufficient. Timely and appropriate policy requires something more. Central banks should not waver in the face of unpopularity and the society at large must be ready to acquiesce. Another important thing that central banks can achieve is to prevent the meltdown of the financial system through its lender of the last resort function to banks. This is the most important role in view of preventing the economy from falling into a severe deflation. Reflecting on the Japan’s financial crisis of the late 1990s and the recent Financial Crisis, missteps in policy could have resulted in a much worse outcome, perhaps akin to the Great Depression of 1930s. The most important difference was that central banks acted as the lenders of the last resort. Shocks could be dampened through central bank actions that mitigated the loss of trust among private economic agents, which hindered the use and acceptance of privately created money. The central bank could stand between two private counterparties and provide its money, which would be unconditionally accepted. The central bank is the only institution that could play this important role in a financial crisis. Furthermore, in a crisis environment, it also becomes imperative to maintain the efficient and uninterrupted functioning of the systems and arrangements through which money and other financial instruments flow. The working of what one might call the plumbing of the financial system requires constant attention, and central banks have, over the last two decades, made various efforts to improve its resilience, for example, promoting real-time gross settlement (RTGS), ensuring delivery versus payment of securities (DVP), and introducing simultaneous BIS central bankers’ speeches settlement of foreign exchange claims. Such exercises are not glamorous but central bank veterans are pleased to reflect on their achievements, which probably contributed considerably in preventing chaos after the recent collapse of Lehman Brothers. What central banks cannot deliver While central banks can achieve a lot, we should not have the illusion that there are no limits to the power of central banks. Central banks cannot reasonably deliver solutions to structural issues. Let me take the current problems in the euro area as an example. The situation in the euro area, whose troubles became evident around the end of 2009, significantly deteriorated since the summer of last year. The fire sales in the government bond markets of the so-called periphery countries led to a vicious cycle of worsening fiscal balance, increasing tensions in the domestic banking system, and dampening of real economic activity. With a view to arresting and hopefully reversing this destructive momentum, ECB has conducted two operations, once at the end of last year and another at the end of this February, supplying an unlimited amount of three-year funds. The subsequent return of relative calm to global financial markets demonstrates that central bank liquidity can play an important role. At the same time, it must also be impressed that liquidity provision has only bought time. One must not lose sight of the fundamental issues, one of which is the current account imbalances within the euro area. When the euro was introduced in 1999, interest rates for all member economies converged on one low level. This led to credit expansion in the periphery, which, at the same time, lost competitiveness because of increases in wages and prices. Now, policies must be put in place to address the root causes of the problem. Structural reforms must be implemented within the breathing space provided by the provision of central bank liquidity. If complacency sets in because of the improvements in market sentiment, we could be headed for a worse outcome. Time bought can equally be usefully spent or wasted. Structural issues are everywhere in the developed economies. Japan is no exception. The Japanese economy has stagnated and the rate of growth is sub-par among the major economies. Given that the ten-year average per capita GDP growth is comparable to other developed economies and per worker growth is the highest among its peers, the challenges facing Japan is not demography per se, but adapting to the rapidly changing demography, which no other country has so far experienced. The low aggregate growth and the huge fiscal hole are both largely the symptoms of the failure to adapt to the demographic reality. The modest deflation is, in turn, largely attributable to the lower growth outlook impacting expected future income and hence current spending. Monetary policy influences economic activity and hence prices in two stages. Firstly, the central bank influences the financial conditions, and secondly, the resulting financial conditions influence the spending decisions of firms and households. Considering that the Japanese financial conditions are probably the most expansionary among developed economies, the failure of Japan to shake off modest deflation can mostly be explained by its deteriorating growth potential. In this sense, if the Japanese economy is to extricate itself from deflation and return to a path of sustainable growth under price stability, it requires both policies aimed at enhancing growth potential and supporting monetary stimuli. This is why the Bank of Japan is fully committed to continuing powerful monetary easing through various measures, including maintaining the policy interest rate at practically zero and purchasing financial assets, until the current goal of year on year CPI inflation at 1 percent is deemed to be achievable. IV. Realizing the full potential of central banking The ultimate objective for central banks is to realize stable and sustainable growth. Operationally, this is going to be achieved through the stability of prices and the financial BIS central bankers’ speeches system. Having said that, it must also be stressed that this goal is not pursued in a vacuum. Such growth can only materialize through the intricate interaction among various economic agents – households, firms, financial institutions and the government – each dynamically pursuing their own goals. While the central bank is probably the actor most responsible for ensuing price stability in a steadily expanding economy, some conditions must be met before the central bank could make the most of its potential. Those conditions have not always been appreciated, but our experiences after the recent global financial turmoil have brought them back in focus. The first condition is ensuring the sustainability of public finances.6 When doubts arise over fiscal sustainability, serious efforts are required to regain confidence. If this is unsuccessful, the only plausibly available options are either inflation or outright default. The operational objectives of the central bank, price stability in the first instance and financial stability in the second will be compromised, with dire consequences for economic activity and the welfare of the people. In this sense, the sustainability of public finances is an essential condition for the central bank to realize its ultimate objective. The second condition is maintaining the credibility of the central bank among the general public. Economic agents can be savers or borrowers, exporters or importers, and while some may benefit from the actions of the central bank, others may lose out. The pain in the short term could be considerable. As a result, it is most important that the general public truly believes that the central bank is acting to maximize the medium- to long-term potential of the whole economy. To begin with, if the central bank is not credible, it may even end up not being able to implement measures that it deems necessary. Furthermore, the effectiveness of the measures heavily depends on expectations formed against the background of credibility. The time-honored reluctance of central banks to enter into quasi-fiscal measures is based on the deference of neutrality, i.e., the need to be seen as not meddling with the allocation of scarce resources, which is crucial for maintaining independence. In this context, the unconventional policies currently implemented by central banks of the major developed economies will truly be tested when central banks deem that the policies are no longer necessary. The appropriateness of the policies will inevitably be judged by how quickly and smoothly such policies could be unwound. The tricky issue is that expectations and credibility are not necessarily malleable or may not behave predictably. While central banks must be bold in times of crisis, they need to be most vigilant at the same time. The third condition is upholding the public support for the market economy. While this goes beyond central bank policies, it is most relevant because all the policies adopted by the central bank presuppose the existence of a competitive market economy. Such support can easily be eroded when the public at large comes to believe that the decks are stacked against them. The increase in unemployment following the recent financial crisis, the widening of the wage gap between skilled and unskilled workers due to deepening globalization, and the antipathy against banks and bankers rescued by taxpayer money, could all result in the weakening of support for a competitive market economy. In the long run, this could pave the way for the adoption of policies that are detrimental to the efficient functioning of the economy. One of the lessons learned from the interwar years in the first half of the twentieth century was that crisis response begets the next crisis, then epitomized by the spread of protectionism and beggar-thy-neighbor competitive devaluation. Policy makers, including central bankers must not forget such lessons of history. See Masaaki Shirakawa, “Sustainability of government debt: preconditions for stability in the financial system and prices,” Banque de France, Financial Stability Review, No. 16, April 2012, forthcoming. BIS central bankers’ speeches V. Concluding remarks In his recent book, the influential author Robert Shiller notes that “Central banks are an invention that served its purpose at a certain time in history, in a certain kind of environment,” and goes on to say that their time may have passed.7 Central banks could not prevent the bubble and the following Crisis. Nevertheless, as I have explained today, the role of central banks has evolved over the years and that process is continuing or has even accelerated after the Great Financial Crisis. Our economic system, while bringing us unprecedented prosperity, is an inherently unstable creature because of its dynamism. If the peoples of the world are to maintain, let alone further improve, their current lifestyles, policy makers, including central banks, must not let the various currents unleashed by the Crisis threaten the foundations of an affluent society. In an ideal world, if we could understand and model why you decided to have latte instead of espresso this morning, it could be possible to design an automatic stabilizing mechanism for the economy, and central banks would become only a chapter in economic history books. Nevertheless, being a complex system that involves people and their emotions, managing the economy will probably remain an art rather than a science, where human actors, who can learn from the past and adapt accordingly, have to play a leading role. Automatic stabilizers and mechanical rules would not work. Continuing this process of learning and adapting, I believe, is at the core of the challenges facing central banks at this juncture, and if central banks can meet those challenges, central banks will still be able to fully serve the good society. Thank you very much. See Shiller, Robert J., Finance and the Good Society, Princeton University Press, 2012. BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan Information and Culture Center (JICC), Washington DC, 19 April 2012.
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Masaaki Shirakawa: Japan-US economic relations – what we can learn from each other Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan Information and Culture Center (JICC), Washington DC, 19 April 2012. * * * Introduction It is my great honor to have this opportunity to speak at the Japan Information and Culture Center (JICC) to celebrate the centenary of the city of Tokyo’s gift of cherry trees to Washington D.C. as an expression of friendship. Regrettably, I missed the chance to appreciate the cherry blossoms on the banks of the Tidal Basin this year, but I can still find consolation in viewing my favorite dogwoods instead. As you may know, dogwoods were sent from the United States to the city of Tokyo as a gift in return, and we can still enjoy the beautiful flowers of these original trees at Tokyo Metropolitan Engei High School (Chart 1). The exchange of cherry and dogwood trees is just one small example of the deep ties that exist between Japan and the United States. From my perspective as a central banker, the economic relationship between our two countries is definitely the cornerstone of a prosperous global economy. This relationship has had its ups and downs, as all inevitably do. As we gradually emerge from the global financial crisis and renew our resolve in maintaining and strengthening the global economic system – thereby ensuring prosperity for all – I believe it is worthwhile to offer my observations on Japan’s economy with special emphasis on Japan-U.S. economic relations. I. Some facts about Japan’s economy Before delving into the main subject, although you may already be familiar with facts about the economic interdependence of the two nations, as well as the state of Japan’s economy, let me share some fundamental ones with you. The economic interdependence of the two nations in recent years First, I would like to highlight a few such facts specific to the economic interdependence of the United States and Japan in recent years. In terms of GDP, the U.S. economy has the largest and Japan’s economy has the third largest within the global economy. The two economies combined enjoy just over a 30 percent share of the global economy (Chart 2). A glance at some economic data easily confirms that the two nations still have close ties and are important partners (Chart 3). For example, looking at trade figures, the United States’ share of 15 percent marks it as the second largest destination for Japan’s exports, after China’s 19 percent. Moreover, it appears that a large portion of the exports to China is eventually sent on to the United States after going through the assembly process in China. As a destination for U.S. exports, Japan has a share of 5 percent, which is the second largest after China when excluding the NAFTA countries. As you can see by the example of Apple’s iPhone, for which Japanese manufacturers produce more than 30 percent of the components, the industries of Japan and the United States are indeed closely connected (Chart 4). In terms of international investment, the share of the United States as a destination for outstanding foreign direct investment from Japan is the largest, at 30 percent (Chart 5). The share of the United States with respect to outstanding inward foreign direct investment to Japan is also the largest, at 34 percent. From the other side of the picture, the share of Japan in terms of outstanding inward direct investment to the United States is the second BIS central bankers’ speeches largest, at 11 percent, after the U.K.’s 20 percent. Looking at securities investment, Japan’s U.S. Treasury holdings of 0.9 trillion U.S. dollars represent a share of 20 percent, second to China’s holdings of 1.2 trillion U.S. dollars, which give it a share of 26 percent. Japan’s economy after the bursting of a bubble Second, I would like to highlight some facts about the current state of Japan’s economy. With regard to growth rates, to our regret, it is hard to claim that our performance has been remarkable, and our experience has often been referred to in a negative context in recent years as “a lost decade” (Chart 6). Having said this, although our GDP growth rates have been on a declining trend, the average growth rate of GDP per capita in the past decade is almost the same as the average for the G-7 countries. Moreover, it is surprisingly not well known even among Japanese people that Japan recorded the highest growth rate among the G-7 countries in terms of GDP per working-age population – that is, the population aged between 15 and 64 years. Needless to say, Japan has confronted a number of difficult challenges, just like other countries. In fact, there has been a series of problems in the past quarter century, including the forming and bursting of a bubble, the subsequent financial crisis, mild deflation, the aging of and decline in the population, and the Great East Japan Earthquake. At the same time, other advanced countries have also ultimately experienced at least some of the same problems as Japan, and this can be seen in developments since the mid-2000s. One clear difference between Japan and other advanced countries is the fact that Japan was the first to experience such problems and, in the absence of a textbook that might address them, had to tackle them through its own efforts. In this sense, Japan suffered from these difficulties in the unique position as a forerunner. Such experiences provided some lessons that helped us recently in dealing with the global financial crisis, as evidenced by the relative soundness of Japanese financial institutions. The long-term developments in Japan’s economy Third, I would like to take a look at how Japan’s economy has developed over a longer time span (Chart 7). Japan opened its doors to the world 160 years ago when a U.S. fleet led by Commodore Perry, who held an official letter from President Fillmore, anchored off the coast near the capital city. After experiencing rapid economic development, Japan became the first industrial nation among non-Western countries. Japan’s real GDP and GDP per capita back in 1870 – for which relevant statistics are available – were 26 percent and 30 percent, respectively, of the relative figures for the United States (Chart 8). The ratios had not changed much by the time the cherry trees were sent to Washington D.C. as a gift of friendship 100 years ago. They gradually rose thereafter, but the ratio in terms of GDP per capita was still a mere 44 percent at the peak before World War II. The war caused disruptive economic damage, but Japan, after making strenuous efforts toward reconstruction, entered a period of rapid and high economic growth. The country’s high growth period started in the mid-1950s and ended in the early 1970s. The average annual growth rate in this 15-year period was high, at 9.7 percent (Chart 9). There have been various discussions about the factors that enabled Japan’s high growth after the war, but given the time constraint, I would like to highlight just three of them. The first factor is favorable demographics. Japan benefited from the so-called “population bonus” that occurred when the total population increased together with the ratio of the working-age population. The second factor is the adoption of a market economy as a development model. Although there were other countries with growth potential, emerging economies including China only started to adopt a market economy model from the 1990s. In such a situation, Japan benefited from the free trade system that was led by the United States after World War II. The third factor is that the Japanese firms and society developed a unique business model that placed importance on long-term relationships, and this model had excellent compatibility with the relatively stable global economic conditions during the period of the Cold War. BIS central bankers’ speeches Even after the high growth period, Japan continued to enjoy a relatively high rate of economic growth compared to other advanced countries. As a result, the economic gap between the United States and Japan narrowed and, at the height of the Japanese bubble economy around 1990, the ratio of Japanese real GDP to U.S. real GDP exceeded 40 percent while the ratio in terms of real GDP per capita exceeded 80 percent (Chart 8). Against the background of the narrowing gap, the two nations experienced rising economic frictions, especially on the trade front, including over textiles in the 1970s and over autos and semiconductors in the 1980s. In such an environment, Japan initiated so-called “selfrestraint” with regard to exports. Over the past half century, the U.S. dollar registered its highest level in nominal terms in 1985. I should note that there is a universal phenomenon that trade frictions take place following the appreciation of currencies (Chart 10). II. The prospects for the U.S. economy: implications from Japan’s experience There is a reason why I have spent a relatively long time on explaining some facts about Japan’s economy. This is because, judging from frequently asked questions from my American friends, I believe that such historical facts might be of some help in considering the prospects for the U.S. economy. One such frequently asked question is related to the policy conduct for the time being – that is, will the United States suffer the Japanese experience of “a lost decade”? The second question is based on a longer-run perspective – namely, how long can China continue to enjoy its current period of high economic growth? This question is seemingly intended to draw implications from Japan’s past experience with regard to the current state of the Chinese economy, which has great importance for the U.S. economy. Will the United States suffer the Japanese experience of “A Lost Decade”? Let me start with the first question. Before the global financial crisis, a prevailing view among economists in the United States was that, even if a bubble existed and burst, the economy could avoid a big downturn similar to that experienced by Japan if aggressive macroeconomic policies were pursued promptly. Since 2009 – probably in reflection of this view – we have witnessed repeated episodes of rising optimism triggered by some signs of economic recovery, which are then followed by the resurgence of pessimism. Let’s look at some data. During the six years since 2006, when housing prices started to drop in the United States, the average real GDP growth rate was low, at 0.9 percent, and real GDP stayed at a level equivalent to 103 percent of the level seen in 2006 before the decline in real estate prices. In the case of the large bubble experienced by Japan in the latter half of the 1980s, the average growth rate for the six years following the record peak year of real estate prices was 2.1 percent and GDP stayed at a level equivalent to 107 percent of that seen in 1990. As is evident from these figures, the negative legacy of the bursting of the bubble is enormous, both in the United States and Japan. A similarity is also observed in terms of real estate price developments in the two countries (Chart 11). Once a bubble bursts, economic entities that have expanded expenditures and debts need to go through a process of reducing debt to a normal level. During that process, downward pressure from balance-sheet repair continues to weigh on economic activity. At the same time, there are many important differences between the two economies. The first difference is that the scale of the bubbles, which determines the significance of damage, appears to be smaller in the case of the United States. Looking at the size of capital gains arising from real estate and financial assets during the bubble period, this was larger in Japan, at 4.6 times nominal GDP compared to 3.1 times in the United States (Chart 12). The same conclusion can be drawn when we compare the size of capital losses. As the scale of this bubble was relatively small, the burden associated with balance-sheet repair should be smaller in the United States. BIS central bankers’ speeches The second difference is with regard to the speed of dealing with non-performing assets, which, importantly, reflects differences in the two economies’ financing structures (Chart 13). The problem in the United States started with an increase in subprime mortgage loans to households, which were financed by banks directly and indirectly in financial markets using securitized products. In this way, relying on market financing tools, banks faced pressure from market participants who recognized valuation losses, and the authorities had no choice but to inject capital into banks at an early stage using public funds. On the other hand, in the case of Japan, the funding of non-performing assets was mainly carried out by banks, which did not rely so much on capital markets. This funding structure failed to exert strong pressure on concerned parties to deal with non-performing assets promptly. The third difference is the relatively small burden shouldered by domestic investors. In the case of the United States, capital losses – that is, the costs associated with balance-sheet repair – were imposed not only on domestic investors but also shared by investors abroad to a significant extent. This corresponds to the fact that investors abroad increased their exposure to the complicated securitized products that originated from subprime loans (Chart 14). On the other hand, in Japan, an increase in debt was mainly reflective of borrowing from domestic financial institutions, which basically shouldered the burden of subsequent balance-sheet repair. The fourth difference is with regard to demographics. Japan faced a rapid aging of the population and its working-age population started to decline after reaching its peak in 1995 (Chart 15). On the other hand, although its pace of increase has been on a declining trend, the U.S. working-age population is still growing, at 0.8 percent. At the same time, however, we need to pay attention to the fact that the pace of increase in the number of net immigrants has been diminishing, reflecting a recent decline in U.S. growth rates. The fifth difference is in terms of the flexibility of the economy. The U.S. economy has more flexibility, as witnessed by vigorous entrepreneurship, efficient and smooth functioning of labor and capital markets, and the country’s leading role in research and development. Nevertheless, we should bear in mind that the entry rate and labor mobility have remained at low levels after the bursting of a bubble. The sixth difference is with respect to the global economic environment surrounding the two nations. Balance-sheet repair in Japan was completed in the early 2000s, supported by global economic upturns such as strong growth in the United States and in emerging economies. However, global economic conditions are not favorable this time around. Japan’s bubble was a domestic one, whereas the recent financial crisis was a global credit bubble. In the current conjuncture, the European debt problem is exerting an impact on the global economy, including the U.S. economy. As is evident from the fact that European financial institutions increased their exposure to U.S. financial products, the U.S. housing bubble and excess debts in Europe are not independent from each other. Thus, the balance-sheet repair in the United States might take some more time. It is sometimes pointed out that one of the differences between the two bubbles is the sector in which excess debt accumulated: the corporate sector in the case of Japan and the household sector in the case of the United States. What matters in shaping the impact of balance-sheet repair on economic activity, however, is whether such an adjustment is taking place in a sector driving economic recovery. In this sense, there is no significant difference between the two cases because, while economic recovery in the past has been led by the corporate sector in Japan, it has been driven by the household sector in the United States. An overall assessment of the differences seemingly indicates that the balance-sheet repair in the United States will likely end earlier than in the case of Japan, and I do hope that is the case. In the end, I think that the most important factor determining economic developments following the bursting of a bubble is the economy’s capacity to develop a new growth model that best suits a changing economic environment. In the case of Japan, its stagnant economic performance largely owed to its failure to adjust to economic globalization BIS central bankers’ speeches associated with the collapse of planned economies, especially the breaking up of the Soviet Union, as well as to the IT revolution, both of which took place almost at the same time that Japan’s bubble burst. In the current conjuncture, the most significant changes taking place on a global scale are the swift rise of emerging economies and the rapid aging of the population. Respective corollaries to these changes are a rise in international commodity prices and a deterioration in the fiscal balance. While Japan has had a tough time trying to develop a new growth model in response to these changes, we do have some strengths in this regard. First, Japan is located in Asia, the engine of global economic growth. Second, it has a high level of technological prowess, which is necessary when adjusting to a rise in energy prices. Third, as they have faced the problem of an aging population ahead of the rest of the world, Japanese firms have been making serious efforts and progress toward developing new business models that focus on markets for the elderly. As the governor of Japan’s central bank, I do sincerely hope that a new growth model for Japan will be developed that takes advantage of these strengths. The prospects for the Chinese economy in light of Japan’s experience of high growth Now I would like to move on to the question of the sustainability of high growth in China.1 Economic history tells us that a convergence of the sizes of two economies is likely to cause some sort of friction. A typical example is the aforementioned economic friction between the United States and Japan that reached its height in the latter half of the 1980s. As I referred to a short while ago, the average annual growth rate in Japan during the 15-year period of high growth that started in the mid-1950s was 9.7 percent. China’s high growth started in the early 1990s, and its average growth rate over the last twenty years is 10.2 percent, almost the same as Japan’s growth rate (Chart 16). What is different is the time span of the high growth period, which has been longer in the case of China. However, no country can maintain high growth forever. Therefore, looking at a slightly longer time horizon, a meaningful question is not whether China’s high growth will continue but whether China can make a smooth transition from a high growth phase to a stable growth phase. This is a challenging task, and I have often been asked by Chinese friends to provide advice in light of Japan’s experience. I always note the following three points. First, do not fall into a mode of complacency. When high growth continues, especially coupled with low inflation, such favorable economic performance tends to engender overconfidence. Although the formation of bubbles involves a complex mechanism, one crucial factor is excessive risk-taking caused by complacency and overconfidence. Second, be prepared for demographic changes. The inverse dependency ratio, which represents workers per non-working population, appears to have a positive correlation with real estate market development (Chart 17). This implies that attention should be paid to demographics as a factor contributing to the formation of financial bubbles. Third, pay attention to changes in financial institutions’ behavior following financial liberalization. Although active lending by financial institutions has been the direct cause of the formation of bubbles in advanced economies, these institutions’ lending attitudes became aggressive as a result of fierce competition and an associated decline in profitability triggered by financial liberalization. While financial liberalization itself is necessary, it should be pursued under a combination of appropriate regulations and supervision. I understand that these three pieces of advice do not directly answer the question from my American friends, which is “How long can China continue to enjoy its current period of high For more details on high economic growth in China, please see Masaaki Shirakawa, “The Transition from High Growth to Stable Growth: Japan’s Experience and Implications for Emerging Economies” (Remarks at the Bank of Finland 200th Anniversary Conference in Helsinki), May 5, 2011. http://www.boj.or.jp/en/announcements/press/koen_2011/ko110506a.htm BIS central bankers’ speeches economic growth?” I hope that China will successfully make a smooth transition from a high growth phase to a stable growth phase, which will arrive at some point in the future. III. The current state of and prospects for Japan’s economy Lastly, I would like to talk about the prospects for Japan’s economy after summarizing its current state. Reconstruction after the Great East Japan Earthquake As for the current state of Japan’s economy, this cannot be described without referring to the effects of the tragic event known as the Great East Japan Earthquake, which occurred on March 11 last year. The economy significantly suffered from the multiple shocks of the earthquake, tsunami, and nuclear power plant accidents.2 During this time of hardship, we received much support and encouragement from the government and people of the United States. Soon after the quake, the United States Armed Forces’ Operation Tomodachi, or “Friends” in English, provided assistance to Sendai Airport and restored its functionality about a month after the disaster (Chart 18). People in Japan really appreciate such support from the United States, from the bottom of their hearts. Looking back at all those efforts over the past year or so to overcome the difficulties caused by the disaster, I would like to make the following four observations. First, I am very impressed by Japanese firms’ competitiveness at worksites. Although the earthquake caused serious damage to factories and business facilities, as well as disruptions in supply chains, such problems were overcome much earlier than initially anticipated thanks to the efforts and new creative ideas of concerned parties. Second, there are differences among areas in terms of the pace of reconstruction. Those areas that suffered serious damage have not yet entered the full-scale reconstruction phase, although they have started to resume some economic activities. In the rest of the disaster areas, however, there are some signs of steady recovery in economic activity, including an increase in reconstruction-related capital investment and a recovery in private consumption, which had plummeted soon after the tragic event. Third, there are new initiatives motivated by experiences accumulated since the earthquake disaster. Firms have been reviewing their approach to risk management as well as relevant business operations, for example, by reexamining business continuity plans and reestablishing supply chains. With lingering uncertainty about the supply of electricity, firms have pursued various technological innovations and established new business models under the slogans of “creating energy”, “saving energy”, and “storing energy”. Such positive initiatives are expected to create new demand and consequently raise Japan’s growth potential in the medium to long term. Fourth, financial system stability was maintained. Despite the tremendous shock caused by the earthquake, we have managed to maintain the working of the financial system and secure the smooth operation of payment and settlement systems. The Bank of Japan Financial Network System, or BOJ-NET, which plays a core role in the payment and settlement of funds and Japanese government securities, has maintained stable operations after the quake without any disruptions. The Bank’s Fukushima branch, which is located about 40 miles from the Fukushima Daiichi Nuclear Power Plant, also continued with business as usual. Despite the shocks arising from the European debt problem, financial For more details on the state of Japan’s economy after the disaster and efforts toward rebuilding and reconstruction, please see Masaaki Shirakawa, “Great East Japan Earthquake: Resilience of Society and Determination to Rebuild” (Remarks at the Council on Foreign Relations in New York), April 14, 2011. http://www.boj.or.jp/en/announcements/press/koen_2011/ko110415a.htm BIS central bankers’ speeches markets have also remained stable, except for a brief period soon after the quake. As can be judged from the level of risk spreads in funding markets, financial markets in Japan have been the most stable among those in advanced countries. The prospects for Japan’s economy Now I would like to move on to the current state of Japan’s economy and its prospects. After experiencing a sharp rebound from a plunge caused by the earthquake toward summer last year, economic activity has been more or less flat, reflecting downward forces deriving from the effects of a slowdown in overseas economies and the appreciation of the yen. More recently, there have been some signs of a pick-up. The Bank of Japan believes that the economy will gradually emerge from the current phase of flat growth and return to a moderate recovery path as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and as reconstruction-related demand after the earthquake disaster gradually strengthens. The plausibility of such an outlook depends on the following two factors. The first factor is global economic developments. In this regard, the good news is that the stagnant European economy has recently stopped deteriorating amid receding tail risks arising from the European debt problem. Although some more time is needed to complete balance-sheet repair, U.S. economic conditions have also been gradually improving, mainly in the areas of consumption and employment. Business conditions in emerging economies are also gaining support from somewhat more stable inflation rates in the recent period, which increases real purchasing power and creates more room for monetary easing. The second factor is reconstruction-related demand. The portion of the government budget earmarked for reconstruction amounts to about 19 trillion yen. This represents about 4 percent of Japan’s nominal GDP and 60 percent of the combined nominal GDP of the three disaster-stricken prefectures. This sizable budget will be disbursed over the next five years. Labor market conditions in the disaster areas have already tightened, especially in construction-related sectors. The implementation of the budget is expected to become fullfledged in the coming period, and this will further contribute to raising domestic demand. At this juncture, let me explain the Bank of Japan’s conduct of monetary policy. For the time being, the Bank will aim to achieve the goal of 1 percent inflation in terms of the year-on-year rate of increase in the CPI and continue to pursue powerful monetary easing until the goal is in sight, mainly through a virtually zero interest rate policy and the purchase of financial assets (Chart 19). Monetary policy measures currently pursued by central banks in advanced economies, including the U.S. Federal Reserve and us, are called “unconventional monetary policy measures”. Looking at the type of assets purchased and the gigantic scale of purchases, they are indeed “unconventional”. However, the transmission mechanism of such unconventional measures is not unconventional but actually quite conventional. As Chairman Bernanke notes, the large-scale purchase of financial assets aims at lowering long-term interest rates. In terms of assessing monetary policy in Japan in light of such an aim, the financial conditions in Japan are extremely accommodative (Chart 20). For example, the interest rate for corporate bonds with a maturity of 5 years is 0.5 percent in Japan and 1.4 percent in the United States. The mortgage loan rate is 2.2 percent in Japan and 3.9 percent in the United States. Long-term interest rates applied for firms and households in Japan have been as low as those in the United States in real terms, based on real interest rates derived from long-run inflation expectations, on which economists place importance. One of the most significant challenges for Japan is to stem a declining trend in the potential growth rate. Although several factors contribute to a drop in this rate, a significant one is responses to a change in demographics – namely, an aging of the population that has been progressing at a pace unprecedented in advanced countries. Although the aging of the population lowers the potential growth rate through various channels, what is causing a profound impact on the economy is not the aging itself but a delay in responding to such a BIS central bankers’ speeches demographic change. This delay is one of the major causes of a deterioration in the fiscal balance in Japan, which is coming into the spotlight these days. Uncertainty regarding future fiscal burden has also led to restrained spending by the working generations. In any case, a gradual decline in the potential growth rate has been significantly contributing to mild deflation by bringing down expected future income and restraining expenditures. In addition to powerful monetary easing pursued by the Bank of Japan, in order to overcome deflation, it is crucial to make strenuous efforts to strengthen the growth potential of Japan’s economy. IV. Concluding words As I have almost used up my time, let me conclude my remarks. Japan-U.S. relations are quite often described as one of the most important relationships in the world. That importance, I believe, is not measured just in terms of the amount of trade between the two countries or their overlapping interests in the sphere of national security. The fact that both can learn a lot from each other is also a valuable asset that forms the cornerstone of the relationship. This is especially true with respect to stewardship of the economy, as it is not possible to conduct controlled experiments as regards economic policy. Of course, as I have noted today on current developments, while the best lessons we might learn from each other remain uncertain, our insights will be much, much better. Thank you very much for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Japan Chamber of Commerce and Industry, Tokyo, 19 April 2012.
