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Summary of a speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kagoshima, 21 June 2012.
Koji Ishida: Recent economic and financial developments in Japan Summary of a speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kagoshima, 21 June 2012. * * * I. Economic activity and prices in Japan A. Recent developments 1. Japan’s economy First, I will talk about recent developments in economic activity and prices in Japan. Economic conditions in Japan worsened sharply in the wake of the severe global contraction that followed the failure of Lehman Brothers in 2008. Thereafter, the economy showed signs of recovery as a result of various policy measures taken as well as efforts made nationwide, but it plunged again due to the Great East Japan Earthquake, which occurred on March 11, 2011. This was followed by additional shocks such as the European debt problem and the flooding in Thailand, making the year 2011 an extremely severe one for Japan’s economy. Since the beginning of 2012, Japan’s economic activity has started picking up moderately as domestic demand remains firm, supported mainly by reconstruction-related demand after the earthquake. Public investment has been increasing with the progress in the implementation of government budgets earmarked for reconstruction related to the disaster. Business fixed investment has been on a moderate increasing trend with corporate profits improving. Against the background of improvement in consumer sentiment, private consumption has continued to increase moderately due to the effects of measures to stimulate demand for automobiles. A high degree of uncertainty remains regarding exports, but they have shown signs of a pick-up. Reflecting these developments in demand, production has started picking up moderately. Price developments in terms of the consumer price index (CPI; all items less fresh food) indicate that, after reaching a historical trough of minus 2.4 percent in the middle of 2009, the year-on-year rate of decline has continued to slow. In recent months, the rate of change has been at around 0 percent. 2. Overseas economies Next, I will talk about recent developments in overseas economies. With regard to the U.S. economy, business fixed investment is maintaining its uptrend, supported by firm corporate profits, and private consumption is also increasing moderately. The employment situation continues to recover modestly as a whole so far, although it appears that the effects of the boost from a record-breaking warm winter are starting to dissipate. On the other hand, the economic activity in the euro area has been sluggish despite signs of a pick-up in exports, because domestic demand there has been stagnant reflecting severe fiscal financial conditions in some peripheral countries, and this has acted as a drag on economic activity. Meanwhile, disparities among countries regarding economic sentiment are widening further. For example, the unemployment rate for April had registered a historically low level of 5.4 percent in Germany since the reunification of East and West Germany, whereas that in Spain was over 20 percent for all workers and over 50 percent for those aged 15–24. BIS central bankers’ speeches Emerging and commodity-exporting economies have been maintaining somewhat high growth rates as a whole, but the pace of growth has been slowing somewhat recently. The Chinese economy continues to show relatively high growth; however, exports have been negatively affected by the sluggishness in the European economy, and the rates of increase particularly in durable goods consumption and private real estate investment have decelerated to some extent, due in part to the effects of measures to restrain the increase in real estate transactions and monetary tightening implemented so far. In the NIEs and the ASEAN countries, the pace of economic growth has begun to pick up, reflecting the restoration following the damage caused by the flooding in Thailand, in a situation where private consumption and business fixed investment remain firm. Overseas economies on the whole still have not emerged from a deceleration phase, but some improvement has been observed, including the recovery, albeit at a moderate pace, of the U.S. economy and some emerging economies. B. Outlook for Japan’s economy and prices I will now turn to the outlook for Japan’s economy. 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. According to the projections in the Outlook Report that the Bank released in April this year, 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 gradually strengthens. With the economy moderately recovering, the outlook for prices in terms of 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 toward the latter half of the projection period through fiscal 2013 as the aggregate supply and demand balance improves. Expressing this outlook in terms of the median of individual Policy Board members’ forecasts, Japan’s real GDP growth rate is projected to be 2.3 percent for fiscal 2012 and 1.7 percent for fiscal 2013. The year-on-year rate of change in the CPI is expected to be 0.3 percent and 0.7 percent for fiscal 2012 and 2013, respectively. Looking at the current state of Japan’s economy, while the pace of recovery in overseas economies has been slower than expected in the April 2012 Outlook Report, domestic demand in Japan has been relatively stronger, and therefore Japan’s economy as a whole so far is generally in line with the forecast in the April Outlook Report. C. Uncertainties about the outlook The outlook I have just mentioned is the scenario for economic activity and prices considered to be the most likely by the Bank, or the baseline scenario. In the April 2012 Outlook Report, the Bank raised the following four risk factors concerning this outlook as warranting attention: developments in overseas economies, especially the European debt problem; uncertainty with regard to reconstruction-related demand; possible changes in firms’ and households’ medium- to long-term growth expectations reflecting the shift of production sites to overseas as well as problems concerning the supply and demand of electric power; and problems regarding Japan’s fiscal sustainability. At present, the chief concern is developments in overseas economies, especially the European debt problem. Tensions in global financial markets rose rapidly in the second half of 2011, but eased somewhat from the start of 2012 due to the massive liquidity provision by the European Central Bank (ECB), in addition to the decision on the second financial support program for Greece by the European Union (EU) and the International Monetary Fund (IMF), BIS central bankers’ speeches the signing of the European Fiscal Compact by EU member states, and the agreement to raise the lending capacity of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). From February to March 2012 in particular, sentiment in global markets was “risk on,” leading to purchasing of stocks and selling of the yen. However, market sentiment thereafter shifted gradually to a “risk off” mode and risk aversion among global investors has been increasing again as a result of growing concerns about the political situation in Greece, as well as the health of Spanish banks and the consequent deterioration in Spain’s fiscal condition. Yields on government bonds issued by countries with debt problems have risen, while yields declined on Japanese, German, and U.S. government bonds, which are regarded as safe assets. Stock prices have fallen and the yen has resumed its rise in the foreign exchange market. The efforts made by Germany and other core European countries are expected to ultimately help avert a significant worsening of the problems in Europe, leading to a period of brief respite. However, a comprehensive solution will take quite a while. This is because at the root of the European debt problem lies a structural problem: countries with large disparities in fiscal conditions and economic strength share a single currency without having an integrated fiscal policy, making it difficult to adjust imbalances in these countries. A key element in the Bank’s baseline scenario for Japan’s economy is that, while domestic demand supports the economy, external demand will strengthen, prompting the virtuous circle of production, income, and spending to start operating before reconstruction-related demand begins to decline. The economy is very likely to follow this main scenario, barring an unexpected worsening of the situation in Europe. This is because the U.S. economy is expected to continue growing at a moderate pace, and the growth rate of the Chinese economy – one of the main emerging and commodity-exporting economies – is expected to stop decelerating, with the economy likely heading toward a recovery due to the fine-tuning of the current set of restrictive policies. If the European and U.S. economies become unstable, however, this would weigh heavily on emerging and commodity-exporting economies, exerting a large negative impact on Japan. Therefore, due attention should be paid to developments in the United States and Europe. II. The bank’s conduct of monetary policy Next, I will outline the measures currently implemented by the Bank to pursue powerful monetary easing. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. A. Pursuit of powerful monetary easing Based on this recognition, the Bank has been pursuing powerful monetary easing through the comprehensive monetary easing measures. In February this year, the Bank introduced “the price stability goal in the medium to long term” and announced that it would pursue powerful monetary easing until the price stability goal was in sight. With the aim of achieving the goal of a 1 percent year-on-year rate of increase in the CPI, the Bank announced that it would encourage a decline in longer-term market interest rates and a reduction in various risk premiums. Specifically, the Bank announced that it would (1) continue its virtually zero interest rate policy of encouraging the policy interest rate to remain at around 0 to 0.1 percent; and (2) implement the Asset Purchase Program (hereafter the Program) mainly through the purchase of various financial assets, such as government securities, commercial paper (CP), corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). Since the establishment of the Program in October 2010, the Bank has expanded its size successively. After the start of 2012, the Bank increased it in February and April, and the BIS central bankers’ speeches outstanding amount of the asset purchase is to reach about 65 trillion yen by around the end of 2012 and about 70 trillion yen by around the end of June 2013. The outstanding amount of the Program stands at approximately 51 trillion yen as of June 10, and thus the Bank will increase it by approximately 14 trillion yen – at a pace exceeding 2 trillion yen per month on average – by the end of this year. The amount of the Bank’s purchases of assets, including those of Japanese government bonds (JGBs) conducted regularly at the pace of 1.8 trillion yen per month, will total as much as 4 trillion yen per month on average. Due to such pursuit of powerful monetary easing, market interest rates in Japan have been moving at an extremely low level. For example, yields on JGBs with maturities of up to three years have been at around 0.1 percent, which is almost equivalent to money market interest rates, and those on ten-year JGBs have been below 0.9 percent. In these circumstances, firms’ funding costs, as measured by lending rates, and credit spreads in corporate bond and CP markets, have both been moving at low levels. These rates, unlike those in the European and U.S. markets, have been stable at low levels even when market concerns about the European debt problem intensified significantly. The Bank will continue to pursue powerful monetary easing with the aim of achieving the goal of a 1 percent year-on-year rate of increase in the CPI so that firms and households can gain easier access to loans at a lower interest rate. B. The bank’s efforts to strengthen the foundations for economic growth I will now talk about the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility), which has been implemented concurrently with the Bank’s measures to pursue powerful monetary easing. The measure was introduced in June 2010 with the aim of supplying long-term funds at a low interest rate to financial institutions in accordance with their efforts in terms of lending and investment to strengthen the foundations for economic growth. The initial ceiling of the total amount of loans was set at 3 trillion yen. Subsequently, in June 2011, the Bank established a 500 billion yen new line of credit, separate from the existing one, for equity investments and asset-based lending (ABL), in which assets such as accounts receivables and inventories are used as collateral, based on the consideration that it was essential for the Bank to devise ways to encourage the provision of equity-like funds, such as equity investments, and of loans without conventional collateral or guarantees. In March 2012, the Bank decided to enhance the Growth-Supporting Funding Facility by (1) increasing the ceiling for the total amount of loans from 3 trillion yen to 3.5 trillion yen; and (2) establishing special rules for a new lending arrangement of 500 billion yen for small-lot investments and loans, as well as those for a new U.S. dollar lending arrangement of 12 billion U.S. dollars (equivalent to 1 trillion yen) for foreign currency-denominated investments and loans. Looking at the amount of loans disbursed so far under the Growth-Supporting Funding Facility, the outstanding balance of the total loans stands at approximately 3.2 trillion yen as of the beginning of June 2012. With regard to loan disbursement under the special rules for the U.S. dollar lending arrangement, the first disbursement of loans is to take place in September 2012. A breakdown of financial institutions’ individual investment or lending in April 2010–March 2012 by the areas for strengthening the foundations for economic growth shows that their investment and loans covered a wide range of areas; in particular, almost 30 percent of the total funds was provided to environment and energy business and almost 20 percent was provided to medical, nursing care, and other health-related business. The Bank expects that this facility will act as a catalyst to promote financial institutions’ loans without conventional collateral such as real estate collateral as well as investment and lending to growth areas using long-term funds provided at a low interest rate. The Bank expects that this will lead to an increase in the number of entrepreneurs and firms starting new businesses, and that this will in turn enhance the growth potential of Japan’s economy. BIS central bankers’ speeches III. Growth strategy for japan These are the recent economic and financial developments and the Bank’s policy measures taken in response. I will now take a look at Japan’s economy from a longer-term perspective. Similar to Europe, Japan faces a structural problem, although in Japan’s case the problem is declining growth rates amid population aging. I will also touch upon this issue. A. Growth rates in the past two decades Looking back at Japan’s economic growth from a long-term perspective, the annualized GDP growth rate averaged more than 10 percent during the high-growth period of the 1960s. In the 1970s and 1980s, the rate did not reach double-digit figures but was stable, averaging an annualized 4 to 5 percent. Subsequently, the economic bubble burst and low growth ensued, moving around 1.5 percent in the 1990s and falling below 1 percent during the 2000s. The stagnation of the 1990s can be largely attributed to the bursting of the economic bubble and malfunctioning of the financial system. It was widely believed that the economy would regain strength once the nonperforming-loan (NPL) problem was resolved. In reality, however, economic growth did not return to the previous levels, even after the mid-2000s, when the NPL problem had largely been resolved. The periods of persistent low growth during the 1990s and 2000s have together been called the “two lost decades,’’ but I believe the slumps in these two periods had different causes. Contributions to economic growth come from increases in both labor productivity and the labor force. Growth in labor productivity, measured by the rate of growth in real GDP per worker, had been on a downward trend throughout the 1990s and has been sluggish recently, although it remains narrowly in positive territory. The labor force measured by the rate of change in the number of workers, on the other hand, started to decline in the 2000s. The lackluster economic performance during these two decades reflects the different contributions of these two factors. Turning to the issue of future growth, if we assume that the current labor force participation rate in Japan does not change, then the number of workers based on the long-term demographic forecast is expected to decline by 0.6 percent during the 2010s, and further by 1.2 percent during the 2030s. Assuming that productivity growth remains at around 1 percent, which has been the average over the past two decades, the growth rate from 2010 onward may be forecast at an annualized average of about 0 to 0.5 percent. During the 2030s, negative growth is likely to become the norm. B. Measures to counter the declining population Given that this situation is clearly foreseeable, the utmost efforts must be made to improve it. Currently, the real GDP growth rate per worker is fairly high in Japan compared with other countries. If no action is taken, however, the rate per capita will decline as a result of the lower ratio of workers to population caused by population aging. Real GDP growth per capita serves as a benchmark of national wealth. Thus, it is possible that the current standard of living and welfare, achieved through hard work over many decades, will not be enjoyed by our children and grandchildren. In order to avert this situation, it is imperative to increase labor productivity per worker and ensure that the number of workers is maintained despite the declining population. 1. Increasing labor productivity In order to raise labor productivity, it is generally agreed that the following steps must be taken: (1) develop new technology, products, and services; (2) ensure the full application of BIS central bankers’ speeches information technology, while redistributing resources from sectors and firms with low productivity to those with higher productivity; and (3) facilitate regeneration of industries. I will not elaborate on this broad subject today, but will focus instead on the issue of measures to halt the decline in the number of workers. 2. Increasing the number of workers As often pointed out in the past, given the declining population – which is an undeniable and unavoidable development – it is necessary to increase the labor participation of women and create job opportunities for the elderly in order to stop the number of workers from declining. a. Women In 2011, the number of Japanese women aged 25–64 without jobs and not seeking employment averaged as many as 10 million (women under 24 are assumed to be at school and are excluded). A breakdown of the labor force participation rate by age group shows that the rate dips in Japan for women in their 30s, indicating the burden of raising children. Consequently, the data represented in a line graph are “M-shaped.” There has been an increase in recent years in the number of nursery schools to address the serious shortage in Japan of such schools, which has prevented mothers from working. Some consider this an aspect of social welfare policy, but I believe it is also an economic policy for growth. Raising children in Japan, which used to be seen as a mother’s full-time role at home, could be passed on to those undertaking it as a job, allowing mothers to continue their jobs outside the home. This would be a division of labor at work. Subsequently, the number of jobs would expand, and together with a rise in income, payers of taxes and social insurance premiums would increase, contributing greatly to the growth strategy. Furthermore, it is not just an increase in the number of nursery schools in Japan that is needed for the raising of children. Schools and employers need to take steps to remove various obstacles in the way of working mothers. Families described as “double income with two kids” – a term heard recently – could become the basic unit of society, and existing structures and systems should be changed so that women would feel secure in their balance of work and raising children. The removal of some of the barriers to having children would raise the labor force participation rate of women, and also help stop the decrease in the birth rate. b. The elderly The share of the elderly seeking employment falls sharply in Japan from 65 years of age onward. Statistics show that in 2011 the labor force participation rate averaged 78 percent for people aged 50–59 and 60 percent for those aged 60–64. It went down to 38 percent for those aged 65–69, and declined further to 23 percent for those aged 70–74. This trend could be attributed to the fact that in Japan corporate pensions are paid from the age of 60, and the widely held perception that the elderly – who are often defined as those aged 65 years or more – do not work or are not expected to work. Many studies, however, show that the percentage of healthy people aged 65 or more is increasing. Data from the World Health Organization (WHO) as of 2007 revealed that healthy life expectancy, which is the average number of years a person can expect to live in full health, was 76 years in Japan, the highest in the world. Another study shows that the capacity of judgment and understanding, acquired through education and training, peaks at around 60 and gradually declines thereafter. Apparently, however, findings show that such capacity for those in their 80s roughly equals that of people in their mid-20s. In fact, in the agricultural sector 60 percent of workers are aged 65 or above, and in the fishing sector the proportion is more than 30 percent. This is evidence of the capability of people at 65 or more to continue to work. According to the Organisation for Economic Co-operation and Development (OECD), an increasing number of countries have raised the pension age to 67 or above. BIS central bankers’ speeches Therefore, although it is not immediately possible, it seems necessary to change Japanese society’s definition and perception of the elderly. If the nation’s working-age population is redefined to include the population up to 69 years of age, the number of employable population would increase by slightly less than 8 million. The working-age population up to 64 years of age is 82 million at present and is expected to decline. If the population up to 69 years of age is included in the working-age population, we would have approximately ten more years before it approached the present level of 82 million and started to decrease. In order to bring about the acceptance of new social perceptions of age and work that I have just mentioned, it is necessary to change various social structures and systems substantially. In Japan, with its rapidly aging population and fall in childbirth, it is essential to construct cooperative networks and systems that encourage older members of society to join forces with the rest of the working population. C. Increasing job opportunities In order to both increase the labor participation rate of women and draw on the labor of the elderly, it is necessary to significantly expand the number of available jobs. Various opinions have been expressed on how to deal with the current decrease in the workforce caused by population aging with fewer children. Among them is the suggestion that Japan should accept more immigrant labor from overseas. At present, however, there are not enough job opportunities on offer to meet an increase in the workforce. Although improvements have been made recently, the ratio of job offers to applicants in April 2012 was 0.79, while the unemployment rate was 4.6 percent. The number of unemployed was 3.15 million (seasonally unadjusted), and if figures are added for the hidden unemployed – who are willing to work but not actively seeking a job – the total number of unemployed amounts to about 7.53 million.1 To promote growth of the economy, new job openings must be created to accommodate these unemployed people, in addition to more women and the elderly. In view of the current imbalance between supply and demand of goods and services, with demand falling short of supply, it is necessary to respond to the changing social structure and create demand by replacing old products and services with new ones. The structure of consumption, or spending patterns, has also changed largely reflecting the population aging with fewer children. The outcome of competition among firms now depends on how they adapt to such changes. New job opportunities will be created in the process of such corporate endeavors. It is also essential to seek overseas demand, since the population in Japan is declining. Rapidly expanding Asian markets are located close to Japan. In view of an expected rise in income levels in the area, these markets are likely to become extremely important for high-quality goods produced in Japan that offer superior features in terms of safety and reliability, although production of “volume-zone,” widely used goods, may have to be done overseas. Moreover, looking further ahead, it is very likely that Japan will be able to offer products and services developed for its aging society to other Asian nations, since their populations too are bound to mature. With this favorable outlook in mind, stepping up investment for growth would lead to a larger flow of funds, an expanded job market, and ultimately sound economic growth in Japan as well as Asia. The data for April 2012 were taken from the Labour Force Survey released by the Ministry of Internal Affairs and Communications. The number of “hidden unemployed” represents those “wishing to work” in the category of “not in the labour force.” A breakdown of figures for those “not in the labour force” is not published on a monthly basis, and therefore, the simple average of three months for the period between January through March 2012 (4.38 million) was used. BIS central bankers’ speeches D. Regional areas Viewed from a different perspective, the decline of the population is likely to have a larger effect on regional areas than on urban ones. If job opportunities in these areas are insufficient, youthful job seekers will leave, causing a population drain and leading to a further shrinkage of regional economies. To respond to this situation, it is important to make full use of the resources unique to each region, in addition to human resources of the elderly and women: for example, to draw on the labor of the elderly in the areas of nursing care, where demand is growing, or of childcare; and to revitalize the primary industry. Business opportunities may also lie in agricultural and food industries in rural Japan. It is possible that the supply-demand conditions for food will tighten worldwide reflecting the rapid growth of emerging economies, and as the income levels of emerging economies rise, demand is likely to increase for Japan’s expensive but safe, reliable, and high-quality food products, in which the country has a competitive edge. Efforts to expand exports of agricultural and marine products to other Asian countries could bear fruit through, for example, selective breeding of grain species and improvement in aquaculture technology by means of effectively utilizing fallow and abandoned fields, as well as Japan’s coastline, which is the sixth longest in the world. The agricultural and fisheries industries by themselves account for a relatively small share of Japan’s GDP, but if related businesses such as food processing, transportation, and distribution are included, they contribute a great deal to regional economies. Furthermore, regional areas in Japan possess scenic and cultural resources unrivaled by many other countries: you can find mountains, volcanoes, hot springs, valleys, beaches, lakes, a mild climate with four seasons, historic sites, cultural events such as festivals, and safe towns with hospitable people, all in this small country. Unfortunately, despite such abundant tourist attractions, Japan ranks only 30th or so in terms of the number of foreign tourists. Considered another way, however, this implies that there is much room for growth in tourism. If Japan’s regional areas could capture tourism demand from other countries in Asia that have a great potential for growth, this would have a significant impact on employment. In order to strengthen such efforts, local governments need to take detailed measures. Support from local financial institutions is also important, as funds from various sources will be required. As I mentioned earlier, the Bank supports the efforts of financial institutions through the Growth-Supporting Funding Facility. The amount of funds provided through the facility to such businesses as tourism and to childcare services is still small, and there is much room to increase the funding provided to these businesses as well as to others. The Bank thus expects greater use of the facility. 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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Hiroshima, 25 July 2012.
Hirohide Yamaguchi: Path toward overcoming deflation and pursuit of monetary easing Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Hiroshima, 25 July 2012. * * * Introduction Thank you for giving me an opportunity to exchange views with administrative and business leaders in Hiroshima. And I express my gratitude to everyone for your cooperation in various business operations of the Bank of Japan’s Hiroshima Branch. Today, before exchanging views with you, I will first talk about the developments in overseas economies, including the European debt problem, followed by a short-term outlook and medium- to long-term challenges Japan’s economy is faced with, while focusing on the recent developments in domestic demand. Finally, I will talk about the recent monetary policy conduct of the Bank of Japan. I. Developments in overseas economies: future recovery that stands back to back with a big risk Let me start with the developments in overseas economies. While the economies were recovering after around mid-2009 from the Lehman shock in autumn 2008, the pace of recovery has somewhat slowed after the second half of 2011 and they still have not gotten out of a deceleration phase. By region, the U.S. economy has been moderately recovering, partly supported by accommodative financial conditions. While there are cautious views in the market on the outlook for the U.S. economy as the growth in the number of workers has been slowing since early spring, private consumption has been increasing moderately and home sales, which remained low for a long time, have been showing signs of a pick-up. That suggests that the household sector’s debt burden, which weighed on the economy after the Lehman shock, has been gradually easing. It is also expected that a decline in gasoline prices since early spring will increase households’ real purchasing power and underpin an increase in private consumption. Therefore, while the pace of growth might not accelerate markedly, it is likely that a moderate recovery will basically continue without interruption. The European economy as a whole has been stagnant, due partly to the European debt problem, which I will talk about later, and will continue to be in a severe situation for the time being. In the meantime, in China, the economic slowdown has been still continuing. The year-on-year growth rate of real GDP was on a downtrend after it peaked at the beginning of 2010 at 12 percent, and fell below 8 percent in April–June 2012. Such developments were partly due to a tightening policy implemented by the Chinese policy authorities, who were concerned over an acceleration of inflation and a surge in asset prices. Such policy has had an impact to some extent and the inflation rate, which was over 6 percent a year ago, has fallen to about 2.0–2.5 percent. A decline in the inflation rate increases households’ real purchasing power and encourages spending. In view of stable general prices and asset prices, the Chinese authorities have started to implement full-fledged economic stimulus both on the financial and fiscal fronts by reducing the policy rate for two consecutive months in June and July and deciding to make fiscal support to promote consumption, including energy-saving home appliances. While attention should be paid to the weakness in exports to Europe, which accounts for about 20 percent of China’s total exports, the Chinese BIS central bankers’ speeches economy is likely to return to the moderate recovery path mainly led by domestic demand in the not too distant future. Consequently, as for the outlook, overseas economies are likely to gradually escape from the current deceleration phase and gradually increase their growth rates with a moderate recovery in the U.S. economy and a pick-up in the Chinese economy as a driving force. However, there remains high uncertainty about the outlook for overseas economies, including the United States and China. In a way, a situation, in which a baseline scenario for economic recovery and a risk scenario have been standing back to back, has been continuing. Among others, the development in the European debt problem, which I will talk about next, is a risk factor that warrants most attention. II. The European debt problem: still a bumpy road ahead Let me now take some time to talk about the European debt problem. The trigger for the problem was the revelation of a massive hidden fiscal deficit of Greece in October 2009. Subsequently, concern over fiscal conditions spread to Portugal and Ireland, and, in the second half of 2011, further to southern European large countries, Spain and Italy. In Spain, as a housing bubble burst triggered by the Lehman shock, an injection of massive fiscal funds became necessary for the disposal of financial institutions’ nonperforming loans and for economic stimulus, despite a decline in tax revenue. As a result, in recent several years, fiscal conditions have deteriorated rapidly. In Italy, fiscal deficit has become chronic as the government has been supplementing a decline in domestic industries’ external competitiveness with fiscal support. Against such a backdrop, with a bloat of government debt outstanding, the market has been concerned over weakening of the economy’s growth potential. Deterioration in fiscal conditions raises suspicion of the country’s government bonds not being redeemed as promised, which leads to a decline in the government bond prices or, in other words, a rise in the government bond yields. In Greece, the government had not been able to raise funds on its own to redeem government bonds, and, after last December, yields on Greek government bonds once rose to a level more than 35 percent. Subsequently, in order to reduce the heavy fiscal burden itself, Greece was faced with a situation in February to request private investors to forgive part of their claims. Government bond yields in Spain and Italy have been unstable since the second half of 2011, and, in particular, those of Spain have recently risen to a level above 7 percent and hit a record high since the introduction of the euro. As government bond yields of those countries, which were called peripheral countries, have risen substantially, namely, their prices have fallen sharply, assets of financial institutions in Europe that held a large amount of those government bonds have deteriorated significantly. Consequently, some financial institutions in Europe have lost market confidence and faced with an increase in funding costs or difficulties in funding themselves. Financial institutions that are struggling with funding become cautious in providing loans to firms, which will exert downward pressure on the real economy. A stagnant real economy will induce a vicious cycle by further worsening fiscal conditions, which will again adversely affect financial institutions’ management through destabilizing developments in the yields of government bonds. It has become a big problem that such an adverse feedback loop among fiscal conditions, the financial system, and the real economy has been at work. Therefore, what is necessary for the moment is to cut off the adverse feedback loop. At present, a focus has been on rehabilitation of Spanish financial institutions that shoulder a large amount of nonperforming loans, and, in June, the Euro members decided to provide financial support in the maximum amount of 100 billion euros. Since December 2011, the European Central Bank has been providing the financial market with three-year loans, which are an extraordinarily long-term fund provisioning by a central bank. Reflecting such a stance BIS central bankers’ speeches of the authorities, short-term money markets, in which financial institutions exchange funds with each other, have regained stability to some extent compared with around the end of 2011, when there was an elevated sense of crisis. While those responses are essential as a first aid to stem the adverse feedback loop, it will not be a fundamental solution of the European debt problem. If one goes back to the cause of the problem in the peripheral countries, it is necessary for those countries to carry out drastic fiscal consolidation as well as economic structural reform toward strengthening their medium- to long-term growth potential. Europe as a whole is also faced with a challenge that, while using a single currency “euro,” stability of the economies and financial systems can be achieved with each country’s fiscal policy and bank supervision remaining separate. While this might be a somewhat crude analogy, you might be able to understand the difficulty of the problem if you imagine a situation in which each local government totally independently carries out fiscal policy and bank supervision in Japan where the same currency yen is used. Having said that, the problem is an essentially fundamental one of how to draw a future picture of political, economic, and social integration in Europe. Given the size and complexity of the problem and difficulty in each country’s political decision making, we have to be prepared that it will take some time. On the other hand, markets request conclusions in haste. They will not wait. While such difference in time frames has been leading to jittery responses by the markets, at the same time it might bring forward the solution of the European debt problem. The policy authorities are aware that tepid measures, if announced, will immediately induce disappointment in the markets and will be pressed for further measures. The international community that will be affected substantially by the European debt problem has been increasingly keeping a close eye, and Japan and many other countries have been requesting a swift solution of the problem at international conferences and other opportunities. Above all, through past discussions, the common recognition of not to let the euro fall apart has nurtured in Europe as a whole. Given such a situation, while the path is still rough, I hope that there might be progress toward the solution of the European debt problem in the not so distant future. III. Fiscal problem and long-term interest rates: importance of efforts toward fiscal consolidation I have so far talked about the European debt problem. In relation to the problem, let me touch on Japan’s fiscal condition and the recent developments in long-term interest rates before moving on to Japan’s economic developments. The ratio of gross government debt outstanding to GDP in Japan is now exceeding 200 percent. That is extremely high internationally and exceeds that of even Greece, which is 130 percent. Seizing that point, some people voice concern that, as things stand, Japan might tumble into trouble like Greece. However, in reality, Japanese government bonds (JGBs) have been issued smoothly and their yields have been stable at extremely low levels. As a reason for that, it has been frequently said that, in Japan, households and firms have ample savings, and thus there is no need to worry, for now, about lack of money to purchase JGBs. To be sure, that is a factor supporting a smooth issuance of JGBs. But if a situation arises in which prices of JGBs decline significantly or people worry about repayment of the principal, nobody will be willing to purchase JGBs even though the Japanese public has ample savings at present. To begin with, amid rapid progress in the demographic vortex, there is no guarantee that such ample savings will last, and thus discussions that rely on the continued existence of ample savings might not necessarily be appropriate. Then, why have JGBs been issued smoothly? I believe that it is because there is confidence in Japan’s future policy conduct. Namely, despite deterioration in fiscal balance, market participants believe that “the Japanese have the will and ability to eventually address fiscal consolidation.” In fact, such efforts are steadily underway. That is the critical difference BIS central bankers’ speeches between Japan and Greece. As efforts to ensure fiscal sustainability have been progressing, in my view the public also believes that monetary policy has been conducted toward fulfilling the intended purpose of achieving sustainable economic growth with price stability. Namely, the public believes that the Bank’s money will not be used for facilitating government financing. Worldwide, since the Lehman shock, global investors have increasingly become more risk averse than before, and that has also caused Japanese government bonds’ prices to rise and yields to fall. Credibility of securitized products in the United States, which used to be considered as safe assets with little risk, and government bonds in peripheral European countries, has declined and the supply of financial assets, internationally, that can meet investors’ propensity for safety has declined substantially. Against such a backdrop, investors worldwide have channeled funds into the Japanese government bond market in pursuit of limited safe assets, having led to a recent rise in government bond prices. One major reason for the persistent yen appreciation seen in recent several years has been such flow of funds. As mentioned earlier, the source of credibility in JGBs is the confidence in Japan’s fiscal and monetary policy. As Japan’s government debt outstanding is extremely high to begin with, if Japan’s fiscal discipline is questioned, being triggered by some cue, credibility of government bonds could decline and long-term interest rates could rise. To avoid such a situation, I recognize that the policy authorities have always been required to make sincere efforts to maintain market confidence and, based on those efforts to achieve fiscal consolidation itself. IV. Short-term outlook for Japan’s economy: moderate recovery and associated uncertainty Now I will move onto the state of Japan’s economy. After experiencing a plunge caused by the Great East Japan Earthquake in March 2011, Japan’s economy recovered toward the summer much earlier than initially anticipated thanks to the efforts by firms and the public. Since early autumn 2011, economic activity has been more or less flat, reflecting the effects of a slowdown in overseas economies and the appreciation of the yen as well as the flooding in Thailand, but has recently started to gradually pick up again. An assessment of recent developments will be, in short, that domestic demand has been somewhat stronger than expected and external demand somewhat weaker. As overseas economies have yet to get out of a deceleration phase, Japan’s exports have also been slightly lagging expectations. On the other hand, domestic demand has been somewhat stronger than expected. The first reason for that is an increase in reconstruction-related demand, which includes an increase in public investment and demand for repair and rebuild of disaster-stricken facilities and houses, as well as a recovery in demand that had been restrained due to the effects of the disaster, namely, manifestation of pent-up demand. Investments in strengthening earthquake resistance and the purchase of disaster prevention goods and energy saving products, triggered by the earthquake, can also be considered as reconstruction-related demand in a broad sense. Policy support, including subsidies for eco-friendly cars, has also been effective. An improvement in business sentiment due to a recovery in corporate profits, and ensuing cease of decline in wages and income, seem to have exerted positive effects on recent investment and consumption. In addition, there has recently been a marked increase in consumption of the baby-boom generation and other elderly people. With some reflection, a grave trial for Japan’s economy, including progress in aging and the earthquake disaster, has also brought a substantial change in firms’ and households’ behavior. And that is becoming new buds for new demand. Let me explain that later in detail. As for the outlook, the Bank assumes that the firm domestic demand will support the moderate recovery of Japan’s economy. However, there is a possibility that the budget for BIS central bankers’ speeches the subsidies for eco-friendly cars will run out as early as this summer, and pent-up demand will gradually subside. Against such a backdrop, in order to ensure the positive developments in the economy as a whole, it is necessary that exports steadily gain momentum while firm domestic demand is supporting the economy. Taking account of those points, the Bank recently published its latest economic outlook for the next two years. The real GDP growth rate for fiscal 2012 was projected to be slightly above 2 percent due to firm domestic demand. The growth rate for fiscal 2013 was projected to maintain 1.5 to 2 percent because, while reconstruction-related demand will gradually subside, exports will start to recover as overseas economies pick up. On the price front, the year-on-year rate of change in the consumer price index (CPI) of all items but volatile food is currently about 0 percent. The rate of change is projected to remain at around 0 percent for the time being, and gradually rise to a range of above 0.5 percent and less than 1 percent toward fiscal 2013, as the economy returns to a recovery path and the aggregate supply and demand balance improves. The Bank’s goal for the time being of 1 percent will be achieved in the not so distant future from fiscal 2014 onward. From a longer term perspective, Japan’s economy is expected to return to the moderate recovery path with price stability. However, such an outlook is associated with various uncertainties. In particular, the effects of developments in the European debt problem and fluctuations in foreign exchange rates on Japan’s economy continue to warrant close attention. In addition, even if economic activity and prices develop as projected, it will be fiscal 2014 onward that the year-on-year rate of change in the CPI reaches 1 percent, and thus still some time is needed to overcome deflation. V. Medium- to long-term challenges to Japan’s economy: nascent bud for growth I have so far explained the outlook for Japan’s economy. From now on, let me consider medium- to long-term challenges Japan’s economy is faced with. Japan’s economic growth rate has been on a downtrend amid unprecedented rapid progress in aging. Therefore, there is an aspect that firms’ and households’ growth expectations, in other words, spending appetite has been restrained, and that induced a chronic demand shortage. In order to overcome deflation, it is necessary not only to achieve short-term economic recovery but also to strengthen medium- to long-term growth potential of Japan’s economy and remove structural downward pressure on demand. At individual firms’ level, there are not a few initiatives to strengthen their own growth. While the earthquake disaster and the nuclear accident were big challenges for Japan, those at the same time changed the public recognition of energy and environment. Changes always bring business opportunities to firms. Recently, in addition to next generation cars that have superior environmental designs, renewable energy supply and “smartization-related” projects have gradually started to take the form of a full-scale business. Growth in those areas is expected to have large spillover effects on firms, including small firms, which provide cutting-edge materials and nanotechnology. The challenge of rapid aging Japan’s economy is faced with could, from firms’ perspective, provide a new business opportunity. The elderly, who are 60 or over, account for more than 40 percent of private consumption, and, among them, the baby-boomer generation has a remarkably higher propensity to consume than the previous and next generations. Such elderly people vary from individual to individual in financial resources, life styles, health conditions, and hobbies, and are with diverse values. There are many promising areas, ranging from travel and leisure, medicine and nursing care, and construction of houses and cities that correspond to the aging society. In fact, in the Tankan survey released at the beginning of July, business sentiment of industries, including accommodation, eating, and drinking services, improved substantially, and that was partly attributable to the fact that an improvement in the quality of services for the elderly has turned out be successful. BIS central bankers’ speeches As explained, the recent firm domestic demand seems to reflect the fact firms have been positively tackling challenges Japan’s economy is faced with, including aging and energy constraints, and tapping new demand. If that is the case, the current strength in domestic demand might not only be a recovery factor in the economy for the time being, but also the start of a larger wave that will lead to future strengthening of potential growth, and have the possibility to serve as a trigger to solve the medium- to long-term challenges Japan’s economy is faced with. In the periods ahead, it is necessary to carefully nurture such buds for growth. Growth-fostering areas are not exclusive to Japan. Aging and energy constraints are problems that other Asian countries have to face in the near future. In China, it is said that the working-age population will start to decline as early as around 2015, and the number of elderly people, who are 60 or over, will reach 300 million. It would be a waste not to utilize know-how accumulated at home in the neighboring giant market. A decline in the working-age population might, in the near future, accelerate China’s investment in resource conservation, and that area could be a new business field for the Japanese machinery industry. In a grand trend of increasing infrastructure demand and transition to low carbon society, needs for Japan’s cutting-edge energy technology will gradually increase in the future. Strengthening growth potential of Japan’s economy will become possible through, above all, efforts of firms that have a great deal of fighting spirit. Of course, to that end, financial institutions’ support on the financial front will be necessary and, to the extent of preparing an environment that facilitates such challenges, the role of the government will be important. If private firms, financial institutions, and the policy authorities continue their efforts in line with their respective roles, it might be possible to successfully nurture nascent buds for growth and let them fully bloom. VI. Bank of Japan’s conduct of monetary policy: pursuing monetary easing and supporting strengthening growth potential Finally, let me talk about the Bank’s recent monetary policy conduct. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to the sustainable growth path with price stability. Based on that recognition, in February the Bank clarified its monetary policy stance toward overcoming deflation. Specifically, the Bank clearly stated that it will continue pursuing powerful monetary easing with the aim of achieving the goal of 1 percent inflation in terms of the year-on-year rate of increase in the CPI until it judges the 1 percent goal to be in sight. To actually pursue monetary easing, the Bank has been implementing a program to purchase financial assets called “the Asset Purchase Program.” It is a measure to encourage a decline in longer term interest rates and risk premiums through purchasing government bonds and a wide range of financial assets from the market, and lead to a decline in firms’ funding costs. The Bank expanded the total amount of the Program in February and April so that the amount outstanding of the Program will reach about 70 trillion yen by the end of June 2013. The current amount outstanding of the Program is 53 trillion yen. We are now in the process of increasing the amount outstanding of the Program toward 70 trillion yen and the effects of monetary easing will strengthen in a continuous manner day after day as the process continues. In retrospect, the Bank’s monetary policy stance since the Lehman shock has been changing according to the state of Japan’s economy. Initially, inclusive of the Lehman shock and the subsequent earthquake disaster, the policy stance was geared toward mitigating repeated downward pressure on economic activity and underpinning the economy. Afterwards, Japan’s economy gradually escaped from such shocks and reached a situation in which an outlook of returning to the sustainable growth path with price stability can be shown. The BIS central bankers’ speeches reason the Bank strengthened monetary easing in February and April nevertheless was to, together with the cumulative effects of past monetary easing, further ensure the outlook to materialize. At present, while daily purchasing assets under the increased total amount of the Program, the Bank is deliberately examining the effects of monetary easing as well as the outlook and risks for economic activity and prices. Of course, due to some shocks, when the outlook turns out to be weaker than expected or the risk associated with it intensifies, the Bank will not hesitate to implement additional monetary easing. The Bank will continue to strive for proper monetary policy conduct. As I mentioned earlier, to overcome deflation, in addition to the measures I have mentioned, efforts to strengthen growth potential by private firms, financial institutions, and also by the policy authorities will be necessary. In that regard, the Bank has been implementing a “fund-provisioning measure to support strengthening the foundations for economic growth,” a measure extraordinary for a central bank. It is 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 measure was introduced two years ago, expanded sequentially, and, in March 2012, small-lot investments and loans less than 10 million yen, which used to be not eligible, were made eligible for the Bank’s support. In addition, the Bank decided to provide U.S. dollar loans for financial institutions’ investments and loans denominated in foreign currencies. As a result, at present, the total size of the measure stands at 5.5 trillion yen. As part of it, the first fund provisioning for small-lot investments and loans was made last month, in an amount of 3 billion yen for nine financial institutions. Utilizing the measure, financial institutions have been making loans and investments to back up growth in firms in wide-ranging areas, such as medicine and nursing care, environment and energy, agriculture, forestry and fisheries, and tourism. Not a few financial institutions made investments and loans to support opening of new businesses. Although the fund provided was yet small as it was the first time, the Bank intends to contribute to nurturing new buds for the growth of Japan’s economy. The Bank strongly anticipates that, such measure being a catalyst, the private sector’s efforts to strengthen growth potential will further expand both in terms of region and industry. Concluding Remarks As time is running out, let me conclude my speech today while touching on the economy of Hiroshima Prefecture. Hiroshima Prefecture is one of the major industrial prefectures in Western Japan, with a variety of industries located, including automobile, machinery, and steel. Also in recent periods, firms’ high technical expertise has been fully displayed as seen in the development of a next generation engine that has a superior environmental design. In addition, many firms, including those in nonmanufacturing such as logistics and men’s apparel, have been actively expanding businesses overseas, mainly in Asia. Furthermore, this region has tourism resources with two world heritage sites and rich natural surroundings as well as a worldwide high recognition as a cosmopolitan area, and, in fact, Hiroshima city and Miyajima have recently received a record high number of tourists. The local administration has also been actively supporting the private sector’s positive efforts. I have heard that, to promote innovation in local firms, Hiroshima Prefecture was the first local government to establish a wholly government-owned operating company to manage a regional support fund, and the first firm to invest in was decided in April. The firm aims at becoming an international leader in a niche business area through the development of a unique non-contact inspection system that could be applied to smartphone displays. On the financial front, through efforts, including increasing the number of staff in the consulting section or actively holding meetings for business matching, local financial institutions have been supporting local firms’ growth and launch of new businesses. Several financial institutions have been participating in the Bank’s “fund-provisioning measure to support strengthening the foundations for economic growth.” BIS central bankers’ speeches In order to further encourage positive efforts of local firms, we appreciate it if you could utilize the measure effectively. The Bank expects you to make efforts to meet challenges ahead and will continue to provide utmost support as a central bank. BIS central bankers’ speeches
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Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan Conference hosted by the Futures Industry Association Japan, Tokyo, 26 July 2012.
Masaaki Shirakawa: Issues facing the futures markets and the industry Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan Conference hosted by the Futures Industry Association Japan, Tokyo, 26 July 2012. * * * Introduction The futures market is a key building block of the financial structure of an economy, and its efficiency and soundness contribute to the economic well being of the public at large. The Futures Industry Association has, I believe, provided important input into the evolution of this vital market. The Bank of Japan appreciates your efforts, and that is why I am pleased to appear as the keynote speaker for the FIA Japan Conference today. To be honest, the futures market in Japan is falling behind those in other international financial centers. If you were to ask a man or a woman on the street in Tokyo, what he or she knew about it, you would in all likelihood get a blank face. This is rather unfortunate, considering that Japan was probably home to the world’s first organized futures exchange. In the early eighteenth century, rice futures began trading in Dojima, Osaka, complete with a system of margining and cash settlement. The price of rice, which as you know is the staple food in Japan, was set through day-to-day trading at the exchange in Dojima, called kome-kaisho, and the trading houses lining the streets around the exchange provided essential financial services to the ruling warrior class, which relied on rice as its main source of income. The exchange was ingrained in the economic life of late-feudal Japan for almost two centuries. The fact that such a sophisticated market grew organically on its own makes me somewhat optimistic that, given the right conditions, the futures industry can flourish in Japan. In fact, margin trading in foreign-exchange, which is quite similar to futures trading, is popular at the retail level in Japan. Today, I would like to offer you some thoughts on how to create or enhance the conditions that would be conducive to increasing public welfare, by embracing financial innovation, as well as the advancement of futures markets in Japan. For this purpose, I need to reflect on our experiences of the recent Great Financial Crisis. While almost five years have passed since the first dislocations in the U.S. mortgage securities market became evident, the global financial system has not yet recovered to the point where we can confidently venture out onto new frontiers. This is especially true on the European continent, where confidence in the outcome of the policies adopted by some euro area members to contain their debt dynamics has not been rebuilt sufficiently. We are still in the process of tackling issues that came to light during the crisis, and my remarks will therefore reiterate this point. There are two broad themes. One is to pick up the many loose ends that manifested themselves while we frantically dealt with one emergency after another. Broadly speaking, financial market infrastructures weathered the Crisis relatively well, and yet they have revealed many weaknesses. In my view, as I will explain later, Japan has done a fairly good job in this regard. Another theme is more philosophical. While it is very important to reinforce the structural integrity of our financial architecture, finance cannot function without the trust of the society. The Crisis has raised questions about the role of finance in the broader society. Given the public’s displeasure with finance in general and speculation in particular, the futures industry must articulate its case much more strongly if it hopes to thrive in the years ahead. Criticism against banks and bankers is not as pronounced in Japan today as it was ten years ago or as we see it now in the United States or Europe, but that should not be an excuse for us gathered at this Conference to avoid reflecting on this important issue. BIS central bankers’ speeches I. Improving the infrastructure of financial markets Let me begin with the infrastructure issues. During the height of the Great Financial Crisis, especially in the second half of 2008, financial markets, particularly in the United States and Europe, virtually ceased to function. Market participants were not lending to each other even in secured markets such as the repo market. Households and non-financial corporations could not borrow as banks stopped lending to preserve cash and new debt issues ground to a halt. Stock markets, while they continued to function, were in a freefall and generated much anxiety. It is not an exaggeration to say that the global financial system, and hence the economy, was only one step away from total collapse. Problems with U.S. sub-prime mortgages were exacerbated many-fold by the lack of transparency regarding the distribution of risk. Another important factor that amplified uncertainty was the buildup of transaction backlogs. There were transactions worth billions of dollars and euros, but it was difficult to get any idea of who bore the ultimate risk. Big swings in market prices suggested that potential losses could be enormous. Nobody would dare trade in the face of the fear that their counterparty might be on the losing side of trades and therefore could be teetering on the brink. The issue was especially acute in the over-the-counter (OTC) derivative markets, including credit default swaps (CDS), where the sheer volume and arcane processing systems conspired to hide the true state of affairs even from the most experienced observers. Thus, it is no wonder that, when the leaders of the Group of Twenty (G20) countries met in Pittsburgh in September 2009, they decided to do something about this state of affairs.1 As regards the OTC derivatives markets, the leaders drew heavily from the experiences of the futures markets, which remained relatively unscathed during the crisis. They decided to enhance the transparency and resilience of the OTC derivatives market by encouraging the use of more standard instruments and moving them onto electronic platforms and centralized clearing. When the reforms are finally in place, which the leaders have promised will happen by the end of this year, the OTC derivatives market will more closely resemble the futures market. Even those instruments that could not readily be standardized will be subject to margining and reporting requirements, concepts that are already proven in the futures markets. If this were the end of the story, I would not have brought up the issue today. While the futures market provides us with a good off-the-shelf model, in the form of exchanges and their associated clearing infrastructures, that model could be improved further. For example, although centralized clearing will insulate market participants from the failure of counterparties, the effectiveness of the arrangement depends heavily on the design of the system. A clearing house must ensure that its integrity will not be compromised when its members fail. This is easier said than done. How should it set the initial margin? How frequently and in what form should it collect variation margins? How much of an additional buffer should it hold against the risk of margin shortfalls? There will not be a “one size fits all” solution, but a set of broad principles could be drawn up. That is why central banks and regulators have been working on the “Principles for Financial Market Infrastructures,” which were published by the Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO) back in April this year. The new Principles contain 24 elements, covering all aspects of financial market infrastructures including basic governance structures, day-to-day operations, risk management, and crisis resolution.2 They are designed to ensure See Leaders’ Statement released after the G20 Pittsburgh Summit held on September 24–25, 2009. See Committee on Payment and Settlement Systems (CPSS) and Technical Committee of the International Organization of Securities Commissions (IOSCO), “Principles for financial market infrastructures, assessment BIS central bankers’ speeches that the infrastructure supporting global financial markets is robust and thus well placed to withstand financial shocks. Compared with existing recommendations, the new Principles introduce new or more demanding requirements. For example, clearing houses that are systemically important and multi-jurisdictional and those that clear complex products will be required, at a minimum, to withstand the simultaneous failure of the two largest participants, instead of the largest participant, as in the current set of recommendations. The Principles will apply to all systemically important payment systems, central securities depositories, securities settlement systems, central counterparties, and trade repositories, which collectively clear, settle, and record transactions in financial markets. The Bank of Japan, in close cooperation with the Japanese Financial Services Agency, has participated in the international discussions leading to the agreement on the new Principles and is firmly committed to implementing them as soon as practicable. Along with this international push for more robust and resilient market infrastructures, there have also been efforts that reflect Japanese domestic experiences. While the failure of Lehman Brothers did not cause much disruption in Japan, and hence cross-border spillovers were minimal, it was found that the crisis resolution mechanism at the Japan Government Bond Clearing Corporation (JGBCC) could be further improved. It took herculean efforts at the JGBCC to come up with securities and funds that Lehman Brothers could not deliver after its bankruptcy filing. It was a close call. Much progress has been made to reduce risk and ensure the continuity of operations even in extremely stressful situations, especially in the area of dealing with a large number of fails and raising emergency liquidity. As I have noted at the beginning, these efforts to strengthen market infrastructures in Japan are moving forward at a good speed. For example, with respect to the G20 commitment to move OTC derivative trading onto centralized clearing by the end of this year, Japan has set up the necessary legal and institutional framework, and is probably the first market of any significant size to do so. On this basis, the clearing of CDS began from July 2011, and yen interest rate swaps will also be centrally cleared by this October. Another significant risk-reducing measure is the shortening of the settlement cycle for JGBs. Since this April, the settlement cycle of JGBs was shortened to T+2 from T+3, thereby reducing unsettled positions. Market participants have also decided to begin laying the groundwork for shortening the settlement cycle further to T+1. Working together, authorities in Japan and the industry are committed to enhancing the robustness and resiliency of the Japanese market infrastructure, which should enable Tokyo to thrive in the increasingly competitive quest to become a global financial center. Before moving on to my second theme, let me add a few footnotes concerning financial market infrastructures. One is the tradeoff that arises from the increasing use of centralized clearing. Centralized clearing has unambiguous advantages – for example, the mitigation of counterparty risk, better collateral management, increasing transparency, and enhanced market liquidity through standardization. These positive effects should augment the robustness and resiliency of market infrastructure. That is why the G20 has aimed for its wider adoption in view of the lessons of the Great Financial Crisis. At the same time, centralized clearing has its own issues. It may increase, if not properly designed, moral hazard among market participants, who will be less concerned with counterparty risk. Centralized clearing also concentrates risk in the clearing entity itself, which might become “too big to fail.” The Bank of Japan has always been aware of such a tradeoff and has continually stressed managing it wisely. This brings me to the second and third footnotes. methodology and disclosure framework,” April 2012. The original text is available on the BIS website. http://www.bis.org/publ/cpss101.htm. BIS central bankers’ speeches If the negative effects of centralized clearing are to be effectively managed, central banks and other regulators must strengthen the oversight and supervision of clearing entities. As we have already seen with the new Basel banking rules, the move will inevitably result in higher contingency buffers at the clearing entity in the form of collateral or margining requirements, loss-absorption pools, or paid-in capital. Since the users of centralized clearing, who are going to face less risk, will not have the incentive to increase the costs of clearing by committing more financial resources, higher buffers must be imposed by the authorities. This may increase the costs of trading, but that is a necessary price to pay in light of our experiences of the Great Financial Crisis. Lastly, the access of clearing entities to central bank services must be well thought out in the context of wiser management of centralized clearing. The advantages of using central bank money for settling accounts are obvious. In Japan, the Bank of Japan has long had constructive relations with various domestic financial market infrastructures, including the Japanese stock exchanges and the Tokyo Financial Exchange. At the same time, it must be stressed that an account at the central bank should not be confused with automatic central bank liquidity provision in times of stress. The Bank of Japan wishes to see operators and members of all infrastructures further enhance their liquidity management arrangements. II. The role of the futures industry in the broader society Now, let me turn to the philosophical issue. Unless it has provided significant services to public welfare, the futures industry would not have evolved to where it stands today. Nevertheless, even in the best of times, the futures markets face some skepticism by the public. Futures trading is a pure transfer of risks. Participants trade on the basis of their outlook on the direction of prices. Some of them wish to protect themselves, or hedge, against adverse price movements. Others just bet on the direction of prices, hoping to profit from it. In pure pecuniary terms, one participant’s gain is another’s loss. Although in terms of utility, the whole process is not zero sum because hedgers’ utility is greater in view of risk reduction, the zero-sum nature of the pecuniary gains and losses leads some people outside the industry to regard such activity as reprehensible, especially when it seems to encourage wild price swings. In some jurisdictions, hostility to speculation surfaces as outright bans on futures trading on certain products. For example, in the United States, the definition of commodities under the Commodity Exchange Act explicitly states “except onions,” while corn, wheat, frozen concentrated orange juice, and all other kinds of edible products are included. This idiosyncrasy could be traced to a cornering of the U.S. onion market in 1955, which then led to the enactment in 1956 of the Onion Futures Act. Potatoes failed to make the list of banned products in 1964, but lawmakers were persuaded enough to add a ban on the trading of “motion picture box office receipts” in the recent Dodd-Frank Act. Here in Japan, the resumption of rice futures, notwithstanding their historic significance that I mentioned at the outset, has taken a long time. In the days before the Great Financial Crisis, however, the futures industry could still find many sympathetic ears for its case. It was a widely shared credo that the pursuit of individual interest in financial markets would result in the transfer of various risks to those economic agents who were most willing to take on such risks. Given the different risk preferences of economic agents, the resulting redistribution of risks to those who were most capable of managing them was believed to enhance the efficiency of the whole economy. It was believed that the invisible hand would inevitably bring about a good outcome. The futures markets, sometimes regarded as the closest one could get to perfect markets, were thus regarded as increasingly important links in the various chains of risk transfer in economies. The public could be persuaded that the speculative activities of the futures industry were not only beneficial to the direct participants but also an essential pillar of the institutions that BIS central bankers’ speeches realize the optimal distribution of risks within the broader society, and thus should be encouraged with as few restrictions as possible. That belief, however, was badly shaken during the Crisis. Not a few people have now come to believe that the financial industry was only greedily pursuing its self-interest with total disregard for the benefits to the broader society, and that the culmination of such a trend was the bailout of the industry at a great cost to taxpayers. As a result, while draconian prohibitions on the trading of certain products are still the exception rather than the rule, regulations to curb so-called excessive speculation, such as restrictions or bans on short selling, have been strengthened during and after the Great Financial Crisis. The public is no longer willing to give the benefit of doubt to the view that what was good for the industry was good for the economy. Now, it is not sufficient for the futures industry to maintain that speculation itself is good. It must make the case that speculation actually brings about good outcomes. In other words, it must explain why futures trading is an essential building block of the economy. Therefore, the industry must reflect on its original purpose. The futures market came into being so that economic agents could protect against the future movement of prices. For example, the price of West Texas Intermediate crude oil delivered at Cushing, Oklahoma in three months’ time could be influenced by many factors. If the U.S. economy were booming and people resumed driving huge pickup trucks, demand would skyrocket and so would the price for crude oil. On the other hand, if new sources of supply, such as oil sands and shale oil, were to come on line in significant quantities, a supply glut would send prices of oil tumbling down. If we knew the probability distribution of all possible outcomes, we could of course calculate one fair price, but this is never the case. No matter how hard we try to see the future, it is uncertain. Protection could never be bought unless there were economic agents that were willing to speculate and take the other side of the transaction. This does not necessarily mean that all futures trading must be underpinned by an actual need for protection. Even if two speculators trade against each other, the cumulative effects of such activity – a continuous process of trial and error – should ensure that the resulting price would be the best-informed guess that society could make. Since each trade is backed by a financial commitment, there should be little incentive to misquote prices. Substantial speculative activity should also make it easy to enter and exit the market with the smallest price impact, i.e., it should enhance market liquidity. Furthermore, such prices are formed in the most transparent manner. By allowing speculation to go on, society could ensure the availability of protection against unwanted price movements and be confident that the price charged for the service is fair enough. So, one can reasonably conclude that speculation should have a role to play in our economy. However, there may also be limits to speculation. As I noted earlier, a futures trade between two speculators, or two agents without any underlying positions to protect, is a zero-sum game. By itself, such a trade does not create any new value. A hundred million trades with a profit of one basis point will generate a profit of 1 million dollars, but that money must come out of the pocket of other market participants. It just does not make sense to put too many resources into such a venture. Herein lies a paradox. If appropriately conducted, speculation does bring about useful outcomes for society. Nevertheless, if there were only speculation, there would be no economic basis for sustaining it, because the expected return of such activity is zero (or negative if one factors in the costs). The only reason why speculative activity can continue is that costs are in effect borne by agents that wish to obtain protection. That sort of structure suggests that there must be an inherent limit to the level of speculative activity in a futures market. Growth for growth’s sake is not acceptable. Can market forces sort this out? This is a question that the futures industry must ask itself, and I hope that the industry takes it seriously. BIS central bankers’ speeches In this regard, the fact that many commodity futures in Japan are not flourishing might lead us to conclude that any market that fails to attract a sufficient amount of non-speculative activity will languish. The market might take care of the balance between speculative and non-speculative activities. In the case of financial futures, banks have legitimate hedging needs, and such activity will support a certain level of speculation in the market. Meanwhile, the depressed levels of activity in financial futures for short-term instruments, in today’s ultra-low-interest-rate environment, might be consistent with the self-correcting forces of the markets. Concluding remarks Today, I have reflected on how far the industry, especially in Japan, has progressed in meeting the challenges arising from the Great Financial Crisis. I have also pointed out that the industry still needs to redefine its role in the post-Crisis environment. In order to end my remarks on a positive note, I would like to quickly outline two opportunities for the industry. One is that there are still many risks for which the introduction of a traded market could be beneficial to the economy. An example is longevity risks. As I have stressed on numerous occasions, Japan is facing acute challenges in terms of demography, which in turn weaken potential growth. A well-designed product that could deal with longevity risks could facilitate Japan meeting those challenges. Another opportunity is in terms of leveraging the advantages of the futures market structure. One feature that comes to my mind is the transparency of prices. There may be many areas in which prices determined on futures exchanges could become benchmarks for related economic activity. The recent attention over the setting of LIBOR seems to confirm such a view. Such positive contributions should confirm that the futures industry will continue to perform useful and indispensable functions within the society. We are now in a period of great changes. Last night, we heard the remarks of the Minister of State for Financial Services, Mr. Matsushita. He told us that Japan had implemented and was planning to introduce many reforms that would enhance the competitiveness of and strengthen the confidence in the Japanese financial markets. Considering that a period of change is a period of opportunities, I believe that the industry could potentially accelerate its growth by satisfying the unfulfilled needs of the Japanese economy. From a broader perspective, Japan’s headline growth figures over the last 20 years remained low, and the period is often described as the lost decade or decades. Nevertheless, the impact of the bubble bursting in the 1990s was well contained, relative to what we saw recently following the Great Financial Crisis. Weak growth, at least in the second decade after the bursting of the bubble, can be explained, to some extent, by adverse demographic trends, or more precisely, a failure to adapt to such trends. As I have repeatedly pointed out, Japan’s per capita growth is about the average among the G7 economies, and the growth of output per working age population is the highest in the G7.3 Compared with most developed economies, the increase in unemployment has been modest. Japan no longer offers the low-hanging fruits found in fast-growing emerging economies, but, as one of the richest economies, it offers tremendous opportunities. In the financial sector, most Japanese financial institutions are now beginning to compete from a position of strength. Their credit spreads remain more stable relative to their global peers, and they are gradually and 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 carefully filling the void created by the retreating European financial institutions. Since I see many guests from overseas in the audience today, I would like to stress that if we can combine the tremendous opportunities that I mentioned with a stable financial system, Japan could perhaps be one of the most promising markets. I do hope that the Bank of Japan can continue its dialogue with the industry to facilitate this process. Thank you for your attention. BIS central bankers’ speeches
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Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Reserve Bank of Australia-BIS Research Conference "Property markets and financial stability", Sydney, 21 August 2012.