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Hirohide Yamaguchi: Agenda for Japan’s economy and challenges facing small and medium-sized enterprises Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Japan Chamber of Commerce and Industry, Tokyo, 19 April 2012. * * * Introduction It is my great honor to have an opportunity to speak in front of front-line business leaders. The Bank of Japan and the chamber of commerce and industry have had a close relationship for more than a century. The first president of the Tokyo Chamber of Commerce, Japan’s first chamber of commerce and industry, was Mr. Eiichi Shibusawa, who is called the father of Japan’s capitalism, and his grandson was Mr. Keizo Shibusawa, the 16th Governor of the Bank of Japan. The 15th Governor Mr. Toyotaro Yuuki was President of the Japan Chamber of Commerce and Industry (JCCI) before taking office as Governor. The Bank also received valuable advice from the successive Presidents of the JCCI as Counsellors, and staffers of the Bank have been exchanging views directly on various occasions with the regional Chamber of Commerce members and firms. Financial and economic information obtained on those occasions has been valuable in the Bank’s policy conduct, and I take this opportunity to thank you for your cooperation. Today, I will review the recent developments in Japan’s economy, followed by challenges facing it, while bearing in mind the activities of small and medium-sized enterprises (SMEs). Then, I will explain the Bank’s recent monetary policy conduct. I. Recent developments in Japan’s economy Recent economic developments and outlook for the immediate future Let me start with the recent economic developments in Japan (Chart 1). Japan’s economy rapidly recovered from the plunge following the Great East Japan Earthquake through last summer. While the economy has subsequently been more or less flat due partly to the effects of a slowdown in overseas economies and the yen’s appreciation, there have recently been some signs of a pick-up. Public investment has started to increase and private consumption has firmed up due in part to the effects of measures to stimulate demand for automobiles. Overseas economies on the whole still have been in the deceleration phase, but some improvement has been observed, including continued moderate improvement in U.S. economic conditions. As for the outlook, we expect that Japan’s economy will resume a moderate recovery as overseas economies will pick up, led by emerging and commodity-exporting economies, and reconstruction-related demand after the earthquake disaster increases. Uncertainties about the outlook Such economic outlook is associated with various uncertainties. Today, I will point out three uncertainties that require special attention. The first uncertainty surrounds developments in overseas economies, especially the European economy. Thanks to massive liquidity provision by the European Central Bank and financial support to Greece, the possibility that the European debt problem will induce turmoil in global financial and capital markets through funding problems of financial institutions has at least lessened. However, it is not yet known whether European peripheral countries can smoothly carry out more drastic measures of fiscal and economic structural reform. Recently, BIS central bankers’ speeches Spain’s struggle with fiscal reform has started to be recognized as a new destabilizing factor to financial and capital markets. The second uncertainty surrounds developments in international commodity prices, including crude oil prices. A rise in crude oil prices will put downward pressure on Japanese firms’ profits and households’ real purchasing power. If inflationary pressure increases globally, we cannot rule out the possibility that overseas economies, in which some improvement has started to be seen, will slow down again. The third uncertainty surrounds the domestic electricity situation. The electric power supply and demand situation might become increasingly severe, mainly during the summer. There is also a problem of an increase in electricity costs associated with a shift to thermal power. Those will increase future uncertainty particularly for the SMEs, which lack self-defense tools including privately-owned electrical power facilities. If the severe electricity situation becomes protracted, it may become an incentive for firms, which aim at the optimal division of labor at home and abroad, to expand production and business overseas. Unless alternative domestic production is generated, Japan’s growth potential might decline. In relation to the first uncertainty about developments in overseas economies, let me touch on developments in foreign exchange markets. While the yen has been weakening somewhat since February, it remains at a substantially high level compared with that prior to the Lehman shock. That is because global investors have become increasingly risk averse partly in response to the Lehman shock and the ensuing aggravated European debt problem, and have thus purchased assets including the yen, which were considered to be relatively safe. In the current phase of high uncertainty about the outlook for overseas economies, the Bank believes special attention should be paid to the possibility that the yen’s appreciation will have a negative impact on Japan’s economy through a decline in exports and corporate profits as well as a worsening of business sentiment. The yen’s appreciation has various merits, including reduction in import costs. Nevertheless, it might be difficult even for domestic demand-oriented firms, which are supposed to benefit from the yen’s appreciation, to step out and take positive action utilizing the merits in the current situation, in which they struggle to visualize future growth. Uncertainty about the future of the economy will, to some degree, put a brake on firms’ current economic activity. In that sense, medium- to long-term economic developments and firms’ views on those developments are reflected in the current economic activity. Keeping those points in mind, from a somewhat longer-term perspective, I will review developments in Japan’s economy and consider the agenda for its revival. II. Medium- to long-term agenda for Japan’s economy Downtrend in economic growth rate Japan’s economy achieved a high real growth rate of an average of about 10 percent during the high-growth period. While the growth rate subsequently declined, a relatively high average growth rate was maintained at about 5 percent in the 1970s and 4–5 percent in the 1980s. It fell substantially to around 1.5 percent in the 1990s and further to less than 1 percent in the 2000s (Chart 2). Such decline in the economic growth rate is partly attributable to the ending of Japan’s process of catching up with advanced economies, which had continued since the high-growth era, and a decrease in the working-age population associated with progress in aging. Even when the population of workers declines, if added value earned by a worker, namely, labor productivity increases, the growth potential of the economy as a whole can be maintained. However, as economic globalization has been progressing rapidly since the 1990s and emerging economies have become rivals, Japan’s economy has not been able to adapt sufficiently to such a changing environment and Japanese firms’ international competitiveness and productivity have declined. For two major reasons Japanese firms were BIS central bankers’ speeches unable to adapt to the changing environment. First, the effects of the bursting of the bubble overlapped. Japanese firms were busy resolving “three excesses” of debt, employment, and business capacity that had piled up during the bubble period, and did not have leeway to pursue proactive economic activity. Second, economic structural reform was delayed, namely, labor and capital did not smoothly move from low-productivity areas to high-productivity areas. In the case of Japan, aggressive fiscal and monetary policies continued to underpin the economy since the 1990s. In the meantime, while the need for drastic structural reform was pointed out many times, in reality the reform did not progress except for deregulation in some areas. It could be one reason for the downtrend in Japan’s economic growth rate since the 1990s that structural reform, which was essentially necessary in strengthening growth potential, did not progress smoothly. Low growth and deflation Such downtrend in growth potential is also one reason for Japan’s long-standing problem of deflation. If the downtrend in the economic growth rate becomes protracted, people will become unable to have confidence in or expectations for future growth. As I mentioned earlier, concern over future growth shrinks people’s current spending. If that results in a decline in the actual growth rate, it forms a vicious cycle of once again lowering people’s future growth expectations. Such structural vicious cycle will induce a chronic demand shortage. When there is a lack of demand compared with the supply of goods and services, normally, prices will fall. Since the second half of the 1990s, Japan’s economy experienced a downturn three times triggered by the financial system crisis, the bursting of the IT bubble, and the Lehman shock. Whenever Japan was faced with a substantial decline in the economy, the aforementioned vicious cycle was strongly recognized, and, even in the ensuing economic recovery phase Japan repeatedly encountered the situation in which growth expectations did not sufficiently rise and it could not escape from a demand shortage. The result was a protracted deflationary trend. Output gap and a mismatch between demand and supply According to an estimate by the Cabinet Office, the current annualized output gap is about 15 trillion yen. As it was estimated to be about 40 trillion yen immediately after the Lehman shock, the gap has narrowed considerably but has remained substantial. In that regard, some point out that if economic activity is stimulated by fiscal or monetary policy to create a demand of 15 trillion yen, the output gap will be filled and Japan’s economy can immediately overcome deflation. It is not that simple. The output gap in numerical terms is the difference between the size of demand for the existing goods and services and the existing production capacity to supply those goods and services. However, in reality, people’s demand itself has been changing due to structural changes in society, including aging. If the supply side has not been able to sufficiently meet such new demand, then it might not merely be the problem of an output gap but the problem associated with a mismatch between demand and supply, namely, demand has not been meshing well with supply. For example, in medical and welfare industries, it has been often said that, despite expectations for further demand due to aging, sufficient services have not consequently been provided due to various regulations and a labor shortage in the field. In addition, if there is a case in which, even while recognizing the expansion of Asian markets or an increase in foreign tourists as business opportunities, firms are unable to establish systems for export expansion or sales strengthening due to a lack of market information or the difficulty in finding suitable personnel, thereby letting the demand just pass, it is also a kind of mismatch. Based on such line of thinking, it is obvious that the idea of merely filling the output gap is insufficient. It is necessary to change the supply structure, namely, reduce supply capacity in areas where future demand is not expected on one hand, and expand a supply system that meets people’s new demand on the other. If potential demand leads to actual added value, corporate profits and productivity will rise and, as a result, the growth potential of the BIS central bankers’ speeches economy as a whole will increase. In the following I will consider firms’ efforts toward the revival of Japan’s economy. III. SME’s challenges for revival of Japan’s economy Looking at the productivity of the Japanese manufacturing industry over the past 20 years, the rate of growth in productivity, both of large firms and SMEs, stagnated in the 1990s. After entering the 2000s and up to the Lehman shock, the growth rate of large firms’ productivity increased again due partly to an increase in exports, while that of SMEs’ productivity continued to be more or less flat (Chart 2). Therefore, during that period, the profitability difference between the large firms and SMEs widened more than ever. However, in retrospect, the increase in exports during that period was partly supported by the credit bubbles in the United States and Europe as well as the substantial depreciation of the yen. Namely, in my view, the middle of the 2000s was a period especially in favor of large firms, and the strength of SMEs did not get weaker than it used to be and their underlying strength was firmly maintained. In fact, there have recently been not a few episodes that strongly impress the underlying strength of SMEs, such as “only one” companies that have honed their skills and leaped to the world level and “competitiveness in the field,” or genbaryoku, that enabled a rapid recovery from the earthquake disaster. What is necessary for the revival of Japan’s economy is that individual firms continue to meet challenges so that such underlying strength will be exerted as the strength of Japan’s economy to the maximum extent. The first challenge is to utilize the wide trend of globalization (Chart 3). SMEs that started to export or make foreign direct investment have achieved a relatively high rate of productivity growth, compared with those that did not. In that regard, according to the White Paper on Small and Medium Enterprises, while the average productivity growth rate of SMEs that made foreign direct investment was about 1.8 percent, the growth rate of those did not was about 1.0 percent. Utilization of imports, incorporation of inbound foreign tourists, utilization of foreign personnel, and transactions with foreign firms are also effective ways to utilize globalization. With an increasing unification of markets at home and abroad, there are plenty of catalysts for growth around us in terms of personnel and goods. The second challenge is to tap domestic demand (Chart 4). While various areas, including environment and energy, can be considered, aging and the demographic vortex are also creating great business opportunities. Looking at the entry rate of SMEs by industry, recently, the entry rate has been relatively high in such industries as medical and welfare services, in addition to information and communications, diet, accommodations, and education and learning support that have started to incorporate the elderly as new customers. People who were called baby-boomers are known to have a high propensity to consume, compared with the previous or next generations. Inclusive of such generation, now called the “active seniors,” those 60 years old or older already account for more than 40 percent of private consumption. In meeting new challenges, it is important to utilize the strength unique to SMEs. Merits of SMEs are “quick in decision-making” and “can turn on a dime.” Because of their small size, SMEs can make bold decisions according to changes in the surrounding environment, and thus have potential for a great leap forward. “Able to make finely-tuned responses” is also a merit of SMEs. I have heard that, as aging progresses, the locally-based business of providing services by visiting homes has been received well. Such face-to-face business is a promising area for SMEs that large firms cannot easily imitate. Firms’ challenges sometimes bring changes to regional economies. For example, we have often heard an opinion that how to maintain local employment will become an issue as for the outward shift of firms’ production bases. However, in tandem with exploitation of overseas demand, if the review of a division of labor at home and abroad as well as an enhancement of domestic business is pursued, that will consequently have a positive impact on local BIS central bankers’ speeches employment. On that point, the White Paper on Small and Medium Enterprises pointed out that “in firms that made direct investment overseas, the number of workers once decreases by about 10 percent after the investment, but in six to seven years, domestic workers increase compared with firms that did not make investment” (Chart 3). What is important is to consider, from a long-term perspective, how a firm can grow and the regional economy can be vitalized. I hope people here representing the regional economy and the Chamber of Commerce in each region will exert strong leadership. IV. Conduct of monetary policy Finally, let me talk about the Bank of Japan’s recent monetary policy conduct. The Bank recognizes that Japan’s economy is faced with the critical challenge of overcoming deflation and returning to the sustainable growth path with price stability. Based on the recognition, the Bank implemented in February and March 2012 the following two measures. In February, the Bank clarified its monetary policy stance and further enhanced monetary easing (Chart 5). Specifically, the Bank introduced “the price stability goal in the medium to long term” and, on that basis, will aim at achieving the goal of 1 percent in terms of the year-on-year rate of increase in the CPI, and will continue with the powerful easing until it judges the 1 percent goal to be in sight. And to confirm the policy stance not only by word but also by action, the Bank decided to increase the total size of the Asset Purchase Program by purchasing an additional 10 trillion yen in government bonds. Subsequently, in March, to support private firms’ efforts to strengthen the growth potential, the Bank decided to substantially enhance the fund-provisioning measure to support strengthening the foundations for economic growth, “the Growth-Supporting Funding Facility” in short, both in terms of the yen and a foreign currency (Chart 6). The Growth-Supporting Funding Facility was introduced two years ago as a measure for the Bank to provide financial institutions making investments and loans that contribute to Japan’s economic growth with long-term and low interest rate funds. The March decision has two points. First, the Bank established special rules for a new lending arrangement of 500 billion yen for small-lot investments and loans that had not been deemed eligible in the past being less than 10 million yen. Regional financial institutions have been expressing that, even among small-lot borrowers, there were not a few SMEs that could make a great leap forward depending on their efforts to meet the challenges. Such opinion was a trigger for setting the special rules. Second, the Bank established a new U.S. dollar lending arrangement of 1 trillion yen equivalent (12 billion U.S. dollars) for financial institutions’ investments and loans denominated in foreign currencies. That aimed at supporting the efforts to strengthen domestic growth potential by utilizing the trend of globalization. In that regard, it is not only large firms but also SMEs that have been making efforts in overseas expansion and import increase. Therefore, the Bank crafted the arrangements, including setting a maximum amount of foreign currency-denominated loans per project, so that the new arrangements will not be used heavily on large projects but to a wide range of projects including small and medium ones. The Bank believes that, in order for Japan’s economy to overcome deflation, the efforts to increase the economy’s growth potential and support from the financial side are both necessary. The February and March measures implemented on the basis of such recognition are a policy package toward overcoming deflation. The Bank considers that those measures will work together to encourage moves to achieve the goal of overcoming deflation and returning to the sustainable growth path with price stability. Concluding remarks I have today mainly spoken about the challenges facing Japan’s economy and efforts to meet them. While the severe business environment has been continuing since the burst of BIS central bankers’ speeches the bubble in the 1990s, even against such a backdrop, I have heard that there are many SME managers who promote the utilization of women and the elderly and actively pursue “work-life-balance.” Such, on the surface, behind-the-scenes activity will also, through increasing the retention rate, consequently lead to an improvement in productivity and an increase in competitiveness. Furthermore, such efforts have been providing many people that have the will and ability to work with various employment opportunities that suit individual lifestyles and life stages. Japanese SMEs are an engine for the richness of public life that cannot be measured only by numbers, such as GDP and productivity. Also from such a perspective, unless SMEs get vitalized, Japan will not be vitalized. The Bank will steadily support firms’ activities through taking appropriate policy action if necessary in the powerful monetary easing stance. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Bank of France Financial Stability Review launch event, Washington DC, 21 April 2012.
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Masaaki Shirakawa: The importance of fiscal sustainability – preconditions for stability in the financial system and in prices Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Bank of France Financial Stability Review launch event, Washington DC, 21 April 2012. * * * Relationship between fiscal sustainability and central banks The mission of a central bank is to contribute to sustained growth of the economy by maintaining public confidence in money, and price stability and financial system stability are two facets of this mission. Fiscal sustainability is an important element that has a fundamental impact on both. According to conventional wisdom, when the government loses its credibility with respect to the sustainability of government debt and does not make enough effort to regain it, this ultimately leads to either inflation or a default on the debt. To put this differently, it is often said that a central bank comes to face a tradeoff between price stability and financial system stability. However, since both are essential preconditions for sustained economic growth, it is not at all meaningful to consider which of the two we should choose. What is crucially important is to prevent the economy from getting into such a tradeoff in the first place; for that reason, fiscal sustainability itself is an essential precondition for the proper functioning of a central bank. Let me now elaborate on this point. In normal times, government bonds are traded in large volumes in financial markets and used as collateral, reflecting their characteristics as safe assets. They are also held by financial institutions as liquidity buffers and investment assets. As such, a heightened risk for government debt default is likely to lead to instability in the financial system, through an increase in the liquidity risk and the capital loss of financial institutions. In such a situation, a central bank may be called into action as a “lender of last resort” by providing liquidity in order to maintain the stability in financial markets and the financial system, and such operations are expected to be effective at least in the short term. Taking an example from Europe, the ECB’s Long-Term Refinancing Operations (LTROs) have helped to restore calm in financial markets. We are fully aware of the importance of such operations, but one has to also keep in mind that they can only be used to “buy time.” A central bank’s operations to “buy time” may help the government to garner time to build a public consensus on the need for fiscal consolidation and gain the credibility of market participants for a consolidation plan. However, the side effects of such operations become significant when the government’s commitment to fiscal reforms is weak and the plan for fiscal consolidation is less effective. Specifically, a temporary lull in financial markets due to a decline in government bond yields is likely to dilute the sense of urgency among the government and the public, and thus weaken the momentum for progress toward fiscal reforms. If the government continues to run fiscal deficits, a possibility arises in which the central bank is forced to supply an unlimited amount of liquidity – in the form of either liquidity provision against government bonds as collateral or an outright purchase of government bonds – in order to get around a re-emergence of financial system instability. Historically, the consequence of such a large-scale supply of money is uncontrollable inflation. If market participants and the public, which have the knowledge of this history, were to anticipate a regime shift at some point, the credibility with respect to government bonds and money would be lost abruptly, and a process leading to uncontrollable inflation would begin. After all, without solid progress toward fiscal consolidation, we cannot avoid significantly adverse impacts on economic activity and the standard of living. BIS central bankers’ speeches The case of Japan Now I would like to take up the case of Japan, which attracts frequent questions. As is well known, the ratio of gross government debt to GDP in Japan is the highest among developed countries. In spite of such unfavorable fiscal conditions, the government bond yields remain low and stable, and policy discussions are focused on mild deflation instead of concerns regarding inflation, as evidenced by the fact that the consumer price index has fallen by 3.4 percent in cumulative terms since 1998, which can be translated to 0.2 percent annually. The low level of the government bond yields is consistent with the growth rate of the economy and the inflation rate, and at issue is the interpretation of the premium that could arise from worsening fiscal situations. It seems difficult to explain the case of Japan in light of the conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuances of Japanese Government Bonds (JGBs) and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the government bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms in both the economic and fiscal areas. At the moment, such expectations are not firmly backed by concrete reform plans; the public therefore restrains spending on concerns over future fiscal developments, and this constitutes one factor behind sluggish economic growth and mild deflation. If this is indeed the case, the experience of Japan indicates a possibility that a cumulative increase in government debt, combined with weak growth expectations, might generate deflationary pressures as long as the government retains its credibility with respect to eventual fiscal consolidation. In other words, this is the situation before the loss of fiscal sustainability leads to either inflation or a default on the debt. Behind the decline in growth expectations and the cumulative increase in government debt are the aging of the population and the failure of the Japanese economy to adjust to it in a flexible manner. There is a limitation, at least in the short run, to changing the demographic trend itself. Therefore, given that the rapid aging of the population is likely to continue, strengthening the growth potential through productivity improvements and making the fiscal structure sustainable in the situation of an aging population are the most important challenges for Japan in terms of maintaining macroeconomic stability over the medium to long term. BIS central bankers’ speeches
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Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hyogo, 22 March 2012.
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Yoshihisa Morimoto: Economic activity and prices in Japan and monetary policy Speech by Mr Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hyogo, 22 March 2012. * * * I. Recent financial and economic developments A. Japan’s economy I will first provide a brief overview of Japan’s economy. Through summer 2011, the economy picked up rapidly after the sharp decline following the Great East Japan Earthquake. While domestic demand such as private consumption since then has been firm, economic activity as a whole has been more or less flat, reflecting the decline in overseas demand mainly due to the slowdown in overseas economies and the appreciation of the yen, both triggered by the European debt problem and other factors. Although there remains considerable uncertainty regarding the outlook, Japan’s economy is expected to return to a moderate recovery path in the first half of fiscal 2012 as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and as reconstructionrelated demand after the earthquake gradually strengthens. In what follows, I will review the situation after the Lehman shock – the financial crisis following the September 2008 failure of Lehman Brothers – which is the starting point of the current recovery phase of Japan’s economy and also an underlying cause of the European debt crisis, and talk about developments thereafter. I will also talk about the uncertainty surrounding the current state of Japan’s economy. B. From the Lehman shock to the March 2011 earthquake The global economy contracted rapidly and severely in the wake of the Lehman shock. Economic conditions deteriorated sharply not only in the United States and Europe, which were the epicenter of the financial crisis, but also in Japan as well as emerging economies especially in Asia due to the fall in U.S. and European demand. Real GDP in Japan recorded a decline of more than 10 percent on an annualized basis – a larger drop than that in the United States – for two consecutive quarters from the October-December quarter of 2008. Subsequently, Japan’s economy picked up rapidly after leveling out around spring 2009, owing to the progress in global inventory restocking, the expansion of fiscal spending, and substantial monetary easing. In 2010, the pace of recovery slowed temporarily from summer through autumn, but the recovery trend remained intact until early 2011. C. Current conditions and outlook The Great East Japan Earthquake struck in March 2011, and Japan’s economy once again came under strong downward pressure. Many facilities were damaged by the disaster, and the production and distribution of manufactured goods came to a standstill. In contrast with the so-called “evaporation of demand” seen after the Lehman shock, this time it was constraints in supply that severely affected the economy: industrial production for March 2011 fell by 15.5 percent on a month-on-month basis, the largest one-month drop on record. In this situation, business and household sentiment deteriorated, and spending declined. As a result of strenuous efforts by the parties concerned, supply chain disruptions were subsequently speedily resolved and economic activity picked up at a pace faster than widely expected immediately after the earthquake. Production and exports almost recovered to their pre-quake levels in summer 2011. BIS central bankers’ speeches Just when some positive signs were on the horizon, Japan’s economy encountered new challenges, namely, the slowdown in overseas economies and the appreciation of the yen, both stemming from the European debt problem. Together with the effects of the flooding in Thailand, the developments led to a gradual slowdown in the pace of increase in exports and production, and both exports and production have been more or less flat recently. Domestic demand, on the other hand, has been firm mainly due to reconstruction-related demand after the earthquake. Private consumption has firmed up in part because of a recovery in demand, which had been temporarily subdued mainly reflecting the disaster, and because of a surge in new car sales due to the boost provided by government subsidies. Business fixed investment for now continues to be on a moderate increasing trend, aided by the fact that full-fledged rebuilding efforts such as efforts to restore and reconstruct disaster-stricken facilities as well as efforts to strengthen the earthquake resistance of existing structures are now getting underway, although some exporting firms that have greatly revised their profit forecasts downward might restrain their investment in the future. Public investment is also expected to gradually expand with the implementation of large-scale rebuilding projects now getting underway, given that local governments in disaster areas have been making progress in the development of reconstruction plans. Although there remains considerable uncertainty regarding the outlook, Japan’s economy is expected to return to a moderate recovery path in the first half of fiscal 2012 as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and as reconstruction-related demand after the earthquake gradually strengthens. According to the Bank of Japan’s forecasts released in January 2012, the real GDP growth rate is projected to be 2.0 percent for fiscal 2012 and 1.6 percent for fiscal 2013. D. Overseas economies Since summer 2011, the European debt problem has been weighing on the global economy. Concerns over fiscal sustainability spread from countries like Greece to Italy and Spain, which are the third and fourth largest economies in terms of GDP, respectively, in the euro area. As a result, the European debt problem worsened. Yields on 10-year Italian government bonds at one time spiked to more than 7 percent. This led to intensified concerns over the financial health of European financial institutions holding large amounts of these bonds. These institutions, for their part, tightened their lending stance because of liquidity concerns, which in turn affected economic activity. Since the end of 2011, however, concerns over European financial institutions’ liquidity have been receding thanks to the implementation of 36-month longer-term refinancing operations with full allotment by the European Central Bank (ECB) and to the lowering of interest rates on the U.S. dollar funds-supplying operations decided on in coordinated action by the six major central banks, including the Bank of Japan. More recently, the second bailout package for Greece, totaling 130 billion euros, was approved by the European Union (EU) member states and the International Monetary Fund (IMF), allowing Greece to stave off a disorderly default. However, the situation still entails numerous uncertainties, and the fundamental issues underlying the European debt problem have not been resolved. Under these circumstances, overseas economies still have not emerged from the deceleration phase. Looking at the average growth rate of overseas economies weighted by the value of Japan’s exports, overseas economies grew quite rapidly at a rate of 6.8 percent on a year-on-year basis in 2010 during the recovery following the Lehman shock, and at a rate of 6.5 percent on an annualized quarter-on-quarter basis in the January-March quarter of 2011. However, growth declined to less than 4.0 percent in the July-September quarter of 2011 and recorded only 0.9 percent in the October-December quarter. Regarding European economies, since the second half of 2011, fiscal austerity measures and financial institutions’ tightening of their lending stance have dampened business and household sentiment. Economic activity in some European countries is increasingly sluggish because the countries have fallen into a vicious cycle, in which the deterioration in economic BIS central bankers’ speeches activity leads to a further worsening of the financial conditions of governments and financial institutions. There have been some signs of recovery recently, such as an improvement in economic sentiment in Germany. However, as the impact of fiscal austerity persists, some more time is needed before a positive cycle takes hold in European economies as a whole. In the United States, from summer to autumn 2011, economic sentiment deteriorated due to strains in global financial markets and fiscal problems. Reflecting the accommodative financial environment, stock prices recently reached their highest levels since the Lehman shock. Private consumption has also been firm due to an improvement in the employment situation. However, with pressure from household balance-sheet adjustments persisting, the recovery of the economy as a whole has generally been moderate. As for the outlook, the pace of recovery is likely to remain moderate because, in addition to these balance-sheet adjustments, fiscal problems will also likely persist. Meanwhile, the pace of growth in emerging and commodity-exporting economies has moderated somewhat mainly due to the slowdown in European economies. Nevertheless, these economies maintain relatively high growth overall spurred by robust domestic demand. The Chinese economy has been enjoying high growth, although – at a rate of 9.2 percent for 2011 – growth was slower than the previous year due to the slowdown in exports and real estate investment, among other things. Private-sector forecasts expect growth to decelerate further in 2012 to around 8.5 percent. Although growth may decelerate as China makes the transition to more stable growth, there remains considerable room for further expansion in domestic demand because of structural factors such as the rise in income levels and urbanization, so that China can be expected to continue to achieve relatively high growth. The pace of economic growth in the NIEs and the ASEAN countries slowed in the second half of 2011 due to the rise in inflation, the decline in exports to advanced countries, and the effects of the flooding in Thailand. As for the outlook, however, the reconstruction efforts from the flood damage as well as the accommodative financial environment are expected to underpin economic activity. Moreover, looking at emerging and commodity-exporting economies as a whole, inflation has been declining gradually and the accompanying recovery in real purchasing power is expected to underpin consumption. Hence, growth in emerging and commodity-exporting economies is likely to continue to spearhead global economic growth. E. Uncertainty surrounding the outlook As I mentioned earlier, the Bank’s main scenario is that Japan’s economy will return to a moderate recovery path in the first half of fiscal 2012. However, there is a considerable degree of uncertainty exerting downward pressure on the economy. Here, I would like to discuss three risks that will significantly affect economic activity: developments in the European debt situation; the possibility of a surge in crude oil prices resulting from heightened geopolitical risks involving Iran; and uncertainty over the supply and demand balance of electricity in the coming summer. The most serious risk concerns future developments in the European debt problem. The bailout package for Greece has somewhat eased the tension surrounding the problem, but this does not eliminate the possibility of another worsening of the situation in the future, which could in turn cause turmoil in global financial markets and a sharp drop in trade. Thus, it is necessary to keep in mind the so-called “tail risk” – that is, a risk which has a low probability but could have a large impact if it materializes. One of the fundamental causes of the European debt problem is that under the single currency system, growing disparities in fiscal conditions and competitiveness among the euro area member states cannot be corrected through the foreign exchange mechanism, resulting in the accumulation of current account imbalances. As a result of adopting the single currency system, Greece and other peripheral countries were able to borrow funds at interest rates below what their real economic strength warranted, leading to increased spending both in the private and the public sector. On the other hand, highly competitive core countries, such as Germany, BIS central bankers’ speeches expanded their exports to these peripheral countries, resulting in swelling current account deficits in these countries. Greece depended on overseas investors to purchase 70 percent of its government securities and was unable to rein in the increase in fiscal deficits after the Lehman shock. Against this background, overseas investors adopted a cautious investment stance, giving immediate rise to concerns over peripheral countries’ ability to raise funds. Although the second bailout package for Greece has recently been approved, it is unclear whether the country can succeed in implementing the fiscal austerity measures it promised the international community, given the domestic situation. At the same time, there has been some progress in the moves to strengthen fiscal discipline within the euro area, as evidenced by the fact that most of the EU member states have signed the new “fiscal compact.” Yet, it is still uncertain whether individual countries will be able to steadily correct the imbalances through fiscal reforms and increases in their competitiveness. Moreover, initiatives to address the crisis, such as the establishment of the European Stability Mechanism and the enhancement of other “firewalls” for containing market turmoil, are still in progress. Thus, uncertainty regarding the outlook has not been resolved. Moreover, there are heightened geopolitical risks relating to Iran. Crude oil prices have been rising recently, reflecting the situation in the Middle East. If the situation intensifies and crude oil prices surge, this could further decelerate the global economy and also exert downward pressure on Japan’s economy through a deterioration of the trade balance and corporate profits. A domestic risk concerns the uncertainty over the supply and demand balance of electricity in the coming summer of 2012. If operations at all nuclear power plants in Japan were to be suspended at that time, the supply capacity for electricity could fall short of the demand at summer peak times, which would have a negative impact on economic activity. There is a possibility that the increase in imports of crude oil and liquefied natural gas (LNG), amid relatively high crude oil prices, will exert downward pressure on Japan’s net exports. Attention should also be paid to the possible effects of a rise in electricity costs on corporate profits. For example, in addition to the regular adjustments in electricity charges reflecting fluctuations in fuel costs, a rise in electricity costs due to the increase in the weight of thermal power generation could be passed through to firms. II. Recent price developments Next, I will talk about price developments. International commodity prices began to rise from around spring 2009 mainly due to growth in emerging economies, but softened somewhat from summer 2011, reflecting the slowdown in the global economy. Most recently, however, commodity prices have begun to increase again against the backdrop of heightened geopolitical risk surrounding Iran. In this situation, the year-on-year rate of increase in the domestic corporate goods price index (CGPI) gradually decelerated for several months, but this trend came to a halt in February 2012 reflecting the recent rise in international commodity prices. Going forward, the CGPI is expected to move slightly upward. Next, turning to the consumer price index (CPI) for all items less fresh food, the year-on-year rate of decline slowed from around 2009 thanks to the improvement in the aggregate supply and demand balance, and since summer 2011 the year-on-year rate of change has been around 0 percent. It is expected to stay at this level for the time being. Thereafter, assuming that medium- to long-term inflation expectations remain stable, the rate of change is likely to gradually turn positive as the negative output gap narrows. In its forecast released in January 2012, the Bank projected the year-on-year rate of increase in the CPI (all items less fresh food) to be 0.1 percent for fiscal 2012 and 0.5 percent for fiscal 2013. BIS central bankers’ speeches III. Medium- to long-term challenges for Japan’s economy A. Background to the protracted decline in prices Let me talk about the background to the current deflationary situation in Japan. Japan’s economic growth rate has been on a long-term downward trend: the average annual rate declined from 4.4 percent in the 1980s to 1.5 percent in the 1990s, and then to 0.6 percent in the 2000s reflecting in part the impact of the Lehman shock. In this situation, consumer prices also continued to decline. Such price developments are attributable to a protracted negative output gap. Specifically, in addition to cyclical factors such as the decline in overseas demand, structural weakness in domestic demand brought about by demographic developments in Japan has resulted in a protracted shortage of demand relative to supply in the economy as a whole. Japan’s population is aging faster than that of any other of the advanced countries, and its working-age population (defined as those aged between 15 and 64) has begun to decrease. The pace of population decline is likely to accelerate in the future. The National Institute of Population and Social Security Research forecasts that Japan’s working-age population will decline to 44.18 million in 2060, which is roughly half of the peak of 87.27 million in 1995. B. Toward achieving sustainable growth For Japan’s economy to achieve sustainable growth despite the structural downward pressure I just mentioned, it is essential to increase the economy’s growth potential and raise growth expectations. To this end, it is necessary to (1) create new demand and boost the domestic labor force as much as possible even at a time when the working-age population is shrinking, and (2) raise productivity in industries with significant potential for job creation. On the first point, in order to create new demand and boost the labor force, it is necessary to not only tap potential consumer needs that arise as the population ages but also develop highly creative markets linked to social innovations in the areas of medicine, healthcare, and new energy sources. To capture growing global demand, particularly in emerging economies, it is important to both make efforts to increase exports and shift to business models that focus on local production for local consumption and the international division of labor and thereby increase revenues from overseas. However, a key point in this context is that if the shift to overseas production occurs gradually, this will allow domestic workers to transfer to other growing sectors of the economy, and therefore maintain employment levels in Japan; on the other hand, if the shift to overseas production takes place rapidly as a result of the appreciation of the yen or other factors, it will lead to a decline in domestic employment and thus be detrimental to the economy. Moreover, with the working-age population decreasing, in order to boost the labor force – which in turn can sustain the newly created domestic demand – it is important to increase labor market flexibility to allow workers to change industries more easily and to boost labor market participation of the elderly and of women who wish to work but are not currently working. The second requirement for increasing the growth potential of the economy, as mentioned earlier, is to improve productivity in industries with significant potential for job creation. Economic growth comes from increases in three factors: the number of workers, the number of hours worked, and labor productivity. Therefore, in order to strengthen Japan’s growth potential, labor productivity must be improved along with efforts to boost the labor force. During the two decades from 1990, the average annual rate of increase in labor productivity stagnated at around 1 percent. This is attributable to the shift of workers to service industries, where labor productivity growth is slow. According to a report by the Japan Productivity Center, while labor productivity in manufacturing industries grew at a relatively high average pace of 2.5 percent a year during the two decades, that in service industries – which have significant potential for job creation – grew by only around 1.0 percent a year. At the same time, Japan’s labor market structure changed, with the number of workers in manufacturing industries falling since the mid-1990s, while that in service industries has been rising, so that BIS central bankers’ speeches service industries now account for 30 percent of workers in all industries. In particular, along with the aging of the population, there has been a notable increase in demand for services for the elderly, such as in the areas of healthcare and nursing care. This trend is expected to continue. Therefore, the key to enhancing the growth potential of Japan’s economy lies in improving labor productivity in service industries by, for example, offering unique and highvalue-added services. This should be combined with efforts to increase employment by further tapping potential demand and improving labor productivity to create a virtuous cycle. Based on considerations such as these, the Japanese government has formulated a growth strategy and has actively been taking related measures. Recognizing the importance of strengthening Japan’s growth potential, the Bank introduced the fund-provisioning measure to support strengthening the foundations for economic growth in June 2010 and has since enhanced the measure. I will elaborate on this later when I explain the Bank’s conduct of monetary policy. Together with the strenuous efforts undertaken by firms, the support provided by the Bank from the financial side, including the provision of funds to areas with growth potential, can help us to overcome deflation. In order to achieve this, it is also necessary for the government to create the right environment. With this in mind, the Bank will continue exerting itself in its role together with firms, financial institutions, and the government. C. Efforts to ensure fiscal sustainability Alongside strengthening Japan’s growth potential, a key issue that needs to be addressed is ensuring the sustainability of the public finances. Japan’s government debt outstanding exceeds 200 percent of nominal GDP, which is the highest level among advanced economies. Nevertheless, yields on government bonds remain stable at low levels. This is often explained by the fact that Japan has a current account surplus and a large portion of government bonds are held by domestic investors. It should be noted, however, that, as the European debt crisis shows, once market participants start doubting the government’s determination to work toward fiscal sustainability, the situation could change in a nonlinear fashion. Given that social security spending will continue to exert upward pressure on fiscal expenditure, it is necessary to push ahead with structural reform of the public finances in terms of both expenditure and revenue while the public still has confidence in fiscal discipline. IV. Monetary policy A. The conduct of monetary policy I would now like to turn to the Bank’s conduct of monetary policy. The Bank recognizes that Japan’s economy is faced with the extremely important challenge of emerging from deflation and returning to a sustainable growth path with price stability. Based on this recognition, the Bank has been consistently making contributions as the central bank, using a three-pronged approach consisting of (1) pursuing powerful monetary easing under the comprehensive monetary easing policy, (2) ensuring stability in financial markets, and (3) providing support to strengthen the foundations for economic growth. 1. Pursuit of powerful monetary easing With a view to pursuing powerful monetary easing, the Bank decided to take the following three actions at the Monetary Policy Meeting held in February. a. Introduction of “the price stability goal in the medium to long term” First, the Bank has decided to introduce “the price stability goal in the medium to long term” as the inflation rate it judges to be consistent with price stability sustainable over the medium BIS central bankers’ speeches to long term. The previously released “understanding of medium- to long-term price stability” showed the range of inflation rates that each of the nine Policy Board members understood as price stability from a medium- to long-term viewpoint, while “the price stability goal in the medium to long term” represents a clear judgment by the Bank. Specifically, the Bank judges “the price stability goal in the medium to long term” to be within a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI and, more specifically, sets a goal of 1 percent for the time being. b. Clarification of the determination to pursue monetary easing through policy duration effects Second, the Bank has clarified its determination to pursue monetary easing through policy duration effects that are generated by “the price stability goal in the medium to long term” it introduced. Specifically, the Bank states that for the time being, it will aim to achieve the goal of 1 percent inflation in terms of the year-on-year rate of increase in the CPI through the pursuit of powerful monetary easing, conducting its virtually zero interest rate policy and implementing the Asset Purchase Program (hereafter the Program) mainly through the purchase of financial assets. The Bank will continue with this powerful easing until it judges the 1 percent goal to be in sight. Some might think that 1 percent inflation, which the Bank has set as the goal for the time being, is too low. In this regard, when formulating “the price stability goal in the medium to long term,” the Bank took three aspects into consideration: (1) the measurement bias in the CPI; (2) the need for a safety margin that acts as a buffer against the risk of a vicious cycle of deflation and stagnation; and (3) households’ and firms’ perception of price developments. Regarding the perception of price developments, it needs to be noted that even before the fall into deflation, inflation in Japan was consistently lower than in other major economies. Therefore, if the inflation rate the Bank aims to achieve were to diverge from this historical experience, this might in fact considerably increase uncertainty among households and firms. The Bank thus considers the current goal of 1 percent inflation to be appropriate. As a separate issue from developments in consumer prices, if a rise in asset prices creates a bubble, this could in turn substantially undermine stability in economic activity and prices in the long run. Therefore, the Bank has set the condition for the pursuit of powerful monetary easing that it identifies no significant risk to the sustainability of economic growth, such as from the accumulation of financial imbalances. c. Expansion of the Asset Purchase Program Third, the Bank has decided to purchase another 10 trillion yen worth of Japanese government bonds (JGBs) under the Program, increasing the total size of the Program from about 55 trillion yen to about 65 trillion yen. The Program was instituted in October 2010 to further enhance monetary easing by encouraging a decline in longer-term interest rates and various risk premiums in a situation where there was little room for a further decline in short-term interest rates. The Bank has established the Program on its balance sheet, through which it conducts the fixed-rate fundssupplying operation and the purchasing of various financial assets – namely, government securities, commercial paper (CP), corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). The aim of expanding the Program at this particular time, with uncertainty surrounding economic developments both at home and abroad continuing to be high, was to provide further support for recent positive developments from the financial side and to better ensure that the economy returns to a moderate recovery path. As a result of the increased JGB purchases under the Program, the Bank will be purchasing, together with regular purchases to meet a trend increase in banknote demand, a large amount of JGBs until the end of 2012 at the pace of 3.3 trillion yen per month, or about 40 trillion yen for the year. The purpose of BIS central bankers’ speeches this significant scale of JGB purchases is to achieve sustainable growth with price stability and, needless to say, not to finance government debt. 2. Measures to ensure financial market stability The Bank has also been doing its utmost to ensure financial market stability by making use of various funds-supplying operations. When strains in financial markets heighten as seen in the case of the Lehman shock and the worsening of the European debt problem, financial institutions’ funding conditions deteriorate, leading to a tightening of their lending attitudes. To prevent this from happening, immediately after the earthquake in March 2011 the Bank provided ample funds on an unprecedented scale, exceeding the amount provided immediately following the Lehman shock. Moreover, in response to the emergence of strains in U.S. dollar short-term funding markets, the Bank re-established U.S. dollar fundssupplying operations in May 2010. It lowered interest rates on the operations as part of coordinated measures among six major central banks at the end of November 2011, when the European debt problem worsened. At the same time, the central banks also agreed to establish bilateral liquidity swap arrangements enabling the provision of liquidity in any of their currencies in addition to the already available U.S. dollar. 3. Measures to support strengthening the foundations for economic growth As I briefly mentioned earlier, in June 2010 the Bank introduced the fund-provisioning measure to support strengthening the foundations for economic growth for the purpose of providing support, from the financial side, for the critical challenge of enhancing the growth potential of Japan’s economy. Through the measure, the Bank supplies funds at a low interest rate of 0.1 percent for, if rolled over, up to four years to private financial institutions in accordance with their efforts in terms of lending and investment to strengthen the foundations for economic growth. The Bank has provided 18 examples, including “environment and energy business,” “medical, nursing care, and other health-related business,” and “tourism business,” of areas for which financial institutions’ lending or investment would be funded by the measure. It should be noted that a large amount of funds has been invested in the area categorized as “others,” such as lending or investment to support local industries. The outstanding balance of loans disbursed by the Bank under the main rules for the measure has reached the initial ceiling of 3 trillion yen. Moreover, a wide range of financial institutions have been actively making a number of efforts targeting their specific customer base or the region they serve, such as establishing new dedicated funds that will support economic growth, so that the amount of financial institutions’ lending and investment greatly exceeds the amount of loans disbursed by the Bank. Therefore, it could be said that the measure has played its intended role as a catalyst in prompting financial institutions to develop their own initiatives to strengthen the foundations for economic growth. In June 2011, the Bank introduced a new lending arrangement of 500 billion yen for the measure, through which it extends loans to financial institutions for their equity investments and asset-based lending (ABL). The loans for ABL allow financial institutions to use their expertise to identify and lend to potential growth firms without conventional collateral or guarantees. The outstanding balance of loans disbursed by the Bank under this arrangement is 89.1 billion yen as of March 2012. Although this is not a particularly large amount, the new arrangement has been producing some positive effects in terms of providing support for financial institutions’ new initiatives. At the Monetary Policy Meeting held on March 12 and 13, 2012, the Bank decided to enhance the fund-provisioning measure to support strengthening the foundations for economic growth by introducing new lending arrangements and increasing the total amount of loans available through the measure from 3.5 trillion yen to 5.5 trillion yen. The decision was made with a view to underpinning efforts to strengthen the foundations for economic growth and encouraging a wider range of investments and loans that serve this purpose. Here are the specifics. First, the Bank decided to extend the deadline for applications for new BIS central bankers’ speeches loans by two years to March 31, 2014. Second, the Bank decided to introduce a new lending arrangement of 500 billion yen for small-lot investments and loans of 1 million yen or more but less than 10 million yen, in response to requests by relatively small financial institutions. Third, the Bank decided to increase the 3 trillion yen ceiling for the outstanding balance of loans under the main rules by 500 billion yen for the purpose of providing support to initiatives by financial institutions that started to participate in the measure at a later time. And fourth, the Bank decided to introduce a new lending arrangement of 1 trillion yen that will use its U.S. dollar reserves in order to support, through the provision of foreign currency liquidity, financial institutions’ own initiatives to help firms capture increasing global demand and thereby enhance their growth potential. The details of the arrangement will be examined at the next Monetary Policy Meeting, to be held in April 2012. B. The Bank’s measures following the Great East Japan Earthquake It has been about one year since the Great East Japan Earthquake, which hit Japan on March 11, 2011. I would like to take this opportunity to extend my sincere condolences to all those who have suffered from the disaster. Let me explain the Bank’s measures following the earthquake. Since immediately after the earthquake, the Bank has swiftly taken a range of measures, such as the provision of ample liquidity and the further enhancement of monetary easing, focusing on three major aspects: maintaining the functioning of financial and settlement systems, ensuring the stability of financial markets, and supporting the economy. On March 14, 2011, the first business day after the disaster, the Bank increased the amount of the Program, mainly of the purchases of risk assets, by about 5 trillion yen, and thereby prevented any deterioration in business sentiment from adversely affecting economic activity. In April, the Bank decided to introduce a funds-supplying operation that supplies financial institutions in disaster areas with longer-term funds in order to provide support to their initial response efforts to meet demand for funds for restoration and rebuilding. It also decided to broaden the range of eligible collateral for money market operations. So far, loans of about 500 billion yen of the total amount of 1 trillion yen for this fundssupplying operation have been disbursed. The reason that financial institutions in disaster areas have made relatively little use of loans under this operation is that their funding conditions have generally been favorable. Nevertheless, it can be said that the operation has been effective in that it has provided a safety net to help these institutions with their efforts to meet demand for funds for restoration and rebuilding. Given that full-fledged rebuilding efforts are now getting under way, and taking into account requests from financial institutions in disaster areas, the Bank decided to extend the deadline for new applications for loans by one year to April 30, 2013 at last week’s Monetary Policy Meeting on March 12 and 13, 2012. BIS central bankers’ speeches
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Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Akita, 10 May 2012.
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Sayuri Shirai: Recent global economic developments and monetary policy in Japan – strengthening Japan’s growth momentum through opportunities in emerging Asia Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Akita, 10 May 2012. * I. * * Introduction Good morning, everyone. My name is Sayuri Shirai, and I am a Policy Board member of the Bank of Japan. I am delighted to be speaking to you today, representing as you do the administrative, economic, and financial communities in Akita Prefecture. And as well, I feel deeply honored to be able to exchange views with you about performance and other issues related to Japanese and overseas economies, particularly with regard to the developments in this region. First, let me briefly outline the content of my presentation. I would like to begin by summarizing recent economic and price developments. These are described in great detail in the Bank’s Outlook for Economic Activity and Prices, which was published last month and which I will refer to as the Outlook Report. In this first part of my presentation, I also wish to discuss matters regarding Japan’s monetary policy and related developments. Following that, I aim to shed light on recent economic and financial developments in emerging economies, particularly in Asia – “emerging Asia.” This is because I believe that this region could provide Japanese firms with an opportunity to increase the demand for their products and services. At the same time, emerging Asia has the potential to revitalize the Japanese economy, if economic relations between Japan and this region could be enhanced – not only in terms of trade and tourism, but also through cross-border financial movements. II. Recent developments in economic activity, prices, and Japan’s monetary policy A. International financial markets and overseas economies As we are all aware, strains in global financial markets intensified last summer, mainly owing to concerns about the European debt problem. However, since then the strains have eased somewhat, thanks to the following factors: (1) large-scale longer-term refinancing operations (LTROs) with a maturity of 36 months conducted by the European Central Bank (ECB); (2) coordinated action undertaken by the six central banks, including the Bank of Japan, to lower the pricing on existing temporary U.S. dollar liquidity swap arrangements by 50 basis points; and (3) achievement of orderly public debt restructuring between the Greek government and private creditors – and the subsequent second-round financial assistance from the European Union (EU) and the International Monetary Fund (IMF). Under such improved circumstances, risk aversion among global investors has weakened compared with the second half of 2011, and positive market developments have been observed, including a pick-up in stock prices around the world. In the foreign exchange market, the yen has depreciated somewhat against both the U.S. dollar and the euro compared with around the end of 2011. Nonetheless, we should continue to monitor developments in international financial markets, including foreign exchange markets, since there still remains a high degree of uncertainty related to market conditions. With regard to overseas economies, the pace of growth began to slacken in spring 2011. In recent months, however, some positive developments have been observed. The U.S. BIS central bankers’ speeches economy continues to recover at a moderate pace. The sluggishness in the European economy remains strong mainly due to the effects of fiscal austerity measures. More recently, however, the economy generally stopped deteriorating further as financial markets have regained some stability. In the case of emerging and commodity-exporting economies, the relatively high growth has on the whole been maintained since domestic demand has been solid, and exports to advanced economies appear to have recovered. B. Developments in economic activity and prices in Japan: present conditions and outlook We all recall how the Great East Japan Earthquake undermined the Japanese economy and caused serious damage to supply chains in the manufacturing sector. With the restoration of supply chains, Japan’s economic activity picked up steadily, though that recovery lasted only until autumn 2011. From the second half of fiscal 2011, economic activity remained more or less flat mainly due to an adverse effect on exports and production of the slowdown in overseas economies and the appreciation of the yen. More recently, however, it has become increasingly evident that the economy is shifting toward a pick-up phase, although economic activity has remained more or less flat (Chart 1). As for the outlook, the Japanese economy is expected to return to a moderate recovery path in the first half of fiscal 2012. This is a likely scenario, since the pace of recovery in overseas economies should pick up – led largely by the emerging and commodity-exporting economies – and reconstruction-related domestic demand after the Great East Japan Earthquake should gradually strengthen. In fiscal 2013, the economy is expected to continue to grow at a pace above its potential, as overseas economies continue to achieve relatively high growth. However, the economic growth rate is expected to be somewhat lower than that in fiscal 2012 because the positive effects from reconstruction-related domestic demand are likely to gradually diminish (Chart 2). With regard to prices, developments in the consumer price index (CPI; for all items less fresh food) indicate that after reaching a historical trough of 2.4 percent in August 2009, the yearon-year rate of decline has continued to slow consistently since around the end of 2009. In recent months, that rate of change has been at around 0 percent. In terms of the outlook for prices, the rate of change will remain in positive territory and show a gradual increase as the aggregate supply and demand balance is expected to continue improving with the moderate recovery. International commodity prices are likely to follow a moderate rising trend owing to an expected increase in demand for food and energy in line with the growth in emerging economies. Assuming that medium- to long-term inflation expectations remain stable, the rate of change in the CPI is projected to gradually rise to a range of above 0.5 percent and less than 1 percent toward the second half of fiscal 2013. Thereafter, it will likely be not too long before the rate reaches the Bank’s “price stability goal in the medium to long term” of 1 percent for the time being, as specified in the Bank’s statement released in February (Chart 2). Comparing the current projection for real GDP growth rates with that in the January 2012 interim assessment, the rate of growth for fiscal 2012 is likely to be higher than initially assessed. This reflects an improvement in the financial markets driven by the reduced tail risk associated with the European sovereign debt crisis. Comparing the current CPI projection with that in the January 2012 interim assessment, the rates of change for fiscal 2012 and 2013 are also likely to be somewhat higher than originally assessed. This is partly because the upwardly revised economic projection is expected to improve the aggregate supply and demand balance. The correction of the sharp appreciation of the yen and a rise in crude oil prices also contributed to the upward revision in the CPI projection. BIS central bankers’ speeches C. Upside and downside risks The aforementioned outlook is the scenario the Bank considers to be the most likely – in other words, its baseline scenario. As described in detail in the Outlook Report, the following four major risks concerning the outlook for economic activity warrant attention: (1) uncertainty related to developments in overseas economies; (2) uncertainty with regard to reconstruction-related domestic demand; (3) uncertainty associated with firms’ and households’ medium- to long-term growth expectations; and (4) issues related to Japan’s fiscal sustainability. Among developments in overseas economies, various challenges remain in Europe. Though the tail risk of global financial market turmoil causing a significant global economic downturn has decreased, the fundamental cause of such a risk has not been resolved. There is a possibility that strains in global financial markets will once again intensify if concerns reemerge about implementing fiscal and structural reforms, especially in the peripheral European countries. If such strains reemerge, they are likely to act as a downside risk to the global economy – and thus to the Japanese economy. Moreover, given that there is a high degree of uncertainty surrounding the progress in households’ balance-sheet adjustments, the prospects for the U.S. economy also present some downside risk. It is possible that the pace of its economic recovery will remain more moderate than expected. Regarding risks associated with prices, there are mainly two types. The first risk concerns developments in firms’ and households’ medium- to long-term inflation expectations; the second risk relates to developments in import prices. With this second risk, there is a possibility that crude oil prices will surge mainly reflecting geopolitical risk. If that does occur, there will be a deterioration in Japan’s terms of trade, which will squeeze firms’ profits and reduce households’ purchasing power, ultimately having an adverse effect on the whole Japanese economy. D. Conduct of monetary policy The Bank is naturally concerned about the long-term prevalence of deflation in the Japanese economy. To help the economy overcome deflation, comprehensive monetary easing was introduced in 2010 by establishing the Asset Purchase Program. Subsequently, monetary easing has gradually been enhanced through expansion of the Program. On February 14 of this year, the Bank introduced “the price stability goal in the medium to long term,” which is defined as the inflation rate consistent with price stability sustainable over the medium to long term. The purpose of this action was to promote public understanding of the Bank’s determination to overcome deflation. It was decided that the goal would be “within a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI,” and the goal was set at 1 percent for the time being. Moreover, the Bank made it clear that it would continue pursuing powerful monetary easing – through its virtually zero interest rate policy and continued implementation of the Program – until it judged the 1 percent goal to be in sight, on condition that it identified no significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances. At the same time, the total size of the Program was raised by 10 trillion yen, from about 55 trillion yen to about 65 trillion yen (Chart 3). On April 27, the Bank decided to increase the total size of the Program further by about 5 trillion yen, from about 65 trillion yen to about 70 trillion yen with the following changes in its composition. First, the purchase of Japanese government bonds (JGBs) was increased by about 10 trillion yen. Second, the purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) were raised by about 200 billion yen and 10 billion yen, respectively. Third, the maximum outstanding amount of the Bank’s fixed-rate fundssupplying operation against pooled collateral with a six-month term was reduced by about 5 trillion yen, taking into account the recent episodes of undersubscription. And fourth, the remaining maturity of JGBs to be purchased under the Program was extended from “one to BIS central bankers’ speeches two years” to “one to three years.” The same treatment was applied to the remaining maturity of corporate bonds to be purchased under the Program. In addition, it was decided that the schedule for increasing the outstanding amount of the Program to about 65 trillion yen by around the end of 2012 would be maintained. It was further decided to increase the outstanding amount of the Program to about 70 trillion yen by around the end of June 2013. Now, given that the outlook for the performance of economic activity and prices has not been adjusted downward compared with the January 2012 interim assessment, some may argue that the timing of the Bank’s action at this time was questionable. On this point, I would like to stress that there remains a high degree of uncertainty surrounding the assessment, as already explained. The positive signs in economic and price developments that have emerged in recent months do not necessarily imply that the baseline scenario will be realized as projected. Even though the scenario may eventually materialize, it is still not certain how soon it may do so. Considering recent episodes, for example, there were some cases where the baseline scenario was not fulfilled, even though the economy appeared to be on the track of sustainable economic growth and prices also initially appeared to be rising steadily. Therefore, the Bank decided to seize this occasion and further enhance monetary easing to better ensure the return of the Japanese economy to sustainable growth with price stability. I believe this action also demonstrates the Bank’s determination to implement its monetary policy commitment, as explained earlier. In order to overcome deflation, however, it is important to stress the need to address Japan’s long-term structural challenge of declining trend growth rates amid rapid population aging. To meet this challenge and establish a new basis for economic growth, firms need to become more innovative and competitive in an effort to add value to their activities and explore new sources of demand both at home and abroad. The government also needs to support the business community by creating a more business-friendly environment. Financial institutions should make further efforts to strengthen the foundations for economic growth by giving financial support to innovative and viable firms and providing new types of financial and other services, which are increasingly being demanded. Meanwhile, the Bank’s accommodative monetary policy will certainly support such privatesector activities through a steady decline in the cost of raising capital. By promoting longerterm economic growth, the Bank has supported the business community indirectly: it introduced the fund-provisioning measure to support strengthening the foundations for economic growth (the Growth-Supporting Funding Facility) in 2010, and it has provided longer-term fixed-rate funds to financial institutions. This facility was expanded in March and April of this year (Chart 4). It should be emphasized that the goal of overcoming deflation will be achieved through such continuous, comprehensive efforts by firms, financial institutions, the government, and the Bank within their respective roles. III. Changing economic features of advanced and emerging economies As already mentioned, I believe that overcoming deflation in Japan requires policies and private-sector initiatives to promote economic growth in addition to the Bank’s accommodative monetary policy. In line with this view, I would like to explain the importance of emerging economies as a potential source for generating economic growth in the Japanese economy. A. Growing presence of emerging economies The Japanese economy has confronted a series of large-scale shocks in recent years. Among them, the global financial crisis of 2008–09 presented the greatest shock to both the global and Japanese economies, causing a rapid shrinking in production and trade around the world. In response, it was agreed at the G20 Summit that coordinated policy actions would be conducted to quickly stabilize financial markets and prevent the global recession BIS central bankers’ speeches from deepening further. Thus, central banks and governments collectively reacted to the crisis with liquidity injections into the financial sector, bailouts, and fiscal stimulus packages. Since these accommodative policies helped stimulate both domestic and overseas demand, the global economy succeeded in avoiding a deep recession like that of the Great Depression in the 1930s, and the average rate of global growth dropped by only 0.7 percent in 2009. What has become evident after the global financial crisis is that the overall economic performance of emerging economies has been better than that of advanced economies. Advanced economies were formerly viewed by emerging economies as role models. They were highly respected and deemed worthy of emulation, because advanced economies had already achieved a higher level of living standards and produced numerous firms with advanced skills, management styles, and knowledge. Their macroeconomic performance also used to be regarded as relatively stable, as exemplified by low, stable inflation and sound government fiscal positions. Advanced economies were also equipped with welldeveloped legal and judiciary systems and mature democratic societies. Most of these features are unchanged today, but there is a growing view among emerging economies that the path toward economic and social development need not be the one adopted by advanced economies: alternative approaches can be explored according to a particular country’s conditions and history. B. Features of emerging economies I would now like to highlight four features that have developed in emerging economies since the occurrence of the global financial crisis. B-1. Impressive growth-generating power The economic size of emerging economies is rapidly expanding. As a result, they are increasingly functioning as an engine of global growth. Based on IMF data, for example, the purchasing power parity (PPP)-adjusted share of global GDP of advanced economies dropped from a high level of 63 percent in 2000 to 51 percent in 2011. By contrast, that of emerging economies rose from 37 percent to 49 percent over the same period (Chart 5). China stands out among the emerging economies. It has exhibited an impressive performance, having doubled its share of the global GDP from 7 percent in 2000 to 14 percent in 2011. India follows China, with its global GDP share having jumped from 3.7 percent to 5.7 percent over the same period. Brazil ranks third in terms of economic size after China and India, but its global GDP share was unchanged at around 3 percent over that period. Thus, it can be stated that emerging Asia has made more impressive progress than emerging economies in other regions. The rapid growth of emerging economies implies that their growth-generating power is greater than that of advanced economies. This can be grasped by considering historical movements in real GDP growth rates. Here, the period of 2000–11 will be divided into two sub-periods – before and after the 2007 global financial crisis – namely, 2000–07 and 2007–11. It is evident that the difference in average growth rates between emerging and advanced economies increased from 3.9 percent in 2000–07 to 5.3 percent in 2008–11.1 It is true that the growth rate for emerging economies has declined during this period, but their average growth rate decreased only modestly – from 6.5 percent in 2000–07 to 5.6 percent in 2008–11. Among them, China’s growth rate declined only from 10.5 percent to 9.6 percent over that period, and it still exhibits one of the highest economic growth rates in the world. In the case of India, its rate showed an increase of 7.1 percent to 7.7 percent over this period. Like India’s, the growth rate of Brazil rose from 3.5 percent to 3.8 percent during this period. Overall, the growth performance in emerging economies, particularly those of Asia, is impressive. BIS central bankers’ speeches This growing gap is mainly attributable to the decline in the average growth rate of advanced economies. Their average rate of growth almost reached minus 4 percent in 2009; though their subsequent growth became positive, it has remained modest (Chart 6). In Japan, the average growth rate in the pre-crisis period reached 1.5 percent, but it dropped to minus 1 percent following the crisis. In particular, its economic activity plunged by 5.5 percent in 2009. Japan managed to achieve a 4.4 percent growth rate the following year, but the country then suffered further blows in 2011: the Great East Japan Earthquake and flooding in Thailand caused serious damage to supply chains in the manufacturing sector mainly through a sharp curtailment of production and exports. In the United States, the average growth rate dropped from 2.6 percent in the pre-crisis period to 0.2 percent following the crisis. The U.S. economy experienced its sharpest decline of 3.5 percent in 2009, though it has since displayed modest but positive growth. B-2. Favorable fiscal performance Emerging economies enjoy a relatively favorable fiscal position, and in sharp contrast to advanced economies they have continued to show an improvement in this regard. This may indicate not only that the likelihood of succumbing to a sovereign debt crisis in the near future has declined for emerging economies, but also that they have some room to adopt an accommodative fiscal policy in the downturn phase of the economic cycle. According to IMF data, the fiscal deficit as a share of GDP jumped from 1.5 percent in 2001 to 6.5 percent in 2011 among advanced economies; among emerging economies, however, this deficit was reduced from around 2.8 percent to under 2 percent over the same period (Chart 7). Similarly, the public debt-to-GDP ratio for advanced economies rose from 73 percent in 2000 to 104 percent in 2011, but emerging economies managed to reduce the size of this ratio from 49 percent to 36 percent over the same period (Chart 8). Above all, China’s fiscal position has remained relatively solid: its fiscal deficit-to-GDP ratio dropped from 3.3 percent in 2000 to 1.2 percent in 2011, and its public debt-to-GDP ratio rose from only 16 percent to 26 percent over the same period.2 Despite its prolonged fiscal deficit performance, India also managed to reduce its deficit ratio from 10 percent in 2000 to 8.7 percent in 2011; it decreased its public debt ratio from 72 percent to 68 percent over the same period.3 By contrast, Japan’s fiscal position deteriorated: its deficit ratio grew from around 7.5–8.0 percent in 2000 to 10 percent in 2011, and its public debt ratio increased from 140 percent to 230 percent over the same period. This debt figure is the largest among advanced economies. B-3. Rising capital inflows from the rest of the world From a consideration of cross-border capital flows, it is notable that private-sector capital flows to advanced countries in the EU have dropped, while those to emerging Asia and Latin America have grown (Chart 9). Private-sector capital inflows consist largely of foreign direct investment (FDI), portfolio investment, and such other forms as loans and deposits. Privatesector capital inflows to emerging economies are concentrated in portfolio investment, followed by FDI. In recent years, there has in addition been an increase in capital inflows in terms of other items. The National Audit Office of the People’s Republic of China reported that the country’s local government debt accounted for around 27 percent of GDP last year. Some observers believe that China’s actual public debt is greater than the officially reported figure and that the debt-to-GDP ratio should stand at around 55 percent. However, this ratio still remains well below that of advanced economies. As for other emerging economies, it has been reported that upgradings of Indonesia’s sovereign debt by some credit-rating firms to investment grade around the end of 2011 has attracted the attention of global investors, including pension and insurance funds. BIS central bankers’ speeches Asian emerging economies face a more rapid pace of capital inflows than emerging economies of other regions. From 2000 to 2011, the amount of capital inflows to emerging Asia showed an 8.8-fold expansion. This growth is greater than that for emerging Latin American economies, whose capital inflows showed only a 4.6-fold increase over the same period. As a result, capital inflows to emerging Asia as a share of total capital inflows to emerging economies rose impressively from 32 percent in 2000–02 to 48 percent in 2011. Latin America lost its leading position in terms of total capital inflows, with its share dropping from 37 percent to 29 percent over the same period. An increase in capital flows to emerging economies indicates that these economies are becoming important capital importers. This trend can be attributed to their continued high economic growth, as well as the presence of a large number of potential investment projects and high demand for credit, which reflects the development stage of their economies. This explanation is supported by the fact that returns on investments to emerging economies have been higher than those on investments to advanced economies (Chart 10). B-4. Gradually evolving external investment activities While it is true that emerging economies are major importers of private-sector capital inflows from around the world, one feature is becoming increasingly evident in emerging Asia: once figures on overseas investment by the monetary authorities and government are added to cross-border capital flow data, it is seen that these economies are also becoming important capital exporters. This suggests that the amount of capital outflows exceeds that of capital inflows in emerging Asia, thereby transforming it into a net capital exporter. In the past, advanced economies played the role of net capital exporters as a result of abundant capital and relatively limited domestic demand for credit. By the middle of the 2000s, however, this situation had changed, as some emerging economies shifted from being net capital importers to exporters. In particular, it is remarkable to note that China has become the largest net capital exporter in the world, followed by Japan and Germany. In other words, China – even though its per capita income is below 8,000 U.S. dollars and thus its income level is regarded as medium – exports more capital than Japan and Germany, whose per capita income of over 30,000 U.S. dollars marks their status as high-income nations. In addition, China is becoming a major financier of advanced economies, such as the United States. In Asia, many economies – including Hong Kong, Indonesia, Malaysia, Singapore, the Philippines, and Thailand – have, like China, also become net capital exporters. IV. Strengthening Japan’s growth momentum through growth opportunities in emerging Asia A. Deepened economic relations between Japan and emerging Asia I have pointed out that emerging Asia has many favorable features relative to advanced economies. I would now like to emphasize how Japan has already begun deepening its economic relations with these economies. Indeed, Japan’s trade value with emerging Asia exceeds that with the United States and Europe. Specifically, China has become Japan’s top trade partner. At the same time, Japan’s trade relations with the Association of Southeast Asian Nations (ASEAN) and South Korea have been rapidly developing. I would like to stress that emerging Asia is not only important to Japan as a trade partner, but also is becoming essential as a tourism partner. According to data released by the World Tourism Organization (UNWTO), Germany, the United States, and China are among the countries with a large overseas tourism expenditure. These days, Chinese tourists are commonly encountered in many places in Japan. There is no doubt that China is becoming one of the most important importers of Japan’s tourism services. BIS central bankers’ speeches In addition to trade and tourism, cross-border capital flows have quickly expanded between Japan and emerging Asia, especially in the form of FDI. Therefore, I would like to address now the possibility of making use of rising growth opportunities in emerging Asia by activating cross-border capital flows with a view to increasing trend growth rates and revitalizing the Japanese economy. This presentation will proceed with the issue of FDI, followed by portfolio investment and banking activities. B. Expanding FDI flows between Japan and emerging Asia With the growing number of middle- and high-income consumers, emerging economies have experienced an increase in domestic demand, and thus the markets for goods and services have expanded. Japanese firms have made efforts to provide such goods and services. They are able to meet such demand if they modify their production capacity to satisfy the specific needs and conditions that exist in various emerging economies by establishing locally based production, marketing, and sales networks. In this regard, Japan’s outward FDI has rapidly expanded over recent years. Data released by the United Nations Conference on Trade and Development (UNCTAD) indicate that Japan’s outward FDI grew by 105 percent year on year to 115.6 billion U.S. dollars in 2011.4 By region, FDI to emerging Asia grew by 63 percent year on year to 3 trillion yen in 2011 (Chart 11).5 In very recent years, Japan’s outward FDI to the ASEAN countries – especially to Thailand, Indonesia, and Vietnam – has exceeded that to China. Japan’s FDI to Thailand has been concentrated in the areas of electrical machinery, general machinery, and iron and nonferrous metals. After the severe flooding in Thailand at the end of last year damaged production facilities in a number of Japanese-operated industrial zones, Japanese firms have boosted FDI into Thailand to restore their production and export capacity. Japan’s FDI to Indonesia has been increasing in the transportation machinery sector thanks to Indonesia’s rapidly growing demand for automobiles. In the case of Vietnam, where labor costs are lower than in neighboring emerging economies, Japan’s FDI has undergone expansion in the electrical machinery sector. Regarding China, Japan’s FDI has traditionally centered on the manufacturing sector; however, recently it has grown in the wholesale and retail sectors, as well as the real estate sector, mainly in provincial cities in the process of urbanization. In India, Japan’s FDI has not undergone a rapid increase despite strong interest on the part of Japanese firms; this is because the slow administrative approval process for investment projects and a shortage of industrial sites are believed to act as obstacles. In addition to Japan’s outward FDI, it is equally important to examine its inward FDI with a view to making use of rising growth opportunities in emerging Asia. Inflows of FDI to Japan may provide the opportunity to promote innovation and thus revitalize the domestic economy. The level of Japan’s inward FDI from emerging Asia has been positive over the past five years, although the value declined moderately in 2011 compared to the previous year (Chart 12). Singapore, whose FDI is concentrated in the construction sector, is the largest supplier of FDI to Japan. In addition, FDI from South Korea has maintained positive growth rates since 2005. Investment from Hong Kong and China to Japan has also remained solid. A major Japanese electronics producer sold some of its electrical appliance operations to a Over half of this figure reflects large-scale M&A activity conducted by a major Japanese pharmaceutical firm. Therefore, outward FDI may not continue at this magnitude in the future. Some observers have pointed out that expansion of outward FDI promotes the hollowing-out of Japanese industry and reduction of employment opportunities in Japan. However, it is equally possible that outward FDI will lead to an increase in production and employment in Japan if establishing global-level production and sales networks increases demand for goods and services produced by Japanese firms. In addition, achieving a global-level division of labor and increased sophistication of domestic industry as a result of reorganizing firms may enhance the international competitiveness and revenue-generating power of those firms. BIS central bankers’ speeches large Chinese electronics firm this year. Last year, a Chinese computer manufacturer formed a personal computer joint venture with a Japanese computer-manufacturing firm. Such moves may reflect cross-border M&A activities in the face of tougher global competition and the need to promote corporate restructuring and reorganization. FDI inflows to Japan have also been witnessed in the area of medical and welfare services – where the potential demand is high due to the rapidly aging society – as well as in energy-saving and environment-friendly businesses. Nonetheless, the scale of Japan’s inward FDI remains roughly one-tenth of its outward FDI to emerging Asia. Since firms in emerging Asia are swiftly growing and becoming multinational, it is likely that the scale of inward FDI to Japan will expand. C. Gradually expanding portfolio investment between Japan and emerging Asia I would now like to examine recent trends in cross-border portfolio investment. At one time, the securities market in emerging Asia was underdeveloped, and the banking sector dominated the financial system. This situation has changed in recent years with the rapid growth of the securities market. Regarding bond markets, it used to be the case that Asian economies had difficulty in issuing domestic currency-denominated bonds internationally, because foreign investors did not want to bear exchange rate risks and thus preferred U.S. dollar-denominated assets. This prevented the market from developing. However, as their macroeconomic performance has stabilized and become more favorable, and their governments have begun to liberalize their financial markets, emerging economies have become increasingly capable of issuing bonds denominated in both foreign and domestic currencies. If East Asia, including Japan, collectively makes further progress in terms of improving each economy’s financial infrastructure – for example, in clearing and settlement institutions and securities depository institutions – as well as standardizing securities regulations, cross-border investment is likely to prosper. With regard to the stock market, the number of listed firms is rapidly increasing in emerging Asia. As a result, the number of initial public offering (IPO)-related listed firms currently accounts for over half of the world total. In addition, the share of stock market capitalization in East Asia and the Pacific region now accounts for over 30 percent of the world total. The development of securities markets in emerging Asia provides a revenue-enhancing opportunity for Japanese investors. But as well, Asia’s growing savings could be utilized on a global scale for a wide range of firms, including those of Japan. Given that investors in each economy generally have different investment patterns and risk attitudes, some Japanese firms may be able to make use of such funds in the process of exploring new business models and strategies. Over the past decade, securities markets have become increasingly synchronized at the international level. In general, securities markets among Japan, the United States, and Europe have shown a relatively high degree of synchronization. This is because cross-border investment has long been carried out through well-developed institutional investors and a large number of multinational firms. In addition, Japan has historically enjoyed a strong economic relationship with the United States. Therefore, the prices of Japanese stocks and bonds tend to be highly correlated with those of the United States and Europe (Chart 13).6 It is well known that Japan has been the world’s largest net external creditor, reflecting its considerable external assets. Generally, Japan’s portfolio investment is centered on medium- and long-term bonds (such as Treasury securities, agency bonds, and corporate bonds in the United States and bonds in Europe). Although some investment had been made in stocks in the United States and Europe, the global financial crisis has promoted a shift of Japanese investors’ preference from stocks to medium- and long-term bonds. Meanwhile, overseas securities investment in Japan is generally concentrated on medium- and long-term bonds and BIS central bankers’ speeches Though there remains a strong one-way influence from the United States to Japan and other Asian economies, there are growing signs that integration of securities markets is steadily taking place between Japan and emerging Asia. In particular, their stock markets have shown increasingly greater integration since the early 2000s. This may be associated with the establishment of region-wide production and trade networks in Asia. Japan has been exerting a strong influence on other Asian stock markets. In recent years, the influence of China on stock markets in this region has increased. And this is consistent with the growing importance of China in the post-crisis period.7 The greater synchronization in Asia suggests that stock markets are more prone to common shocks, rather than country-specific shocks, and therefore investors may benefit less from diversifying their portfolios across the Asian region. At the same time, however, greater cooperation in macroeconomic policies and financial infrastructure may contribute to stabilizing stock markets, and thus encourage their further development (Chart 14). There is also a high degree of synchronization in the bond markets of Japan, the United States, and Europe (Chart 15). However, it is likely that with further development of bond markets, financial integration will deepen in the Asian region in the near future (Chart 16). One contributing factor to an increase in capital inflows to bond markets in emerging Asia is interest rate differentials between emerging and advanced economies. Since interest rates are generally higher in the former than in the latter, global investors tend to engage in carry trade investment – investment in search of higher yields without hedging foreign exchange risk, which is thus highly speculative – in periods of high appetite for risk. Therefore, it should be noted that capital flows to emerging economies tend to become highly volatile, as do their bond prices. D. Increasing cross-border banking activities between Japan and emerging Asia Finally, I would like to consider cross-border banking activities. As mentioned earlier, the financial system in emerging Asia has traditionally been characterized as bank-dominant. In this region, foreign-owned financial institutions are prominent in the fields of long-term finance, such as project finance, and trade credit, some of whose services require sophisticated skills and experiences. With the worsening of the European sovereign debt problem, some financial institutions in Europe have begun to withdraw from those fields. In the case of Japan, overseas lending activities by Japanese-owned financial institutions began to decline sharply in the 1990s, mainly as a result of nonperforming-loan problems. In recent years, there has been a shift in this trend as these financial institutions have begun to actively extend credit overseas again (Chart 17). Lending activities to emerging Asia have undergone a particularly brisk expansion through both Japanese- and non-Japanese affiliated firms. While the presence of European banks has declined in this region, Japaneseowned financial institutions have been swiftly extending credit to such countries as China, Indonesia, South Korea, Malaysia, and Thailand, thereby mitigating the adverse impact of stocks. There was a short-lived but rapid increase in investment from overseas in Japanese short-term sovereign bonds from the autumn of 2011 to the beginning of 2012, when a worsening of the European sovereign debt problems aggravated strains in the global financial markets and increased demand for Japanese sovereign bonds as safe assets. For example, the Progress of Asian Economic Integration Annual Report 2012 compiled by the Boao Forum for Asia reports the correlation of stock market index returns between countries. From 2002 to 2006, Japan was positively correlated with all other Asian economies. After the global financial crisis, there has been a trend of increasing stock market synchronization in Asia. In particular, China has become increasingly important as its correlations with India, Japan, South Korea, Malaysia, the Philippines, and Singapore have grown. Some studies indicate that Singapore, India, and Japan have stronger impacts on Asian stock markets (for example, see Meric et al., “Co-Movements of and Linkages between Asian Stock Markets,” Business and Economics Research Journal, 2012). BIS central bankers’ speeches deleveraging by European banks. In an increasing number of cases, Japanese financial institutions act as leading banks in arranging syndicated loans and project finance. Most economies in emerging Asia still lack basic infrastructure, including systems of transportation, energy supply, information and communications, and water supply and sewerage. A deficiency of adequate long-term funds hinders infrastructure development in this region. This points to the large potential demand for such long-term credit. It is estimated that the scale of this credit demand will amount to 8 trillion U.S. dollars between 2010 and 2020, according to data from the Asian Development Bank (ADB). Public funds are insufficient to meet such credit demand, and this signifies the need for private-sector initiatives and funds in the form of long-term loans and bond finance. There are thus growing business opportunities for Japanese financial institutions. At the same time, it is important for Japanese financial institutions to make greater efforts to support entrepreneurial new businesses that endeavor to supply goods and services in areas of potentially high demand. Those areas include medical treatment and welfare, environment, and energy. Under these circumstances, financial institutions are expected to provide innovative, demand-responsive financial services. Such efforts are likely to bolster the competitive advantages of Japanese financial institutions, since the skills and experiences gained from such activities in Japan may lead to greater business opportunities in other Asian economies. It should be noted that some of these Asian economies are also expected to face growing aging populations in the near future. That brings me to the end of my presentation. Thank you very much indeed for your kind attention. BIS central bankers’ speeches Chart 1 Recent Developments in Japan’s Economy (2) Value of Public Works Contracted (1) Real Exports s.a., tril. yen s.a., CY 2005 = 100 CY 07 CY 07 (3) Private Consumption (4) Industrial Production s.a., CY 2005 = 100 s.a., CY 2005 = 100 Synthetic consumption index (real) Projection CY 07 CY 07 Sources: Cabinet Office; Ministry of Economy, Trade and Industry; East Japan Construction Survey; Bank of Japan. BIS central bankers’ speeches Chart 2 The Bank of Japan’s Economic and Price Forecasts (1) Real GDP y/y % chg. Foreca sts ma de in Apr. Foreca sts ma de in Ja n. 2.3 2.0 1.7 1.6 -0.2 -1 -0.4 -2 -3 -4 FY 02 (2) CPI (all items less fresh food) y/y % chg. 1.5 Forecasts made in Apr. 2012 Forecasts made in Jan. 2012 1.0 0.7 0.5 0.3 0.5 0.1 0.0 0.0 -0.1 The highest figure of all the Policy Board members’ forecasts -0.5 The highest figure of the majority of the Policy Board members’ forecasts -1.0 The median of the Policy Board members’ forecasts The lowest figure of the majority of the Policy Board members’ forecasts -1.5 The lowest figure of all the Policy Board members’ forecasts -2.0 FY 02 Note: The figures for real GDP for fiscal 2011, 2012, 2013, and the CPI (all items less fresh food) for fiscal 2012 and 2013 are the Policy Board members’ estimates. Source: Bank of Japan, “Outlook for Economic Activity and Prices.” BIS central bankers’ speeches Chart 3 The Bank of Japan’s Conduct of Monetary Policy 1. Introduction of “the Price Stability Goal in the Medium to Long Term” The inflation rate consistent with price stability sustainable in the medium to long term. A positive range of 2 percent or lower in terms of the year-on-year rate of change in the consumer price index (CPI). A goal of 1 percent is set for the time being. 2. Clarification of the Bank’s Determination to Pursue Monetary Easing Aiming at achieving the goal of 1 percent in terms of the year-on-year rate of increase in the CPI. Pursuing powerful monetary easing by conducting the Bank’s virtually zero interest rate policy and by implementing the Asset Purchase Program mainly through the purchase of financial assets until the Bank judges that the 1 percent goal is in sight. On condition that the Bank identifies no significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances. 3. Increase in the Asset Purchase Program About 55 trillion yen → about 65 trillion yen (Feb. 2012)→ about 70 trillion yen (April 2012) In addition to purchases under the Program, the Bank regularly purchases Japanese government bonds at the pace of 21.6 trillion yen per year. Chart 4 Enhancement of Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth The Bank decided to substantially enhance the fund-provisioning measure to support strengthening the foundations for economic growth both in terms of the yen and a foreign currency. Provision of funds to financial institutions, equivalent to the actual amount of lending and investment carried out with a view to strengthening the foundations for economic growth, over a long term (maximum duration of four years) and at a low rate (currently 0.1 percent) 1. Main Rules 3.0 trillion yen⇒ 3.5 trillion yen (eligible investments and loans: 10 million yen or more) 2. Special Rules for Small-Lot Investments and Loans 0.5 trillion yen newly added (eligible investments and loans: 1 million yen or more but less than 10 million yen) 3. Special Rules for a New U.S. Dollar Lending Arrangement (April 2012) 1.0 trillion yen (12 billion U.S. dollars) newly added (eligible investments and loans: denominated in foreign currencies) With special rules for asset-based lending (ABL) (eligible investments and loans: equity investments and ABL), the total amount is 5.5 trillion yen. The deadline for applications for new loans is March 2014. BIS central bankers’ speeches Chart 5 Share of Global GDP % Advanced economies Emerging economies CY 00 Source: IMF, “World Economic Outlook.” Chart 6 GDP Growth Rates y/y chg., % -2 Advanced economies -4 Emerging economies -6 CY 00 Source: IMF, “World Economic Outlook.” BIS central bankers’ speeches Chart 7 Fiscal Balance % of nominal GDP -2 -4 -6 Advanced economies Emerging economies -8 -10 CY 00 Source: IMF, “World Economic Outlook.” Chart 8 Government Debt % of nominal GDP Advanced economies CY 00 Emerging economies Source: IMF, “World Economic Outlook.” BIS central bankers’ speeches Chart 9 Net Financial Flows of Emerging Economies tril. U.S. dollars 1.6 Others Projection (IMF) 1.4 Central and Eastern Europe 1.2 Latin America and the Caribbean Developing Asia 1.0 0.8 0.6 0.4 0.2 0.0 CY Source: IMF, “World Economic Outlook.” BIS central bankers’ speeches Chart 10 Rates of Return (1) Advanced Economies and Emerging Economies ％ Emerging economies Advanced economies CY 02 (2) Major Economies ％ China United States Euro area CY 02 Note: Rate of return = financial outflows/external liabilities Source: IMF, “International Financial Statistics.” BIS central bankers’ speeches Chart 11 Japan’s Direct Investment Abroad tril. yen Others Europe Central and South America North America Asia and Pacific Total CY Source: Ministry of Finance, “Balance of Payments.” Chart 12 Direct Investment in Japan tril. yen 3.0 Others 2.5 Europe Central and South America 2.0 North America Asia and Pacific 1.5 Total 1.0 0.5 0.0 -0.5 -1.0 -1.5 CY Source: Ministry of Finance, “Balance of Payments.” BIS central bankers’ speeches Chart 13 Stock Prices Jan. 2011 = 100 Nikkei 225 Stock Average Dow Jones Industrial Average Dow Jones EURO STOXX Jan. Feb. Mar. Apr. May. Jun. Jul. Aug. Sep. Oct. Nov. Dec. Jan. Feb. Mar. Apr. May. Source: Bloomberg. BIS central bankers’ speeches Chart 14 Stock Exchange Listings and Market Capitalization (1) Number of Companies Listed number of listings, thous. 3.0 2.5 2.0 Shanghai Stock Exchange 1.5 Tokyo Stock Exchange 1.0 0.5 0.0 CY 00 (2) Market Capitalization 5.0 4.5 tril. U.S. dollars Shanghai Stock Exchange Tokyo Stock Exchange 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 CY 00 Note: The data are as of the year-end. Source: World Federation of Exchanges. BIS central bankers’ speeches Chart 15 Long-Term Interest Rates ％ United States Germany Japan Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Source: Bloomberg. Chart 16 Outstanding Amount of Local Currency Bonds in Asia tril. U.S. dollars Corporate bonds Government bonds CY Note: The data are as of the year-end. Source: Asian Development Bank. BIS central bankers’ speeches Chart 17 Overseas Loans of the Major Japanese Banks tril. yen Others North America Asia Mar. Sep. Mar. Sep. Notes: 1. Figures are the sum of the three major financial groups (non-consolidated basis). 2. The data are as of the month-end. Sources: Published accounts of each group. BIS central bankers’ speeches
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Opening remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2012 BOJ-IMES Conference, hosted by the Institute for Monetary and Economic Studies, at the Bank of Japan, Tokyo, 30 May 2012.