Kiyohiko G Nishimura: How to detect and respond to property bubbles – challenges for policy-makers Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Reserve Bank of Australia-BIS Research Conference “Property markets and financial stability”, Sydney, 21 August 2012. * * * Let me begin by commending the impressive achievements of this BIS project, as exemplified by the presentations yesterday and this morning. In this regard, I am sure you will join me in applauding the efforts of Frank Packer and his accomplished colleagues at BIS Asia & Pacific. In spite of this impressive progress, however, I still think that we are only at the starting line: many problems remain to be solved before this project can provide guidelines for policy-making. Learned academics may be experts in “explaining” the causes and effects of past events that have shaken the world. To put it metaphorically, failures in the last war are always scrutinized thoroughly, and their lessons are presented. In contrast, we policy makers should be looking forward into the future. We should not be fighting the last war when things are changing rapidly, no matter how well we may have learned the lessons of the last war. The two main questions from the policy maker’s point of view are: How can we detect malign property bubbles? and, How should we respond to them? 1. How to detect malign bubbles Let me start with the first question: How can we detect malign bubbles? Here we should be aware that not all property bubbles lead to financial crises, and not all financial crises are preceded by property bubbles. International panel studies have shown that two-thirds of 46 systemic banking crises were preceded by house price boom-bust patterns, while 35 out of 51 house price-bust episodes were followed by a crisis.1 So there are both malign bubbles and benign ones. Then, what leads to a malign bubble? Looking back at past experience of malign bubbles, we find another factor which has not been touched upon by the presentations so far: the demographic transition from a “population dividend” to the “burden of an ageing population.” Let us look at the charts comparing the Japanese property bubble of the 1990s, the US house price bubble of the 2000s, and the possible Chinese property bubble. In these three charts, I juxtapose, first, the ratio of working-age population to the rest (the inverse dependency ratio), second, the real property price index, and third, total loans in real terms.2 In Japan (Chart 1), we have two peaks in the working-age population ratio, accompanied by two peaks in the real property price index, which is the real land price index. Of these two, Claessens, Stijn, M. Ayhan Kose, and Marco E. Terrones, (2008), “What Happens During Recessions, Crunches and Busts?” IMF Working Paper 08/274 (Washington: International Monetary Fund) and Claessens, Stijn, Giovanni Dell’Ariccia, Deniz Igan, and Luc Laeven, (2010), “Cross-Country Experiences and Policy Implications from the Global Financial Crisis,” Economic Policy, Volume 25, pp. 267–293. The ratios of working-age population to the rest (inverse dependency ratios) are taken from the homepage of the United Nations. Property prices in real terms (CPI adjusted) are: JAPAN: Total Average, Urban Land Nationwide, Urban Land Price Index, Japan Real Estate Institute, US: US 10 cities, S&P/Case-Shiller Home Price Indices, Standard & Poors, and CHINA: Zhongfang Shanghai Residential Property Index, Zhongfang Shanghai Real Estate Index Office. Loans in real terms (CPI adjusted) are JAPAN: Loans of Depository corporations, Flow of Funds, Bank of Japan, US: Loans and leases in bank credit, all commercial banks, not seasonally adjusted, Federal Reserve, and CHINA: Financial Institution Loans, People’s Bank of China. BIS central bankers’ speeches the second peak, around 1991, happened to be a malign bubble which triggered a subsequent long period of stagnation. Then, what is the difference between the two? The volume of total loans in real terms may suggest an answer. Real loans were increasing at the time of the first peak, but their level was not as high as during the second peak. A remarkably similar picture is found in the United States (Chart 2). We have two peaks in the working-age population ratio, though not as pronounced as in Japan. And the real property price index, which is the real house price index, seems to have two peaks, roughly coinciding with the demographic change. Again, the second peak triggered the financial crisis of 2008, though the first peak coincided with the S&L problem, which had a far less severe effect on the economy. Adding the real total loans to the chart, we find a quite similar pattern to the Japanese case. The level of the real total loans in the first peak was high, but far lower than in the second peak. The last chart shows the figures for China (Chart 3). China has not yet peaked with respect to working-age population ratio, but it is close. The property price index was taken from the web site of a Shanghai index provider, who unfortunately and unexpectedly shut down their site and vanished about a year ago (June 2011). I tentatively use this index since it has a longer span than other indexes, although I am not entirely sure how it was constructed. The chart shows a clear upsurge in property prices up to 2010. Again the real total loan also shows a tremendous increase along with the working-age population ratio and the property price index. What lessons can we learn from this rather cursory examination of the recent history of two advanced economies and the present situation of one emerging economy? It is clear that not every bubble-bust episode leads to a financial crisis. However, if a demographic change, a property price bubble, and a steep increase in loans coincide, then a financial crisis seems more likely. And China is now entering the “danger zone.” Although demographic factors are not the subject of the studies in this conference, there is a growing body of cross-national evidence that compositional change in population has a significant effect on property prices (especially the land component).3 This comes as no surprise since, in the population dividend phase, young baby boomers want to buy more land and save more real money for their retirement. Since the supply of land is physically limited, the real price of land will go up. Similarly, if nominal money supply is held constant, the “price” of real money holdings, which is the inverse of the price level, should also go up, implying deflation. Being mandated to maintain price stability, the central bank is then likely to increase nominal money to keep prices stable. The result is an increase in property prices while general price levels remain stable.4 However, this raises the problem of quantitative significance. Though this hypothesis can explain “correlation” qualitatively, it is not sufficient to explain these malign property price bubbles quantitatively. The magnitude of these bubbles is simply mind-boggling. Also, not every country experiencing this sort of demographic change has a malign property bubble and a financial crisis. Therefore, we should not think of this strong positive correlation between demographic factors and malign bubbles as a strict causal relationship. Rather we should regard the demographic conditions of population dividend as “fertile ground” for malign property bubbles. See, for example, Takáts, Elod (2012): “Aging and house prices”, Journal of Housing Economics, vol 21, no 2, June, pp 131–41, and Nishimura, Kiyohiko G. (2011): “Population ageing, macroeconomic crisis, and policy challenges”, Panel discussion at the 75th Anniversary Conference of Keynes’ General Theory, University of Cambridge, 19–21 June 2011. See Nishimura and Takáts, “Ageing, Property Prices, and Money Demand” work in progress, which includes both theory and empirical analysis of a panel of 22 advanced economies. BIS central bankers’ speeches In the final analysis, malign property bubbles can be considered a manifestation of overly optimistic expectations at their extreme.5 Since the financial crisis, many attempts have been made in the economic profession to explain malign bubbles as the consequences of rational economic agents acting under circumstances of asymmetric information and certain not-soefficient regulatory conditions. These explanations are quite ingenious, using arrays of sophisticated neoclassical apparatus. However, from the practitioner’s viewpoint, it is more helpful simply to admit the frailties of human nature whereby we are so prone to be overly optimistic in some cases (and overly pessimistic in others), and our decisions are so easily influenced by other people’s opinions, especially the opinions of those in the higher realms of policy making. I will come back to this point later. 2. How to respond to a malign bubble Let me now turn to the second issue, which is how we should respond to a malign bubble. Fundamentally, we should distinguish two stages in the history of a malign bubble. The first is the early or prevention stage of the bubble, while the second is the late or collapsing stage. When considering our response to the early or prevention stage of a bubble, a consensus seems to have emerged in favor of the so-called BIS view. First, use various macroprudential policies to rein in overly optimistic expectations in the market. Second, if the bubble is truly malign, we should not hesitate to use monetary policy as well. Third, in using macro-prudential measures we should be aware of their long-run consequence of distortion in resource allocation. However, in practice, I have strong reservations over the effectiveness of some macroprudential measures in a malign bubble. Take the loan to value (LTV) ratio as an example. In the heyday of a ballooning bubble, the denominator of the LTV, i.e., the market value of property, goes up higher and higher. Thus, the LTV that seemed sufficient to cap the loan volume becomes grossly insufficient in a few months or even weeks. The same is true for quantitative constraints on loans, since instruments bypassing the constraints emerge, as exemplified in the experience of the Japanese property bubble of the 90s.6 Moreover, macroprudential measures are sometime used to halt the advance of a bubble only temporarily, which eventually comes to the surface again later with greater force than before. So an apparent success in the present may be an omen of failure in the future. There is another issue which has been unfortunately overlooked in the discussion of dealing with a bubble, but is potentially most problematic of all: communication with the public. How can policy makers convince the public that we are facing a ballooning malign bubble when there is no apparently imminent threat to the system? It is extremely difficult to persuade people who (want to) believe “this time is different” and are convinced they are now on the foothills of eternal prosperity, just as long as their path is not blocked by some stupid policy maker. In retrospect, I have to point out sadly that the public sector is often partly responsible for nourishing such overly optimistic expectations in the public.7 Although I have expressed some reservations so far about the emerging policy consensus in the early or prevention stage of a malign bubble, these problems are almost trifling in From this perspective, both the malign property bubbles of Japan and the United States, and the European sovereign crisis have a similar origin: overly optimistic expectations of the future in the population dividend phase. For more detailed discussion on macro-prudential policies in the case of the Japanese property bubble, see Nishimura, Kiyohiko G. (2011) “Macroprudential Lessons from the Financial Crisis: A Practitioner’s View,” in: Kawai, Masahiro. and Eswar Prsard (eds.) Asian Perspectives on Financial Sector Reforms and Regulation: Washington, D.C., Brookings Institution Press, 180–195. See Nishimura (ibid.) about the report of one Japanese government agency which became foundation of overly optimistic view about the office-space demand in Tokyo in the late 80s. BIS central bankers’ speeches comparison to the daunting policy difficulties faced in the late or collapsing stage. To my disappointment, there has been little discussion dealing squarely with these difficulties. In the late stage of a bubble, there is, on the one hand, a danger of restraining policy being “too little, too late”, and just postponing the collapse until a later stage and on a larger scale. On the other hand however, there is also the danger of too bold a policy leading to an “overkill” of the economy. Most difficult, however, is the appropriate response during the collapsing stage of malign bubbles. First, the magnitude of the collapse is mind-boggling. Chart 4 shows first the real property price movement of Japan. Here I use the RRPI index for greater Tokyo (roughly 10% of the total population), which is the quality-adjusted condominium price index. Then I have added the US real property price movement of 10 cities (again roughly 10% of the total population), which is based on the S&P Case-Shiller index. The magnitude of the price decline is clear: Japanese real residential property prices at their lowest point are only one third of their peak. In the United States, real residential property prices are currently more than 40% lower than their peak. At this moment, it is not clear whether US prices have hit the bottom. In any case, a decline of this magnitude implies a severe balance-sheet adjustment for the economy. Moreover, this severe balance-sheet adjustment, which is necessary for sustained recovery, is taking place when demographic factors are changing from positive (population dividend) to negative (burden of an ageing population) in Japan and the United States, as already shown in Charts 1 and 2. A severe balance-sheet adjustment under population ageing hampers the effectiveness of conventional policy tools. Moreover, seemingly overly pessimistic expectations aggravate the problem of policy effectiveness. The disturbing fact is that little is known about the appropriate policy for the late or collapsing stage of a malign bubble. What tools are available? What are the pros and cons of their use? These are the most pressing challenges for policy makers, and they should form the research agenda of the immediate future. So in conclusion, I’d like to reiterate again that we are still only at the starting line. Thank you for your kind attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Central Bank of the Republic of Turkey, Istanbul, 27 August 2012.
Kiyohiko G Nishimura: Demographic transition, impact of ICT, and globalization – a long view of the post-crisis world Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Central Bank of the Republic of Turkey, Istanbul, 27 August 2012. * * * Introduction: Turkey and Japan – friendship and cooperation on the rim of Asia It is my great pleasure to visit the Central Bank of the Republic of Turkey, and I am especially delighted to have the opportunity to speak before you on global economic issues that I think are relevant both to Turkey and Japan. Turkey and Japan are nations on the opposite sides of the rim of Asia, separated by a distance of some 9,000 kilometers. However, the distance has not hindered friendship and cooperation between the two nations in the past and the present. We must not forget that the two nations faced the same challenges as they tried to modernize themselves in the second half of the 19th century. It was in this context that the Turkish Emperor Abdul Hamid II sent the frigate Ertuğrul to Japan with more than 600 men on board in 1889. The voyage, as we know, ended in a tragedy caused by a typhoon. Nonetheless, the rescue efforts of Japanese locals and the subsequent exchanges of goodwill laid the firm foundations of the friendship and cooperation between the two nations. Today, the world, including Japan and Turkey, is facing many challenges, some of which were caused by the recent financial crisis. On this occasion, I would like to share with you some thoughts on issues that I have been thinking about for the last few years. These issues are not directly related to current macroeconomic developments per se, but relate to medium- to long-term influences on the post-crisis global economic environment. My presentation will consist of three parts. First, I will examine three emerging trends that seem to define the post-crisis economy. These three trends are: mismatches in the labor market, lower trend growth, and the end of wage disinflation. I will then turn to the possible root causes of these symptoms. I will identify four: demographic trends, balance-sheet adjustment, the influence of information and communication technology, and globalization/polarization. Finally, I will conclude by discussing the policy implications of these trends for the future. 1. Economy after the Crisis: labor market mismatch, low trend growth and inflation – the United States and Japan So, let me jump into the first part. What are the most important trends in the global economy? Different people will surely have different views, but I believe the three most important emerging trends in the post-crisis economy are: seemingly increasing mismatches in the labor market, persistently lower trend growth, and the stalling momentum of services wage disinflation. I will explain each in turn. 1.1. Increased mismatch in the labor market An indicator of the increasing mismatch in the labor market – the first trend – is an outward shift of the Beveridge Curve, which is a well-known way to illustrate the state of the labor market. The Curve represents the relationship between the unemployment rate and the job vacancy rate, or the ratio of the number of job vacancies to the sum of employment and job vacancies. In its typical format, with vacancies on the vertical (y) axis and unemployment on the horizontal (x) axis, the curve slopes downward, as a higher rate of unemployment normally occurs with a lower rate of vacancies. Data points are expected to move up and down the curve along with the business cycle. BIS central bankers’ speeches The graph of the U.S. labor market on this slide shows that data points moved down on the curve as the recession took hold in the early 2000s, climbed back up during the subsequent expansion until they reached their high point in December 2006, then fell again after the Great Financial Crisis struck, all the way down to June 2009. If we extend the data to June 2012, the data points climb back up again along with the recovery. Nevertheless, after about three dozen data points, it seems sufficiently clear that we are not moving back up the old curve, but along a new curve. As I have said, the outward shift in the curve, which means higher unemployment for a given level of vacancies, is usually interpreted as an indication of increasing mismatches in the market. The implication is that, ceteris paribus, we would see a higher unemployment rate for a particular stage in the business cycle. This development reminds me of what we experienced in Japan ten years earlier, which you can see on the next slide. Data points after the bursting of the bubble, shown in black, are clearly on a different curve. 1.2. Lower trend growth As to the second trend, evidence for lower trend growth can be derived from Okun’s Law, which describes the empirical relationship between unemployment and the decline in a country’s output. In the next graph, annualized quarterly changes in the unemployment rate and annualized quarterly changes in growth for the United States are plotted on the x and y axes respectively. If we draw a regression line for the data points before Q4 2000, the coefficient is -1.8573, which is broadly in line with the rule of thumb advocated by Okun: a 1 percentage point increase in the unemployment rate corresponds to a 2 percent decline in output. 1 The point where this line intersects the y axis, in other words the intercept of the regression line, could be regarded as an estimate of the trend growth, given that such a rate of growth would leave the unemployment rate unchanged. Looking at the data after 2001, we can see that the relationship between unemployment and growth has changed. The regression line is much flatter and has shifted lower after Q4 2000. The change is more pronounced after the so-called Paribas shock of August 2007. This implies that the trend growth is significantly lower than it used to be, at least for the time being. 1.3. Stalling wage disinflation Turning to the third trend, the next graph shows the changing relations between unemployment and wage inflation in the United States. Wage inflation for a given unemployment rate steadily declined in the service industries from the early 1980s into the mid-2000s. In other words, there was a pronounced downward drift in the short-term Phillips Curve. In the early 1980s, on the yellow line, wages increased by about 8 percent even when unemployment stood at around 8 percent. Shortly before the Great Financial Crisis, wage inflation did not even reach 4 percent as unemployment dipped below 5 percent. In other words, we saw substantial wage disinflation relative to the 1980s or 1990s. Having said this, the downward shift seems to have been more or less arrested in recent years. The data points since Q1 2005, around the black line, seem to be resting comfortably on this regression line. Statistically, the coefficient of determination (R squared) is 0.89. Given that services account for more than 60 percent of household consumption expenditure, it is not surprising to find inflation creeping up with the upturn in the business cycle, even if unemployment remains stubbornly high. The recent movements in the trimmed mean of U.S. PCE inflation on the next graph show this point. Here the trimmed mean PCE inflation is usually regarded as representing the steady trend component of PCE inflation. Here I refer to the “difference” version of Okun’s Law. BIS central bankers’ speeches Turning to Japan, we can draw graphs that are quite similar to the U.S. ones that we have just seen. In the next slide, while Okun’s relationship is not very visible in Japan, regression lines for periods corresponding to the U.S. example suggest that trend growth has indeed declined in Japan as well. The short-term Phillips Curve after the bursting of the property bubble in the late 1980s is also stable, as you can see in the next slide, and, as a result, trend inflation as represented by year-on-year changes in the trimmed mean of CPI has been edging up until recently, although the level of inflation is much lower in Japan. 1.4. Temporary or permanent? Are these trends temporary or permanent? Many in the United States certainly believe that they are temporary. One example is the table on the next slide, which shows a projection made recently by the Congressional Budget Office. Potential GDP growth may be lower in the period 2012-2013, but it is expected to return to pre-crisis levels in 2014-2022. Such a view rests on an assessment that the three trends result not from structural changes but from the unusually large shock that was the Great Financial Crisis. More specifically, these observers believe that the Beveridge Curve itself has not shifted: the data points are just following a historical counterclockwise pattern during the upward leg of the business cycle. They also believe that unusually large layoffs and subsequent rehiring in the face of the shock could explain the deviation from Okun’s rule of thumb. Accordingly, they tend to recommend measures to jump-start aggregate demand, which would enable the economy to return to its pre-Crisis trajectory in a relatively short time. The problem with such a view is that reality is beginning to work against it. In particular, the speed of the recovery has remained very slow, and is not expected to accelerate anytime soon. The economy is not rebounding as rapidly as in previous business cycles. It is becoming more difficult to refute the parallels with the Japanese experience since the beginning of the 1990s, which I have just shown. There are also differences with past cycles in the pattern of recovery. For example, the auto sector enjoyed a relatively swift recovery, whereas the housing market shows little signs of life even at the current extremely depressed levels. In addition, some historical research, such as that presented by Reinhart and Rogoff, suggests that recovery from financial crises tends to be slow and prolonged. 2 The fact that not only the United States but also other advanced economies are suffering from similar symptoms, and that emerging economies, which initially weathered the storm fairly well back in 2008, are now visibly slowing down makes us wonder if there are common threads that tie economies to a prolonged period of sluggish growth. I will explore these common factors in the next part of my presentation, but before moving on, I would like to stress that I am not a fatalist. While structural factors play an important role in the economy, and they may have a lasting influence, not all economic developments could or should be attributed to them, and the economy can benefit from sensible aggregate demand policies, including monetary policy. These policies can certainly prevent excessive swings in aggregate demand, in both the upward and downward legs of the business cycle. Policies can still be effective, but they must be formulated, adopted, and implemented with the understanding that structural changes do occur, and when they do, this will change the context and effectiveness of policies. It may be unfair therefore not to mention the potentially profound changes related to energy costs resulting from the so-called shale gas revolution in the United States, to which I will try to return in the final part of my presentation. Reinhart, C., and K. Rogoff (2009), This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press. BIS central bankers’ speeches So, let me now move on to part two. 2. What lies behind mismatch and low trend growth: ageing, balance-sheet adjustment and the impact of ICT on workplace, value chain, and globalization In this part, I will try to explore the root causes of the trends that I have just observed. As I laid them out at the beginning, these trends are: demographic trends, balance-sheet adjustment, the influence of information and communication technologies, and finally, globalization. 2.1. Demographic transition and reduced mobility and flexibility The first force that I would like to identify is the effect of the transition from what we might call demographic bonus to demographic onus. The two graphs on the next slide demonstrate this for Japan and the United States. The black lines show the inverse dependency ratio. This is the ratio of the working-age population between 15 and 64 of age to the rest of population, who are dependent on the working-age population. The inverse dependency ratio shows how many independent working-age persons have to provide for one dependent person (in the form of pensions and expenditure on children). The two humps in the graphs reflect the post-World War II baby boom: the first hump appeared as the boomers reached working age, and the second as the children of boomers reached working age while the boomers themselves had not yet retired. The pink and green lines show real estate prices and the amount of bank loans outstanding respectively, both adjusted for inflation and on a scale where the peak level equals 100. The striking feature of these graphs is that in both Japan and the United States, the peaks in real estate prices and loans have more or less coincided with the peaks in the inverse dependency ratio. The actual peaks are about 15 years apart between Japan and the United States, but the pattern is surprisingly synchronous. Similar experiences are observed in other countries as well. There are several empirical studies, employing multi-country panel analyses, which conclude that demographic changes have a significant effect on economic variables, such as property prices and long-term interest rates. 3 This comes as no surprise since, in the population dividend phase, young baby boomers want to buy more land and save more real money for their retirement. Since the supply of land is physically limited, the real price of land will go up. Similarly, if nominal money supply is held constant, the “price” of real money holdings, which is the inverse of the price level, should also go up, implying deflation. Being mandated to maintain price stability, the central bank is then likely to increase nominal money to keep prices stable. The result is an increase in property prices while general price levels remain stable. 4 At the same time, I should also stress that demography alone does not explain the formation and bursting of asset bubbles. For example, excessive optimism, or the “this-time-is-different” syndrome is also an important contributing factor. Meanwhile, demography makes a lot of difference when a bubble bursts. Generally speaking, the effects are expected to be much more pronounced under the demographic onus of an ageing population rather than the demographic bonus of a young and growing For property prices see, for example, Takáts, Ellőd (2012), “Aging and house prices”, Journal of Housing Economics, vol 21, no 2, June, pp.131–141, and Nishimura, Kiyohiko G. (2011), “Population ageing, macroeconomic crisis, and policy challenges”, Panel discussion at the 75th Anniversary Conference of Keynes’ General Theory, University of Cambridge, 19–21 June 2011. For long-term interest rates see for example, Ichiue, H., and Y. Shimizu (2012), “Factors Affecting Long Term Interest Rates: A Panel Analysis of Major Advanced Economies”, WP 12-J-9, Bank of Japan (in Japanese). See Nishimura, K. G. and E. Takáts, “Ageing, Property Prices and Money Demand” (work in progress), which has both theory and empirical analysis of a panel of 22 advanced economies. BIS central bankers’ speeches population. Let me offer two examples: reduced flexibility or mobility in the economy, and more acute balance-sheet adjustments. Older people tend to be less mobile or flexible than younger people. This is because older people, with fewer productive years ahead, are more reluctant to incur various adjustment costs, for example relocating to a different geographical area or obtaining new skill sets to work in a different sector of the economy. This tendency appears not only in workers but also in entrepreneurs. As a result, when the population ages and the proportion of older people increases, the mobility or flexibility of the whole economy is likely to decline. Reduced mobility or flexibility leads to prolonged mismatches in the economy: job seekers may need more time to find a new job and entrepreneurs may be slow in exploiting new business opportunities. 5 Such a trend would depress productivity growth. I should add that the effects of balance-sheet adjustment, which are aggravated by demographic onus, will also magnify the loss of mobility or flexibility. Such a trend was observable in Japan after its bubble burst in the 1990s. Even the United States, which is one of the most mobile and flexible economies, has been suffering since its housing market collapsed in 2006. There is a wealth of evidence of reduced mobility or flexibility. For example, the slide (on page 20) shows that the mobility rate among house owners declined substantially, by more than 30 percent on average, between 2005 and 2009. The fact that the mobility rate among renters did not change suggests that the change was influenced by the decline in house prices during that period. The next graph shows the rate of births of new business establishments. It can be said that the higher this rate is, the more flexible the economy. Here again, there is a marked decline after 2005, which coincides with the peak in the inverse dependency ratio. Another example on the next slide shows immigration into and emigration out of the United States. Immigrants are the most mobile members of the population and are generally regarded as contributing substantially to the flexibility of the U.S. economy. The concurrent decline in arrivals (inflows to the U.S.) and increase in departures (outflows from the U.S.) once more suggests less flexibility in the United States. To underscore this relationship between demographics and mobility or flexibility, I would like to show you the next slide on Japan. After the bubble burst, there was a sharp brake on the creation of enterprises whereas destruction increased only modestly. 2.2. Severe balance-sheet adjustment Let me now turn to the second force, the severity of balance-sheet adjustments. The next slide (on page 22) shows the changes in inflation-adjusted house prices. The graph on the left compares Japan, the United Kingdom and the United States. It shows monthly changes in real house prices relative to the peak price. The shape of the graphs is strikingly similar. It took more than ten years for the Japanese real house price to hit the bottom at almost one third of the peak price, when her population was ageing. While recent data for the United States is often regarded as showing signs of stabilization in the housing market, it is far from certain that downward trending is finally over, if one takes into account the possible effects of an ageing population that the Japanese experience suggests. Even without any further fall, a 40 percent decline in U.S. real house prices is a deep adjustment. This has led to a significant divergence among industries in the pace of recovery. Some industries are recovering much quicker than others. The proportion of households that have negative equity has jumped since 2010 and continues to increase, which leaves the U.S. housing market still in the doldrums. In contrast, the debt service ratio A sizable number of people change jobs without experiencing a spell of unemployment. Thus, in discussing mismatch or inefficiency in labor markets, simply focusing on the unemployed is misleading. BIS central bankers’ speeches is now markedly lower, reflecting the decline in interest payments as central banks eased monetary policy. Consequently, U.S. auto sales have now recovered to a level closer to what can be considered normal. Another problem related to severe balance-sheet adjustments is the breakdown of the market economy’s natural selection mechanism. The role of financial institutions to channel funds to productive enterprises can be obstructed when those institutions have significant amounts of impaired assets. Suffering from severe balance-sheet problems, institutions may find themselves with no other choice but to keep borrowers on life support, which prevents them from extending new loans to more promising businesses. Such patterns were observed in Japan during the financial crisis of the late 1990s. The market selection mechanism broke down, and the survival of the fittest no longer applied to the world of business. So-called zombie firms were supported by zombie banks. Strong evidence of this phenomenon is found in a study I conducted with Nakajima and Kiyota, the main conclusion of which I have included in the next slide. By conducting a large-scale panel analysis at the firm level, this research was able to show that during the period of the financial crisis of 1997, the total factor productivity of surviving firms was actually lower than that of exiting firms. 6 2.3. Impact of information and communication technology The third force that is shaping the global economy is the impact of information and communication technology (ICT). I argue that ICT has in fact been a polarizing force both in the labor and product markets. Furthermore, the effects are not confined to specific industries, but are more or less ubiquitous and far reaching. Labor markets The reason ICT impacts the labor market is that it can be applied to a variety of moderately skilled tasks, and consequently displaces workers from those tasks. For example, banks used to be inundated with paper. Payments were made in checks, slips of paper were made to record transactions, which were in turn tracked on paper ledgers, and ticker tapes provided up to the minute market information. Banks employed hundreds or even thousands of clerks to literally push the paper around their offices, just to keep track of their operations. Clerks were skilled in the sense that they had to know what was the important information on those pieces of paper, and in which books such information was to be written down. ICT changed all this. Now, virtually all bank transactions are processed electronically with minimal intervention from human workers. As a result, the bank clerk has become extinct, or at least an endangered species. Such changes occurred not only in banking but in all industries. Any task that could be programmed was moved onto electronic platforms, displacing workers in the process. This could be the force behind the graph on U.S. employment according to worker skills, which shows the greatest job losses after the Great Financial Crisis were those for medium-skilled workers. The next two slides (on pages 25 and 26) are schematic illustrations of this development. Let us suppose that there were three broad types of worker defined by their skill sets and a labor market for each type before the prevalence of ICT. We could label them: top management or highly-skilled professional workers, middle management and moderately-skilled workers, and manual laborers or low-skilled workers. Looking at the Nishimura, K. G., T. Nakajima, K. Kiyota (2005), “Does Natural Selection Mechanism Still Work in Severe Recessions? – Examination of the Japanese Economy in the 1990s –”, Journal of Economic Behavior and Organization, 58:1 (2005), pp.53–78. BIS central bankers’ speeches supply curve for the three categories of workers, we would expect a steeper curve for more skilled workers, since it is likely that there would be a smaller number of these skilled workers. On the other hand, the demand curve would be determined by the marginal productivity of workers, which in turn is equivalent to what employers are willing to pay workers as wages. In this regard, employers should be willing to pay higher wages for more skilled workers, because their marginal productivity is higher. The resulting equilibria for the three types of workers could then be illustrated as in this slide (page 25). The effects of the widespread application of ICT are shown on the next slide. The resulting increase in productivity is reflected in the upward shift of the labor demand curve. Meanwhile, the market for middle management and moderately-skilled workers is now gone because tasks performed by those employees are easily replaced by ICT. Since the displaced workers are not likely to have the skill sets required for the top group of workers, they will probably have to compete for jobs with the manual labor or low-skilled workers. This will have the effect of shifting down the labor supply curve for manual laborers or low-skilled workers. The resulting equilibria would offer higher wages for top management or highly-skilled professional workers, reflecting the shift in the demand curve, and only moderately higher wages for manual laborers or low-skilled workers, reflecting the shifts in both the demand and supply curves. In addition, the influx of over-skilled workers into the market for manual laborers or low-skilled workers implies increasing mismatches. What would happen if this mechanism were not allowed to play itself out for historical, cultural or political reasons? Employers may be compelled to (or even be willing to) preserve the status quo. In order to maintain the middle market for labor, employers cannot take advantage of ICT, which becomes a drag on productivity growth. This may explain the slowing of Japanese productivity growth since the 1990s. Historically, up until the 1980s, Japanese firms benefited from the accumulation of firm-specific skills or knowledge in their workforce, particularly among middle management or medium-skilled workers. Nevertheless, the reluctance of firms to replace those workers with ICT since the 1990s, because of the high cost of shedding workers, began to weigh on productivity. I have shown the consequences of this empirically in a panel study of sixteen industries from 1981 to 1998. 7 Product markets Turning to the product market, ICT is influencing business organization and business models. As mass-production developed and economies of scale advanced from the latter half of the 19th century, the cost of getting the right inputs at the right time became more of a concern to firms than the cost of the inputs themselves. Thus, the skills required to organize and optimize the production process and product development became the source of profits. An early solution to this problem was the vertically integrated firm based on the “ore-to-assembly” operation exemplified by the Ford Motor Company’s sprawling River Rouge complex in Detroit. A later solution in the latter half of the 20th century was Toyota’s Kanban operation, which improved the interaction between the car assembly plant and its various suppliers. In both cases, the knowledge and skills of coordinating a complex production system and product development were the major source of profits, and thus assemblers became profit centers. Though not as pronounced as in the automobile industry, the same was true in other areas, including consumer electronics. Considering that such skills boil down to communication and information processing, we can understand why the impact of ICT has been so enormous, especially since around the turn of this century. As ICT dramatically reduced the cost of interfacing between functions, it soon Minetaki, K., and K. G. Nishimura (2010), Information Technology Innovation and the Japanese Economy, Stanford University Press, 2010, Chapter 6, Section 4, pp.133–144. BIS central bankers’ speeches became more efficient to procure products and services from specialized outside suppliers, who could offer better products much cheaper by virtue of specialization and economies of scale. If everyone is buying the same inputs from the same supplier, and the cost for sourcing is leveled due to ICT, there will be less opportunity to differentiate any finished product assembled from those inputs. Consequently, the assembly business became a business of attrition. This is clearly manifested in the next slide (page 26). The operating profit margin is depressed in the downstream: particularly for LCD TV set makers. The same is true for solar cells, where assemblers (system venders) are suffering from dwindling profit margins. ICT also forced changes in business models in many sectors. For example, if you wanted to distribute music in the mid-20th century, you had to cut a master disk from a recording, plate it to make a die, stamp a piece of vinyl with the die to make a record, put the record in a paper jacket and send the final package off to stores around the country. Each record sale had to cover the costs involved in this process. This model did not change much even after the compact disc was introduced in the early 1980s. Now, however, music is distributed digitally: a recording, once converted to an appropriate format, can be copied an infinite number of times at virtually no cost. ICT is making this transition to electronic delivery more practical in many industries. Economics tells us the price of a product will be driven down to the marginal cost of production. Thus, it is not surprising to see the price of electronically delivered products falling ever closer to zero, which is the cost of reproducing such products. These changes introduced by ICT have not only sealed the fate of traditional distribution channels, but have also forced businesses to re-consider how they charge for their products. The rise of platform businesses is perhaps one answer. These developments in the product market interact with the labor market. When huge integrated manufacturing firms are replaced by decentralized networks of smaller firms, some of which are abroad, workers who were responsible for internal coordination are released and replaced by ICT. At the same time, these smaller firms become more efficient than before thanks to ICT, and tend to employ fewer workers to complete a certain task. As a result employment creation in manufacturing is likely to stagnate. Furthermore, jobs are also lost when existing distribution channels, which were a significant source of employment, are replaced by electronic distribution. In contrast, now-flourishing platform businesses, by virtue of being easily scalable, will not be hiring too many workers even if they grow rapidly in terms of sales. Thus, the end result is a headwind in the labor market. 2.4. Globalization ICT also influences globalization, which in turn affects developments in the labor and product markets. As is widely recognized, ICT has been one of the driving forces behind globalization. It has greatly reduced the cost of communicating and coordinating across borders. Coupled with the integration of former communist bloc countries into the global trading system, the horizon has broadened considerably for locating business operations. Not only can firms now create networks across borders in order to attain maximum aggregate output at minimum cost, but they can also change them easily as conditions change in various corners of the world. If you have chance to look closely at the content of your wardrobe, you will be surprised by the wide variety of the countries of origin, even for seemingly similar items from the same brand. A fashion brand may design a T-shirt, but it contracts out the production to specialized factories around the world. The multitude of countries of origin on the labels shows that brands are certainly not shy of taking advantage of an offer from a factory in Dhaka to make a T-shirt more cheaply than a factory in Shenzhen. Such practices put competitive pressure on wages across borders, and contribute to the polarization of wages, because the benefit of increased profitability would accrue mostly to top management or highly-skilled professional workers. Meanwhile, some multinational firms might go one step further and directly play one country’s workers against another’s. These BIS central bankers’ speeches firms might threaten to leave a country and reestablish themselves in another with cheaper wages, thereby extracting concessions from existing workers. This would exacerbate polarization by lowering the wages paid to manual labor or low-skilled workers. Now, I am about to conclude my discussion of demographic trends, balance-sheet adjustment, and the influence of information and communication technology, so before I move on to the next part, I would like to summarize where I think we are. First of all, a period of low trend growth is probably here to stay for some time, together with rigidities that may become more entrenched. It is a problematic combination of factors that could reinforce each other. Secondly, in such a state, economies would be more vulnerable to occasional downward shocks. That could exacerbate inefficiencies. Finally, polarization may become more pronounced, again aggravating general efficiencies. This certainly is a challenging situation, but there are opportunities ahead as well. Let me explain by moving on to the final part. 3. What lies ahead of us? As I have just explained, in my view, the global economy, and the advanced economies in particular, is affected by four strong undercurrents: demographics, balance-sheet adjustment, the impact of ICT, and globalization/polarization. In this final part, since balance-sheet adjustment is essentially a transitional (though prolonged) phenomenon and globalization/polarization has been discussed extensively elsewhere, I will concentrate on the other two, which have been changing the global economy permanently, but the significance of which is grossly underestimated and largely overlooked by many observers. I would like to think about where demographic factors and ICT will take us in the years ahead. 3.1. From demographic bonus to demographic onus Firstly, the global population is now in the midst of a significant transition. One by one, economies are watching their demographic bonus give way to demographic onus. Many countries in East Asia will reach the turning point in around 2015, as you can see from the graph on the next slide (page 27). Meanwhile, Latin American countries like Brazil and Chile have a little more time, but are expected to face the transition in the years between 2015 and 2020, as you can see in the next slide (page 27). In short, many emerging economies are going to lose an important engine of growth in the next decade or so. The effects are not going to be uniform, but those economies are going to face their own version of declining flexibility and mobility, leading to reduced growth potential. Having said this, I should also stress that while this demographic phenomenon is a more or less inevitable outcome of people’s choices reflecting increasing living standards, it is not synchronous across countries. Comparing Japan and Turkey in the next slide (page 28), you can see that the inflection points are roughly 40 years apart, or one and a half generations. If there are complementarities between economies in these cases, for example in terms of resource needs and savings and investment patterns, and if we can take advantage of them, the impact of demographics could be mitigated at the global level. Looking at the impact of aging on individual economies, firms are beginning to respond to this reality. Mass-production, mass-marketing and mass-consumption now prevalent in the advanced economies came about as firms responded to the post-war demographic bonus. Firms targeted their sales efforts at the large group of people entering the workforce and becoming more affluent by the day. As a result, firms’ sales efforts tended to focus on young people, and the portfolio of goods and services available to consumers was tailored to satisfy their preferences. It was the most efficient and effective business strategy. Today, those consumers are ageing, and with it they are becoming more diverse. For example, the majority of young people gather together in schools, whereas older people are divided by their occupation. Young people are generally healthy, but older people are more diverse: some remain quite healthy well into their 80s and even 90s, some prefer to use lifestyle BIS central bankers’ speeches drugs (botox, for example), and there are others suffering from various ailments. The cumulative effect of differences in income and hence wealth could be very large. Firms are finally realizing that, with the shrinking of the young population, they must part with the winning strategy of yesterday that focused on youth. Instead, they should begin catering to older people, if they are to succeed at all. In Japan, there are reports of more and more successes, especially in the retail sector, as the older generation seems willing to pay more for those goods and services that satisfy their needs. 3.2. Adjusting to ubiquitous ICT Now I turn to ICT. As I have explained, ICT disrupts the status quo because it is one great global leveling force. Competitive advantages that existed before the advent of ICT are now being eroded away. At the same time, since factor endowment among economies is necessarily uneven, the law of comparative advantage tells us that, once ICT becomes ubiquitous, a new pattern of product flows should emerge to the advantage of everyone. Looking at Japan and elsewhere, there are promising signs that this new world will offer rich opportunities for economic growth and social advances. For example, in manufacturing, firms are now beginning to realize that selling hardware, be they mobile handsets, flat panel TVs, automobiles or even airplanes, captures only one part of the value accruing to the users over the life of the hardware. Very often, as I have noted earlier, there is a relentless downward pressure on the price that manufacturers can charge for their product. On the other hand, users of mobile handsets for example, will pay many times over the cost of the handset as monthly voice and data subscription charges. They may also pay substantial sums for downloaded content such as music and video. As a result, many firms are now slowly adapting their business models. One option is to become “platform businesses,” making their physical products platforms for various services. The aim is to capture as much of what the users are prepared to pay over the life of the product. Meanwhile, another option is to become the provider of one-of-a-kind inputs (especially materials), which cannot be easily replicated by other firms. Successful firms in Japan and elsewhere are now pursuing these strategies, which I noted in a book published several years ago. 8 One footnote here is the impact of recent breakthroughs in the energy sector regarding shale gas and tight oil production. While the impact is now most visible in the United States, there are many promising geological formations in the world where new exploitable gas and oil deposits might be discovered, including Turkey. While they may or may not become game-changers as some commentators suggest, once discovered and developed, these new sources of energy could affect the global economy in two respects. They will definitely change the energy endowment of economies. However, more uncertain is the effect on energy prices and their impact on the increasing mismatches and polarization we have witnessed in the past decade. 3.3. Challenges for the aged society Finally, what will be the effect of the two forces – demographics and ICT – working together? I explained earlier that if the ubiquitous presence of ICT becomes the new normal, there will be relentless pressure on corporate profits because prices of products will tend to fall and even approach zero, reflecting the very low marginal cost of production for ICT-enabled products. At the same time, the replacement of moderately skilled workers by ICT will lead to a polarization of the workforce, with heavy losses of relatively well-paid jobs in the labor market. That said, the impact of ICT differs between aging societies and those with young and growing populations. Nishimura, K. G. (2004), The Japanese Economy: Inconspicuous Structural Transformation, Tokyo: Nihon Keizai Shinbun, pp.24–34. BIS central bankers’ speeches In the case of ageing societies, ICT may create some new business opportunities, because ICT can help firms adapt to the demands of ageing consumers, who tend to be more heterogeneous than younger consumers. ICT could help firms to tailor their products to individual tastes at a lower cost and hence make them more affordable. However, there is a caveat here in that lower prices, which on the one hand make products more affordable, will on the other hand lower the investment returns for the providers of the products, ceteris paribus. The key is the degree of demand stimulation from the lower prices. If demand generation is not sufficient, it might be necessary in such circumstances to devise mechanisms that are not completely dependent on market forces in order to provide socially useful products. 3.4. Challenges when population is young and growing Meanwhile, in the case of economies enjoying a population bonus, the challenge is to provide the right sort of jobs for the large number of people entering the workforce, who are in many cases, well-educated and technologically adept. When the advanced economies had their population bonus, there were a large number of openings for medium-skilled jobs, where workers could expect to build a career and, with hard work and perhaps some luck, advance into highly-paid management-level jobs. Now, with the prevalence of ICT, those jobs are becoming scarcer. In order not to waste talent in dead-end low-paying jobs, it has become necessary to provide the right social and economic incentives for prospective employers to employ talented youth for the long term, providing them with the training and opportunities to advance their careers. It is not easy to solve the problem of providing goods and services (in the case of advanced economies) and employment opportunities (in the case of developing economies) that the market fails to provide on its own. Some time ago, before joining the Bank of Japan, I advocated the creation of socially-oriented investments trusts, where the public sector provides seed capital to socially desirable projects that would not offer adequate returns on capital but could still be run as market-disciplined entities. The idea is yet to be widely accepted, but more and more people seem to be realizing that such a structure might provide a workable solution. 9 3.5. Challenges facing central banks Central banks are facing enormous challenges, particularly those of the advanced economies. After stepping in decisively to halt the contagious disruption in the global financial markets and economy following the Great Financial Crisis, central banks of the advanced economies have now exhausted the available options for traditional monetary policy. Consequently, these central banks, including the Bank of Japan, are pursuing the most unconventional policies ever imagined. There is still room in this direction for further easing of monetary conditions to support the economy. There are also still means to assist economic agents in making structural adjustments. One such policy is the Fund-Provisioning Measure to Support Strengthening the Foundation for Economic Growth (Growth Foundation Strengthening Facility [GFSF] for short) adopted by the Bank of Japan in June 2010. This measure, while not providing funds directly to non-financial borrowers, is intended to be a catalyst for financial institutions willing to lend to various private-sector initiatives that attempt to overcome structural headwinds and will enhance potential growth in the medium to long run. I believe the “Funding for Lending” scheme, which was recently announced by the Bank of England and the U.K. Treasury, has a similar purpose, and I am carefully following its outcome, although this and the Bank of Japan’s scheme will need a long time before they can show any concrete benefits. Nishimura, K. G., and M. Saito (2003), “On Alternatives to Aggregate Demand Policy to Revitalize the Japanese Economy”, Asian Economic Papers 2:3 (2004), pp.87–126, especially pp.118–123. BIS central bankers’ speeches So far, I have explained the formidable challenges now facing central banks. While monetary policy is not a panacea, as often stressed by Governor Shirakawa of the Bank of Japan and other prominent central bankers, it can usefully support efforts by economic agents. There are risks such as economic polarization leading to political polarization, as I mentioned before, which could prevent governments from implementing the necessary policies. That tail risk is significant. Nevertheless, I am cautiously optimistic that what we are doing now will eventually lead to a better future, although there are going to be ups and downs along the way. In any case, enhanced cooperation between countries and regions is essential in achieving this goal, and I hope my presentation today had been one small step in this regard. 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 BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Keynote Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, to the 6th Irving Fisher Committee Conference, Bank for International Settlements, Basel, 29 August 2012.
Kiyohiko G. Nishimura: Market intelligence, market information and statistics in central banking Keynote Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, to the 6th Irving Fisher Committee Conference, Bank for International Settlements, Basel, 29 August 2012. * 1. * * Introduction: statistics, market information and Irving Fisher It is a privilege for me to address this keynote speech before the distinguished members of the Irving Fisher Committee. I am particularly thrilled, since the name Irving Fisher strikes a chord in my heart. Irving Fisher is an iconic figure at Yale University, where I earned my doctorate. In fact, he received the first Ph.D. in economics ever granted by Yale, in the year 1891. I vividly remember his life-size portrait hung above the mantelpiece of the 19th century mansion house, gazing solemnly at faculty members and graduate students. No new words are needed to attest to his monumental contributions to microeconomics, macroeconomics and monetary theory. He was also influential in laying the foundations of economic statistics, as exemplified in his popular The Making of Index Numbers. In fact he was not content with just theory: he went on to found by himself the Index Number Institute that engaged in computing commodity price indices, and thus became one of the most popular providers of market information at the time. Unfortunately, however, he failed to recognize the significance of the Stock Market Crash of 1929. Just three days before the crash, he wrote that stock prices were at a permanently high plateau. And even after the crash, he continued to assure investors that a recovery was just around the corner. This might testify to his failure in “market intelligence”, in detecting the signs of a fundamental change in the market place. In his latter days, though not immediately appreciated by the public and the profession, he presented a remarkable theory of debt deflation as an explanation of the Great Depression. In fact, this masterful piece of work is the precursor of the vast literature concerning financial stability, which is especially relevant in economic policy making in the aftermath of the financial crisis of 2008. What then can we central bank statisticians learn from these dramatic ups and downs in the life of Irving Fisher? In fact, this is the subject of this speech. In particular, I argue that, although reliable macroeconomic statistics are of course necessary for policy making, even good statistics are sometimes grossly insufficient to guide economic policy, especially when a seismic change occurs in the market and the economy. The recent financial crisis is an example of such change. Thus, central bankers should incorporate “market intelligence”, which I will explain later, and non-statistical market information, into their arsenal of statistics. So a central bank statistician should be more than simply a compiler of well-defined statistics: they should become a sort of sleuth or intelligence agent, detecting signs of future developments that may change the world. I proceed as follows. Section 2 outlines the value of economic information from the perspective of policy decision making. A key theme here is “market intelligence”, which is the active gathering and analysis of market information through central banking activities. To understand the importance of market intelligence, I present three examples, with respect to the past, the present, and the future. Section 3 presents a lesson from the past. I examine the so-called Paribas Shock of 2007, and argue for the absolute necessity of “proactive” market intelligence to avoid this type of financial crisis. Section 4 describes the current achievements of market intelligence in an area of pressing importance: property price statistics. I show that it is possible to get reliable, unbiased information by combining various existing market information sources, even though individually they may have their BIS central bankers’ speeches own biases. Section 5 concerns the future: detecting problems in shadow banking. Shadow banking involves a complicated structure, so it is necessary to grasp its “interconnectedness” to gauge the magnitude of potential problems. As an example, I explain the Bank of Japan’s attempt to reveal the interconnectedness of the Tokyo money markets. Section 6 contains some concluding remarks on market intelligence and central bank statistics. 2. Economic information and policy making Contemporary central banking faces two major accountability, and the other to effective communication. challenges; one related to First, central banks should be accountable for their policies. This is all the more important for those central banks that have independence in determining their monetary policy. Accountability means policy should be evidence-based, that is, based on clear reasoning relying on substantiated data. Second, central banks should be effective communicators. Markets and economies have become increasingly susceptible to changes in economic agents’ expectations. To ensure that policy is effective, central banks must communicate with the public in a persuasive manner. Here again, data supporting policy decisions become important. Thus, for accountability and effective communication, “numbers” or statistics become increasingly important. Moreover, data here means not only quantitative data; qualitative data are equally as important. Knowns and unknowns in Central Bank policy To understand the nature of the economic information central banks want to know, the following three-way classification may be helpful. The first type of information concerns “known knowns”. Here “knowns” are whatever happened in the past. Thus, known knowns are information about what happened, and typical known knowns are contained in statistics. The second type is “known unknowns”. Here unknowns are those things that are happening at present or that will emerge in the future. They are known unknowns, since we already know that they are happening or will happen. You may have come across the word “now-cast”, which is an “estimate” of what is happening now, used in contrast with a “forecast” which predicts future events. A “now-cast” is a typical example of a “known unknown”. Finally, there is the third type, called “unknown unknowns”, things previously unknown but potentially having a significant effect on the economy. Here I quote Donald Rumsfeld, the former U.S. Secretary of Defense, whose enigmatic statement gives perhaps some indication of their nature: “But there are also unknown unknowns – the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.” Keeping in mind this three-way categorization, let me ask the following question: What kind of information does a central bank policy maker want to know when he or she decides on policy? And, in what way is it related to the three-way categorization? First of all, in contemplating appropriate aggregate demand management policy, the central bank policy maker wants to know the momentum of activity in the economy and financial markets. However, this is not in itself sufficient. The experience of the recent financial crisis has shown that the central bank policy maker should also be aware of the signs of previously unknown factors, unknown but potentially significant changes in the economy and financial markets. In fact, with respect to the former, i.e. macroeconomic momentum, we have made significant progress. There have been improvements in the comprehensiveness, accuracy and timeliness of macroeconomic statistics related to aggregate demand management. BIS central bankers’ speeches We now have a rich array of data, both quantitative as in GDP and CPI figures, and qualitative as in business surveys. Not only public but also private institutions produce and disseminate their own data. These are either known knowns (type 1), or known unknowns (type 2). Statistics provide valuable information about known knowns, and they become the foundation for estimating known unknowns. However, statistics are grossly insufficient when it comes to detecting unknown unknowns (type 3). Central-bank policy makers are frequently frustrated by deficiencies in the statistics available, which they find inadequate in helping them detect potential problems in the economy. Perceived deficiency is especially keen in financial information. It should be noted that financial stability is now seen as a prerequisite for economic stability. Moreover, policy makers are alarmed by the increasingly strong negative feedback seen in recent years between financial malaise and economic stagnation. The rapid development of financial factors confounds the problem of detecting malign symptoms. Thus, guarding against previously unknown but potentially devastating factors has become one of the most important issues for policy makers. Thus, in November 2009, the G20 Finance Ministers and Central Bank Governors requested statisticians to fill the so-called data gaps. Twenty recommendations were submitted in the G20 Data Gaps Initiative (DGI) in order to establish timely reporting schemes for detecting both known unknowns (type 2), and unknown unknowns (type 3) . The key to guarding against unknown unknowns A central bank’s intelligence activities are the key to guarding against unknown unknowns. These consist of two parts. The first is so-called “market intelligence”: the central bank’s daily transactions with financial institutions, which provide various kinds of information about market participants, developments in financial products, as well as other “news”. These pieces of market information are valuable in creating a timely and accurate view of particular institutions and the market as a whole. The gathering and analyzing of this information is the core of “market intelligence”. The second part of the central bank’s intelligence activities is monitoring and feedback. Qualitative or supervisory information can be obtained from regular supervisory dialogue with regulated entities. They have valuable information, and by analyzing it thoroughly we get a grasp of the details of market information, which is then fed back to these institutions if necessary. It should be noted here that information coming from individual financial institutions may include subjective or in some cases biased content, regardless of whether it is market information or information acquired through regulatory monitoring. We should be aware of these biases, and good market intelligence is needed to gauge the extent of such bias and to compensate for it. 3. Lessons from the past: necessity of proactive market intelligence Let me now turn to three examples of central bank intelligence. The first example is its failure in the past. This is the so-called Paribas Shock of August 9, 2007, the precursor of the global financial crisis of 2008. On July 10, 2007, S&P and Moody’s announced that they would be reviewing the ratings of several residential mortgage-backed securities (RMBS) backed by subprime housing loan assets. As a consequence, the AAA ratings of asset-backed commercial paper (ABCP) backed by these RMBS would also be downgraded accordingly. This looked like a minor change in a marginal market of the US financial system. Unfortunately however, within just one year, it became the epicenter of a global financial crisis. BIS central bankers’ speeches To understand the problem, we should be aware of the special role of money market funds (MMFs) in the United States. US MMFs were considered to be extremely safe financial assets. One of the primary reasons for this was that MMFs were only allowed to invest in AAA-rated assets. Therefore, when ratings were downgraded for ABCP, MMFs did not reinvest in ABCP. Then, funds that originated ABCP and used it to raise money found themselves in fund-raising difficulties: funds under the Bear Stearns umbrella went bankrupt; BNP Paribas moved to freeze its affiliated funds’ new applications and redemptions. These funds were the structured investment vehicles (SIV) created by banks to issue ABCP. When these SIVs were unable to find funding sources, their parent banks were forced to provide liquidity enhancement instead. At that time, nobody knew for certain which banks’ SIVs were on the brink of extinction, and which banks had serious liquidity problems. Banks, which frequently lend each other money, suddenly became aware of counterparty risk, the risk that the other party in a transaction might suddenly go belly up. They began to worry that some bank somewhere might suddenly be unable to secure liquidity and fail. Indeed, on August 9, a liquidity crisis actually occurred, with liquidity drying up quickly in the interbank market. Many European banks were among those facing liquidity difficulties. Chart 1 shows an unprecedented spike in the three month LIBOR-OIS spread, showing the heightened risk premium in the European interbank market. A liquidity crunch in interbank markets started, and it spread immediately to the United States (Chart 2). Confronted with this situation, the European Central Bank (ECB) promptly announced that it was prepared to supply massive amounts of liquidity into the short-term money market. This was the event that came to be known as the Paribas Shock. Lesson: necessity of proactive market intelligence The circumstances surrounding the Paribas Shock naturally beg the question: Was this event avoidable? Or at least, was there any telling sign that this type of event was just around the corner? As the description of the event shows, there are four important pieces of information that the policy makers should have known and which would have helped prevent this event. The first is the asset position of the MMFs: their composition and quality. MMFs held a large amount of AAA-rated ABCPs of SIVs whose parents were European as well as US banks. These ABCPs were backed by US subprime loans, so that if the subprime loans were downgraded then these ABCPs would also be downgraded. The second vital information is possible side effects of the legal constraints upon the MMFs. MMFs could hold only AAArated assets so that, if US subprime loans were downgraded, MMFs could not reinvest in ABCPs of the SIVs. The third and most crucial information policy makers should have had is knowledge of banks’ involvement in their SIVs. To what extent were those banks obliged to support their SIVs with liquidity injections? Here it was not only a question of contractual arrangements, but reputations were also at stake. The fourth piece of vital information is knowledge about the inter-connectedness among banks in the interbank market. It is clear that existing statistics and routine market intelligence were grossly insufficient to gather the above four pieces of vital information. To my knowledge, few, if any, market participants flagged the alarms that should have been raised by any of these four points. No statistics ever pointed out the danger. However, there were several, though obscure, signs flagging a possible problem, so that a market intelligence unit alarmed by these signs might have detected the problem and could have helped policy makers avoid the disaster. In particular, there was a telling sign in the statistics about US MMFs. Chart 3 shows an upward trend in the total assets of the US MMFs in the first half of 2007. The growth rate of MMFs was fast, though it did not look extraordinary. However, if you look at the share of “safe assets”, it actually declined from the start of the year. So, this chart shows that by looking into these figures, one might BIS central bankers’ speeches have found some sign of abnormal risk taking in non-safe assets, including ABCP. Thus, if in addition, the market intelligence unit had detected the heavy involvement of banks in their SIVs issuing these ABCP, the unit might have sensed a possible danger of liquidity crisis in the interbank market, and might have been able to help the authorities prevent the crisis. In fact, after the Paribas Shock, the safe asset share jumped considerably and the total assets also skyrocketed, showing the strong flight to safety that devastated the ABCP market, and the ABS market in general. To sum up, it is not clear whether the liquidity crisis in the summer of 2007 could have been avoided. However, proactive market intelligence, that is, detection of possible problems in the market based on careful monitoring of market developments and thorough analysis of market statistics, might have helped contain if not avoid the turmoil in the interbank market, and thus might have ultimately lessened if not negated the severity of the financial crisis of the following year. Bearing this in mind, the Fed and other central banks, as well as private institutions, have begun to collect and compile a wide range of statistics that capture securitization. In particular, Chart 4 shows details of the asset composition of US MMFs. The chart indicates that MMFs may have already increased investment in commercial papers in 2006, the year before the Paribas Shock. 4. Present achievement: best use of existing market information Let me now turn to the second example, which is the present achievement of market intelligence. This is about property prices, and the issue is the timing of the availability of market information. The financial crisis of 2008 was triggered by the bubble and subsequent bust in US house prices. There is a wealth of evidence detailing the close relationship between property price bubbles and financial crises. International panel studies show more than two-thirds of 46 systemic banking crises were preceded by house price boom-bust patterns, while 35 out of 51 house price-bust episodes were followed by a crisis.1 However, we have not had access to good property price indexes, based on sound economic foundations and comparable between countries and jurisdictions. Frustrated by this deficiency, in November 2009, the G20 Ministers and Central Governors designated property price indexes as one of the most important data gaps to be filled. To rectify the problem, several conferences were held under the leadership of Eurostat, which gathered a wide range of experts on property prices from theory to data compilation. Based on these conferences and public comments, the Handbook on Residential Property Price Indices has been drafted, and the finalized version of the Handbook will be published very soon. Moreover, many countries and jurisdictions are now preparing their own property price indexes in accordance with the recommendations of the Handbook. In fact, I have learned that Japan’s Ministry of Land, Infrastructure, Transport and Tourism has almost completed the development of a new series of residential property price indexes using the procedure recommended in the Handbook, and the Ministry is about to start publishing new statistics just this morning. Claessens, Stijn, M. Ayhan Kose, and Marco E. Terrones, (2008), “What Happens During Recessions, Crunches and Busts?” IMF Working Paper 08/274 (Washington: International Monetary Fund) and Claessens, Stijn, Giovanni Dell’Ariccia, Deniz Igan, and Luc Laeven, (2010), “Cross-Country Experiences and Policy Implications from the Global Financial Crisis”, Economic Policy, Volume 25, pp. 267–293. BIS central bankers’ speeches Issue of timeliness This is a great leap forward indeed towards having reliable and accurate property price information. However, from the policy maker’s viewpoint, the situation is still far from satisfactory. It should be emphasized that, for a policy maker, timely information is as important as, or in some cases more important than, reliable and accurate information. According to this criterion, many property price indexes are not helpful in immediate policy making, since they inevitably lag behind market movements. To see why, let me give you the example of a typical Japanese property transaction. Property transactions follow a series of stages several weeks apart from each other, and each stage usually entails different prices, namely: the initial asking price, P1; the offered price, P2; the contract price, P3; and the price that is filed with the land registry office, P4. My collaborators and I have been able to get a unique data set of a large number of property transactions in Greater Tokyo which illustrates these four stages. Here I will present the results based on this data set. 2 Chart 5 depicts the timeline graphically. From P1 to P2 takes on average ten weeks, form P2 to P3 five and a half weeks, and finally from P3 to P4 fifteen and a half weeks. Thus, from P1 to P4 takes almost thirty one weeks, more than a half year. We should also take into account the time taken to collect and compile the information, which is itself likely to be substantial, as in the case of GDP and CPI data. Thus, if the authorities use the most reliable transaction price data of P4, it will probably take almost a year. From the policy maker’s viewpoint, this is often too late. To get the timeliest information about property market conditions, earlier reporting of P1, the initial asking price, is preferable. However, this is the asking price, not the transaction price. There might be a substantial bias in this asking price data because a seller wants to sell at a higher price, even though it may take much longer to strike a deal or he is never able to sell. In fact, Chart 6 shows the price distribution of P1, P2, P3 and P4. As expected, the initial asking price P1 has a higher average than the price P4 at the registry office (though there is the caveat that the sample population of P1 is not exactly the same as that of P4). Thus, we face an apparent trade-off: if you want timely information then you use P1, but it has non-negligible bias. If you want accurate information, then you use P4, but it has already become somewhat stale information by the time it is available. Best use of market information There is, however, an important way around this dilemma. It should be noted that the Handbook recommends hedonic quality adjustment in property price indexes based on detailed micro and macro market information. There are various ways to conduct hedonic quality adjustment, among which a hedonic quantile regression approach is one of the most sophisticated and robust. Remarkably, after applying this quality adjustment to both P1 and P4 of our data set, we find the quality-adjusted price distribution based on P1 is very close to, and almost indistinguishable from, the quality-adjusted price distribution based on P4. Let us look at Chart 7, the quantile-quantile plots of two distributions. In the quantile-quantile graph, if two distributions are identical then the plotted line is on the 45 degree line. The upper chart illustrates the result of raw or unadjusted data of P1 (initial asking price) and P4 (registered transaction price). This chart clearly shows the upward bias in the initial asking price relative to the registered transaction price. However, when quality is adjusted using a hedonic quantile regression method, the bias seems almost to have vanished, as shown in the lower chart. Shimizu, C., K. G. Nishimura, and T. Watanabe (2011) “House Prices at Different Stages of the Buying/Selling Process”, Working Paper no. 69, Research Center for Price Dynamics, Institute of Economic Research, Hitotsubashi University. BIS central bankers’ speeches In a nut-shell, the result of this study shows that the initial asking price data, the timeliest of all price information, can be used as reliable information about property prices, so long as quality is appropriately adjusted using a hedonic quantile regression method. So we can benefit from the best use of market information, with respect to both reliability and timeliness. 5. Guarding against future problems: shadow banking and basic information Gathering So far, we have examined the importance of market intelligence and the best use of market information in the past and the present. I am now looking towards the future, and considering what is needed to guard against future problems. The pressing problem that comes first to mind is that of shadow banking, a problem in the past, but still a potential problem in the future. Since regulations on banks are to be tightened further, new types of shadow banking may appear, little known at present but potentially threatening to financial stability in the future. Modern shadow banking activities are largely based on financial markets, and hence are likely to create innovation there. They change themselves rapidly in response to changes in market conditions and regulations. Moreover, they have broad interconnectedness with banks and other financial institutions. Given this situation, in what way should central banks gather valid and vital information about them? Here again, I believe that the key is to utilize various sources of market intelligence alongside other sources of information. Furthermore, I would like to stress that the intelligence work should be properly followed by the establishment of new statistics about shadow banking. Various approaches of market intelligence Let me explain the efforts of the Bank of Japan in this respect. The Bank monitors shadow banking entities and activities through various channels. The nature and scope of the Bank’s monitoring are depicted in Chart 8. Amongst these channels, direct monitoring of major shadow banking entities is of course the most significant. Thus, the bank has increased the number of staff directly monitoring major securities companies. However, it is practically impossible to conduct dialogues with all financial institutions of a shadow banking nature, and moreover, shadow banking activities tend to change rapidly with developments in financial markets. It should be noted that shadow banking entities are deeply involved in funding and investment with various financial institutions. So indirect monitoring through banks, monitoring through the payments and settlements system, and market intelligence through market participants all become important. The Bank also closely watches shadow banking activities in securitization, securities lending and repos. For instance, we have started direct monitoring of hedge funds and investment trusts as well using market intelligence through market participants much more than before. Furthermore, although we do not directly monitor finance companies, since large finance companies are owned by banks, we monitor them by monitoring the banks. It is then crucial to cross-check the information gathered. Chart 9 illustrates the point. In this regard, it is important to monitor banks as counterparties of shadow banking entities. This is because bank activities are interconnected with shadow banking activities. Market information in the financial markets is also particularly valuable. Central banks are especially well-positioned to collect valuable information on the activities of participants in financial markets, since they not only gather information relevant to monetary policy, but they also operate payment and settlement systems. Information on market practices and financial innovations can often provide early warning of risks, and hence are especially important among the various kinds of market intelligence. BIS central bankers’ speeches The case in point is found in the subprime mortgage crisis in the United States. Securitized products were originated with financial engineering and distributed without appropriate risk assessment. This was partly due to an overly optimistic assessment of risk diversification. However, this risk became increasingly visible in the market as the market evolved into a new phase. Feedback of market intelligence Another important role of market intelligence is to feed information back to the market, and thus to find potential information gaps to be filled. For example, based on market intelligence, the Bank of Japan designs and compiles the “Tokyo Money Market Survey”, which provides an overall quantitative assessment of the money markets. 3 The survey depicts, among other things, the current interconnectedness among financial institutions through repo transactions, as is shown in Chart 10. This chart shows that securities companies borrow specific JGBs through SC repos mainly to cover their short position in bond trading. Most of their short-term money is funded through GC repos from trust banks, while some funds come from banks and money market dealers. This kind of quantitative understanding provides both new perspectives for central bank business and wider grounds for dialogue with financial institutions and market participants. In fact, the result of these dialogues will be examined and used by financial institutions to develop more sound business practices. Also, the feedback of any relevant information will be reflected in the next survey data. Starting this year, we will begin to conduct this survey regularly. Overall, market intelligence is absolutely crucial for central banks in maintaining the stability of the financial system. I believe that this flexible system of monitoring shadow banking entities and activities, based on market intelligence, can provide a good pilot study for other central banks to consider when they want to identify emerging risks and vulnerabilities in their own countries and jurisdictions. 6. Concluding remarks Let me now come to my conclusion. As we all know and feel, central banks around the world have faced serious challenges, especially since the financial crisis of 2008. Financial stability is now clearly marked as an essential prerequisite for economic stability, and it is thus the responsibility of central banks to maintain this stability. Moreover, the financial turmoil following the collapse of Lehman Brothers, and still lingering somewhat in the global market, has clearly proved that existing statistics are not sufficient for policy making, in particular policy making involving financial markets. Financial markets are fast moving and “mutate” in many ways in a relatively short period of time. Therefore, I have argued in this speech that gathering and thoroughly analyzing market information, which is often described as market intelligence, is of the utmost importance and should be utilized proactively alongside conventional economic statistics. The reason I have stressed market intelligence, or more specifically, central bank intelligence, is that central banks have a clear comparative advantage in extracting valuable and vital information, especially from financial markets. Central banks are the unique organization that transacts with the widest range of financial market participants. I have explained how this market intelligence works in the case of shadow banking in Japan. The most important point is to extend these intelligence activities to new financial institutions and products to detect possible problems. The existing framework at the Bank of Japan, Financial Markets Department (2009, 2010), “The Development and Challenges of Japan’s Money Markets: Tokyo Money Market Survey” (available only in Japanese). BIS central bankers’ speeches Bank of Japan is versatile and can incorporate new elements relatively easily. However, problems remain about the depth or intensity of these intelligence activities: that is, the quantity and quality of information currently available may not be sufficient for detecting possible risks. Thus, we are only at the starting line, and there is still a long way to go. Finally, I should emphasize that market intelligence has significantly improved central banks’ economic statistics, and will continue to do so in the future. We have learned from the failures in the summer of 2007, that we must extend the coverage and improve the quality of statistics concerning non-depository financial institutions. We can also take advantage of new methods and new information sources to get the best use of market information in constructing timely statistics, as shown in the case of property prices. In closing, I would like to emphasize again the point I stated in the Introduction, the point that I would most like to convey to you. Central bank statisticians should be more than good statisticians, simply maintaining the quality of existing statistics. They should also be good sleuths or intelligence agents, detecting signs of future developments that may change those statistics, and thus may change our world. 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
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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, Ishikawa, 2 August 2012.