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Masaaki Shirakawa: Demographic changes and macroeconomic performance – Japanese experiences Opening remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 2012 BOJ-IMES Conference, hosted by the Institute for Monetary and Economic Studies, at the Bank of Japan, Tokyo, 30 May 2012. * I. * * Introduction Good morning. I am very pleased to have a lot of participants from central banks, international organizations, and academia in this year’s annual BOJ-IMES Conference. On behalf of my colleagues at the Bank of Japan, I am privileged to welcome you all here in Tokyo. The theme of this year’s conference is “demographic changes and macroeconomic performance.” On the theme, I am sure that Japan is the most notable case that provides a basis for discussion. Japan’s population and the working-age population – that is, the population aged between 15 and 64 years – came to decline after their peak-years in 2007 and in 1995 respectively. The share of the population aged 65 years or older rose rapidly to 23% in 2010 from 12% in 1990 (Chart 1). In the meantime, Japan’s economic growth gradually slowed during the past two decades mainly for two reasons. In the former half of the period, the Japanese economy was hobbled by the crippling effect of the burst of the bubble. In the latter half, the rapid population aging hampered the Japanese economy through a variety of channels. In an attempt to illustrate that, I frequently rely on the cross-country comparison of growth rates including Japan. Among G-7 countries, the Japanese GDP growth rate per working-age population – an indicator least affected by demographic changes in the short run – was the highest. By contrast, the Japanese per capita GDP growth rate was almost the same as the average, and the Japanese GDP growth rate, which is subject to the decreases in the total population, was below average (Chart 2). Neoclassical growth theories normally do not distinguish the overall population from the working-age population due to analytical simplicity. However, without taking into account the distinction between the two variables explicitly, the very challenges that Japan is currently faced with will be outside the scope of analysis. In the macroeconomic policy discussions in other economies, Japan’s experiences are frequently cited, and a lot of lessons are drawn over the past decade. However, a general conclusion obtained in such policy discussions without considering the differences in the demographic factors between Japan and other economies could sometimes be misleading. Various challenges posed by demographic changes have been and will be among the paramount issues lying ahead for a broad group of countries including Japan. For example, growth rate of the Chinese working-age population has slowed since the late 1980s, and is projected to turn negative by 2020 (Chart 3). Other Asian economies will also find themselves in the midst of population aging in due course. It is a must-face reality which is just yet-to-come. Looking at Europe, in the Euro-area peripheral countries, immigration contributed to the expansion of the populations until 2007. Conversely, after the global financial crisis, the immigration momentum was lost and some countries in the region are now faced with even some emigration while suffering from lower economic growth owing to the lower population growth or even because of the declining population. Rather than trying to cover all of the relevant topics under the theme of demographic changes and macroeconomic performance in my remark, I focus on Japan’s experience of population aging that, I hope, will help ensuing discussions in this conference, because BIS central bankers’ speeches Japan can be addressed an “advanced country” in a sense that it has been faced with various challenges that stem from population aging ahead of other countries. I begin by explaining demographic changes in Japan briefly, and then move on to identifying the issues related with macroeconomic performance. Finally, I will touch on the policy implications of demographic changes. II. Demographic Changes in Japan I begin by pointing out four relevant facts in order to consider the linkage between Japanese demographic changes and macroeconomic performance. First, in former times, the Japanese population growth rate was high, and the Japanese working-age population was remarkably large. Today, this may sound way beyond our imagination. However, in the aftermath of World War II, overpopulation was considered a challenge to cope with. For example, Japanese emigration to Brazil by sea was restarted in 1952 and continued until 1973. It is usually understood that Japan’s period of high-growth began in the mid-1950s and ended in the early 1970s. The expansion of the working-age population, in tandem with the free trade regime, provided strong grounds for rapid growth. A comparison of the Japanese population by age group between the beginning and the end of the high-growth era clearly points to a rapid increase in the Japanese working-age population taking place during the period as confirmed by Chart 4 showing a blip moving upward in the population pyramid. For your reference, the average growth rate of the total population and the growth rate of the working-age population from 1955 to 1975 were 1.3 percent and 1.9 percent, respectively. A quick cross-country comparison can confirm that Japan’s population and the growth rate of the working-age population in those days were relatively high, or sometimes even the highest, among the advanced countries. Second, the rapid pace of decrease in the growth rate of the Japanese population and that of the working-age population were globally unprecedented. The trend of a population depends crucially on the birth rate and the death rate (Chart 5). The Japanese total fertility rate declined substantially after the 1950s, and reached 1.39 in 2010, a lower level compared to that in other advanced countries. The Japanese death rate also declined substantially after World War II and reached 6.0 (per thousand persons) in 1979. Then it increased gradually and reached 9.5 in 2010. Third, interestingly, the recurrent declines in the total fertility rate have long been regarded as a one-off aberration for each point in time. Such mis-recognition led to the recurrent overestimation in the official projection of the fertility rate every five years, which has been used in the actuarial valuations for the Japanese public pension system, since the year 1976 (Chart 6). In the official projections, the long-run fertility rate have even been assumed to rise to two in due course until 1992 when the projection was revised downward well below two for the first time. Fourth, in addition to the delay in recognition of the ongoing demographic changes, comprehension of the far-reaching implications of the changes was even more delayed. Consequently, it took further time for Japanese people to take the measures to respond to the expected demographic changes. Incidentally, if you look back at 1992, the White Paper on the National Life Style published by the government that year was titled, “The Advent of Society with Low Birth Rates: Its Effect and Response.” With hindsight, Japan around that time was painfully looking for ways to recover in the aftermath of the bubble economy. At that stage, I recall that most Japanese people along with economists did not grasp the gravity of population aging coupled with a low birth rate for Japan’s economy as properly as we later came to realize. In that regard, for example, a database on Japanese news paper articles indicates that articles on population aging or a low birth rate started increasing in the 1990s. However, it was only until in the middle of the 2000s, articles on population aging or a low birth rate outnumbered those on asset price bubbles or non-performing loans (Chart 7). Up until around that time, the working-age population had declined for about ten years. BIS central bankers’ speeches III. Effects of Demographic Change on Japanese Economy In the light of Japan’s experience, I will elaborate on three aspects, first, the economic growth rate, second, inflation and, third, the current account balance, of the impact of demographic changes from the viewpoint of macroeconomic performance. Economic growth rate At the outset, I pick up the most paramount consequence of demographic changes for the Japanese economy, among others, that is, the economic growth rate. The economic growth model supposes that everyone works at a given intensity. With a labor-augmenting technological change, in the long run steady state, per capita variables grow at the rate of technological change, and aggregate variables grow at the rate equal to the sum of population growth and technological change. In aging economies, including Japan, where the working-age population has started decreasing, the labor force also declines, given the participation rate being held constant. Because the scarce labor force imposes a natural constraint on labor supply, the marginal product of capital declines accordingly. As a result, macroeconomic growth would be impeded. With this idea in mind, the Japanese economic data in the past decade indicates that the workforce declined by 0.3 percent point, labor productivity increased by 0.8 percent point, and they add up to real GDP growth rate increase by 0.6 percent1 (Chart 8). Having said that, while such an analysis would provide a useful first-order approximation to consider the effects of population aging and the declining population, for the sake of policy consideration, we need slightly more realistic approaches that incorporate other factors. The first factor is the possibility that labor participation may adjust to the demographic changes in the long run. For example, the labor participation rate of Japanese females was notably lower than that in other advanced countries. In particular, Japanese females in their 30s participate in the labor market noticeably less, which was creating a stark M-shaped curve in the participation ratio over ages in the past and in the present as well. However, the gap between Japan and other advanced countries in the depth of a dip on the M-shape is dissipating in recent years (Chart 9). The second effect comes from the gap between the per capita growth rate and the growth rate per working-age population. The economic growth model by Solow supposes that a nation’s population coincides with that nation’s labor force. In practice, as population aging advances, the gap between the population and the labor force grows larger. In the process of an increase in the share of the old non-working population, the per capita growth rate would be lower than the growth rate per working-age population. The growth rate per working-age population is important from a viewpoint of the supply capacity; however, the growth rate per capita is a more important indicator when we think about the income level of an average consumer who supports aggregate demand for goods and services in the macroeconomy. Even if the growth rate per working-age population is high, as long as the per capita growth rate is decreasing, downward pressure to demand could impede macroeconomic growth. Third, we may need to consider the so-called “spending wave” hypothesis (Chart 10). For one reason, the Japanese asset price bubble was caused by Japanese baby boomers who experienced their peak spending years, particularly, for mortgages. During the bubble period, they indeed actively purchased their homes. Likewise, demographic changes, among other factors, were highly responsible for the decrease in domestic car sales after the late 1990s. On the other hand, the progress in population aging means that the elderly increase demand for services, such as medical and nursing care. Currently, the population aged 60 years or older accounts for around 40% of Japanese consumption. Their shares in the Japanese The contributions do not add up to the total GDP growth rate (0.6 percent) because of the rounding errors. BIS central bankers’ speeches consumption are projected to increase further. If Japanese firms change their products in responding to such increase in the potential demand, their efforts should slow the reductions in the potential growth rate. The fourth factor arising from demographic changes could come into play through fiscal balance (Chart 11). Rapid population aging is the dominant factor in increasing a fiscal deficit. Obviously, the continued population aging increase a fiscal deficit through the decrease in the growth rate of tax revenues reflecting the decrease in the economic growth rate and through the increase in the social security related expenditure, such as medical services, nursing services and public pension. If the uncertainty regarding the future fiscal balance increased, that could restrain the consumption by working-age generations. Demographic changes also affect fiscal balance through a political process. Population aging will necessarily mean the aging of voters. If the elderly have a higher voting percentage compared with the young, and if the elderly have a stronger preference for sustaining the current social security system, then a fiscal deficit tends to increase reflecting the elderly’s preference. Fifth, demographic changes may affect the portfolio selection of households (Chart 12). Especially, we need to examine the effects of an increase in the number of elderly people on the selection of households’ financial assets, from a viewpoint of who and how to supply risk money, which is an indispensible engine for economic growth. However, the determinants of households’ financial asset portfolio include not only age, but also labor income. Moreover, households choose their asset portfolio while making decisions on their housing purchases simultaneously. We do not have empirical studies based on Japanese micro-data enough to answer the following questions, such as, all else being equal, whether the elderly prefer stocks or whether they tend to sell their stocks and buy into the bond market for safer assets.2 Looking ahead, further studies on that area are much awaited. So far, my analyses focus on the effects of demographic changes on macroeconomic performance of the Japanese economy as a whole. In practice, demographic changes, such as population aging or a low birth rate, advance unevenly across regions. For example, the population growth rate, the working-age population and the share of the population aged 65 years or older vary substantially from region to region (Chart 13). Behind the dispersion in prefectural growth rates, regional fiscal balances and the strategies of financial institutions lie uneven developments in demographic changes across prefectures. Rate of price increase Next, I elaborate on the linkage between demographic changes and deflation from a viewpoint of macroeconomic performance. Seemingly, there would be no linkage between demography and deflation. But it may not be the case. A cross-country comparison among advanced economies reveals intriguing evidence: Over the decade of the 2000s, the population growth rate and inflation correlate positively across 24 advanced economies (Chart 14).3 That finding shows a sharp contrast with the recently waning correlation between money growth and inflation (Chart 15).4 How could we square those facts with each other? To some extent, the correlation between population growth and inflation could in part be explained by the co-movement caused by business cycles. In some advanced economies in Europe and North America, it could be the case that the fluctuations in economic activity would vary the size of an output gap, creating pressure up or down on inflation while See Fujiki, Hirakata and Shioji [2012]. Another cross-country inspection based on a broader sample, including developing countries, does not detect positive correlation between inflation and population growth in the 2000s and in earlier periods likewise. See Kimura, Shimatani, Sakura, and Nishida [2010]. BIS central bankers’ speeches attracting or discouraging immigration that amplifies variations in population. That hypothesis, however, appears to be impertinent in some countries including Japan where the impact of immigration on the total population is extremely small and thus can be disregarded. On that ground, business cycle fluctuations have had a minimal impact on demographic changes. A closer look at the case of Japan confirms the increasingly positive correlation between inflation and population growth since the 1990s (Chart 16). That would reflect the momentum towards real income creation being undermined by population aging. As I have discussed, repercussions of the bubble-burst, the rapid aging and stagnation of productivity have been underway in Japan. Against the backdrop, the real per capita GDP growth rate has remarkably declined from somewhere around four percent back in the 1980s to almost one percent these days (Chart 17). With the yet-to-accelerate population aging well envisaged for the foreseeable future, the decline in the real GDP growth rate could undermine the medium- to long-term expectations for potential growth, giving rise to a lower permanent income of households. The decrease in potential growth, which effectively means a stagnant supply capacity, gives rise to a lower permanent income. On the flip side, the corresponding contraction in aggregate supply would offset such decline in aggregate demand. Simultaneous changes in aggregate demand and aggregate supply keep the price level unchanged. I reemphasize the fact, however, that the public had long remained by and large unaware of the dangers created by demographic changes but, over time, the awareness has slowly been phased in. Along with such gradually phased-in public awareness, yet-to-materialize declines in GDP growth have also been factored in, precipitating today’s decrease in aggregate demand and all the forward-looking responses have come into play behind Japan’s deflation.5 In the meantime, the real per capita GDP growth rate in most of American and European advanced economies has declined to Japan’s neighborhood range (Chart 17). Looking ahead, aging and the declining working-age population are expected to continue in those American and European countries. I cannot entirely rule out the looming menace that may unveil itself into downward pressure on inflation rates if such demographic changes are to undermine the momentum toward income creation in the economy. Current account The final issue that I am taking up from a viewpoint of macroeconomic performance and the demographic changes is the current account. Some argue that, as signaled by the swing to a deficit of the Japanese trade balance in fiscal year 2011, the current account balance will also turn into deficit over time (Chart 18). I disagree with such views. The swing to a deficit in the trade balance reflected the declines in exports and increases in imports, both of which are driven by temporary factors: Exports subsided resulting from the disruption to the supply chains due to the Great East Japan Earthquake. The sharp increase in imports of liquefied natural gas and other fossil fuels was needed to meet the increased demand from thermal power plants, which substituted nuclear power lost by the accident. In general, the current account broadly reflects the savings-investment balance of the economy. On one hand, as for savings, a higher elderly population share in the economy would reduce the aggregate savings rate as a life-cycle model indicates. On the other hand, population aging affects investment at least through two channels. First, if a decrease in the labor force substitutes for capital, domestic investment could increase. Second, a decrease in domestic demand due to the declining population reduces domestic investment. If population aging shifts consumption towards the service industry where firms find it hard to See Katagiri [2012] for a mechanism that a series of unexpected revisions in the forecasts for the Japanese population could lead to protracted deflation. BIS central bankers’ speeches substitute labor for capital, the second effect will dominate the first effect. Anyway, the Japanese income balance recorded 12.4 trillion yen, or 2.5 percent of nominal GDP on average from the year 2002 to year 2011, which reflects the net international investment position of 253 trillion yen as of the end of 2011, or more than 50% of nominal GDP. Those figures suggest that the Japanese current account surplus will continue for the time being. IV. Can Japan Respond to Demographic Changes? Demographic changes have affected the Japanese economy slowly but steadily and profoundly. Downward pressure on the Japanese economic growth rate resulting from various channels reflecting the continuing population aging will persist in the foreseeable future. With the pressure underway, should we live with the dwindling economy and quietly accept it as the fate that we cannot escape? My answer is definitely no. The effects of population aging on an economy can vary, depending on the flexibility of that nation’s economy and society. The current difficulties come not from the continued population aging itself, but from the delayed response to it. On that ground, I emphasize that, if society correctly recognizes the challenges coming from demographic changes, and if society judges that changes in the systems are needed, we should find remedies in our hands. I offer a couple of options for possible changes if Japanese people are determined to take action. The first option is to make various efforts to increase the labor force. Setting aside the issues that go beyond the mandate of a central bank governor, for example, whether to accept more foreign workers, we can increase the labor force by raising the birth rate and/or the labor participation rate. Interestingly, labor participation of female workers and the birth rate have a positive relationship, according to a cross-country data analysis. Among 47 Japanese prefectures, labor participation of females aged from 30 to 44 and the birth rate have a positive relationship (Chart 19). Recently, labor participation of Japanese female and elderly workers increased steadily. Efforts to increase the labor force have already started and some progress has been made (Chart 20). The second option is to adjust the supply-side structure with the ongoing changes in line with the demand pattern. Typical examples on the domestic front include the response to the potential demand from the elderly, such as medical and nursing services (Chart 21). In the last decade, the population of aged 65 or over increased 33 percent in Japan and 16 percent in the U.S. During the same period, spending on medical and nursing services increased 11 percent in Japan and 74 percent in the U.S. Those figures suggest the large potential demand not only in the market of medical and nursing services but also in medical equipment and other related investments in Japan. Third, businesses should respond to the growing demand overseas by making the most of the momentum towards globalization. If the Japanese economy is a “closed economy,” Japan will not be able to avoid all the repercussions of the decreasing population. However, Japanese businesses can grow by meeting the demand overseas, especially in economies with higher population growth or in fast-growing emerging economies. One option to meet the foreign demand is exports, while other options may include, for example, bolstering foreign direct investment by Japanese businesses in pursuit of higher profitability which would result in a surplus in the income balance. The real GDP increased by 0.6 percent annually on average in the 2000s while, the real GNI excluding the terms of trade gains/losses, an indicator comparable to the real GDP, grew more rapidly by 0.7 percent (Chart 22). Of related matters, the ratio of Japanese foreign direct investment is notably lower than that in other advanced countries. Room for increasing the ratio would be substantial (Chart 23). Increases in the income balance surplus may require a renewed focus on GNI, which summarizes the income earned by Japanese people. Finally, businesses can better reallocate their capital in line with the aforementioned three options to raise productivity. I have already referred to the growth rate of Japanese labor productivity, and now I point out that the level of labor productivity is lower than that in other advanced BIS central bankers’ speeches countries (Chart 24). Put differently, per capita income could increase substantially if businesses reallocate their capital to be better aligned with the efficient allocations. V. Concluding Remarks I have explained how demographic changes affect the Japanese economy through various channels. In retrospect, up until the global credit bubble-burst, both academics and policy makers did not fully appreciate the significance of a bubble-burst. The Japanese experience of a bubble-burst tended to be underestimated as an idiosyncratic episode. Likewise, bystanders’ apprehension about the ongoing demographic changes in Japan may, I fear, be falling short of the mark. My sense is that full apprehension of the consequences of rapid population aging, coupled with the low birth rate, is yet to be seen in light of the importance of the issue. Economics has dealt with the issue of population, not to mention a few examples such as, Petty’s Political Arithmetic or Malthus’s An Essay on the Principle of Population. For the sake of economic policy formulation, basic research on demographic changes and their policy implications is indispensable. I hope that this conference would help contribute to the accumulation of such research. Thank you. References Fujiki, Hiroshi, Naohisa Hirakata and Etsuro Shioji, “Aging and Household Stockholdings: Evidence from Japanese Household Survey Data,” paper presented in this conference. Katagiri, Mitsuru, “Economic Consequences of Population Aging in Japan: Effects through Changes in Demand Structure,” Discussion Paper Series 2012-E-3, Bank of Japan, Institute for Monetary and Economic Studies, 2012. Kimura, Takeshi, Takeshi Shimatani, Kenichi Sakura, and Tomoaki Nishida, “The Role of Money and Growth Expectations in Price Determination Mechanism,” Bank of Japan Working Paper No.10-E-11, Bank of Japan, 2010. Shirakawa, Masaaki, “Globalization and Population Aging: Challenges Facing Japan,” Speech to the Board of Councillors of Nippon Keidanren (Japan Business Federation) in Tokyo, 2011. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 4 June 2012.
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Masaaki Shirakawa: Japan’s economy and monetary policy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 4 June 2012. * * * Introduction It is a great honor to have this opportunity to address you today at the Naigai Josei Chousa Kai. The last time I spoke here was in late May 2011. At that time, Japan’s economic activity had just started picking up from the sharp decline in production following the downturn resulting from the Great East Japan Earthquake. The pace of the subsequent economic recovery was much faster than initially expected thanks to firms’ strenuous efforts. After the beginning of autumn 2011, however, economic activity temporarily became flat due to the effects of the slowdown in overseas economies, the appreciation of the yen, and the flooding in Thailand. Since then, it has become increasingly evident that the economy is shifting toward a pick-up phase, particularly in domestic demand, which shows signs of firming. Price developments have gradually been improving as well. On the other hand, as evident in financial markets recently, some nervousness has been seen in developments regarding the European debt problem. Today, I will first discuss economic and price developments. I will then explain the Bank’s conduct of monetary policy. After doing so, I will offer my thoughts on the importance of engaging in efforts to overcome challenges facing Japan’s economy, such as strengthening the economy’s growth potential and ensuring fiscal consolidation. I. Current developments in and the outlook for economic activity and prices Current developments in economic activity and prices I will start with developments in economic activity and prices. Overseas economies obviously have the largest impact on developments in Japan’s economy. These economies have yet to emerge from a deceleration phase, but some improvement has been observed. On the whole, the U.S. economy is in the process of moderate recovery. As for domestic demand, reconstruction-related demand including public investment has clearly started to increase. In the corporate sector, business fixed investment has been on a moderate increasing trend, with improvement in business sentiment reflecting a favorable turn in the outlook for corporate profits. In the household sector, private consumption has been increasing moderately against the background of improvement in consumer sentiment. Consequently, as I mentioned earlier, the Bank judges that it has become increasingly evident that Japan’s economy as a whole is shifting toward a pick-up phase. Reflecting these economic developments, gradual changes in prices start to emerge (Chart 1). Deflation is often referred to when discussing developments in Japan’s economy. As for the consumer price index (CPI, all items less fresh food), the year-on-year rate of change registered minus 2.4 percent in August 2009. Thereafter, the rate of decline moderated at a steady pace, recovering to 0 percent in fiscal 2011. The year-on-year rate of change in the CPI for the past two months, for which data is available, registered 0.2 percent. Looking at a breakdown by item, the rates of change are negative for items that are infrequently purchased and for which prices have declined substantially as a result of technological innovation, such as personal computers and televisions, whereas they are around 1.9 percent for those purchased more than about once a month. Focusing solely on items closely related to consumers’ daily lives, such as food, the year-on-year rate of change has more clearly entered positive territory than in the case of other items. BIS central bankers’ speeches Baseline scenario for the outlook through fiscal 2013 Next, I would like to talk about the outlook for economic activity and prices. At the Monetary Policy Meeting (MPM) held at the end of April, the Bank released its assessment of the outlook through fiscal 2013. An economic outlook undoubtedly entails various uncertainties and depends on relevant assumptions. The most important assumption made in the latest outlook rules out the possibility that an extreme intensification of the European debt problem would trigger a significant downturn in the global economy through the turmoil in global financial markets. On this basis, in the baseline scenario – that is, the scenario for economic activity and prices considered to be the most likely by the Bank – Japan’s economy is expected to return to a sustainable growth path with price stability in the longer run. More specifically, the economy is expected to return to a moderate recovery path in the first half of fiscal 2012 as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and as reconstruction-related demand after the earthquake disaster gradually strengthens. In terms of figures, the growth rate of real GDP is projected to be 2.3 percent and 1.7 percent for fiscal 2012 and 2013, respectively. Concerning prices, as the level of economic activity continues to rise moderately, the year-on-year rate of change in the CPI is expected to gradually rise to a range of above 0.5 percent and less than 1 percent by fiscal 2013, the latter half of the projection period. Thereafter, it will likely be not too long before the rate reaches 1 percent, which is the inflation rate that the Bank aims to achieve for the time being. Upside and downside risks to the outlook Such an outlook entails various uncertainties. The first concerns developments overseas, including those in global financial markets (Chart 2). Of these, the European debt problem should be a risk factor that requires the closest attention. From the summer of 2011 to the end of that year, strains in global financial markets intensified due to the effects of the European debt problem. Thereafter, financial markets regained stability temporarily, mainly due to liquidity provision by the European Central Bank (ECB). Recently, however, some nervousness has started to be seen once again. In Greece, a re-election is scheduled for mid-June, as the government failed to form a ruling coalition following the general election in May due to public opposition to fiscal tightening measures. In Spain, concern about financial institutions’ non-performing loan problem has heightened with the delay in efforts toward fiscal consolidation. Reflecting these circumstances, global investors have become increasingly risk averse on the whole. Government bond yields in Greece and Spain have risen while those in the United States, Germany, and the United Kingdom have recorded historical lows, or reached levels close to them. As suggested by the Lehman shock in autumn 2008, whether a risk will materialize in an extreme manner, leading to a significant economic downturn, largely depends on whether stability can be maintained in interbank funding markets. So far, interbank funding markets have generally been stable, mainly due to the massive liquidity provision by the ECB, a situation that stands in sharp contrast to that observed around the end of 2011. Nevertheless, liquidity provision by a central bank is a measure to “buy time”, so to speak. It is therefore vital that governments and authorities steadily proceed with efforts toward achieving sustainable growth and stability in the European economy before time runs out. In addition to risks stemming from developments in Europe, the global economy entails various uncertainties. With regard to the U.S. economy, while business fixed investment and private consumption have been firm, the effects of the bursting of the housing bubble remain deeply ingrained and the pace of recovery in employment is weakening. Although inflation rates have declined compared with some time ago, developments in emerging and commodity-exporting economies – which are expected to lead the global economy – also remain highly uncertain in terms of the extent to which they can grow without causing a resurgence of inflation. BIS central bankers’ speeches In terms of uncertainties, we monitor the recent appreciation of the yen. The development in the foreign exchange market since last summer is closely linked to changes in global investors’ risk aversion against the background of the European debt problem. The adjustment of the yen’s appreciation from February to the first half of March reflected abating risk aversion by global investors as the situation in Europe improved. The movement of the yen thereafter was merely a reflection of the reversal of such investors’ behavior. In any case, the Bank carefully monitors the development of the foreign exchange rate from the viewpoint of how it affects the economy through its impact on business sentiment. Second, developments in reconstruction-related demand at home remain uncertain. The portion of the budget earmarked for reconstruction amounts to about 19 trillion yen – a sizable budget over five years – and most of this is ready for disbursement. This represents about 4 percent of Japan’s nominal GDP and 60 percent of the total nominal GDP of the four severely disaster-stricken prefectures of Iwate, Miyagi, Fukushima, and Ibaraki. Steady disbursement is expected to significantly increase demand. However, a bottleneck – such as a shortage in construction workers – could also occur at various stages of implementation given the large scale of the budget. Third, there is uncertainty with regard to firms’ and households’ expectations or their degree of confidence as pertains to the medium- to long-term growth outlook for Japan’s economy. Japanese firms are currently increasing production overseas against the background of high growth in emerging economies. While this is a rational business strategy, medium- to longterm growth expectations are bound to change in either direction depending on whether new businesses will be created at home. With regard to problems concerning the supply and demand of electric power, the issue for the time being is how businesses will operate during the upcoming summer. Other important points to pay attention to are (1) whether concern about electricity supply constraints and a rise in electricity costs would lead to an eventual decline in medium- to long-term growth expectations, and (2) whether efforts to conserve, create, and store energy would lead to a strengthening of growth potential. Fourth, there is uncertainty with respect to various issues regarding Japan’s fiscal sustainability. Despite unfavorable fiscal conditions, some argue that the situation in Japan is not a problem given the abundant domestic savings and little need to rely on foreign investors. Having said this, no government can keep expanding its liabilities forever. The current stable low level of the government bond yields reflects market participants’ confidence that Japan ultimately has the ability to work on fiscal consolidation. As I will get into later, confidence in fiscal sustainability is the most fundamental prerequisite for stability in prices and the financial system. Once damaged, it will adversely affect the economy. By contrast, considering the possibility that concern about the outlook for the fiscal situation is causing a decline in households’ and firms’ propensity to consume, a clear path toward fiscal consolidation may in fact heighten economic growth over a relatively long term. II. The Bank’s conduct of monetary policy The price stability goal in the medium to long term I will now explain the Bank’s conduct of monetary policy, taking into account the aforementioned economic and price developments. The Bank recognizes that the critical challenge for Japan’s economy is to overcome deflation and return to a sustainable growth path with price stability. Based on this recognition, it has been implementing powerful monetary easing measures for a while. Looking at its policy decisions since the beginning of 2012, it introduced “the price stability goal in the medium to long term” in February while simultaneously further enhancing monetary easing. Taking BIS central bankers’ speeches another step forward, the Bank decided to enhance monetary easing again at the end of April. Let me explain in more detail.1 The first point is “the price stability goal in the medium to long term”. The objective of monetary policy is price stability. As stipulated in the Bank of Japan Act, the Bank conducts monetary policy based on the principle that the policy shall be aimed at “achieving price stability, thereby contributing to the sound development of the national economy”. In light of such principle, the price stability that the Bank aims to achieve must be one that is sustainable in the medium to long term. Among major central banks, the need to place importance on medium- to long-term price stability has been widely accepted. For example, the United Kingdom – known for its adoption of inflation targeting – has continued to register an actual inflation rate exceeding its goal by more than 1 percent for over two years. During this period, however, its central bank has conducted monetary easing, not tightening. Considering that the effects of monetary policy are transmitted with a time lag, price developments in the medium to long term, not those in the short term, must be taken into account, and policy conduct in the United Kingdom is based on its assessment that the inflation rate is expected to decline, judging from the output gap. The level of inflation at which prices can be perceived as stable in the medium to long term depends on such factors as the characteristics of the economic structure of respective countries and the perception of prices held by those who have adapted to such an environment. Taking these into account, the Bank decided to express “the price stability goal in the medium to long term” with a degree of latitude, judging it to be in “a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI”. Furthermore, the Bank more specifically expressed that it set a goal of “1 percent for the time being” and that it would aim to achieve this goal in conducting monetary policy. I will elaborate upon why we chose “1 percent” later in my talk. Pursuit of powerful monetary easing The second point involves the specifics of the monetary easing measures. Given that the overnight call rate, or the policy rate, is already virtually zero, generating easing effects in terms of monetary policy calls for a new approach. This is where the Bank’s comprehensive monetary easing measures implemented in autumn 2010 come in. The first part of its efforts focuses on its commitment aimed at generating policy duration effects – in other words, the Bank’s determination to continue with its monetary easing. The other involves working on longer-term interest rates and risk premiums by establishing a program through which to mainly purchase financial assets, such as Japanese government bonds (JGBs) and risk assets. The Bank, establishing a link with its “price stability goal in the medium to long term”, clarified at the February MPM that it would aim to achieve the goal of 1 percent inflation in terms of the year-on-year rate of increase in the CPI through the pursuit of powerful monetary easing, conducting its virtually zero interest rate policy and implementing the Asset Purchase Program (hereafter the Program) through the purchase mainly of financial assets, and that it will continue with this powerful easing until it judges the 1 percent goal to be in sight. As for the size of the Program, the Bank increased the amount by about 10 trillion yen at the MPM in February and about 5 trillion yen at the MPM at the end of April. In doing so, while reducing its funds-supplying operations with a 6-month term reflecting a decline in market needs, it substantially increased its purchase of JGBs by about 10 trillion yen and expanded the range of eligible JGBs and corporate bonds to be purchased from those with a remaining maturity of up to two years, to those with a remaining maturity of up to three years. For more details on the Bank’s measures to enhance monetary easing in February 2012, please see Masaaki Shirakawa, “The Bank of Japan’s Efforts toward Overcoming Deflation” (Speech at the Japan National Press Club in Tokyo), February 17, 2012. http://www.boj.or.jp/en/announcements/press/koen_2012/ data/ko120217a1.pdf BIS central bankers’ speeches Through these measures, the Bank intends to proceed with and complete its purchase of financial assets under the Program, amounting to about 65 trillion yen by the end of 2012 and about 70 trillion yen by the end of June 2013 (Chart 3). Given that the amount outstanding of the Program has recently been about 51 trillion yen, the Bank is to accumulate nearly 20 trillion yen worth of financial assets in over a year from now and is currently in the process of enhancing monetary easing every month. However, the simple truth about its monthly efforts tends to be overlooked, since the Bank announces such efforts in advance in a collective manner. In any event, this pursuit of powerful monetary easing is expected to exert positive effects on economic activity and prices through the following transmission mechanism, together with the cumulative effects of easing to date. First, the Bank’s purchases of financial assets through the Program and the clarification of the policy time horizon mentioned earlier will encourage a decline in longer-term interest rates and a reduction in risk premiums. For example, while yields on JGBs tend to rise in accordance with an increase in maturity, those on JGBs with a remaining maturity of three years have recently declined to around 0.1 percent, reaching levels close to money market rates. Reflecting these developments in market interest rates, firms’ funding costs have decreased at a moderate pace. Second, such effects of low interest rates in terms of stimulating the economy will strengthen with improvement in economic conditions (Chart 4). Let us consider, for example, an interest rate in two different environments: one in which it is difficult to make profits, and the other in which an adequate return can be anticipated by investing with the use of loans. Of the two cases, the latter provides a larger economic stimulus. Monetary easing effects in Japan are expected to strengthen further in the future, considering that economic conditions and prices are heading toward improvement. Third, financial markets remain extremely stable compared to other countries, as market participants have been reassured by ample fund provision. Reassuring firms and households about their funding plays a role in supporting their confidence, especially at a time when we are witnessing high uncertainty at home and abroad, particularly with regard to the European debt problem. III. Some points about monetary policy So far, I have explained the Bank’s powerful monetary easing and its effects. In the conduct of monetary policy, we recognize that there are different opinions. One opinion is that the Bank should pursue more aggressive easing. Another is that it is too risky to embark on such aggressive measures. For our part, we listen to these opinions and conduct monetary policy as we judge most appropriate. Bearing these differences in mind, let me explain our thinking behind the conduct of monetary policy in order to facilitate better understanding of our policy making. Level of the “price stability goal in the medium to long term” The first is the level of the price stability goal. The general public’s perception of prices is deeply ingrained and it influences their actions; thus, it is hard to imagine a situation that does not take account of experiences over the decades (Chart 5). Although the year-on-year rate of change in the CPI turned negative in 1998, the average rate of inflation since the middle of the 1980s – after the effect of the second oil shock dissipated – is nearly 0.5 percent. It has consistently been lower than the equivalent rates in overseas economies. During the bubble period (1987–89) when the economy was booming, the CPI inflation was 1.3 percent. Over the last 30 years or so, there were only three cases when the year-on-year rate of change in the CPI reached 2 percent. The first was at the beginning of the 1990s, when the remnants of the bubble were still in place. The second was BIS central bankers’ speeches in 1997, when the consumption tax was lifted. The third was in 2008, when the sharp rise in energy and food prices hit the household sector. Notwithstanding