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, Ishikawa, 2 August 2012. * * * I. Recent financial and economic developments A. Global financial markets and overseas economies 1. Global financial markets I would like to start with developments in global financial markets and overseas economies, which affect Japan’s economy. Global financial markets have recently been characterized by a repetitive pattern of rising and declining pessimism reflecting developments in the European debt problem. From the middle of 2011 toward the end of the year, strains in markets increased due to concerns over the sustainability of public finances in peripheral countries. From the turn of 2012 toward early spring, there were phases of easing strains due to the introduction of measures to strengthen fiscal discipline in the member states of the European Union (EU), the decision on the second financial support program for Greece by the euro area member states and the International Monetary Fund (IMF), and the agreement to raise the lending capacity of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). Nevertheless, markets became nervous again from early spring: there was talk of a euro crisis due to the turmoil in the domestic political situation in Greece, and in Spain yields on 10-year government bonds temporarily rose above 7 percent due to concerns about the stability of its financial system. Subsequently, a new government was inaugurated in Greece, and the EU and eurozone summits at the end of June emphasized the need to strengthen growth and agreed to take steps to establish a single supervisory body for eurozone banks with a view to making it possible for the ESM to recapitalize banks directly. These decisions raised hopes that the vicious circle between uncertainty over Spain’s financial system and increasing government debt would be broken, and markets temporarily regained stability. This situation, however, did not last long. At present, yields on 10-year Spanish government bonds are hovering at around 7 percent. On the other hand, interbank funding markets have generally been stable since the beginning of 2012 due to the abundant liquidity provision by the European Central Bank (ECB). It appears, however, that it will take some more time until uncertainties are dispelled over the fiscal and economic structural reforms as well as over measures regarding the financial system in Europe. Thus, developments in the European debt problem continue to warrant careful attention. 2. Overseas economies Under these circumstances, overseas economies have shown some improvement, albeit moderate, but on the whole they have not emerged from a deceleration phase. By region, economic activity in the euro area continues to be sluggish, despite signs of a pick-up in exports, because domestic demand in the area has been stagnant. Peripheral countries in particular have fallen into a vicious circle, in which the downturn in economic activity due to fiscal austerity measures and the deterioration in financial conditions lead to a further worsening of the financial conditions of governments and financial institutions. As a result, disparities between economic sentiment in core countries such as Germany and in peripheral countries are widening. For example, the unemployment rate in Germany stands at around 5 percent, which is a historical low since the reunification of East and West Germany, while in Spain it has reached well over 20 percent and the youth unemployment rate is in excess of BIS central bankers’ speeches 50 percent. Moreover, the deterioration in the economies of peripheral countries is affecting business sentiment in core countries, and thus the European economy is likely to remain sluggish for the time being. Next, the U.S. economy is generally continuing to recover at a moderate pace. Private consumption has been firm due in part to an increase in real purchasing power reflecting the decline in gasoline prices, and the housing market has shown some signs of picking up. Business fixed investment has recently maintained its uptrend against the background of solid corporate profits. However, signs of weakness have been observed in business sentiment, and the momentum of growth in employment has recently been slowing. Furthermore, amid persisting strains from balance-sheet adjustments, households and firms are not likely to increase their spending due to concerns over the adverse impact of the European debt problem as well as uncertainty regarding the “fiscal cliff,” that is, fiscal spending cuts scheduled to be implemented at the beginning of 2013 and the handling of tax cuts set to expire at the end of 2012. Taking these factors into account, the U.S. economy is likely to recover at only a moderate pace. Emerging and commodity-exporting economies still have not emerged from a phase of sluggishness, but on the whole these economies have maintained relatively high growth backed by firm domestic demand. The pace of growth in the Chinese economy has slowed reflecting the deceleration in private real estate investment as a result of monetary tightening earlier, but there are also signs that the slowdown is bottoming out, such as the increasing trend in exports and bank lending. The Chinese government has accelerated approvals for infrastructure investment and introduced subsidies for energy-saving electrical appliances and other goods. With the pace of consumer price inflation decelerating, the authorities have also started stimulating the economy on the monetary front, lowering the benchmark lending rates for two consecutive months. Looking ahead, the growth rate of the Chinese economy is unlikely to reach dramatic levels, but it is likely to rise gradually as these policy measures start producing effects. In the NIEs and the ASEAN economies, exports have been affected by the slowdown in Europe and China, but domestic demand has been firm on the whole, and production has been recovering moderately. As for the outlook, including other emerging economies such as Brazil, the growth rate of emerging and commodity-exporting economies will likely increase gradually reflecting accommodative financial conditions and a recovery in real purchasing power following a decline in inflation rates. B. Japan’s Economy 1. Economic activity I will now explain the current state of, and outlook for, Japan’s economy based on the overseas economic developments I have just outlined. Until the beginning of autumn 2011, Japan’s economy picked up steadily following the plunge caused by the Great East Japan Earthquake, which struck just as the economy was recovering from the Lehman shock. Thereafter, however, it remained more or less flat on the whole until around the early spring of 2012 mainly due to the adverse effects of the slowdown in overseas economies and the appreciation of the yen. More recently, with domestic demand remaining firm – led by reconstruction-related demand and private consumption – and exports continuing to show signs of picking-up, economic activity on the whole has started picking up moderately. The firmness in domestic demand is attributable to the following factors. Demand for restoration and reconstruction of social infrastructure and of disaster-stricken facilities and homes has led to increases in public investment, business fixed investment, and housing investment. Reconstruction-related demand has also been underpinned by changes in the behavior of firms and households triggered by the disaster. Examples are efforts to strengthen the earthquake resistance of buildings and facilities and to bolster business continuity systems, investment in the area of new energy sources, and the purchase of energy-saving products. Meanwhile, private consumption has been boosted by pent-up demand, that is, a recovery in demand following the temporary restraint due to the effects of BIS central bankers’ speeches the disaster, and by policy measures such as subsidies for purchasers of environmentally friendly cars. Private consumption has also been pushed up by an increase in spending on products and services provided by businesses targeting the elderly reflecting firms’ efforts to enhance their line-up in this area. Although considerable uncertainty remains regarding the outlook, Japan’s economy, with domestic demand remaining firm and overseas economies emerging from their phase of deceleration, is expected to return to a moderate recovery path, as also shown in the June 2012 Tankan (Short-Term Economic Survey of Enterprises in Japan) and the Regional Economic Report. Given this situation in demand at home and abroad, the economy is likely to register a relatively high rate of growth in fiscal 2012, supported by a gradually increasing momentum in the virtuous circle of growth in production, income, and spending. In fiscal 2013, with overseas economies continuing to see relatively high growth on the whole, the economy is expected to be firm, although the growth rate is expected to be somewhat lower than that in fiscal 2012, because the positive effects from reconstruction-related demand will gradually diminish. In the Bank of Japan’s projection released in July 2012, the median of the Policy Board members’ forecasts for Japan’s real GDP growth rate is 2.2 percent for fiscal 2012 and 1.7 percent for fiscal 2013. 2. Prices Next, I will talk about price developments. International commodity prices softened somewhat from autumn 2011, reflecting the slowdown in the global economy. After a slight rise in early spring of 2012, especially in crude oil prices against the backdrop of heightened geopolitical risk, they then fell back again through June 2012, and remained more or less flat thereafter. Most recently, prices of crude oil have bottomed out, while those of grains have risen due to unseasonable weather. As for the outlook, international commodity prices as a whole are expected to rise at a moderate pace in line with the growth in overseas economies. Under these circumstances, the year-on-year rate of change in the domestic corporate goods price index (CGPI) has recently been negative. The CGPI is expected to decline moderately for the time being and then start to rise slowly reflecting the expected moderate increase in international commodity prices and the improvement in the negative output gap. Turning to the consumer price index (CPI) for all items less fresh food, the year-on-year rate of change since summer 2011 has been around 0 percent and is expected to stay at this level for the time being. Assuming that medium- to long-term inflation expectations remain stable, 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 in fiscal 2013 as the negative output gap improves. Thereafter, it will likely be not too long before the rate reaches the Bank’s current “price stability goal in the medium to long term” of 1 percent. In the Bank’s projection released in July 2012, the median of the Policy Board member’s forecasts for the year-on-year rate of increase in the CPI (all items less fresh food) is 0.2 percent for fiscal 2012 and 0.7 percent for fiscal 2013. C. Risks to the baseline scenario The baseline scenario for Japan’s economy described thus far is subject to both upside and downside risks. By far the most important risk is uncertainty regarding the outlook for overseas economies, and particularly the European debt problem. Although concerns about the stability of Spain’s financial system had temporarily subsided thanks mainly to the agreement reached at the EU and eurozone summits, in order to fundamentally resolve the debt problem it is nevertheless necessary in Europe to break the underlying negative feedback loop among fiscal balances, the financial system, and economic activity. At the same time, it is crucial that countries on the European periphery, whose international competitiveness has declined, steadily work on fiscal and economic structural reforms. Moreover, as part of the efforts toward deeper integration in the euro area, discussions are ongoing within the EU with the aim of establishing a banking union and a fiscal union, and I believe it is important to press ahead with these steps. In this situation, if reforms make BIS central bankers’ speeches steady progress, this would strengthen market confidence, which in turn would push up global economic growth. However, in core countries such as Germany, there are concerns that the financial burden of providing support to peripheral countries through, for example, greater fiscal integration would increase. Hammering out concrete steps, therefore, is likely to involve a great deal of complication. If in the meantime the European debt problem worsens, or the considerable sense of uncertainty continues for a prolonged period, this could weigh on the economic recovery in other areas such as the United States and China. External demand for Japan’s exports is expected to once again become the driving force of Japan’s economy after the earthquake-related reconstruction demand peaks out, but if exports remain sluggish, a virtuous circle may not take hold. For this reason, overseas economic developments warrant close attention. Next, risks stemming from domestic factors include uncertainty with regard to reconstruction-related demand as well as both upside and downside risks in how medium- to long-term growth expectations will be affected by the supply and demand balance of electricity and by innovation in energy-related technology. Another issue is the sustainability of Japan’s public finances, concerns over which restrain consumer spending due to anxiety about the future and affect long-term interest rates. Given that social security spending will continue to exert upward pressure on fiscal expenditure, it is necessary to push ahead with structural reform of public finances on both the expenditure and the revenue side and maintain the public’s confidence in fiscal discipline. Efforts to restore Japan’s public finances are underway and are something that I will keep a close eye on. Both upside and downside risks persist also in import prices, particularly international commodity prices. II. Monetary policy Next, I would like to turn to the Bank’s conduct of monetary policy under the current economic situation. In order for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability, efforts to strengthen the economy’s growth potential and support from the financial side are of the utmost importance. Based on this recognition, the Bank is currently providing support to raise Japan’s growth potential through its fund-provisioning measure to support strengthening the foundations for economic growth, while at the same time pursuing powerful monetary easing continuously by steadily providing funds through, for example, purchasing financial assets. Moreover, the Bank is doing its utmost also to ensure stability in financial markets. In what follows, I will explain the Bank’s measures in greater detail. A. Pursuit of powerful monetary easing I will begin with the Bank’s pursuit of powerful monetary easing. In October 2010, the Bank introduced the comprehensive monetary easing policy, and has been easing financial conditions continuously since then. The comprehensive monetary easing policy consists of three measures: the implementation of a virtually zero interest rate policy by setting the target for the policy rate, the uncollateralized overnight call rate, at around 0 to 0.1 percent; the purchase of financial assets and funds-supplying operation through the Asset Purchase Program (hereafter the Program); and the clarification of the policy time horizon, that is, the clarification that these measures will remain in place until the Bank judges that price stability is in sight. In this context, financial conditions in Japan have continued to ease. The overnight call rate has been below the 0.1 percent level. With regard to long-term interest rates, yields on Japanese government bonds (JGBs) with a remaining maturity of three years or less are 0.1 percent, and those on 10-year government bonds are at the lowest level in about nine years. Firms’ funding costs have also declined moderately, as shown, for example, by the BIS central bankers’ speeches fact that the average contracted interest rate on new loans and discounts is in the region of only 1 percent. 1. Clarification of the policy time horizon based on “the price stability goal in the medium to long term” At the Monetary Policy Meeting held in February this year, the Bank introduced “the price stability goal in the medium to long term” as a part of its efforts to further clarify its determination to overcome deflation. “The price stability goal in the medium to long term” is the inflation rate judged by the Bank to be consistent with price stability sustainable over the medium to long term. At present, 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. On this basis, the Bank has stated 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, which I mentioned earlier. As you can see, by presenting its commitment regarding the policy time horizon, the Bank has further clarified its determination to pursue monetary easing. 2. Expansion of the Asset Purchase Program The Program currently implemented by the Bank was established 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. Established on the Bank’s balance sheet, the Program is used to purchase various financial assets – such as government securities, CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) – and to conduct fixed-rate funds-supplying operation. Since the establishment of the Program, the Bank has expanded its size successively, including in February and April of this year, so that the outstanding amount of asset purchases would reach about 65 trillion yen by around the end of 2012 and about 70 trillion yen by around the end of June 2013, thereby contributing to the pursuit of powerful monetary easing. Furthermore, in April, in order to encourage a decline in longer-term interest rates, the Bank decided to extend the remaining maturities of JGBs and corporate bonds to be purchased under the Program from “one to two years” to “one to three years.” And in July, the Bank decided to remove the minimum bidding yields for outright purchases of treasury discount bills (T-bills) – which had previously been 0.1 percent per annum – and of CP in order to ensure that the outstanding amount of asset purchases under the Program would reach the planned amount. For the same reason, the Bank also revised the categories of assets purchased and loans provided through the Program. The outstanding amount of the Program stood at 53 trillion yen as of July 20, and the Bank will continue to proceed with powerful monetary easing by steadily increasing the outstanding amount of the Program by about 17 trillion yen by around end-June 2013. It is expected that the effects of the continuing purchases of financial assets under the Program will strengthen further as the economy recovers. B. The Bank’s efforts to support strengthening the foundations for economic growth I will now talk about the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility). The Bank introduced this measure in June 2010 to support strengthening the foundations for economic growth for the purpose of providing support for the critical challenge of enhancing the growth potential of Japan’s economy, and has been providing long-term funds at a low interest rate to financial institutions in accordance with their efforts in terms of lending and investment for strengthening the foundations for economic growth. The maximum duration of loans is four years, and the loan rate is currently set at 0.1 percent. The initial ceiling of the BIS central bankers’ speeches outstanding amount of loans was set at 3 trillion yen. Subsequently, 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. In March 2012, the Bank decided to further enhance the Growth-Supporting Funding Facility by (1) increasing the ceiling for the outstanding amount of loans from 3 trillion yen to 3.5 trillion yen; (2) establishing special rules for another new lending arrangement of 500 billion yen for small-lot investments and loans; and (3) establishing special rules for a new U.S. dollar lending arrangement of 12 billion U.S. dollars – equivalent to 1 trillion yen – using the U.S. dollar reserves already held by the Bank, for foreign currency-denominated investments and loans. The outstanding balance of the total loans disbursed by the Bank, including those extended under the special rules, stood at approximately 3.2 trillion yen as of the beginning of June. The first disbursement of U.S. dollar loans under the special rules is to take place in September. A breakdown of financial institutions’ individual investment and lending for strengthening the foundations for economic growth in the period April 2010–March 2012 by designated business area shows that almost 30 percent of the total funds was provided to “environment and energy business” and almost 20 percent was provided to “medical, nursing care, and other health-related business,” but funds were also provided to business areas falling under the category of “others,” such as lending or investment to revitalize local industries. A wide range of financial institutions have been making a variety of efforts targeting their specific customer base or the region they serve, such as establishing new dedicated funds to support economic growth, so that the amount of lending and investment actually provided by financial institutions using the Growth-Supporting Funding Facility greatly exceeds the amount of loans disbursed by the Bank. The Bank, with its steady disbursement of loans, will continue to support the flow of funds to growth areas in order to contribute as much as possible as the central bank of Japan toward strengthening the foundations for economic growth. C. Measures to ensure financial market stability In addition to pursuing the measures just described, the Bank has been doing its utmost to ensure financial market stability by making use of various funds-supplying operations. 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. When the European debt problem worsened at the end of November 2011, the Bank lowered interest rates on U.S. dollar funds-supplying operations as part of coordinated measures among six major central banks in order to ensure stability in financial markets. At the same time, the central banks agreed to establish bilateral swap arrangements enabling the provision of liquidity in any of their currencies in addition to the already available U.S. dollar. III. Issues related to strengthening the growth potential of Japan’s economy A. The importance of strengthening the growth potential to overcome deflation Earlier, I touched on the Bank’s efforts to support strengthening the growth potential of Japan’s economy. Let me elaborate on the challenges we face in strengthening the growth potential. Japan’s economic growth rate has been trending down due to the effects of the low birth rate and the aging of the population as well as to a decline in its international competitiveness. Consumption and investment have been restrained as a result of a decline in households’ and firms’ growth expectations, so that aggregate domestic demand has remained below the aggregate supply capacity of the economy for a prolonged period, exerting downward pressure on prices. With economic activity picking up, BIS central bankers’ speeches the output gap – that is, the difference between aggregate supply capacity and aggregate demand – has recently been narrowing. Nevertheless, aggregate demand continues to fall short of aggregate supply capacity by about 2 percent. While price developments are subject to various factors, including developments in international commodity prices, in order for Japan’s economy to overcome deflation it is important to address the problem of insufficient demand, which is the key factor underlying deflation in Japan. At the same time, in order to achieve sustainable economic growth amid the low birth rate and aging of the population, it is important to maintain sufficient supply capacity to meet new sources of demand. B. Capturing global demand and creating demand through innovation To resolve the problem of insufficient demand, it is essential to capture global demand, including demand from emerging economies, and to tap latent demand both at home and abroad. With respect to capturing global demand to overcome the shortage of demand at home, in addition to making efforts to increase exports it is important to increase income from overseas investment. While income from foreign direct investment is not included in GDP, it does contribute to gross national income (GNI). Moreover, advances in the international division of labor likely contribute to strengthening the economy’s growth potential through the associated increase in exports of related goods and the shift of the domestic labor force into areas with growth potential. Tapping latent demand, the other essential element in addressing insufficient demand, also requires efforts on a continuous basis. Markets for new types of goods and services usually grow only slowly at the initial stage. They then enter a phase of rapid growth until demand is saturated and growth slows again. In order to maintain the growth potential of the economy as a whole, it is therefore important to continuously secure demand both at home and abroad. To this end, it is necessary to accelerate innovation that taps latent demand for goods and services and consequently creates demand, which will give depth to areas with growth potential. The demographic change resulting from the low birth rate and the aging of the population is also prompting changes in the demand structure. For example, consumption expenditure by households headed by a person aged 60 years or older, including the baby-boomer generation, now accounts for more than 40 percent of total private consumption. Therefore, an important challenge is to supply goods and services that meet the needs of this generation in a timely manner. Corporate profits and business sentiment at Japanese firms have been on an improving trend recently. This reflects not only the positive effects of subsidies and earthquake-related reconstruction demand, but in my view also shows that firms’ active efforts to tap latent demand and address social challenges are paying off. Examples are businesses targeted at the elderly and in the areas of information and telecommunications as well as environment and energy, where challenges in terms of energy creation, energy saving, and energy storage need to be addressed with urgency. For example, in the automobile industry, environmentally friendly cars – such as hybrid cars with better environmental efficiency – have been selling briskly, and it is expected that related markets, such as those for rechargeable batteries, will also expand. In the field of information and telecommunications, smartphones are coming into widespread use, providing the infrastructure for not only the distribution of digital books and music but also a whole range of new services. One example is the use of the Internet and the Global Positioning System (GPS) to provide services such as giving information on cafes and restaurants in the vicinity and guiding smartphone users there. In the convenience store industry, the number of stores was said to be near saturation at one time. However, by expanding the range of products and services aimed at women and the elderly, such as introducing home deliveries, convenience stores have been able to increase their sales per store. Looking ahead, it is extremely important that efforts toward innovation do not come in spurts but are sustained across a wide range of fields. BIS central bankers’ speeches C. Maintaining the labor supply and improving productivity In order to strengthen Japan’s growth potential, it is also important to ensure that supply capacity is commensurate with demand. While the recent employment situation has been on an improving trend, labor supply still exceeds demand. There still remain problems that need to be solved, such as the extremely severe employment conditions for the young. However, Japan’s working age population will continue to decline, and in the medium to long term labor supply may fall short of demand. Economic growth can be decomposed into two components: the rate of growth in the number of workers and that in productivity per worker. Assuming that the labor force participation rate remains unchanged, the negative growth contribution of the decline in the number of workers is forecast to increase to around 1.0–1.5 percent by the 2030s. Meanwhile, the average annual increase in labor productivity has been around 1 percent in recent years, so if things remain the same, Japan’s potential growth rate will fall into negative territory. In order to mitigate the impact of these developments as much as possible, with regard to the labor force, 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. On the other hand, regarding labor productivity growth, this is actually quite high in Japan when compared with other major countries and may be difficult to raise further. However, since labor productivity is the ratio of aggregate value added to labor input costs, productivity growth could be improved if growth areas provide sufficient opportunities for the creation of high-value-added goods and services, so that firms can generate sufficient profits. This could then produce forward momentum through generating income, thus mitigating the impact of the decline in the working-age population. Given that Japan has a low birth rate and the fastest aging population in the world, achieving such a strengthening of the growth potential is extremely difficult and represents a challenge that requires the efforts of the nation as a whole, since it requires raising demand, labor supply, and productivity to the limits of Japan’s potential. Based on this perspective, the Japanese government has compiled the “Strategy for Rebirth of Japan” to create an environment allowing firms to meet the challenges of the task. The strategy places priority on eleven areas. These areas include “green innovations,” which focuses on Japan’s aim to lead the world in the energy revolution and create new industries and employment related to this field; “life innovations” with the aim of turning businesses related to medical services and nursing care into growth industries, fostering new related industries and markets, and developing markets overseas; human resources development; and turning Japan into a tourism nation. In order to boost the efforts undertaken by firms, support from the financial side is essential, in addition to the creation of the right environment. With this in mind, the Bank will continue exerting itself in its role together with firms, financial institutions, and the government. 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 Yomiuri International Economic Society, Tokyo, 6 September 2012.
Masaaki Shirakawa: Toward stronger growth – challenges facing Japan’s economy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the Yomiuri International Economic Society, Tokyo, 6 September 2012. * * * Introduction It is a great honor to be invited to this meeting hosted by the Yomiuri International Economic Society today. Both the global economy and Japan’s economy currently face mounting challenges. Looking back, it has already been six years since U.S. housing prices peaked, five years since the subprime mortgage problem surfaced in the form of what has come to be known as the Paribas shock, and about four years since the Lehman shock. Thanks to aggressive policy implementation by authorities and other measures following the Lehman shock, the global economy succeeded in avoiding a downturn as significant as the Great Depression in the 1930s. Nevertheless, the pace of recovery in advanced economies thereafter has remained very sluggish, unlike anything they have experienced since World War II. Taking the year 2007 – that is, prior to the Lehman shock – and setting the level of GDP at 100, the current level stands at 113 for the global economy as a whole and 102 for advanced economies (Chart 1). While these latest figures correspond to those seen in the mid-1990s, in terms of timing when compared with Japan’s post-bubble period, the pace of recovery in real GDP for the United States and Europe is either comparable to or even worse than that for Japan in the period leading up to the mid-1990s (Chart 2). Moreover, the emergence of such a situation, regardless of the advanced economies’ highly aggressive policy conduct, suggests the severity of the situation we face today. As for fiscal policy in advanced economies, the amount outstanding of government debt has been increasing substantially against the background of massive fiscal deficit. Turning to monetary policy, central banks continue to implement extraordinary measures, including the zero interest rate policy, a commitment to maintaining low interest rates, the significant expansion of central bank balance sheets, and purchases of risk assets. The long-term interest rates of advanced economies are at historically low levels. Meanwhile, the coexistence of the sovereign and financial crises continues in the euro area. These types of crises used to be widely regarded as phenomena unique to developing or emerging economies during the post-war period. Such a conventional view, however, has been overturned. In retrospect, considering that the period leading up to the mid-2000s had been referred to as the age of “Great Moderation” for its continued high growth, low inflation, and low interest rates, times have certainly changed. And now, reflecting on the past quarter-century with a fresh eye, bubbles and financial crises have been emerging more frequently worldwide over time, with Japan’s economic bubble in the late 1980s, the Asian financial crisis in the late 1990s, and the global financial crisis in the 2000s, to name a few. Against these backgrounds, historical precedents have been drawing increasing attention as topics for economic debate in recent years. This trend appears to reflect the growing sense of awareness that the global economy and financial conditions are in the midst of drastic changes. If this really were the case for the era we live in, it might be a sign that adopting historical as well as medium- to long-term perspectives is key to taking appropriate action in response to problems facing the economy. Time has revealed that the decline in Japan’s economic growth rate over the past two decades is the result of the delay in the post-bubble disposal of nonperforming loans as well as the delayed responses to rapid globalization and BIS central bankers’ speeches the aging and declining population. If the gravity of such problems had been recognized at an earlier stage, allowing for swifter responses, the developments that followed might have turned out differently from what we find today. The most powerful lesson Japan has learnt in the past 20 years is that we must act on the basis of medium- to long-term perspectives in order for the economy to grow at a sustainable pace. In view of this, my address to you today is entitled “Toward Stronger Growth: Challenges facing Japan’s Economy”, and this will take into account medium- to long-term perspectives. I. Recent developments in Japan’s economy As the starting point of my talk, let me kick off with the recent developments and the outlook for Japan’s economy. In its Monetary Policy Meeting held last month, the Bank of Japan judged that Japan’s economic activity had started picking up moderately as domestic demand remained firm, mainly supported by reconstruction-related demand, while overseas economies had not yet emerged from a deceleration phase and overseas demand had been somewhat weak. The real GDP growth rate was 5.5 percent and 1.4 percent year on year in the first and second quarter of 2012. Among the G7 economies, Japan registered much faster growth in the first half of this year. Looking ahead, the economy is expected to return to a moderate recovery path as domestic demand remains firm and overseas economies emerge from the deceleration phase. This outlook rests on whether domestic demand remains firm while overseas economies emerge from the deceleration phase. As for domestic demand, there are factors on the one hand that will eventually subside, such as effects stemming from subsidies for purchasing environmentally-friendly cars. On the other hand, there are factors that are more fundamental to maintaining firmness in domestic demand, such as creating new business to meet demand associated with the aging of the population. In terms of reconstruction-related demand, this is not just a matter of repairing facilities and housing damaged by the earthquake or tsunami, together with the pent-up demand following the disaster. It is more broad-based and includes the demand associated with consumers’ conscious will to prevent disaster, as well as firms’ increased needs for building disaster prevention centers or business continuity centers and shifting their resources to renewable sources of power. As such, we would expect firmness in domestic demand to continue for some time to come, although there is evidence of certain factors that require attention, such as weak bonuses this summer. In overseas economies, deceleration has continued for somewhat longer than expected and, reflecting such developments overseas, exports and industrial production both appear to be somewhat weak. Against this background, we downgraded our assessment in the Monetary Policy Meeting last month by saying that “the pick-up in exports has moderated, and the recent reading on production has been relatively weak”. Subsequent readings showed that real exports and industrial production in July were somewhat weak. On the whole, there is a wide range of uncertainties about the outlook for the economy. As I recently talked about the short-term outlook for economic developments, I wish to pick up today on some underlying factors that are essential to assessing the outlook for economic activity and prices, and to conducting policy, while taking into account the medium- to long-term perspectives. There are six topics on which I wish to elaborate: the first is the mechanism of Japan’s economic growth before the Lehman shock; the second is the recent development and outlook for overseas economies; the third is the growth potential of Japan’s economy; the fourth is deflation; the fifth is a stronger yen; and, the sixth is the fiscal situation in Japan. After covering all these topics, I will explain the recent conduct of the Bank’s monetary policy. II. Mechanism for economic recovery in Japan before the Lehman shock Let me start with the first topic – namely, the background explanation of economic recovery in Japan before the Lehman shock. The reason I chose to open with this topic is that there are several clues to draw from when formulating a process for generating economic recovery BIS central bankers’ speeches after the Lehman shock. Looking at the turning points of economic expansion and recession, as announced by the Cabinet Office, the previous economic recovery started in January 2002 and ended in February 2008. While the average growth rate during these years was not high, compared with those in the past, the duration of economic expansion lasted six years and a month, the longest period of economic expansion in the post-war era, longer than the “Izanagi Boom” (Chart 3). There are three reasons behind this. The first is that the balance-sheet adjustment, which had weighed on Japan’s economy after the bursting of the bubble, ended. In particular, the completion of resolving excess debts at the beginning of the 2000s had a non-negligible impact. The second reason is the long-lasting high economic growth in the global economy (Chart 4). The average growth rate of the global economy from 2004 to 2007 was 5.0 percent, which was much higher than the average rate of 3.0 percent in the 1990s. These periods were often referred to as the “Great Moderation”, where inflation remained low. Under such circumstances, optimism about the economic outlook prevailed around the globe, and a boom in the real estate market and a rise in durable goods consumption took place in the United States and Europe. On the financial front, financial institutions increasingly favored taking risk, and a rapid expansion of leverage – i.e., the accelerated expansion of credit – occurred. In retrospect, the high economic growth in the global economy during those periods was largely sustained by the creation of credit bubbles. The third reason is the increase in exports under a depreciating yen. The yen appreciated somewhat in the first half of the periods under quantitative easing, but subsequently depreciated after 2005 – in particular, from 2006, when the quantitative easing was lifted, to 2007 (Chart 5). This reflects active carry trades against the background of continued extremely low interest rates in Japan, while interest rates started to rise in overseas economies due to high growth rates. Supported by the continued weaker yen, exports increased markedly, particularly in the automobile-related area and in capital goods and equipment (Chart 6). After the Lehman shock, two out of three factors – namely, high growth in overseas economies and the yen’s depreciation – no longer hold. Setting the level of real GDP in 2007 (i.e., a year before the Lehman shock) at 100 and looking at its development since then, the present level of Japan’s economy is 99. This falls short of the pre-Lehman level. In an international context, the present level is 97 for Great Britain, 99 for the euro area, and 102 for the United States; hence, Japan stands somewhere in the middle of the advanced economies (Chart 7). In terms of per capita GDP, the picture is somewhat different. The level of economic activity falls short of those before the Lehman shock in any country or region. Amongst all, Japan has registered the smallest decline. Furthermore, in terms of real GDP per working-age person, only Japan exceeds the level seen before the Lehman shock. This reflects the effect of the rapid aging of the population, but I will come back to this topic later on. III. Overseas economies Let me now move on to the second topic, i.e., the recent development and outlook for overseas economies. This is the major factor that could change the course of Japan’s economy. Overseas economies started decelerating since the second half of last year, mainly due to the European debt problem, and still have not emerged from a deceleration phase. Accommodative financial conditions are an important factor for sustaining economic recovery, but there is a wide range of uncertainties, including when those economies might emerge from the deceleration phase. Current situation and outlook for the overseas economies As for the U.S. economy, borrowing the terminology from Chairman Bernanke’s recent speech, there are three “headwinds” that are restraining economic activity. Specifically, these BIS central bankers’ speeches are the headwinds coming from the housing market, the fiscal situation, and the European debt problem. Among the three, it is heartening that the adjustment in the housing market is making progress at a gradual pace, though it still weighs on the economy. Concerning the fiscal situation, the “fiscal cliff” is a problem; hence, the pace of economic recovery entails a wide range of uncertainties. The European economy continued to be stagnant in the midst of the sovereign debt crisis. After 2010, not only did Greece, Ireland, and Portugal receive support from the EU and the IMF, but the fiscal problems are now spreading to the larger southern European economies of Spain and Italy. Yields on government bonds in those countries rose, or, in other words, bond prices fell. The assets of financial institutions deteriorated, generating instability in their respective financial systems. As a result, firms’ and households’ confidence and financial conditions deteriorated substantially, exerting downward pressure on the real economy. The slowdown in the real economy and the instability in financial systems created an adverse feedback loop on the fiscal problem by reducing revenues and increasing the burden of bailing out financial institutions. As such, Europe currently faces a difficult situation as a result of the adverse feedback loop among the fiscal situation, the financial system, and economic activity. Lastly, as for China, its economy has gone through a somewhat longer deceleration phase. While there are signs of improvement in domestic demand, such as investment in infrastructure and real estate sales, we should maintain a vigilant watch on whether it can make a smooth transition towards a sustainable growth path. In terms of the future for the Chinese economy, its exports to Europe, which have a large weight, require attention. Another important issue is the evaluation of rising real income as a result of a number of policy measures – such as monetary easing, the advanced execution of building infrastructure, and the stimulus consumption package – as well as declining inflation rates. From a somewhat long-term perspective, the most important point is whether China would succeed in making a smooth transition from high economic growth to moderate growth. The high-growth period in Japan started in the middle of the 1950s and ended at the beginning of the 1970s. The average growth rate between these periods was 9.7 percent, nearly identical to the 10.1 percent registered by the Chinese economy since the 1990s (Chart 8). As was the case in Japan, the transition from high economic growth to stable growth will not be an easy path. From such a perspective, in comparing recent indicators between Japan and China, per capita GDP in China is approximately 5,500 U.S. dollars, almost the same as that in Japan in the middle of the 1970s. The share of business fixed investment relative to GDP in China is significantly higher than that of Japan during the high-growth era. As for labor or demographic changes, the “Lewisian Turning Point” – that is, when the excess labor surplus in rural areas eventually disappears – and demographic changes in the working-age population are important issues (Chart 9). Once the “Lewisian Turning Point” occurs, it will increase upward pressure on wages, and the pick-up in labor productivity is likely to decelerate. While the jury is still out on whether the Chinese economy has passed this point, the working-age population will start to decrease around 2015 and the aging of the population will proceed at a rapid pace. In Japan, there was a time lag of about 30 years from the “Lewisian Turning Point” to a decrease in the working-age population; it might be that China will experience such changes in relatively short periods of time (Chart 10). Effect of the bursting of the credit bubble on the overseas economies As I explained so far, the U.S., European, and Chinese economies fluctuate by their intrinsic factors. On the other hand, they are also driven by a common factor. In this regard, it is useful to examine the global economy from a broad perspective. On this point, the impact felt around the globe from the bursting of the credit bubble in the mid-2000s is an important point to consider. As for the headwinds against the U.S. economy, the collapse of the housing BIS central bankers’ speeches market was caused by the bursting of the bubble, and the problem associated with the “fiscal cliff” is largely regarded as an aftereffect caused by the bursting of the bubble. European financial institutions suffered massive losses from the U.S. subprime loan problem. At the same time, the bubbles in the real estate markets of some peripheral countries burst, creating grave damage to the balance sheets of the respective governments and financial institutions. Let me come back to the European debt problem later, when I will talk about monetary unions, which are unique elements in Europe that have made it more difficult and complex to address the bursting of bubbles. Emerging economies have grown at the potential rate, in large part due to their intrinsic factors. However, they are not immune from the aftereffects of the bursting of the bubbles in advanced economies (Chart 11). As we have seen, problems emerge in different ways between advanced economies and emerging economies. From the perspective of the effect of the bursting of the bubble, which is the common factor surrounding the global economy, what should we expect in terms of policy-making and business management? The research done by Professors Reinhart and Rogoff, who analyzed the financial crisis, is worth noting.1 These two professors looked back at the episodes of serious financial crises in 14 countries after World War II, including the experience of the Japanese bubble, the Nordic banking crisis, and the Asian currency crisis. They showed that per capita real GDP had declined from its peak to the bottom in almost two years. Furthermore, they showed that it had taken 4.4 years on average to recover the pre-crisis level of economic activity. Taking into account these past episodes and ongoing events – namely, the large bubbles burst in the United States and Europe – and given that it takes time to establish a new growth model in economies including Japan and emerging countries, it is important to realize that the situation of subdued growth in the global economy is going to last for some time. Under such circumstances where the subdued growth is less than satisfactory according to the previous criteria, excessive policy measures intended to engender higher growth may end up failing to achieve such policy goals, and we may be left with a number of distortions. The common challenge facing each country after the Lehman shock is to make the utmost efforts to achieve sustainable growth by conducting macro-policies subject to the structure of each economy at the time, and to proceed with economic and fiscal reforms in each country and region in order to raise economic growth in the medium to long term. On this front, the challenge differs from one country to the next. Emerging economies should aim to achieve balanced growth by cultivating domestic demand, which has the potential to grow while relying less on overseas demand. Moreover, while the speed of aging may differ, Japan, advanced economies, and some emerging countries in Asia face the challenge of addressing their aging populations. Lastly, innovation in the area of natural resources and energy is a challenge that needs to be tackled through the collective wisdom of all human beings in order for the global economy to achieve sustainable growth. European debt problem and its challenges The key to understanding the current state of the global economy is the adjustment after the bursting of bubbles. Let me now describe the European debt problem, which goes well beyond the post-bubble adjustment. Since the introduction of a single currency – the euro – in 1999, some countries were able to raise funds at lower rates than those justified by their economic strength, and this led to rapid accumulation of external debts. In those countries, wages have risen at a faster pace than productivity growth, and consequently the competitiveness of industries has declined. Nonetheless, as a result of the euro area having adopted a single currency, there is no Reinhart, Carmen M., Kenneth S. Rogoff. 2009. This Time Is Different: Eight Centuries of Financial Folly. Princeton, NJ: Princeton University Press. BIS central bankers’ speeches option to recover balances or mitigate severe adjustment pressure by depreciating its own currency. This makes it even more difficult to resolve the problem in the area. Against such a background, the European Central Bank (ECB) undertook two longer-term refinancing operations (LTROs) with a maturity of 36 months, which provided virtually unlimited liquidity in the euro area. In addition, central banks including the Bank of Japan arranged the coordinated U.S. dollar fund-supplying action. Owing to these policy measures, financial chaos – as we saw at the time of the Lehman shock – has been avoided so far. The liquidity provision by central banks can only provide a temporary reprieve – in other words, it is a measure to “mitigate the pain” or “buy time”, so to speak. Central banks’ actions themselves will not solve the problem. Thus, two things are necessary to stop the adverse feedback loop among the fiscal situation, the financial system, and the real economy. First, economies with fiscal problems must proceed with drastic fiscal reforms as well as economic structural reforms, such as reforming the labor market and maintaining and strengthening the soundness of financial systems. Second, Europe as a whole must set out clearly the future of economic integration and reconstruct a sustainable single currency zone. Europe, as part of its process of creating a European banking union, is considering the establishment of a single supervisory mechanism. Conditional on the establishment of such a mechanism, a principle is currently being discussed that allows the European Stability Mechanism (ESM) to inject capital directly into financial institutions. In addition, in order to strengthen the fiscal consolidation of the respective countries in the region, the European authorities are in the process of drafting a road map that sets out the deadline for achieving such a target. These are the challenges – that have been recognized by the public – beyond a “monetary union”, and European authorities share a broad sense of the necessary direction to follow. At the same time, these are essential and difficult tasks that will define the future of Europe’s economy, society, and politics. For that reason, there are a number of issues that ought to be resolved, and it will be difficult to form consensus in such a short time. While a difficult task, the European monetary union has progressed over the years under the grand vision to realize peace, prosperity, and stability in the region through political and economic integration. In order to realize this vision, a strong political will is imperative. I sincerely hope that the European authorities – by taking advantage of the responsiveness that has been nurtured and the mutual trust that has been established through the course of history in Europe – will take bold measures to address the fundamental problem. IV. Growth potential Japan’s growth potential So far, I have addressed the issue of overseas economies. I would now like to change the subject to the domestic economy and present the third topic: Japan’s growth potential, or potential growth rate. To have some idea of where the potential growth rate lies is vital both in terms of making policies and managing firms. This is because the output gap of Japan’s economy has tightened to about –2 percent at present, and the economic growth rate over the next 10 or 20 years is largely underpinned by the potential growth rate. Both monetary policy and fiscal policy are aimed at stimulating demand by closing the output gap, and neither is quite able to raise potential growth. To understand potential growth, let us look back at the long time-series of real GDP growth rates in Japan. While it was around 4.4 percent in the 1980s, real GDP declined gradually, reaching around 1.5 percent in the 1990s and around 0.6 percent in the 2000s (Chart 12). The real GDP growth rate can be decomposed into the growth rate of the workforce and the BIS central bankers’ speeches growth rate of real per capita GDP, i.e., the growth rate of value-added productivity. The decline in real GDP from the 1980s to the 1990s owes much to the declining growth rate of value-added productivity (Chart 13). This is mainly due to the remnants of the bubble; in other words, economic activity stagnated during the course of removing excesses in terms of business equipment and debts that had accumulated during the bubble period. However, its decline from the 1990s to the 2000s owes much to the fact that the working-age population started to decrease, rather than increase, while the growth rate of value-added productivity stopped declining. The decline in the workforce reflects the rapid aging of the population that is in progress. What is going to happen in the next 10 years? Assuming that the labor participation of male/female workers and that of different age groups remain constant, the future course of the working-age population can be calculated with great accuracy. In the 2010s and 2020s, it is expected to decline by 0.6 percent and 0.8 percent, respectively. Meanwhile, value-added productivity for the last 20 years is 0.9 percent on average. Taking the average between 2000 and 2008 – excluding the 1990s when the aftereffects of the bursting of the bubble still remained – value-added productivity becomes 1.4 percent. Assuming that it will grow at 1.0–1.5 percent, the economic growth rate will be 0.4–0.9 percent and 0.2–0.7 percent in the 2010s and 2020s, respectively. This computation is mechanical, and I do not place absolute significance on these numbers. Nevertheless, I still believe that they are useful in terms of being able to grasp future economic growth in a situation where no efforts were made to change the status quo. Measures to raise Japan’s growth potential Between the two components that constitute economic growth, the way in which value-added productivity is assumed warrants further discussion. Value-added productivity per workingage person in Japan is at a level comparable to other major economies. In fact, it is even higher than some other countries. While it is lower than emerging economies, this reflects the difference in economic structure between the economies that are in the process of catching up and those that have matured. It is rather unrealistic to expect that value-added productivity in Japan will pick up at a rate similar to those in the high-growth era. It may sound as though I am trying to emphasize that we should accept low growth as fate. This is not my intention. Changing the demographic trend itself, were it possible, would take a long time. Thus, we must face the reality that aging will proceed anyway, and make efforts to carry out structural reforms in view of the aging society. This is the only way to reinvigorate Japan. It is not only the declining population or aging itself that lies behind the low growth rate. The lack of advancing structural reforms to create higher value-added in response to demographic changes is at its core. When thinking in such a way, it becomes clear where we should be headed in order to raise economic growth. The first move would be to increase labor participation, or to increase the share of those who actually work relative to the working-age population. In order to do so, it is necessary to make serious efforts to lay the foundation for allowing more females and the elderly to participate in the labor market. Leaving the current labor participation as it is, the workingage population would decline by 0.6 percent in the next 10 years. If the labor participation of female workers became as high as that in Sweden, for instance, the working-age population would rise, rather than decline.2 Please see Masaaki Shirakawa, “Japan’s Economy and Monetary Policy” (Speech at a Meeting Held by the Naigai Josei Chousa Kai <Research Institute of Japan> in Tokyo), June 4, 2012. http://www.boj.or.jp/en/announcements/press/koen_2012/data/ko120604a1.pdf BIS central bankers’ speeches The second is to exert efforts to raise or at least stop a further decline in value-added productivity. The emphasis here is on productivity that requires efforts to raise it. If firms raise their profitability by cutting wages and suppressing input prices, this will only end up suppressing household income and the profit base of suppliers; hence, the value-added in the economy as a whole will not increase. Therefore, in order to raise value-added productivity, one has to develop new goods and services that meet the potential needs at home and abroad, initiate successful business models, and raise value-added productivity. Here, the spirit of challenge on the part of firms plays an important role. There are two ways in which firms can make a maximum contribution: the first is to generate highly value-added goods and services by capturing overseas demand and cultivating domestic demand; and the second is to shift their human, commodity, and financial resources to areas that have the potential to increase demand. In order to encourage firms to demonstrate their spirit of challenge, it is necessary to lay the foundation through initiatives such as deregulation. Turning areas where potential demand has not been cultivated due to existing regulation into growing markets may well be a big opportunity for Japan’s economy. At the same time, the society’s willingness to accept such challenges is also important. V. Deflation When I talk about the importance of raising the growth potential, the likely response might be that overcoming deflation is also important. Indeed, this is an important issue, but we need to think carefully about what it means to overcome deflation. Next, I would like to present the results of the Opinion Survey on the General Public’s Views and Behavior. The Bank conducts this survey on a quarterly basis, based on the responses collected from individuals who are chosen through a stratified two-stage random sampling method. This survey is an opinion poll designed to gain insight into the general public’s perceptions on their household circumstances, including questions with regard to the perception of price levels (Chart 14). According to recent survey results, among the respondents who felt that prices have gone up, more than 80 percent viewed the price rise as “rather unfavorable”. In contrast, among the respondents who felt that prices have gone down, about one third of them deemed the price decline as “rather favorable”. While the exact number changes from one survey to the next, the responses have tended to be rather stable. Reading the newspaper, in contrast, one often comes across an article stressing the necessity to overcome deflation and representing this as the voice of the general public in Japan. Given that deflation is a state in which prices keep declining, these two outcomes are inconsistent with each other. How can we reconcile these outcomes? In my view, the answer lies in the fact that “deflation” means different things to different people. Some use this terminology in the context of consecutive declines in prices, while others believe it means deteriorating economic activity and the rest view it as declining wages. There are even those who use deflation in the context of falling asset prices. According to the opinion survey that I have just mentioned, most Japanese people are not hoping that prices would simply rise. If prices rise while real GDP remains stagnant, this will lead to higher nominal GDP, which represents a situation where costs rise in a number of items and cost-push inflation prevails. This does not lead to a higher living standard. In the minds of most people, overcoming deflation is not simply a state in which prices rise in general, but rather one where better economic conditions are realized by increasing corporate profits, employment, and income. In economists’ jargon, it represents a rise in the real GDP growth rate. When the real GDP growth rate rises, the demand and supply balance improves, generating upward pressure on prices and wiping out deflation. The question is how to raise the real GDP growth rate. There is a combination of forces that needs to be addressed: first, strengthening the economy’s growth potential; and second, providing support from the financial side. BIS central bankers’ speeches VI. Stronger yen Recent developments in foreign exchange rate and its background Related to the current economic developments, I would now like to talk about the problem associated with the stronger yen, the fifth topic of my speech today. This is the issue that I have been asked about most frequently. Looking at the foreign exchange developments after the Lehman shock, the tide changed from a weaker yen up until then to a stronger yen. The effective exchange rate, weighted by trade volumes, shows that the yen and the Swiss franc appreciated sharply while the euro depreciated (Chart 15). The U.S. dollar, while it appreciated temporarily after the Lehman shock, has been depreciating moderately on the whole. Meanwhile, the Korean won depreciated sharply after the Lehman shock and has remained at that depreciated level. In the foreign exchange market, a large volume of transactions takes place on a daily basis, and capital transactions account for 98 percent of total transactions (Chart 16). In the formation of foreign exchange rates, capital transactions play an important role. There are basically two types of capital flows behind the stronger yen following the Lehman shock. The first is the reversal of yen carry trades that had actively taken place before the Lehman shock. Prior to the Lehman shock, a very low interest rate was observed in Japan, but now interest rates around the globe have also become extremely low. Second, overseas investors have become more risk averse against the background of uncertainties about the outlook for the global economy as well as the European debt problem, and the yen has become a safe-haven currency that is more likely to be purchased under the current situation. In a case where the European debt problem raises urgent concerns, the currency of the country with abundant overseas assets – which is the outcome of the past current account surplus – is regarded as a safe-haven currency. Effects of foreign exchange rate movements and responses A stronger yen creates a significant impact on the economy and prices. The way in which its effect is realized depends on economic conditions and the passage of events. At present, the stronger yen causes a decline in exports and corporate profits as well as deterioration in business sentiment; hence, I recognize that the negative effect is dominant. Indeed, in domestic demand driven sectors such as retail sales, the decline in import prices has been beneficial, and the stronger yen also reduces costs associated with energy-related imports under the current circumstances. Taking into account all of the negative and positive effects together, the Bank judges it necessary to watch more carefully for negative effects on the economy and prices, given that the outlook for the global economy faces significant uncertainty. In particular, under the current circumstances where there is a wide range of uncertainties regarding the outlook of overseas economies – not to mention the outlook for the European debt problem – we need to closely monitor developments including the accelerated outward shift of Japanese firms to overseas and the decline in medium- to longterm growth expectations. As foreign exchange rates are important variables in the management of firms, the sharp volatility in the foreign exchange market creates a problem in terms of firms’ ability to respond to such changes. Towards the middle of the 2000s, when the yen depreciated sharply, production shifted back to Japan and the rising trend in the overseas production ratio came to a halt. Now that the yen is appreciating, a swing in the foreign exchange rate makes it more painful for firms to adjust to these changes. As announced in the statement of G7 Finance Ministers and Central Bank Governors, both the Government and the Bank of Japan judge that excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. In response to disorderly movements in foreign exchange rates, the government has intervened in foreign exchange markets at a time judged to be the most effective. As for BIS central bankers’ speeches monetary policy, which will be addressed later, the Bank has been implementing monetary easing, taking account of the implication of the deceleration in overseas economies and the stronger yen on the outlook for Japan’s economy and prices. Sometimes we hear the view that the Bank should purchase foreign bonds with the objective of weakening the yen. However, this is identical to intervention in foreign exchange markets. It is clearly stipulated in the law that the Bank shall buy and sell in the foreign exchange markets as an agent handling national government affairs when the purpose of the buying and selling is to stabilize the exchange rate of the Japanese currency. As such, this should be discussed in the context of whether or not it is necessary for the government to intervene in the markets. In terms of a response to the stronger yen, together with government initiatives, how firms react to such changes is also important. Under the floating exchange rate system, firms at home and abroad have been making efforts to minimize the effects stemming from exchange rate moves. Above all, in order to cope with foreign exchange movements, one has to develop goods and services that are highly competitive. On this point, the Swiss experience is a good example. Over the last 10 years, the Swiss franc has appreciated more than the yen, but in terms of value, the Swiss exports, mainly of medical goods and watches, increased by much more than those of Japan (Chart 17). In evaluating the competitiveness, the international competitiveness coefficient – the net export value relative to the sum of export and import values – is calculated for Japan’s merchandise representatives. Among them, there are items that continue to be highly competitive under the appreciating yen, but there are also other items that lost competitiveness even before the yen’s appreciation started (Chart 18). In the short run, the volatility associated with foreign exchange movements affects the competitiveness, and we are fully aware that it is all the more difficult for firms, particularly small firms, to respond to the rapid appreciation of the yen. Nonetheless, from a somewhat long-term perspective, the competitiveness that enables one to succeed in the globalized economy comes from having differentiated products as well as highly value-added products. VII. Fiscal sustainability Next, I will talk about fiscal sustainability – the sixth topic of my speech today. This is a particularly important issue for Japan from a somewhat long-term perspective. When the fiscal balance deteriorates over the long run, there are only three ways to regain fiscal sustainability in terms of logical consequences and historical experience. The first is to regain fiscal sustainability by raising economic growth and reforming revenue and expenditure. The second is simply to default. The third is to create higher inflation, wiping out the debts. If no effort is being made to restructure the fiscal system, or if improving the fiscal balance in the future rests on unrealistic assumptions about high economic growth, it will not be possible to make both ends meet and investors will be left with two remaining options: either default or suffer high inflation. Defaulting sovereign debts will jeopardize the stability of the financial system by generating large losses on financial institutions. Inflation will jeopardize price stability. In either case, the stability of the economy’s own currency – the most essential prerequisite for stability of the economy and society as a whole – will be lost, causing grave damage to the possibility of achieving sustainable economic growth. In perhaps a less extreme scenario than the one described above, when there is uncertainty with regard to fiscal sustainability, firms and households will be concerned about the future and become more likely to reduce their expenditure. It is for this very reason that maintaining fiscal sustainability is vital to realizing sustainable growth of the economy. Related to this, I am often asked why Japan finances itself smoothly and long-term yields remain low and stable, despite the fact that Japan has a large fiscal deficit and the ratio of government debt outstanding to GDP is extremely high compared to other countries. There BIS central bankers’ speeches are two reasons. First, there is confidence in the market that Japan has the will and ability to eventually address fiscal consolidation. The second reason is that investors anticipate that yields have been stable thus far and will continue to be so. It may be hard to believe at this juncture, but in the euro area, every country issued bonds at the same level as Germany up until a few years ago. Of these two reasons, I believe that the first one is more convincing as an explanation of why a severe fiscal situation does not lead to higher bond yields in the market. In essence, confidence is firmly embedded in the minds of market participants that Japan has the will and ability to address fiscal consolidation. Nonetheless, such strong will and ability eventually have to be proven by the track record. From a medium- to long-term perspective, it is particularly important to maintain the market’s confidence by steadily making progress toward fiscal consolidation. At the same time, in the making of monetary policy, it is important to maintain the market’s confidence that a central bank conducts its policy with the aim of achieving sustainable growth with price stability. In that context, let me emphasize that the Bank of Japan’s purchase of government bonds will never be intended to be construed as financing government debt. In terms of improving the fiscal balance, one often hears the view that raising the nominal growth rate is important. I find this to be rather misleading. Whether or not the fiscal balance improves rests heavily on how the rise in nominal growth rate is achieved. When the nominal rate rises as a result of higher inflation, tax revenue increases, but at the same time, expenditure also increases due to higher wages and costs. Until now, the government bonds already issued at higher rates have been refinanced by those newly issued at lower rates, and the total interest payments of government bonds have been reduced. Going forward, however, not much from such a refinancing effect can be counted on (Chart 19). Under such circumstances, higher inflation will lead to an increase in interest payments, a factor that increases government expenditure. Thus, simply raising inflation will not lead to an improvement in fiscal balances (Chart 20). In contrast, when a rise in the nominal growth rate is accompanied by a rise in the real growth rate, government expenditure does not increase, due to rising costs, and the fiscal balance improves through an increase in tax revenue. An increase in nominal growth – the key to successful fiscal consolidation – has to be accompanied by an increase in real growth. Accordingly, when the real growth rate rises, prices will rise and the nominal growth rate will rise as well. In this sense, strengthening the growth potential is also important from the perspective of improving the fiscal balance. VIII. The Bank’s conduct of monetary policy Pursuing powerful monetary easing Based on the current state of the global economy and Japan’s economy as well as challenges they face, I would now like to talk about the Bank’s conduct of monetary policy. The Bank of Japan recognizes that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. Based on that recognition, the Bank has been conducting powerful monetary easing. At present, its powerful monetary easing is being pursued in the context of “comprehensive monetary easing policy”. Let me first elaborate on this. Comprehensive monetary easing was introduced in October 2010, almost two years ago. Essentially, it was an ingenious means to generate further accommodative effects when the overnight call rate – the Bank’s target rate – had already been at virtually zero percent. The first aspect of such ingenuity comes from the clarification of the policy time horizon; that is, to BIS central bankers’ speeches clearly state that for the time being the Bank will proceed with powerful monetary easing with the aim of achieving the goal of 1 percent inflation – in terms of the year-on-year rate of increase in the CPI – until it judges the 1 percent goal to be in sight.3 Another aspect of the ingenuity is the establishment of a program under which not only JGBs and T-Bills but also various types of risk assets can be purchased, including CP, corporate bonds, exchangetraded funds (ETFs), and Japan real estate investment trusts (J-REITs). This program is aimed at encouraging a decline in longer-term market interest rates and a reduction in risk premiums. The total size of the Program initially started off with about 35 trillion yen, and it will reach about 70 trillion yen by cumulatively expanding the amount of the Program. At present, the Bank is in the process of increasing the size of the Program in order to reach 70 trillion yen. The size of the Program as of August 31 was about 58 trillion yen, which implies that the Bank will purchase more than 10 trillion yen worth of financial assets from now on (Chart 21). In this way, the Bank will steadily increase the size of the Program and proceed with further monetary easing in a continuous manner; thus, the effects of monetary easing will strengthen with every passing day as this process continues. The Bank will proceed with the monetary easing in a continuous manner by steadily increasing the amount outstanding of the Asset Purchase Program. Accommodative financial conditions and measures to take advantage of these conditions Under such powerful monetary easing, stability in financial markets and the financial system has been maintained even during the period when they faced strong headwinds – that is, when the Great East Japan Earthquake and the European debt problem hit the markets. Firms’ funding costs have declined, and the sense of security regarding the availability for funds is firmly secured. In fact, the average contract interest rates on new loans and discounts – both the short- and long-term rates – have registered an unprecedented level of almost 1 percent, even lower than that registered during the first half of the 2000s, the era of quantitative easing (Chart 22). Under such circumstances, the average interest rate paid by firms declined to 1.49 percent. Given that the firms’ profitability relative to total assets, i.e., the ROA, was 3.24 percent, this is at an extremely low level (Chart 22). In short, firms have been able to raise ample funds at a rate substantially lower than their profitability. As such, financial conditions in Japan are accommodative. Thus, the first stage of the monetary transmission mechanism – namely, the effect of monetary easing permeating financial markets – is well under way. Once firms and households take advantage of such accommodative financial conditions and embark on business investment and consumer spending, the second stage of the transmission mechanism – namely, financial conditions permeating economic activity and prices – will strengthen. What is important at this juncture is to carry out measures to support strengthening the foundations for economic growth, as I emphasized before. The growth rate rises when investment at home draws investors’ attention by means of drastic deregulation, or when new markets or goods and services are cultivated through firms’ innovative efforts. As firms’ efforts bear fruit, the public’s expectation for rising corporate profits and household income strengthens, and this will eventually lead to higher demand for the funds. In this way, accommodative financial conditions will be able to fulfill their original purpose of stimulating aggregate demand to the maximum extent. Once such a virtuous cycle manifests itself, the aggregate supply and demand balance improves, and it is likely that the inflation rate will start to rise. While keeping such a mechanism in mind, on a number of occasions, I have 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 been emphasizing that in order for Japan’s economy to overcome deflation and return to a sustainable growth path with price stability, we need two things: first, having a wide range of economic agents exert efforts to strengthen the economy’s growth potential; and second, support from the financial side. In strengthening the growth potential, firms play a pivotal role. At the same time, it is important to provide the grounds for letting them meet the challenge to cultivate new markets. Based on such recognition, the Bank has embarked on a highly extraordinary measure for a central bank since June 2010: that is, the establishment of the “FundProvisioning Measure to Support Strengthening the Foundations for Economic Growth” (Chart 23). Under this measure, the Bank provides long-term funds at low rates to financial institutions carrying out lending or investment in support of strengthening the foundations for Japan’s economic growth. The Bank strongly believes that such a measure plays a catalytic role in allowing financial institutions to proceed with their voluntary efforts. In June 2011, the Bank introduced a special scheme, as part of its overall support measures, that established a new line of credit for equity investments and asset-based lending (ABL), which, unlike traditional lending, uses assets that are closely tied to firms’ businesses – such as their inventories, equipment, and machines, as well as accounts receivables – as collateral. The advantage of ABL is that it creates ways for firms without conventional collateral or guarantees to gain access to loans. In addition, in March and April 2012, the Bank established and expanded special rules for small-lot investments and loans – those less than 10 million yen – as well as special rules for U.S. dollar lending arrangements. At present, the total size of the measure stands at 5.5 trillion yen. With such measures initiated by the Bank, private financial institutions have started making their voluntary moves, and I judge that our measures are serving as a catalyst by encouraging the private sector’s efforts to strengthen growth potential. In sum, the Bank of Japan’s message – that is, that strengthening the growth potential is all the more important and financial institutions must play their respective roles – has been well-received. The Bank of Japan has been providing the utmost support as a central bank, including the development of unconventional policy tools in the sphere of monetary policy. While attention tends to focus on discussions on monetary policy surrounding interest rates and quantitative issues when it comes to central bank policies, central banks are capable of making a wider range of contributions. At present, the Bank of Japan pays the most attention to maintaining the stability of financial markets and the financial system even if nervousness regarding the European debt problem increases. The Bank continues to conduct monetary policy in an appropriate manner. The Bank will also do its utmost to ensure the stability of Japan’s financial system while giving particular attention to developments in global financial markets, where nervousness with respect to the European situation continues to be seen. Concluding remarks Let me conclude. Today, I have touched on a number of issues, but the most important topic that I wanted to emphasize in my speech is that we must make serious efforts to strengthen the growth potential of Japan’s economy. In order to advance efforts on this front, the most important thing is to understand that the real problem facing Japan’s economy is the declining growth rate. This appears to be better understood in the public domain, but it has not reached a satisfactory level. At the outset of my speech, I reviewed the past 20 years of Japan’s economy. Be it the nonperforming loan problem or the rapid aging of the population, it took some time to recognize BIS central bankers’ speeches them, and as a result, the response had been delayed.4 We must not make the same mistake again. Another thing that we should do, and that is important in terms of strengthening the growth potential, is to assess the strength of Japan’s economy dispassionately and try not to fall into excessive pessimism. During my earlier description of the situation surrounding the global economy, I referred to the challenge facing the United States, Europe, and China. Each country or region has its own difficult problems to overcome. From an objective perspective, we may be underestimating the potential strength of Japan’s economy. First and foremost, Japan is at the center of Asia, the growth engine for the global economy. In finance, Japanese financial institutions ended the disposal of non-performing assets as early as the beginning of the 2000s, and they now enjoy high credit rating standards relative to their overseas competitors (Chart 24). There are areas one can find in firmness of domestic demand where changes could be turned to advantages. Knowing that consumption by the elderly aged over 60 years constitutes more than 40 percent of total consumption, and that potential demand is being created to develop new energy and environment-related businesses in the aftermath of the earthquake, such big changes provide good opportunities for cultivating new markets. It has been almost 20 years since the bubble burst in Japan. The next 20 years will surely be different if we accurately recognize the problem we currently face and make serious efforts to strengthen growth potential. Thank you very much. As for the nonperforming loan problem, it was the summer of 1992 when the possible injection of public money was first discussed in public. A large-scale injection of public money was carried out in 1998, nearly eight years after the bursting of the bubble. A similar story applies to the response to the aging and declining population. While the working-age population started to decline in 1996, this coincided with a period when people suffered from the severe effects of the bursting of the bubble. At that time, neither the general public nor economists recognized the implication of demographic changes (i.e., aging and a declining population) for Japan’s economy to the much fuller extent that we do at present. 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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Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the reception to commemorate 25 years of the Deutsche Bundesbank in Tokyo, Tokyo, 6 September 2012.