these past benchmarks, simply announcing out of the blue that the Bank aims to achieve 2 percent inflation is not enough. Above all, this might raise unnecessary uncertainties for businesses and households. Furthermore, if the announcement was trusted and inflation expectations rose accordingly, it is financial markets that would respond most quickly. There would then be a risk of a premature rise in long-term yields before actual prices and wages start to rise. Under such circumstances, the prices of Japanese government securities, a large share of which is owned by financial institutions, would go down, thereby heightening the risk of undermining such institutions’ lending activities. Owing to these concerns, we judged that it was best to leave the CPI inflation rate at 1 percent for the time being and exert efforts to achieve that goal. On top of this, the Bank will review “the price stability goal in the medium to long term” once a year while analyzing the level of progress that has been made toward strengthening the growth potential and the changes that have occurred in the general public’s perception of prices. Achieving the “price stability goal” and conduct of monetary policy The second point concerns the timing of achieving the price stability goal and its relationship with the conduct of monetary policy. In the Outlook Report published in April 2012, the median of the Policy Board members’ forecasts of CPI (all items less fresh food) for fiscal 2013 was 0.7 percent year on year. Our decision to enhance monetary easing at that time was not made simply because our forecast fell short of the goal of 1 percent. Rather, given that it will likely be not too long before the year-on-year rate of change in the CPI reaches the Bank’s “price stability goal in the medium to long term” of 1 percent for the time being, the Bank judged from a somewhat long-term perspective that the likelihood of Japan’s economy returning to a sustainable growth path was fairly high. It was against such a background that the Bank enhanced monetary easing. A central bank aims to achieve price stability in the medium to long term, and no country has accepted the idea that its central bank must achieve a certain percent of inflation by a certain period of time in an automatic manner. Having said that, we are hoping that 1 percent inflation, specified as the Bank’s “price stability goal in the medium to long term” for the time being, is achieved at the earliest possible time. However, there are structural and corrosive problems behind the cause of deflation. Furthermore, one has to take into consideration that there is a long time lag before the effects of monetary policy permeate the economy. Under such circumstances, if the Bank presses on too aggressively with the purchase of financial assets – the monthly purchase of JGBs, for example, has already reached a significant level – this could hold down long-term yields temporarily; however, it subsequently could trigger an event that would lead to a jump in such yields as a result of the government bond market being too dependent on the central bank’s purchases (Chart 6). This will have a significant impact on financial institutions’ management, and will jeopardize price stability as well as the sound development of the economy. The Bank continues to examine whether economic activity and prices are moving in the right direction, and to assess risks including the accumulation of financial imbalances. The Bank will conduct policy in an appropriate manner while carefully assessing the effects of further monetary easing in the pipeline. Large-scale purchase of government bonds and the credibility of currency The third point is related to the large-scale purchase of government bonds and its relationship with maintaining the credibility of currency. Related to this point, we sometimes hear the criticism that once the purchase of government bonds by a central bank is perceived BIS central bankers’ speeches as financing government debt, and not conducted for the purpose of monetary policy, this could entail a risk of undermining the credibility of currency. The Bank conducts such purchases for two different purposes. First, it regularly purchases long-term government bonds under the ceiling of the amount of banknotes in circulation. This is based on the rationale that, as long as such purchases are in line with an increasing trend of demand for banknotes, the Bank should hold long-term assets instead of short-term assets. From this viewpoint, a ceiling has been set that is equivalent to the amount of banknotes in circulation. The second purpose is to purchase long-term government bonds through the aforementioned Asset Purchase Program, with a view to pursuing its powerful monetary easing. Such purchase is aimed at encouraging a decline in longer-term market interest rates on the basis of its conduct of monetary policy, and is not restricted to the ceiling of the amount of banknotes. At the end of May, the amount of JGBs held by the Bank for this purpose was about 10 trillion yen, and it will be increased by about 29 trillion yen by the end of June 2013. Adding these values together, the total amount of the Bank’s holdings was approximately 73 trillion yen at the end of April 2012, is expected to total 92 trillion yen at the end of this year, thereby exceeding the amount of banknotes in circulation, and reach 97 trillion yen at the end of June next year (Chart 7). Given that special deficit-financing bonds issuance in fiscal 2012 is about 38 trillion yen, the growth in size of the Bank’s purchase of JGBs appears fairly straightforward. Nevertheless, the Bank’s purchase of long-term government bonds has never been – and will never be – intended as financing government debt. I emphasize that the Bank’s intention is crystal clear on this point. Considering the relationship between currency and government securities, it is important to go back to basics.2 The Bank purchases the government securities because the banknotes it issued against such purchases are ultimately accepted by the public, whose confidence in banknotes is maintained. However, such confidence is backed by the government securities. Put differently, it is hard to imagine a situation where public confidence in banknotes is maintained but not that in the government securities. Hence, once the confidence in the government securities is lost, so is that in banknotes. After all, if the central bank’s purchase of the government securities exceeds the amount of banknotes the public wishes to hold, this will eventually lead to inflation. Alternatively, the anticipation of inflation will lead to a preemptive hike in long-term yields, exerting a negative influence on the economy and the financial system. Thus, the amount of the government securities that the Bank can purchase has a ceiling that is specified by “confidence”. The Bank has been purchasing a significant amount of JGBs, but its operation rests on a subtle balance that is based on sustaining such confidence. Above all, it is vital that steps toward fiscal consolidation make steady progress in order not to create any room for misunderstanding the Bank’s action as financing government debt. Role of monetary easing The fourth point is the role of monetary easing and its relationship with other policies and measures. Related to this point, we hear the view that insufficient monetary easing has caused both the persistent deflationary pressure and the resurgent appreciation of the yen. At the same time, we are aware of the opposing view that monetary easing has delayed structural reforms in the economy and fiscal situation. Our thinking on this is clear: we need On the relationship between currency and government securities, please see Masaaki Shirakawa, “The Importance of Fiscal Sustainability: Preconditions for Stability in the Financial System and in Prices” (Remarks at the Banque de France Financial Stability Review Launch Event in Washington D.C.), April 21, 2012. http://www.boj.or.jp/en/announcements/press/koen_2012/data/ko120422b.pdf BIS central bankers’ speeches to make efforts to strengthen growth potential and provide support from the financial side. For our part, we will make our utmost efforts from the financial side. Monetary easing permeates the economy through two stages. The first consists of the central bank’s action influencing financial conditions, and the second involves such conditions inducing increased spending by firms and households. As far as financial conditions are concerned, the levels of interest rates in Japan – whether they be interest rates on loans or issuance rates of corporate bonds – are at least as low as those in the United States (Chart 8). This is also the case whether they be nominal interest rates or real interest rates adjusted for inflation expectations. Nevertheless, the reason behind the recurring argument for insufficient monetary easing comes from a misunderstanding concerning the amount of currency the central bank supplies. Under a zero interest rate, the cost associated with holding either banknotes or the central bank’s current deposits is negligible; no matter how much money it supplies, this will be held in such a form as the central bank’s current deposits. In terms of quantity, this is completely ineffective. In fact, Chairman Bernanke has stated that the degree of monetary accommodation cannot be measured properly based on the quantity. Having said that, the fact is that the quantity itself is the highest in Japan. Considering that Japan had been increasing its quantity well before European countries and the United States, which started boosting their quantities after the Lehman shock, perhaps the public has been used to such an environment without being particularly aware of it. It is our strong desire that advantage be taken of such accommodative conditions. IV. Importance of strengthening growth potential Up to now, I have explained our thinking behind the conduct of monetary policy. In order for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability, support from the financial side is an important and necessary condition, and the Bank will do its utmost while examining the developments in economic activity and prices, as well as assessing risks. Nevertheless, this is not enough to lead Japan’s economy toward overcoming deflation and returning to a sustainable growth path with price stability. Efforts to strengthen growth potential are particularly important. With this in mind, I would now like to change the subject and talk about how to strengthen growth potential. Growth potential is the potential growth rate of real GDP. In the short run, the economy fluctuates at a rate around the potential growth path, but will converge to that path in the long run, say over 10 and 20 years. The real GDP growth rate is decomposed into the growth rate of the workforce and the growth rate of real per capita GDP. Japanese data for the last 10 years show that the working-age population declined by 0.3 percent year on year and labor productivity increased by 0.8 percent year on year. When combining these numbers, the real GDP growth rate increased by around 0.5 percent. The decline in the workforce reflects the rapid aging that is in progress. For the next 10 years, assuming that the labor participation of male/female workers and that of different age groups remain constant, the working-age population is expected to decline by 0.6 percent. Meanwhile, labor productivity in Japan increases at a somewhat higher rate than in other major economies. With that in mind, there are only two ways to boost economic growth: either raise the rate of growth in the working-age population or raise labor productivity. Of course, the economic growth rate can still increase somewhat once the output gap has been filled through the process of encouraging an unutilized labor force to participate. According to the Cabinet Office, the recent output gap estimate is nearly 2 percent, and it appears that this does not provide enough impetus to lift the economic growth rate once the output gap is filled (Chart 9). BIS central bankers’ speeches Raising labor participation and productivity Based on the information provided thus far, the direction in which we should be heading is clear. The first move would be to increase labor participation, or at least make efforts to stop its decline. In particular, society has to take steps to allow more females and the elderly to participate in the labor market. If, by 2030, (a) the labor participation of female workers became as high as that in Sweden, (b) the participation of those at the age of 60–64 became as high as those at the age of 55–59, and (c) the participation of those at the age of 65+ went up accordingly, then the working-age population would rise by 0.2 percent in the 2010s, not decline by the 0.6 percent that I mentioned earlier (Chart 10). The second is to exert efforts to raise productivity. This sounds as though we need technological advances in order to achieve efficiency gains, but this is not necessarily the case. Labor productivity is the value added – the sum of wages and profits – per worker, and raising productivity is equivalent to creating goods and services that satisfy consumers’ needs and shifting resources to produce such goods and services. Here, it is imperative to further efforts toward cultivating overseas demand and capturing domestic demand. Given that emerging economies are the driving force of global economic growth, it is imperative not just to accelerate exports but also to increase production in those areas. While Japanese firms’ aggregate income associated with foreign direct investment and M&A activity is not included in the GDP, it will lead to an increase in the GNI, which represents the aggregate income earned by Japanese. As for domestic demand, efforts are called for that aim to realize potential demand that has been increasing as the aging of the population proceeds. In this regard, there have been some promising episodes. The recent firming in household consumption is not just supported by policy measures such as tax credits for the purchase of hybrid cars and other eco-friendly cars. It is also supported by firms’ efforts to successfully provide products and services – at somewhat higher prices than usual – that meet the diversifying needs of households, particularly those of the elderly. Related to the aging of the population, the prospects for medical and nursing services will become all the more important. In fact, the number of employees in the medical and nursing service industry is clearly on an increasing trend over the long run. Moreover, in this industry, there are many firms that have only recently started up but have expanded their businesses successfully. However, given that one often hears about a lack of medical and nursing services that meet the needs of elderly people who have enough cash, it seems likely that, in Japan, either not enough of these services have been provided or not enough progress has been made in facilitating an infrastructure that makes the provision of these services possible in view of the potential demand arising from the aging population. In fact, among leading economies, the growth rate of the elderly population during the last 10 years is the highest in Japan. During the same period, expenditure related to medical and nursing services increased at the slowest pace in Japan (Chart 11). The case for the medical and nursing service industry merely serves to illustrate the point concerning increasing potential demand. Indeed, there are a number of opportunities that lead to the strengthening of economic growth potential, such as capturing the diversifying consumer demand and purchasing power in a rapidly growing Asia, in addition to efforts dealing with resources, energy, and environmental problems. Relationship between strengthening growth potential and overcoming deflation Next, how should we interpret the importance of strengthening growth potential or making efforts to raise the growth rate of real GDP, and their relationship with raising nominal GDP or overcoming deflation? Here, I stress the importance of generating domestic demand through making efforts to raise economic growth in order to overcome deflation. The reason I say this is that it has been the case that prices start to rise as the output gap improves. There BIS central bankers’ speeches were cases in the past where upticks in inflation took place without economic improvement, but these occurred as a result of rising import prices – crude oil prices, for example – that were then passed on to domestic prices. We are not waiting for such a situation to take place. Of key importance is how to raise growth expectations. Will to overcome deflation The issue is how we should encourage efforts to raise economic growth in Japan. I believe that, if Japanese make a collective effort, the goal of overcoming deflation can surely be achieved. On this issue, the following two factors provide good starting points. The first is that we ourselves need to accurately recognize the challenges facing Japan. While the country still enjoys a fairly high level of income, this will not be sustainable without taking necessary measures. The fundamental problem facing Japan’s economy is its declining growth, and deflation is a reflection of such a problem. At this juncture, however, neither pessimism nor fatalism is called for. For example, both the declining birthrate and the aging population generate strong headwinds for Japan, but they are not the fundamental cause of low economic growth and deflation. Delayed responses to structural changes such as these and to globalization – a large structural change for Japan – are the fundamental causes of low growth and deflation.3 Based on such recognition, necessary measures will surely be made. Second, be it raising economic growth or overcoming deflation, all economic entities – including business firms, financial institutions, the government, and the Bank – need to share the recognition that it is imperative that they continue to exert themselves in their respective roles. Without delving into the Schumpeterian view of innovation, the challenging spirit of enterprises is all the more important. More concretely, it is necessary for firms to switch their fundamental strategy from the “Red Ocean Strategy”, under which they continue price competition in the shrinking markets, to the “Blue Ocean Strategy”, under which they create new markets and provide high value-added. If firms are successful in raising profitability not by cutting costs but by generating value-added, they can pay higher wages to their employees. Subsequently, consumers will have higher incentives to purchase valueadded goods and services; hence, a virtuous circle prevails. The role of financial institutions to support such firms’ efforts is also important. In order to lay the foundation for firms to demonstrate their spirit of challenge, such government initiatives as deregulation are also important. I understand that such initiatives will move forward steadily through the launch of the comprehensive strategy for the rebirth of Japan, by mid-2012. Ultimately, these reforms will only move forward with the help of the general public’s understanding. In this sense, it is important to build a society, which accepts the economy’s metabolism as a concept of values, promotes deregulation to support such metabolism, and provides the safety net that enables entities to embark on a renewed challenge. I have touched on the roles of firms, financial institutions, and the government, as well as the general public’s understanding. For our part, the Bank continues to make its utmost effort to overcome deflation and return to a sustainable growth path with price stability. As for problems accompanying the aging of the population, please see Masaaki Shirakawa, “Demographic Changes and Macroeconomic Performance: Japanese Experiences” (Opening Remark at 2012 BOJ-IMES Conference hosted by the Institute for Monetary and Economic Studies, the Bank of Japan), May 30, 2012. http://www.boj.or.jp/en/announcements/press/koen_2012/data/ko120530a1.pdf BIS central bankers’ speeches Concluding remarks The world now faces a big challenge. Each country, including the United States, those in Europe, and those in emerging economies, also faces respective challenges. Japan is by no means an exception. There is commonality among the challenges each country faces, but there also are differences. Over the past quarter of a century, Japan has gone through a number of challenges: the emergence and bursting of the bubble, the outbreak of a financial crisis, corrosive deflation, and the rapid progression of an aging population. Japan has faced these challenges much earlier than any other leading economies. While we are accustomed to learning lessons from overseas experiences, these only provide hints – not solutions. We ourselves must face reality, struggle to find solutions, and then put them into effect. Given that Japan managed to significantly change its structure of foreign trades, Japanese certainly have the potential to adapt to and cope with changes. In conclusion, let me reiterate that the Bank continues to do its utmost as a central bank to overcome deflation and achieve sustainable growth with price stability. Thank you for listening. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Remarks (via videoconference) by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Federal Reserve Bank of San Francisco Conference, San Francisco, 11 June 2012.
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Masaaki Shirakawa: The era of linkages among Asia and across the Pacific Ocean Remarks (via videoconference) by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Federal Reserve Bank of San Francisco Conference, San Francisco, 11 June 2012. * 1. * * Introduction I am privileged to have the opportunity to speak at this invaluable conference being held by the Federal Reserve Bank of San Francisco. Today, I would like to talk about the strengthened linkages among Asia and across the Pacific Ocean, as well as the challenges in finance to be tackled to achieve sustainable growth in Asia. Unfortunately, our Monetary Policy Meeting scheduled for the day after tomorrow does not allow me to join you in San Francisco. Nonetheless I am grateful for being given the opportunity to speak in this way. I now realize that a new linkage across the Pacific, which relates to the topic I want to discuss today, is being formed through such innovative information technology like this. Since the voyage of Christopher Columbus in 1492, there have been economic, cultural and political exchanges between the two sides of the Atlantic Ocean for more than five centuries. Since the nineteenth century, the two sides of the Atlantic Ocean have been regarded as the center of the civilized world. Compared to this long history of trans-Atlantic linkages, the history of trans-Pacific linkages is quite brief. Thirty years after Columbus made his voyage, the fleet led by Ferdinand Magellan discovered and crossed the Pacific Ocean during the years 1520 and 1521. However, more substantive trans-Pacific economic exchanges only began after the Forty-niners came to join the California Gold Rush and the population of the U.S. Pacific Coast increased substantially. The only exception was the Manila-Acapulco galleon trade, in which Spanish trading ships sailed between Acapulco and Manila once or twice a year when the Spanish viceroy of Mexico ruled the Philippines. The biggest obstacle to linkages across the Pacific was the gigantic scale of the Ocean. In order to sail between Acapulco and Manila, Spanish people of the 16th century had to build the largest galleons they could, whose size was as much as 2,000 tons (Chart 1). Compared with the famous Mayflower whose size was estimated to be 180 tons, we can easily imagine how exceptionally big the Spanish galleons were. Even in the modern era, the first trans-Pacific undersea telegraph cable was built in 1903, 45 years after the construction of the trans-Atlantic cable. Non-stop trans-Pacific flights became widespread only 40 years ago, in the 1970s, after Boeing 747 “Jumbo Jets” were fully introduced (Chart 2). Thus, it was not long ago that people began to see the Asia-Pacific region as an economic bloc. Indeed, the Asia-Pacific Economic Cooperation, or APEC, was established as a forum for the governments of Asia-Pacific countries only in 1989. Although there remains the geographical distance between Asia-Pacific economies, owing to technological innovation it is far less an obstacle to economic exchanges than before, and the Asia-Pacific countries have become able to enjoy the benefits of sitting around the same sea together. Apart from the historical context, last year there were a couple of big events that reminded me of the strong linkages that exist within Asia and across the Pacific. The first one was the tragic Great East Japan Earthquake. This massive earthquake severely damaged supply chains of manufacturing of Japan (Chart 3). When factories of micro-controllers, integral parts of automobiles, came to halt, the resultant shortage substantially affected not only automobile production lines in Japan but also those in overseas in Asia and the United States (Chart 4). In terms of negative impacts on supply chains, the floods in Thailand since BIS central bankers’ speeches last summer also struck production lines of hard disk drives, disrupting computer manufacturing in other Asian economies including Japan. These natural disasters revealed the strength of linkages among Asia-Pacific economies. Another event that reminded me of strong linkages across the Asian-Pacific region was extremely quick popularization of tablet PCs and smart phones. Indeed, we now see people looking at smart phones almost everywhere. Today’s industrial linkages do not necessarily take the traditional form of division of labor depicted in textbooks on international trade. With new “concepts,” firms have become increasingly capable of attracting wide-ranging resources from all over the world to bring these new concepts to reality. As is shown in the case of tablet PCs, the Asia-Pacific region has become more and more important as an “incubator” of innovation. An estimated break-down of the costs of Apple’s iPhone, whose retail price is 649 dollars, consists of manufacturing cost of 8 dollars, component costs of 188 dollars and a gross profit margin of 453 dollars (Chart 5). The concepts of iPad and iPhone were generated in Silicon Valley. During the process of turning these concepts into real merchandise, there were trans-Pacific flows of goods, human resources and financial services in all directions, such as in the development of component technologies, manufacturing processes and distribution channels. In such processes, not only Silicon Valley companies but also many Asian firms in China, Korea, Taiwan and Japan are involved. 2. Asia in the global economy Asia acting as growth pole to enhance resilience of global economy Now, let me briefly illustrate the economic growth of the Asia-Pacific region and the strengthened linkages among the countries of that region, as the basis for further discussion. The economic growth of Asia has continuously exceeded that of the global economy in recent years. Indeed, the relative strength of the Asian economy has been more pronounced since the global financial crisis. According to the IMF World Economic Outlook, Asian growth, which stood at 5.9 percent in 2011, is expected to continue growing at a relatively high rate of 6 percent in 2012. Meanwhile, the growth of advanced economies, which stood at 1.6 percent in 2011, is expected to remain as low as 1.4 percent in 2012 (Chart 6). According to the IMF, Asian economies are expected to increase their share of the global economy from 30% to 40% or more by the year of 2030 if the current trend of Asian growth is maintained (Chart 7). The Asian share of the global economy is also increasing in terms of trade (Chart 8). In this regard, Japan’s “White Paper on the International Economy and Trade” published in 2011 provides an insightful analysis on the global trade structure. This Paper divides the world into six areas, that is, NAFTA, the EU, ASEAN, MERCOSUR, China and Japan (Chart 9). According to this analysis, the share of the trade between advanced economies such as NAFTA, EU and Japan to the total was as much as around 60 percent in 1990, but this figure declined to a little more than 30 percent in 2008. On the other hand, the share of trans-Pacific trade among NAFTA, ASEAN, MERCOSUR, China and Japan excluding that between NAFTA and Japan increased from around 25 percent in 1990 to around 45 percent in 2008 (Chart 10). This fact illustrates the dramatic development of trade network among the Asian-Pacific region. The growth of Asia is leading global economy even after the global financial crisis. Despite the bursting of the housing bubble in the U.S. and the financial turmoil after the failure of Lehman Brothers, the global economy has not fallen into a deep and prolonged slump such as that experienced in the Great Depression in 1930s (Chart 11). As to the background of such resilience in the global economy, let me point out the contribution made by emerging economies, especially by emerging Asia, as well as various policy responses taken by governments and central banks worldwide. With the strong growth of emerging economies, BIS central bankers’ speeches the global economy now has multiple growth “pillars”, which fortify its resilience. Needless to say, it may not be appropriate to overemphasize so-called “de-coupling” in this globalized economy. Nonetheless, further endogenous economic development associated with the rise in living standards in Asian and other emerging economies will surely continue enhancing the robustness of global economy. Asia as a new frontier for global economic growth I would also like to emphasize that the high growth of Asia, which enhances the resilience of global economy, also expands new growth frontiers for non-Asian economies. As many advanced countries are now facing common issues of an aging population and fiscal imbalances, enhancing the growth potential has become an imminent challenge for these countries.1 In addition, the solution to the European debt problem ultimately rests with the ability and efforts of peripheral countries to boost their productivity and growth sufficiently. In this regard, Asian economies could offer great potential, as they have a vast pool of human resources and are now becoming major high-tech suppliers. Moreover, emerging Asia is expected to substantially grow as consumption markets. According to an industry survey conducted early this year, China has surpassed the U.S. to become the world’s largest smart phone market by shipments. To exploit Asia’s potential, advanced economies should build systematic and productive linkages with Asian economies, instead of viewing Asia simply as labor-intensive production base. Case in point is Japanese retailers, medicare service industries and private education industries which used to focus on the domestic markets. They are now formulating global business strategies targeting the broader Asian market. Moreover, through their environmental and energy-saving engineering technologies, advanced economies could contribute to alleviating growth constraints associated with the rapid rise in living standards in Asia. It would also be fruitful for advanced economies to consider how they could make use of Asia’s human resources and supply capacity to overcome the problems associated with their aging population. Establishing such strategic and coordinated linkages with Asian economies would expand growth frontiers and thus bring about “win-win” relationships, which would be beneficial to both Asia and the rest of the world. 3. Economic development and financial stability in Asia Asia’s strength and challenges in terms of finance Next, I would like to talk about the relationship between the economic development of Asia, new linkages and the role of finance, which is indeed the main topic of this conference. As mentioned earlier, Asian economies recovered relatively smoothly and swiftly after the global financial crisis and remain a driving force of the world economy. As one of the major factors behind the resilience of Asia, I would like to point out the overall stability of Asian financial systems. In my view, there are three major factors behind such financial stability in Asia. First, Asia’s economic fundamentals are relatively strong. Most emerging Asian countries have excess domestic savings and their fiscal conditions are also better than those of advanced economies. The external balances of these countries generally remain in surplus. Regarding the issues associate with demographic changes, see Shirakawa, “Demographic Changes and Macroeconomic Performance: Japanese Experiences” (Opening Remark at 2012 BOJ-IMES Conference) BIS central bankers’ speeches Against this background, capital inflows to Asia quickly rebounded after the sudden contraction during the initial stage of the crisis. Second, the business models of Asian financial institutions are different from those of European and U.S. institutions. In Asia, traditional banking businesses play a major role in financial intermediation, and the “originate to distribute” business model, which was one of the major causes of the financial crisis, has never been popular. Moreover, Asian banks’ exposures to structured products were limited. Third, based on the Asian experiences of financial crises in the 1990s, many Asian countries including Japan have already made various efforts to enhance the stability and resilience of their financial systems, such as strengthening banks’ capital and building financial safety nets. Now advanced economies are focusing on “macro-prudential” policies. In this regard, some Asian economies, based on the experiences of financial crises in 1990, have already made use of various macro-prudential tools such as loan-to-value ratio to curb excessive real estate loans. As such, some Asian economies have moved ahead of advanced economies in terms of implementing macro-prudential policies. In spite of their relative stability, Asian financial systems also face challenges. One of the policy challenges is to foster the development of capital markets, especially the corporate bond markets. In emerging Asia, there would be huge financing needs for building social infrastructure such as public transportation, energy supply and communication networks. In view of the length of financing needs for building infrastructure as well as the risks associated with possible maturity mismatches, a well-functioning capital market, as well as credit intermediation through banks, should play an important role in such long-term domestic financing. Moreover, the co-existence of different financing tools such as bank borrowing and corporate bonds could enhance the resilience of the financial systems. In this regard, Asia has already taken various steps including the introduction of Asian Bond Fund. Japan’s possible contribution toward financial developments in Asia On this front, I firmly believe that Japan is able to contribute to Asian financial stability as well as to the development of financial infrastructure in Asia, for two reasons. First, Japan’s financial system, on the whole, is being stable and resilient. Given that Japan experienced a financial crisis in 1990s, various measures have already been taken to strengthen its financial system. Partly due to such efforts, Japan’s financial system have remained mostly stable, surviving successive events such as the failures of Lehman Brothers and other financial institutions, the Great East Japan Earthquake and the European debt problem. To date, internationally active Japanese banks have generally set aside sufficient capital, and are in a position to contribute, as financial intermediaries, to satisfying Asian needs for various financial services. Second, not only for internationally active Japanese banks but also for Japanese non-financial firms, establishing linkages with other Asian economies is now at the core of their overseas business strategies. Internationally active Japanese financial institutions are now allocating their resources to Asian businesses as a part of their global strategies and increasing their lending in Asia. They are also exploring various businesses such as M&A financing in Asia. For example, Japanese “mega” banks’ loans to Asia as a share of their total overseas loans is continuously increasing, and has now reached around 30 percent (Chart 12). Recently, some European banks are streamlining their exposures to emerging economies, and Japanese banks are filling a part of the void created by such “deleveraging” of European banks (Chart 13). Such Japanese banks’ activities would certainly contribute to stable financial intermediation in Asia. BIS central bankers’ speeches Also for Japanese non-financial firms, economic developments in Asia also provide a new growth frontier. In view of the widening gap between savings and investment in Japan’s corporate sector due to the sluggish growth in domestic investment opportunities, Japanese non-financial firms are now expanding their direct investments and M&A activities in emerging Asia so as to explore their business frontiers and to seek for higher rate of return. Such activities are not confined to large companies, but medium-sized manufacturers and service providers are also involved. In 2009, the aggregate amount of Japanese firm’s direct investments in Asia exceeded the amount invested in the European Union (Chart 14). Such activities of Japanese financial institutions and firms would contribute to sustainable growth in Asia by facilitating a steady flow of risk capital into productive investment in Asia, including Japan itself. On the other hand, in order for the Japanese economy to enhance its growth potential, it is critical that financial institutions and firms improve their productivity and profitability by taking advantage of the growth potential of Asia in terms of both supply and demand. 4. Toward a new “win-win” relationship In view of the strengthened linkages among Asia and across the Pacific, I would like to highlight three tasks for policymakers in order that both Asia and the rest of the world achieve sustainable growth through establishing a win-win relationship from a broader perspective. First of all, I would like to reiterate the importance of each Asian country continuing its effort to maintain economic stability by strengthening fundamentals and the policy framework. As Asia’s share of the global economy increases, possible impacts on the global economy stemming from fluctuations in the Asian economy and policies adopted by each country in Asia could become more pronounced. In terms of economic fundamentals, emerging Asia, lagging a bit behind advanced economies, will also be required to tackle the issue of ageing population in the near future. For example, the working age population in China is expected to start decreasing in around 2020 (Chart 15). How effectively and promptly each country responds to this issue, after enjoying the “population bonus”, could have significant implications for their economic fundamentals. Regarding growth constraints on Spaceship Earth, policy efforts aimed at protecting the environment and saving energies would also become more important. As emerging economies’ share of the global economy increases, growth expectations for the global economy often lead to rise in commodity prices, which constrains policy conducts of emerging economies by intensifying inflationary pressures. In this regard, policy efforts in environmental protection and energy savings will alleviate such growth constraints and enhance emerging countries’ resilience against fluctuation of commodity prices. I believe that Japanese firms, which have strength in environment-related technology, could and should make a valuable contribution on this front. From the policy framework perspective, it is also imperative that each influential economy maintain sufficient exchange rate flexibility. Under economic and financial globalization, inflexibility of exchange rates may trigger abrupt changes in international capital flows and increase the burden of monetary and prudential policies. In this regard, I truly welcome recent efforts Asian countries have made to enhance exchange rate flexibility. Second, with regard to financial stability policy, we are still struggling with the question of reconciling the borderless nature of globalized financial services and the national nature of financial intermediaries located within the border of a home-country sovereign state. If we look at the first half of the decade since 2000, or at western nations since the end of 19th century before the World War I, we can see that the periods of economic prosperity have BIS central bankers’ speeches almost always coincided with big waves of globalization. Looking back at such history, we cannot avoid further progress in globalization, for it would be the surest way to raise growth potential for advanced economies which are faced with unfavorable demographics and for emerging Asia which is trying to raise living standards further. As a financial aspect of larger economic globalization, we cannot escape from financial globalization either. Moreover, since money is scalable and can now move beyond borders instantly at an extremely low cost, it is little wonder if financial globalization goes further in future. On the other hand, financial service providers cannot be free from their home country’s “nationality” no matter how far financial services themselves are globalized, as long as the current system of national borders is maintained. There have been debates on whether these providers could or should be saved in an emergency at the cost of taxpayers in a specific jurisdiction. Ultimately, the perceived quality of debt issued by financial institutions cannot be separated entirely from the credibility of their home country and the resilience of its regulatory and supervisory framework. At the very least, in order to perform their functions sufficiently, financial service providers must be backed up by public confidence under institutional frameworks such as home country’s effective supervision. In fact, we see some signs of “re-nationalization” of funds under the current financial environments. At present, under the initiative of G20 and Financial Stability Board, policymakers are discussing various issues stemming from tensions between financial globalization and sovereign states, such as cross-border resolution of globally active financial institutions. Indeed, this issue is a quite big challenge for policymakers now. Third, it is also important to further promote mutual understanding of different national economies and financial structures. As I already mentioned, the resilience of Asian economy played a key role in preventing global economy from falling into a deep and prolonged slump. As this fact illustrates, global economy would be more vulnerable to shock when it consists of homogeneous countries in terms of economic structure and policy framework than when it is a hybrid system embracing diversity. In spite of the development of information technology and strengthened linkages among global economy, various “differences” among countries and regions are likely to continue existing at least for a foreseeable but substantially-long period of time. Nonetheless, creative concepts, innovations and sources of growth will emerge from new linkages between such economic diversity. Since we are living in a world of diversified economies, there should also be various forms of linkages, ranging from an ultimate form of currency union to much looser ties. Thus, it is important for policymakers to seek the most appropriate form and combination of linkages, taking differences in economic structures and nations’ development stage fully into account. In addition, at the occasion of international discussions, constructive dialogue is needed to foster a mutual understanding of such differences and to learn from one another. The economies of advanced countries tend to be affected by common economic cycles, and thus, their policy discussions inevitably tend to focus on similar themes such as the “Great Moderation”. In this regard, the developments in Asian and other emerging countries are adding diversity to the world economy, and their fresh viewpoints will enable policymakers to explore new frontiers of policy debates. 5. Conclusion In my speech today, I have sought to explain my current thinking given the deepening linkage among Asia and across the Pacific. Before concluding my speech, I would like to refer to one issue to which we might need to pay attention as financial linkages within this economic area continue to deepen. That is, the issue of time zone differences. BIS central bankers’ speeches You are now watching me live, with only a slight time lag as video signals are transmitted from Tokyo to San Francisco. That said, it is the 12th of June for me, which is tomorrow for you, and I am actually talking to you from “the island of the day after” over the International Date Line. For you, my speech is being delivered on the 11th of June, but my diary shows this important speech is scheduled for the 12th of June. We are communicating across the Pacific in real time, but the dates in our minds are different. As for the dates of a speech, I can rely on my secretary to ensure that there is no misunderstanding. However, when it comes to finance, dates mean a lot more. Suppose I am committed to sending money to some of you two days from now. Should the money reach the recipient on the 13th, or on the 14th? Moreover, if both sides take account of mutual weekends, there are only 4 days in a week when transactions can be processed. These problems could probably be solved by laying down rules beforehand. Still, complicated issues could arise in terms of risk management, including when bankruptcy procedures are set in motion. The foreign exchange settlement risks associated with time zone differences have been substantially reduced by CLS settlement. Nonetheless, many of the currencies of emerging economies are not yet available for CLS settlement (Chart 16). The example I have used today is seemingly a small problem. Nonetheless, through solving these practical problems one by one the world will become closer to a seamless economy and the global economy including Asia-Pacific region will become able to realize its full potential. In this regard, I sincerely hope that the discussions held in this conference will constitute another step in the right direction. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the 77th meeting of the Society for the Economic Studies of Securities, Tokyo, 9 June 2012.