Masaaki Shirakawa: Wishing the best for the Bundesbank’s new move in Tokyo Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the reception to commemorate 25 years of the Deutsche Bundesbank in Tokyo, Tokyo, 6 September 2012. * * * Good evening ladies and gentlemen. It is a great honor to be invited to this reception celebrating the 25th anniversary of the Deutsche Bundesbank in Tokyo and the opening of its new and enlarged office. I would like to extend my sincere congratulations to Dr. Andreas Dombret and Dr. Joachim Nagel, the Executive Board members of the Bundesbank, Dr. Karlheinz Bischofberger, the head of the Financial Stability Department, Mr. Klaus Merk, the Representative of the new Tokyo office, and other staff members of the Bundesbank. Now please allow me to extend a few words of congratulations. Relationship between Germany and Japan Last year coincided with the 150th anniversary celebrating the signing of a treaty of amity and commerce between Germany and Japan. A variety of events were held in many places in both countries. In March 2011, I was given the opportunity to speak at Goethe University Frankfurt. 1 The commonly held image of Germany and Japan is that both countries are seen as nations with advanced manufacturing technologies and highly diligent populations. According to the global public opinion poll of 2011 conducted by the BBC World Service, Germany was seen as having the most positive influence. This year, Japan is top of this category with Germany as the runner-up. The reason for the positive perception of the two nations was their contribution to the global economy and to industry. The history of modernization in Japan shows that the country learned a lot from Germany when establishing the social infrastructure necessary for its economic development in the nineteenth century. There are a number of stories related to the Germany-Japan relationship that every Japanese citizen knows. For example, in the early nineteenth century during the Edo period, at the time of Japan’s self-imposed isolationist policy, a German medical doctor, Philipp Franz von Siebold, opened a school called Narutaki-juku near Dejima in Nagasaki, for Japanese people to learn Western medicine. Large parts of modern Japanese law, including the civil code, are based on German law. And, as a central banker, I must of course remind you of the great contribution made by Germany to banknotes in Japan. Today, Japan possesses the most advanced anti-counterfeit technology for banknotes. However, when the first notes were printed, Japan learned its printing techniques mostly from Germany. In 1872, ten years before the establishment of the Bank of Japan during the Meiji period, the Japanese government issued the first standardized yen notes, called the Meiji Tsuho. Since it was difficult with Japanese technology at that time to produce original plates with a delicate design and a pattern suitable to prevent counterfeiting, the Japanese government placed an order with a printing company in Frankfurt, Dondorf and Naumann, to create original plates for printing and asked for technical support. 2 In this regard, we owe a lot to Germany for the production of the first yen notes. See the Bank of Japan's website, Masaaki Shirakawa, “150 Years of Innovation and Challenges in Monetary Control,” Speech at Goethe-Universität Frankfurt am Main in Celebration of the 150th Anniversary of German-Japanese Diplomatic Relations on March 8, 2011. http://www.boj.or.jp/en/announcements/press/ koen_2011/data/ko110309a.pdf. See the Currency Museum page on the website of the Institute of Monetary and Economic Studies of the Bank of Japan: “Short Essays on Monetary History Contained in Monetary and Economic Studies: Paper Money in BIS central bankers’ speeches Relationship between the Deutsche Bundesbank and the Bank of Japan It is said that the German Chancellor Helmut Kohl once stated that “I did not like many of the monetary policy decisions of the Bundesbank, but as a citizen, I am very glad about the existence of the Bundesbank.” As this episode shows, the Bundesbank is well known for its independence and achievements in securing price stability. The Bank of Japan opened its Representative Office in Frankfurt in 1956, and in the following year, the Bundesbank was established by succeeding the Bank deutscher Länder. Since then, cooperation and friendship between these two central banks has grown, and our representatives in Frankfurt have visited the Bundesbank and conducted various meetings so that both sides can exchange opinions, quite frankly and frequently, on important economic and financial issues. I would like to take this opportunity to express my sincere gratitude to all those who have contributed to nurturing the close bonds of cooperation and friendship between the Bundesbank and the Bank of Japan. Given the ever-increasing pace of economic and financial globalization, I believe the strong human networks that thrive among central bankers are becoming ever more important. In addition, I would like to express our sincere gratitude for the heartwarming support from the Bundesbank a year and a half ago. As you know, on March 11, 2011, Japan was hit by the Great East Japan Earthquake. The President of the Bundesbank Regional Office in Hesse arranged a charity concert to be held in the office’s auditorium. Furthermore, a large number of German people donated a great deal of money to Japan through the International Red Cross. Such generous and heartfelt support proved once again that Germany is indeed our good friend, as they say in Germany, “In der Not erkennt man den wahren Freund (A friend in need is a friend indeed)”. Expansion of Tokyo Representative Office The Bank of Japan would like to congratulate the Bundesbank in Tokyo on its 25th anniversary and on the opening of its new enlarged office. The Bundesbank chose Tokyo as the home for one of its two overseas Representative Offices, together with New York. In addition, the Bundesbank made the decision to establish a trading office in Tokyo this September. The decision shows that the Bundesbank recognizes the importance of the Japanese economy as well as the role of the Tokyo financial market in the Asia-Pacific region. The Bank of Japan greatly appreciates the Bundesbank’s decision, which I believe will be highly welcomed by all the people involved in the Tokyo financial market. Let me say in closing, that I strongly believe the enhancement of the new Tokyo office will deepen the friendship and cooperation, not only between the Deutsche Bundesbank and the Bank of Japan, but also between Germany and Japan. Congratulations. Japan; 2-8 Shin-shihei Note (Meiji Tsuho Note)”. http://www.imes.boj.or.jp/cm/english_htmls/feature_gra28.htm. 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, Yamaguchi, 5 September 2012.
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, Yamaguchi, 5 September 2012. * * * Introduction Thank you for giving me this opportunity to exchange views with people representing Yamaguchi Prefecture, who have taken time to be here despite their busy schedules. Allow me to also express my gratitude for your cooperation with the activities of the Bank of Japan’s Shimonoseki Branch. Today I will review economic activity and prices in Japan, whose economy is heading toward recovery despite the effects of the global economic slowdown, and then discuss the Bank’s monetary policy. My concluding remarks will touch briefly on the economy of Yamaguchi Prefecture. Following my speech, I would like to listen to your views on the actual situation of the local economy and your candid opinions. I. Recent developments in economic activity and prices A. Overview After the turn of the year, economic activity in Japan started picking up moderately; domestic demand has been firm, supported mainly by reconstruction-related demand and policy effects. While overseas economies as a whole are still in a deceleration phase, domestic economic activity has also been firm. Domestic demand – including private consumption, public investment, and housing investment – has been improving and this improvement has compensated for a delay in recovery in production and exports due to a slowdown in external demand. As for the outlook, while Japan’s economy is expected to return to a moderate recovery path as domestic demand remains firm and overseas economies emerge from their deceleration phase, there is an increasing risk that a recovery in overseas economies will be delayed, which warrants attention. I will first review the recent developments in overseas economies, followed by the current situation of and the outlook for Japan’s economy. B. Overseas economies Economic sentiment, mainly in the corporate sector, has become cautious globally, and there is an increasing risk that the slowdown in the global economy will be a protracted one. In the European economy, particularly in Spain, Italy, and other peripheral countries, an adverse feedback loop encompassing the fiscal situation, the financial system, and the real economy has been operating, and a sense of stagnation has been increasing as a whole. In addition, given that a decline in demand in peripheral countries has started to affect household and business sentiment in core countries such as Germany, partly through a decline in intra-regional exports, and that long-term interest rates in Spain and Italy have remained high, there appears to be an increasing risk that economic recovery will be delayed. As for the European debt problem, since the Greek crisis that began in May 2010, for more than two years a process has continued in which governments respond only intermittently to pressure from the markets. If this process continues into the future, stagnation in peripheral countries might start to feed back into core countries and the stagnation in the European BIS central bankers’ speeches economy might become even more prolonged and aggravated, weighing on the global economy. This is a matter of concern. Looking at the background of this problem from a longer-term perspective, we need to recognize the merits and demerits of the single-currency euro in the 13 years since its introduction. On the merit side, one can point out that the absence of foreign exchange risks within the region and reduced transaction costs stimulated intra-regional trade and investment, and that the converging low level of interest rates in member countries for more than ten years induced an expansion in economic activity. On the demerit side, one can point out that the converging low level of interest rates encouraged loose fiscal spending, and this, together with an optimistic economic outlook, led to a bubble in the real estate market. In addition, necessary structural reforms, including labor market reform aimed at containing labor costs, did not progress and the disparity in competitiveness within the region was left unaddressed. In a sense, we can say that the European debt problem represents the surfacing of the demerits accumulated over a period of more than ten years, so it should not be a surprise that the resolution of the problem will take a long time. Having said this, with an aim of resolving the problem as quickly as possible, it is necessary for European leaders to respond appropriately to the challenges, such as improving fiscal conditions in peripheral countries and enhancing growth in Europe, as well as to present a specific roadmap for the longer-term challenges of forming a banking union, issuing Eurobonds, and pursuing fiscal integration, and thereby dispelling uncertainties regarding the euro zone economies. In this regard, while some gradual achievements have been made, the European leaders are expected to show further leadership. While the U.S. economy has been recovering moderately, supported by accommodative financial conditions, the pace of the recovery seems to be slowing somewhat. The real GDP growth rate for the April-June 2012 quarter (seasonally adjusted; the annualized growth rate compared with the previous quarter) rose to only 1.7 percent, and growth decelerated in domestic demand, including private consumption, business fixed investment, and housing investment. While economic indicators since July have been mixed, what concerns me is that there seem to be signs of weakening in the buoyant corporate sector, which has been supporting the recovery in the household sector. Let me amplify this point. In the household sector, private consumption has been firm on the back of moderate improvement in employment and income, and housing starts and sales have shown signs of bottoming out, while a balance-sheet adjustment has been progressing as seen in a gradual decline in the ratio of debt to disposable income. On the other hand, in the corporate sector, sluggishness in exports and deterioration in business confidence have become apparent, reflecting the European debt problem and a slowdown in the Chinese economy. So far, given that corporate profits and business fixed investment have been firm and the household sector has been generally solid, it seems that the recovery mechanism originating from the corporate sector remains active. However, I recognize that attention should be paid to the possibility that employment and business fixed investment will be hampered by a further worsening in business confidence, thereby leading to an economic slowdown. As for a future risk to the U.S. economy, in addition to a delayed economic recovery in Europe and China, I would point to the “fiscal cliff” problem. While a cut in fiscal spending and expiration of a tax reduction are downside factors for economic activity, the range and size of the factors are highly uncertain at present, and are factored into the U.S. economic outlook differently by private research institutions. Some point out that because of uncertainty associated with the problem, firms have already been deferring investment and new hiring, and we need to be alert to how the situation will evolve going forward. BIS central bankers’ speeches In the meantime, in U.S. financial markets, stock prices have bounced back to a level prior to the Lehman shock, and long-term interest rates – despite rising somewhat – have generally been hovering at low levels. As for the Asian emerging economies, a decelerated pace of growth has become somewhat protracted due to the recent slowdown in exports to Europe, but the economies are likely to pick up the pace of growth led by China. Attention should be paid, however, to the possibility that the timing of a recovery will be delayed to the autumn or later. As for the Chinese economy, the effects of the authorities’ policy measures have started to emerge, including an increase in new lending and the bottoming out in housing prices, but future economic indicators need to be monitored carefully, since stagnation in the European economy has been spreading to the Chinese economy through trade and concern over an increase in inventories has not been dispelled. As for the NIEs and the ASEAN economies, domestic demand has been strong, but it is a matter of concern that indicators related to exports and production have recently been sluggish or deteriorating in economies like South Korea and Taiwan. I believe that a key to the future of these economies will be whether China regains its pace of growth and their exports recover. From a longer-term perspective regarding the sound development of the global economy, it is critical that the Asian emerging economies maintain a balance between economic growth and price stability. In particular, for China – which is expected to lead the global economy together with the United States – careful attention should be paid to future developments, including whether economic policy management is maintained smoothly following the appointment of the new Chinese leadership. C. Economic activity and prices in Japan In Japan, economic activity as a whole has been picking up moderately, with domestic demand improving mainly due to reconstruction-related demand and policy effects, which has compensated for a delay in recovery in production and exports due to a slowdown in external demand. The real GDP growth rate (seasonally adjusted; the annualized growth rate compared with the previous quarter) was high at 5.5 percent in the January-March 2012 quarter and maintained steady growth in the April-June quarter at 1.4 percent. To elaborate on this, amid the continued slowdown in overseas economies, a pick-up in exports has been slowing and production – affected by the slowdown in exports – has also been relatively weak. As for domestic demand, public investment has continued to increase and business fixed investment has been on a moderate increasing trend with improvement in corporate profits. Private consumption has continued to increase moderately due partly to the effects of measures to stimulate demand for automobiles, and housing investment has generally been picking up. At the same time, there are signs of concern. There is some inventory stockpiling on the back of the continued slowdown in exports and production; machinery orders, a leading indicator of business fixed investment, have shown signs of weakening; the coincident index in the Indexes of Business Conditions has been shifting from “improving” to “weakening”; and indicators of business sentiment are showing signs of weakening. While the economy as a whole has been improving, causes for concern seem to have increased in number. As for the outlook, Japan’s economy is expected to return to a moderate recovery path as domestic demand remains firm and overseas economies emerge from their deceleration phase. Such a scenario can be confirmed in the forecasts of the majority of the Policy Board members; in terms of the median forecast as of July 2012, real GDP was projected to grow at 2.2 percent in fiscal 2012 and 1.7 percent in fiscal 2013. BIS central bankers’ speeches These forecasts are associated with upside and downside risks, and I am paying greater attention to the downside risks, as follows. First, there is a risk of overseas economies slowing further. As I have already mentioned, the risk that the economic slowdown in Europe, the United States, and Asia will become protracted has increased somewhat, and if the slowdown actually becomes protracted, it will weaken Japan’s move toward a self-sustaining recovery in which increases in exports and production lead to an increase in income and spending. Second, there is a risk of further appreciation of the yen. While a positive case can be made for yen appreciation to a certain extent, excessive appreciation will worsen the competitiveness and profits of exporting firms again and act as a headwind against firms. If a trend of falling stock prices intensifies, together with the trend of yen appreciation, then firms’ and households’ confidence will deteriorate and currently solid business fixed investment plans and private consumption will be contained, which will weigh on Japan’s economic recovery. Third, there is a risk related to the first and second risks: a risk that the timing of recovery in exports and production will be delayed and the transition from domestic demand to external demand will not occur as expected. Since subsidies for environmentally friendly cars have already used a large portion of the budget and growth in reconstruction-related demand is likely to slow down from the second half of fiscal 2012 onward, we need to carefully monitor whether external demand will recover by compensating for a slowdown in domestic demand. In addition, attention should be paid to whether ambitious business fixed investment plans will be steadily implemented and whether the moderate improving trend in employment and income conditions will be maintained. In the meantime, consumer prices (all items less fresh food; on a year-on-year basis) have so far been hovering around 0 percent in 2012. A baseline scenario for the outlook for prices is that the year-on-year rate of change in consumer prices will hover around 0 percent for the time being, and subsequently increase moderately as aggregate supply and demand balance improves. In the forecasts of the majority of the Policy Board members, in terms of the median forecast as of July 2012, the year-on-year rate of increase in consumer prices was projected to be 0.2 percent in fiscal 2012 and 0.7 percent in fiscal 2013. While there are also upside and downside risks to prices, I am paying greater attention to downside risks, given that concern over the economic outlook has been increasing and a decline in commodity prices during the first half of fiscal 2012 will put downward pressure on prices for the time being. Attention should also be paid to the effects of the continued low short-term inflation expectations on future price developments. II. Monetary policy A. Conduct of monetary policy Let me now discuss the Bank’s efforts to enhance monetary easing. The Bank introduced comprehensive monetary easing in October 2010, and has subsequently been enhancing monetary easing. Comprehensive monetary easing comprises three measures: the virtually zero interest rate policy of maintaining the uncollateralized overnight call rate at around 0 to 0.1 percent; purchases of financial assets through the Asset Purchase Program (hereafter the Program); and the clarification of the policy time horizon, that is, the clarification that such measures will remain in place until the Bank judges that price stability is in sight. At the February 2012 Monetary Policy Meeting, to further clarify the Bank’s stance toward overcoming deflation, it introduced “the price stability goal in the medium to long term.” That is an inflation rate the Bank judges as consistent with price stability sustainable in the medium to long term. At present, “the Bank judges “the price stability goal in the medium to BIS central bankers’ speeches 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 at 1 percent for the time being.” On this basis, the Bank will continue pursuing powerful easing until it judges that the 1 percent goal is in sight. The Program was established with the aim of encouraging a decline in longer-term interest rates and various risk premiums mainly through the purchase of financial assets. The Bank established the Program on its balance sheet and has been purchasing various financial assets, such as government securities, commercial paper (CP), corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) as well as conducting the fixed-rate funds-supplying operation against pooled collateral. Since its establishment, the total size of the Program has been increased from time to time. It was expanded further in February and April this year, and at present the Bank is scheduled to increase the outstanding amount of the Program to about 65 trillion yen by around end-2012 and to about 70 trillion yen by around end-June 2013, thereby pursuing powerful monetary easing. In particular, for asset purchases, the total size has expanded from 5 trillion yen at the time of introduction to 45 trillion yen, and the purchase of long-term government bonds has increased substantially from 1.5 trillion yen to 29 trillion yen. At the April Monetary Policy Meeting, the Bank decided to extend the remaining maturity of government bonds and corporate bonds to be purchased under the Program from “one to two years” to “one to three years.” In addition, in July, with the aim of ensuring that the target outstanding amount of the Program is met, the Bank removed the minimum bidding yield (previously 0.1 percent per annum) for outright purchases of treasury discount bills and CP, and revised the composition of the Program. The outstanding amount of the Program as of August 20, 2012 stood at about 58 trillion yen, and a further increase of about 12 trillion yen will be necessary by around end-June 2013. The Bank will continue to steadily increase the outstanding amount of the Program as scheduled. Under such powerful monetary easing, market interest rates have been at extremely low levels. The overnight call rate has been at a level below 0.1 percent, yields of government bonds with remaining maturities up to three years are around 0.1 percent, and yields on 10-year government bonds are at the extremely low level of around 0.8 percent. As for firms’ funding costs, the average contracted interest rates on new bank loans and discounts have declined to about 1 percent and spreads of corporate bonds and CP have been stable at low levels. As a result, financial conditions viewed from the fund-raising side have been accommodative. B. Monetary policy and long-term interest rates In considering the effects of such monetary easing, let me summarize the relationship between monetary policy and long-term interest rates. This is also important for understanding the background of the current historic low levels of long-term interest rates in advanced countries. Let us recall how long-term interest rates are determined. Long-term interest rates are considered to be determined mainly by two factors: first, the forecast of future short-term interest rates, and second, an extra interest rate required for risk associated with long-term bond investment. Regarding the first factor, if the future economic growth rate or the future inflation rate is forecasted to increase, for example, then the future path of short-term interest rates will rise accordingly and one can expect a higher return by investing repeatedly in short-term bonds. As a result, demand for long-term bonds will decline and prices of the bonds will fall and yields will increase. As for the second factor, long-term bond investment is associated with risks. It might become necessary to exchange bonds for cash before maturity is reached, and in such a case there will be uncertainty about the selling price. As compensation for taking such risks, an extra yield – the risk premium or term premium – is required and the long-term interest rate will rise to that extent. BIS central bankers’ speeches Based on such a mechanism, let me summarize the effects of a central bank’s asset purchases, more specifically purchases of long-term government bonds, in two parts. First, there is the effect through the aforementioned risk premium, which focuses on supply and demand in asset markets. This effect is called the “portfolio balance channel.” When a central bank purchases government bonds in the bond market and absorbs the amount of bonds in circulation, the bond price will rise and the yield will decline. In this case, as the price change is due to the supply and demand factor, the risk premium will decrease and long-term interest rates or longer-term interest rates in general will fall. Second, there is the effect through the risk-neutral forecast of future short-term interest rates. If an implementation or announcement of a nontraditional policy action of asset purchases is interpreted as a signal that a central bank’s economic and price forecasts have worsened further, then the forecasted duration of a zero interest rate might lengthen and the future path of short-term interest rates will decline, and longer-term interest rates – mainly in the short- to medium-term zone – will decline accordingly. Or if a central bank’s asset purchases are received as a signal that a central bank’s future policy stance has changed – for example, a central bank takes more aggressive policy responses in the face of developments in economic activity and prices, or there is an adjustment in the policy goal – the forecasted path of short-term interest rates will decline, and longer-term interest rates – mainly in the short- to medium-term zone – will decline accordingly. Both of these effects encourage a decline in longer-term interest rates. What is more important, however, is whether such a decline leads to an improvement in a wider range of financial conditions and, through an increase in spending, eventually stimulates economic activity and prices. If such transmission mechanism is forecasted to work, then it will put upward pressure on long-term interest rates in terms of both effects. Let me elaborate on this point. As one effect of a decline in longer-term interest rates due to government bond purchases, it is expected that confidence will improve among investors, firms, and households, thereby encouraging a shift of investment from government bonds and other safe assets to a wider range of risk assets, such as corporate bonds, equities, and overseas assets, and this in turn will lower risk premiums of these assets and increase asset prices. This can be considered a portfolio balance effect in a broad sense and means an improvement in wide-ranging financial conditions. In such a situation, demand for government bonds will decline and there will be a certain amount of upward pressure on term premiums of government bonds (that is, a rise in the extra interest rate required for risk associated with long-term bond investment). In addition, if spending is forecasted to increase with a longer and variable time lag, thereby stimulating economic activity and prices, it will shift upward the forecast path of short-term interest rates, steepen the yield curve, and put upward pressure on long-term interest rates (that is, a rise in the forecast of future short-term interest rates). While encouraging a decline in longer-term interest rates on one hand and expecting a rise in long-term interest rates in the longer run on the other hand seems contradictory at first glance, in fact it is nothing of the kind. Then, how should we understand the fact that long-term interest rates in advanced countries have been hovering at historic low levels? It seems that a declining trend in these countries’ long-term interest rates involves the effects of powerful monetary easing, including asset purchases. More recently, the trend of risk aversion on the back of concern over a slowdown in the global economy and the European debt problem has been further encouraging a decline in long-term interest rates. Some say that a 1 percent yield on 10-year government bonds in the United States and Europe is quite low, based on a general recognition of the long-term potential growth rate and inflation expectations. In the United States, the level of the target policy interest rate in the longer run is expected to be about 4 percent, according to the economic projections by Federal Open Market Committee (FOMC) members. If such views are correct, this can be interpreted to mean that risk aversion, or a preference for BIS central bankers’ speeches safety, in the government bond markets has been firmly maintained. And this might work as a headwind for what I mentioned earlier, the transmission mechanism of stimulating economic activity and prices through the portfolio balance effect in a broad sense. Naturally, greater attention is warranted as to whether the current sources of concern regarding the slowdown in the global economy and the European debt problem will return to normal or continue to weigh on the global economy and cause further deterioration. C. The need to strengthen growth potential For Japan’s economy to overcome deflation and return to a sustainable growth path, both support from the financial side and efforts to strengthen growth potential are necessary. Thus far, I have discussed support from the financial side. To strengthen growth potential, it is important for every member of society, from his or her standpoint, to make positive efforts steadily to boost growth potential. Such steps will also help increase the stimulative effect of powerful monetary easing on economic activity and prices. Of course, to genuinely strengthen growth potential, a certain period of time is necessary, since such efforts need to occur in concert with other measures, including implementation of economic and fiscal structural reforms. This is obvious even without citing the example of Europe, and if growth potential increases through the simultaneous pursuit of aggressive efforts from the financial side to overcome deflation and economic and fiscal structural reforms, it will lead to favorable effects on the fiscal side, including an increase in tax revenue. In this regard, in July 2012, the government compiled the Comprehensive Strategy for the Rebirth of Japan, which prioritizes key issues. These comprise policy packages such as the “Green Growth Strategy” (aimed at realizing an innovative energy and environment-oriented society), the “Health/Life Science Growth Strategy” (aimed at achieving a society with the world’s leading health and medical care and welfare), and the “Agriculture, Forestry and Fisheries Revitalization Strategy” (which seeks to double the vitality of regions driven by agriculture, forestry and fisheries). The government has presented specific strategies and their timetable. In addition, bills related to the comprehensive reform of the social security and taxation systems passed recently in both the House of Representatives and the House of Councillors, marking an important step forward in maintaining public confidence in medium- to long-term fiscal sustainability. The Bank has also been implementing the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth, and has been supporting financial institutions’ individual initiatives. The measure provides long-term funds for up to four years at a low interest rate – currently 0.1 percent – to financial institutions carrying out lending and investment in growth areas, and was launched in June 2010 with the initial ceiling on the outstanding amount of loans at 3 trillion yen. Subsequently, the Bank introduced a new lending arrangement for the measure, through which it extends loans to financial institutions for their equity investment and asset-based lending (ABL) without conventional collateral or guarantees. This year, the Bank increased the ceiling for the outstanding amount of loans under the main rules for the measure from 3 trillion yen to 3.5 trillion yen, and established special rules for another new lending arrangement for small-lot investments and loans as well as for a new U.S. dollar lending arrangement. The current outstanding balance of the total loans disbursed by the Bank, including those extended under the special rules, is approximately 3.3 trillion yen. The Bank will continue to do its utmost to contribute to strengthening the foundations for economic growth. I have now discussed recent monetary policy in Japan. In the actual conduct of monetary policy, the outlook for economic activity and prices should be carefully examined and, if judged necessary, meticulous and decisive measures should be taken. The Bank will continue to steadily pursue powerful monetary easing by increasing the outstanding amount of the Asset Purchase Program as scheduled. The Bank will strive to conduct proper BIS central bankers’ speeches monetary policy, and closely monitor developments in international financial markets and do its utmost to ensure the stability of the financial system in Japan. Concluding remarks: The economy of Yamaguchi Prefecture My conclusion will touch on the economy of Yamaguchi Prefecture. In my view, the economy of Yamaguchi Prefecture enjoys a number of competitive advantages. The first is its location, since it is close to other East Asian countries where demand has been expanding markedly. Second, it enjoys a concentration of basic materials industries with growth potential – mainly the chemical industry, which accounts for more than 40 percent of the industrial production index. And third, the prefecture has the nation’s highest labor productivity, mainly in basic materials industries. Recently the region has experienced a series of negative events, such as accidents at the plants of major chemical manufacturers, together with the withdrawal and closure of factories of several electronics components manufacturers. On the positive side, however, amid concern over the hollowing out of domestic industries due partly to the appreciation of the yen at the national level, firms in the prefecture as a whole – comprising mainly manufacturers – have maintained their vigorous investment stance. In fact, the Bank’s Shimonoseki Branch’s Tankan (Short-Term Economic Survey of Enterprises in Japan), released on July 2, showed that the business fixed investment plan of Yamaguchi Prefecture’s firms for fiscal 2012 was likely to maintain a substantially higher growth rate than that of Japan as a whole. The prefecture recorded a year-on-year growth rate of 12.4 percent, compared with Japan’s a year-on-year growth rate of 4.0 percent. In fiscal 2011, the business fixed investment plan of the prefecture’s firms also exceeded that of Japan. As specific examples of this, in fields related to chemicals, next-generation energy, and medical care, there have been moves among local firms to pursue overseas expansion in existing fields with potential for an increase in global demand in the medium to long term, and some local firms are actively conducting additional investment to increase capacity or research and development in high-value-added areas with potential for growth. For example, in connection with the growing need for energy conservation by firms and households, small and medium-sized construction firms have entered the geothermal air-conditioning business. An increasing number of firms have been making such moves. I expect that local firms, by utilizing their characteristics and strengths, will proceed with reforms to nurture new areas with potential for growth, achieving further development. In addition, Yamaguchi Prefecture enjoys extremely bountiful resources for tourism, with numerous attractive sightseeing areas as well as scenic spots and historic sites, and many excellent structures, including the historic Kintai Bridge, which harmonizes beautifully with its surrounding natural landscape. Efforts are proceeding to draw on these ample resources for tourism, mainly by the prefectural government and cities, and thereby promote the tourism industry. I expect that by coordinating its regional characteristics and strengths, the tourism industry will generate further momentum. BIS central bankers’ speeches
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Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, given at the Bank of Finland, Helsinki, at the Sveriges Riksbank and at the Stockholm University, Stockholm, 3-7 September 2012.
Sayuri Shirai: Have demographic changes affected Japan’s macroeconomic performance? Some implications for monetary policy Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, given at the Bank of Finland, Helsinki, at the Sveriges Riksbank and at the Stockholm University, Stockholm, 3–7 September 2012. * I. * * Introduction Hello everyone. My name is Sayuri Shirai, and I am a Policy Board member of the Bank of Japan. I am delighted to be giving a talk today on the theme of demographic changes and their impact on macroeconomic performance with some implications for monetary policy. I feel that it is important to be addressing you and exchange views with you about this issue here in Europe, especially in the Nordic countries, for two main reasons. First, after having undergone a process of rapid industrialization, many European countries encountered a rapid decline in their fertility rates, beginning in the second half of the nineteenth century. This promoted active debate on population-related issues in Europe, including those related to neo-Malthusianism and the conservative view of encouraging both a traditional family style and childbirth. By the 1930s, Sweden was faced with the lowest fertility rate in Europe. The Swedish Nobel Laureate Karl Gunnar Myrdal was concerned about the consequence of this declining rate – namely, an eventual decrease in the total population and its medium- to long-term impact on macroeconomic performance, such as a decline in investment and living standards, a rise in unemployment, and the prevalence of poverty. In his influential book Crisis in the Population Question (Kris i Befolkningsfrågan) which he published together with his wife Alva Myrdal in 1934, and in a number of other associated papers, he stressed the importance of social policies to reverse the declining trend in the fertility rate and promoted the concept of socialization of consumption related to childbirth and childcare, while respecting women’s choices in this matter. These policies included free services to all child-bearing households, and would be financed by a progressive income tax system. This idea of using social policies to mitigate any negative externalities caused by depopulation contributed to the creation of the contemporary Swedish welfare model. Today, the Nordic countries, including Sweden and Finland, are famed for their distinguished universal, comprehensive social welfare systems, which have generated some successful outcomes, such as the maintenance of reasonably high total fertility rates (TFRs),1 high levels of human capital, and high labor participation ratios for women. Second, the 2012 Ageing Report published by the European Commission provides long-term macroeconomic and budgetary projections for the period of 2010-60, and it stresses the challenges posed by population ageing. Assuming that the TFR in the European Union (EU) will moderately increase from the current rate of 1.59 to 1.64 by 2030 and further to 1.71 by 2060, and assuming that net migration inflows as a percentage of the total population remain at about 0.2 percent throughout the 2010-60 period, the report projects that the total population will decline only after 2040. However, the size of the working-age population (aged 15 to 64 years old) is projected to decline after 2012. The simple fact is that both Japan and Europe are facing a common structural issue – population ageing. Japan is taking the lead with demographic and associated macroeconomic issues. It is widely known that Japan has already witnessed a reduction in its The TFR refers to the number of children that would be born to a woman if she were to live to the end of her child-bearing years and bear children in accordance with current age-specific fertility rates. BIS central bankers’ speeches working-age population in absolute numbers since the mid-1990s. About a decade after this time, the total population declined in 2005 and 2009, and it is projected to decrease constantly from 2011 onward. As a result, Japan has become the most progressed ageing society: the share of the population aged 65 and over was 23 percent in 2010 – the highest level in the world. The rapid pace of decreases in the growth rate of the working-age population and total population appears to be unprecedented globally. This has certainly generated various unfavorable impacts on Japan’s macroeconomic performance, thereby also affecting the environment related to monetary policy management. Given that Japan and Europe face similar phenomena (i.e., increases in life expectancy and the relative size of their elderly populations), it is necessary to deepen our understanding of the impact of demographic changes on macroeconomic performance and possibly also about the environment surrounding monetary policy management. However, these issues are not yet being actively debated among central banks around the world. Let me outline the sequence of my presentation. It comprises four sections. In Part II, I will briefly examine demographic changes in Japan in the post-1945 period. Part III will focus on the impacts of these changes on macroeconomic performance. Then, the issues of the longstanding output gap and mild deflation, which are partially influenced by demographic changes, will be discussed in Part IV together with monetary policy management. In Part V, I will present concluding remarks. II. Demographic changes in the post-1945 period I would like to begin my presentation by making an overview of Japan’s demographic changes in the post-1945 period. Rapidly reduced fertility rate and working-age population In the aftermath of World War II, Japan enjoyed a period of so-called “population dividend,” which helped produce higher economic growth. This refers to a period when the total dependency ratio (defined as the youth and elderly population over the working-age population) decreases drastically with a decline in the number of children. In Japan, the total population rose rapidly in the second half of the 1940s with the first postwar baby boom in 1947–49; this was followed by the second-generation baby boom in 1971–74 (Chart 1). This trend helped Japan become one of the most populous nations globally – with a total population of 128 million in 2011, or the 10th-largest country by population size as of 2010. Starting with a very high TFR at around 4 in the late 1940s, the TFR dropped to around 2 – a rate much lower than before but still close to the replacement rate (the rate enabling natural population growth) – by 1958. Thereafter, the TFR remained at a still high level of 2 or above (Chart 2). During that period, Japan enjoyed a growing working-age population. Since then, the situation has changed dramatically. First, the number of childbirths started to show a constant decline after the second-generation baby boom in the 1970s. In parallel, the TFR began to decrease sharply from over 2 in the 1970s to 1.39 in 2011 – notwithstanding that a moderate recovery in the TFR is currently in progress. The declining trend could be attributed to such factors as rising income, a growing focus on work and education among women, the rising cost of child care and education, the decreasing size of families, and a growing number of unmarried people (resulting in a smaller number of children given that few unmarried couples in Japan have children). Second, about 20 years after the decline in the TFR, a decrease in the working-age population occurred. The size of the working-age population started showing a clear decrease from the mid-1990s. According to official projections, the total population will decline from the current level of 127.8 million to 120 million by 2026, to under 100 million by 2048, and further to 86.7 million by 2060. The working-age population is projected to decrease more drastically – from the current level of 81.3 million to 44.2 million by 2060. BIS central bankers’ speeches Emergence of the most progressed ageing society One of the most structurally important challenges for Japan is dealing with the progressive ageing of the population. The pace of ageing accelerated as life expectancy at birth increased rapidly from 50.1 years in 1947 to 79.6 years in 2010 for men, and from 54.0 years to 86.4 years, respectively, for women. This has put Japan among the nations with the highest longevity in the world (Chart 3). This could be the consequence of such factors as medical advancements, higher living standards, universal public health insurance, and elderly care systems. As a result, the ratio of the population aged 65 and over to the total population rose steadily from just 4.8 percent in 1947 to about 23 percent in 2010. This percentage is the highest in the world, being followed by that of Germany (20.6 percent) and Italy (20.3 percent). The pace of increase in the elderly ratio accelerated after the 2000s. Reflecting expected increases in life expectancy over the period of 2010–60 (from 79.6 to 84.2 years for men; from 86.4 to 90.9 years for women), the proportion of the elderly population is officially projected to grow further to 25 percent in 2013. Thus, elderly people will comprise one-fourth of the total population. According to projections, this proportion will reach 33.4 percent by 2035, giving rise to a society in which one in three people will be elderly. This ratio is projected to rise to about 40 percent by 2050. By this time, the population aged 75 years and older will account for a quarter of the total population. III. Demographic changes and macroeconomic performance Having outlined trends in Japan’s demographic changes, I would now like to move to Part III of this presentation and show some impacts of demographic changes on the Japanese macro-economy. Though a large number of studies have investigated the supply side (i.e., the impact on potential economic growth), shedding light on the demand side is equally important. Impact of demographic changes on economic growth Japan achieved high real GDP growth of 10.4 percent in the 1960s, which enabled it to catch up with a number of advanced countries. This period was followed by moderately highgrowth rates of 5 percent in the 1970s and then 4.3 percent in the 1980s. Following the collapse of bubbles in real estate and stock prices in the early 1990s, however, Japan entered a prolonged period of low economic growth. Real GDP growth rates dropped to 1.5 percent in the 1990s and further to 0.6 percent in the 2000s (Chart 4 [1]). First, the impact of population developments on economic growth can be observed by decomposing the real GDP growth rate into (a) the population growth rate and (b) the per capita real GDP growth rate. Chart 4 (2) shows that population growth made a positive contribution until the 1990s, even though the scale of that contribution dropped in the 1980s and 1990s. The positive contribution virtually disappeared in the 2000s. Second, the impact of population ageing on economic growth can be traced by decomposing the real GDP growth rate into (c) the growth rate of the number of employed workers (or the growth rate of employment) and (d) the real GDP growth rate per employed worker. Population ageing tends to reduce both the size of the working-age population and the labor participation rate for the whole economy, thereby reducing total employment. Chart 4 indicates that the contribution of employment to economic growth turned from positive to negative in the 2000s. Third, the labor market has transformed drastically over the same period, and this has contributed to a decline in the total number of working hours. The number of part-time and non-regular workers has increased relative to that of regular workers, reflecting the increasing rate of female labor participation. In addition, the number of hours worked per regular worker has decreased in accordance with global trends and the growing sophistication of society. Although these developments have no direct links with BIS central bankers’ speeches demographic changes, the increasing number of female and elderly workers is likely to reduce the total hours worked for the whole economy. Thus, it may be useful to examine the impact of working hours on economic growth. This can be achieved by decomposing the real GDP growth rate into (e) the growth rate of hours worked and (f) the real GDP growth rate per hour (or the growth rate of labor productivity per hour). Chart 4 (4) reveals that a decrease in hours worked after the 1990s contributed negatively to economic growth. Charts 4 (2)–(4) indicate that both demographic and labor market changes have contributed directly to a declining trend in economic growth (these changes are referred to as the population effect, the labor force effect, and working hour effect). At the same time, the per capita, per worker, and per hour growth effects shown in the same charts all revealed declining trends over the same period. The per capita real GDP growth rate is a good proxy for measuring the average living standard of a country. The growth rate per employed worker is a useful indicator related to labor productivity or supply capacity. The growth rate per hour is valuable when one wants to see the impact of changes in hours worked. In the future, this hourly based indicator may become even more important in measuring a country’s efficiency; this is because further efforts to raise the labor participation rates for women and elderly people – in addition to a decline in the absolute number of full-time workers – are expected to reduce the total number of hours worked in the whole economy. Generally speaking, the per capita GDP growth rate tends to become lower than the real GDP growth per employed worker when the working-age population declines or the population ages. In any case, the overall declining trends based on the three indicators could be explained by (a) a decline in the TFP growth rate (which could be explained by, for example, a completion of the catching-up process and a shift in the industrial structure as will be described later) and (b) a decrease in the growth rate of capital stock. Nonetheless, it is important to note that Japan’s real GDP growth rate per hour has been comparable to those of the United States and the United Kingdom, and it has been higher than those of Germany and France (Chart 5). At the same time, this implies that Japan needs to raise the per hour growth rate to a level far higher than those of other advanced countries just to maintain the same per capita economic growth rates. Impact of demographic changes on fixed asset investment demand The declining working-age population and ageing population may contribute to sluggish demand for residential housing and fixed-asset investment. In this regard, Dr. Myrdal already thought through the impact of these factors in his 1940 book Population: A Problem for Democracy. According to him, a decrease in the population is expected to produce a negative impact on (aggregate) demand, particularly investment (Fujita [2010]). The growth rates of demand are projected to decline mainly because of (a) an increase in investmentrelated risk (or the heightened possibility of causing over-supply and associated loss) for firms as well as (b) a decrease in investment incentive (for example, a decline in new residential investment owing to a reduction in the working-age population and a drop in replacement demand due to falling housing prices). The impact of demographic changes on housing investment was also pointed out by Bakshi and Chen (1994). According to their life-cycle investment hypothesis, investors in their 20s and 30s enter the family-building stage, and so housing becomes a desirable investment. During this period, a higher portion of their wealth is allocated to housing and other durable goods. As investors grow older, the demand for housing will stabilize or decrease; instead, the demand for financial assets will rise. This hypothesis was demonstrated to be applicable to the United States, and it implies that an ageing population is associated with declining housing prices. Mankiw and Weil (1989) also showed that the baby-boom generation contributed to the U.S. housing boom in the 1970s. I believe that some of the impacts discussed by Dr. Myrdal and other researchers are already being felt in Japan. During the bubble period in the second half of the 1980s, for example, the growing size of the working-age population stimulated residential investment demand. BIS central bankers’ speeches Chart 6 shows a clear positive correlation between the (inverse) total dependency ratio and real land price level. This real demand, fueled by speculative investment activities, contributed to higher real estate prices and a credit boom. The number of housing starts has since dropped constantly, partly because of a decrease in the working-age population – the generation that builds families. Moreover, Japanese firms increasingly focus on outward foreign direct investment (FDI), and they especially target emerging economies, where the returns on investment are generally higher than in Japan and other advanced countries (Chart 7). Firms continue to invest domestically but not to a great extent, as evidenced by the declining trend of new business fixed investment as a percent of GDP (and cash flow) (Chart 8). In line with this, the main investment incentives for companies are concentrated on upgrading, earthquake-proof strengthening, and energy saving or clean-energy production – rather than bolstering their production capacity. One plausible consequence of reduced investment demand is weak demand for credit by firms and households, as pointed out later. For example, even though the fund-raising conditions of firms and households have generally been favorable, the loan officer opinion survey on bank lending practices consistently reports weak diffusion indices (DIs) of demand for loans by both firms and households. This result is consistent with the low loans-todeposits ratios – amounting to only around 70 percent in Japan, which is far below the 200 percent of Sweden and over 150 percent of Finland. And yet the banking sector in Japan still faces an increase in deposits; thus, the issue of how to raise profitability out of ample liquidity is becoming one of the main challenges for this sector. In recent years, the banking sector has increasingly allocated funds toward Japanese government bonds (JGBs) and overseas lending, which reflects the deteriorating fiscal position of the government and the higher potential economic growth in emerging economies. Impact of demographic changes on consumption demand and employment Population ageing may induce a demand shift from manufacturing (and other traditional areas) to nonmanufacturing sectors. This is because the elderly population tends to demand more services (such as medical and nursing care, tourism, and social services) and fewer durable goods (such as cars and home electronics). Given that households whose heads are 60 years and older already account for over 40 percent of total consumption, this shift in preference by ageing is gradually affecting the structure of private sector consumption in Japan, and it is predicted that there will be further expansion of the service-related industry in the near future (Chart 9). A number of studies have identified the possible impact of demographic changes on the demand structure in Canada, Germany, and the United Kingdom (Börsch-Supan [2003]; Fougère et al. [2007]; Lührmann [2008]; and Rausch [2009]). Naturally, this change in the demand structure has also brought about a shift in the employment structure – a growing proportion of workers in the nonmanufacturing sector and a reduced proportion of workers in the manufacturing sector and other traditional areas. At the same time, a shift in the demand structure may result in an increase in structural unemployment unless a smooth relocation of labor resources from manufacturing to nonmanufacturing sectors takes place. Katagiri (2012) points out that a rise in structural unemployment in the 1990s – and the subsequent sustained high level – could be associated with various labor market frictions, triggered by a shift in the population ageing-induced demand structure. Impact of demographic changes on labor productivity I have already noted that the growing demand for services brings in a greater number of workers engaged in the nonmanufacturing sector. However, this may lower the level of labor productivity for the whole economy. This reflects the fact that, as in Japan (Chart 10), the level of labor productivity per employed worker tends to be lower in the nonmanufacturing BIS central bankers’ speeches than in the manufacturing sector. This is mainly due to the nonmanufacturing sector being more labor-intensive and more regulated while having limited opportunity for exercising economies of scale. Of course, it is possible to raise labor productivity in the nonmanufacturing sector in such ways as intensifying the use of information and communication technology (ICT), improving the quality of services, offering innovative services that stimulate potential demand, and promoting competition through deregulation. However, the fact that the nonmanufacturing sector tends to produce lower labor productivity than the manufacturing sector is a globally observed phenomenon. A low level of labor productivity and sluggish growth could be referred to as the Baumol effect, which focuses on limited growth in productivity in certain nonmanufacturing sectors (public services, such as public hospitals and public colleges). Thus, population ageing may affect economic growth not only directly through a reduction in the working-age population and employment (as indicated by the labor force effect in Chart 4 [3]), but also indirectly through a constant decline in labor productivity caused by a continuous demand shift – as illustrated by the per worker growth effect in the same chart. Katagiri (2012) demonstrated that the decrease in labor productivity, together with a rise in the structural unemployment rate, contributed to the lowering of Japan’s real GDP level. As for the future, the ratio of nonmanufacturing to manufacturing workers (and the ratio of value added in the nonmanufacturing sector to GDP) is projected to rise constantly; thus, the downward pressures on labor productivity may be further enhanced (Sakura et al. [2012]). Possible impact of demographic changes on the financial asset structure According to the previously mentioned life-cycle investment hypothesis of Bakshi and Chen (1994), investors gradually shift from housing investment to financial investment for retirement as they get older. These authors showed that when people of the baby-boom generation reached the stage where they changed their asset composition from housing investment to financial asset investment, they helped raise stock prices in the 1980s and 1990s in the United States. At the same time, Bakshi and Chen demonstrated that population ageing tends to raise the market risk premium. This is not only because elderly people are unwilling to take on a lot of financial risk since they have fewer opportunities to use their labor income to cover potential losses, but also because uncertainty related to their remaining lifetime discourages them from accepting such risk. This suggests that population ageing may raise investors’ preference toward cash, deposits, and bonds when they are close to or already at retirement age. These demographic movements possibly bring about fluctuations in asset demand on capital markets. Currently, the size of households’ total financial assets in Japan amounts to about 1,500 trillion yen (19 trillion U.S. dollars) – the second largest total in the world after the United States. Despite nearly zero-interest rates, the share of deposits (and cash) accounts for about half of total assets. In general, young households start to accumulate financial assets in the form of deposits. As they become older, they may gradually shift their financial asset allocation toward life insurance and securities (setting aside housing investment). As they become much older, households with extra financial resources may increase their share of relatively safe assets, such as deposits and bonds (for example, JGBs). This makes sense since elderly people are more concerned about the stability of the valuation of their financial assets and thus tend to be more risk-averse than younger people. Regarding stock investment, elderly households hold much larger assets than any other generation, and so they may allocate part of their assets to stock holdings while keeping the ratio of stock holdings at a reasonably contained level. However, if the future elderly generation has readier adaptability to ICT, greater use of online securities trading may promote the investment demand for stocks. BIS central bankers’ speeches Impact of demographic changes on fiscal balance A natural impact of Japan’s demographic changes is deterioration in fiscal balance. It is clear that the rapid pace of population ageing in Japan, especially since the 2000s, has been the single driving force behind growing social security-related expenditure (i.e., public pension benefits, elderly care, and medical services) (Chart 11). Meanwhile, population ageing, together with sluggish economic performance, has contributed to low growth in tax revenues. Population ageing tends to reduce not only the income tax base, but also tax income as a result of the downward pressure on economic growth, while raising government expenditure through increased social security costs. It is expected that population ageing will raise the cost of the social security system while reducing the amount of insurance premium contributions paid by the working-age population. This will increase the burden on fiscal balance, which suggests the need for some kind of reform in the future. IV. Demographic changes, the output gap, and mild deflation My broad view regarding the impact of population ageing on macroeconomic performance is summarized in Chart 12. Based on this, I would now like to focus on the issues related to the output gap and mild deflation, which will be followed by a brief description of monetary policy conduct. Presence of the long-standing output gap Japan’s output gaps have remained negative for almost the entire period since the mid1990s, although the magnitude varies depending on the methods employed to assess them (Chart 13). Some argue that the output gap has deteriorated following a series of domestic and external shocks, such as the collapse of the asset bubbles in the early 1990s, the Japanese financial crisis and East Asian currency crises in the second half of the 1990s, the collapse of the IT bubble in the early 2000s in the United States, the global financial crisis of 2008, the European sovereign debt crisis since 2010, and the Great East Japan Earthquake of 2011. Looking at this issue from a more academic standpoint, there appears to be consensus among researchers regarding the presence of a long-lasting output gap in Japan. By contrast, little consensus has emerged as to which factors contributed to the phenomenon. When we plot the relationship between demographic data (e.g., growth rate of the workingage population) and the output gap, we usually do not see a strong direct correlation. This may reflect the fact that the impact on the output gap may be felt indirectly through various complex channels. For example, a number of researchers point out three main factors as having contributed to the negative output gap: (1) a decline in the natural rate of interest and a resultant interest rate gap caused by the zero lower bound on the nominal interest rate; (2) a decrease in economic growth expectations caused by a reduction in potential economic growth; (3) banks’ risk-averse lending behavior. Of course, these factors are not necessarily mutually exclusive. Regarding factor (1), it is possible that population ageing may result in a decrease in the natural rate of interest through various channels – for example, a decline in demand for loanable funds by firms and households, while a lower expected permanent income induces households to accumulate more savings (Ikeda and Saito [2012]). And when the natural rate of interest falls below the actual real interest rate (namely, an interest rate gap emerges), the monetary condition becomes relatively tight and contributes to deterioration of the output gap. Since the natural rate of interest is non-observable, researchers often use (per capita) potential GDP growth as a proxy for the natural rate of interest. Various estimates point to a decline in the potential growth rate over the period of 1985–2011, but none of them show a constantly negative potential growth rate except for a brief interval caused by the 2008 global financial crisis, for example, as shown in Chart 14 (Watanabe [2012]). Therefore, it is not certain whether the natural rate of interest has turned negative on a permanent basis. In BIS central bankers’ speeches addition, Saito et al. (2012) indicated that the effects of the zero lower bound of the nominal interest rate are rather small (based on the dynamic stochastic general equilibrium [DSGE] models, where the estimated monetary policy shocks are assumed to capture the effects of the zero bound). Thus, whether factor (1) provides a convincing reason for the presence of the long-standing output gap remains debatable. As for factor (2), the declining trend in potential GDP growth, which partially reflects population ageing, may worsen the output gap through a long-term reduction in growth expectations (Chart 15). Provided that growth expectations affect both the supply and demand sides, there could be cases where an adverse impact on demand may be stronger than one on supply – for example, in the case of a permanent negative shock on productivity (Saito et al. [2010]). Another example is the case of a slow adjustment of the supply side in response to a demand shift caused by population ageing, as suggested in Part II. This process may exacerbate the output gap in the existing (manufacturing) sector. The services sector is unable to fully exploit the potential demand for services targeting the elderly population owing to inadequate supply of innovative and potentially highly demanded services by firms. The lower potential growth and resultant decline in growth expectations could provide a reasonable explanation for the presence of the negative output gap. On this matter, I would like to mention the view of Dr. Myrdal, as described in his previously mentioned 1940 book. Although he did not appear to have considered the concept of expectations, I was pleasantly surprised to find that he had already thought through the impact of demographic changes on both the supply and demand sides. According to him, a reduction in the population caused by declining fertility rate would be expected to provide a negative impact on the demand side much earlier than on the supply side. This is because (1) the negative impact on supply capacity could be temporarily offset by technological progress and (2) the impact of the decreased fertility rate on supply capacity will cause a decline in the working-age population with a time lag of about 15–20 years. Factor (3) sheds light on banks’ lending behavior, which could be affected by such factors as tighter financial regulation and the value-at-risk constraint. Those constraints may induce banks to prefer investment in JGBs or other bonds rather than financing the private sector, thereby worsening the output gap (Aoki and Saito [2012]). I am not sure how important this impact is in reality since the DIs of lending attitudes of financial institutions have been very accommodating for large firms and neutral for small and medium-sized enterprises. Moreover, there is a view that the depressed collateral value may have affected the behavior of the banking sector. The collapse of the real estate price bubble in the early 1990s together with population ageing may have resulted in a permanent decline in the collateral value, thereby reducing banks’ incentives to lend. Based on a balance sheet analysis, it has been pointed out that newly established firms tend to possess a limited amount of real estate while holding a relatively large amount of receivables and movable properties. Thus, for new firms, the constraints they face could likely be mitigated if a new lending method or asset-based lending (ABL) were promoted. This would involve a financial institution taking receivables and movable properties that were closely tied to the firm’s business cash flow (e.g., accounts receivable and goods in stock) as collateral for a loan. On this issue, the Bank of Japan has been providing funds to financial institutions that undertake ABL in order to promote lending without depending on real estate as collateral, as will be pointed out later. Presence of mild deflation Japan has been facing mild deflation over almost the entire period since the second half of the 1990s (Chart 16). Though the issues related to a flattening of the Phillips curve in Japan and other advanced countries are hotly debated, I will not address this matter today. Rather, I would like to state that a clear positive correlation between inflation and the output gap prevails in Japan. Meanwhile, little correlation has been observed between inflation and money, which suggests that money velocity is not very stable (Nishizaki et al. [2012]). BIS central bankers’ speeches A number of factors have contributed to the mild deflation. One is the presence of the longstanding negative output gap, which could be partially affected by demographic changes, as already described. The other is a long-term decline in inflation expectations. Since various measures indicate a clear trend, there is growing consensus among Japanese researchers with respect to the long-term decrease in inflation expectations over the period of 1990–2011 (Chart 17). Some argue that this could be related to the Bank of Japan’s monetary policy, such as weak inflation forecasts damping inflation expectations. However, I feel that inflation expectations have been affected more strongly by structural factors, including demographic changes. For example, the rapid pace of population ageing and stagnant productivity growth (which contributed to lower actual and potential economic growth) could possibly dampen economic growth expectations of firms and households. This is because firms expect a shrinkage of the markets for goods and services, and households expect lower permanent income growth in the future. Sluggish economic growth expectations may induce an immediate impact on the demand side through weaker investment plans by firms and reduced consumption (and increased savings) by households. This may lead to a long-term decrease in inflation expectations, thus providing downward pressure on the actual rate of price change. In other words, firms that expect lower demand for their products and services and anticipate lower prices demanded by households are likely to set their prices conservatively. A number of surveys have reported that firms tend to anticipate a decrease in their sales prices even though their input prices are expected to rise, which suggests that the degree of passing on the input cost to the final sales prices is limited. Based on data from many countries, the Cabinet Office (2011) in Japan has reported a positive correlation between inflation expectations and the expected ratio of the working-age population – in addition to a positive correlation between economic growth expectations and the expected ratio of the working-age population. These observations seem to be consistent with my own understanding. Conduct of monetary policy Given this background, the Bank of Japan is naturally concerned about the long-term prevalence of mild deflation. To help the economy overcome this deflation, so-called Comprehensive Monetary Easing has been implemented since 2010 and the Asset Purchase Program (hereafter, Program) has been established.2 Subsequently, monetary easing has gradually been enhanced through expansion of the program. In February 2012, the Bank introduced its “price stability goal in the medium to long term” to promote public understanding of the Bank’s determination to overcome deflation. It was decided to set the goal within a positive range of 2 percent or lower in terms of the year-on-year rate of change in the consumer price index (CPI), and the goal for the time being was set at 1 percent. Moreover, the Bank made it clear that it would continue the monetary easing policy – the virtually zero-interest rate policy and continued implementation of the program – until it judged the 1 percent goal to be within 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 increased from about 55 trillion to about 65 trillion yen in the same month; it was further lifted to 70 trillion yen this April (Chart 18). The comprehensive monetary easing policy consists of (1) the virtually zero interest rate policy, (2) setting the policy time horizon based on the “understanding of medium- to long-term price stability” (commitment policy), and (3) establishment of the Asset Purchase Program. Of these, item (2) was modified to “the price stability goal in the medium to long term,” as indicated above. BIS central bankers’ speeches Tackling the long-term structural challenge Next, I would like to address an issue commonly faced by a number of major central banks in advanced countries and regions. Namely, the extremely accommodative monetary environment has not led to as much increased domestic demand, such as investment and consumption, as had been expected (Chart 19). Though there are structural factors related to this issue, the root causes are country- or region-specific, and thus they differ from one another. In the case of Europe, the short-term depressing impact of the fiscal austerity measures and deleveraging of the banking sector make it difficult to increase bank lending. In the case of Japan, the ageing population, as discussed throughout this presentation, has contributed to the long-term declining trend in economic growth and mild deflation. To overcome mild deflation, we need to raise economic growth expectations by enhancing productivity growth of the working-age population while increasing the labor participation rates for women and elderly people. However, it may be said that implementation of the necessary structural reforms for boosting growth and productivity has been sluggish – as evident in charts 4 [1]–[4] – and the shift in the economic and industrial structure has been limited. Issues related to mounting government debt and social security reforms have also generated uncertainty over the future economic outlook. Moreover, a series of recent negative shocks, such as the global financial crisis, the European sovereign debt crisis, and the Great East Japan Earthquake, have also worsened this outlook. Despite a very accommodative financial environment driven by monetary stimulus measures, these factors have combined to deter expectations of further rises in growth by firms and households. To meet the diverse challenges 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. By promoting longer-term economic growth, moreover, the Bank of Japan has been helping to sustain the business community indirectly. It introduced a fund-provisioning measure to help reinforce the basis for economic growth (the so-called Growth-Supporting Funding Facility) in 2010, and it has provided longer-term fixed-rate funds to financial institutions.3 This facility was expanded in March and April of this year (Chart 20). I believe that it is important to stress that the goal of overcoming deflation can be achieved through such continuous, comprehensive efforts by firms, financial institutions, the government, and the Bank operating within their respective roles. V. Concluding remarks After having suffered from declining fertility rates since the second half of the nineteenth century, European countries, especially the Nordic countries, dealt with population ageing issues promptly and acquired considerable know-how and expertise in the process. As a result, European countries enjoy more favorable outcomes and currently manage to maintain higher TFRs than Japan: as of 2010, 1.9 each in Finland and Sweden, and 1.6 in the EU. Since June 2010, the Bank of Japan has provided 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. The 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 June 2011, this program was extended by providing funds to financial institutions that undertake equity investments and offer ABL. In April this year, a U.S. dollar lending arrangement was also introduced under this framework. BIS central bankers’ speeches Nonetheless, the rate remains below the replacement rate – the rate that ensures a national population gain. Furthermore, European life expectancy at birth is approaching that of Japan: as of 2010, it is 77 years in Finland, 79 years in Sweden, and 77 years in the EU for men; it is 83 years in Finland and Sweden and 82 years in the EU for women. Thus, Finland, Sweden, and other EU member states are all projected to face a decline in the working-age population ratio after 2012. In Europe, therefore, population ageing and the declining working-age population are becoming important structural issues, as the 2012 Ageing Report, compiled by the European Commission, warned. Finally, I would like to emphasize that the impact of demographic changes on macroeconomic performance is a newly emerging issue in the contemporary world. Few research studies have been carried out on the impact of population ageing and depopulation. Since Japan is taking the lead in these demographic changes and there is a possible strong linkage with the monetary policy environment, the Bank of Japan is doing its best to deepen the understanding of this topic. Given our experiences, I strongly believe that we Japanese and Europeans can learn from each other, and this could possibly lead to advances in academic research in the near future. Thank you very much indeed for your kind attention. BIS central bankers’ speeches Charts 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 References Aoki, Kosuke and Nao Sudo, “Asset Portfolio Choice of Banks and Inflation Dynamics,” paper presented at the conference on “Price Developments in Japan and Their Backgrounds: Experiences Since the 1990s,” Bank of Japan, 2011. Bakshi, Gurdip S. and Zhiwu Chen, “Baby Boom, Population Ageing, and Capital Markets,” Journal of Business, 67 (2), 1994, pp. 165–202. Börsch-Supan, Axel, “Labor Market Effects of Population Ageing,” Review of Labor Economics and Industrial Relations, 17, 2003, pp. 5–44. Cabinet Office (Japan), Annual Report on the Japanese Economy and Public Finance 2011: Enhance the Essential Power of the Japanese Economy, 2011. European Commission and Economic Policy Committee, The 2012 Ageing Report: Economic and Budgetary Projections for the 27 EU Member States (2010–2060), European Economy 2, 2012. Fougère, Maxime, Jean Mercenier, and Marcel Mérette, “A Sectoral and Occupational Analysis of Population Ageing in Canada using a Dynamic CGE Overlapping Generations Model,” Economic Modelling, 24 (4), 2007, pp. 690–711. Fujiki, Hiroshi, Naohisa Hirakata, and Etsuro Shioji, “Ageing and Household Stockholdings: Evidence from Japanese Household Survey Data,” Paper submitted to the 2012 BOJ-IMES Conference, Bank of Japan, 2012. Fujita, Nanako, Myurudaru no Keizaigaku (Myrdal’s Economics), NTT Publishing Co., Ltd., 2010. Ikeda, Daisuke, and Masashi Saito, “The Effects of Demographic Changes on the Real Interest Rate in Japan,” Bank of Japan Working Paper Series, No. 12-E-3, 2012. Katagiri, Mitsuru, “Economic Consequences of Population Aging in Japan: Effects through Changes in Demand Structure,” IMES Discussion Paper Series, No. 2012-E-3, Bank of Japan, 2012. Nishizaki, Kenji, Toshitaka Sekine, and Youichi Ueno, “Chronic Deflation in Japan,” Bank of Japan Working Paper Series, No. 12-E-6, 2012. Lührmann, Melanie, “Effects of Population Ageing on Aggregated UK Consumer Demand,” mimeo., 2008. Mankiw, N. Gregory and David N. Weil, “The Baby Boom, The Baby Bust, and the Housing Market,” Regional Science and Urban Economies, 19, 1989, pp. 235–258. Nishimura, Kiyohiko G., “How to Detect and Respond to Property Bubbles: Challenges for Policy-Makers,” Remarks at the 2012 Reserve Bank of Australia-BIS Research Conference, Bank of Japan, 2012. Saito, Masashi, Takuji Fueki, Ichiro Fukunaga, and Shunichi Yoneyama, “Nihon no Kozo Mondai to Bukka Hendou (Structural Problems and Price Dynamics in Japan),” Paper presented at the conference on “Price Developments in Japan and Their Backgrounds: Experiences Since the 1990s,” Bank of Japan, 2011. Sakura, Kenichi, Saori Naganuma, Kenji Nishizaki, Naoko Hara, and Ryuhei Yamamoto, “Nihon no Jinkodotai to Chuchokitekina Seichoryoku (Demographic Changes and Medium- to LongTerm Growth Rates in Japan),” Bank of Japan Reports and Research Papers, August 2012. Rausch, Sebastian, Macroeconomic Consequences of Demographic Change, Springer, 2009. Shirakawa, Masaaki, “Demographic Changes and Macroeconomic Performance: Japanese Experiences,” Opening remark at the 2012 BOJ-IMES Conference, Bank of Japan, 2012. Watanabe, Tsutomu, “Zero Kinri no Moto no Choki Defure (Long-Lasing Deflation Under the Zero Interest Rate Environment),” Bank of Japan Working Paper Series, No. 12-J-3, 2012. Williams, John C., “Heeding Daedalus: Optimal Inflation and the Zero Lower Bound,” Brookings Papers on Economic Activity, 2009. BIS central bankers’ speeches
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Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Asian Affairs Research Council, Tokyo, 24 September 2012.
Hirohide Yamaguchi: Economic slowdown and monetary easing Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Asian Affairs Research Council, Tokyo, 24 September 2012. * * * Introduction Thank you for giving me an opportunity to speak at the Asian Affairs Research Council special lecture in front of distinguished members who are active in a wide range of areas. For half a century since 1964, the Council has been, through its various kinds of research and studies about the Asia and Pacific region, contributing to the deepening of mutual understanding and harmonious development of the region. The year 1964 was when the Tokyo Olympics were held and when Japan joined the Organisation for Economic Co-operation and Development. Japan’s trade balance turned into a clear surplus from that year and continued to be in surplus for 47 years up to 2010. The year 1964 could be said as a milestone for Japan’s economy. In September 1964, the Annual Meetings of the International Monetary Fund (IMF) and the World Bank Group were held in Tokyo. Half a century since then, Japan’s economy has grown significantly and, amid globalization, a linkage between Japan and the rest of the world has been further closely interrelated. In the week after next, from Tuesday, October 9, the Annual Meetings of the IMF and the World Bank Group will be held in Tokyo for the second time. The Bank of Japan, together with the Ministry of Finance, is preparing for the Meetings as a host country. About 20 thousand participants and concerned parties from all over the world are expected to join, and many conferences and seminars on the global economy, financial systems and other various issues are to be held. In order to let people know further about Japan’s economy, the best way is to let them actually see Japan. I believe many of you are already planning to participate, and hope that you will seize the opportunity for a lively exchange of views. Today I will talk under the theme of the “Economic Slowdown and Monetary Easing.” In the first half, I will present an overview of the current state and outlook for the global economy and Japan’s economy. In the second half, based on such things about the economies at home and abroad, I will explain the Bank of Japan’s conduct of monetary policy. To summarize the thrust of my speech in advance, there are five points. First, looking at overseas economies, due to the effects of the European debt problem, business sentiment has become cautious in many countries and regions, mainly in the manufacturing sector, and the economies have moved somewhat deeper into a deceleration phase. Future uncertainty remains high. Second, in considering the background to the slowdown in overseas economies, it might be better not to focus only on the effects of the European debt problem, but to view from a broader perspective. Namely, we need to have the following big picture in mind. During the period up to the mid-2000s of the so-called Great Moderation, a bubble was generated in advanced countries and they are still suffering from the balance-sheet adjustments after the burst of the bubble. In emerging economies, as an excess supply capacity of a low cost labor force, which was a factor in supporting the Great Moderation, becoming low, it has become difficult to simultaneously achieve economic growth and price stability. Third, Japan’s economy registered relatively high growth in the first half of 2012, but the pick-up in economic activity has come to a pause, reflecting the weak developments in overseas economies. Economic activity is expected to level off more or less for the time being. Fourth, in response to a weaker outlook for economic activity, the Bank of Japan further enhanced monetary easing at the Monetary Policy Meeting held last week so that the future economy will not deviate from the orbit of “returning to the sustainable growth path with price stability.” Fifth, in order for Japan’s economy to BIS central bankers’ speeches overcome deflation, in addition to such support from the financial side, it is important to make efforts to strengthen growth potential and take advantage of accommodative financial conditions. After explaining those issues, I will answer to some of the questions raised about this time’s monetary easing. I. Current state and outlook for overseas economies Let me start with the current state of the global economy. Overseas economies have moved somewhat deeper into a deceleration phase. While the global economy has been on a deceleration phase, it seems that the extent of deceleration has recently increased mainly in manufacturers in many countries and regions. Current state of the European economy The European economy is currently in a deceleration phase. Three years have already passed since concern over the government debt was recognized in international financial and capital markets, and, at present, the problem has not been limited to Greece, Portugal, and Ireland, which have already been receiving support from the European Union (EU) and the IMF but also spread over to major southern European countries, including Spain and Italy. In those countries, due to a rise in government bond yields, namely, a decline in government bond prices, financial institutions’ assets have deteriorated, which has led to a rise in funding costs and instability of financial positions. As a result, financial conditions surrounding firms and households have worsened, posing pressure to suppress economic activity. Such deterioration in the real economy and concern over the financial systems have been fed back to the fiscal problem through a decline in revenue and an increase in support for financial institutions. In such a way, in Europe, a vicious cycle of public finance, the financial system, and the real economy has been at work, mainly in peripheral countries. Therefore, the stagnation in the European economy has been protracted, and that has recently been spread to core countries, including Germany, mainly in terms of business sentiment. The growth rate of the euro area economy has been negative for three consecutive quarters. In the meantime, the European authorities have been taking various policy measures. In July, a financial support measure to inject public funds into Spanish financial institutions was compiled, and in the beginning of September, the European Central Bank (ECB) introduced a new program to purchase government bonds with a maturity of between one and three years, with no ex ante quantitative limits on the size of purchases. However, in starting purchases of government bonds, the ECB is going to make some conditions. For example, the issuer countries of bonds to be purchased will have to accept monitoring by the EU and the IMF on the progress of fiscal consolidation. Thanks to those various policy responses, stability has been maintained in interbank funding markets, and investors’ risk aversion has abated somewhat in international financial and capital markets as a whole. The policy responses by the ECB and other policy authorities are indispensable for containing the vicious cycle of public finance, the financial system, and the real economy. However, in order to resolve the European debt problem fundamentally, it is necessary for countries whose fiscal sustainability has been a cause for concern to make some progress in meeting the challenges such as fiscal consolidation, strengthening medium- to long-term growth potential, and reinforcing the stability of the financial system. In addition, for Europe as a whole, integrating fiscal policy and banking supervision of the nations is an unavoidable challenge. None of these challenges is easy to meet and thus it is likely that high uncertainty will continue to surround future progress. Speaking of risks associated with the European debt problem, there is a risk that stagnation in the real economy might become protracted under the vicious cycle of public finance, the financial system, and the real economy, and there is a risk that a financial crisis might occur due to concern over the financial system. Put simply about the recent developments in BIS central bankers’ speeches Europe, it can be summarized that the risk that stagnation in the real economy, including the spillover to core countries, might become protracted has still been large, while the risk that a financial crisis might occur has subsided due to various policy responses. Current state of the U.S. economy Let me turn to the United States. The U.S. economy has been on a modest recovery trend with a moderate increase in private consumption, including automobile sales, and signs of a pick-up in the housing market. However, there have been weak developments. Improvement in employment has been slow and, amid economic adjustment in Europe being protracted, business sentiment, mainly of manufacturers operating globally, has recently become cautious and an increase in business fixed investment has been slowing. Against such a backdrop, the Federal Reserve has recently decided to keep the target range for the federal funds rate at 0 to 1/4 percent and changed the outlook for the duration in which exceptionally low levels for the federal funds rate are likely to be warranted, from “at least through late 2014” to “at least through mid-2015.” In addition, it has decided to purchase mortgage-backed securities (MBS) issued by governmental financial institutions, called agency MBS, at a pace of 40 billion dollars per month until the outlook for the labor market improves substantially in a context of price stability. In the United States, while balance-sheet adjustments due to the burst of a housing bubble have been progressing to a certain degree, it has steadfastly remained. In such a situation, in addition to the effects of the European debt problem, there are no prospects for a solution to the so-called fiscal cliff problem and there is an increasing awareness about uncertainty of fiscal consolidation over time. Those factors are likely to continue to constrain economic activity for the time being through growing cautiousness in household and business sentiment. While the U.S. economy is expected to continue recovering partly supported by accommodative financial conditions, the pace of recovery for the time being is likely to be only moderate. Current state of the Chinese economy Next is China. While the Chinese economy has been growing at a relatively high rate, the state of slowdown has become protracted. It has been pointed out that, in the background, there are a slowdown in exports to Europe and a deceleration in private real estate investment due to the effects of past monetary tightening and policy measures to control real estate transactions. With final demand at home and abroad declining, pressure for inventory adjustments in the raw material industry and a wide range of areas has recently been increasing, which has been spreading to production in the manufacturing industry. In China, as the authorities were taking policy responses, including monetary easing and advancement of infrastructure investment, the economy was considered to gradually accelerate the pace of growth if those effects would manifest themselves. While I believe such a scenario is still maintained, the slowdown has been lingering longer than expected and it is certain that the time when economic activity gets out of the state of slowdown will be deferred. While it is due mainly to greater-than-expected stagnation in the European economy, which is the largest trading partner, there might be a more structural problem. One is that the policy authorities seem to be hesitant about stepping on the gas pedal toward economic growth. That might be due to a bitter experience that a large-scale fiscal spending and monetary easing after the Lehman shock led to a rise in prices and a surge in real estate prices. A simultaneous achievement of both economic growth and price stability is a common challenge to many emerging and commodity-exporting economies, which I will talk about in detail later. Another reason might be that, in China, as a result of continued growth for a long period led largely by public investment and business fixed investment, industries, mainly the raw material industry, have been carrying a structural problem of excessive investment, and the balance between supply and demand has been prone to be lost. In the process of China’s transition from high growth to sustainable growth, an BIS central bankers’ speeches answer to the question on how to change the balance between investment and consumption, domestic and external demand, urban and rural areas, and coastal and inland areas is yet to be found, and that might have been increasing uncertainty about the future economic activity. Overall picture of the global economy While I have explained Europe, the United States, and China, respectively, that will not suffice to see the overall picture of the global economy. There are other elements, including challenges advanced countries are commonly faced with and challenges emerging economies are faced with, that should be understood in the overall picture of the global economy. In order to consider the challenges common to advanced countries, let us go back to the period up to the mid-2000s, which was called the “Great Moderation.” At that time, as various favorable factors including a rise in emerging economies and technological innovation in finance overlapped, extremely favorable economic conditions of high growth, low inflation, and low interest rates continued for a long period. Against such a backdrop, an optimistic view on the economic outlook spread globally and an investment boom and a boost of demand for consumer durables surfaced in the United States and Europe. On the financial front, financial institutions’ risk-taking attitude became aggressive, and a rapid bloat in credit and a rapid increase in leverage took place. In short, an excess was generated both on the real economy and financial front, and such excesses were finally corrected by the Lehman shock. Subsequently, the experience the United States, Europe, and other advanced countries had is that, once a large-scale bubble bursts and a financial crisis occurs, economic adjustment becomes protracted and, in the meantime, the economy is forced to grow at a low rate – a phenomenon repeated over and over in history. In the United States, substantial impairment of households’ balance sheets due mainly to the subprime mortgage problem has made a recovery in the U.S. economy a sluggish one. In Europe, amid an optimistic mood called “europhoria,” which is a word coined by combining “euro” with “euphoria,” loose fiscal management in Greece and excessive real estate investment in southern Europe took place, and left a severe problem in the balance sheets of the governments and financial institutions. In the process of balance-sheet adjustments, economic activity will not recover as wished. An economy that is unlikely to accelerate and remains vulnerable to the downside will continue for a long period. Without recognizing that fact, frustrations of “why the growth rate is not increasing despite those policy responses” or “why the unemployment rate does not decline” are prone to surface. It seems that both the United States and Europe are yet to identify “a normal pace of economic growth” in the balance-sheet adjustment process. That seems to have induced difficult problems of heightening expectations for economic policy and social unrest or dissatisfaction. While it might be somewhat too much to say, from such a viewpoint, there is in a sense a commonality among dissatisfaction among young people in Spain for a high unemployment rate, demonstrations against fiscal austerity in Greece, and repeated conflicts on fiscal management in the United States. At least, resulting increased reliance on central banks in the United States and Europe is an obvious tendency. In the meantime, China and other emerging economies were affected by a plunge in advanced economies immediately after the Lehman shock, but they subsequently restored growth at an early stage on the back of buoyant domestic demand and have been growing at somewhat high rates. The continued capital inflow to emerging economies, while advanced countries have been continuing monetary easing and providing ample funds, seems to have also been boosting domestic demand in emerging economies. Recently, contribution to the global economic growth by advanced countries has been declining markedly and that by emerging economies has been increasing. According to the IMF, the proportion of BIS central bankers’ speeches advanced countries and emerging economies in world GDP has shifted substantially from “7 to 3” to “5 to 5” in the past 30 years. While emerging economies have been leading the global economy, they have been faced with a new challenge after the Lehman shock. That is a simultaneous achievement of high growth and price stability. One important element that supported the “Great Moderation” was a dramatic increase in the world’s supply capacity due to emerging economies’ industrialization on the back of an ample and inexpensive labor force. However, demand in emerging economies increased accordingly and that resulted in putting constant upward pressure on commodity prices and food prices. In addition, for example in China, while development in inland areas has progressed, a mechanism, in which an increase in the labor force was covered by a population inflow from rural to urban areas, has recently been changing. As a labor population as a whole is expected to decline in the future, labor supply will become more prone to fall short than in the past, and inflationary pressure might also stem from that aspect. At present, in response to the pressure of economic slowdown from Europe and other advanced countries, emerging economies have been taking policy responses, including monetary easing, but it has been difficult to take drastic measures as the economy has been susceptible to inflationary pressure. There is uncertainty as to when those policy effects will surface in emerging economies and the pace of growth will accelerate. As crop prices have recently been surging, a simultaneous achievement of economic growth and price stability is likely to continue to be a challenge for emerging economies. In such way, the global economy has moved somewhat deeper into a deceleration phase, with the effects of the European debt problem combined with unique factors various countries and regions have been involved in – namely, a great challenge of balance-sheet adjustments in advanced countries and that of searching for a sustainable growth path in emerging economies. As mentioned earlier, with the U.S. economy continuing to recover moderately and policy effects gradually surfacing in the Chinese economy, the global economy is likely to get out of a deceleration phase, but the exit has been deferred. II. Current state and challenges of Japan’s economy Let me move on to Japan’s economy. As I have just explained, overseas economies have moved somewhat deeper into a deceleration phase. As a result, exports and industrial production have been relatively weak. The month-on-month rate of change in real exports has been negative for four consecutive months since May due to a weakness in exports to Europe and China, and, against such a backdrop, industrial production declined again in July relative to the April-June quarter, following a decline in the April-June quarter relative to the previous one. On the other hand, domestic demand has been resilient mainly supported by reconstruction-related demand. Public investment has been clearly increasing and business fixed investment has been on a moderate increasing trend with an improvement in corporate profits. Private consumption has been resilient with improving employment and housing investment has generally been picking up. However, there have recently been somewhat weak indicators in private consumption. While that is partly due to a weather factor, a sluggish pace of growth in overtime wages mainly in the manufacturing industry due to weak production and a decline in summer bonuses might have contributed to constraining consumption from the income side. While an application for receiving subsidies for eco-friendly cars ended at the end of last week, last minute demand was not observed. That was partly because efforts by car sellers after ending of the application, including a rebate in place of the subsidies and the release of popular fuel-efficient new-models, had been anticipated, but it perhaps should be interpreted as a sign that pre-consumption of future demand has reached its limit. As for business fixed investment, while it is likely to continue increasing as a trend, attention should be paid to whether there are any effects of a global deterioration in business sentiment. While domestic demand as a whole is likely to maintain its firmness, it might be difficult to expect domestic demand to BIS central bankers’ speeches have power to offset the weakness in external demand and further elevate economic activity. As explained, Japan’s economy registered relatively high growth in the first half of 2012, supported by the firmness in domestic demand, but the pick-up in economic activity has come to a pause, reflecting the developments in overseas economies. Economic activity is expected to level off more or less for the time being. On the price front, the year-on-year rate of change in consumer prices excluding volatile food has been around 0 percent and was minus 0.3 percent in July as the earlier fall in crude oil prices has been exerting downward pressure. The year-on-year rate of change in consumer prices is expected to remain at around 0 percent for the time being. Regarding risks, there remains a high degree of uncertainty about the global economy, including the European debt problem, the momentum toward a recovery in the U.S. economy, and a simultaneous achievement of price stability and economic growth in emerging and commodity-exporting economies. Furthermore, attention should be paid to the effects of financial and foreign exchange market developments on economic activity and prices. III. The bank’s conduct of monetary policy Comprehensive Monetary Easing Based on the state of the economy at home and abroad, let me turn to the Bank’s 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, and has been pursuing powerful monetary easing. As powerful monetary easing is pursued within the framework of Comprehensive Monetary Easing, let me first briefly explain the framework. It was October 2010 when Comprehensive Monetary Easing was introduced and about two years have passed since then. The basic reason for the introduction was, amid the policy rate virtually becoming 0 percent, to further generate easing effects. The specifics of the framework were as follows. First, the Bank has been encouraging the policy rate of the overnight rate in the uncollateralized call market, namely, an interest rate of a quite short-term of one-day borrowing, to move at around 0 to 0.1 percent, which can be said as virtually 0 percent. Second, the Bank introduced financial assets purchasing program named an Asset Purchase Program (hereafter referred to as “the Program”) and under the Program has been purchasing short-term and long-term government securities as well as a wide range of risk assets, such as commercial paper (CP), corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). That has been a measure, through influencing longer-term interest rates and risk premiums, to urge the effects of monetary easing to spread steadily over to firms’ funding costs. Third, the Bank has been aiming at 1 percent in terms of the year-on-year growth rate in consumer prices for the time being and made a commitment to continuing its powerful monetary easing through the pursuit of virtually zero interest rate policy and purchases of financial assets until it judges the 1 percent goal to be in sight. By a central bank making a commitment to continuing monetary easing for a long period, there will be momentum for pushing down the entire yield curve, including longer term yields. Background to the enhancement of monetary easing At the Monetary Policy Meeting held last week, the Bank further enhanced monetary easing. Specifically, first, the Bank decided to increase the total size of the Program by about 10 trillion yen, from about 70 trillion yen to about 80 trillion yen. The completion of the purchases under the Program was extended for six months and the purchases will continue until around the end of 2013. Second, the Bank decided to remove the minimum bidding BIS central bankers’ speeches yield, which used to be set at 0.1 percent per annum, for the outright purchases in order to ensure smooth purchase of the Japanese government bonds (JGBs). Looking at the developments in economic activity and prices that led to the decisions, as explained earlier, while overseas economies have moved somewhat deeper into a deceleration phase, the pick-up in economic activity has come to a pause and is expected to level off more or less for the time being. The year-on-year rate of change in the CPI excluding volatile food is to hover at around 0 percent for the time being. In the meantime, attention should be paid to the effects of financial and foreign exchange market developments on economic activity and prices. Until recently, the Bank had judged that, from a longer term perspective, Japan’s economy would return to the moderate recovery path as domestic demand remained firm and overseas economies gradually emerged from the deceleration phase. And, the year-on-year rate of change in the CPI excluding volatile food would start to gradually increase and was likely to reach 1 percent in the not so distant future from fiscal 2014 onward. However, taking into account the current developments in economic activity and prices, the time of “overseas economies to gradually emerge from the deceleration phase” and the time of “Japan’s economy to return to the moderate recovery path” are both likely to be delayed. While to what extent the delay will be is not clear amid continued high uncertainty concerning China and other overseas economies, roughly speaking, it is likely to be about six months. If things had remained as they were, Japan’s economy would have been on the verge of deviating from the assumed orbit of “return to the moderate growth path with price stability.” To avoid that, the Bank judged it necessary to further strengthen monetary easing this time. The aim of the measures this time is, by pursuing powerful monetary easing, inclusive of the measures this time, to bring back the outlook for economic activity and prices in the long run to the orbit of returning to a sustainable growth path with price stability. Specifics of the enhancement of monetary easing As mentioned earlier, the Bank decided this time to increase the total size of the Program substantially by about 10 trillion yen. Based on the recognition of the current state of economic activity and prices, the Bank considered that a large amount of funds would be necessary in order to prevent the outlook for economic activity and prices in the long term from deviating from the orbit of returning to the sustainable growth path with price stability. While there was a choice to increase additional purchases in risk assets, as the current financial conditions in Japan were not in a situation in which risk premiums increased due to investors’ anxiety or risk aversion, the Bank opted to increase purchases of short-term and long-term government securities. By increasing purchases of those by about 5 trillion yen each, the Bank aimed at influencing the entire yield curve. Japanese firms’ funding structure, unlike that of the United States in which the proportion of long-term corporate bonds and mortgage loans are high, has a characteristic of a high proportion of bank loans of three years or less. In particular, bank loans of one year or less account for about one-third of new loans, and there are also long-term loans with variable rates. Taking into account such structure of corporate finance, the effects on the entire yield curve, and financial institutions’ sense of security in their funding, the Bank considers that purchasing government securities with a remaining maturity of three years or less in a balanced manner will be effective in further spreading monetary easing effects. While the increase in the outstanding amount of the Program was to be completed by the end of June 2013, it is extended to be completed by the end of December 2013. Given the economic situation, the Bank has judged it necessary to beef up the aforementioned “commitment to continuing monetary easing for a long period” by extending the accumulation period of the Program. BIS central bankers’ speeches In addition, while the minimum bidding yield for purchases of the JGBs and corporate bonds was set at 0.1 percent, the Bank has decided to remove it. With the Bank pursuing monetary easing, the bidding yield for the JGB issuance as well as actual market transaction rates up to three years have often fallen below 0.1 percent. To that end, in the purchases of the JGBs, aggregate bids falling short of the Bank’s offers, or the so-called undersubscription, has taken place. While such phenomenon itself is an indication that monetary easing has been spreading powerfully, in order to further ensure purchases of financial assets, the Bank has decided to remove the minimum bidding yield. By combining an increase in the total size of the Program and the removal of the minimum bidding yield, the Bank believes that the effects of monetary easing will occur more powerfully. As the current amount outstanding of the Program is about 60 trillion yen, hereafter, toward the scheduled amount of 80 trillion yen by the end of 2013, the Bank will accelerate its purchase schedule to further accumulate 20 trillion yen of financial assets. The Bank will continue to proceed with monetary easing in a continuous manner by steadily increasing the amount outstanding of the Program. Accommodative financial conditions Then through what transmission channels will this time’s measures influence economic activity and prices and “ensure the return of Japan’s economy to the sustainable growth path”? First of all, since the measures are to increase the amount of purchase by the Program and to enable the Bank to purchase the JGBs at a yield level of 0.1 percent or lower, they will add further downward pressure on market interest rates. That will encourage a decline in financial institutions’ lending rates and influence interest rate formation in various financial markets, thereby making financial conditions surrounding firms and households more accommodative. That is an effect that could be clearly confirmed in two years’ experience of Comprehensive Monetary Easing. Under the Bank’s powerful monetary easing, Japan’s financial conditions are accommodative. Since the introduction of the Program, longer term market interest rates have been steadily declining. Looking at the yields of the government securities, in a manner of spreading from short-term to long-term, yields up to about three years have already been hovering at an extremely low level of about 0.1 percent. A 5-year yield has also declined to about 0.2 percent. Such a decline in market interest rates has encouraged a decline in firms’ funding costs and increased a sense of security for funding. According to a survey on firms about their cash management and financial institutions’ lending stance, diffusion indexes have clearly improved to the levels better than the average since 2000. Issuing conditions of CP and corporate bonds have generally been favorable and banks’ average contracted interest rates on new loans and discounts have been at about 1 percent for both short and long terms, which are at historically low levels of even lower than those during the period of quantitative easing policy in the first half of the 2000s. Against such a backdrop, average interest payment on firms’ interest bearing debt has declined to around 1.5 percent. That is an extremely low level compared with firms’ return on asset (ROA) being around 3.0–3.5 percent. Consequently, firms can now borrow a sufficient amount of funds at much lower interest rates than their own profitability. In such a way, as for the effects monetary policy exerts on the real economy, it can be said that the effects of monetary easing have thoroughly spread in terms of the first stage of transmission from monetary policy to financial conditions. What is important for Japan’s economy is that firms and households take advantage of the accommodative financial conditions and increase investment and spending aggressively. By that, the second stage of transmission from financial conditions to the real economy will be strengthened. BIS central bankers’ speeches Efforts to take advantage of accommodative financial conditions In that regard, currently, as firms are not confident about their future profits environment, they have not necessarily been able to take full advantage of such accommodative financial conditions. What becomes important here is the efforts to strengthen growth potential. If strengthening growth potential actually proceeds and growth expectations for Japan’s economy pick up, the outlook for firms’ profits will increase or the expected rate of return of investment will increase, which will lead to positive developments like firms’ investment. If that happens, accommodative financial conditions will further exert their effects. Once such virtuous cycle starts, inflation will be more likely to rise through an improvement in aggregate supply and demand balance. In such efforts to strengthen growth potential, it goes without saying that private economic entities will play the most important role. Recently, as seen in an increase in consumption by the elderly and in renewable energy-related investment, the move to convert challenges Japan’s economy is faced with into an opportunity to tap new demand has been gradually taking place. It is important to grow such bud of growth and nurture it to a larger market. In doing so, the role of financial institutions in providing funds necessary for firms’ activity, including in their startups, and the role of the government in preparing an environment that facilitates firms’ activity, including promotion of deregulation, are also important. Also the Bank, from the viewpoint of making utmost contribution that a central bank can do, has been implanting the extraordinary “Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth” since June 2010. The measure is for the Bank to provide long-term funds at a low interest rate to financial institutions carrying out lending and investment that contribute to Japan’s economic growth, and the total amount of line of credit has now reached 5.5 trillion yen, inclusive of the U.S. dollars. While the measure is an extraordinary one, given the intrinsic role of a central bank, the reason the Bank dares to do it is that the Bank expects the measure to play the role of a “catalyst” in strengthening growth potential. In addition to the impact of actually providing funds, significance of sharing the recognition that strengthening growth potential is important is not small at all. In fact, since the introduction of the measure, there have been not a few examples of promoting voluntary initiatives toward strengthening foundations for economic growth, such as some financial institutions setting up a dedicated fund for the regions’ promising businesses. If such efforts further develop and, as the moves to take advantage of the current accommodative financial conditions increase, the effects of monetary easing will be further exerted. While accommodative monetary conditions have reached a state of saturation as I have explained earlier, from the viewpoint of taking advantage of such accommodative financial conditions, a strong possibility still remains for monetary easing exerting greater effects. Assessment of the economy and the timing of monetary easing As for this time’s measures, I have explained a grand view of the assessment of underlying economic activity and prices and the aim, the specifics of the measures, assumed transmission channels, and the importance of strengthening growth potential to utilize them. In the following, I will answer to some questions raised related to the measures taken this time. First, the question on “why the Bank decided monetary easing at this time’s Monetary Policy Meeting.” That originates both from a view that “the past assessment of the economy might have been too optimistic” and a view that “the Bank could have waited until it checked the result of the Tankan survey to be released at the beginning of October and it conducted the full examination in the Outlook Report scheduled for the end of October.” As for the assessment of the economy, in recent months, it has been said that the deceleration phase of overseas economies has been continuing on such occasions as BIS central bankers’ speeches Governor’s press conferences, speeches, and interviews. Against such a backdrop, it has been confirmed that the extent of deceleration has recently increased in many countries and regions, mainly in the manufacturing industry, and that the phenomenon has been clearly spreading to Japan’s exports and industrial production. The weaker-than-expected developments in the global economy in the meantime were, as shown in a deterioration in business sentiment indicators, beyond many people’s expectations, including us. As for the question on what cases the Bank will make policy responses in, I myself mentioned at various opportunities that “when the outlook turns out to be weaker than expected or the risk associated with it intensifies, the Bank will not hesitate to implement additional monetary easing.” The Bank, not only in the Monetary Policy Meeting to publish the Outlook Report but also in every Meeting decides on the conduct of monetary policy by examining the baseline scenario of the outlook for economic activity and prices as well as risk factors surrounding it based on available information. As a result of such examination at the latest Meeting, the Bank judged that the scenario it assumed had been delayed or weaker than expected. As long as there is such judgment, there is no reason to procrastinate a policy response. In such a way, the decision this time was quite an orthodox one in line with the basic concept expressed at various opportunities. The further enhancement of monetary easing decided this time, together with the cumulative effects of the past measures, will ensure the return of Japan’s economy to a sustainable growth path with price stability. Then, in the Outlook Report scheduled to be released at the end of October, based on new indicators and developments being added by then, the outlook for economic activity and prices as well as risk factors are to be examined comprehensively. As for the Bank’s decision on enhancement of monetary easing at this timing, there have been comments, for example, from market participants that “the Bank has followed central banks in the United States and Europe.” Each country’s central bank has been striving to pursue optimal policy according to each country’s economic and financial situation, and does not consider taking policy action following another country’s central bank. As long as the economy itself has been interrelated globally, there is a good chance that the economies of countries and regions simultaneously become weaker than expected and, as a result, each country’s or region’s central bank takes the same kind of response at the same period. As for this time’s policy actions, amid a sense of slowdown in the global economy becoming stronger than widely predicted, it appears to be the case that major central banks have examined the situation of each country or region and have respectively chosen responses deemed appropriate. As a policy stance going forward, the Bank has clarified its view that “[t]he Bank continues to conduct monetary policy in an appropriate manner. The Bank will also do its utmost to ensure the stability of Japan’s financial system, while giving particular attention to developments in global financial markets.” As has been the case, the Bank will examine the outlook for economic activity and prices as well as risk factors, and, when judged necessary, respond decisively and flexibly. Comparison with overseas central banks In relation to monetary easing by overseas central banks, we sometimes receive an opinion that “the Bank should pursue bolder monetary easing, like the Federal Reserve, by purchasing assets without setting a ceiling and a time limit or clarifying the duration for the zero interest rate.” In that regard, as said before, a central bank strives to choose the most effective policy measure or policy framework based on policy challenges and the financial and economic situation of each country or region. While there are various differences in policy conduct between the Bank of Japan and the Federal Reserve, both share the view of doing its utmost as a central bank to achieve respective goal. It might not be desirable to argue which central bank is bolder, based on the difference in specific monetary easing measures. BIS central bankers’ speeches To be somewhat specific, let me point out three things. First, the relationship with policy challenges. The Bank, with the recognition that Japan’s economy is faced with the critical challenge of overcoming deflation and returning to the sustainable growth path with price stability, has been purchasing various assets, including risk assets, and, at the same time, ventured into taking an extraordinary measure, as a central bank, to support strengthening foundations for economic growth. Central banks of major countries are choosing policy responses in line with challenges each central bank is faced with. Second, about a ceiling and time limit. While the Bank has set a ceiling and time limit for the Program, they have been increased or extended from time to time. What started initially at about 35 trillion yen in the total amount and to be completed by the end of 2011 has now become a much larger and much longer easing measure than initially planned, with the total amount of about 80 trillion yen and to be completed by the end of 2013. Regardless of whether there is a predefined ceiling or time limit, the idea of strengthening monetary easing if those are judged insufficient in achieving a policy objective is the same in every central bank. Third, how to show the duration for maintaining the virtual zero interest rate. The Bank, while presenting the outlook for economic activity and prices of two to two and a half years ahead, has clearly made a commitment to pursuing powerful monetary easing through measures, including the virtually zero interest rate policy and purchases of financial assets, until it judges “the price stability goal in the medium to long term” for the time being of 1 percent in terms of the year-on-year rate of change in the CPI to be in sight. From a perspective of practical effects, we recognize that there is not a great difference between such approach and the Federal Reserve’s approach, which specifically shows the duration for maintaining the zero interest rate on the basis of the outlook for economic activity and prices at a certain point and change the duration in accordance with subsequent changes in the outlook. Therefore, it seems to be no significant difference in the basic idea and effects of policy conduct between major central banks, albeit some difference in specific ways of conduct. Purchase of government bonds and confidence in currency Finally, in relation to the Bank’s decision to increase the purchase of the JGBs, we sometimes receive concern that “the Bank’s massive purchase of government bonds is fiscal monetization by a central bank and eventually confidence in currency will not be maintained.” Let me touch on that point. At present, the Bank has been purchasing the JGBs according to two different objectives. One is the purchase of the JGBs corresponding with the trend increase in demand for banknotes associated with economic growth. In that case, as long as the purchase corresponds with the trend increase in demand for banknotes, it is rational to hold not short-term assets but long-term government bonds. And in light of the thrust of such purchase, the outstanding amount of banknotes issued is set as the ceiling of the JGB purchases. The other purchase of the JGBs is through the Program, which I have repeatedly mentioned today. As those purchases are decided based on monetary policy judgment to influence longer-term interest rates and other rates, there is no such condition that the total size of the purchases should be kept within the amount of banknotes issued. The outstanding amount of the JGBs held by the Bank has increased from about 66 trillion yen at the end of 2011 to about 84 trillion yen at present, coming to exceed the outstanding amount of banknotes issued. That is due to an increase in the JGB purchases through the Program under pursuing powerful monetary easing. As it is expected that the outstanding amount of the JGBs held by the Bank will increase to about 92 trillion yen at the end of 2012, it will be an increase of about 26 trillion yen in one year. Given that this year’s issuance of special deficit-financing bonds is about 38 trillion yen, it can be said that, the Bank’s purchase of the JGBs has already reached to a substantial size. BIS central bankers’ speeches If by any chance such massive purchase of the JGBs is interpreted, apart from the necessity in monetary policy conduct, as aiming at fiscal monetization, confidence in the Bank could be eroded considerably and long-term interest rates could rise substantially. That will affect significantly the government which issues the JGBs and financial institutions which hold the JGBs, thereby could impair the stability of the financial system and the real economy. In order to avoid such things, the Bank considers it important to firmly convey the idea to the market that the Bank will not carry out fiscal monetization. In addition, so that the market can always check the Bank’s actions, the Bank will continue to disclose the state of purchases under the Program in a transparent manner. Concluding remarks I have spent quite a time talking about the current state and outlook of the global economy and Japan’s economy, and the Bank’s conduct of monetary policy based on them. In conclusion, let me briefly touch on the prospects of Asian economies and Japan’s economy. Japan’s economy was faced with a structural challenge of declining growth potential due to rapid aging and has long been struggling to overcome it. As mentioned earlier, recently there have been increasing moves to seize it as an opportunity to tap new demand. Such moves have been factors underpinning the relatively resilient domestic demand. If such moves continue in Japan, it will have a significant meaning for the Asian economy as a whole in the future. That is because aging is a problem that other Asian countries also have to be faced with in the not so distant future. As the income levels of Asian emerging economies rise, the potential market size of business for the elderly has a chance of expanding dramatically. To utilize the fruits of the efforts to tap demand of the elderly that has accumulated in Japan as a result of facing the challenge ahead of other countries, namely, to utilize the wisdom of maintaining and improving the vitality of the economy even with aging in Asian markets will not only raise the growth potential of Japan but also enhance the economic and social sustainability of other Asian countries and lead to benefits for the Asian economy as a whole. Those are not limited to the problem of aging. I recognize that it will become increasingly important to have a perspective that Japan’s efforts to overcome various challenges will lead to global benefits. BIS central bankers’ speeches
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Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Introductory Program on Bank of Japan Policies and Operations on the occasion of 2012 Annual Meetings of the IMF/World Bank Group, Tokyo, 9 October 2012.
Masaaki Shirakawa: Evolution of the Bank of Japan’s policies and operations – looking back on fifty years of history Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Introductory Program on Bank of Japan Policies and Operations on the occasion of 2012 Annual Meetings of the IMF/World Bank Group, Tokyo, 9 October 2012. * * * Good morning, honorable ministers, honorable governors, and distinguished delegates to the 2012 Annual Meetings of the IMF/World Bank Group. I am truly delighted to welcome you to the Bank of Japan today. Before I begin my remarks, please allow me to take this opportunity to express my sincere gratitude for the warm support we received from you and many other friends around the world when we were hit by the devastating tremor of the Great East Japan Earthquake last year. This is the second time Tokyo has hosted the Annual Meetings of the IMF/World Bank Group. The last time was in 1964 when Japan was at the zenith of a high-growth period and still one of the “emerging market economies”. Comparing the size of economy at that time to that of the United States, nominal GDP was 12% and per capita nominal GDP was 24% of that of the U.S. That roughly corresponds to Russia or Brazil today. Japan went through a reconstruction period after World War II, and from the mid-1950s to early 1970s, it enjoyed high economic growth that marked an annual rate of 10%. Among the conditions that contributed to this high growth, I believe the most important ones were, first, the migration of the labor force from rural areas to the cities and from the agricultural to the manufacturing sector, which resulted in higher productivity, second, the high level of education, and third, the benefits of the free trade system. However, no economy can maintain high growth indefinitely. From a certain point, the potential growth rate starts to decline gradually. The most important task for policy makers is to achieve a smooth transition from high growth to stable growth. Yet, it is by no means easy to identify in real-time the change in potential growth rate. The attempt to maintain high growth beyond its potential may cause various imbalances. Let me take the case of Japan as an example. Japan suffered from high inflation in the first half of the 1970s, amplified by the first oil shock. Later, the country tried hard to make its industrial structure energy efficient, and monetary policy was focused on price stability. Against such a backdrop, the Japanese economy achieved the best economic performance among major developed economies in terms of price and growth rate. This situation, albeit good in itself, fomented excessive optimism about Japan’s higher potential growth and, together with the influence of prolonged easy monetary policy, contributed to the creation of economic bubbles of unprecedented scale in the latter half of the 1980s. In the 1990s, Japan suffered from deleveraging of excess debt, the aftermath of the bursting of the bubbles. And, since the early 2000s, the Japanese economy has gradually come to face a different issue from that in most of your countries. The challenge here is the rapid ageing of the population dragging down the potential growth rate. Since the beginning of the 2000s, the growth rate itself has remained low, while the growth rate per working-age population in Japan has been 1.5% per annum, the highest among the major developed economies, along with Germany. It is impossible for me to go through the fifty years’ history of Japanese economy in just a few minutes. What I would like to stress is that we need to identify the new issues that always emerge at different stages of economic and financial development, and find the appropriate policy responses in a timely manner. In any case, changes in the economic environment require a constant review of a central bank’s policies and operations. Let me start with the exchange rate system. Japan currently uses a floating exchange rate system. Fifty years ago, we had a fixed exchange rate system. Cross-border capital BIS central bankers’ speeches transactions were still quite regulated in those days, despite Japan’s acceptance of IMF Article VIII obligations. These restrictions were gradually removed and cross-border capital transactions increased dramatically. There was also a sea change in the financial system during the same period. In the 1960s, interest rates were strictly regulated and the capital market was underdeveloped. The major tool for the Bank of Japan’s monetary operations at that time was the allotment of central bank loans with a below-market interest rate, and the role of open market operations was limited. Today, the major monetary operation tools have been shifted to the open market operations to control money market interest rates. Incidentally, the Bank of Japan has been deploying various non-traditional policies over the past 15 years, given that we are faced with short-term interest rates that are currently practically zero. In the area of payment and settlement systems, the development of computer systems and information technology brought major changes in the way funds and securities were settled. Fifty years ago, settlement was conducted by deferred netting. Today, the BOJ NET system settles the funds among the counterparty financial institutions on-line and on a real-time gross basis (RTGS). The evolution of the Bank of Japan’s policies and operations reflects the different stages of development in the Japanese economy and the changes in the domestic and external financial environment. In addition, the systems specific to Japan and its historical background are also reflected in the Bank of Japan’s operations. Here I would like to pick up two examples from different areas. One is the inclusion of securities companies or investment banks among the counterparties of the Bank of Japan. Following the bankruptcy of Lehman Brothers, investment banks in the United States became bank holding companies and gained access to the central bank’s facilities. For more than seventy years, the Bank of Japan has allowed securities companies to open BOJ current accounts. And it has conducted on-site examination of those account-holding securities companies. This treatment of securities companies made it possible for the Bank of Japan to swiftly provide liquidity, as the lender of last resort, when the financial crisis triggered by the unprecedented scale of the bursting of its bubbles forced the collapse of Yamaichi Securities, then one of the biggest securities companies. I believe that was one of the reasons why Japan was able to avoid becoming the epicenter of a global financial crisis at that time. Another example from a different field is the business survey known as the TANKAN. The Bank of Japan has been sending a special quarterly questionnaire to Japanese companies since 1957. The survey currently covers about ten thousand medium-sized to large companies, in both manufacturing and non-manufacturing industries. As such, the TANKAN provides information valuable to gaining an understanding of the state of the economy. Central banks must strive to provide the operations best suited to their own environment. I believe this is also true for the central banks of African countries, represented by many of the governors here today. A few years ago, I attended a conference held by the BIS with the governors of African central banks. There, I learned that banking services provided through mobile phones are widely used in Africa. Although I was initially surprised to hear this, I quickly realized that it is indeed quite a natural development given the geographical environment of Africa, and is something which may have bearing on the operations that African central banks are endeavoring to provide. I referred earlier to the evolution of central bank monetary policies and operations over the past fifty years by taking the experience of the Bank of Japan as an example. In considering these changes, I have realized once again the difficulty of reaching a universal definition for such a unique organization as a central bank. Today, instead of trying further to precisely define the central bank, I would like to talk about the three points I always highlight regarding the roles of a central bank. BIS central bankers’ speeches First, the most important role of a central bank is to provide a stable financial environment. Sustainable economic growth tends to be achieved in a stable financial environment, even if that is not always the case. Second, a central bank is an organization that plays its role through banking services. The specialized knowledge required of a central bank is not only knowledge of macroeconomics, but the wisdom to cover a wide range of activities. What is especially important for central banks is practical knowledge related to the details of the circulation of money. Borrowing the phrase of one central banker I respect, this kind of knowledge is akin to the knowledge required by a good plumber. Third, a central bank is an organization that needs to learn constantly from the changes in the world. Earlier, I referred to a stable financial environment. The specific elements from which a stable financial environment is constructed also change with time. When price stability is achieved, many economic entities gain the confidence to take more risk. And, as a result, the stability of the financial system is compromised. This paradox of price stability is a good example of the need for the central banks to stay vigilant and keep learning in a changing environment. The staff members from the Bank of Japan will now explain the current central bank policies and operations of the Bank. We would also like to take this valuable opportunity to learn from your experience and to deepen the ties of cooperation with you. Thank you for your attention. BIS central bankers’ speeches
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Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 30th Anniversary Luncheon of the Swiss Chamber of Commerce and Industry in Japan (SCCIJ), Tokyo, 10 October 2012.
Masaaki Shirakawa: Reviewing the economies of Switzerland and Japan Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the 30th Anniversary Luncheon of the Swiss Chamber of Commerce and Industry in Japan (SCCIJ), Tokyo, 10 October 2012. * * * Before I begin, I would like to thank Chairman Thomas Jordan for his detailed and informative presentation on the state of the Swiss economy and the issues faced by the Swiss National Bank. I believe that everybody in this room would agree that we have learned a great deal. In the next five minutes, instead of commenting directly on what Thomas has just explained, let me offer you some thoughts that come to my mind when I look at the Swiss and Japanese economies. Switzerland and Japan are very different. Switzerland is land-locked. It is in effect an island in the sea of the European Union, where about 60 percent of its exports are headed and 80 percent of its imports derive (Chart 1). Japan is far more populous. The Japanese economy is about nine times as large as the Swiss economy. Nevertheless, there are similarities. For example, both countries enjoy, or even suffer from, very stable prices. The average annual inflation, measured by headline CPI, over the twenty years from 1992 to 2011 was 1.1 percent in Switzerland and 0.1 percent in Japan (Chart 2). In August this year, the year-on-year change was –0.5 percent in Switzerland and –0.4 percent in Japan. Consequently, interest rates are also low (Chart 3). In recent weeks, the yield on ten-year government bonds has been hovering around 0.5 percent in Switzerland, slightly below Japan’s 0.7 to 0.8 percent range. Both currencies, as Thomas has explained, are at historically elevated levels. In this regard, the news media and the public are usually focused on a specific traded exchange rate between currencies, such as the Swiss franc to the euro or the yen to the U.S. dollar. These rates are important, but there are additional indicators for exchange rates. In order to understand what would happen in an economy when exchange rates fluctuate, exchange rates for all the trading partners must first be taken into account. From this viewpoint, we must look at the nominal effective exchange rate, which is a trade-weighted index of exchange rates. In the case of Switzerland and Japan, compared with January 2000, the nominal effective exchange rates in August 2012 were 41.4 percent and 17.4 percent higher, respectively (Chart 4). Secondly, we also need to consider the fact that higher inflation will erode competitiveness. In other words, further information could be derived from the real exchange rate, which is the nominal rate adjusted for inflation. When a higher nominal exchange rate is offset by lower inflation, the real exchange rate stays at the same level. Actual calculation of these rates is admittedly difficult because of issues involved with comparing inflation between economies, but the rates fluctuate considerably over the long term. For example, between January 2000 and August 2012, the real effective exchange rates for Switzerland appreciated by 12.5 percent, whereas Japan’s depreciated by 19.3 percent (Chart 5). More recently, between December 2007 and August 2011, the real effective exchange rates for Switzerland and Japan moved in tandem with each other, appreciating by 16.9 percent and 23.3 percent, respectively. These movements of the last few years are to an extent representative of the fallouts from the Great Financial Crisis. The prevalent mood of risk aversion resulted in the unwinding of carry trades. Both countries are now also confronted by the so-called flight-to-safety capital flows. The appreciation of the two currencies coincided with the most severe financial and economic dislocations in the advanced economies. With regard to interventions in the foreign exchange market, in Switzerland, the Swiss National Bank has the power to intervene. In Japan, the government – not the central bank – BIS central bankers’ speeches is mandated by law to direct such interventions. The Bank of Japan is conscious of the effects that the rapid appreciation of the yen could have on Japan’s economy and inflation outlook in terms of the conduct of the Bank’s monetary policy. Concern over these effects of exchange rate developments has been one of the factors that influenced the Bank’s series of decisions to further ease its monetary policy. While both Switzerland and Japan suffer from strong exchange rates, I am also struck by the dynamism of the Swiss economy. The U.S. dollar value of exports in Switzerland increased by 192 percent between 2000 and 2011, a threefold increase, whereas the comparable figure for Japan was an increase of 74 percent. Meanwhile, the domestic currency values increased by 53 percent and 28 percent, respectively (Chart 6). Exports by the pharmaceutical, precision machinery, and watches industries have increased considerably. This is particularly remarkable in view of the Swiss franc’s significant appreciation during the period, which was more than the yen’s, and such large shocks as the Great Financial Crisis and the more recent turmoil in the euro area. All in all, one often underappreciated benefit of globalization is the enhanced opportunity to learn from each other’s similarities and differences. Today, Thomas has provided us with a valuable insight into Switzerland, and I hope that he can take something home from this visit to Japan. Let me now conclude by thanking him once again for his superb presentation. Thank you, Thomas. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the BOJ CEMLA Seminar on Regional Financial Cooperation, Tokyo, 11 October 2012.
Kiyohiko G Nishimura: Future of central bank cooperation in Asia, Latin America and Caribbean States Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the BOJ-CEMLA Seminar on Regional Financial Cooperation, Tokyo, 11 October 2012. * 1. * * Introduction: central bank cooperation in Asia Good morning, honorable speakers and distinguished guests. Welcome to the Annual Meetings of the IMF/World Bank Group, and in particular, to this BOJ/CEMLA seminar on regional financial cooperation, which is one of the most relevant and pressing issues in our increasingly inter-connected world. Today, in my remarks, I would first like to touch upon the history of cooperation among central banks in Asia, followed by an assessment of what has been achieved since the Asian Currency Crisis of the late 1990s, and how this helped Asia weather the shocks of the current global financial crisis. Then I will discuss the issues we face today in this post-crisis world. The Bank for International Settlement, the BIS, is the first name that comes to mind when considering cooperation among central banks. The BIS provides opportunities for major central banks to discuss various issues, including international banking standards and global financial stability.1 However, most Asian central banks had to wait until the latter half of the 1990s to become directly involved in BIS activities. It was this circumstance that led the Bank of Japan to propose the establishment of the Executives’ Meetings of East Asia and Pacific Central Banks, or the EMEAP, which was officially established in 1991 with the members of eleven economies of East Asia and Oceania.2 The EMEAP plays a particularly important role in promoting the exchange of opinions among practitioners and the maintenance of a surveillance network. Member central banks share information at the working group meetings which cover financial markets, banking supervision, payment and settlement systems, and information technology. To take a prominent example, the Working Group on Payment and Settlement Systems (WG/PSS) regularly updates its “Red Book”, using methods similar to those adopted by the BIS, to explain details of the payment and settlement systems of the member economies. Currently, the Working Group on Financial Markets (WG/FM) is closely monitoring the impact of the European sovereign debt crisis upon financial markets in Asia and Oceania. 2. Two financial crises and Asian financial markets In the past two decades, member economies of the EMEAP have experienced two financial crises: the Asian Currency Crisis of the late 1990s, and the current global financial crisis. However, the impact of these crises was very different: severe in the former, and relatively mild in the latter. I believe the difference is partly due to the enhanced cooperation among the central banks of the EMEAP member economies. The BIS provides secretariat services to various committees and high-level meetings of central banks and supervisory authorities such as the Financial Services Board, the Basel Committee on Banking Supervision, the Committee on Payment and Settlement Systems, and the Committee on the Global Financial System. The BIS also functions as the study and research center for global finance and economics. The primary objective of the EMEAP resembles that of the BIS. It is to strengthen the cooperative relationship among its members. The EMEAP started as the regular meetings for the Deputy Governors. Since 1996, it has developed into a triple layered system similar to that of the BIS, with the Governors’ Meetings, Deputy Governors’ Meetings and Working Group Meetings. BIS central bankers’ speeches The Asian currency crisis highlighted the structural vulnerabilities in the region’s economies: first, there was the double-mismatch of currency and maturity in the region’s financial sector, and second, corporate finance remained highly dependent on banks. As a result, Asian countries were vulnerable to sudden changes in global financial markets and their abundant savings were not being mobilized effectively within the region. To rectify the problem of overdependence on banks, the EMEAP started the Asian Bond Fund (ABF) initiative to promote local-currency bond markets, a project giving members the opportunity to invest in bonds in Asia. In parallel, the governments of ASEAN+3 member countries are now implementing the Asian Bond Market Initiative (ABMI) to foster deregulation and to create an environment conducive to investment. The results have been impressive: the local-currency bond markets in Asia have developed significantly, as shown in Figure 1, in terms of amount outstanding for both government and corporate bonds. The share of Asian-currency bonds in global bond markets increased from 2.1% at the end of 1996 to 8.4% at the end of 2011. What is remarkable here is that the presence of foreign investors in a number of local-currency bond markets in Asia is rapidly increasing, as shown in Figure 2. This can be attributed to the enhancement of the market infrastructure of these economies, not just because of improvements in the risk/return profile of these bonds in terms of the creditworthiness of the issuers and the relatively higher yields of the papers. Moreover, there has also been a significant improvement in the problem of currency mismatch. The share of foreign lenders’ loans denominated in local currencies has increased remarkably, as shown in Figure 3, although the maturities of such loans are still one year or shorter. It is worth mentioning here that some countries have implemented measures explicitly to reduce the mismatch. A case in point is the Republic of Korea which obliges local banks to hold a certain proportion of short-term foreign currency assets against short-term foreign currency debt. The Asian economies have weathered a series of shocks starting from the bankruptcy of Lehman Brothers to the European debt crisis of today. I believe the improved market structure described above has contributed to this performance, together with good economic fundamentals and the relatively plain business models of banks in Asia. 3. Challenges for the future – beyond the boundary of Asia The financial market developments described so far pose new challenges for central bankers in Asia. I believe these challenges are also relevant for our colleagues in Latin America and Caribbean states. The first challenge is how to cope with cross-border capital flows. Given that the bond markets have developed and that the proportion of non-resident holders has increased, there have been calls for categorical restrictions on cross-border capital flows to prevent the sudden reversal of portfolio flows that could cause a financial crisis. This problem may be particularly keen when the growth of the bond markets is so rapid that the market infrastructure fails to keep pace. In fact, there is some evidence suggesting a positive correlation between the ratio of non-residential holders and the volatility of bond yields.3 However, we need careful benefit-cost analysis here since such restrictions may impose substantial efficiency loss on the country in the long run. What is essential is to strengthen market infrastructure: for the bond issuer to maintain sound creditworthiness, and for the market to increase its transparency. In fact, in Germany, the share of non-resident holders of government bonds reaches almost sixty percent, yet this is not seen as any cause for concern. For example, see Jochen R. Andritzky, “Government Bonds and Their Investors: What Are the Facts and Do They Matter?”, IMF Working Paper, June 2012. BIS central bankers’ speeches The second challenge is to improve the resilience of financial markets against financial stress, and here collateralized markets are the key. While the bond markets show remarkable growth in Asia, the collateralized money markets, including the repo markets, are underdeveloped, except in Japan. In most of the emerging market economies, repo transactions are largely used for the monetary policy operations of the central bank, while they are rather rarely used between private market participants. Legal uncertainty regarding the effectiveness of collateral has often been pointed to as the main reason for this scarcity of private repo transactions. However, in order to maintain the functioning of the money market, especially under very stressful conditions, it is essential to have well-functioning markets for collateralized transactions, including repos. The third challenge is cross-border financial regulations. In particular, this is the issue of how Asia, Latin America, and Caribbean states should respond to the latest regulatory developments in the United States and Europe. There have been moves to extend U.S. and European regulations beyond their domestic borders to be applied in other jurisdictions, based on the argument of guaranteeing a “level playing field”. A level playing field is undoubtedly important for fairness. Nonetheless, what we really need is a playing field that leads to fair competition among financial institutions of different types and backgrounds. The regional and functional heterogeneity of Asia, Latin America, and Caribbean states should be honored in the appropriate way. However, I am also aware of the danger of “spaghetti regulations” once each and every country starts insisting on its own unique regulations, where we end up with extremely complicated and entangled regulations with unintended cross-border consequences. As such, we need to formulate a “regional voice” to make sure that the global regulatory framework is clear and consistent. Last but not least, given the mutual linkages among the regions of Asia, Latin America and Caribbean countries, it is all the more important to monitor whether there are any financial imbalances in any countries. To achieve this goal, we need to improve not only the credibility and the accuracy of our economic data, but also their timeliness. Central banks should play a major role in such regional surveillance work and economic data improvement. To conclude, I believe candid discussion and collaboration on nuts and bolts issues among central bank experts are truly important in the context of central bank cooperation. I hope the rewards of our endeavors will be the formulation of fruitful new ideas and the expansion of rewarding human networks. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Initial remarks by Mr Ryuzo Miyao, a member of the Policy Board of the Bank of Japan, for the Panel Discussion at the Asian Development Bank Institute, Tokyo, 12 October 2012.