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Sayuri Shirai: Europe’s economic and financial developments and monetary policy in Japan Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the 77th meeting of the Society for the Economic Studies of Securities, Tokyo, 9 June 2012. * I. * * Introduction Good afternoon, members of the Society for the Economic Studies of Securities. My name is Sayuri Shirai, and I am a Policy Board member of the Bank of Japan. It is indeed a great honor and a pleasure for me to give a talk at this esteemed society. Today, I would like to focus on Europe, which is the common theme of today’s meeting, with the greater emphasis being on the euro area, where developments have shown considerable uncertainty over recent months. First, let me briefly outline the content of this presentation, which will consist of four parts. I would like to begin by describing recent changes seen in the euro area. Next, I will summarize my view on the fundamental issues facing the euro area. Following that, I will review the region-wide responses to the European sovereign debt crisis. In the final part, I would like to summarize recent economic and price developments in Japan, the impact of the European sovereign debt crisis on the Japanese economy, and Japan’s monetary policy and related developments.1 I very much look forward to a lively discussion with you after my talk. II. Changes in the political situation and greater emphasis on growth – two recent transformations in the Euro Area As we are all aware, global financial markets have been nervous in recent months following a period of some easing of strains in the first quarter of 2012. I believe that two important changes have been associated with the recent enhanced sensitivity of global financial markets: one is changes in the political situation; the other is growing focus on growth, the interpretation of which appears to be somewhat different from what it was in the past. Recent changes in the political situation With regard to political changes, I view the first event in the euro area as having been the collapse of the coalition government in the Netherlands on April 23, 2012. This occurred as a result of disagreement over budget cuts. That dispute emerged because then-Prime Minister Mark Rutte had stressed the need for additional budget cuts in order to meet the 3-percent fiscal deficit target – the common target set by the EU – by 2013. However, his minority coalition partner, the Freedom Party, rejected the proposal and demanded that the target year be postponed. As you are aware, the Netherlands is one of the “core” countries of the EU,2 which are known for having achieved favorable macroeconomic performance over a long period. Prior to the global financial crisis of 2008–09, the fiscal balance of the Netherlands had recorded a surplus, and the ratio of sovereign debt to GDP had remained below the EU’s 60-percent threshold. Since the crisis, the fiscal balance has shifted to a deficit, with a peak of 5.5 percent of GDP in 2009; however, the Netherlands managed to The data used in this speech cover the period up to June 6, 2012. Here, I refer to Germany, Austria, the Netherlands, and Finland as the core countries. All these countries enjoy current account surpluses and a very high-grade credit rating on their sovereign bonds. BIS central bankers’ speeches reduce that to 4.6 percent by 2011. Owing to the continued fiscal deficit, the sovereign debt to GDP ratio has risen to 65.2 percent, though this is well below the euro-area average of 88 percent. Moreover, the Netherlands is, like Japan, a net external creditor nation, thanks to its accumulated current account surpluses – a phenomenon that is in contrast with the “peripheral” countries of the EU. The unemployment rate in the Netherlands is also low at around 5 percent. Therefore, I was genuinely surprised by the news about the political turmoil. This event reminded me that fiscal austerity measures are painful even for the core countries, and the Dutch public felt frustrated about the recession that had continued over three consecutive quarters from July to September 2011 and the resultant rising unemployment rate. On April 26, nonetheless, the Dutch government managed to produce an agreement with some opposition parties on austerity measures worth around €12.4 billion in 2013 to meet the 3-percent target; however, the Dutch general election is scheduled to take place in September. The next regime change took place in France – the second-largest economy in the euro area – and that event surprised the world. The first round of voting in the presidential election was held on April 22, 2012, in which Mr. François Hollande, the candidate for the Socialist Party, took a lead over Mr. Nicolas Sarkozy, the incumbent president and candidate for the Union for a Popular Movement. During the election campaign, Mr. Hollande promised to renegotiate the terms of the EU Fiscal Compact, which was signed by 25 of the 27 EU member countries in March 2012.3 Like Mr. Sarkozy, he is also committed to meeting the 3-percent fiscal deficit target in 2013 and subsequently balancing the budget by 2017. Mr. Hollande’s plan was to achieve this by, for example, imposing a tax on financial transactions, introducing a 75-percent income tax on earnings above €1 million euros, and raising the corporate tax on the biggest companies to 35 percent, while reducing taxes on small and medium-sized enterprises (SMEs) and scrapping a value-added tax (VAT) increase proposed by Mr. Sarkozy. Mr. Hollande has also promised to expand public spending by such efforts as raising state spending, reducing the retirement age to 60 years for those having worked more than 41.5 years, hiring 150,000 youths in state-subsidized jobs, and hiring more teachers and police officers. In the second round of presidential voting held on May 6, Mr. Hollande won the first vote and became the country’s first socialist president in 17 years. The market now appears to have adopted a wait-and-see attitude before it judges the credibility of his fiscal consolidation plan as well as the fate of the Fiscal Compact. The biggest political change occurred in Greece after the general election held on May 6, 2012, in which the Panhellenic Socialist Movement (PASOK) and New Democracy (ND) – who had joined in a grand coalition in November 2011 headed by Mr. Lucas Papademos, the former European Central Bank (ECB) vice-president – lost by wide margins. Since no political party won an absolute majority of seats, President Karolos Papoulias attempted to offer successive exploratory mandates to the leaders of the three main parties in accordance with the constitution. However, each party ended up failing to form a government and returning their mandates to the president. After the president had failed in his final attempt to form a government after meeting all party leaders, it was decided that Mr. Panagiotis Pikrammenos, head of the Council of State, would become the leader of a caretaker administration until a new election could take place on June 17. The result of the Greek election intensified the nervousness of markets amid fears that a new government other than The Fiscal Compact is an intergovernmental treaty signed by all the EU members except the Czech Republic and the United Kingdom on March 2, 2012. The compact is expected to go into force on January 1, 2013 if 12 members of the euro area ratify it by that time. According to the compact, the structural fiscal deficit must not exceed 0.5 percent of GDP, and this fiscal rule has to be specified in each country’s national legal system at least at the statutory level, although some deviation may be permitted under exceptional circumstance. The rule contains an automatic correction mechanism in the event of deviation, with a possible penalty equivalent of up to 0.1 percent of GDP. According to the enhanced Stability and Growth Pact, moreover, countries whose sovereign debt exceeds the 60-percent threshold level should reduce it at an average rate of 1/20 per year as a benchmark. BIS central bankers’ speeches PASOK and/or ND could reject the fiscal consolidation and economic reform programs already agreed with the troika – the European Commission, the International Monetary Fund (IMF), and the ECB. Greece would thus fail to receive its scheduled financial support, thereby leading to the collapse of the government administration and a possible exit from the euro area. Increasing attention on growth Against the background of these political changes, I noticed that a second type of change has occurred in recent months: a number of key policy players have begun to actively use the key word “growth,” though in a different context from how it was used in the past. For example, ECB President Mario Draghi stressed the need of a Growth Compact in addition to the already-agreed Fiscal Compact on April 25, 2012. On May 3, he subsequently elaborated the idea of a Growth Compact by proposing the following: (1) an increase in the involvement of the European Investment Bank (EIB) and a redirection of EU structural funds toward the low-income areas; and (2) prioritizing an expenditure cut (especially a cut in current, rather than investment, expenditure) over a tax increase.4 On May 5, European economics commissioner Olli Rehn made remarks somewhat similar to those of Mr. Draghi and stated that the EU needs to increase public investment to promote growth and jobs in the region. Mr. Rehn said it should do so by creating project bonds for infrastructure development (as proposed by the European Commission in October 2011), increasing the lending capacity of the EIB, and improving accessibility of EU structural funds for guaranteeing lending to SMEs. Mr. Rehn also stressed that, based on economic analysis, the Stability and Growth Pact contains considerable scope for judgment regarding public deficit and debt and also that its legal provisions applied to excessive deficit procedure; he encouraged countries with fiscal surpluses to boost public spending. On May 8, European Commission President Barroso announced a plan to expand infrastructure investment in the EU by, for example, issuing project bonds by June 2012. Regarding the feasibility of a renegotiation of the Fiscal Compact, Mr. Jean-Claude Juncker, head of the Eurogroup, has taken a balanced position between the demand by Mr. Hollande to renegotiate the compact and resistance to this by Ms. Angela Merkel. On May 7, Mr. Juncker declared that it would not be possible to renegotiate the Fiscal Compact, although it would be possible to add growth elements, but not necessarily in the form of a treaty. Reflecting these new moves, EU President Herman Van Rompuy called for an informal European Council (EU summit) to be held on May 23 to discuss the balance between growth and fiscal austerity measures. EU’s approach to growth thus far The question emerges as to why the growth agenda has now suddenly become a focus of attention. Does it mean that previously the EU had barely paid attention to the issue? It is clear that the EU has been tackling the issue of promoting growth together with fiscal consolidation over the past few years. As you may recall, for example, the European Council in June 2010 adopted the growth strategy called “Europe 2020,” whereby each member country had to undertake structural reforms toward strong, sustainable recovery. The strategy also targeted EU needs to better focus on boosting Europe’s competitiveness, productivity, growth potential, and economic convergence to deliver more growth and jobs. This approach over fiscal consolidation has gained some support in recent years. For example, World Economic Outlook compiled by the IMF (2010) stresses that fiscal contraction that relies on spending cuts tends to have smaller contractionary effects than tax-based adjustments. This is partly because central banks usually provide substantially greater stimulus following a spending-based contraction than after a tax-based contraction. Monetary stimulus is particularly weak following indirect tax hikes (such as VAT), which raise prices. BIS central bankers’ speeches Accordingly, five headline targets were agreed to as common objectives for guiding the action of member countries.5 In line with this approach, the EU introduced a so-called “European Semester” in 2011, whereby each member country submitted a medium-term budgetary strategy and a National Reform Program to the European Commission for assessment. The commission then published a country-specific report on detailed policy recommendations, covering fiscal consolidation and structural reforms. Moreover, the EU introduced the “Macroeconomic Imbalance Procedure (MIP)” in December 2011, which, as the name suggests, is a surveillance mechanism that aims to prevent and correct macroeconomic imbalances within the EU. This alert system uses a “scoreboard” of 10 indicators as well as detailed country studies. Each indicator is given a threshold, so a large divergence in each country’s performance from the threshold functions as a warning signal.6 As in the original “Excessive Deficit Procedure,” which was applied to the size of fiscal deficits, strict rules come into effect in the event of a large divergence in the form of a new “Excessive Macroeconomic Imbalance Procedure (EIP)”; this carries a possible financial penalty of up to 0.1 percent of GDP for euro-area member countries. The decision-making process in the new regulations will employ reverse qualified majority voting to make all the appropriate relevant judgments before a penalty is introduced. This semi-automatic procedure makes it difficult for member countries to form a blocking majority. In February 2012, the European Commission disclosed the first Alert Mechanism Report. Of the 27 EU member countries, those that are already under enhanced economic surveillance – Greece, Ireland, Portugal, and Romania – were exempted from examination under the macroeconomic imbalances. The report indicated that 12 countries – Belgium, Bulgaria, Denmark, Spain, France, Italy, Cyprus, Hungary, Slovenia, Finland, Sweden, and the United Kingdom – bore some potential risk related to macroeconomic imbalances and thus warranted further detailed analysis.7 According to the report, Spain, for example, will take time to correct its external and internal imbalances despite the efforts being made to rectify its imbalances owing to the sheer size of the internal and external debt. It has also been pointed out that a fall in employment linked to downsizing in the construction sector and the economic recession has been aggravated by a sluggish adjustment of wages. At the end of May 2012, the commission confirmed that the 12 countries need to correct the large macroeconomic imbalances and that the adjustment process should be closely monitored. The five targets were as follows: (1) an increase of the employment rate for women and men aged 20–64 to 75 percent; (2) achieving combined public and private R&D investment levels to 3 percent of GDP; (3) reducing greenhouse gas emissions by 20 percent compared with 1990 levels; (4) reducing school drop-out rates to 10 percent and increasing the proportion of the population aged 30–34 having completed tertiary or equivalent education to 40 percent; and (5) promoting social inclusion, particularly by reducing poverty and aiming to lift at least 20 million people out of the risk of poverty and exclusion. The 10 indicators are divided into two areas: external imbalances and competitiveness, and internal imbalances. The external imbalances and competitiveness comprise the following: (1) three-year average of current account balance as a percent of GDP (with an indicative threshold of between plus 6 percent and minus 4 percent); (2) net international investment position as a percent of GDP (minus 35-percent lower quartile); (3) three-year percentage change in real effective exchange rate (between plus and minus 5 percent); (4) five-year percentage change in export market shares (minus 6-percent lower quartile); and (5) three-year percentage change in export market shares. The internal imbalances comprise the following: (6) year-on-year change in deflated house prices (plus 6-percent upper quartile); (7) private sector credit flow as a percent of GDP (plus 15-percent upper quartile); (8) private-sector debt as a percent of GDP (160-percent upper quartile); (9) general government debt as a percent of GDP (60 percent); and (10) three-year average of the unemployment rate (10 percent). The report concludes that the following countries do not require a further detailed review: the Czech Republic, Germany, Estonia, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Austria, Poland, and Slovakia. BIS central bankers’ speeches Background to the refocus on growth Thus, it could be said that greater efforts have been made over recent years at the EU level to boost growth and competitiveness. Why, then, has the question of growth been discussed so intensively over recent months? In general, boosting growth requires the implementation of various structural reforms (Chart 1). And some peripheral countries have only just launched some needed structural reforms and are thus far from being in a position of completing them. The answer to this question may be associated with public anxiety because some reforms may be accompanied by social transformation and short-term economic suffering, such as wage restraints, job losses, and profit losses in protected sectors. Moreover, the public may become frustrated by fiscal austerity measures that end up squeezing domestic absorption and promoting deleveraging of the banking sector in the short term; this is because it takes time to realize long-term gains, such as an improvement in credibility and a cut in long-term interest rates. Furthermore, sluggish growth in the rest of the world has not generated sufficient external demand for the euro area that could offset the shrinkage in domestic demand driven by the collective acts of fiscal consolidation. In addition, it is important to recognize that the context of growth has shifted from improving competitiveness, which could be achieved in the medium to long term, to moderating short-term pains caused by austerity measures implemented during the economic recession. Various interpretations related to growth Despite the above reasoning, it is my impression that the word “growth” is interpreted differently from the way it was in the past and by the people employing the term. It appears that there are at least three types of interpretation.8 According to the first interpretation, the EU should expand its region-wide infrastructure investment by issuing project bonds and more actively utilizing EIB and EU structural funds to mitigate the adverse impact of fiscal austerity measures adopted by a number of member countries. The second interpretation holds that the current fiscal consolidation schedule could be slowed down – for example, by extending the target year for fulfilling the 3-percent fiscal deficit goal if the situation allows it.9 With this interpretation, the better mix of revenue-generating and expenditure-reducing measures is also stressed. According to the third interpretation, structural reforms should be prioritized so as to effect an immediate positive impact on growth and employment. This latter option may help reduce the sense of exhaustion with austerity programs that some countries have experienced. However, I believe that these interpretations do not rule out the structural reforms needed for boosting growth in each country. Some action has recently been associated with the first interpretation. On May 23, the informal European Council agreed that the board of the EIB would be invited to consider an increase of its capital by June for financing projects across the EU. The previous day, political agreement was also reached by the Council of the EU, European Commission, and Parliament with regard to the pilot phase of the project bonds. Based on the guarantee of €230 million from the EU budget, project bonds could possibly finance up to €4.6 billion of key infrastructure projects in the areas of transport, energy, and Other proposals include Eurobonds, which would be issued jointly by euro area member countries by pooling their debt. This idea was rejected by Ms. Merkel in 2011, but it was brought up again by Mr. Hollande at the European Council on May 23, 2012. While Eurobonds could be a long-term strategy for integration, Ms. Merkel stressed that they would reduce incentives for countries to contain their fiscal deficits. Recently, the European Commission addressed an idea of a banking union, with integrated financial supervision and a single deposit guarantee scheme. The idea of a uniform deposit guarantee scheme was proposed and rejected by member countries a few years ago. It would appear to require quite some time before this proposal can be agreed upon. On May 2012, the European Commission suggested, for example, that Spain, France, the Netherlands (the impact of an additional deficit cut agreed at the end of April was not taken into account), Slovenia, and Slovakia might not meet the 3-percent fiscal deficit target unless additional measures were undertaken. BIS central bankers’ speeches communications.10 The second interpretation, or a moderation of the fiscal consolidation schedule, might be feasible if a country could present a credible medium-term plan. But this may not be possible for some peripheral countries owing to a lack of market confidence. On this issue, the European Commission made an initial move with Spain by suggesting a possible extension of one year on the schedule for meeting the 3-percent fiscal deficit target to 2014 – on condition of improved expenditure control over local governments and the submission of a credible two-year budget plan for 2013–14. III. Three fundamental issues related to the Euro Area So far, I have discussed recent changes in the political situation and the increased focus on growth in the euro area. My observation is that those changes reflect deeper fundamental issues pertaining to the region: (1) issues arising from accumulated current account imbalances; (2) issues related to the savings-investment gaps that constitute the current account imbalances; and (3) issues arising from accumulated fiscal imbalances. These issues are of course interconnected, but the distinction may assist in understanding the fundamental problems that the region faces. Accumulated current account imbalances Regarding the first fundamental issue, the current account imbalances have expanded in the euro area since the adoption of the euro (Chart 2). Thanks to an elimination of exchange-rate risk and a decline in inflation differentials, peripheral countries – such as Greece, Ireland, Portugal, and Spain – gained access to considerable financial resources from the region at substantially lower interest rates than before. In real terms, their interest rates were lower than those of the core countries. Cheap external finance enabled the peripheral countries to swell their net external debt (Chart 3).11 Major financiers to the peripheral countries were largely concentrated in the core countries (with current account surpluses) and France. Since capital inflows to the peripheral countries mostly took the form of bank loans and bond issues, the growing net external debt made those countries more prone to changes in investor sentiment. In retrospect, if those countries had allocated the external financial resources toward more productive investment and investment leading to a shift to higher-value-added economic structure, they could have improved their economic productivity and enhanced international competitiveness. Subsequently, this would have enabled those countries to repay their external debt by gradually shifting to current account surpluses. Instead, the capital inflows largely financed domestic consumption and the real estate and construction sectors (although this comment does not necessarily fully apply in the case of Ireland, where a number of high-technology multinational firms have been operating). Thus, the foreign borrowing did not promote sustainable economic growth or contain external debt growth (Chart 2). To reduce net external debt, it is necessary to achieve a current account surplus. At this stage, only Ireland, whose current account deficit was initially small, has succeeded in achieving a current account surplus. It is fair to say that the other countries have made efforts to reduce their current account deficits – at the scale of around 5 percentage points or more of GDP in the case of Greece and Spain and 4 percentage points in Portugal during the period of 2007–11. Nonetheless, it will be some time before these three countries could achieve current account surpluses, and so their net external debt The EIB will manage the project. If the EIB could guarantee the project bonds, more bonds could be issued on the market. Private sector participation would also be expected. Italy is not included in this analysis, because its current account to GDP ratio is small and its net external debt to GDP remains below the indicative threshold of 35 percent specified under the macroeconomic imbalance procedure. Its primary fiscal balance is in surplus, although its government debt to GDP ratio is large. BIS central bankers’ speeches is unlikely to decline soon. In other words, the external imbalance on a stock (debt) basis will remain for the time being. Meanwhile, among the core countries, Finland reduced its current account surplus to GDP ratio by 5 percentage points over the same period, though Germany, Austria, and the Netherlands barely reduced their current account surpluses. In particular, the current account surplus to GDP ratio remains high in Austria (around 2 percent), Germany (around 5 percent), and the Netherlands (over 7.5 percent). This enables these core countries to further accumulate their net external assets. In other words, the surplus countries have continued to accumulate net external assets, and the deficit countries net external debt – despite some emerging improvements over the current account imbalances in the euro area (Chart 3). I believe that this partly explains why the debtor peripheral countries currently find it difficult to resume adequate private-sector-based capital inflows despite their adjustment efforts. Growing savings-investment gaps With respect to the second issue listed above – savings-investment gaps – the savings–GDP ratio (hereafter, saving rate) showed a declining trend in the four peripheral countries before the global financial crisis. The scale of the decrease was greatest in Greece followed by Portugal (Chart 4). It could be said that Greece and Portugal allocated a large part of their capital inflows to both private and public consumption (such as public pay, pensions, and medical care). Owing to the tendency for Germany to increase the saving rate, the current account imbalances between Greece and Portugal, on the one hand, and Germany, on the other, could be explained primarily by the difference in saving-rate patterns. However, the saving rates of Ireland and Spain were not very different from that of Germany: Ireland and Spain increased the investment-GDP ratios (hereafter, investment rates), while that of Germany remained at a low level. Thus, the current account imbalances between Ireland and Spain, on the one hand, and Germany on the other, could be attributed largely to the difference in investment patterns (Chart 5). An increase in the two countries’ investment rates reflected a boom in real estate and construction investment. It is a well-known fact that those two countries underwent rapid real estate price appreciation prior to the global financial crisis. Since the global financial crisis erupted, all four peripheral countries have faced a decline in their saving rates. This implies that the improvement in the current account balances, as indicated earlier, arose solely through a sharp decrease in the investment rates. This was particularly the case in Ireland, where the drop in real estate prices was more drastic than in Spain and which experienced the sharpest decline in the investment rate. However, the decline in the investment rates for the other three countries has also been great. Given that the four peripheral countries have suffered from a substantial fall in investment, it is understandable that the idea of expanding EU-wide infrastructure-investment projects to offset the adverse impact of austerity measures has been widely stressed recently, as noted earlier. Growing fiscal imbalances On the third fundamental issue listed above – that related to accumulated fiscal imbalances – Greece was the only country where the size of the fiscal deficit was large and whose general government debt as a share of GDP exceeded 100 percent even before the global financial crisis (Charts 6, 7). In Ireland and Spain, the ratio of general government debt to GDP remained below the 60-percent target thanks to their accumulated fiscal surpluses. Portugal had been poised to bring its fiscal deficit–GDP ratio down toward the 3-percent target prior to the global financial crisis, and so its general government debt–GDP ratio remained at around 70 percent. Since the global financial crisis, the fiscal balances of most euro-area countries have deteriorated because of the implementation of fiscal-stimulus policies and measures to bail BIS central bankers’ speeches out the banking sector. The size of deterioration of the fiscal balance between 2007 and 2011 reached minus 2.6 percentage points in Greece, minus 13.2 percentage points in Ireland, minus 1.1 percentage points in Portugal, and minus 10.4 percentage points in Spain. By contrast, the deterioration in Germany’s fiscal deficit–GDP ratio was a mere 1.2 percentage points over the same period, which contributed to the widening gap in fiscal balances in the euro area. Moreover, Germany’s fiscal deficit–GDP ratio is already below the 3-percent target and, according to the European Commission, the ratio is projected to drop to around 1 percent in 2012 and reach a balance by 2013. Germany achieved more than 3 percent economic growth for 2010–11, and its unemployment rate dropped to a historical low of 5.6 percent. These favorable outcomes have helped Germany conduct fiscal consolidation without having to introduce drastic measures to cut its fiscal deficit. Meanwhile, the peripheral countries are obliged to contain their fiscal deficits further to prevent overall government debt from swelling. Since Germany faces a decline in the ratio of general government debt to GDP in the near future, this means that the internal imbalances on a stock (debt) basis are likely to expand in the region. IV. Assistance at the EU or Euro-Area level Given this background, the peripheral countries, rather than the core countries, are expected to make greater economic adjustments, such as fiscal consolidation and structural reforms. Some of these reforms will take time and cause hardship before they bear fruit. To mitigate the adverse impact of the adjustments, financial assistance at the EU or euro-area level is necessary. This is especially true for the peripheral countries because of their lack of private-sector capital flows. Without regional or international financial support, such countries would have been forced to squeeze domestic absorption so drastically that the public would have had to go through intolerable suffering – notwithstanding that a correction could have been made more rapidly for both the internal and external imbalances. First recipient of international financial assistance – Greece As is well known, Greece was the first country in the euro area to receive international financial assistance. The total amount was set at €110 billion in the first round of assistance, which was agreed to be shared between the euro-area member countries (€80 billion) and the IMF (€30 billion). Since the general government debt for Greece had been growing rapidly, the idea of private-sector involvement (PSI) gained favor in the euro area. After negotiations, a large number of private sector creditors finally agreed to voluntarily accept restructuring of the Greek debt. This PSI took place before the completion of the first round of financial assistance scheduled for Greece and was regarded as a precondition for the second round of financial assistance.12 The total amount for the second round of assistance was set at €172.7 billion, including undisbursed amounts from the first program. The cost was agreed to be borne by the euro area (€144.7 billion) mainly through the platform of the European Financial Stability Facility (EFSF) and the IMF (€28 billion). The contribution from the euro area included the amount related to the PSI incentive and bank recapitalization. Newly established financial support system in the Euro Area It will be recalled that the Greek sovereign debt crisis had a contagious effect on other peripheral countries such as Ireland and Portugal. As a result of the contagion, these countries found it difficult to raise funds in the market and thus asked the EU, the euro area, The PSI ended up covering €205.6 billion, including both Greek and foreign law sovereign bonds, and the rate of participation reached 97 percent as of the end of April 2012 as a result of applying collective action procedures to the Greek law bonds. With the PSI and additional international financial assistance, Greece’s general government debt ratio is expected to decline to below 120 percent of GDP by 2020. BIS central bankers’ speeches and the IMF for financial support – in November 2010 in the case of Ireland and in May 2011 in the case of Portugal.13 The EFSF was established by the euro area following the decisions made in May 2010, and it began operations in August 2010. It is backed by guarantee commitments of €780 billion from the member countries and has a lending capacity of €440 billion. In November 2011, furthermore, it was agreed to increase the EFSF’s power by (1) providing partial protection certificates to a sovereign bond issued by member countries, and (2) creating a coinvestment fund to purchase sovereign bonds in primary and secondary markets. To prevent contagion of the sovereign debt crisis to other larger member countries, the euro area decided to create a permanent crisis mechanism called the European Stability Mechanism (ESM). The ESM, which will become operational in July 2012, will take over all the features of the EFSF and have a maximum lending capacity of €500 billion, based on the paid-up capital of €80 billion. Both the EFSF and ESM will coexist until the EFSF expires in mid-2012. The new treaty to create the ESM was signed in February 2012. The decisions to grant stability support are generally taken by mutual agreement, but in the case of urgency they could be decided by a qualified majority of 85 percent of the votes cast. In addition, the IMF has made efforts to raise funds globally in an effort to establish sufficient power to be able to deal with a potentially contagious crisis arising from Europe. At the G20 summit of April 2012, the IMF announced that it had raised more than $430 billion, including contributions from the euro area ($200 billion) and Japan ($60 billion). Although not all of the IMF funds will be available to Europe, it certainly reduces uncertainty related to the issue of how to handle larger countries, such as Italy and Spain, in the case of contagion. ECB monetary policy as a crisis response In response to the recent sovereign debt crisis, the ECB has adopted a series of measures since the middle of 2011. After having raised its policy rate or the interest rate on the main refinancing operations from 1 percent to 1.5 percent by raising 25 basis points each in April and July 2011, the ECB reduced the rate back to 1 percent by cutting 25 basis points each in November and December. Other recent measures included US dollar liquidity-providing operations, a cut in the reserve ratio, a modification of collateral requirements, fixed-rate longer-term refinancing operations (LTROs) with full allotment, a securities market program, and a covered-bond purchase program. Among these measures, two notably appear to have contributed substantially to the stabilization of global financial markets: (1) the US dollar liquidity-providing operations, and (2) the LTROs with a maturity of 36 months. The ECB has been conducting US dollar liquidity-providing operations as part of coordinated actions with five other central banks to address pressures in the global money markets: namely, the Bank of Canada, the Bank of England, the Bank of Japan, the Federal Reserve, and the Swiss National Bank (Chart 8). The new action emerged in November 2011 as a response to the growing strains in US dollar financial markets. These central banks agreed to lower the pricing on the existing temporary US dollar liquidity swap arrangements by 50 basis points so that the new rate would be the US dollar Overnight Index Swap rate plus 50 basis points. At the same time, it was agreed that these swap arrangements would be extended to February 1, 2013. As a contingency measure, these central banks agreed to establish temporary bilateral liquidity swap arrangements so that liquidity could be provided in each jurisdiction in any of their The amount of financial assistance for Ireland amounted to €67.5 billion, which was received from the EFSF (€17.7 billion), European Financial Stabilization Mechanism (EFSM; €22.5 billion), and IMF (€22.5 billion), and included bilateral assistance from the United Kingdom, Denmark, and Sweden (€4.8 billion). The assistance for Portugal amounted to €78 billion, from the EFSF (€26 billion), ESM (€26 billion), and IMF (€26 billion). The EFSM is a financing facility for EU member countries with a lending capacity up to €60 billion based on borrowing on the market by the European Commission. BIS central bankers’ speeches currencies if necessitated by market conditions. In particular, the cut in the interest rate on the US dollar liquidity-providing operations succeeded in substantially lowering the cost of swapping euros for US dollars (Chart 9). Furthermore, the decline in the US dollar funding cost encouraged many European banks having difficulty in raising funds from the market to borrow directly from the ECB, thereby preventing forced fire sales of assets and a cut in loans denominated in the US dollar. The second measure contributing to the stabilization of the financial market was the LTROs with a maturity of 36 months, which were conducted on December 21, 2011 and February 28, 2012. On December 8, 2011, the ECB decided to reduce the reserve ratio and modify collateral requirements together with an announcement of the three-year LTROs. The reserve ratio was reduced from 2 to 1 percent as of the reserve maintenance period, starting on January 18, 2012. To increase collateral availability, the ECB decided to reduce the credit-rating threshold for certain asset-backed securities and, as a temporary solution, allow national central banks to accept as collateral additional performing credit claims (i.e., bank loans) that satisfied specific eligibility criteria. In allowing the application for the three-year LTROs, the modification of the collateral requirements can be regarded as having contributed to easing the funding situation of European banks caused by the shortage of eligible collateral. As a result, the LTROs succeeded not only in lowering the euro-denominated funding costs in the money markets, but also bringing down the spread of the yields on Portuguese, Spanish, and Italian sovereign bonds vis-à-vis German bonds. In addition, the LTROs helped promote the issuance of senior unsecured bank bonds (Charts 10–13). Thus, it is widely regarded that the LTROs prevented a bank funding crisis and thus deleveraging on a massive scale. Recent Developments in Financial Markets Since uncertainty over European political and economic developments has intensified over recent months, some interest rates have risen accordingly. Nonetheless, the scale of the increase in the US dollar funding cost borne by European banks, for example, has so far been modest compared with the situation prior to the new arrangement related to the US dollar liquidity-providing operations at the end of November 2011 (Chart 9). Likewise, the euro-denominated funding cost in money markets has remained calm (Charts 10, 11). Meanwhile, the spreads of the yields on Portuguese, Spanish, and Italian sovereign bonds vis-à-vis German bonds have risen, as has the Greek spread; this was partly owing to the decline to the record low level of the yield on German sovereign bonds (Chart 13). The Spanish banking sector faces a surge in the credit spread over its financial bonds, which reflects recent growing concerns over the soundness of that banking sector (Chart 14). Stock prices are generally showing declining trends as a reflection of