Ryuzo Miyao: Eurozone crisis – implications for Asian economies Initial remarks by Mr Ryuzo Miyao, a member of the Policy Board of the Bank of Japan, for the Panel Discussion at the Asian Development Bank Institute, Tokyo, 12 October 2012. * I. * * Introduction I am honored to be invited to this panel discussion at the Asian Development Bank Institute. In discussing today’s topic, “the Eurozone Crisis and Its Implications for Asian Economies”, I would like to speak briefly about three key aspects. I will begin with reviewing the current Eurozone crisis, then consider its implications for Asian economies, and lastly I will outline the Bank of Japan’s contribution to regional monetary cooperation in Asia. II. Nature of the Eurozone crisis I am sure that most of today’s audience is already familiar with developments in the current Eurozone crisis, but I would like to emphasize two points about the nature of the crisis. The first is that the Eurozone crisis highlights the difficulties of so-called monetary union without fiscal union. Eurozone countries introduced the single currency, the euro, under the European Central Bank, while each member country maintains its own fiscal sovereignty. However, there have been ongoing intensive discussions, since even before monetary union began, especially in academic circles, about the necessity for an adjustment mechanism in the form of fiscal transfers, labor mobility etc., if a common currency is to work. Thus, the issue of how to manage fiscal policies under a single currency regime is one of the most fundamental and most enduring challenges for the Eurozone. Second, as long-term interest rates in member countries converged at low levels following the introduction of the single currency, the Eurozone enjoyed the benefits of the expansion of trade and investment. At the same time, however, it also gradually accumulated economic and financial imbalances, such as loose fiscal spending and a bubble in the real estate market. Because these imbalances were built up over a period of more than a decade following the introduction of euro in 1999, it would not be surprising if it takes a long time for the Eurozone to achieve a full recovery. If this is indeed the case, we must be aware that there is a risk of the crisis becoming a severe headwind against the global economy in the longer-term perspective. I will come back to this point later. III. Implications for Asian economies It took about 50 years, from the signing of the European Coal and Steel Community Treaty in 1951, for Europe to achieve the introduction of the euro. Meanwhile, the possibility of deeper economic and financial integration in Asia, and in particular the introduction of an Asian single currency, has been discussed at various levels. There may seem to be little possibility, at the present time, of a common currency being established in Asia, but the day might come some time in the future when the introduction of an Asian single currency might be discussed as a concrete option. In preparation for such a future possibility, I think it is important for Asian countries to deepen their understanding of the implications and lessons to be learned from the current Eurozone crisis. I would like to touch briefly upon three issues. First, as we all recognize, the Eurozone crisis has had a notable impact on Asian economies through several channels: through trade, through the financial system and through asset prices. Although Asia has been enjoying relatively high economic growth, it would be overly optimistic to expect a complete decoupling of Eurozone economies and Asian economies. Considering in particular the degree and persistence of the Eurozone crisis, we must be aware that the downside risk continues to weigh on the Asian economies. BIS central bankers’ speeches Second, the question of how to develop and manage fiscal policy under a single currency regime is a huge topic for Asia, if in fact it considers monetary union as a concrete option. As I mentioned, in the case of European monetary union, monetary policy was centralized under the European Central Bank, while fiscal policy remained the responsibility of each member country. Furthermore, Article 125 of the Lisbon Treaty, the so-called no bailout clause, makes it illegal, in principle, for one member state to assume liability for another member state. This means that, even if one member country falls into a fiscal crisis, other member countries are not allowed to support the troubled member with fiscal transfers. Thus, the crisis management of fiscal problems has become a major challenge for Eurozone countries. If the Asian region makes a step towards monetary union in the future, a consensus must be achieved in advance among the members as to how fiscal integration should proceed and how social security systems, such as pension and health care systems, should be harmonized. Third, the risk of economic and financial imbalances must be monitored closely. The Eurozone, especially the peripheral countries, enjoyed good economic performance after the introduction of the euro. That is because foreign exchange risks were eliminated within the Eurozone, expanding trade and investment in the area, and also because the long-term interest rates of these countries went down toward the level of German government bonds and converged at low levels, which also stimulated the economy in the peripheral countries. At that time, market participants called this convergence of interest rates the “interest rate bonus”, and praised it as being “the fruit of monetary union”. In hindsight, however, this convergence of long-term interest rates encouraged loose fiscal policies, or combined with overly optimistic economic projections, led to real estate bubbles in some countries. Meanwhile, necessary structural reforms were stalled, including labor market reforms, and the competitiveness gaps within the region remained unsolved. Given that growth potential in Asia is high and its middle-class is expected to grow further, Asia must avoid over-heating of the economy such as excess investment or the creation of bubbles. This lesson should be relevant even when Asia faces the downside risk associated with the Eurozone crisis, because excessive short-term policy stimulus may increase the potential risk of these imbalances. In addition, even though economic growth is relatively high in the region, it is still important that Asia makes progress on the structural reforms that are necessary for it to maintain this growth over the medium- and long-term. IV. Bank of Japan’s contribution to regional monetary cooperation in Asia In the light of this discussion, I would like to outline the Bank of Japan’s contribution to regional monetary cooperation in Asia. The European Council and the European Commission have played a major role in market integration in Europe, through what we might call “top-down integration”. However, it seems to me that market integration in Asia is moving forward autonomously through trade and foreign direct investment by the private sector, that is to say, through “bottom-up integration”. In light of this, central banks in Asia are working together in promoting regional monetary cooperation to develop deep financial markets. The Bank of Japan also contributes to these undertakings. For example, the Bank of Japan is a leading member of the Executives’ Meeting of East Asia and Pacific Central Banks, or EMEAP, an international forum for 11 central banks from the Asian and Pacific regions. Under the umbrella of the Governors’ Meeting, EMEAP has a number of meetings at different levels: the Deputies’ Meeting, the Working Group on Financial Markets, the Working Group on Banking Supervision, the Working Group on Payment and Settlement Systems, the IT Directors Meeting, and the Monetary and Financial Stability Committee. To address a wide variety of practical on-site issues, member central banks cooperate closely with each other, which could also be described as a bottom-up approach. One specific example of an EMEAP initiative is the effort to develop liquid local bond markets that are able to link directly the region’s abundant savings and its investment opportunities. BIS central bankers’ speeches This grew out of the experience of the Asian currency crisis of 1997, where there was a fundamental recognition that Asia remained highly dependent on banks, indicating that the local bond and other capital markets were not sufficiently developed. To address this problem, the EMEAP central banks established an investment trust called the Asian Bond Fund (ABF) in 2003, and became the initial buyers by investing in sovereign and quasisovereign bonds in eight EMEAP member economies. When it was launched, the Fund was limited to investment only in U.S. dollar-denominated bonds, but in 2005 began to purchase local currency-denominated bonds as well. In the same framework, EMEAP also launched an exchange-traded fund (ETF) called the Pan Asia Bond Index Fund (PAIF) , which was first listed on the Stock Exchange of Hong Kong in 2005, and later cross-listed on the Tokyo Stock Exchange in 2009. In addition, the Bank of Japan, together with the Japanese Ministry of Finance, participates actively in the ASEAN +3 meetings. Under the Chiang Mai Initiative, it has contributed to the creation of a framework to prevent currency crises, and to respond once they occur. Through these kinds of practical activities, members cooperate to develop robust financial markets and establish stable financial systems. V. Conclusion I have discussed the current Eurozone crisis and its implications for Asian economies, as well as the Bank of Japan’s contribution to regional monetary cooperation in Asia. Given its growth potential, Asia is expected to maintain an increasingly large presence in the global economy even when it faces the downside risk associated with the crisis. In that process, a variety of financial supports will obviously play important roles, where the bottom-up nature of the Asian integration process must be recognized and respected. But we should also be fully aware of the potential risk of economic and financial imbalances such as excess investment and credit bubbles in the case of Asia. In deepening regional financial integration, we should always remember the basic viewpoint of achieving sustainable long-term growth in the region. Thank you very much for your kind attention. BIS central bankers’ speeches
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Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Panel Discussion hosted by the Deutsche Bank Group, Tokyo, 12 October 2012.
Kiyohiko G Nishimura: The future of the euro – challenges ahead Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Panel Discussion hosted by the Deutsche Bank Group, Tokyo, 12 October 2012. * I. * * Introduction I am very grateful to the organizer for giving me the opportunity to participate in this panel hosted by the Deutsche Bank Group. The panel cannot be more timely: its theme, as I interpret it, is how the current eurozone crisis should be resolved and what the eurozone will look like in the future, with particular emphasis on the role of Asian investors, especially those from Japan. Since the European authorities share a firm commitment to save the euro, I believe that the whole project of the euro ultimately will succeed. Given the scale and complexity of the problems facing Europe, however, there is likely to be a long and bumpy road ahead toward a genuine monetary and economic union. Today, I will share my views – which also reflect some of the concerns of Japanese market participants – on critical issues regarding the euro in three time horizons: short, medium, and long term. II. Short-term challenge: crisis containment Let me start with the short-term issue of crisis containment. In this respect, to convince investors is the key, and thus top priority should be given to having a strong firewall and putting in place powerful fire extinguishers in sufficient numbers. Money markets remain stable currently, and sovereign bond yields in Spain and Italy have declined noticeably in response to the promise of bond purchases by the European Central Bank (ECB). However, the yields remain at elevated levels, while in contrast major European countries’ shorter-end sovereign yields continue to be extremely low and in some cases negative due primarily to investors’ preference for safety. In short, strong nervousness continues to linger in financial markets. Thus, it is vital to prevent further shocks from triggering market disruptions. Right now, there seem to be no particular funding problems for financial institutions outside Europe, including those in Japan. Nevertheless, in view of the lingering nervousness among market participants globally, it is critical to alleviate the funding uncertainty to the extent possible. The stability of eurozone money markets has been maintained by the ample liquidity provision from the ECB. Still, how the European Stability Mechanism (ESM) and the ECB’s bond-purchasing operations will play their role is the key to preventing contagion of a financial crisis across borders. In this regard, there are two issues. First, one may argue that once these operations start, it will become extremely difficult to cancel them outright even if the outcome is unsatisfactory, since cancellation might imply cutting the lifeline of the recipient (in other words, a classical time-inconsistency problem will arise). Thus, the success of these operations depends critically on their “gateway”: how to craft the conditionality of the operations sufficiently to bring about the desired outcome, not sacrificing much in the recipient country, and how to construct the mechanism to ensure and encourage its compliance. Second, market participants are concerned with possibility beyond the immediate problem: in particular, (1) whether the ESM’s firepower will be sufficient to fulfill its mandate; and (2) whether the ESM will be used flexibly and in a timely manner. In both respects, recent developments are encouraging, and it is anticipated that further clarification of these points will help dispel concerns in financial markets. BIS central bankers’ speeches III. Medium-term challenge: avoiding further negative feedback The second issue is how to avoid a further adverse feedback loop among fiscal conditions, the financial system, and the real economy. To this end, creating a European banking union has enormous significance. A banking union will also redress the inconsistencies in the current banking framework, that is, financial institutions operate freely within the euro area, while bank supervision and the safety net provision are fragmented along national borders. For a banking union to be effective, it is crucial to secure sufficient funds to cover losses if the default of a financial institution occurs. This is a lesson Japan learned from the financial crisis of the late 1990s. In Japan, under the revised Deposit Insurance Act, when a particular financial institution’s default raises real systemic concerns, the losses can be borne by not only the deposit insurance but also the national coffers. This ensures the credibility of Japan’s financial safety net, thereby contributing undoubtedly to financial system stability. To be sure, in Europe, loss sharing of this kind involves the difficult issue of fiscal transfer among member countries. It is very much hoped that appropriate measures will be taken in this regard in a European way. IV. Long-term challenge: convergence Over the longer time horizon, economic convergence is a prerequisite for the euro area financial markets to become a genuine single market with high liquidity. However, what we observe right now is divergence or fragmentation, not convergence. The economies of the euro area countries had not converged sufficiently when the euro was introduced, and the gaps among them widened further after the bubble burst in the middle of 2000s. Divergence is evident in unit labor cost growth and current account balances. Yield differentials in the European bond markets have also widened. Such market fragmentation has forced investors to reconsider country risks, which had been considered eliminated with convergence to a single financial market. To accomplish a greater degree of convergence, while taking into consideration strong national identities and the slow process of population movements across borders, three options are often mentioned, ones that are not mutually exclusive. The first is to carry out so-called internal devaluation in the periphery. The second is to boost productivity and create value-added industries in the periphery. And the third is to implement fiscal transfer from the core to the periphery on the grounds of mutual benefits. Here I believe that the keys to success are the European people’s belief in the euro system and their “solidarity” or the common cause of “European citizenship”. Although achieving any of these options will take a long time and painstaking effort, it is hoped that the euro area nations will continue to do their best on these fronts. V. A new hope: strengthening market infrastructure Finally, I would like to touch briefly on the new hope seen in the strengthening of market infrastructure both in Europe and Japan. For many market participants, strengthening market infrastructure is important for sustained investment in Europe and elsewhere. In this regard, the Eurosystem has been pushing forward with TARGET2-Securities (T2S), a single pan-European IT platform for securities settlement. At the same time, the Bank of Japan is working to revamp the Bank of Japan Financial Network System (BOJ-NET) to enhance the system’s flexibility and accessibility. It is hoped that both of these initiatives will succeed in making global financial markets more resilient and efficient. Thank you very much for your kind attention. BIS central bankers’ speeches
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Remarks by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the workshop co-hosted by the Asian Development Bank Institute and the Reinventing Bretton Woods Committee, "Adjusting the World to the New Realities of the International Financial System", Tokyo, 12 October 2012.
Sayuri Shirai: The euro area crisis, the flight-to-safety premium, and cooperation and coordination among central banks Remarks by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the workshop co-hosted by the Asian Development Bank Institute and the Reinventing Bretton Woods Committee, “Adjusting the World to the New Realities of the International Financial System”, Tokyo, 12 October 2012. * I. * * Introduction Good morning. My name is Sayuri Shirai, and I am a Policy Board member of the Bank of Japan. It is indeed a great honor for me to be here, giving a talk at the workshop co-hosted by the Asian Development Bank Institute (ADBI) and the Reinventing Bretton Woods Committee (RBWC) under the title of “Adjusting the World to the New Realities of the International Financial System”. Currently, one of the major sources of global uncertainty arises from stresses in the euro area. Therefore, I would like to focus today first on the current situation of the euro area crisis. I would then like to move on to the issue of how the euro area crisis has been affecting Japan and other developed countries through financial channels. Finally, I would like to address the challenging issue of cooperation and coordination among central banks. II. Current situation of the Euro area crisis In the euro area, there remains a high degree of uncertainty over political and economic developments. Along with the (short-term) adverse impact of fiscal consolidation measures, the crisis initially led to deteriorating economic conditions in the peripheral countries. Initially, the crisis was largely contained in those peripheral countries. However, the crisis is now affecting the core countries through trade and financial channels and a rapid deterioration in corporate and consumer sentiment. Consequently, the euro area has reentered a recession, and this has contributed to a slowdown in global economic growth. The sluggish economy in the euro area is likely to last at least until the end of the year, according to European Central Bank (ECB) estimates released last month (whereby the central rate of real GDP growth rate for 2012 was adjusted downward from minus 0.1 percent in June to minus 0.4 percent in September). To deal with the financial sector’s funding difficulty in the peripheral countries, the ECB has been actively engaging in a number of accommodative monetary policy measures over the past year – including longer-term refinancing operations with a maturity of 36 months (conducted in December 2011 and February 2012), resumption of the Securities Markets Programme (SMP), reducing the reserve ratio, a cut in key interest rates, and modification of collateral requirements. In July this year, moreover, the ECB cut key interest rates by another 25 basis points: the interest rate on the main refinancing operations was reduced from 1 percent to the historically lowest figure of 0.75 percent, that on the marginal lending facility from 1.75 percent to 1.5 percent, and that on the deposit facility from 0.25 percent to 0 percent. These actions helped lower the short-term interest rates in the euro-denominated money markets and moderated tensions in the area’s financial markets. The yields on long-term sovereign bonds have also declined in the whole euro area, including the peripheral countries. A decline in bank lending rates has also followed in line with the decrease in yields. Nonetheless, the scale of the decline in those rates for the peripheral countries has not been sufficiently large to narrow the gap with those rates in the core countries (Chart 1). This is mainly because the vicious cycles between sovereign and financial stresses – and BIS central bankers’ speeches their repercussions on the real economy – have not been curtailed in the peripheral countries. The high bank lending rates in the peripheral countries are closely associated with the highrisk premiums charged on the yields on their sovereign bonds by investors. Given that these premiums are far above those justified by the economic fundamentals, according to an estimate by the Organisation for Economic Co-operation and Development (OECD) (Chart 2), they could be called a “fear premium”. The International Monetary Fund (IMF, 2012) also reports that these premiums are predominantly driven by a common factor rather than country-specific macro/liquidity risks. As long as there is the fear of possible reversibility of the euro – even in a situation where the expected probability of that tail-risk scenario is extremely low – the ECB will find it very difficult to lower the yields on sovereign bonds of these peripheral countries on a sustainable basis. The fear premium has also promoted fragmentation of the financial markets within the euro area by discouraging cross-border financing activities in the private-sector between the core and peripheral countries. This has resulted in greater dependence of the financial sector in the peripheral countries on the ECB’s refinancing operations, or Emergency Liquidity Assistance (ELA) provided by their national central banks. These operations have led to expansion of the consolidated balance sheet of the Eurosystem. However, it is increasingly recognized that the very accommodative monetary policy has not promoted active lending activities that would stimulate domestic demand (such as investment and consumption) as much as had been expected (Chart 3). In the euro area, sluggish lending activities (for example, the August data on credit growth indicated minus 1.1 percent for firms and minus 0.4 percent for households) reflect a sharp decline in credit demand – caused by weak economic outlook, balance-sheet adjustments, and highly risk-averse behavior as well as banks’ higher lending rates and tightened lending conditions. These sluggish lending activities also reflect a cautious attitude on the part of lenders – driven by growing uncertainty, elevated funding costs, and tighter financial regulations. The weak link between an accommodative monetary policy and private-sector credit growth is a feature observed not only in the euro area but also in other developed countries, including Japan and the United States. There are structural factors behind this issue, but their root causes are country or region specific, and they thus differ from one another. In the case of Europe, the short-term depressing impact of fiscal austerity measures and deleveraging of the banking sector – exacerbated by the fear premium – make it difficult to promote bank lending at present. All these data point to the fact that the transmission mechanism of monetary policy to the real economy may have been hampered by the severe distortions prevailing in the sovereign bond markets which are largely caused by the fear premium. This is why the ECB announced outright monetary transactions (OMTs) last month (and terminated the SMP) together with a strict, comprehensive conditionality attached to the European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) program (whether it is based on a full or a precautionary program) in the event of their activation. This conditionality is a necessary condition, since the ECB Governing Council will decide on the start, continuation, and suspension of OMTs in accordance with its mandate, once a country under examination adopts the program. I believe that such an imposition of conditionality on the activation of an asset purchase program is an action rarely seen in the recent history of central banking. The ECB made it clear that the proper transmission mechanism of monetary policy could be restored if progress was also made in the following areas: fiscal consolidation programs, structural reforms (i.e., labor-market reform, deregulation, privatization, and efficiency of public administration), and region-wide institution building (or regionally coordinated actions to strengthen the firewall limiting the contagion of a crisis from one country to another in addition to the possibility of EFSF/ESM primary market purchases). In other words, it was BIS central bankers’ speeches made clear that monetary policy could contribute to narrowing the output gaps and preventing disinflation. This should be regarded as a temporary measure in providing breathing space, while governments and regional institutions (such as the European Union [EU] or the Eurogroup) deal with the structural issues that are necessary to lower the fear premium and raise the potential (trend) economic growth. Here, the IMF could play an important role as a third party in the process. Meanwhile, Japan also suffers from a weak link between a very accommodative monetary policy and private-sector credit growth (Chart 4). However, the root causes of this weak linkage in Japan differ from those in the euro area. Japan’s financial conditions have been very accommodative. The financial sector – which has hardly been affected by the euro area crisis thanks to relatively sound balance sheets, low leverage ratios, and ample deposits – has largely maintained an accommodative lending attitude. Therefore, sluggish credit growth is largely a consequence of limited demand for credit (such as loans to finance business investment and mortgages), as evidenced by the declining trend in new business fixed investment as a percentage of GDP (and cash flow) and the moderate increasing trend in housing investment. This phenomenon is closely associated with the declining potential (trend) economic growth, long-standing mild deflation, and persistent output gaps. These features characterize the Japanese economy and partially reflect cyclical factors. But more importantly, these features are attributable to structural factors – such as demographic changes (the rapid pace of aging, the declining working-age population from the mid-1990s, and the constantly declining population projected from 2011 onward), structural rigidity (which hinders smooth inter-industry and intra-industry structural adjustments), growing global competition, and completion of the catching-up process (Shirai 2012). Against this background, it is becoming increasingly important to differentiate between cyclical and structural factors, when considering the effectiveness of monetary policy. While an accommodative monetary environment is being maintained, efforts by the government and private sector are also important in order to raise potential economic growth and leap from a mild-deflationary phase onto a sustainable path. III. Impact of the Euro area crisis on Japan and other developed countries through financial channels The euro area crisis has been adversely affecting the global economy mainly through trade and financial channels. Japan has also been affected through sluggish exports over the past few months owing to both a direct and indirect decline in exports to Europe through the supply-chain network centered on mainland China. The lower-than-expected export activities were one of the factors considered when the Bank of Japan (BOJ) made a downward adjustment of the economic outlook at the Monetary Policy Meeting last month. At the same time, the BOJ decided to enhance monetary easing to ensure the return of Japan’s economy onto a sustainable growth path with price stability. In addition, the euro area crisis has promoted capital inflows to “safe haven” countries, such as Japan, the United States, and core European countries, and it has amplified the “flight-tosafety premium” or “scarcity premium” charged on yields on their long-term sovereign bonds. There are various measures for estimating these premiums. One simple approach is to estimate the difference between the observed long-term interest rate (e.g., the yield on 10-year sovereign bonds) and expected nominal GDP growth (or the sum of expected real economic growth and expected long-term inflation). Based on recent data, the differences indicate a negative figure for Japan, the United States, Germany, and the United Kingdom in the range of between minus 1 percent and minus 3 percent, which appears to confirm the presence of the flight-to-safety premium. A more sophisticated approach is to conduct a regression analysis using the long-term interest rates as the dependent variable and various structural and relevant indicators (such as fiscal conditions, foreign borrowing, labor productivity, demographics, and inflation) as the BIS central bankers’ speeches independent variable. Then, the residual could be interpreted as reflecting the flight-to-safety premium, the impact of monetary policies, and so on. To separate the possible impact of monetary policy from this analysis, Ichiue and Shimizu (2012) employed the 5-to-10-year forward rate as the dependent variable (rather than the 10-year bond yield). In this case, the residual could be interpreted as reflecting the flight-to-safety premium (assuming that unexplained factors are limited). If the residual shows a negative sign, it can be interpreted as indicating the presence of such a premium. The estimates of the residual or the difference between the observed 5-to-10-year forward rate and the estimated forward rate derived from the model indicate a negative figure for Japan, the United States, Germany, and the United Kingdom (Chart 5). This means that the observed long-term interest rates were lower than the estimated rates in those four countries, which suggests the presence of the flight-to-safety premium. This is in contrast to a rising fear premium applied to the yields on sovereign bonds of the peripheral countries. My view is that the increase in the flight-to-safety premium is attributable to the supply shortage of “safe assets” because the repeated credit rate downgrading on sovereign bonds has reduced the number of high-quality sovereign bonds in Europe. Moreover, the global financial crisis triggered by the bankruptcy of Lehman Brothers had already reduced the number of triple-A-rated private-sector bonds (such as mortgage-backed securities [MBSs] and other asset-backed securities [ABSs]), thus contributing to the relative shortage of safe assets globally. Meanwhile, demand for safer liquid assets has been growing in the world owing to continued uncertainty related to the euro-area stresses, an increase in foreign reserves held by emerging economies and oil-producing countries, and tighter financial regulations. Consequently, capital inflows into securities investment from abroad have contributed to the appreciation of the exchange rates of some of these countries, as typically seen in the case of Japan (Chart 6). This has adversely affected the export manufacturing sector, which had been recovering from the supply-chain disruption and resultant plunge in exports caused by the Great East Japan Earthquake on March 11, 2011. Moreover, the flight-to-safety premium, while lowering the cost of financing for borrowers, may amplify the sudden reversal risk in Japan and other related countries. The IMF stressed the possibility of such a risk in the medium term. Given the high degree of correlation between Japanese government bonds and other sovereign yields during normal periods, such a risk could materialize through a spillover effect from one country to another. That report also suggested that a sudden rise in the yield, when most developed countries’ policy rates are at the zero bound, might result in the output of Japan and other countries falling below their baseline growth paths. IV. Cooperation and coordination among central banks Finally, I would like to talk about issues related to cooperation and coordination among central banks. It is true that a number of central banks in developed countries, including Japan, have been conducting a very accommodative monetary policy (such as a virtually zero-interest rate policy and an asset purchase program) to cope with weak economic growth and prevent disinflation (or to achieve recovery from mild deflation in the case of Japan). These policies are necessary and consistent with the mandate of our central bank laws under the current situation. But it is also true that such policies could exert positive and/or negative spillover effects on other countries. It is often pointed out that the exceptionally low interest rates and injection of ample liquidity using nonstandard measures in developed countries have contributed to the generation of volatile capital flows and exchange rates and amplified the boom-bust cycle in emerging economies. For example, Mr Caruana, the General Manager of the Bank for International Settlements (BIS), noted that credit to U.S. households and businesses has barely resumed its growth since the crisis, whereas dollar loans to such borrowers in the rest of the world BIS central bankers’ speeches have increased by up to 20 percent (2012). He also pointed out that the Federal Reserve’s recent large-scale bond purchase has reduced global bond yields under the increasingly integrated international bond markets. At the same time, central banks in emerging economies may be conducting asymmetric monetary policy to mitigate the volatile exchange-rate movements. For example, some countries have maintained relatively low interest rates for a long time in the face of massive capital inflows, though a rise in the interest rate could be executed relatively quickly in the case of capital outflows. This kind of action could be related to the failure of policy coordination since each country attempts to avoid exchange-rate appreciation relative to competing countries in order to maintain competitiveness, and thus each waits until some other country takes the initiative. This results in the prolonged accommodative monetary policy stance, thereby contributing to a rapid increase in commodity prices, credit growth, and overheating of economies. Considering the possibility of a fallacy of composition, Mr Caruana stresses the importance of assessing the impact of central bank policies on global outcomes. In this sense, the IMF’s attempt to focus on the external effects of policies in major economies in the Spillover Reports launched in 2011 is a welcome step to promote understanding of this issue. Active discussions at the G20 meetings can also contribute to global awareness. Though fulfilling its mandate is an important obligation for a central bank, each central bank increasingly pays attention to the possible trade-off between price stability and financial stability. This arises from the lesson of the global financial crisis, whereby relatively low policy rates in a low inflationary period can contribute to accumulating financial imbalances. Since financial activities take place on an increasingly global basis and financial markets are rapidly integrating, it is also becoming increasingly important for central banks to pay attention to global investors’ risk appetite and capital-flow movements when the transmission mechanism of monetary policy is considered. Thus, I myself feel that promoting further information sharing among central banks is becoming important. With the growing interdependence of financial markets, the importance of policy coordination among central banks has increased. As an example, I would like to point out one effective coordinated policy action recently undertaken by six central banks (the Bank of Canada, the Bank of England, the Bank of Japan, the ECB, the Federal Reserve, and the Swiss National Bank) – namely, the U.S. dollar liquidity-providing operations. These were aimed at addressing pressures in the global money markets (Chart 7). The action was taken in November 2011 as a response to growing strains in U.S. dollar financial markets. Those central banks agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points so that the new rate would be the U.S. dollar overnight index swap rate plus 50 basis points. As a contingency measure, moreover, these central banks agreed to establish temporary bilateral liquidity swap arrangements so that liquidity could be provided in each jurisdiction in any of their currencies if necessitated by market conditions. As a result, this action – particularly the cut in the interest rate on the U.S. dollar liquidityproviding operations – succeeded in substantially lowering the cost of swapping euros for U.S. dollars (Chart 8). Furthermore, the decline in the U.S. dollar funding cost encouraged many European banks that were having difficulty in raising funds from the market to borrow directly from the ECB, thereby preventing a forced fire sale of assets and a cut in loans denominated in U.S. dollars. In closing, the recent global and euro-area crises have reminded us of the deepened financial integration and resultant greater spillover effects of shocks from one country to another. I feel that efforts to deepen an understanding of these issues could be an important first step toward achieving economic and price stability globally. Thank you very much for your attention. BIS central bankers’ speeches Chart 1 Policy rate and lending rates in the Euro area Source: European Central Bank. Chart 2 Gaps between observed and expected spreads over German bonds Notes: 1. Actual spreads refer to 10-year bond yields as of September 4, 2012. 2. Expected spreads are based on the past relationships between yields and debt rates. Source: Organisation for Economic Co-operation and Development. BIS central bankers’ speeches Chart 3 Money stock, monetary base, and loans in the Euro area Sources: Bank of Japan; Cabinet Office; European Central Bank; Eurostat. Chart 4 Money stock, monetary base, and loans in Japan Sources: Bank of Japan; Cabinet Office. BIS central bankers’ speeches Chart 5 Estimated premiums charged on sovereign bond yields Note: Estimated premiums in Japan, the United States, and the United Kingdom are differences between observed and estimated 5-to-10-year forward rates as of May 2012, and those in France, Italy, Spain, Ireland, Portugal, and Greece are differences between observed and expected 10-year bond yields, shown in Chart 2. Sources: Organisation for Economic Co-operation and Development; Bank of Japan. Chart 6 Nominal effective exchange rates Sources: Bank of Japan; European Central Bank; Bloomberg. BIS central bankers’ speeches Chart 7 Basic scheme of U.S. dollar funds-supplying operations Note: Participated in by the central banks of Canada, the United Kingdom, Japan, the euro area, the United States, and Switzerland. Chart 8 European banks’ U.S. dollar funding costs (3-month) Source: Bloomberg. BIS central bankers’ speeches References Caruana, Jaime, “Policymaking in an Interconnected World”, Luncheon Speech at the Federal Reserve Bank of Kansas City’s 36th Economic Policy Symposium on “The Changing Policy Landscape”, Bank for International Settlements, 2012. Ichiue, Hibiki, and Yuhei Shimizu, “Determinants of Long-Term Yields: A Panel Data Analysis of Major Countries and Decomposition of Yields of Japan and the US”, Bank of Japan Working Paper Series, No. 12-E-7, 2012. Ichiue, Hibiki, and Takeshi Kimura, Toshifumi Nakamura, and Hikari Hasebe, “Anzen Shisan no Jyukyu to Kokusai no Kishousei Puremiamu”, Bank of Japan Review Series, 2012-J-1, 2012 (available only in Japanese). International Monetary Fund, “2012 Spillover Report”, 2012. Organisation for Economic Co-operation and Development, “What is the Near-Term Global Economic Outlook? An Interim Assessment”, 2012. Shirai, Sayuri, “Have Demographic Changes Affected Japan’s Macroeconomic Performance? – Some Implications for Monetary Policy –”, Speeches at the Bank of Finland, the Riksbank, and Stockholm University, Bank of Japan, 2012. Shirakawa, Masaaki, “International Policy Response to Financial Crises”, Remarks at the Symposium Sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, Bank of Japan, 2009. BIS central bankers’ speeches
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Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the International Council Meeting of the Bretton Woods Committee, Tokyo, 13 October 2012.
Masaaki Shirakawa: Lessons from the global financial crisis – Asian and global perspectives Remarks by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the International Council Meeting of the Bretton Woods Committee, Tokyo, 13 October 2012. * * * It is an honor to be a part of this esteemed panel. With the hope of stimulating further debate, I would like to discuss three lessons from the global financial crisis and the resulting challenges they present. First, in this globally interconnected world, nothing is purely regional anymore. A global perspective is crucial. When the euro area crisis was initially brewing a couple of years back, there was reluctance from our European colleagues to discuss it as an issue with global implications. The euro area economy was recovering and it was argued that the current account of the euro area as a whole was balanced and that intra-area imbalances were manageable. It was presented as a regional problem with regional solutions. We all know now that this was not the case. The euro area crisis has impacted global growth through both trade and financial channels, probably in a much larger way than initially expected. Resolving the euro area crisis has become a key agenda item for the G20, and the IMF is playing a key role together with the euro area core countries towards its resolution. To give another example, when economic growth decelerated in the advanced economies last year, there was hope that the emerging economies, especially those in the Asia would pick up the slack. Asian economies provided approximately 40% of global growth in 2011 and their share in global exports was more than 30% in 2011. This, however, did not mean they were immune from the slowdown of the European economy. Weakness in Europe has impacted Chinese exports, and through the regional supply chain, exports and growth have been impacted broadly throughout Asia. The IMF, in its Regional Economic Outlook published yesterday, points out that two-thirds of emerging Asia’s exports are linked to demand from Europe and the United States, and Fund has reduced its growth outlook for Asia in 2012 from 6.0% to 5.4%, and that of 2013 from 6.5% to 5.9% respectively. They have also noted that this estimate is based on the premise that conditions in Europe improve gradually and that the fiscal cliff in the United States will be avoided. Considerable downside risks remain. The second lesson is that putting one’s house in order is an essential prerequisite condition for each country to achieve sustainable growth, but not a sufficient condition. In formulating macroeconomic policy, the traditional emphasis was to ensure domestic stability or to put one’s house in order. However, the simple sum of each country’s policy actions may not necessarily achieve an optimal outcome at the global level. Although policy-makers in each country may be acting rationally from its own individual perspective, collectively there is the risk of a fallacy of composition. Currently, many central banks in advanced economies have entered the realm of unconventional monetary policy such as the purchase of various types of assets to spur growth and to buy time as the sectors of the economy go through balance-sheet repairs. However, as the domestic monetary transmission mechanism is constrained, there may also be unintentional cross-border spillover effects, such as increases in capital inflows to other countries. The effects could also feedback to the originating country. Meanwhile, central banks in emerging economies have also shifted toward monetary accommodation or relaxed recent tightening moves. These steps are necessary to support growth. But what this global monetary accommodation ultimately means for global BIS central bankers’ speeches commodity prices and inflationary pressures, and as a result to global macro-economic stability, is something that will likely require close monitoring. Another dimension would be the tendency to focus on external demand to spur domestic growth. This is a natural reaction when domestic demand is fragile. When the global economy as a whole is growing rapidly this would not be an issue, but when global growth is weak, this could mean taking away possible opportunities from other economies. If rapidly growing emerging economies were to succumb to the temptation to resist the appreciation of one’s currency, this could be counterproductive from a global perspective. The third lesson is that although measures taken by central banks, both individually and collectively, have been successful in stabilizing the economy and the financial system during the crisis, policy-makers, including central banks, cannot be complacent. For example, the ECB’s OMT has significantly taken away tail risks in the euro zone. This respite is probably, nonetheless, only temporary and this opportunity must be used to fundamentally resolve the root causes of the crisis within the euro area. Another example would be the central bank swap lines which were introduced during the height of the crisis after the collapse of Lehman Brothers and still function as a backstop to maintain stability in global interbank markets. The swap lines substantially reduced stress in the interbank funding market for foreign currencies. The flexibility that central banks have to act when necessary, and to introduce measures as necessary, is a powerful framework in times of crisis. However, they are not permanent in nature and do not resolve the possible risks arising from global imbalances and volatile capital flows. The liquidity that central banks provide can be quite effective in alleviating the pain of the adjustment process, or temporarily stabilizing the situation in times of stress. The key is to use this temporary respite to initiate a positive cycle of fundamental reforms which will provide the foundation for strong, sustainable and balanced growth. I have presented what I believe to be three lessons from the global financial crisis. How could they be seen from both an Asian and global perspective? First, putting one’s house in order does remain a key objective for all countries. Sound macro-economic policies will continue to be of utmost importance. Second, in putting one’s house in order, policy-makers need to be conscious of the cross-border spillover effects and the ensuing feedback effects on their own economies. Such elements in their totality will need to be internalized within the decision-making process. Such considerations will be important not only for macro-economic policy, but also macro- and micro-prudential policies. Prudential rules to stabilize a financial system in one jurisdiction could push business across borders or influence global capital flows. Furthermore, extra-territorial application of domestic rules, in spite of its good intentions, could have unintended negative consequences for the stability of financial systems of other countries. Third, regional frameworks such as the Chiang Mai Initiative can play a vital role in maintaining financial stability in the region. It reflects the unique characteristics of the region and provides strong incentives to countries in the region to work together. At the same time, it does not replace existing international financial arrangements, but rather supplements them. Furthermore, the stability of the Asian region naturally has global implications. Thus, the regional surveillance provided by the ASEAN+3 Macroeconomic Research Office, AMRO, together with the global surveillance provided by the IMF will both play a pivotal role in the effective operation of the Chiang Mai Initiative. Thank you. BIS central bankers’ speeches
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Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a high-level seminar, co-hosted by the Bank of Japan and the International Monetary Fund, Tokyo, 14 October 2012.
Masaaki Shirakawa: International financial stability as a public good Keynote address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a high-level seminar, co-hosted by the Bank of Japan and the International Monetary Fund, Tokyo, 14 October 2012. * * * Introduction Once again, it is a great pleasure for me to welcome you to Tokyo on the occasion of the annual IMF-World Bank Meetings. About two years ago, at the Per Jacobsson Lecture in Basel, my old and respected friend, the late Tommaso Padoa-Schioppa, offered his insights on how to strengthen the governance of the rapidly integrating global economy. 1 Since then, the subject has been in a corner of my mind. Today, I am happy to co-host with the International Monetary Fund a high-level seminar devoted to that topic. Many of you here today probably heard Tommaso forcefully present his case, but for those members of the audience who were not on hand at that time, I would first like to offer you a brief summary. Tommaso observed that one of the causes of the Great Financial Crisis was the failure of national governments to properly rein in market forces, which were fast becoming global in nature. He saw that the increase in cross-border financial activities required a corresponding increase in the provision of basic facilities or services – supporting or facilitating those activities – including prudent regulation and supervision from a cross-border perspective. Nevertheless, the supply of such facilities or services was deficient or lacking because national governments inherently could not provide for them. The solution, he argued, was to enhance supranational governance of the global economy. I. The Great Financial Crisis and the supply of global public goods As Tommaso and many others have pointed out, the Great Financial Crisis has exposed the naïve simplicity of the view that, if the economic policies of individual economies are geared towards domestic economic stability, and private actors are allowed to operate freely in such an environment, the global economy would be all right. The painful realization is that the self-correcting power of the market goes only so far. Markets must sometimes be nudged, pushed, or even forcefully shoved off their existing trajectory so as to prevent them from running into disasters. In order to function properly, markets also depend on things that are not provided spontaneously by themselves, such as the rule of law, respect for private property, and the safety and freedom of passage. “Public goods” is the name ascribed to these facilities or services in economics textbooks, and global public goods are those needed for the global economy to function properly. So, what are the global public goods that support the functioning of the global financial system? One obvious but only partial answer is the appropriate regulation and supervision of cross-border financial activities. The Great Financial Crisis has demonstrated that there were many shortcomings in this area, and the international community has taken steps to correct them. Good regulation and supervision are important, but by themselves are not sufficient. The soundness of individual financial institutions is one building block of financial stability. In this sense, the international public good supporting global financial Padoa-Schioppa, Tommaso, "Markets and Government Before, During, and After the 2007–20XX Crisis," The Per Jacobsson Lecture in Basel, Switzerland, June 27, 2010. BIS central bankers’ speeches markets is not provided solely by regulators and supervisors. Various agents, including but not limited to central banks, ministries, and regulatory boards, work together to realize a stable international financial environment through conducting prudent monetary policy, performing effective regulation of financial actors, and promoting robust market infrastructures. By looking at international financial stability as a public good, we can apply a well-established microeconomic analytical framework to it. A public good is a good that is both non-rivalrous and non-excludable: that is, one’s use of a public good does not reduce the availability to others and one cannot effectively prevent the use by others. Consequently, two important features of public goods are that they will not be provided if left solely to the market, and that they tend to be consumed excessively when they are provided at all. The latter insight allows us to interpret the Great Financial Crisis as being the consequence of overconsumption of a public good – namely, international financial stability. Financial institutions took stability for granted and shouldered excessive risks. This exaggerated the impact when the risks were manifested; markets could not regain stability by themselves and had to wait for interventions by the public sector, including the coordinated provision of liquidity by central banks. II. Providing global governance in a globalized world In a world where globalization is deepening, and where national financial systems are becoming more interconnected, financial stability must increasingly be achieved at the global level. To make this happen, good governance at the global level is essential. Fortunately, nobody is against strengthening global governance as a concept. Everyone instinctively realizes that something must be done to ensure the proper functioning of the financial system, which has expanded beyond national borders and has become global. Unfortunately, progress, though accelerated by the Great Financial Crisis, has still not been fast enough. Why is this the case? Professor Dani Rodrik of Harvard University has offered us an informative perspective.2 He claims that hyperglobalization, the nation state, and democratic politics cannot be maintained simultaneously. For example, in recent years, the advances in information and communication technologies have enabled financial institutions to expand their activities across borders. As we have seen recently in Iceland and Ireland, such institutions could get into trouble because of activities outside their home markets. When the government of the home market attempts to bail out these institutions without destabilizing the global financial markets, the cost could be so huge that it would exceed the ability of the home-country taxpayer to pay, thereby compromising democracy. If we wish to avoid this outcome, we would either have to opt for a democratically elected global government that could provide a global safety net, thus compromising the nation state, or opt to restrict the global activities of financial institutions to the extent manageable by democratically elected national governments, thus compromising globalization. Of the three potential outcomes, Professor Rodrik prefers the third one, calling not for hyperglobalization but “smart globalization.” Many reasonable people would probably agree. In view of the slow and limited progress in strengthening global governance, and without any meaningful prospect of acceleration, such a choice seems sensible. The problem, however, is that it may be difficult to restrain globalization effectively. The flip side of overconsumption of public goods is insufficient internalization of the costs for Rodrik, Dani, The Globalization Paradox: Democracy and the Future of the World Economy, W. W. Norton & Company, February 2011. BIS central bankers’ speeches providing such goods. This could imply that profit opportunities arising from globalized financial activities may be sufficiently large such that there is a strong incentive to circumvent any restrictions. At the same time, the advances in transportation, and in information and communications technologies, make it ever easier for private actors to dodge inconvenient rules and regulations. From our experience, we know very well that the ingenuity of the private sector in this regard should never be underestimated. We all remember the Bretton Woods System, which was an attempt at smart globalization, and the collapse of this system offers us a cautionary tale. Furthermore, in a world where public and private actors taking part in economic activity are becoming ever more diverse, it would be quite a challenge to agree on what is desirable globalization and what is not. If, in despair, unilateral action, such as trade bans, mandatory domestic incorporation, or forced repatriation, is taken, everybody would become worse off. Is there a way out of this predicament? If the objective of global governance is to secure global financial stability, and if global financial stability is a public good, global governance can be analyzed as a microeconomic problem regarding public goods. There are well-known options to solving the problems posed by public goods. The most straightforward is to have the public sector provide the public goods. Alternatively, rules could be established regarding the consumption of public goods. Another option is to tax the consumption of public goods or subsidize the production thereof. There are still other options, such as changing the public character of the goods by increasing their exclusivity. Not all may be applicable to international financial stability, and some may be more easily implemented than others. In view of the discussions during various international fora in which I have participated, I have a feeling that we are making it more difficult for ourselves by opting for the seemingly most obvious option – tasking the public sector with providing international financial stability. As Tommaso observed, there is a limit to what individual nation states can provide as global public goods. A coherent set of public goods provided by a single global public entity would be desirable, but there is no workable way of introducing such an arrangement consistent with our democratic principles. International organizations are often criticized for deficits in democratic accountability. On the other hand, a democratically elected world government with the power to tax is unthinkable in the near future. The current situation in the euro area is an example of this intractable problem. We therefore should aim for a more practical approach, combining various options that are known for solving the public good problem. Some public goods, such as effective supervision of globally important financial institutions, could be provided at the national level. Supranational institutions could be asked to take on specific tasks, such as monitoring global financial developments and identifying macroprudential risks, without undermining democratic principles. Private actors could be made to follow certain rules, such as the Basel rules on capital adequacy, which are in fact rules regulating the consumption of global financial stability. It may even be possible to devise ways to influence the behavior of these actors through taxes and subsidies. For example, capital adequacy standards could also be seen in this light, considering that they would increase costs of engaging in riskier behavior. Some might even argue for financial transaction taxes as an option, though I do not believe that benefits would outweigh the costs, such as their impact on market liquidity. In any case, we must be willing to adopt a flexible and multi-tracked approach to global governance, which should be more adaptable to and consistent with the increasingly diverse global landscape. III. Global governance and central banks Turning to what central banks could do in the context of global governance, they are without doubt important actors given their role in monetary, prudential, and payment systems policies. Stable and sustainable growth in individual economies, which is the ultimate BIS central bankers’ speeches objective of central bank policies, is an important building block of a stable global financial environment. In times of emergency, as we have seen during the Great Financial Crisis, the coordinated provision of liquidity by central banks plays an important role in maintaining financial stability. Central banks are deeply involved in international rule making as well. At the same time, a central bank is constrained by its mandate, which is granted by the nation state (or nation states in the case of the European Central Bank). While it is independent of the national government, its actions must be accountable, ultimately to the people of the nation. The central bank must be conscious of the legitimacy of its actions. Nevertheless, if this prevents it from thinking outside the box, when that is necessitated by a changing economic environment, a good outcome cannot be ensured. The gradual and sometimes spontaneous evolution of central banking since the middle of the 19th century underscores this point. One issue that immediately comes to my mind in this regard is the international spillover and feedback effects of monetary policy. Global financial stability would be elusive if these effects were not sufficiently internalized. Concluding remarks Every so often, we are tempted to say that big problems need big solutions. The reality, however, is that the best big solution turns out to be an aggregate of small steps. Global problems, therefore, require global solutions, but such solutions can be broken down into more manageable parts. I hope that all of you find today’s seminar to be such a small but important step forward. Thank you for your attention. BIS central bankers’ speeches
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Remarks by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Securities Analysts Association of Japan Annual Conference commemorating its 50th anniversary, Tokyo 15 October 2012.
Hirohide Yamaguchi: Strengthening growth potential, role of the market, and “production of information” Remarks by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at the Securities Analysts Association of Japan Annual Conference commemorating its 50th anniversary, Tokyo 15 October 2012. * * * Introduction Thank you for having me at the annual conference jointly hosted by the Securities Analysts Association of Japan (SAAJ) and Asian Securities and Investments Federation (ASIF). All the participants here have been striving for the development of securities markets, and, through such efforts, have been contributing to the sound development of Japan’s economy. On behalf of the Bank of Japan, I will pay great respect to your efforts. Today, under the title “Strengthening Growth Potential, Role of the Market, and ‘Production of Information’,” I will talk about my views on the importance of the financial function that supports economic growth and how securities markets should be, and then I will send cheers to securities analysts while referring to their expected roles. I. Japan’s economy and securities markets 50 years ago, in 1962 when the SAAJ was established, Japan’s economy was in the midst of a high growth period. Japan’s economy grew by an annual average of 9.7 percent from 1956 up to 1970. It made a transition to stable growth, triggered by the oil shocks, but was on a constant growth path until a bubble burst at the beginning of the 1990s. After the burst of a bubble, things changed completely and the average growth rate declined substantially to around 1.5 percent in the 1990s and around 0.5 percent in the 2000s. The history of securities markets developed in tandem with such a long-term trend in the real economy. During the high growth period, firms’ buoyant fund demand was mainly supported by indirect finance. However, even during such period, the securities markets gradually came close to people as the phrase “goodbye banks, hello securities firms” began to be heard in the early 1960s when investment trust started to spread among people. Subsequently, the markets continued to grow by weathering trials, including securities markets’ slump after the Tokyo Olympics and, in the 1980s, both the stocks market and the corporate bonds market got into full swing amid financial liberalization and globalization. While equity finance by convertible bonds and warrant bonds rapidly increased during the bubble period on the back of strong expectations for a rise in stock prices, market expansion based on excessive expectations did not last long after all. Since the 1990s, a variety of reforms have taken place mainly to address various events that surfaced in accordance with the emergence and the burst of a bubble, and the markets have steadily improved. However, amid the continued low economic growth, the environment surrounding securities markets has been severe and there has recently been concern over a decline in the competitiveness of Japanese securities markets compared with those overseas. II. Finance, which holds the key to strengthening growth potential I have been mentioning repeatedly on various occasions the fundamental background to a declining trend in the growth potential of Japan’s economy. Put it simply, the economy has not sufficiently adapted to major changes of the demographic vortex and globalization. Therefore, to strengthen growth potential, it is essential to tap new potential demand associated with progress in aging and to incorporate expanding global demand, mainly that BIS central bankers’ speeches of Asian economies. To that end, firms’ attempts and an improvement in the environment that supports such attempts are required. Given that new attempts are always associated with risks, it is not too much to say that the power of finance that evaluates and shoulders such risks will be a key to strengthening the growth potential of Japan’s economy. Encouraging firms’ attempts and unlocking their growth potential will promote business fixed investment and research and development, expand employment, raise wages, and, through an increase in interest and dividend as well as capital gain, strengthen households’ income and asset formation. In the 2000s, Japan’s economy experienced an economic expansion of six years and one month, which was longer than the Izanagi boom during the high growth period, and the Nikkei Stock Average once rose to about 18,000 yen. However, corporate behavior to achieve an improvement in business performance through cutting wages and costs was retained strongly during that period. And, to start with, the economic recovery relied heavily on exports on the back of financial bubbles in the United States and Europe. Therefore, while the economic expansion continued for a long time on the surface, it did not become a sustainable economic recovery backed by an autonomous mechanism. Given such recent experience, it is not an easy task to bring out many firms’ incentives to take on the challenge of tapping potential demand and thereby strengthening growth potential amid further progressing aging. However, that is why there are high expectations for the role of financial and capital markets, in which growth money is created. Of course, among eventual fund providers in the financial and capital markets, there are those who want to invest their funds safely by making deposits and there are those who want to increase their investment profits by taking certain risks. It is necessary to enhance the capability of financial and capital markets as a whole to convert a variety of fund management needs into economic growth, while utilizing each characteristic of indirect and direct finance. III. Three conditions required for securities markets Based on what I have said, now, I will focus on the securities markets in which analysts are directly involved, and from the viewpoint of strengthening power that creates economic growth and developing securities markets themselves, I will mention three conditions for a desirable form of markets. First, a high degree of efficiency and fairness. Securities markets can function efficiently only after proper pricing for risks and returns is made. Therefore, it is deemed desirable that many investors who have a variety of evaluation criteria should participate and that the markets should be highly liquid. To that end, first of all, offers of versatile solutions for each fund raiser and fund investor as well as securities trading in the secondary markets have to be made at low costs, namely, the markets need to be a place of efficient financial transactions. In addition, in order for the markets to be a place in which many investors feel safe in participating, the fairness of transactions based on proper governance and high ethical standards has to be guaranteed. In Japanese securities markets, especially after the burst of a bubble, various kinds of system reform have been made in order mainly to achieve a sound competitive environment. However, securities markets have recently been exposed to harsh global competition. In order to maintain the international competitiveness of Japanese securities markets, it is critical to unflaggingly implement efforts to enhance the markets’ efficiency and fairness in the future. In that regard, a move to establish Asia’s number one stock exchange by merging the Tokyo Stock Exchange and the Osaka Securities Exchange is highly expected as a new start of Japanese securities markets. Second, the existence of investors who aim at increasing their medium- to long-term returns. Of course, I do not deny that aiming at short-term trading profits is one of investment strategies or that it enhances market dynamism and liquidity. However, not only to chase short-term profits but, for example, for investment institutions, including pension funds and BIS central bankers’ speeches insurance companies, to make utmost efforts to raise medium- to long-term returns will enhance securities markets’ function of selecting promising firms and projects and eventually contribute to achieving sustainable growth of Japan’s economy. In that regard, it is also important that households, which are the eventual fund providers, become highly interested in their own asset management. Given that most of households’ financial assets of 1,500 trillion yen have still been in cash or deposits even though long time has passed since “savings to investment” was called for, there seems to be plenty of room for improving the environment which gets growth money out of sleep. For example, to promote initiatives to raise interest in asset management, including the enhancement of financial education that fits each age-group, could encourage investment institutions, which receive households’ long-term funds, to compete at a higher level. Third, the markets need to be a place in which high quality information is created to steadily support investment judgment. What is important, first of all, is disclosure of fund raisers and investors relations. While it goes without saying that honest and fair disclosure is required, in addition to that, it is critical that firms strive to actively and convincingly explain their own management strategies. Firms’ information will be analyzed and evaluated from various angles by market participants, and utilized for investors’ decision making. In financial theory, a situation in which fund providers do not have sufficient information of fund-raisers is called “information asymmetry” and, if the asymmetry is substantial, even growth of firms with great potential will be constrained from the funding side. Therefore, it is considered that the resolution of “information asymmetry” is the intrinsic function of finance and added-value that finance contributes to economic activity. Added-value is created through “production of information.” While the “production of information” is somewhat an abstract expression, simply put its specific meaning, it is nothing less than high-quality analysis and evaluation of the investment asset class. And, those who play an important role in that regard are securities analysts. IV. “Production of Information” and expectations for securities analysts Now let me offer three specific expectations for securities analysts. First, neutral information transmission based on accurate analysis. The standpoint of securities analysts varies according to organizations they belong to, such as the sell-side, the buy-side, and the rating agency. However, for the information they transmit to be trusted and influential, the accuracy of analysis as well as a fair and neutral perspective will be inevitable elements. As for a specific angle of analysis and message to be emphasized, individual securities analysts should devise ways by fully utilizing their respective expertise and knowledge. With securities analysts stimulating each other from different perspectives, “production of information” in the markets as a whole will be elevated both in terms of quality and quantity. What I especially expect is the “production of information” that contributes to exploring growing companies. Although the growth potential of Japan’s economy has been declining, if looked at individually, there are many firms with high profits and growth, and there will be further more potentially growing firms. Finding out such promising investment opportunities one by one and nurturing them, while it seems a roundabout approach, will offer a potent breakthrough for eventually increasing growth potential of Japan’s economy. Second, maintaining full communication with firms. While the role of securities analysts is basically to provide investors with analysis on firms, cherishing connection with firms that are the subject of analysis eventually means that securities analysts will ask those firms their unique questions. Namely, securities analysts can contribute to the process, in which firms constantly develop their business strategies while incorporating investors’ perspectives. In other words, securities analysts play a valuable role as an interactive connecting point between firms and investors. Third, playing an active role as global human resources. While currently a slowdown in emerging economies has become somewhat protracted, those economies have high BIS central bankers’ speeches growth potential in the medium to long term and, on the financial front, it is likely that especially Asian securities markets will expand substantially. Just like today’s conference, information exchange and interaction of people at a global level will become increasingly active in the future. In order to improve the attractiveness of Japan’s securities markets and attract overseas investors, and also to utilize expanding overseas investment opportunities in the asset formation of Japanese households, I expect securities analysts to play an active role with the key words “Asia” or “global.” Concluding remarks From the perspective of strengthening growth potential of Japan’s economy, today I have talked about the importance of the role securities markets and securities analysts play. I think the aforementioned term “production of information” illustrates how financial business is a knowledge-intensive industry. In Japan’s economy, in which the labor force has been declining in association with aging, increasing the growth rate of added-value per capita is a necessary condition for economic growth. If the typical knowledge-intensive industry of financial business enhances the ability of creating added-value and grows, it will itself contribute to strengthening the growth potential of Japan’s economy. I have high hopes that securities analysts, while holding their strong intellectual curiosity and sensibility to read the times, will make a valuable contribution to the development of Japan’s securities markets and eventually to the development of Japan and Asia. 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, 12 November 2012.
Masaaki Shirakawa: Toward sustainable growth with price stability Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Kisaragi-kai Meeting, Tokyo, 12 November 2012. * * * Introduction It is a great honor to have the opportunity to address you today. As you are well aware, the Bank of Japan undertook further aggressive monetary easing for two months in a row, in September and October 2012. Today, I will begin by explaining these policy measures while outlining our assessment of the underlying economic activity and prices. I will then discuss various issues regarding deflation and monetary policy conduct and explain our thinking behind these issues. I. Developments in overseas economies Let me start with developments in overseas economies. Overseas economies entered a deceleration phase in the second half of 2011. Recently, many countries and regions – in particular, their manufacturing sectors – have moved deeper into that phase. As forecasts by international organizations and economists in the private sector show, the outlook for the global economy has been downwardly revised rapidly since this summer (Chart 1). There are two factors behind this. First, the effects of the European debt problem have been spreading. Since the second half of 2011, concern about government debt stemming from Greece has spread to Spain and Italy. As a result, the negative feedback loop among fiscal balances, the financial system, and the real economy is in effect. Since the beginning of 2012, such negative effects have spread to core countries such as Germany. The real GDP growth of the euro area remained negative for three consecutive quarters, from October–December 2011 through April–June 2012, and it is believed that negative growth cannot be avoided for the July–September quarter. As such, the effects of the economic recession in Europe have been exerting downward pressure on the global economy not only through a decline in trade activities – a direct channel – but also through cautious business activities resulting from heightening uncertainty. Second, the deceleration in the Chinese economy has been more prolonged than expected. In China, exports to Europe have declined and private real estate investment has slowed. Against the backdrop of such weakening of demand at home and abroad, inventory adjustment has been prolonged, especially in materials industries with excess production capacity. While the annualized real GDP growth rate is still somewhat high, it has been declining for seven consecutive quarters through this past July–September. In response, authorities have carried out economic stimulus measures on the monetary and fiscal fronts. So far, however, they appear to maintain a cautious policy stance toward achieving sustainable growth even when they are at the crossroads of changing their policy stance toward easing, partly based on past experience – namely, the large-scale policy measures following the Lehman shock that in the end brought about an excess in capacity and overheating in the real estate market. At the G-20 meeting that I attended last week, it was noted that economic activities in some regions have reportedly stopped deteriorating and started to show signs of stabilization. On the whole, however, my impression is that momentum for recovery in the global economy following the Lehman shock has been weak. Looking back at where we came from, strong growth in the United States and Europe toward the mid-2000s owes much to the credit bubble, which had reached an unprecedented level, and the amount of debt in the private sector has increased markedly (Chart 2). At present, the United States and Europe are in the BIS central bankers’ speeches process of adjusting excess debt, and until such adjustment is completed, these economies will suffer from a low growth rate, based on our experience from the aftermath of the bubble bursting. Indeed, from the perspective of the recovery in real GDP after the bursting of bubbles, economic performance in the United States and Europe has been worse to date in those economies than that of Japan after its bursting of the bubble, notwithstanding the aggressive monetary policies of central banks, including the Federal Reserve (Chart 3). Based on such recognition, overseas economies are likely to remain in a deceleration phase for the time being, but will gradually emerge from that phase and turn toward a moderate recovery thereafter. Factors behind this scenario include an improving trend in U.S. housing investment, reflecting the bottoming-out of house prices, and monetary easing effects underpinning momentum for recovery. As for the European debt problem, a safety net has been put in place, which includes such moves as the European Central Bank (ECB)’s decision to launch a new government bond purchasing program and the establishment of the European Stability Mechanism (ESM). Against this background, a number of policy measures for economic and fiscal reform are expected to make progress gradually, which would improve business and household sentiment. In China, the effects of economic policy measures as well as continued inventory adjustment are expected to materialize. In fact, in its projections for global economic growth released last month, the International Monetary Fund (IMF) has forecasted that the global economy will gradually post higher growth, from 3.3 percent in 2012 to 3.6 percent in 2013, and further to 4.1 percent in 2014. I fully recognize, however, that such projections regarding overseas economies rest on considerable uncertainties, including future developments in the European debt problem, the outcome of the problem surrounding the “fiscal cliff” in the United States, and the likelihood of economic deceleration in China being prolonged further. The Bank will closely monitor these developments. II. Developments in Japan’s economy Next, I will outline the current situation of and the outlook for Japan’s economy, taking into account the developments in overseas economies I have touched upon. As for recent developments, exports have shown a marked decline in the July–September quarter of 2012 following a rapid increase in April–June, and industrial production has decreased for two consecutive quarters, as overseas economies have moved deeper into the deceleration phase. Looking at exports by destination, those to the European Union (EU) have been declining for four consecutive quarters and those to China have recently shown a notable decline (Chart 4). The implications of the relations between Japan and China have begun to affect Japan’s economy, reflected in areas such as trade activities and tourism. Whether the implications of Japan’s relations with China will expand any further requires close attention. In contrast, domestic demand had been relatively firm on the whole until recently, mainly against the background of an increase in demand related to reconstruction following the Great East Japan Earthquake. Effects of the weakness in exports have gradually appeared in the employment situation, however, as seen in the fact that the number of new job offers in the manufacturing sector has been negative on a year-on-year basis since June. Private consumption has also lost some of its momentum compared with the period leading up to early summer, partly due to the ending of subsidies for the purchase of environmentally friendly cars. As for business fixed investment, firms’ investment plans for fiscal 2012 in the September Tankan (Short-Term Economic Survey of Enterprises in Japan) have posted relatively high growth for that time of year. Nevertheless, attention needs to be paid to whether firms might abandon their business fixed investment plans. Taking this situation into account, the Bank has continued to revise downward its assessment of Japan’s economy as a whole, and assessed at the Monetary Policy Meeting on October 30 that the economy has been “weakening somewhat.” BIS central bankers’ speeches Going forward, developments in Japan’s economy will basically depend on those in overseas economies. Using the outlook for overseas economies I mentioned earlier as an assumption basis, Japanese economic activity is expected to be more or less flat for the time being. Exports and production are likely to remain relatively weak for the time being, and domestic demand as a whole is unlikely to increase at a pace that will outperform the weakness in exports. Under such circumstances, the Bank decided to undertake further aggressive monetary easing at the Monetary Policy Meeting on October 30. As for the outlook for economic activity after incorporating the effects of such monetary easing and those of the government’s efforts to invigorate the growth potential, the economy, which will be more or less flat for the time being, is expected to return to a moderate recovery path in due course. Expressing this in numerical terms, the median of the Bank’s nine Policy Board members’ forecasts for the annualized growth rate is 1.5 percent, 1.6 percent, and 0.6 percent for fiscal 2012, 2013, and 2014, respectively (Chart 5). Reflected in these figures, however, are the effects of the front-loaded increase and subsequent decline in demand prior to the consumption tax hike, and adjustment of such effects brings the median of the forecasts to 1.0–1.5 percent for both fiscal 2013 and 2014. The output gap is therefore expected to improve steadily, given that these forecast figures exceed the potential growth rate, which appears to be around 0.5 percent. This naturally affects price developments as well. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is currently around 0 percent. It is expected to hover around that level for the time being, but will start rising gradually thereafter as the output gap that I just mentioned narrows. In terms of the median of the Policy Board members’ forecasts, figures for fiscal 2012 and 2013 are –0.1 percent and 0.4 percent, respectively, and 0.8 percent for fiscal 2014 excluding the effects of the consumption tax hike (Chart 6). The Bank publishes, in a numerical form, “the price stability goal in the medium to long term,” which is the inflation rate that it aims to achieve in conducting monetary policy. In concrete terms, 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 has set a goal of 1 percent for the time being. 1 The Bank is determined that it will continue with the current powerful easing until it judges the 1 percent goal to be in sight, but on the condition that it identifies no significant risk to the sustainability of economic growth, such as from the accumulation of financial imbalances. The forecast that I have provided suggests that, in fiscal 2014, it appears likely that the rate will move steadily closer toward this goal of 1 percent. At the same time, we have not reached a stage where the 1 percent goal is in sight. Such an outlook is attended by considerable uncertainties – in particular, the future developments in overseas economies described earlier – that could deviate either upward or downward from the projection, and relatively closer attention should be paid to the downside risk for the time being. III. Bank of Japan’s conduct of monetary policy I will now move on to the Bank’s conduct of monetary policy. The Bank’s implementation of further aggressive monetary easing on October 30 marks the fourth time this has been done, counting from the beginning of this year – in February, April, September, and October. At its Monetary Policy Meeting on October 30, the Bank made the following two decisions. First, it For details on the introduction of the Bank's "Price Stability Goal in the Medium to Long Term," 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 decided to increase the size of the Asset Purchase Program (hereafter, the Program) by about 11 trillion yen, from about 80 trillion yen to about 91 trillion yen. Second, it established a new lending facility called the “Stimulating Bank Lending Facility.” In the following, while I will mainly discuss our monetary policy decision on October 30, in order to facilitate a better understanding of the aim and content of such a decision, I will start by concisely explaining how a monetary easing policy permeates the economy and prices. The monetary transmission mechanism can be divided into two stages. The first stage is the transmission of monetary easing effects from the realm of monetary policy to the financial environment, where firms and households can achieve necessary financing from financial markets and financial institutions at low costs. The second stage is the transmission of effects from the financial conditions to economic activity and prices; in other words, the extent to which firms and households can take advantage of the accommodative financial conditions to increase their investment and spending. Increase in the size of the Asset Purchase Program: stimulating the first stage of the Monetary Transmission Mechanism Among the decisions at the Monetary Policy Meeting on October 30, the increase in the size of the Program is aimed at stimulating the first stage of the transmission mechanism more forcefully (Chart 7). The Program was introduced in October 2010 in order to generate further easing effects in a situation where the overnight call rate – that is, the Bank’s target rate – had already been at virtually zero percent. Through the Program, the Bank purchases not only Japanese government bonds (JGBs) and T-Bills but also various types of risk assets, including CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). Such purchases of risk assets are unprecedented for a central bank (Chart 8). The aim of the Program is to encourage a decline in longer-term market interest rates and a reduction in risk premiums. Since the introduction of the Program, longer-term market interest rates have been declining steadily (Chart 9). Government bond yields up to three years have declined to an extremely low level of 0.1 percent. The 5-year bond yields have come to nearly 0.2 percent. Reflecting such developments in the market rates, bank lending rates have also been declining. Recently, these rates, both in the short term and long term, have hit 1.0 percent – an unprecedented level. The lending attitudes of financial institutions as perceived by firms have also improved clearly, and have reached a level that exceeds the average since the 2000s. The issuing conditions for CP and corporate bonds are also accommodative on the whole. The Bank decided to increase the size of the Program with additional purchases of a wide range of assets that comprise not only JGBs but also risk assets including ETFs. Through such measures, the Bank intends to firmly maintain extremely accommodative financial conditions, even after entering next year, and support Japan’s economy forcefully from the financial side. Establishment of the Stimulating Bank Lending Facility: stimulating the second stage of the Monetary Transmission Mechanism On top of this, the extent to which the private sector can make use of such accommodative financial conditions – in other words, the second stage of the transmission mechanism – becomes crucial. On this issue, while firms’ profitability relative to total assets – i.e., ROA – has recovered to 3–3.5 percent, the average interest rate paid by firms declined to nearly 1.5 percent, and the gap between these two indicators has become large (Chart 10). Why is it the case that business activity has not necessarily been invigorated even though it is profitable for firms to raise funds and make business outlays? Among several reasons that I can think of, the first reason owes to the difference in profitability between existing and new investments. The ROA that I just mentioned indicates the profitability of past investment. If the profitability of new investment is lower than that in the past, firms are unlikely to invest. The second reason is that, as a result of prolonged periods of low growth, business BIS central bankers’ speeches sentiment has become cautious and there is not enough risk-taking activity in the corporate sector. As for the third reason, it is far more profitable to invest overseas than at home (Chart 11). The Bank hears from many corporate managers that there are only a few attractive investment opportunities at home. Unless we somehow manage to change this view, it will be difficult to stimulate business investment. The flipside is that investment will increase if we are able to change this view. While the first stage of the monetary transmission channel is the process of encouraging a further decline in market interest rates, we also need efforts to raise “natural interest rates,” if I may use an economist’s jargon. In order to encourage the second stage of the transmission mechanism, it is vital that a wide range of economic entities, including firms, financial institutions, and the government, play their respective roles with a view to invigorating the growth potential of the economy. However, the Bank also strongly asserts that we will also do our best, making every possible effort from the perspective of monetary policy. This assertion led to the introduction back in 2010 of the Growth-Supporting Funding Facility, which is now generating some positive outcomes. Moreover, the Bank decided to establish the “Stimulating Bank Lending Facility” in October in order to promote the proactive lending activity of financial institutions and help stimulate the credit demand of firms and households (Chart 12). Under this facility, the Bank will provide yen-denominated funds – up to an amount equivalent to the net increase in lending – to financial institutions, at their request. The total amount of funds provided by the Bank will be “unlimited” – that is, there shall be no upper limit. In calculating net increases in loans, only those extended to the non-financial private sector will be counted, and this can take the form of either yen-denominated lending or foreign currency-denominated lending. This is because firms’ overseas activities and financial institutions’ encouragement of such activities through lending have important implications for the development of Japan’s economy in the midst of globalization. Loans with a duration of up to three years can be chosen by the banks, and loans can be rolled over up to four years at the request of these banks. Furthermore, the interest rate charged by the Bank will be 0.1 percent per annum for now. Thus, financial institutions can borrow funds at a long-term fixed rate equivalent to the Bank’s target for the uncollateralized overnight call rate. The size of this facility will be determined by the voluntary efforts of depository institutions to increase lending. According to data for the 12 months up through August 2012, the amount of loans increased by a total of approximately 15 trillion yen for financial institutions that saw a rise in their lending. Of this, 11 trillion yen constitutes loans that originated at domestic branches and 4 trillion yen at overseas branches (Chart 13). Going forward, if these institutions manage to increase their lending more aggressively, the amount of funds that can be provided by the Bank will rise accordingly. At present, the Bank is in the process of making the necessary arrangements. We plan to release the details of this facility before the end of the year and start its operation as soon as possible. The Bank decided to call the combination of the Stimulating Bank Lending Facility and the aforementioned Growth-Supporting Funding Facility the “Loan Support Program.” The aim of this program is to vigorously push forward use of the accommodative financial conditions by the private sector. In doing so, the importance of the Growth-Supporting Funding Facility will not be undermined at all. Under this facility, the Bank – irrespective of whether or not lending has increased – continues to encourage financial institutions to carry out lending or investment in support of invigorating the foundations for Japan’s economic growth, and to ensure that the public is well aware of the need to raise the growth potential. IV. Issues concerning the overcoming of deflation Next, in order to facilitate a better understanding of the Bank of Japan’s conduct of monetary policy, I wish to go “back to basics” and describe what it really means to overcome deflation, and what is necessary to accomplish this goal, by referring to several issues. BIS central bankers’ speeches Relationship between overcoming deflation and the rate of price rises The first issue is the relationship between overcoming deflation and the rate of price rises. In general, the term “deflation” is used to describe a continued decline in prices. Thus, to overcome deflation means to achieve a state in which such a drop in prices comes to a halt or in which prices start rising at a very moderate pace, if one looks at the definition of deflation from the opposite angle. According to the Bank’s forecasts that I touched upon earlier, prices are expected to rise moderately from fiscal 2013 toward fiscal 2014. Given that its price stability goal of 1 percent for the time being has not come in sight, the Bank is committed to continuing with aggressive monetary easing. In any case, when we say that overcoming deflation is an important challenge, we are not simply looking for a pick-up in the price index. On this point, we can derive important implications from the Opinion Survey on the General Public’s Views and Behavior that the Bank conducts, based on the responses collected from individuals (Chart 14). Among the respondents who felt that prices had gone up, more than 80 percent viewed the price rise as “rather unfavorable.” In contrast, among those who felt that prices had gone down, about one third deemed the price decline as “rather favorable.” The results of the survey may seem odd at first sight, considering the broadly shared goal of the Japanese population to overcome deflation. On second thought, however, they may not come as a surprise at all. Respondents in the former group may have chosen “unfavorable” when they were asked solely about prices; they had to base their response on a situation where prices rose without the associated increase in wages. Our goal is to overcome deflation and have Japan’s economy return to sustainable growth with price stability. In other words, in overcoming deflation we are not merely aiming to achieve a state in which prices simply rise, but one where better economic conditions are realized on the whole by increasing corporate profits, employment, and wages. There may also be a state in which the economy is overheating but the inflation rate is low. The bubble period in the second half of the 1980s is a typical example. The rate of change in the CPI remained below 1 percent for three years starting from 1986, but nobody refers to that period as one in which Japan was in a state of deflation (Chart 15). In short, what is necessary is to check economic activity, prices, and the financial environment in a balanced manner from the perspective of realizing sustainable growth. Reality of inflation expectations The second issue regarding the overcoming of deflation concerns inflation expectations. Counter to the view that economic growth is necessary to overcome deflation, we hear the argument that the priority should be to lift inflation expectations in order to improve the economy, and that this is exactly what a central bank should do. The mechanism underlying this argument is that lifting inflation expectations in the private sector will lead to a decline in the real interest rate, which is derived by subtracting the inflation expectation rate from the nominal rate, which will in turn stimulate the economy. Nonetheless, in an environment where neither prices nor wages have risen for a number of years, it is not realistic to believe that the general public’s inflation expectations will go up all of a sudden, or that we can manage to lift these expectations somehow. We can think of a situation where inflation expectations alone go up – for example, when the economy is hit by oil shocks – but this is not exactly the same as the overcoming of deflation that we seek. According to the opinion survey that I have just mentioned, the fact that most of the respondents viewed the price rise as “rather unfavorable” suggests that there is a possibility of wide acceptance in the public realm that it is normal for prices not to rise, or that price rises cannot be tolerated. In fact, looking at detailed consumer price data for the last 15 years or so, in the United States, those items for which prices pick up at the rate of 2.5–3.0 percent have the largest weight, whereas in Japan, those items for which prices pick up at the rate of 0–0.5 percent have the largest weight (Chart 16). On the whole, the CPI is slightly less than 0 percent, but this is due in part to the fact that, compared to the United States, there are a few items – such as televisions and personal computers – for which, for BIS central bankers’ speeches the purpose of statistics, prices are deemed to be declining significantly in reflection of their improved qualities. The general public’s common understanding on prices – or its perception regarding prices – has been formulated on the basis of such conditions, and this is the reality of the abstract notion of “inflation expectations” in economic theory. Consumers, with the perception that prices should not rise, are unlikely to accept price hikes by firms, who in return reduce costs including wages; hence, it will take longer for the economy to overcome deflation. After all, it is more important to generate material changes in the economy, including strengthening the economy’s growth potential and achieving higher wages. I will come back to this point shortly. Meaning of the output gap The third issue regarding overcoming deflation concerns the meaning of the output gap. According to the Cabinet Office’s estimation, the output gap amounts to about 2 percent of GDP or approximately 10 trillion yen on an annual basis, in line with the Bank of Japan’s estimation. Given that it was about 40 trillion yen right after the Lehman shock, the output gap has narrowed substantially, though it still exists. Because the output gap is generally recognized as a shortage of demand, one can argue that, if a fiscal measure equivalent to the amount of the gap is taken, the gap will be wiped out and this will put an end to deflation. Surely, if such a shortage is temporary in nature, this argument may hold. Nevertheless, one has to bear in mind that the output gap assumes only the present supply-side structure and merely captures the shortage of demand corresponding to that structure. Society and the economy keep changing all the time, and in Japan new demand is being created constantly on the back of the aging population, women’s entry into the labor market, and increasingly diverse preferences. In the medical and nursing business, one often hears that services sufficient to meet demand are not being provided, mainly due to various regulations and labor shortages at worksites, even though there is rapidly expanding potential demand resulting from the aging population. Moreover, with regard to the elderly’s spending – which has received considerable attention lately – there is a big difference among the elderly in terms of income, health conditions, and taste. Therefore, unlike the consumption by younger members of the population, the elderly’s spending pattern is increasingly granular, and depending on the creativity of the supply side, there is considerable room left to expand the elderly’s spending. The cause of this inability to meet potential demand – namely, the shortage of supply in growing business areas – is not measured in the output gap. Put differently, in a rapidly changing economy, the output gap only captures the shortage of demand in terms of the current supply of goods and services, and does not capture the shortage of supply against new potential demand. In this sense, the notion of the output gap is asymmetric. Put differently, what should essentially be recognized as the mismatch between supply and demand is instead perceived in the form of the shortage of demand. In order to improve the output gap in a sustainable manner, it is necessary to restructure the supply side according to economic changes, which enables potential demand to materialize. The newly created demand is based on what people willingly want; hence, this is likely to create a virtuous circle of increasing expenditure, revenue, and income. As such, not only short-term macroeconomic policies but also initiatives to change the economic structure in which new businesses are more likely to emerge, such as enhancing the metabolism of the economy, play an important role in achieving improvement in the output gap. Importance of invigorating the growth potential Last, but not least, is the importance of invigorating the growth potential. This is the issue that provides an overall summary of what I have been talking about. The Bank has been emphasizing repeatedly that Japan’s economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability, and that this challenge can only be met if efforts by a wide range of economic BIS central bankers’ speeches agents to strengthen growth potential and support from the financial side proceed hand in hand. Growth potential is ultimately the ability to differentiate from the existing goods and services and to cultivate new demand swiftly at home and abroad. If one succeeds in providing attractive goods and services that consumers can acknowledge as having worth, one can maintain the ability to control prices while preserving value-added. Such value-added will initially generate an increase in corporate profits. If this is eventually distributed in a balanced manner to the household sector in the form of a rise in employment and higher wages, it will result in a broad-based increase in purchasing power. Furthermore, this will lay out the foundation for the economy where cultivating new demand is likely to be successful. Once the virtuous circle in which rising wages leads to an increase in expenditure and income starts to work through, the general public will begin to willingly accept the idea of moderately rising prices. This is the avenue that the change in price perception – that is, a rise in inflation expectations – will take in line with the economic reality, and this is the fundamental mechanism for overcoming deflation. After the Lehman shock, wages have been relatively firm compared with the immediately preceding recovery phase, and we will monitor carefully how they feed into prices in the future (Chart 17). The ability to cultivate new demand derives from firms’ spirit of challenge. At the same time, however, financial institutions need to support the funding of firms that exhibit risk-taking behavior arising from this spirit, and the government should lay out foundations such as expanding, through decisive deregulation, business areas for firms; such efforts play pivotal roles in helping firms take on challenges. This recognition is shared by the government. At the Monetary Policy Meeting held on October 30, in addition to the aggressive monetary easing, the Bank decided to release the “Measures Aimed at Overcoming Deflation” jointly with the government in order to state clearly their shared understanding. In this “shared understanding,” the government showed a clear recognition that, in order to overcome deflation, it is essential to reform an economic structure that is predisposed to deflation, as well as conduct appropriate macroeconomic policy management. The Bank strongly expects the government to vigorously promote measures for strengthening Japan’s growth potential. Of course, the Bank will make its utmost efforts from the financial side. Once various efforts by a wide range of economic entities come into play, I am confident that sustainable growth with price stability can be achieved. V. Issues concerning the Bank of Japan’s conduct of monetary policy In the following, I will introduce issues concerning the conduct of the Bank’s monetary policy, bearing in mind questions that are often raised. Is monetary easing enough or not? We have heard the opinion that, with a view to overcoming deflation as early as possible, the Bank’s policy stance is not enough. By contrast, there is another opinion arguing that financial conditions are already accommodative enough and asking if there is anything meaningful to be gained by further enhancement of monetary easing. At the press conference held after the Monetary Policy Meeting at the end of October, I received questions based on both arguments. 2 As I have argued so far, in order to create a situation in which prices would rise, it is imperative to pursue powerful aggressive easing – that is, the first stage of the monetary transmission mechanism – and make efforts to strengthen the growth potential – i.e., the main feature of the second stage of the mechanism. It will take some time before the efforts to strengthen the growth potential bear fruit. For our part, the effect of monetary easing will For details, please refer to the minutes of the Governor's regular press conference (available only in Japanese) on October 30, 2012. http://www.boj.or.jp/announcements/press/kaiken_2012/kk1210b.pdf. BIS central bankers’ speeches be maximized by pursuing further aggressive measures at a pace most consistent with these efforts. It is certainly true, as pointed out at the press conference, that financial conditions have already become quite accommodative, but there is no question that the Bank should exert every effort to enhance its easing effects as much as possible, in an effort to achieve its goal by imaginatively using its policy instruments. In view of this, the Bank decided to further enhance monetary easing at this juncture, when the economy has started to weaken somewhat, after carefully examining economic activity and prices. Should the bank announce “unlimited” purchases of financial assets? With respect to the second issue for discussion regarding monetary policy, we have heard a view that the effect of monetary easing will be reinforced if we announce unlimited purchases of financial assets. In support of this view, the Federal Reserve’s policy is sometimes pointed to as an example. Specifically, the Federal Reserve decided at the Federal Open Market Committee in September to continue purchasing agency mortgage-backed securities until improvement in the labor market is achieved in the context of price stability. The Bank of Japan has also stated clearly that it will continue to pursue aggressive monetary easing until it judges the rate of change in the CPI of 1 percent to be in sight. In other words, the Federal Reserve and the Bank of Japan share things in common in their conduct of monetary policy, in the sense that both central banks are determined to continue with necessary policy measures to achieve appropriate economic conditions and prices to which they are committed. Indeed, looking back at the track record of the Bank of Japan’s monetary policy conduct, the Program started off at a size of about 35 trillion yen, with purchases of financial assets expected to be completed by end-2011. At present, its size has become about 91 trillion yen and its timeframe has been extended until end-2013. The Program has become far more aggressive than the one envisaged at the time of its introduction. Furthermore, the Bank has embarked upon a number of policy measures – including the enhancement of the growth-supporting funding facility and the introduction of the stimulating bank lending facility – in response to changes in economic developments. I stress once again that the Bank of Japan has been conducting further aggressive monetary easing until it judges the 1 percent goal – in terms of the rate of change in the CPI – to be in sight, and that the Bank has been making full use of new policy measures while not setting any timeframe a priori. I should also note that, in terms of purchasing financial assets without any timeframe, the Bank regularly purchases JGBs in line with the increasing trend in banknote demand, which grows with the economy, and continues to purchase at the rate of 21.6 trillion yen per year. Does increasing “money” solve the problem? As for the third issue, there is a view that the Bank should increase “money” more aggressively in order to overcome deflation as early as possible. There are a number of indicators of “money.” Looking at the monetary base – which is the central bank’s liabilities and consists of banknotes in circulation and current account balances held at the Bank of Japan – its ratio relative to nominal GDP in Japan has been higher than those in the United States and Europe (Chart 18). In the case of the United States and Europe, it was only after the Lehman shock that this ratio started to rise. On the contrary, in the case of Japan it has been rising for longer periods of time, which gives the impression that the increase in Japan following the Lehman shock has not been very noticeable. However, even when focusing specifically on the period after the Lehman shock, the amount of increase in the monetary base as a ratio relative to nominal GDP is about the same for Japan as it is for the United States and the euro area. Similarly, looking at the money stock – which is equivalent to the amount of cash held by non-financial private sectors – its ratio relative to nominal GDP in BIS central bankers’ speeches Japan has again been outperforming those in the other two economies, and it is currently on a clear uptrend (Chart 19). The quantity theory of money – under which one argues that increasing the amount of money will lead to a pick-up in prices – is easy to understand but cannot explain the reality of the current circumstances of zero interest rates that persist in Japan and the United States (Chart 20). For the sake of clarity, starting from fiscal 2000, if one assumes that an increase in money will feed into prices in accordance with the quantity theory of money, the average rate of inflation in terms of the year-on-year rate of change in the CPI would become 4.8 percent when one uses the monetary base and 1.6 percent when one uses the money stock. These two figures are considerably different from –0.2 percent, which is what we actually see in the real world. The same argument can be made in the case of the United States and Europe. The point that I have been making so far – that is, in order to overcome deflation, it is necessary not only to achieve accommodative financial conditions but also to have the ability to make use of them – can also be understood from the perspective of the actual money-price relationship. Apart from the discussion based on quantitative indicators of money, we often hear the view that the Bank should print money more aggressively, which is a somewhat loose term. Everyone would welcome a situation in which money was distributed freely. But such a story sounds too good to be true, of course. When one talks about “money,” this means either cash or deposits; in other words, liquidity at hand. Normally, however, this means either income or wealth. “A man with a lot of money” (“Okanemochi” in Japanese) refers to a person with abundant income or wealth. But the money the Bank supplies is different from this. The fact that fund provisioning by the Bank is often referred to as “printing money” likely generates such a misunderstanding. The Bank’s fund provisioning is usually done in the following way: first, the Bank purchases government bonds from financial institutions; and second, those institutions in return receive money in the form of increasing the amount outstanding of the current deposits held at the Bank. In other words, monetary easing is not simply printing money and distributing it for free. It is distributed in exchange for equivalent purchases of financial assets, such as sovereign bonds, as well as loans with sovereign bonds as collateral. Neither income nor wealth will increase at this stage. What increases is “money” in the form of the current deposits at the Bank. Such an action by the central bank generates a decline in interest rates, stimulates the credit demand of firms, and invigorates a variety of economic activities such as investment. Ultimately, it will increase “money,” which represents income and wealth. A possible counter-argument is that dropping money from a helicopter – or money from heaven – will stimulate the economy and raise prices. 3 This is also a loose expression. Recently, whether or not to cancel the holding of government bonds by the central bank was discussed in the United Kingdom, and this is essentially equivalent to what one means by dropping money from a helicopter. Were this to be done, the central bank would record losses, resulting in either a reduction of the bank’s profit disbursements or a request to the government for injection of capital. Whatever the outcome, the resulting action by the government would have to be backed up by tax receipts. This action falls into the domain of fiscal policy, which must be determined by the government and the parliament. In his speech on October 23, 2012, Governor King of the Bank of England (BOE) referred to the thinking behind money creation as well as the problem of combining monetary and fiscal policies. http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech613.pdf. BIS central bankers’ speeches Under the current circumstance of zero interest rates, holding money does not incur any cost; no matter how much money the Bank supplies, money is absorbed just as water is by a sponge. I acknowledge that the total amount of money is important and that the monetary base is expected to continue expanding substantially on the back of the Bank’s current purchases of financial assets. At this juncture, however, it is more important to ensure that money is actually deployed, by invigorating the growth potential of the economy. Should the bank purchase foreign bonds? Lastly, there is a view that the Bank should purchase foreign bonds in order to correct the strong yen. However, the Bank of Japan Act stipulates that the Bank shall buy and sell foreign exchange as an “agent handling national government affairs” – that is, an agent of the Finance Minister – when the purpose of the buying and selling, like that of foreign exchange intervention, is to stabilize the exchange rate of the Japanese currency. The Finance Minister is responsible for foreign exchange intervention. This reflects, as I understand, the debates in the Diet on the bill that became the current Bank of Japan Act, when the view was presented that it was desirable to centralize this currency diplomacy under the auspices of the government because there was always a counterparty when it comes to the issue of foreign exchange policy. Under the current legal framework, the government intervenes when it judges that it is necessary to do so, and the amount of intervention since 2010 has in fact exceeded 15 trillion yen (Chart 21). In addition, the government can issue financing bills (FBs) to raise ample funds for intervention at virtually a zero interest rate. Meanwhile, the Bank monitors with great interest any development in the foreign exchange market and its effect on economic activity and prices. In particular, under the present circumstances where there is a high degree of uncertainty with regard to future developments for overseas economies, we should be mindful of the negative effects on Japan’s economy as a result of the yen’s appreciation leading to a decline in corporate profits and deterioration in business sentiment. The Bank has been conducting monetary policy by taking due account of such effects, and it will continue to do so. While factors determining foreign exchange rates are complex, there are several forces behind the appreciation of the yen after the Lehman shock, including the following: first, as the interest rates in the United States and Europe have declined markedly and the interest rate differentials with Japan have narrowed, there was a reversal of yen carry trades; second, the yen has come to be perceived as a relatively safe currency on the back of the European debt problem. As for determinants of the foreign exchange rate, one sometimes hears a view that the aforementioned developments in the monetary base have influenced the formation of the exchange rate. Based on historical experience, there seems to be no clear relationship between the monetary base and the exchange rate on the whole (Chart 22). In any event, the fact that the Bank has been pursuing powerful monetary easing by depressing the already low interest rates to an even lower level should have mitigated upward pressure on the yen to some extent. Concluding remarks Today, I have covered a wide range of topics, including issues concerning the Bank’s conduct of monetary policy and the importance of invigorating the economy’s growth potential. Let me conclude by raising two key subjects that I believe are important in order for the economy to overcome deflation and return to a sustainable growth path – namely, “perception” and “mood.” Such topics may be viewed as the last things to be on the mind of a central bank’s governor. They do, however, raise the same awareness as did Keynes’ reference to “animal spirits.” In handling these topics, let me introduce a fact that I often times refer to these days, that is, an international comparison related to changes in the real GDP between the year 2007 – BIS central bankers’ speeches prior to the financial crisis – and today (Chart 23). Japan’s current real GDP, like that of European countries, remains below the level seen in 2007. Looking at per capita GDP figures, this trend holds true for major countries including the United States. It is worth noting, however, that the drop for Japan is the lowest among these countries. Furthermore, Japan’s real GDP per working-age population has exceeded its pre-crisis level, while those for the United States and Europe remain below their levels at that time. Put differently, while Japan as a whole tends to register low growth because of the decline in the working-age population, each individual Japanese worker contributes to an increase in value-added at a pace exceeding that in the United States and Europe. This suggests that we should not become excessively pessimistic. At the same time, however, this implies that merely maintaining the status quo and abandoning efforts to invigorate the economy’s growth potential could quite easily send Japan’s economy into a severe condition. The average growth rate for the next decade or two is defined by the potential growth rate. The potential growth rate can be broken down into the rate of growth in the number of workers and that of real GDP per worker – in other words, the labor productivity growth rate. Future developments in the number of workers can be determined quite accurately on the assumption of the most recent labor participation rate by gender and age. According to such estimates, the number of workers will grow at a rate of –0.6 percent in the 2010s and –0.8 percent in the 2020s. The labor productivity growth rate for the years 2000 through 2008 – a period characterized by relatively favorable economic conditions – was 1.5 percent (Chart 24). Efforts to raise the labor productivity growth rate are necessary, of course. However, we cannot expect advanced economies – having already completed their “catching up” process – to maintain a growth rate as high as 2 or 3 percent. In objectively acknowledging this reality, it is important to continue making efforts to raise the labor productivity growth rate and to increase the number of workers through a rise in the labor participation rate. The starting point of such efforts is the combination of the dispassionate appreciation of the facts that I have just mentioned, and a positive mood generated from awareness of the strengths of Japan’s economy. While the economy faces an unprecedented headwind – namely, the rapid aging of and decline in the population – it seems to be that its strengths in such a situation are not objectively understood. For example, today, many Japanese firms maintain sound balance sheets and the business conditions of financial institutions have been stable, since Japan did not encounter any large-scale credit bubbles in the mid-2000s. This situation is in stark contrast to the 1990s, when the country was faced with the task of resolving the “three excesses,” as evident at least in the fact that a financial base for supporting efforts to invigorate the economy’s growth potential is readily available. What is more, the fact that Japan leads the world in addressing the global issues of population aging and energy constraints can be interpreted as an opportunity to heighten its presence by continuing to be the world’s driving force when dealing with these issues in the future. The so-called soft power is another of Japan’s strengths that must not be overlooked. At the annual meetings of the IMF and the World Bank held in Tokyo last month, for the first time in 48 years, Japan successfully reinforced a strong impression on the world of its high operational skills for event management, and of its warm hospitality. I have found this to be a reflection of Japan’s soft power. As such, it is important for Japan to unite its strengths and make determined efforts toward invigorating its economy’s growth potential. In doing so, we must recognize the various positive qualities that I have just mentioned while holding onto a sense of urgency, although without falling into pessimism. The Bank is determined to continue making its utmost efforts as the central bank toward overcoming deflation as early as possible and realizing sustainable growth with price stability. Thank you. 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Keynote address by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Joint Forum Meeting, Tokyo, 14 November 2012.
Kiyohiko G Nishimura: Ageing, finance and regulations Keynote address by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Joint Forum Meeting, Tokyo, 14 November 2012. * * * Introduction: population ageing, economy and finance It is my great pleasure to have the opportunity to speak at the Joint Forum Meeting in Tokyo. The Joint Forum has for many years been at the forefront of dealing with various cross-industry issues related to banking, securities and insurance. The Forum has thereby contributed greatly to the evolution of successful regulatory and supervisory frameworks. However, many challenges remain. For example, as economic globalization and information technology advance, “cross-border” and “cross-industry” risks have become increasingly important in financial services, and failure to regulate and supervise them effectively may result in profound economic consequences. “Structured” securitized products and monoline insurances are examples of such risks, as we have learned to our cost in the recent crisis. Today, I would like to consider another significant challenge, which I think is increasingly important worldwide, though not yet widely recognized as crucially important. This is the issue of population ageing and how to regulate and supervise financial products and services to cope with problems arising from it. Indeed, these issues are deeply related to the fundamental nature of financial services, including all financial sectors such as banking, securities and insurance. In fact, I have warned of the unpleasant and in some cases grave consequences of ignoring demographic factors in our economic thinking in a series of recent speeches and papers, especially with respect to asset price bubbles, money demand and inflation. 1 In particular, I have pointed out that asset price bubbles are most likely to occur at the final stage of the “demographic bonus” in which a country enjoys the benefits of an increase in the size of the working population. In contrast, a decline in growth potential due to “demographic onus” is likely to result in prolonged economic stagnation once the bubble bursts. These phenomena have been observed not only in Japan, but also in other countries such as the United States and peripheral euro area countries. What underlies the recent distress in the euro area is in fact deeply rooted in the structural changes resulting from demographic transition or population ageing. Figure 1 shows the relation between changes in the working age population curve and the timing of bubble bursts. These coincided in Japan around March 1991, in the United States in December 2005, in Ireland in September 2006, and in Spain in September 2007. And this is not simply a problem affecting advanced economies: the problem is just around the corner for some emerging economies like Korea, China, and Brazil. Population ageing is likely to have a significant impact on financial services, and requires a new policy response. Here I would like to raise two issues: one is the necessity of cross-industry and even cross-border coordination, and the other is the question of how to deal with the fundamental uncertainty surrounding population ageing. Necessity of cross-industry and cross-border coordination Let me first consider the necessity of cross-industry and cross-border coordination. As a society begins to age, its older citizens become the dominant holders of financial assets. For example, see Nishimura, K. G., and E. Takáts, “Ageing, property prices and money demand”, BIS Working Paper No. 385 (2012). BIS central bankers’ speeches However, with the coming of age, many people are likely to become risk-averse in managing their financial assets, for natural reasons. Thus, a mature economy, with its lower growth potential due to ageing, faces the serious problem of how to provide risk money to promising sectors of the economy so as to encourage entrepreneurs’ sound risk-taking and enhance value production. To be more specific, financial products and services should enable older citizens to maintain their quality of life and help foster an environment where longevity is seen as a gift, rather than a risk. These products, in addition to retirement savings, are expected to play diverse roles. Given the improved average health of senior citizens in many countries, it is increasingly important that these financial products and services help the older population stay active and contributing to the community to the best of their abilities, while mitigating age-related risks such as illness. To provide such products, financial institutions must cooperate with other industries to take full advantage of their advanced technologies and expertise. At the same time, financial institutions should utilize their own expertise to measure, distribute, and manage the various risks as intermediates between asset-rich older citizens and prospective entrepreneurs. These attempts inevitably involve “cross-industry” elements. Furthermore, with the transition from a growing economy to a mature economy, it is natural for people in an ageing economy to pursue higher returns by investing their savings in growing overseas economies. Thus, it is also important for a mature economy to make full use of the benefits of cross-border transactions while managing the accompanying risks. This upcoming trend of cross-industry and cross-border expansion of financial products and services will pose a serious challenge to the current regulatory and supervisory frameworks. It will certainly call for a comprehensive approach. Regulation and supervision focusing only on a specific sector will likely result in a “waterbed effect”: problems will be simply shifted to other sectors rather than being dealt with effectively. Fundamental uncertainty regarding life expectancy and fertility The second issue is the fundamental uncertainty surrounding the pace of population ageing. I first note the two kinds of risk involved: the first relates to life expectancy or longevity, and the second to birth rates or fertility. I then discuss the fundamental uncertainty in measuring these risks in the economy as a whole, and the possible consequences of this for regulation and supervision. Among the various risks we face in the real world, the longevity risk is the most fundamental one. No one can tell exactly how long he or she will actually live. While economic textbooks impersonally state that efficient allocation of resources can be achieved more easily if there is no uncertainty, very few people would prefer to know the exact date on which they are going to pass away. As human beings we need to accept such unavoidable uncertainties, and financial services have a critical role to play in helping us manage the risks associated with such inherent uncertainties while enabling us to enjoy a life full of surprises. As the population ages, the social need increases for financial products and services to respond to the longevity risk. To provide the tools necessary to respond to the longevity risk, providers need to be able to manage the accompanying risks in the economy as a whole. To this end, financial service providers such as insurers have traditionally utilized “the law of large numbers,” a rule assuming that as the number of samples increases, the average figure of these samples, such as average life expectancy, becomes more predictable. The same is considered to be true for fertility. Although the exact number of children for a given couple is not known for sure, the average rate of birth per couple becomes largely predictable. The popular perception that demographic change is in general predictable is based on this law of large numbers. BIS central bankers’ speeches Unfortunately, this perception is not always true, or to put it bluntly, not true in many instances. Take Japan for example. Between the 1970s and early 2000s, the total fertility rate forecasts regularly turned out to be wrong and were consistently revised down. The government repeatedly published its forecast in which the decline in the fertility rate was declared to be only temporary and the birth rate expected to rise again soon (Figure 2.) Similarly, life expectancy forecasts have shown that the actual figures consistently exceeded the forecasts (Figure 3). These forecast errors show the fundamental uncertainty surrounding the pace of population ageing. And if the actual outcome deviates from the estimated life expectancy and longevity of the entire population in an economy, all service providers will be affected. For example, in the case of longevity risk products, even a slight deviation could significantly increase the exposures of service providers. Avoiding patchwork and “spaghetti code” problems Regulatory and supervisory reform is often called for once such deviation causes an unexpected accumulation of losses. However, this kind of loss-induced regulatory and supervisory reform often leads to patchwork plumbing, which in turn results in a vicious circle of further losses and more patchwork. The repetition of such ad-hoc adjustments to the framework can cause what computer programmers refer to as “spaghetti code” problems, in which the framework becomes too complex and entangled, like spaghetti, so that no one knows how to fix the problem. Thus, we must be careful not to make over-optimistic forecasts, especially when these forecasts underlie the overall framework and any forecast error might bring about irrevocable losses. It is also important to have in advance a clear strategy on appropriate policy responses when a forecast error is observed, especially in dealing with “spaghetti code” risks. The performance of the framework should be subject to continuous review, and necessary measures should be readily available at all times. With these measures in place, it should be possible to prevent a mere forecast error from turning into an “irreversible” disorder of the whole system. In this sense, it is better to address the challenges of population ageing by incorporating a second best “fail-safe” mechanism into our overall institutional framework, rather than by chasing the first best solution while pretending our forecasts are always rational and unbiased. 2 Concluding remarks The recent financial crisis has completely changed the landscape of financial services, both for financial institutions and for supervisors. Before the Lehman crisis, people tended to see only the “bright side” of new financial products, such as securitized products, derivatives, and cross-border transactions, believing them to be backed by advanced and innovative risk-management and investment tools. However, since the crisis revealed the risks and problems associated with them, people have come to see mostly the “dark side” of these services. Nonetheless, there is still an essential need for financial products and services that can help individuals and firms manage their risks, since sustainable economic development can only be achieved through sound risk taking by private entities. Moreover, financial institutions will be expected to play an even more active role as more countries face the problems arising from population ageing. This is especially relevant to satisfying the need for longevity risk For a theoretical framework of rational decision under investment irreversibility and (fundamental) uncertainty à la Frank Knight, see Nishimura, K. G., and H. Ozaki, “Irreversible investment and Knightian uncertainty,” Journal of Economic Theory, 136 (2007) 668–694. BIS central bankers’ speeches management and in coping with the problems of declining fertility, since financial institutions’ full use of their technologies and resources is the key to solving these problems. Thus, financial service providers should be able to contribute to the economic society by providing people with the tools to address the risks and harsh uncertainties of life, while enabling them to enjoy its thrills and happy surprises. In this respect, I believe that regulators and supervisors should bear the following two things in mind: First, regulators and supervisors should always have a cross-industry and in some cases cross-border perspective, and they should also have a grand design as to how the economy can spread the risks necessary for sustainable growth, especially under population ageing. Second, regulators and supervisors should be aware that a desirable regulatory framework will continuously evolve, partly due to population ageing and the consequent structural changes in the economy and financial services. The current structure and regulatory framework will not last forever, and neither will sectoral classifications such as “banking,” “insurance,” and “securities”. For example, increased demand for longevity risk management could perhaps foster new cross-industry innovation between medical and financial services. From its unique vantage point, the Joint Forum is able to observe the signs of structural changes in financial services and to identify the need for regulatory and supervisory evolution. I sincerely hope that the Forum will continue to be attentive to new developments in financial services and lead the global debate on regulation and supervision. Now I come to the final words of my speech about ageing. Just as we mortal individuals mature and come of age, so too do institutions. Here is the Bank of Japan (Figure 4) more than a hundred years ago, in its youthful, burgeoning days. And here is the Bank of Japan as it is today (Figure 5), surrounded by new architectural additions to the city skyline and still the focal point of the landscape. The building itself has indeed matured, and in its maturity has come to fit itself perfectly to the new age. I believe the same can surely be said of the Joint Forum. 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 Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 26 November 2012.
Masaaki Shirakawa: Path toward overcoming deflation Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 26 November 2012. * * * 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. Today, I will start by touching upon economic developments at home and abroad, and then move on to explain the Bank’s conduct of monetary policy. I will then discuss the economy’s path toward overcoming deflation. I. Developments in overseas economies and in exchange rates Considering that I have paid this region a visit every year just around this time in November, let me begin my talk by reflecting on developments in the economic environment surrounding Japan’s economy over the past year, especially in overseas economies and exchange rates. To start with, I will outline developments in overseas economies. Around this time last year, developments with respect to the European debt problem – the biggest risk factor for the global economy at that time – had been highly uncertain and nervousness in financial markets had been so strong that even a worst-case scenario – namely, the collapse of the euro zone – had been envisaged (Chart 1). In comparison with last year, the risk of the European debt problem triggering an extreme event such as a global financial crisis has subsided, thanks to progress with reinforcing the safety net including such moves as the European Central Bank (ECB)’s decision to launch a new government bond purchasing program and the inauguration of the European Stability Mechanism (ESM). Nevertheless, an adverse feedback loop among the fiscal balance, the financial system, and economic activity continues to operate in Europe, particularly peripheral countries, and the effects have recently started to spill over to core countries as well. Consequently, the European economy has entered a moderate recession phase, as evident in the fact that it has posted successive negative growth since the fourth quarter of 2011. Meanwhile, the U.S. economy – its household sector in particular – has been undergoing recovery at a moderate pace. In terms of changes over the past year, it is a positive indication that housing investment appears to be bottoming out despite its continued low level (Chart 2). However, the situation regarding the “fiscal cliff” – the same issue as was raised a year ago – has not changed. In fact, there is increasing concern about this issue as the economy moves closer to the cliff. Relative to the past year, the economy that has encountered the most significant change is China (Chart 3). Deceleration of the Chinese economy has been prolonged mainly due to a decline in exports bound for Europe and inventory adjustment in materials industries, as evident in the fact that its real GDP growth rate on a year-on-year basis has continued to decline for seven consecutive quarters since the first quarter of 2011, though it remains at a high level. Apart from these short-term developments, whether the Chinese economy can make a smooth transition from high growth to moderate and stable growth appears to be growing into a matter of great interest in terms of policy conduct. I will now turn to developments in exchange rates (Chart 4). Focusing solely on this past year, the yen has depreciated against the U.S. dollar by 4 percent and the Korean won by 8 percent while appreciating against the euro by 2 percent. A weighted average of these developments based on the value of trade – in other words, the nominal effective exchange rate – results in a 4 percent depreciation of the yen. Of course, putting aside developments that have occurred in the past year, I am well aware that corporate managers here in BIS central bankers’ speeches Nagoya, where export-driven manufacturing plays a significant role, have been feeling that they continue to face a severe situation as the value of the yen has remained at a high level following its rapid appreciation since the Lehman shock. On this point, the share of overseas business fixed investment has been rising further in recent years and Japanese firms have been increasingly expanding their overseas business activities (Charts 5 and 6). Fundamentally, this reflects firms’ efforts to capture demand in overseas economies with relatively high economic growth; however, it also appears to reflect that the persistent trend of the yen’s appreciation is accelerating such business activities. From an even longer perspective, developments in the yen’s exchange rate have shown large swings. Looking back, the yen depreciated considerably toward the mid-2000s, mainly against the euro, against the background of yen carry trades (Chart 4). Following the Lehman shock, however, it started to appreciate rapidly. Forces behind such appreciation include a reversal of yen carry trades as interest rate differentials between the United States and Japan and those between Europe and Japan narrowed, and the fact that the yen had come to be perceived as a safe currency as the European debt problem became aggravated. Such large swings in the exchange rate have significant effects on corporate performance, and I do acknowledge that achieving a stable exchange rate is highly desirable in authorities’ policy conduct. The Bank is concerned that the appreciation of the yen could have adverse effects on Japan’s economy – mainly through a decrease in exports and corporate profits as well as deterioration in business sentiment – in the current phase, in which there is high uncertainty regarding the outlook for overseas economies. The yen’s appreciation should also be viewed as a risk in terms of whether it would accelerate firms’ shift of production overseas or whether it would lead to a decline in medium- to long-term growth expectations. As I will explain shortly, the Bank has been pursuing aggressive monetary easing while assessing developments in economic activity and prices, while also keeping in mind the risks I have just mentioned. Meanwhile, the government has carried out foreign exchange intervention as necessary in line with the understanding – shared again at the last G-20 meeting – that reads “disorderly movements in exchange rates have adverse implications for economic and financial stability.” II. Recent developments in and the outlook for Japan’s economy I will now explain recent developments in and the outlook for Japan’s economy, taking into account the developments in overseas economies and exchange rates that I have just explained. In the first half of 2012, Japan’s economy registered the highest growth rate among the advanced economies. The situation changed rapidly since the summer, however, and the economy is currently weakening somewhat. Its transition to this somewhat weakening phase is mostly attributable to the prolonged deceleration in overseas economies. Exports decreased in July–September and then in October, and industrial production has fallen for two consecutive quarters (Chart 7). Developments in October–December warrant vigilance, as effects of the Japan-China relations are projected to be reflected in exports as well. While domestic demand has been relatively firm until recently, mainly against the background of an increase in reconstruction-related demand, the effects of the prolonged deceleration in overseas economies have gradually begun to spill over to domestic demand too. Private consumption has lost some momentum, partly due to the decline following the ending of subsidies for the purchase of environmentally friendly cars. While business fixed investment has been on a moderate increasing trend, it has shown some weakness in manufacturing mainly due to the deceleration in overseas economies. Based on these developments in overseas demand, the economy is expected to remain relatively weak for the time being. Thereafter, however, it will return to a moderate recovery path as overseas economies gradually emerge from the deceleration phase. Meanwhile, the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) is expected to remain at around 0 percent for the time being and start rising gradually thereafter BIS central bankers’ speeches as the supply and demand balance improves in accordance with a pick-up in economic activity. In fiscal 2014, it appears likely that the CPI will move steadily closer toward the Bank’s “price stability goal in the medium to long term” of 1 percent for the time being. Whether developments in Japan’s economy will follow the projected path, however, hinges on those developments in overseas economies. At international conferences that I have attended recently, the delegates from the United States, Europe, and China have similarly pointed to developments in overseas economies as a factor exerting a considerable impact on their own economies. If these economies are considered in terms of the global economy as a whole, however, this overseas factor does not exist. Put differently, it is important to grasp the global economy as a whole in an era that is witnessing significant progress in economic globalization. In this regard, we surely cannot forget that global economic expansion in the mid-2000s – particularly from 2004 toward 2007 – was characterized by extraordinarily favorable economic conditions supported by an unprecedented credit bubble (Chart 8). As a consequence of the bursting of this bubble, even six years since the bursting of the U.S. housing bubble and four years since the Lehman shock, and despite aggressive monetary easing in advanced economies, the pace of global economic recovery is extremely moderate (Chart 9). This suggests that it will be difficult for the global economy to return to a high growth path until adjustments of excess debt after the bursting of the bubble are completed. III. Recent conduct of monetary policy Let me now move on to the conduct of monetary policy.1 Based on the aforementioned assessment of economic activity and prices, the Bank of Japan undertook further aggressive monetary easing for two months in a row, in September and October 2012. The Bank’s decision can be summarized within the following two components. First, it decided to increase the size of the Asset Purchase Program (hereafter, the Program; Chart 10). The Program’s size was increased by about 21 trillion yen when adding together the decisions made in September and October. Looking back to autumn 2010, when the Program was introduced, it started off at a size of about 35 trillion yen; within two years, its size increased by about 56 trillion yen to about 91 trillion yen and its timing of completion was also extended from end-2011 to end-2013. The Bank has clearly stated that it aims to achieve the goal of 1 percent for the time being 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 Program mainly through the purchase of financial assets, as was announced back in February 2012. The Bank is determined to continue with this powerful easing until it judges the 1 percent goal to be in sight, while it will ascertain whether there is any significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances. The second aspect of the Bank’s decision is the establishment of a new lending facility called the “Stimulating Bank Lending Facility” (Chart 11). Under this facility, the Bank will provide funds to financial institutions, at their request, up to an amount equivalent to the net increase in their lending. The total amount of funds provided by the Bank will be “unlimited” – that is, there shall be no upper limit. If we take account of the fact that firms’ overseas activities and financial institutions’ support of such activities through lending have important implications for the development of Japan’s economy in the midst of economic globalization, then financial institutions’ lending can be the form of either yen-denominated or foreign currencydenominated. The interest rate charged by the Bank will be equivalent to its target for the uncollateralized overnight call rate at the time of loan disbursement, and is currently For details on various issues concerning the Bank’s monetary policy conduct, please see Masaaki Shirakawa, “Toward Sustainable Growth with Price Stability” (Speech at the Kisaragi-kai Meeting in Tokyo), November 12, 2012. http://www.boj.or.jp/en/announcements/press/koen_2012/data/ko121112a1.pdf BIS central bankers’ speeches 0.1 percent per annum. Furthermore, loans can be rolled over up to four years at the request of financial institutions. In sum, these institutions can have access to long-term stable funding at a low cost through the Bank. According to data for the 12 months up through August 2012, the amount of lending increased by a total of approximately 15 trillion yen for financial institutions that saw a rise in their lending. Going forward, if financial institutions manage to increase their lending more aggressively, the amount of funds that the Bank can provide will rise accordingly. At present, the Bank is in the process of making the necessary arrangements, and we plan to release the details of this facility before the end of the year and start its operation as soon as possible. The Bank’s aggressive monetary easing, which consists of its virtually zero interest rate policy and its purchases of financial assets through the Program, coupled with measures including the government’s intervention in the foreign exchange market, has fended off the yen’s appreciation to some extent. Nonetheless, we have heard the opinion that the Bank’s monetary easing is not enough because Japan’s economy has yet to overcome deflation. This opinion often refers to the amount of “money” supplied by a central bank. Looking at the monetary base – which is the amount of “money” supplied by a central bank, percentage point changes in its ratio relative to GDP since the Lehman shock have been more or less the same as in Europe and the United States, where the monetary base is thought to have been increased aggressively during this period (Chart 12). Furthermore, as Japan experienced its financial crisis much earlier than other economies, the ratio of the monetary base relative to GDP also started rising in earlier years and has now reached the highest level among the advanced economies.2 Now the question is, how can we further strengthen the effect of monetary easing? In order to answer this question, I would like to discuss the monetary transmission mechanism. This can be divided into two stages. The first stage is the transmission of monetary easing effects from the realm of monetary policy to the financial environment, where firms can raise sufficient funds at low costs on the back of monetary easing. The second stage is the transmission of effects from the financial conditions to economic activity and prices; in other words, the extent to which firms and households actually take advantage of the accommodative financial conditions to increase their investment and spending (Chart 13). As for the first stage of the transmission, the effect of aggressive monetary easing has thoroughly permeated the financial environment, and extremely accommodative financial conditions have been achieved both in terms of interest rates and access to financing. If the effect of aggressive easing permeates the second stage of the transmission, it surely can be seen in economic activity and prices. The Bank considers that the key to the overcoming of deflation lies in the extent to which a wide range of economic entities – such as firms and households – actually make full use of current accommodative financial conditions. With this in mind, I would next like to discuss the necessity to invigorate growth potential, or to raise the potential growth rate of the economy. IV. Path toward overcoming deflation Fluctuations in economic activity can be broken down into two components: one is the trend growth and the other is cyclical growth – that is, the fluctuation of economic activity around the trend growth path. The first half of my talk today mainly dealt with the issue of economic cycles, and monetary policy is aimed at ensuring price stability while leveling out such fluctuations. Under the current zero interest rate environment, the cost of holding money is zero, so money is unlikely to circulate in the economy no matter how much a central bank injects. What is important at this juncture is to raise the velocity of money through the strengthening of growth potential. BIS central bankers’ speeches From this viewpoint, the output gap – which became as large as –8 percent after the Lehman shock – has shrunk to around –2 percent recently (Chart 14). Reflecting such developments in the economy, the year-on-year rate of change in the CPI (all items less fresh food) became as low as –2.4 percent in summer 2009, but overall it has been on an improving trend since then, as exemplified by the recent figure of around 0 percent. In contrast, the trend growth rate has been declining gradually. When corporate managers – those of SMEs in particular – say that they cannot feel there has been any economic recovery, what they are expressing is exactly in line with the situation that I just described; namely, that the trend growth rate has been declining gradually. The average growth rate for the next decade or two is defined by the potential growth rate, which can be broken down into the rate of growth in the number of workers and that in the real GDP per worker – in other words, the labor productivity growth rate. The number of workers declined at a rate of –0.2 percent in the 2000s, and it is estimated that there will be an acceleration in the pace of decline to –0.6 percent in the 2010s and –0.8 percent in the 2020s, given the present labor participation rates by gender and generation (Chart 15). The labor productivity growth rate for the years 2000 through 2008 – a period characterized by relatively favorable economic conditions – was 1.5 percent. Taking these numbers together, the potential growth rate for the next two decades will be less than 1 percent. This leads us to conclude that, in order to lift the potential growth rate to 2 percent, for example, it is imperative to make serious efforts both to increase the number of workers and to raise the labor productivity growth rate. As for the number of workers, increasing the labor participation rates of the elderly and women is a key factor. In terms of labor productivity, the average labor productivity growth rate in G-7 countries over the last 20 years is 1.3 percent (Chart 16). Admittedly, it is difficult to expect that advanced economies including Japan – having already completed their “catching up” process – will maintain high labor productivity growth rates, but one has to make tenacious efforts to raise the growth rate. We need to acknowledge the need to make efforts on these two fronts; that is, efforts to strengthen the growth potential. In an economy where a rise in income is hardly expected to occur in the near future, expenditure keeps declining and thus prices are unlikely to rise. It is in this context that the Bank notes the importance of efforts to strengthen the economy’s growth potential and support from the financial side in order for Japan’s economy to overcome deflation as early as possible and return to the sustainable growth path with price stability. I have already explained the Bank’s own efforts to overcome deflation. For the last part of my remarks, I would like to discuss the respective roles of business firms, private financial institutions, and the government with regard to achieving the same goal of overcoming deflation. First, business firms obviously are the main actors in the strengthening of growth potential. Among others, firms here in Nagoya have overcome a number of difficulties in the past and have actually cultivated the frontier for growth. I am fully confident that you have the strength to generate highly value-added goods and services in spite of severe circumstances. Second, as for private financial institutions, their major lasting role is to support firms’ efforts toward strengthening growth potential from the financial side. On this point, it is important that financial institutions, while assessing the growth potential of businesses and cultivating credit demand for promising projects, provide funds smoothly to firms and projects with high growth potential, despite the high risks, through devising lending measures. In addition, financial institutions have the advantage, compared with other sectors, of maintaining corporate information and the customer network. Making use of such an advantage, they are expected to help customers solve challenges by providing services that meet the needs of those customers, such as developing a sales network at home and abroad, helping those customers start overseas businesses, and supporting M&A and business succession. BIS central bankers’ speeches Last, but not least, it is really important for the government – through measures including decisive deregulation – to raise the attractiveness of domestic investment and lay the foundations that encourage firms to embark on challenges. It is also important for the government to continue making efforts to ensure fiscal consolidation. In order to aggressively cultivate new potential demand at home, firms have to produce new goods and services that meet highly diversified customers’ needs, partly due to the aging society; at the same time, the government must lay the foundations that allow households to use money without feeling unease about the future. In order to do so, the social security system and pension system need to be sustained. In recent years, Japanese financial institutions have been aggressively increasing the amount of Japanese government bond (JGB) holdings in light of declining credit demand in the private sector (Chart 17). Accordingly, interest rate risk stemming from fluctuations in market rates is heightening (Chart 18). Therefore, it is also extremely important from the viewpoint of financial institutions – which support the growth of business firms through lending activities – that the government makes every effort to ensure fiscal consolidation. Concluding remarks Japan’s economy now faces a big challenge, but we should not be trapped by pessimism. Unlike Europe and the United States, Japan is one of a handful of countries for which real consumption per capita has exceeded the levels prior to the Lehman shock (Chart 19). As I have noted today, in order to overcome deflation, firms, financial institutions, the government, and the central bank must play their respective roles, through which this challenge can surely be met. Let me close by saying that the Bank is determined to continue making its utmost efforts toward overcoming deflation as early as possible and returning Japan’s economy to the sustainable growth path with price stability. 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 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, Kumamoto, 29 November 2012.