European sovereign debt problems and concerns over the global economic slowdown (Chart 15). Given the sensitivity of market developments, I will continue to watch closely the impact of European political and economic developments on global financial markets. V. Impact of European sovereign debt problems on the Japanese economy and monetary policy of the Bank of Japan (the Bank) I would now like to move to the final part of my presentation, and I will begin by summarizing recent economic and price developments. Outlook on economic activities and prices with risk factors Recently, it has become increasingly evident that the Japanese economy is shifting toward a pick-up phase, although economic activity has remained more or less flat (Chart 16). With regard to outlook, the Japanese economy is expected to return to a moderate recovery path in the first half of fiscal 2012. This is likely since the pace of recovery in overseas economies BIS central bankers’ speeches should gradually improve – led largely by the emerging economies and reconstruction-related domestic demand in the post-Great East Japan Earthquake period. In fiscal 2013, Japan’s economy is expected to maintain its growth at a pace above its potential as overseas economies continue to achieve relatively high growth. However, the economic growth rate is expected to be somewhat lower than in fiscal 2012 because the positive effects from reconstruction-related domestic demand are likely to gradually diminish (Chart 17). With regard to prices, developments in the consumer price index (CPI; all items less fresh food) indicate that after reaching a historical trough of 2.4 percent in August 2009, the year-on-year rate of decline has continued to slow consistently since around the end of 2009. In recent months, that rate of change has been around 0 percent. In terms of the outlook for prices, the rate of change will remain in positive territory and show a gradual increase as the aggregate supply and demand balance is expected to continue improving with the moderate recovery. International commodity prices are currently bearish, partly reflecting concerns over the European sovereign debt problems; though these prices may follow a moderately rising trend owing to an expected increase in demand for food and energy in line with the growth in emerging economies. Assuming that medium- to long-term inflation expectations remain stable, the rate of change in the CPI is projected to gradually rise to a range of above 0.5 percent and less than 1 percent toward the second half of fiscal 2013. Thereafter, it will likely not be too long before the rate reaches the “price-stability goal in the medium to long term” of 1 percent for the time being, as specified in the statement released by the Bank of Japan (hereafter, Bank) in February 2012. The aforementioned outlook is the scenario the Bank considers to be the most probable: it is, in other words, its baseline scenario. As described in detail in the Outlook for Economic Activity and Prices, or the Outlook Report for short, the following four major risks concerning the outlook for economic activity warrant attention: (1) uncertainty related to developments in overseas economies; (2) uncertainty with regard to reconstruction-related domestic demand; (3) uncertainty associated with firms’ and households’ medium- to long-term growth expectations; and (4) issues related to Japan’s fiscal sustainability. Among those risks, I personally am particularly mindful of those relating to adverse spillovers of the European sovereign debt issues and political developments to the baseline scenario. There are mainly two types of price-associated risks. The first type concerns developments in firms’ and households’ medium- to long-term inflation expectations; the second type relates to developments in import prices. With this second type, the possibility exists that crude oil prices will surge, mainly as a reflection of geopolitical risk. If that does occur, Japan’s terms of trade will experience deterioration, which will squeeze firms’ profits and reduce households’ purchasing power, and ultimately it will have an adverse effect on the whole Japanese economy. Impact of European sovereign debt problems on the Japanese economy Concerning European sovereign debt problems, the impact can be ascertained mainly by means of three channels – international trade, finance, and exchange rates. With international trade, it would seem that the direct impact on Japan’s exports has been limited, given that exports to the euro area account for only around 10 percent (Chart 18). Rather, a more significant impact could be felt indirectly through a slowdown in trade and foreign direct investment activities in emerging countries, such as China, where the euro area represents one of the largest trade partners (Charts 19, 20). With regard to finance, the US dollar funding market and money markets remain calm. The US dollar funding cost remains low for Japanese banks since their exposure to the euro area has been limited and their balance sheets have been relatively sound. It is true, though, that Japanese banks faced a moderate increase in US dollar funding costs in the middle of the deepening European sovereign debt crisis from the middle of 2011. After the introduction of BIS central bankers’ speeches the new coordinated arrangement of the six central banks at the end of November, however, the US dollar funding market has remained calm, especially for Japanese banks (Chart 21). Money markets have also been relaxed (Chart 22). Long-term yields on Japanese government bonds (JGBs) have shown further deceleration thanks to increased demand for them as safer assets (Chart 23). Like European stocks, nonetheless, Japanese stocks are in decline (Chart 24). The direct impact of the European sovereign debt crisis has been felt mainly through exchange rates. Because of its current status as a safer currency, the yen tends to appreciate with intensifying strains in global financial markets (Chart 25). This suggests that changes in the risk-taking behavior of global investors have become closely associated with movements in exchange rates. Recent movements have shown that enhanced nervousness in global financial markets caused by resurgence of the European debt crisis has increased risk aversion among global investors and promoted the yen’s appreciation relative to mid-March this year. The yen has appreciated against the euro, partly because of the reversed interest rate differentials between German and Japanese bond yields with a remaining maturity of less than two years. If sustained, the yen’s appreciation may be detrimental to Japanese firms, adversely affecting their investment and production behavior and making it harder for the Japanese economy to recover. This perspective also makes me feel that developments in Europe demand careful attention. Conduct of monetary policy The Bank is naturally concerned about the long-term prevalence of deflation in the Japanese economy. On February 14 of this year, the Bank introduced “the price-stability goal in the medium to long term” – defined as the inflation rate consistent with price stability sustainable over the medium to long term. The purpose of this action was to promote public understanding of the Bank’s determination to overcome deflation. It was decided that the goal would be within a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI, and the goal was set at 1 percent for the time being. Moreover, the Bank made it clear that it would continue pursuing powerful monetary easing – through its virtually zero-interest rate policy and continued implementation of the Asset Purchase Program (hereafter, Program) – until it judged the 1-percent goal to be within sight; this was on condition that it identified no significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances. At the same time, the total size of the Program was raised by 10 trillion yen – from about 55 trillion to about 65 trillion yen (Chart 26). On April 27, the Bank decided to increase the total size of the Program further by about 5 trillion yen – from about 65 trillion to about 70 trillion yen – following changes in its composition, including the increase in the purchase of JGBs by about 10 trillion yen.14 Regarding the decision to enhance monetary easing in April, I would like to stress that a high degree of uncertainty remains in terms of the Bank’s assessment, as already explained. The positive signs in economic and price developments that have emerged in recent months do not necessarily imply that the baseline scenario will be realized as projected. Even though Moreover, the purchases of exchange-traded funds and Japan real estate investment trusts were increased by about 200 billion yen and 10 billion yen, respectively. The maximum outstanding amount of the Bank’s fixed-rate funds-supplying operation against pooled collateral with a six-month term was reduced by about 5 trillion yen, taking into account the recent episodes of under-subscription. In addition, the remaining maturity of JGBs to be purchased under the Program was extended from one to two years to one to three years. The same treatment was applied to the remaining maturity of corporate bonds to be purchased under the Program. In addition, it was decided that the schedule for increasing the outstanding amount of the Program to about 65 trillion yen by around the end of 2012 would be maintained. It was further decided to increase the outstanding amount of the Program to about 70 trillion yen by around the end of June 2013. BIS central bankers’ speeches the scenario may eventually materialize, it is still not certain how soon it may do so. Considering recent episodes, for example, there were some cases of the baseline scenario not having been fulfilled, even though the economy appeared to be on the track of sustainable economic growth and prices also initially appeared to be rising steadily. Therefore, the Bank decided to seize this occasion and further enhance monetary easing to better ensure the return of the Japanese economy to sustainable growth with price stability. As explained above, I believe this action also demonstrates the Bank’s determination to implement its monetary policy commitment. Tackling the long-term structural challenge Finally, I would like to address an issue commonly faced by a number of major central banks in advanced countries and regions: the extremely accommodative monetary environment has not necessarily led to increased domestic demand, such as investment and consumption, as much as had been expected (Chart 27). Though there are structural factors relating to this issue, their root causes are country- or region-specific and thus different from each other. In the case of Europe, the short-term depressing impact of the fiscal austerity measures and deleveraging of the banking sector, as explained earlier, make it difficult to increase bank lending for the moment. It is likely to be some time before the region starts to enjoy sustainable, favorable growth in lending activities. In the case of Japan, the working-age population has been in decline since the mid-1990s, and this has contributed to the decreasing trend in growth rates. To overcome deflation, it is thus important to stress the need to address Japan’s long-term structural challenges of diminishing growth rates amid a rapidly aging population. It is clear that we need to enhance productivity growth (of the working-age population) so as to overcome the depressing impact caused by the rapid pace of the decrease in the population and working-age population growth rates. However, it may be said that implementation of the necessary structural reforms for boosting growth and productivity has been sluggish, and the shift in economic structure has been limited. Issues related to mounting government debt and social security reforms have generated uncertainty over the future economic outlook. Moreover, a series of shocks – such as the global financial crisis, the Great East Japan Earthquake, the European sovereign debt crisis, and the 2011 Thai floods – also contributed to this outlook. These factors combined to deter expectations of further rises in growth by firms and households despite a very accommodative financial environment driven by monetary stimulus measures. To meet the diverse challenges that arise out of this background and establish a new basis for economic growth, Japanese firms need to become more innovative and competitive in an effort to add value to their activities and explore new sources of demand, both at home and abroad. The government also needs to support the business community by creating a more business-friendly environment. Financial institutions should strive toward strengthening the foundations for economic growth by giving financial support to innovative, viable firms and providing new types of financial and other services, which are increasingly under demand. Meanwhile, the Bank’s accommodative monetary policy will certainly shore up such private-sector activities through a steady decline in the cost of raising capital. By promoting longer-term economic growth, the Bank has helped sustain the business community indirectly: it introduced a fund-provisioning measure to help reinforce the basis for economic growth (Growth-Supporting Funding Facility) in 2010, and it has provided longer-term fixed-rate funds to financial institutions. This facility was expanded in March and April of this year (Chart 28). It should be emphasized that the goal of overcoming deflation will be achieved through such continuous, comprehensive efforts by firms, financial institutions, the government, and the Bank operating within their respective roles. In conclusion, I would like to express once more my gratitude to the Society for the Economic Studies of Securities for giving me this wonderful opportunity to make a presentation in front of its distinguished members. Thank you very much for your kind attention. And I wish you all every success in your work and further development in the Society. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the 8th Tokyo Beijing Forum, Tokyo, 2 July 2012.
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Hirohide Yamaguchi: European debt problem and its impact on Asia Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the 8th Tokyo-Beijing Forum, Tokyo, 2 July 2012. * * * Introduction Thank you for giving me an opportunity to speak at the 8th Tokyo-Beijing Forum. Today, I will talk about the European debt problem’s spillover to Asia and measures taken to address it. I. Essence of the European debt problem The European debt problem is a rapid correction process of three things which emerged under the unified currency euro, namely, excessive financial expansion, profligate fiscal spending, and ineffective economy. In the process, in the European Union (EU), mainly in Southern European countries, financial contraction, fiscal austerity, and economic stagnation occurred simultaneously, and an adverse feedback loop has been formed among the three. That adverse feedback loop is the essence of the European debt problem and when and how the loop can be cut off are the key to solving the problem. II. Future of the European debt problem While fiscal integration and financial integration have been under discussion within the EU toward a fundamental solution of the European debt problem, the discussions are likely to have a long and bumpy way to go. There seems to be two risks to the way. One is the so-called tail risk of international financial and capital markets tumbling into turmoil and the global economy deteriorating substantially. The other is strains in financial and capital markets might continue, albeit intermittently, and the global economy might not recover solidly. Of course, given the efforts by the countries concerned, the first risk can hardly manifest itself. However, there is not a remote possibility that the second risk will become a reality. In the wake of the agreement reached at the EU summit, international financial and capital markets are regaining stability for now. However, the fundamental solution of the problem is yet to be achieved. There still seems to be a jittery sentiment at the root of the markets. III. European debt problem’s spillover to Asia In Europe, the adverse feedback loop among private finance, public finance, and economic activity has been at work and financial and capital markets have still basically been jittery. Needless to say, such a situation has been affecting the Asian region including Japan and China. First, economic stagnation in Europe has led to put downward pressure, directly or indirectly, on economic activity in the form of a decline in exports from Asian to European countries. In particular, there seems to be not a small impact on China, which relies heavily on exports to European countries. Second, the effects of financial contraction in Europe, especially deleveraging of European financial institutions, are a matter of concern. While the presence of European financial institutions is not so large in Japan and China, there are some other Asian countries that rely BIS central bankers’ speeches heavily on those institutions. At this stage, as the pace of deleveraging by European financial institutions has been moderate and Japanese financial institutions have partly been substituting such deleveraging, funding conditions of Asian firms have not been deteriorating substantially. However, changes in Europe might change the situation drastically. Third, moves in international financial and capital markets. A decline in stock prices contains private consumption and other forms of economic activity through the negative wealth effect. Changes in foreign exchange rates, for example, a substantial yen appreciation might, especially for Japan’s economy, worsen corporate profits and put downward pressure on economic activity. In addition, it is very likely that a jittery market sentiment itself will make Asian economic entities’ sentiment cautious, thereby containing their spending. IV. Japan’s and China’s efforts Like that, the European debt problem has been affecting substantially both the Chinese and Japanese economies. Therefore, for both China and Japan, it is extremely important that the European debt problem will be fundamentally solved as soon as possible. Toward achieving fiscal soundness and financial system stability, I believe it necessary to urge the EU to further accelerate their efforts. Meanwhile, from a viewpoint of minimizing the spillover of the European debt problem to Asia, first of all, each Asian country has to make policy responses properly on both fiscal and financial fronts to cope with downward pressure on economic activity. In addition, in order to maintain the financial facilitation in Asia, I believe there is not a small role Japanese financial institutions should play. In fact, based on such judgment, Japanese major banks have been actively providing loans. If those responses are smoothly carried out, a risk that economic entities’ sentiment becomes substantially cautious could be reduced. Of course, from a long-term perspective, it will be necessary to consider a case that, if by any chance, an extremely large negative shock emerges from Europe. In Asia, trading ties have been further deepened, along with the development of supply chains. It also means that, as revealed during the earthquake disaster in Japan and the flooding in Thailand, once the supply chains are disrupted for some reasons, there will be a large negative impact on economic activity in Asia as a whole. As already seen in some firms, it will be critical to take action including diversifying supply chains. In addition, preparations should be made for possible massive capital outflows. While a safety net has been improving in recent years through various initiatives including Chiang Mai Initiative, it is necessary to continue to think very hard about how to promote regional cooperation in order to enhance the robustness of financial markets and financial systems. In that regard, I realize that a viewpoint of ensuring stability of the settlement system has become more important than ever before. Japan and China are required to take the role of leading various efforts. Concluding remarks I have talked about the European debt problem’s spillover to Asia and measures taken to address it. In conclusion, let me add that fiscal sustainability will be a solid basis for ensuring economic stability in a country or a region, and, from a central bank’s standpoint, the stability of the financial system will be extremely important. BIS central bankers’ speeches
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IntRemarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at CEMLA's 60th Anniversary Commemorative Conference "Central Bank Cooperation at the Beginning of the 21st Century", Mexico City, 19 July 2012.
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Kiyohiko G Nishimura: Inter-regional financial cooperation – another layer of financial cooperation towards financial stability Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at CEMLA’s 60th Anniversary Commemorative Conference “Central Bank Cooperation at the Beginning of the 21st Century”, Mexico City, 19 July 2012. * 1. * * Introduction First of all, I am grateful to the organizers for inviting me to the 60 th Anniversary Commemorative Conference of CEMLA, a symbol of financial cooperation between central banks in Latin America. I am especially thrilled, because this is the ideal opportunity to discuss international monetary stability and central bank cooperation from the integrated perspective that spans Latin America and Asia. Latin America and Asia are among the most developed regions in terms of financial cooperation.1 Today, I would like to take the concept of financial cooperation one step further by considering the topic of inter-regional financial cooperation. Although the theme of financial cooperation at the global, intra-regional, and bilateral level has been discussed at a variety of international forums such as G20, I believe inter-regional financial cooperation, especially between Latin America and Asia, represents another important layer between the global and the intra-regional or bilateral levels. 2. Latin America and Asia in the 21st Century: from low to high correlation Let me begin by giving a brief summary of the linkage between Latin America and Asia with respect to real economic and financial activities, focusing particularly on the period since 2000. Both regions have experienced several large-scale financial crises since the 1980s, namely the Mexican Debt Crisis in 1982, followed by the so-called Tequila Crisis in 1994, the Asian Financial Crisis in 1997 accompanied by the Russian Crisis, and the Argentine Crisis in 2000. However, roughly speaking, this period in our history also highlights the fact that, until the collapse of Lehman Brothers in 2008, we had never faced a large-scale financial crisis simultaneously. In fact, the cross-country correlation of real GDP growth between Latin America and Asia shows relatively small coefficients in the early 2000s (Slide 1). The reason could be that the regions are geographically distant, and thus relatively less influenced by each other, particularly in terms of trade activity. However, this relationship had already begun to change during the era of the so-called Great Moderation, and has changed dramatically since the Lehman shock and the recent European sovereign debt crisis. In fact, the above-mentioned cross-country correlation shows a significant increase since 2008 in the correlation coefficients of all major Asian economies, This 60th anniversary event implies that CEMLA began its activities in 1952, merely seven years after the end of World War II. Asia and the Pacific (hereafter, referred to simply as Asia unless otherwise noted) also has a long and very active history of regional financial cooperation. The central bank leaders of seven South East Asian nations gathered in Bangkok, Thailand in 1966, and established the foundation of SEACEN, which plays an important role as a training and learning hub in the region. In 1982, the SEACEN Center was established to provide the secretariat function in Kuala Lumpur, Malaysia, and has since been hosting and co-hosting a number of valuable and timely seminars and conferences. Seminars and conferences were co-hosted with CEMLA, and the Bank of Japan contributed to them as a speaker and lecturer. In 1991, the Bank of Japan invited Asian counterparts to form EMEAP, consisting of eleven central banks and monetary authorities in the region. EMEAP has since then celebrated a number of concrete achievements in regional financial cooperation, including the establishment of the Asian Bond Fund. BIS central bankers’ speeches following a gradual increase in China and Japan a few years earlier. Although geographical distance has not changed, our mutual dependency in trade has dramatically increased since the mid-2000s, driven largely by China, and owing to significant improvements in transportation technology and a decline in various trade-related costs (Slide 2). The linkage of trade, and thus economic and financial activities, between Latin America and Asia is expected to be strengthened further in the future. Trade volume is determined by the size of population and the degree of complementariness of goods and services, if transaction costs are sufficiently small. The combined populations of Latin America and Asia are forecast to remain at more than 60 percent of the global population. As income levels increase, the two regions combined are expected to become one of the largest consumer markets in the world (Slide 3). Moreover, the two regions have a well-balanced supply-and-demand relationship, ranging from agricultural goods and raw materials to capital goods. This implies that future trade activity in a combined Latin America and Asia can be self-sustained without having to rely substantially on advanced countries. As mutual linkage of economy is enhanced through trade, eventually so is financial linkage between the two regions, including an increase in foreign exchange transactions for the purpose of real demand and hedging, as well as an increase in stock price correlation reflecting active cross-border corporate transactions. This heightened inter-dependency of economy and financial markets implies that a financial crisis in one region has a direct impact on the other. Moreover, as the importance of a combined Latin America and Asia increases, so too does the chance that they happen to become the epicenter of a global financial crisis. In this regard, policy makers of the two regions are mutually responsible for the stability of the global economy and financial market. To fulfill such responsibility, financial cooperation should not be confined to one region. Latin America and Asia have many issues in common. Addressing capital flows is one such issue. A variety of regulations and macroprudential measures has already been introduced, and has been to a certain extent effective in each of the jurisdictions or regions. However, more structural issues associated with financial stability should be discussed, not only at the intra-regional level, but also at the inter-regional level between Latin America and Asia. These structural issues include the development of liquid and deep capital markets, and improvements in financial infrastructure, including deregulation and harmonization of regulations. Moreover, from a longer-term perspective, issues related to population aging, and corresponding arrangements of social security and tax systems, also need to be considered comprehensively with an inter-regional view in mind. 3. Asian experience on financial cooperation Let me now turn to the Asian experience on financial cooperation, anticipating similar discussion of the Latin American experience later from other participants. (Vulnerabilities in Asia) Although overall economic and financial stability has been improved remarkably in Asia since the Asian Financial Crisis, there are still vulnerabilities in the region. First, there remains the double-mismatch of currency and maturity in the banking sector. Such vulnerabilities materialized in some Asian economies when U.S. dollar liquidity dried up after the collapse of Lehman Brothers. We have seen similar impacts recently with the deleveraging by European banks. Second, in Asia, including Japan to some extent, the financial intermediation function has still been served largely by indirect financing, mostly through banks. Given this financing structure, a large negative shock hitting financial institutions makes it difficult for non-financial corporations to gain smooth access to debt financing from these institutions, almost regardless of their financial soundness. Third, there is still the issue of scant investment opportunities in Asian local currencies. Abundant savings in Asia have not been invested BIS central bankers’ speeches sufficiently within the region, and have thus eventually been invested outside the region, such as in bonds in the United States and developed Europe. To put it in a different perspective, the Asian financial sector remains highly dependent on banks, indicating the underdevelopment of regional bond and other capital markets. Owing to such an unbalanced market structure, Asian economies are exposed to the risk that domestic asset prices become volatile because of rapid global capital flows, resulting in a sharp increase in the volatility of foreign exchange rates. Also, the immature local derivatives market makes appropriate risk-taking transactions difficult, as risk-hedging instruments are limited (Slide 4). Moreover, owing to their less-developed securitization markets, Asian economies do not sufficiently enjoy the merits of the securitization schemes that attract a variety of investors depending on their risk-taking capacities (Slide 5). (Authorities’ efforts to address vulnerabilities) How have the Asian authorities responded to these vulnerabilities? I would like to explain their efforts in three aspects. To develop local currency-denominated bond markets The first is a project aimed at developing liquid bond markets to provide a bridge between abundant local savings and local investments: the ABF of EMEAP, and the ABMI of ASEAN+3. The Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP) established the Asian Bond Fund (ABF) investment trust in 2003, and became the initial buyers by investing in sovereign and quasi-sovereign bonds in the eight member jurisdictions. When it was launched, the Fund was limited to investment only in U.S. dollar-denominated bonds. However, since 2005, the Fund has begun to include those denominated in the local currencies of the eight members. In addition, EMEAP launched an exchange-traded fund (ETF) called the Pan Asian Index Fund (PAIF). The PAIF was first listed on the Hong Kong Stock Exchange in 2005, and later cross-listed on the Tokyo Stock Exchange in 2009.2 As part of the ASEAN+3 process, the authorities have launched the Asian Bond Markets Initiative (ABMI),3 aimed at promoting bond markets. The most notable recent achievement is the establishment in November 2010 of a trust fund in the ADB called the Credit Guarantee and Investment Facility (CGIF). The CGIF plans to start its credit guarantee operations for local currency-denominated corporate bonds issued in the ASEAN+3 jurisdictions in the third quarter of 2012 at the earliest. At the Finance Ministers’ and Central Bank Governors’ Meeting in May this year, another new roadmap for the ABMI was proposed and endorsed to further promote resilient capital markets in the region, for example, by improving the regional credit rating system, developing small and medium-sized enterprises’ finance and securitization markets, and raising the level of financial education. To establish and enhance a currency swap network The second response by Asian authorities to the region’s vulnerabilities is a project to establish and develop a mutual framework of U.S. dollar liquidity provision, called the Chiang Each listed fund, as well as the PAIF, aimed at raising awareness among private investors, has steadily gained recognition among investors, although the extent of this recognition varies across the markets. Moreover, the project has been functioning as a catalyst for improving market infrastructure, such as deregulation and exemption of withholding taxes for non-resident investors, through its reviewing process among the EMEAP members. ABMI advocates four main issues, namely i) facilitation of demand for local currency-denominated bonds, ii) promotion of their issuance, iii) improvement of the regulatory framework, and iv) improvement of the relevant infrastructure for the bond market. BIS central bankers’ speeches Mai Initiative (CMI). Aimed at improving the region’s resilience against external shocks, the CMI started building a bilateral currency swap network in the region, which involves a contingent claim on foreign currency reserves held by each ASEAN+3 authority. The CMI has since enhanced its effectiveness by increasing its size and the number of participants. In fact, in March 2010, the authorities evolved the CMI framework from its original bilateral swap arrangements to the multilateral Chiang Mai Initiative Multilateralization (CMIM), which is a collective decision-making framework signed by all member jurisdictions in a single contract.4 To ensure the effective implementation of crisis prevention and actual U.S. dollar liquidity support, it is essential for the authorities to monitor closely the regional economy and financial markets, and exchange views on their respective macroeconomic policies. The ASEAN+3 authorities thus established their own but independent surveillance unit, called the ASEAN+3 Macroeconomic Research Office (AMRO), in Singapore in April 2011. Recent efforts to enhance financial stability In addition to the above-mentioned two projects, momentum is building among Asian central banks to make cross-border collateral arrangements (CBCAs), aimed at further enhancing financial stability in the region. CBCAs are arrangements whereby a central bank provides local currency liquidity by accepting foreign currency assets, such as sovereign bonds in foreign countries, as eligible collateral. Such arrangements already exist in some advanced countries. CBCAs are thought to be an effective framework particularly in times of short-term money market stress. Foreign financial institutions’ branches and subsidiaries often lack stable local funding sources, such as retail deposits. However, under a CBCA, they can still continue to provide credit to their customers, who are in most cases branches and subsidiaries of non-financial corporations domiciled in their home countries. In fact, a CBCA was established in November last year between the Bank of Japan and the Bank of Thailand, as there are many Japanese non-financial corporations operating in Thailand. At almost the same time, a CBCA was announced between Bank Negara Malaysia and the Monetary Authority of Singapore, and early this year between Bank Negara Malaysia and the Bank of Thailand. Meanwhile, EMEAP has formed an action group and made a CBCA reference template for their future expansion in the region. So far, they are bilateral negotiations between two jurisdictions, depending on their necessity. Moreover, Japan and China are making efforts to enhance mutual cooperation towards the development of financial markets in the two largest Asian economies. Owing to cooperation between the authorities and private market participants, many tangible outcomes have already been achieved, including the purchase of Chinese government bonds by the Japan’s Foreign Exchange Fund Special Account and the start of direct exchange between Japanese yen and Chinese renminbi on the Tokyo and Shanghai markets. 4. Towards inter-regional financial cooperation As economic and financial linkages deepen, I believe that the above-mentioned efforts and issues addressed in Asia can be shared more or less with Latin America. Both regions also have common structural problems. I believe that it is fruitful for regions bearing similar problems to resolve them collaboratively. First, let me raise the issue of demographic change and economic potential. Slides 6, 7, 8, and 9 show the ratio of working-age population to the rest, that is, how many people of At the same time, the authorities expanded the total borrowing amount from USD 90 billion to USD 120 billion, enabling prompt and effective U.S. dollar support in times of crisis. Moreover, at the above-mentioned Finance Ministers’ and Central Bank Governors’ Meeting, the authorities agreed to double the size of the CMIM to USD 240 billion, and expand its scope to also cover crisis prevention. BIS central bankers’ speeches working age have to provide for one dependent person, for Japan, the United States, Asia, and Latin America, respectively. Low fertility rates and population aging have been the main cause of prolonged low economic growth in Japan since 1990. This is also likely to become a big issue even for Korea and China in the not-so-distant future. Some Latin American countries may also have similar concerns, although the degree varies across jurisdictions. Having this future vision well in mind, we have to be prepared even now to implement the necessary social reforms, including the restructuring of social security systems, tax reforms, and revision of employment systems. Second, let us consider the development of asset prices and credit expansion. In Slides 10, 11, 12, and 13, the development of property prices and loans in real terms is added to the chart of the working-age population ratio (inverse dependency ratio) in the previous Slides 6, 7, 8, and 9, respectively. In Japan and the United States, we see a significant relationship between population dynamics and real asset prices. A similar tendency is also observed in China, as representative of Asia, and Brazil, as representative of Latin America. Whether this development leads to the generation and bursting of asset bubble depends largely on future policy implementation in the respective regions. To address these structural problems, it might be more effective for both regions to collaborate, rather than to deal with them individually and independently. The following three points are also issues to be considered cooperatively. First, as an economy develops and a middle-income class emerges, we need to implement measures to realize a more balanced growth between domestic and external demands. At the same time, the population eventually ages as the economy matures, and thus the key to success will be the promotion of domestic demand appropriately in line with the developmental stage of the economy. Second, from the viewpoint of reducing asset price volatility, it is also important to further develop regional capital markets with the aim of enhancing resilience against external shocks. In this regard, we need to take into account market differences within the region. Third, it is essential for each jurisdiction to harmonize its market regulations and practices with the global standards in promoting cross-border transactions. However, unilateral effort by a single jurisdiction has its limitations, and thus collective effort is desirable to improve market infrastructures effectively in both regions. While respecting diversity across jurisdictions, we should not introduce arbitrary regulations or ignore global contractual practices. Needless to say, even if we are successful in dealing with these issues, we cannot completely prevent financial crises. However, we can improve our resiliency in times of crisis by preparing multi-layered safety nets as backstops in the financial system. Such safety nets include the development of deep and liquid capital markets, the establishment of currency swap networks, and cross-border collateral arrangements. Moreover, it is also important to establish solid foundations for individual and regional economies by addressing at an early stage long-term social structural problems such as declining fertility rates and population aging. A resilient real economy is an indispensable factor in financial stability. Last but not least, as you already know, the IMF-World Bank Annual Meetings will be held in Tokyo this coming October. The Bank of Japan plans to take advantage of this opportunity to co-host a seminar with CEMLA. I will participate in this wonderful event, representing the Bank of Japan, and I look forward to the enthusiastic proposals and discussions regarding financial stability in Latin America and Asia, and thus global financial stability, among a variety of participants, including senior officials of central banks in the two regions. I will stop here. Thank you for your kind attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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