Sayuri Shirai: Demographic changes in Asia and Japan’s economic and financial developments Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kumamoto, 29 November 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 deeply honored to be able to speak to all of you, as you represent the administrative, economic, and financial communities in Kumamoto Prefecture. First, let me briefly outline the content of my presentation. It will be divided into two parts. In the first part, I will focus on the current demographic situation and review demographic changes in Japan and other Asian economies, as well as associated trends in household consumption patterns. After giving this background, the second part of my presentation will summarize Japan’s recent economic developments and price movements, as well as monetary policy and related issues. After I finish, I am looking forward to exchanging views with you about my presentation, economic performance in the region, and measures undertaken to revitalize the economy. II. Economic growth and demographic changes in Asia As we are all aware, Japan is a society with a rapidly-aging population caused mainly by a low birth rate. It is also increasingly recognized that other Asian economies are soon about to follow Japan’s path. Therefore, I would like to look at this issue today and talk about demographic change, as well as the demographic outlook in the region over the next few decades. A. Demographic dividend and demographic burden The world is increasingly concerned with demographic issues. This is because demographic changes are closely associated with national living standards and economic growth. To understand the connection between living standards and economic growth, let us consider a hypothetical country in the early stage of economic development. Generally speaking, a country with low living standards and an inadequate medical and welfare services system tends to face slow population growth largely due to high fertility counteracted by high child mortality rates. As the economy gradually develops, the country is likely to experience a decline in the child mortality rate and resultant rapid growth in the “youth population” (those aged below 15). Subsequently, further growth of per capita income will reduce the fertility rate. When the fertility rate first begins to decline, a country generally has an abundance of relatively young workers, and the growth rate of the “working-age population” (aged 15 to 64) exceeds that of the total population. 1 In other words, the youth and elderly dependency ratio (hereafter called the “total dependency ratio”) – defined as the ratio of the combined population of the youth and the elderly (aged 65 and over) to the working-age population – tends to decline. During this period, the high growth rate of the labor force directly stimulates economic growth. Moreover, the working-age population tends to save more than other generations and these higher savings indirectly contribute to economic growth through supporting infrastructure and productive investment activities. Considering these positive The ratio of the working-age population to the total population tends to rise as well. BIS central bankers’ speeches effects of demographic change, this period is often called “the period of the demographic dividend.” 2 Eventually, the demographic dividend period ends and a country enters a new stage of demographic change. In this new stage, a country faces a growing number of elderly retirees. As the growth rate of the working-age population lags that of the total population, the total dependency ratio rises. During this period, the decline in the working-age population is likely to directly depress the economic growth rate. The economic growth rate may also decline as lower national savings reduce the available support for investment activities. Because of these possible adverse effects, this period could be called “the period of the demographic burden.” 3 B. Japan in the stage of the demographic burden Summarizing the points made so far, the demographic dividend period starts when the total dependency ratio begins to decline, and the demographic burden period starts when this ratio begins to rise (after averaging out fluctuations driven by baby boom periods). Chart 1 reports the general conditions and outlook for demographic changes. Japan has already entered the demographic burden period, based on United Nations data since 1950. Since the second half of the 1950s, the total fertility rate has almost always declined, and reached 1.39 in 2011 (Chart 2). 4 Over the same period, life expectancy at birth increased rapidly. Male life expectancy increased from 50.1 years in 1947 to 79.6 years in 2010, and female life expectancy increased from 54.0 years to 86.4 years over the same period. In 1970 the ratio of the elderly population to total population exceeded 7 percent (the threshold used to define an “aging” society), and in 1995 it exceeded 14 percent (the threshold used to define an “aged” society). This shift from 7 percent to 14 percent took only 25 years in Japan, compared with 61 years in Italy, and 85 years in Sweden. The elderly population ratio currently stands at 23 percent (as of 2011), which puts Japan among the nations with the highest longevity in the world (Chart 3). Reflecting both the rapid decline in the fertility rate and the rapid pace of aging, Japan entered the demographic dividend period around 1955 and transitioned into the demographic burden period around 1995. Thus, Japan is already more than 15 years into the demographic burden period (charts 4 and 5). C. Demographic changes occurring in Asia Now, let us look at demographic changes in other Asian economies. In contrast to Japan, most Asian economies are still enjoying the demographic dividend period (Chart 5). Asia’s remarkable economic success is widely attributed to an emphasis on education, high savings and investment ratios, export-oriented economic growth strategies, government-led industry promotions, and various measures to attract foreign capital. In addition, the availability of low-cost labor owing partly to the demographic dividend period has not only supported successful economic performance, but has also attracted Japanese outward foreign direct investment (FDI) to the region since the 1980s. However, divergent features related to demographic changes have recently begun to emerge in Asia. I think that the economies of the region can be divided into two groups: one group in In the initial stage of the demographic dividend, a country faces rapid growth in the population of young workers aged in their late teens to forties, a demographic segment with a tendency to form families. This period is likely to see rapid expansion of expenditure on pension benefits as well as medical and nursing services for the elderly. Consequently, the fiscal balance and social security system sustainability are likely to deteriorate. The total fertility rate refers to the number of children that would be born to a woman who lives through her child-bearing years and bears children in accordance with current age-specific fertility rates. BIS central bankers’ speeches an advanced stage of demographic change (the so-called “advanced group”) and a second group at a less advanced stage (the so-called “follower group”). Advanced group economies approaching the end of the demographic dividend period The advanced group includes the so-called newly industrialized economies (NIEs), which industrialized and achieved high economic growth much earlier than other Asian economies. The NIEs – which comprise Hong Kong, South Korea, Singapore, and Taiwan – experienced a rapid decline in the ratio of the young population to the total population due to a decreasing fertility rate in the 1970s. The group also includes China and Thailand. Hong Kong entered the demographic dividend period by 1965; South Korea and Singapore followed by 1970, Thailand by 1975, and Taiwan and China by 1980. 5 Hong Kong and South Korea will exit the demographic dividend period and enter the demographic burden period during 2010–15 (charts 5 and 6). China, Singapore, Taiwan, and Thailand are likely to exit the demographic dividend period by 2015. All economies in the advanced group will enter the demographic burden period by 2020. When the demographic dividend period ended around 1990, Japan’s per capita income had already reached about 27,000 U.S. dollars – a level that ranked it among the high income economies. Similarly, the NIEs are likely to enter the new stage of demographic burden with per capita incomes already above 20,000 U.S. dollars. Economies with high income levels as well as an adequate social capital infrastructure and social security system will be better prepared to cope with aging-related challenges. In contrast, China is projected to enter the demographic burden period when its per capita income remains in the range 8,000 to 10,000 U.S. dollars (according to the projection of the International Monetary Fund [IMF]) – the level that defines a medium income economy. This reflects the effect of China’s one child policy in rapidly reducing fertility rates since its launch in 1979 and the decline in the youth population ratio from around 1980 (Chart 6). Simultaneously, rapid aging has already made China an aging society, and the elderly population ratio surpassed the 7 percent threshold by 2000. This means China is likely to face aging-related challenges before it builds an adequate social capital infrastructure and social security system. Unless the country can increase the workforce participation of the elderly, the substantial cost of aging may be borne by the government and younger generations. The ratio of the elderly population to the total population is only about 10 percent in China, which is well below the ratios of Japan (23 percent in 2011), Hong Kong (13 percent in 2010), and South Korea (11 percent in 2010). However, China is unique in the sheer size of its elderly population (about 100 million). Like China, Thailand is also likely to end its demographic dividend period while its per capita income remains at a medium level. Follower group economies enjoying the demographic dividend period The follower group also experienced a decline in the youth population ratio since the 1970s and an increase in the elderly population ratio since the 2000s, but this group is likely to continue to enjoy the demographic dividend period for decades to come (Chart 5). The demographic dividend period began in India, Malaysia, and the Philippines by 1970 and in Indonesia and Vietnam by 1975. The demographic dividend period is likely to end in Indonesia by 2025, Vietnam by 2035, India by 2040, Malaysia by 2045, and the Philippines by 2050. These economies face a slower decline of the youth population ratio and a slower pace of aging than economies in the advanced group (Chart 7). Differences in fertility rates and life expectancy at birth cause different demographic patterns. While the total dependency ratio in China began to decline in 1970, the scale of the decline remained limited during the 1970s. Thus, the demographic dividend period is considered to have started in 1980, the year a clear declining trend was observed. BIS central bankers’ speeches III. Demographic changes and expenditure patterns in Asia The aforementioned demographic changes affect macroeconomic performance in various ways. Typically, they affect economic growth through movements in labor supply, savings, and investment. Demographic changes also affect the sustainability of the fiscal balance and social security system. Today, I want to focus on the impacts of demographic changes on consumption movements. 6 A. Japan’s expenditure patterns Having outlined demographic trends, I would now like to talk about historical movements of household consumption in Japan. Based on time series data from the 1950s, per capita domestic final household consumption expenditure appears positively correlated with per capita GDP or per capita disposable income. Per capita consumption expenditure rapidly expanded from the 1970s to the 1980s, when per capita income grew rapidly. The aggregate consumption expenditure data also exhibited an expansionary pattern, partly due to population growth. This suggests that a country experiencing rapid income growth is also likely to see rapid consumption growth. However, once per capita income reaches about 3 million yen on a GDP basis – or 2.5 million yen on a disposable income basis – consumption appears to level out (Chart 8). This may reflect that Japan’s average income level has become comparable to other advanced countries and so marginal consumption demand has weakened. Regarding future trends, the consumption level may decline as the decline of Japan’s total population from 2011 reduces the total number of consumers. Next, I want to explore the impact of demographic changes on consumption patterns. As the average income level in Japan rose, expenditure on durable consumption goods also increased. This trend was observed for (a) transportation equipment (including passenger cars) and (b) TVs and information/communication equipment (Chart 9). Particularly, expenditure on transportation equipment rose rapidly in the second half of the 1980s, probably reflecting a shift in consumer preferences from motorcycles to passenger cars and from low-quality cars to high-quality cars. Since then, expenditure on durable consumption goods has flattened. The number of new passenger-car registrations has declined moderately in recent years (Chart 10). The population’s declining trend that started in 2011 is likely to reduce the sales volume of durable consumption goods. B. Age-driven changes in Japan’s consumption structure While consumption appears to have peaked owing to the constraints imposed by demographic changes, it is important to pay attention to the changing characteristics of the consumption structure. First, the elderly are becoming a major consumer generation. The share of consumption by households whose heads are aged 65 and over has been rapidly rising and already accounts for more than 30 percent of total consumption (Chart 11). If households whose heads are aged 60 and over are added, the share of consumption by elderly households exceeds 40 percent of total consumption. According to analysis based on household survey data, elderly households tend to allocate a greater proportion of their consumption to medical and nursing services, tourism, social expenses, and foods than younger households. Meanwhile, elderly households spend less on education and transportation/communication (including passenger cars) than younger households. These Generally, in the early stage of the demographic dividend households tend to increase their demand for durable consumption goods (such as cars and home electronics) and actively conduct residential investment. This is because households belonging to young generation are likely to form families. As a country passes through the demographic dividend period, a growing number of households complete the child rearing stage, and so more money can be allocated to savings for retirement. During the demographic burden period, households, as population aging proceeds, may increase demand for medical care, nursing care, and housekeeping services, as well as recreation, tourism, and cultural activities. BIS central bankers’ speeches consumption patterns make sense since many elderly households have already completed child rearing. Other data show that medical and nursing related expenditure in Japan increased cumulatively by more than 30 percent between 2000 and 2010. This increase is larger than in other advanced countries. For example, the cumulative increase during the same period was 25 percent in Germany (with an elderly population ratio of 20 percent), 11 percent in France and the United Kingdom (each with 18 percent), and 16 percent in the United States (13 percent). In other words, the market for goods and services targeting the elderly is likely to expand further as the population becomes more aged. The elderly population generally has lower income from earnings than the working-age population. However, the elderly population is often observed to have more varied consumption preferences and tastes, reflecting divergent asset sizes, health conditions, and living environment compared with the younger generation. Given the large and diverse potential demand of the elderly population, firms can pursue new business opportunities involving high quality goods and services that meet this demand. Furthermore, I would also like to look at the pattern of residential investment – a major investment item for households – although it is not regarded as consumption. The size of the working-age population is positively correlated with total housing investment. Chart 12 shows that private housing investment has clearly declined since the mid-1990s, when the working-age population began to decline. In the present era of declining population, the number of residential investment projects is unlikely to grow much. Instead, demand growth in housing is likely to come from renovation of existing houses or the purchase of new houses that are suitable for elderly persons or located in convenient urban areas. Thus, I want to emphasize that the aging population can create new business opportunities for Japanese firms if they develop ways to tap this potentially large consumption market. C. The case of the NIEs: transforming to an aging society What about the consumption patterns of the NIEs in the advanced demographic group? As I have highlighted, since these economies already have high incomes, their consumption is likely to grow further in the near future, as Japan previously experienced. According to the historical data, Japan’s ratio of household consumption expenditure to GDP dropped from the 1950s to the 1960s. This happened because GDP growth exceeded consumption growth. However, the ratio resumed a positive trend from the 1970s, when per capita income rose rapidly (Chart 13). Thus, the ratio of consumption to GDP has room to grow as per capita income increases. Moreover, the life-cycle hypothesis indicates that the national savings rate is likely to decline and the consumption-GDP ratio is likely to increase as the elderly population grows. 7 Thus, countries with large populations of youth and elderly tend to have a lower national savings rate than those with large working-age populations. In particular, the increase in the elderly population, whose life expectancy has been increasing, is likely to further reduce the national savings rate. Most Asian economies are still enjoying the demographic dividend period, and population aging has not progressed as far as in Japan, Europe, and the United States. Therefore, their consumption-GDP ratios tend to be much lower than those of the advanced economies (Chart 14). Above all, Asia is well known for having a higher propensity to save than any other region of the world. This saving habit not only stimulates investment but also creates a Over their life cycle, individuals attempt to smooth their consumption by accumulating savings during their working years and using those savings during retirement. Regarding an analysis on the impact to the Japanese economy of aging, see Muto, Ichiro, Takemasa Oda, and Nao Sudo, “Macroeconomic Impact of Population Aging in Japan: A Perspective from an Overlapping Generations Model,” Bank of Japan Working Paper Series, No.12-E-9, 2012. BIS central bankers’ speeches large current account surplus. Hong Kong is the most aged economy among the NIEs and is second to Japan in Asia, and its ratio of elderly persons to the total population approached 14 percent in 2010. Hong Kong’s consumption-GDP ratio declined in the 1970s, but has increased since the late 1980s. As for South Korea, the consumption-GDP ratio remains low, but has increased during the 2000s. Singapore’s consumption to GDP ratio shows no signs of increasing. China and Thailand have shown divergent patterns despite their similar income levels. Overall, a clear rising trend is observed only for Hong Kong. Nonetheless, the consumption-GDP ratio in the NIEs is expected to grow further in the near future, as aging accelerates in the region. The Asian Development Bank (ADB) has conducted an interesting analysis on this subject. 8 The study found that the impact of aging on the consumption-GDP ratio (or on the savings-GDP ratio) is smaller (or larger) in Asia than elsewhere. However, it also found that the consumption-GDP ratio tends to increase in Asia when population aging reaches a certain point. Asia’s relatively low consumption ratio may reflect that the pace of aging is slower there than in other regions: for example, the report mentioned that the elderly population ratio is only 9 percent in Asia compared with 12 percent globally. Namely, the presence of a relatively large working-age population in Asia supports the tendency to save rather than consume. 9 The ADB concluded that the Asian region is unlikely to stably expand consumption and domestic demand in the near future, since many economies remain in the early demographic dividend period. In other words, it may take time for the region to reduce its current account surpluses – mainly caused by high saving rates – or re-balance the saving-investment relationship. In the Asian region, the NIEs are likely to re-balance the saving-investment relationship and experience increased demand for services, particularly since their faster aging may stimulate demand for related services. 10 The demand for a better social security system may also encourage the government to provide more services for the elderly. The elderly population ratio in these economies is expected to reach a level comparable to the advanced countries by 2030. Thus, Japan, as a leader in the aging trend, may be able to develop creative goods and services that cater to the demand of the elderly population, which may eventually find markets in other aging countries. Given that the service sector is increasingly internationalized and tradable, penetration into other countries could happen relatively rapidly. D. The case of China: rising income and growing consumption market China has developed its economy as a center for industrial production in the Asian region by utilizing its large pool of low-cost labor from rural areas. Thus, wage growth has long lagged labor productivity growth. The resultant low unit cost of labor appears to have contributed to household consumption growth lagging GDP growth (Chart 14). In recent years, the supply See Estrada, Gemma, Donghyun Park, and Arief Ramayandi, “Population Aging and Aggregate Consumption in Developing Asia,” ADB Economics Working Paper Series No. 282, 2011. As one of the factors contributing to the relatively low consumption-GDP ratio in Asia, it is noted that elderly persons in other regions tend to depend more heavily on pension benefits and income support provided by the public sector, while those in Asia tend to accumulate savings and assets prior to retirement. See Lee, SangHyop and Andrew Mason, “The Economic Life Cycle and Support Systems in Asia,” ADB Economics Working Paper Series No. 283, 2011. In other words, the Asian region tends to save more under an inadequate social security system and social capital accumulation. The share of services in GDP is found to be positively related with the level of per capita income. Eichengreen and Gupta (2009) identified two waves of service sector growth: the first is related to lodging, meal preparation, housecleaning, and beauty shops, which typically generate moderate growth until per capita income level reaches about 1,800 U.S. dollars; the second is related to financial services, computing, communication services, and business services, which support accelerating growth once income reaches about 4,000 U.S. dollars. See Eichengreen, Barry and Poonam Gupta, “The Two Waves of Service Sector Growth,” NBER Working Paper No. 14968, 2009. I believe there follows a third wave of service sector growth, based on aging-related services. BIS central bankers’ speeches of low-cost labor from rural areas has become limited. As a result, minimum wages have been rising in many areas. Further tightening of the supply-demand balance in low-cost labor is expected to ensure continuous wage growth, raising per capita disposable income and the presence of middle class income earners. The further deregulation of financial and capital markets may strengthen those markets and help the middle class accumulate financial assets. All these factors are likely to contribute to near term consumption growth. If this growth happens, households are likely to expand demand for durable consumption goods (such as cars, air conditioners, microwaves, etc.); demand for such goods has high income elasticity. Residential investment is likely to follow this trend. According to “China 2030,” a report compiled by the World Bank and China’s Development Research Center of the State Council, China is projected to experience rapid urbanization – the nearly 50 percent of the population living in cities in 2009 will increase to nearly two-thirds by 2030. 11 This implies about 13 million new urban residents each year – comparable in scale to Tokyo. It is reported that the 20 fastest-growing cities in China are located inland, and per capita incomes in the interior cities are rapidly catching up with the coastal cities. If urbanization is accompanied by better infrastructure, demand for passenger cars is likely to increase substantially given the low car ownership rate. Accordingly, demand for better public services, recreation activities, education, and financial services is likely to grow further. The aforementioned report projects that the share of industry to GDP will shrink constantly from 44 percent in 2015 to 41 percent by 2020, 38 percent by 2025, and 35 percent by 2030. This may imply that some production locations may shift to other Asian economies enjoying longer demographic dividend periods. Since it takes time to strengthen social capital infrastructure and the social security system, the consumption-GDP ratio may not rise as rapidly in China as in other countries even if the pace of aging accelerates. However, the aforementioned report projects that greater upward pressure on wages and the resultant rising share of household income in GDP will eventually reverse the steady decline in the share of household consumption in GDP. Accordingly, the share of services in GDP is also projected to grow steadily from 48 percent in 2015, to 52 percent by 2020, 56 percent by 2025, and 61 percent by 2030. Meanwhile, the investment-GDP ratio is expected to decline from 42 percent in 2015 to more sustainable 34 percent by 2030. It is important to note that these projections are based on the assumption that China will implement necessary structural and policy reforms to promote a more market-oriented, innovative economy and maintain high productivity to generate economic growth. China also needs to implement measures to facilitate the portability of pension and social security rights and to further reform the hukou system. Also, the retirement age needs to be extended from 60 years old for men and 55 years old for women, and elderly workers require employment opportunities and job training. 12 The one child policy also needs to be further adjusted. In Japan, it only took 25 years for the elderly population ratio to increase from 7 percent to 14 percent, much faster relative to European countries. While the same period for a shift from 7 percent to 14 percent is projected in China, some believe that it could be even shorter. Thus, China faces many forthcoming challenges from its rapidly aging society. IV. Japan’s structural problems and the outlook for economic activity and prices In the first part of my presentation, I talked about past, current, and projected demographic changes in Japan and other Asian economies, as well as related shifts in consumption See The World Bank, “China 2030: Building a Modern, Harmonious, and Creative High-Income Society,” The World Bank and Development Research Center of the State Council, the People’s Republic of China, 2012. In the case of blue-collar workers, the retirement age is 50 years old. BIS central bankers’ speeches patterns. In the next section, I will shed light on the outlook for Japan’s economic activity and prices. But, before that, I would like to point out various structural changes, including demographic changes, which have affected the environment surrounding monetary policy management. A. Why are the structural issues so important? As mentioned earlier, demographic changes are one of the most important ongoing structural issues faced by Japan. Simultaneously, other advanced countries, especially in Europe, have begun to recognize these changes as important medium-term structural issues. Recently, some central banks have increasingly confronted the need to better understand the impact of demographic changes on macroeconomic performance and even on the environment surrounding monetary policy management. Globally, Japan is taking the lead in dealing with demographic trends and associated macroeconomic issues. It is well known that Japan has seen a reduction of its working-age population in absolute terms since the mid-1990s. The trend of a declining total population began from 2011. As a result, Japan has become the furthest progressed aging society globally. The rapid reversals in the growth rates of the working-age population and total population seem unprecedented globally. This demographic trend has already exerted various negative impacts on Japan’s macroeconomic performance, and thus it is important for the Bank of Japan (hereafter called “the Bank”) to consider new impacts on the environment surrounding monetary policy management. Let me give you one example. Japan’s output gap (or the aggregate demand and supply balance) has remained negative almost continuously since the mid-1990s. Generally, the negative output gap is regarded to be caused by cyclical factors or temporary shocks to the economy (such as natural disasters). However, in the case of Japan, structural factors have also contributed to the long-standing negative output gap. In regard to cyclical and temporary factors, the output gap has deteriorated following a series of domestic and external shocks – such as the collapse of the asset bubbles in the early 1990s, the Japanese financial crisis and East Asian currency crises in the second half of the 1990s, the collapse of the IT bubble in the United States during the early 2000s, the global financial crisis of 2008, the European sovereign debt problems since 2010, the Great East Japan Earthquake and the Thailand floods of 2011, and the spreading effects of recent developments in the relations between Japan and China. These continuous shocks have prevented the negative output gap from narrowing quickly. On the other hand, Japan faces various structural issues including the already-mentioned demographic changes and growing global competition. The aging population has contributed to the long-term slowing of economic growth. Thus, it is important to conduct structural reforms to strengthen the potential for economic growth by enhancing productivity growth of the working-age population while increasing the labor participation rates for women and the elderly. However, the implementation of the necessary structural reforms for boosting growth and productivity has been sluggish. Issues related to mounting government debt and social security reforms have also generated uncertainty over the economic outlook. In this environment, firms may form a pessimistic medium- to long-term outlook on their market growth while households may come to more strongly expect limited future income growth. Consequently, firms and households may become cautious in expanding current investment and consumption activities. If the adjustment of current production capacity by firms in declining industries and their entry into newly emerging or promising industries occur very slowly, these structural factors may persist and cause long-standing sluggish domestic BIS central bankers’ speeches demand. This slows the narrowing of the negative output gap. These structural factors have also contributed to generating depressed prices. 13 Nonetheless, I remain optimistic that deflation can be overcome in the medium term. This is because many Japanese firms are striving to become more innovative and competitive, and to explore new sources of demand, both at home and abroad. With their high technology level and experience, I believe Japanese firms can take the lead in developing innovative, higher value-added goods and services in the areas of robotics, medical treatment and elderly care, medical supplies, biotechnology, energy-savings, etc. Many newly-developed goods and services are likely to contribute to creating a more convenient, comfortable life for the elderly. Such business opportunities can also be explored globally – especially in Europe, where the pace of aging is rapidly progressing, and in the high-income aging economies in Asia. In line with this view, the government is also expected to support the business community by creating a more business-friendly environment. Financial institutions are expected to provide diverse, new types of financial support to innovative, viable firms that tap into growing demand. Under this environment, the Bank will continue to support the business community by ensuring an accommodative monetary environment and providing long-term funds through financial institutions (as explained later). Therefore, I would like to emphasize that the baseline scenario of the outlook for Japan’s economic activity and prices, which I will introduce shortly, is based on the assumption that various agents are making the expected efforts. B. The statement “Measures aimed at overcoming deflation,” jointly released by the Japanese government and the bank of Japan Based on the perspectives presented previously, I feel that the statement “Measures Aimed at Overcoming Deflation,” jointly released by the Bank of Japan Governor Shirakawa, together with Mr. Maehara (Minister of State for Economic and Fiscal Policy) and Mr. Jojima (Minister of Finance), is very significant. Given that deflation is a long-standing, structural challenge, it is important that both the Bank and the government confirm their mutual understanding of the causes of deflation and measures to overcome it. On the one hand, the Bank will continue to pursue its CPI-based inflation goal of 1 percent annually, given that the medium- to long-term price stability goal is set within 2 percent annual inflation. A monetary easing policy – based on the virtually zero interest policy and the Asset Purchase Program – will be pursued until the 1 percent inflation goal is in sight. Simultaneously, the government is expected to vigorously promote measures to help reduce structural constraints and thus strengthen Japan’s growth potential. I personally believe that this statement signals to the public a strong will on both sides to overcome deflation and restore sustainable economic growth with price stability. Therefore, I regard this action positively. C. Outlook for economic activity and prices: a baseline scenario Outlook for economy Japan’s economy grew at a rate of about 3 percent in the first half of 2012, as domestic demand remained firm, while both public and private reconstruction-related demand increased following the Great East Japan Earthquake. Since then, the economy has weakened somewhat, as shown by a marked decline in exports and industrial production. This reflects weakened demand from overseas economies – especially exports destined for For example, see Shirai, Sayuri, “Have Demographic Changes Affected Japan’s Macroeconomic Performance? – Some Implications for Monetary Policy –,” Speeches at the Bank of Finland, the Riksbank, and Stockholm University, Bank of Japan, 2012. BIS central bankers’ speeches the European Union (EU) and China. The implications of recent developments in the relations between Japan and China have affected Japan’s economy in areas such as trade and tourism. Moreover, weakness in the manufacturing sector has gradually affected employment, as seen in a decline in overtime and the number of new job offers in the sector. Private consumption has also lost some of its momentum compared with the period leading up to early summer, partly because of the ending of subsidies for purchasers of environmentally friendly cars. As for business fixed investment, firms’ investment plans for fiscal 2012 as revealed in the September Tankan (Short-Term Economic Survey of Enterprises in Japan) – a survey conducted by the Bank – indicate relatively high growth for that time of year. Nevertheless, some manufacturing firms appear to have begun to postpone their business fixed investment plans. Considering this situation, the Bank has assessed the economy as weakening somewhat. Going forward, Japanese economic activity is expected to remain relatively weak for the time being. Both exports and industrial production are expected to decline against the background of prolonged deceleration in overseas economies. The weakness in exports and industrial production will constrain business outlays in the manufacturing sector, and may lead more firms to postpone their business fixed investment plans. Domestic demand is expected to remain resilient on the whole, mainly supported by broad reconstruction-related demand, including investment related to disaster prevention and energy. Since private consumption has generally remained resilient, labor market conditions are likely to continue an improving trend. Nonetheless, the weak performance of the manufacturing sector is likely to deteriorate supply-demand imbalance in the labor market for the time being. Regarding per capita wage compensation, firms’ poor performance during fiscal 2011 caused by the earthquake is expected to suppress winter bonuses. Meanwhile, we need to pay closer attention to the issue of how long the adverse impact of the expiration of subsidies for purchasers of environmentally friendly cars will last. Therefore, domestic demand is unlikely to increase enough to offset the weakness in exports, and the economy is expected to remain relatively weak for the time being (Chart 15). Thereafter, as overseas economies gradually emerge from the deceleration phase, exports and industrial production are likely to start picking up and private consumption is expected to remain resilient. Residential investment is likely to continue to show a mild improvement partly because of reconstruction demand in affected areas and partly because of moderate growth in demand for condominiums in metropolitan areas based on the low interest rate environment. In fiscal 2013, the economy is expected to grow faster than its potential, as overseas economies gradually pick up and private domestic demand increases robustly, coupled with rising corporate profits and labor income. However, support from reconstruction-related public demand may diminish slowly. In the second half of fiscal 2013, a large front-loaded increase in demand prior to the consumption tax hike is likely to occur, thereby boosting growth temporarily but significantly. In fiscal 2014, the underlying trend of the economy – excluding fluctuations stemming from the consumption tax hike – is projected to be growth that slightly outstrips its potential. This is because overseas economies are likely to grow faster than the historical long-term average and accommodative monetary policies based on low interest rates attract a more positive response through increased investment activity and optimistic growth expectations. Nonetheless, a decline in demand following the front-loaded increase prior to the consumption tax hike is likely to occur in the first half of fiscal 2014 and this will limit the growth rate for the whole of fiscal 2014 to slightly above 0 percent. Outlook for prices As for trends in the CPI (all items less fresh food), the year-on-year rate of decline – after reaching a historical trough of 2.4 percent in August 2009 – has continued to slow consistently since around end-2009 with a gradual improvement in the output gap. Against this background, the CPI has remained almost unchanged – with the year-on-year rate of BIS central bankers’ speeches change of nearly 0 percent (Chart 15). From a somewhat long-term perspective, there is a slight positive correlation between the rate of change in the CPI and the output gap. Looking at the outlook for prices, the negative output gap is likely to remain relatively large for the time being, reflecting the aforementioned economic outlook. Eventually, the output gap is expected to maintain a trend of moderate improvement, with some fluctuation caused by the effects of the hike in the consumption tax. Medium- to long-term inflation expectations can be assumed to remain stable throughout the projection period, given that the expectations of market participants and economists have been stable at around 1 percent and households have not changed their views significantly. However, a moderate drop in medium- to long-term inflation expectations appears to have emerged very recently, so I will pay close attention to future developments. Households’ expectations have not changed perceptibly, and the future outlook is expected to remain stable. As for international commodity prices, crude oil and crop prices have increased slightly because of heightened geopolitical risks and poor weather conditions. On average, however, prices are expected to remain nearly flat, reflecting the deceleration of overseas economies. Thereafter, they are likely to rise moderately against the background of increased demand for food and energy arising from growth in emerging economies. The year-on-year rate of change in the CPI is expected to hover around 0 percent for the time being and then gradually rise as the output gap shrinks. In fiscal 2014, it is projected to move steadily closer toward 1 percent, the inflation goal set for the time being. D. Risk factors affecting the outlook Having talked about the baseline scenario, I would like to touch on risk factors concerning the outlook for economic activity. While both upside and downside risks exist, I personally assess the downside risks as greater. The main downside risks include (a) possible downward adjustments related to overseas economies, including issues such as the sovereign debt problems in the euro area, the “fiscal cliff” in the United States, and the continued slower economic growth in China, (b) uncertainty related to firms’ and households’ medium- to long-term growth expectations, which may be adjusted downward by the delayed efforts of various agents to strengthen the growth potential of Japan’s economy, (c) the greater-than-expected adverse impact of the consumption tax hike, and (d) Japan’s fiscal sustainability issues. Regarding the risks concerning the outlook for prices, I also assess that the risk balance is tilted to the downside, while the Bank’s projection could deviate either upward or downward. First, the responsiveness of prices to the output gap may be less elastic than projected. Thus, careful attention should be paid to whether firms will raise prices with improved economic conditions as expected. Second, if firms and households increasingly expect the pace of price increases to remain slow based on price behavior in the recent and more distant past, downward pressure may be exerted on both actual prices and wages (even if the medium- to long-term inflation expectations remain stable). Third, there is a possibility that volatility in crude oil and other commodity prices may fluctuate, mainly reflecting geopolitical risks and weather conditions. Fluctuations in foreign exchange rates could also affect consumer prices, both directly through changes in import prices and indirectly through changes in economic activity. E. Conduct of monetary policy Finally, I would like to talk about the conduct of monetary policy. So far, financial conditions in Japan have been accommodative, as the Bank continuously pursues powerful monetary easing. Specifically, firms’ funding costs have remained low, with the average contracted interest rates on new loans and discounts – both short- and long-term rates – registering just 1 percent. Issuing conditions for commercial paper (CP) and corporate bonds have remained favorable thanks to resilient demand among investors – notwithstanding the widening of some credit spreads because of worsening corporate performance. A range of indicators BIS central bankers’ speeches reflecting (a) financial institutions’ lending attitudes as perceived by firms, as well as (b) the financial positions of firms have been above the historical average since 2000. Nevertheless, attention needs to be paid to the recent moderate deterioration of the financial positions of small and medium-sized firms. Overall, business credit demand has been recovering gradually, mainly for funds related to reconstruction following the Great East Japan Earthquake and for funding of corporate takeover activities. Looking at funding in the corporate sector at home, the year-on-year rate of increase in outstanding bank lending has recently risen somewhat. The rate of change in outstanding CP issuance has generally been slightly positive. In response to what it perceived as a weakened economy, the Bank made two decisions on October 30 regarding further monetary easing (Chart 16). First, the total size of the Asset Purchase Program was increased by about 11 trillion yen to reach approximately 91 trillion yen – from around 80 trillion yen previously. The Japanese government bonds (JGBs) and treasury discount bills (T-Bills) are to increase by about 5 trillion yen each, CP by about 0.1 trillion yen, corporate bonds by about 0.3 trillion yen, exchange-traded funds (ETFs) by about 0.5 trillion yen, and Japan real estate investment trusts (J-REITs) by about 0.01 trillion yen. The increased purchases are intended to be completed by around end-2013. Second, the Bank decided to establish a new lending facility called the fund-provisioning measure to stimulate bank lending (“Stimulating Bank Lending Facility”) to promote lending by financial institutions. The new facility will enable financial institutions to obtain long-term funds up to an amount equivalent to the net increase in lending at the interest rate equivalent to the Bank’s target for the uncollateralized overnight call rate (currently 0.1 percent per annum). There will be no upper limit to the total funds provided by the Bank to the financial institutions – the facility is unlimited. The duration of each loan will be one, two, or three years, as requested by financial institutions, and the loans will be able to be rolled over for up to four years. The specifics of the facility are still under deliberation and will be announced in the near future. However, the key point is that the Bank may provide substantial funds to support financial institutions’ efforts to increase their lending. I hope that this facility will encourage financial institutions to provide diverse and innovative financial services not only to existing customers but also to pioneering, newly-emerging firms. The Bank will designate this facility, together with the fund-provisioning measure to support strengthening the foundations for economic growth (“Growth-Supporting Funding Facility”) established in 2010, as the “Loan Support Program.” Finally, I would like to emphasize that the Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation as early as possible and achieving sustainable growth with price stability. Given that Japan’s long-standing negative output gap and resultant deflation reflect both cyclical and structural factors, overcoming this challenge will require a strong will, as well as collective efforts by firms, financial institutions, government, and the Bank. The Bank will continue to conduct monetary policy in an appropriate manner. Meanwhile, I will continue to constantly consider how the Bank can best respond to the current challenging environment. This brings me to the end of my presentation. Thank you very much 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 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 the Paris EUROPLACE Financial Forum, Tokyo, 3 December 2012.
Masaaki Shirakawa: Looking through prices in financial markets Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Paris EUROPLACE Financial Forum, Tokyo, 3 December 2012. * * * Introduction Today, I am very pleased to appear before you, for the second time since 2009, at the Paris Europlace Financial Forum in Tokyo. When discussing the issues facing the financial industry at a meeting like this, it is clear that we have yet to put behind us the Great Financial Crisis (hereafter “the Crisis”), the scars of which have hardly healed, even three years after I last spoke here. We are still dealing with the consequences, not only in terms of needing to fix problems in the real economy but also with regard to rebuilding confidence in finance. There is also extensive discussion on how we could improve the conduct of monetary, prudential, payment and other policies in the light of the Crisis. In the following few minutes, I would like to pick up one theme on which I have not fully offered my views so far – that is, how we should view prices in financial markets. The crisis that never should have happened The starting point for my discussion is what people generally thought about finance in general and financial markets in particular before the onset of the Crisis. The prevailing worldview at that time was along the following lines. It all started from the innocuous belief that the market was the best arbiter of economic outcomes. If markets seamlessly covered every economic activity, and if they functioned flawlessly in transmitting price signals, decisions made by economic agents on the basis of such signals would intrinsically maximize social welfare. Any effort to achieve such a state – completing markets and removing regulation – was regarded as desirable in its own right. Of all markets, financial markets were generally regarded as the ones closest to such an ideal state of the economy. On top of this foundation, the financial institutions built an intricate system of risk management. Prices determined by financial markets were deemed to reflect the fair value of financial assets. By looking at historical patterns of price fluctuations, it was thought that risks arising from future price movements could be managed effectively. Observations of prices were fitted into the bell curve and transmuted into concrete numbers such as value-at-risk. Such tools gave financial institutions confidence that they had firm control over the risks they were taking. If too much risk were being taken, then just the right amount of excess risk could be offloaded most quickly and inexpensively by using derivatives, or offsetting positions could be conjured up swiftly and cheaply from the wide universe of financial products. Market participants – banks, securities houses, insurers, hedge funds, and all the rest – were thought to have had every incentive to manage the risks they were taking, because, as individual firms, their survival was at stake. If each participant could thus be assumed to act prudently, there was no reason to question the stability of the whole financial system. The sum of the parts would at least be equal to the whole. In official jargon, microprudence would ensure macroprudence. Meanwhile, in the area of macroeconomic policy, it was supposed that, macroeconomic stability would be achieved, if central banks would implement monetary policy with a view to BIS central bankers’ speeches reducing the variability of inflation at around a certain level. The nexus between price and financial stability, however, was not adequately addressed. 1 It was a wonderful world of macroeconomic stability while it lasted. This came to be called the Great Moderation, sometime in the early 2000s. In the advanced economies, 10-year average inflation fell from 6.3 percent in the 1980s to 2.9 percent in the 1990s, and further to 2.0 percent in the decade before the Crisis – that is, from 1998 to 2007. The financial industry flourished, and cities around the world aimed for the status of a global financial center. The beauty of the whole development was that not only were actual macroeconomic and financial performance good, they also were founded on established economic and financial theories. There were hiccups, of course, with some of them quite serious, like the collapse of Long-Term Capital Management in September 1998, but these were regarded as failures to employ the theoretical framework rigorously enough. Structural roots of the crisis From the viewpoint of actors during the Great Moderation, the Crisis should never have happened. If central banks had maintained price stability, public authorities had worked to remove impediments to market functioning, and financial actors had continued to refine their risk management framework, it was inconceivable that a global credit bubble so large could develop in the first place, let alone pop with such devastating consequences. A consensus has yet to emerge on the reason why the Crisis occurred, but it seems to me that blaming it solely on the greed or fallibility of the actors involved is definitely not appropriate. We can now identify a widely-shared mind-set regarding prices in financial markets that bred the Crisis. Today, I would like to illustrate the shortcomings of this mind-set from two angles. One is the fact that financial markets can and sometimes do overshoot. The other is that there is only so much information that could be extracted from prices in financial markets. The prevailing view before the Crisis drew an important conclusion from the apparent “random walk” of market prices, which reflected all available information. Prices changing at random, most often reflecting new information, were regarded as the best estimate of the intrinsic value of financial instruments. In such a market, a market participant that consistently makes mistakes and keeps on selling low and buying high will inevitably be forced out because of mounting losses. Consequently, the market will have to be populated by participants who can generally make the right calls, and a market populated by such well-informed participants should not be susceptible to persistent price overshoots. As a footnote, short selling and derivatives are seen as beneficial practices in this context, because they will allow market participants to bet against misalignments more easily and cheaply. Why, then, do bubbles appear? In other words, how can market prices continue to overshoot for a long time? One way to answer this question is to place the blame on market participants’ excess optimism. When market participants become too optimistic, this distorts market prices, which then begin to overshoot. This can even happen among perfectly rational market participants, because the intrinsic value of any financial instrument cannot be observed. Prices in the market may be “fair value,” in the sense that this is the best of all available estimates. Nevertheless, that does not guarantee that the market price equals the intrinsic value. In order for that to happen, market participants have to compete to determine the For a discussion of the prevailing monetary policy framework, see Mervyn King, “Twenty years of inflation targeting” (The Stamp Memorial Lecture at the London School of Economics), October 9, 2012. http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech606.pdf. See also 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/data/ko1004e.pdf BIS central bankers’ speeches intrinsic value of a traded instrument. As pointed out by Lord Keynes, however, market participants could instead be focused on anticipating what other market participants would consider the market price to be. The market price would then be the best estimate of the average opinion on that price, and not the best estimate of the intrinsic value. If, for some reason, market participants come to believe that other market participants would expect prices to rise, the market price will rise irrespective of any changes in intrinsic value. Such a self-fulfilling cycle would lead to overshooting prices and bubbles. The confusion of fair value and intrinsic value also led to the mistaken belief that information extracted from market prices would prevent future disasters. The prevailing financial theories and financial technology derived from such theories masked the obvious fallacy of such a view. It was widely believed that, by observing the past patterns of market price fluctuations, the intrinsic probability distribution of such fluctuations and the correlations between various prices could be estimated. Once the probability distributions – conveniently reduced to volatility and the mean under the assumption of the bell curve – and correlations were determined, those numbers were fed into computers to compute measures of risk, such as value-at-risk. Estimated probability distributions also gave market participants a sense of security that, if they could construct reasonably diversified portfolios, outcomes would be in line with the expected returns implied by the distributions. As a result, market participants became too sanguine in their risk-taking activities. They conveniently assumed that, as long as they followed the models and heeded the risk measures, they were taking only small risks and were managing them very carefully. The situation was exacerbated by the fact that the alignment of expectations among market participants, which led to an ever-widening gap between intrinsic value and market prices, had the effect of reducing volatility and thus risk measures. The risk measures were reaching their lows just as the Crisis was about to strike. This is why market participants were so dumbstruck when volatility exploded and correlations became unhinged in 2008. The Crisis was not meant to happen if the reality fitted the models and theories, and if information extracted from prices had forewarned all calamities. Sadly, however, models and theories are descriptive views on how the world is working, and not prescriptive views on how the world should work. Financial markets will inevitably deviate from what could be inferred from models, theories, and past patterns of market prices. Lessons of the crisis for central banks So, what are the lessons of the Crisis with respect to our approach to markets? It may be strange to say this after a lengthy description of faults in processing market information, but developments in the financial markets will continue to be some of the most important sources of information from the perspective of central banks, as they conduct their monetary and financial stability policies. Financial markets mirror what is happening in the broader economy. Even if central banks were not completely free of the prevailing attitude toward the market that led to the Crisis, there were forceful voices within the community that warned against the buildup of risks based on market observations. Central banks should continue to make every effort to extract information from the markets. As Alan Blinder once remarked, broad, deep, fluid markets are indeed repositories of enormous power and wisdom. 2 Having said this, the first lesson is that central banks should not look away from market reactions of which they may disapprove. For example, during the 1990s and early 2000s, after the bubble burst in Japan, in spite of repeated assurances by the Japanese government Blinder, Alan, Central Banking in Theory and Practice, The MIT Press, 1998. BIS central bankers’ speeches and the Bank of Japan, markets questioned the viability of the Japanese banking system. There was dissatisfaction with this tyranny of the markets. Because of the self-fulfilling nature of problems in the banking sector, the situation could easily have gotten out of hand. Similar developments were observed in the recent Crisis as well. Nevertheless, looking back, there was some measure of reason in the reactions of markets. One should never stop talking to the mirror, even if it says that the prettiest of them all is somewhere else. The second lesson is that, central banks should never forget the ephemeral nature of information that could be extracted from market prices. As I explained earlier, these are prone to overshooting. Central banks can calculate all sorts of implied information, but the informational content of such numbers is heavily influenced by the models adopted. Sometimes, market prices may only be reflecting the positions and actions of the central banks themselves. Accordingly, while market prices allow central banks to come up with the best estimates, central banks must not lose sight of what they are trying to estimate. The third lesson is the importance of the diversity of market participants, especially in terms of their risk preferences and investment horizons. Homogenous market participants tend to magnify mistakes, increasing the risks of market instability. Diversity is preferable, but irresistible forces such as rules and regulations regarding capital, risk management, and disclosure could inadvertently homogenize the risk preferences and time horizons adopted by market participants. Unfortunately, there are no good answers, and central banks must stand ready to fix any problems as they arise. Lastly, while central banks should have deep respect for financial markets, for the reasons I have just explained, they should be willing to stand up to the market from time to time. In order to deliver sustainable economic growth under price stability, central banks must have a very long time horizon. This point is especially relevant for financial stability, because financial cycles tend to be quite long. As Alan Blinder had noted, central banks must avoid a situation where “the market reacts, or rather overreacts, to perceptions about what the central bank might do, and the central bank looks to the markets for guidance about what it should do.” 3 An example of how a central bank should conduct its policy in the face of market expectations is the Bank of Japan’s current commitment to ease monetary policy aggressively. That commitment is conditional on there being no significant risk to the sustainability of economic growth, including the accumulation of financial imbalances. The Bank of Japan will, in this context, conduct an assessment independent of what markets might be thinking, while taking full account of information derived from markets. Turning to Europe, the European Central Bank is committed to fixing the transmission mechanism of monetary policy in the euro area, showing that the Bank may have a different view from the market on where the various sovereign spreads should be. Concluding remarks Today, I have offered my views on how overconfidence in extracting information from financial markets contributed to the formation of financial bubbles that brought about the Crisis. The strong emphasis, by market participants as well as public authorities, on the deep wisdom of financial markets before the Crisis has now brought about a public backlash against anything that even has a whiff of using finance or market forces to solve social issues. This is unfortunate because, if used wisely, the market is still the best arbiter of economic outcomes, finance is the art of the possible, and well- functioning markets will open new horizons. The lessons for central banks that I have just described apply largely to market participants as well. The financial industry should also read the writing on the wall Blinder, Alan, id. BIS central bankers’ speeches about acceptable behavior regarding profits and compensation in the aftermath of the Crisis. What the market will bear is no longer an acceptable attitude. With the full recognition of such changes, leading to a more nuanced approach to information extracted from market prices, financial institutions should be able to maximize their contribution to global economic recovery. Thank you for your attention. BIS central bankers’ speeches
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Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the GIC (Global Interdependence Center) Conference on "The Global Financial Crisis - lessons from Japan", Tokyo, 3 December 2012.
Kiyohiko G Nishimura: Funding for financing economic growth – a Schumpeterian perspective Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the GIC (Global Interdependence Center) Conference on “The Global Financial Crisis – lessons from Japan”, Tokyo, 3 December 2012. * I. * * Introduction: beyond standard macroeconomics Having experienced prolonged stagnation after the global financial crisis of 2008, economists, market participants, and policymakers alike have arrived at the painful recognition that per capita real output has a long path toward recovering its pre-crisis level. To tackle this stagnation, the standard macroeconomic prescription is simple and straightforward: the policymaker should conduct an expansionary policy to fill the gap between actual and potential GDP, treating potential GDP as exogenously given. Although it is difficult to tell in real time whether the observed weakness in economic recovery is cyclical or structural, it seems obvious that the current GDP gap is large no matter how one measures the potential. Under this prescription, and facing the zero bound on nominal interest rates, central banks in advanced countries are currently employing unconventional measures, such as large-scale asset purchase programs. However, I believe we need to go beyond such a standard way of policy thinking in order to bring about effective policy in this slow growth environment. We should consider policies that influence the growth potential itself. In particular, I suggest that central banks should find tools to support the efforts to strengthen the foundation for economic growth. This may look even more unconventional than already unconventional asset purchase programs. But it should be noted that price stability, the goal of central banking, becomes difficult to achieve once growth expectations diminish and the economy becomes prone to hit the zero bound. 1 Thus, it is absolutely necessary to raise growth expectations in order to alleviate the difficulty in maintaining price stability. And I presume that monetary policy can influence the growth potential over a long term, although such effects are uncertain and indirect. Indeed, there have been several signs of these diminished growth expectations in many countries. The aftereffect of a financial crisis has been discussed extensively. 2 Population ageing is another factor that is already impacting advanced economies and coming soon to several emerging economies. 3 A not-so-growth-friendly change in the current technological Persistent deflation found in Japan in the past decade was at least partly caused by recurrent negative shocks that caused continuously diminishing growth expectations. When a negative shock happens to diminish growth prospects, management refrains from engaging in capital investment and giving pay raises, and households cut consumption expenditures to increase savings for the future. If a fall in growth expectations were a one-off event, price levels would stabilize soon after necessary adjustments were made. However, when such a decline happens several times, a chronic demand shortfall would keep placing downward pressure on price levels and deflation would persist. Persistent deflation may also have been caused by the following mechanism that operates through the price-and wage-setting behavior of firms. Japanese export firms dealt with the severe competition coming from low-cost emerging countries by cutting costs – that is, cutting wages and delivery prices. This had a spillover effect on the non-manufacturing and public sectors in Japan, resulting in a fall in the general price level. This led to an appreciation of the Japanese yen through the purchasing power parity (PPP) mechanism. As this currency appreciation partly offsets the effects of initial cost cuts by export firms, the whole cycle starts once again, beginning with cost cuts by firms. Deflation persists in that process. See Reinhart and Rogoff (2012) and IMF (2009). The impact of population ageing is multifaceted. Obviously, it creates the financial burden of supporting a larger older population with a smaller younger generation, leading to fiscal problems. The dominance of elderly consumers changes the demand structure and thus necessitates structural changes in corporate BIS central bankers’ speeches advancements is another element that deserves more extensive discussion, especially in terms of its impact on employment. 4 In my remarks today, I explain my own view about the role of the central bank in a slow growth environment, which is distinctively Schumpeterian, and describe the policies adopted by the Bank of Japan from this viewpoint. But first, let me briefly review the development of the real growth rate in Japan and other advanced countries. II. Evolution of post-crisis economic growth: Japan as a spearhead of change Japan has an extraordinary history of real GDP growth over the past six decades, from the annual average of a roaring 9.7% in the 1960s to a meager 0.6% in the 2000s, as depicted in Chart 1. Chart 2 decomposes real GDP growth into the growth in labor productivity and that of labor inputs. Note that the peak of the Japanese property bubble is around 1990. Comparing pre-bubble growth (1980s) and post-bubble growth (1990s), we find that most of the change in growth is from the substantial slowdown in labor productivity growth. There are several factors explaining this slowdown in labor productivity growth, which can further be decomposed into the growth of total factor productivity (TFP) and the contribution of the change in capital-labor ratio. Firstly, TFP growth slowed because technological catch-up opportunities were exhausted, the illusory TFP growth of the bubble period evaporated, 5 and information and communication technology failed to improve the productivity of Japanese firms, unlike the case for firms in the United States. 6 Secondly, and more importantly, the increase of the capital-to-labor ratio was reduced sharply because firms hesitated to invest in new projects or even to replace old equipment: the firms’ top priority then was to “deleverage” – namely, to reduce the excessive stock of capital and debt that had been built up during the bubble period. Japan has faced a consecutive set of difficult problems during the last quarter century, starting with a property bubble of an unprecedented magnitude and its bursting, followed by financial crises in Asia and at home in the situation of a fast-paced population ageing and now declining population. However, the development of the global economy since the mid-2000s suggests that other advanced countries also face similar problems, making Japan look like a spearhead of change. Indeed, Chart 3 depicts the rolling ten-year average of per capita real GDP growth rate among advanced economies between 1971 and 2010, which in theory is closely related to the natural rate of interest. Since the financial crisis, this has fallen in the United States and Europe to a level similar to that in Japan. Thus, the issue of raising growth potential is likely to become a common policy challenge for advanced countries. strategies. Moreover, coupled with the progress of information and communication technology (ICT), an ageing workforce may result in lower productivity. In Japan, the ageing workforce during the 1990s contributed to the deceleration in labor productivity growth, since ICT made obsolete the existing firm-specific know-how and human capital. See Minetaki and Nishimura (2010). Gordon (2012) lucidly explains a changing, non-linear nature of technological progress and suggests that improvement may be reduced substantially in the near future. This is especially relevant with respect to profit prospects and employment generation. First, ICT widely reduces profits because more and more products are becoming digitized and these digitized products’ prices are subject to constant downward pressure due to the fact that their reproduction costs are almost zero. Second, ICT replaces middle management both at the workshop and in the office, and thus reduces the number of relatively well-paid and career-oriented medium-skill jobs (Nishimura 2012). The best example may be the construction industry, where huge TFP gains are found in the bubble period, although construction is an industry of low TFP growth in many countries and many periods. In the bubble period, irrational exuberance or conspicuous purchasing behavior was often observed, in which the higher the price of the building, the quicker it was sold. See Minetaki and Nishimura (2010). See footnote 4. BIS central bankers’ speeches III. A Schumpeterian perspective: banks’ role in innovation dynamics What should be done to lift the growth potential and thus growth expectations, especially in a time of population ageing? The key is to raise labor productivity – that is, to increase the value-added generated by labor inputs. There are two ways to do this: cutting costs and creating new demand. Cost cuts are best fit to a growing population that is demanding more high-quality products at lower prices. 7 However, when demand does not grow as the population matures, creating demand is much more important than cutting costs. It is all the more important to figure out the potential needs of the society and to provide those goods and services for which people are willing to pay. When firms attempt to engage in demand-creating innovation, financial intermediaries should play the crucial role of supporting them financially. In the absence of active financial intermediations, high-risk but high-return projects may end up not being undertaken, the technology spillover may be severely limited, and the economy may fall into stagnation. Indeed, it is Schumpeter who emphasizes the role of the “banker,” in addition to the role of the “entrepreneur” that carries out demand-creating innovation. 8 Crucial role of the banker in the Schumpeterian creative destruction Creative destruction, as Schumpeter defines it, starts from a phase of shaking up the existing market structure. At this phase, the “entrepreneur” brings in a new combination of technology and knowledge while the “banker” provides to the entrepreneur investment funds, which are raised through the process of credit creation. Of course, the “banker” here is not limited to the bank as it literally means, and it also includes venture capitalists. The banker plays two roles in this process. First, the banker screens prospective entrepreneurs and selects the most promising ones. This is often called the “expert eye” function of bankers. Second, and more important in practice, the banker often provides firms with information related to business matching and new markets, which helps to improve the recipient firms’ performance even after the initiation of funding. 9 A banker who selects successful entrepreneurs and provides appropriate advice to them at a lower cost than other bankers can earn steady profits from an ongoing relationship with them. 10 Such long-term profit-maximizing behavior of the banker improves the efficiency of risk allocation evaluated The main strength of Japanese companies until the 1980s was their ability to manufacture and sell a large volume of high-quality products. That was made possible by product quality improvement as well as cost-cutting efforts that enhanced the operational quality and efficiency. A famous example is the “just-in-time” system for production and inventory management. There was a limit to maintaining this kind of “cost-cutting innovation,” however: the room for further improvement gradually diminished. Furthermore, the rapid catch-up by emerging countries in Asia made it difficult for Japanese manufacturers to continue increasing profits through cost-cutting efforts since the 1990s: standardization based on information technology as well as globalization have enabled Asian emerging countries to combine technology and capital in advanced countries with the abundant labor available in their own countries to pursue international specialization that helps them to achieve an optimal production structure. To put it differently, the old business model that had supported the high growth of Japanese firms gradually became out of touch with the renewed economic environment characterized by advances in information technology and globalization. See Nishimura (2012). See Schumpeter (1926). Although the second role is not explicitly examined by Schumpeter in his treatise, it becomes increasingly important in innovation as the economy enters the age of ICT. In the United States, for example, venture capital firms contributed to the product development of biotech firms, through both fund provision and other kinds of assistance (Michalopoulos et al. 2009). The latter includes the provision of information related to management and help in business contracts. In fact, small and medium-sized enterprises often complain that, although this information-providing function is most demanded, Japanese banks unfortunately have failed to provide it adequately in post-crisis Japan. BIS central bankers’ speeches at the macro level and leads to an endogenous increase in the economic growth rate through an expansion in the production possibility frontier. 11 Necessity of Schumpeterian banks, particularly in a recession Innovation entails long-term investment in research and development (R&D), teaching workers new technologies, and the search for new markets. In what phase of the business cycle is such long-term investment stimulated? In theory, long-term investment such as R&D should gain momentum in a recession, when short-term investment to meet current demand decreases. 12 In reality, however, the opposite is true: innovation drops sharply in a recession. 13 The reason the theory fails provides an important clue for policy. The opportunity cost of long-term investment, which is the foregone profits of not undertaking a short-term investment that meets the current demand, decreases in a recession when the current demand is weak. Consequently, the theory predicts that the entrepreneur will find innovation to be more profitable in a recession. 14 On the contrary, many empirical studies point out that long-term investment such as R&D may in fact be pro-cyclical, and drop in a recession. The most plausible explanation is that the theory implicitly assumes that firms are not subject to credit constraints, but this is not the case in practice. To use Schumpeter’s terminology, the theory assumes that the “banker” is always willing to provide financial support to the innovative “entrepreneur.” In reality, however, the “banker” is not willing to do so in a recession because credit constraints usually tighten due to firms’ worsening balance sheet conditions and renewed concern about an uncertain return on R&D. The consequence is that the tone of firms’ innovation activity as a whole becomes low, and the risk of impeding long-term growth potential becomes elevated. Thus, from the Schumpeterian perspective, the monetary authority should make every effort to maintain stability in the financial environment, particularly in a recession, so that firms’ innovative activity is not held back. Admittedly, this is a very subtle balancing act, since we should avoid bank loans from going bad and at the same time preserve efficiency in the allocation of funds. Necessity to consider externality in innovation Lastly, from the Schumpeterian perspective, the policymaker or the monetary authority should properly take into account “externality” in innovation when it seeks to support the innovative activity of entrepreneurs. To take as an example, R&D investment leading to the development of frontier technology has a clear positive externality: such investment has a social benefit, in that it encourages competition toward technology revolution, which eventually gives rise to a knowledge spillover. For each individual firm, however, the private return on such investment is not sufficiently high unless the society-wide spillover benefits are internalized. 15 In fact, we often hear that firms actually give up many projects with high Michalopoulos et al. (2009) present an endogenous growth model that features the entrepreneur and the banker, and provide a theoretical perspective to Schumpeter’s idea. However, the model focuses only on the “expert eye” function of the banker. See Aghion et al. (2005, 2010). See, for example, Aghion et al. (2008) and Mannasoo and Merikull (2011). This is the heart of the so-called “cleansing effect” of a recession: a recession stimulates innovation activity and rectifies inefficiencies in the economy. The word “cleansing effect” sometimes refers exclusively to efficiency gains from the exit of inefficient firms, but the innovation-induced mechanism should properly be taken into account. Social return has the elements of both dynamic scale effect and learning effect. Specifically, although the initial investment is costly, the cost decreases as the scale of production increases: even if the private return is low initially, the social return that takes into account the subsequent benefits may be high. BIS central bankers’ speeches social return because of their low private return. 16 To summarize, in the presence of externalities, long-term investment such as R&D is not carried out sufficiently from a social point of view, since each individual firm may not have enough incentive to do so. Here, a Schumpeterian perspective of innovation becomes important. A standard policy tool to rectify this problem is the government subsidy or so-called Pigovian tax. However, such a direct intervention of public authority may severely undermine market efficiency because the authority does not have sufficient information and the monitoring ability to implement it. Then, it may be desirable to move indirectly toward using financial institutions’ Schumpeterian role, stimulating firms’ incentive for innovation while preserving efficiency at the same time. The policymaker provides funding for the bankers’ support to promising innovations, counting on the bankers’ ability to produce information; namely, the “expert eye” function and “opportunity provision” function. In other words, we need a social system to promote innovation, providing backing to private returns and shifting allocation of funds and resources toward investment projects with high social return. Having this kind of social system is particularly important when low private return prohibits firms from making an effort toward innovation that generates social benefits in terms of growth expectations and employment opportunities. IV. Central banking in the post-crisis world: funding for financing economic growth Let me now explain the policy initiatives of the Bank of Japan, which specifically aim at raising the growth potential and thus growth expectations of firms and households. In June 2010, the Bank introduced the “fund provisioning measure to support strengthening the foundations for economic growth,” which I call the GFSF (Growth Foundation Strengthening Facility). 17 In October 2012, the Bank announced the introduction of the “fund provisioning measure to stimulate bank lending,” which at this moment is being carefully prepared. In a nutshell, we can combine both measures into “funding for financing economic growth.” These measures aim to contribute to lift the potential growth rate through financial intermediation. Specifically, they supply long-term funds at a very low interest rate against eligible collateral to financial institutions in order to encourage their lending and investment to businesses. Chart 4 depicts steadily increasing GFSF loans provided to financial institutions by the Bank of Japan, which consist of the main-rule loans starting in September 2010 as well as three special-rule ones introduced afterward. Chart 5 shows the amount of financial institutions’ loans to firms that the GFSF generated, categorized by growth-related business lines. Here, the “environment and energy business” accounts for the largest share, followed by the “medical, nursing cares, and other health-related business” and the “development and upgrading of social infrastructure.” Indeed, the GFSF has induced sizable efforts by financial institutions to support strengthening the foundations for economic growth. Let me point out three theoretical rationales of these fund-provisioning measures or facilities from the Schumpeterian perspective that I have explained. First, they make the most of the Schumpeterian bankers’ informational capacity in screening innovative entrepreneurs and providing information valuable that will allow them to grow. The “expert eye” of the bankers plays a vital role in screening projects, and their good-advisor function substantially As one example, consider an anonymous manufacturer’s plan to develop a mine detection robot. In this company, there were several research projects that had the objective of stimulating the R&D activity of the company. One of the projects was the R&D of a mine detection robot, which utilized the sensor technology owned by the company. The company eventually gave up on the project because, as a private company seeking profits, it was difficult to continue with a project that seemed to yield little return. The problem was that there was a lack of demand to properly reflect the social importance of the robot. See Nishimura (2004). See Nishimura (2010) for details. It also describes possible measures to strengthen the foundation for economic growth through financial intermediation. BIS central bankers’ speeches increases the value of innovation. 18 Second, the policy measures try to counter the negative effect of a recession by providing financial support to the “banker” at a time of many headwinds to the economy. Third, the policy measures aim to act as a catalyst for financial institutions’ lending and investment to businesses with high social return. By offering long-term funds at a very low interest rate, they supplement the low private return that mirrors the presence of externality in innovation. The policy philosophy here is different from that of the Keynesian approach. These measures aim to improve financial intermediation’s long-term efficiency in resource allocations, while the Keynesian approach endorses public spending to fill the short-run shortage in aggregate demand. It also differs from neoliberalism, which rests on the superiority of free and competitive markets and thus makes every effort to avoid public interventions. 19 It is distinctively Schumpeterian, in that it has the aim of raising the growth potential or liveliness of the economy. For this very reason, one could say that it is unconventional in the domain of monetary policy design. I certainly do not dispute such claim. However, we should recognize that a secular decline in the real growth rate and sluggish growth expectations have plagued Japan in past decades. Thus, the Bank’s indirect intervention through the financial system – that is, the Bank of Japan’s fund-provisioning measures – is perfectly consistent with the principle of monetary policy stipulated by the Bank of Japan Act; namely, “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.” V. Concluding remarks: a way forward Let me now conclude. Sluggish productivity growth reduces potential growth. It not only scales down the supply side but also places a negative impact on the demand side. This is because household consumption and corporate investment are held back once the households’ income prospects and the firms’ earnings forecasts are weakened. Both the supply and demand sides lose momentum due to productivity declines, resulting in a persistent fall in the natural rate of interest. Deleveraging in the aftermath of the bubble bursting and the financial crisis reinforces the fall of the natural rate of interest, since the private sector reduces expenditures rapidly and by a large amount. 20 As the policy rate reaches the zero lower bound and room for further unconventional – as well as conventional – monetary easing diminishes, it becomes even more difficult for central banks to stabilize the economy and price levels. In such a situation, the central bank needs to shape policy frameworks so as to contribute to growth potential and thus growth expectations, and hence raise the natural rate of interest. The situation I have described is no longer unique to Japan and rather common in other advanced economies, and even for some emerging economies facing population ageing in the near future. I believe that the seemingly unconventional activist policy of the Bank of Japan in funding for financing economic growth may be relevant for these economies as well in the coming years. My interpretation of the Funding for Lending Scheme in the United Although it is not widely recognized, this good-advisor function is important in helping the entrepreneur grow. Unfortunately, Japanese financial institutions failed to act as good advisors in improving the performance of borrower firms (Fukao et al. 2005). See Aghion (2012) for this classification. Aghion et al. (2012) claim with both theory and empirical evidence that monetary policy influences aggregate productivity through its impact on R&D investment by firms. Guerrieri and Lorenzoni (2011) point out that an unanticipated tightening of borrowing constraints during a financial crisis leads to a fall in the natural rate of interest. First, borrowers facing financial constraints have to deleverage. Second, even lenders not facing financial constraints have to increase precautionary savings once they become aware of the risk that their constraints may bind in the future. Similarly, Eggertson and Krugman (2012) claim that the natural rate of interest declines and deflationary pressure becomes large during the deleveraging process, induced by a tightening in the financial constraints. BIS central bankers’ speeches Kingdom is that it has similar Schumpeterian effects, although this scheme’s origin may be different from those of the fund provisioning measures of the Bank of Japan. References Aghion, P. (2012), “From Growth Theory to Growth Policy Design,” LSE, Economic & Social Research Council (E.S.R.C.). Aghion, P., G.-M. Angeletos, A. Banerjee, and K. Manova (2005), “Volatility and Growth: Credit Constraints and Productivity-Enhancing Investment,” NBER Working Paper Series No.11349. Aghion, P., G.-M. Angeletos, A. Banerjee, and K. Manova (2010), “Volatility and Growth: Credit Constraints and the Composition of Investment,” Journal of Monetary Economics, Vol.57, pp.246–265. Aghion, P., P. Ashkenazy, N. Berman, G. Cette and L. Eymard (2008), “Credit Constraints and the Cyclicality of R&D Investment: Evidence from France,” Banque de France, Notes d’états et de Recherche-R#198. Aghion, P., E. Farhi, and E. Kharroubi (2012), “Monetary Policy, Liquidity, and Growth,” NBER Working Paper Series No.18072. Eggertson, G. and P. Krugman (2012), “Debt, Deleveraging and the Liquidity Trap: A Fisher-Minsky-Koo Approach,” Federal Reserve Bank of New York, Working Paper. Fukao, K., K. G. Nishimura, Q.-Y. Sui, and M. Tomiyama (2005), “Japanese Banks’ Monitoring Activities and the Performance of Borrower Firms: 1981-1996,” International Economics and Economic Policy, Vol.2, No.4, pp.337-362. IMF (2009), “What’s the Damage? Medium-Term Output Dynamics after Financial Crises,” World Economic Outlook, Chapter 4, October 2009. Gordon, R. J. (2012), “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds,” NBER Working Paper Series No.18315. Guerrieri, V. and G. Lorenzoni (2011), “Credit Crises, Precautionary Savings and the Liquidity Trap,” MIT, mimeo. Mannasoo, K. and J. Merikull (2011), “R&D in Boom and Bust: Evidence from the World Bank Financial Crisis Survey,” Working Papers of Eesti Pank No.7/2011. Michalopoulos, S., L. Laeven, and R. Levine (2009), “Financial Innovation and Endogenous Growth,” NBER Working Paper Series No.15356. Minetaki, K. and K. G. Nishimura (2010), Information Technology Innovation and the Japanese Economy, Stanford University Press. Nishimura, K.G. (2004), The Japanese Economy: Inconspicuous Structural Transformation, Nihon Keizai Shinbun Sha. Nishimura, K. G. (2010), “Toward Strengthening the Foundation for Economic Growth: Efforts of Financial Institutions and the Bank of Japan,” Speech at Symposium 2010 on “Cooperation among Finance, Industry, Academia, and Government” Organized by the Kanto Bureau of Economic, Trade and Industry, December 2, 2010, available at: http://www.boj.or.jp/en/announcements/press/koen_2010/ko1012c.htm/ Nishimura, K. G. (2012), “Demographic Transition, Impact of ICT, and Globalization: A Long View of the Post-Crisis World,” Speech at the Central Bank of the Republic of Turkey, August 27, 2012, available at: http://www.boj.or.jp/en/announcements/press/koen_2012/ data/ko120828a1.pdf Reinhart, C. M. and K. Rogoff (2012), “This Time is Different, Again? The US Five Years After the Onset of Subprime,” VOX. BIS central bankers’ speeches Schumpeter, J. A. (1926), Theorie der wirtschaftlichen Entwicklung: Eine Untersuchung über Unternehmergewinn, Kapital, Kredit, Zins und den Konjunkturzyklus, 2nd revised ed. Leipzig: Duncker & Humblot. (The Theory of Economic Development, Translated by Redvers Opie, Transaction Publishers: New Brunswick, New Jersey, 1983.) 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, Niigata, 5 December 2012.
Kiyohiko G Nishimura: A tale of two programs in the early resolution of the deflation problem Speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Niigata, 5 December 2012. * * * Introduction I am privileged and honored to be here today to exchange views with administrative and business leaders in Niigata Prefecture. I deeply appreciate your support and cooperation in taking part in interviews and surveys conducted by our Niigata branch. The information from these interviews and surveys is invaluable for the Bank of Japan in grasping Japan’s financial and economic developments and conducting monetary policy. What is more, we are delighted to share with you information – not only on what is happening in Japan but also around the globe – on various occasions, including events at branches like the opportunity we are enjoying today. I would like to express my sincere gratitude and also ask for your continued cooperation. Today I will be talking about the early resolution of the deflation problem and the Bank’s two programs. In the first half of my talk, let me outline financial and economic developments since the summer. In the latter half, I will explain the Bank’s basic thinking on monetary policy conduct, focusing on its two programs: the Asset Purchase Program, the total amount of which the Bank at the end of October decided to increase for the second month in a row; and the Loan Support Program, which it decided to newly establish. I. Developments in overseas economies Deceleration in overseas economies becoming more severe Looking at developments in overseas economies since the second half of 2011, the negative impact of the European debt problem has spread globally through the effects on trade and business sentiment. As a result, economic activity in many countries and regions, especially in the manufacturing sector, has remained in a deceleration phase. Every April and October, the Bank releases the Outlook for Economic Activity and Prices (hereafter, the Outlook Report), which presents Policy Board members’ assessment of economic activity and prices based on their forecasts. In addition to the semiannual Outlook Report, the Bank also releases interim assessments in January and July that present the Bank’s revised forecasts. The interim assessment in July 2012 listed uncertainty regarding overseas economies as one of the risk factors for Japan’s economy, and frankly speaking, my impression is that these risks actually materialized within a short period of time since this summer. Specifically, risks related to the European debt problem materialized and their effects spread. The negative impact of this problem has grown, not only in peripheral European countries but also in the core countries, through a decline in trade within the euro area and weakening business sentiment. Economic activity in Europe has receded slowly, with real GDP for the euro area now having registered negative growth for four consecutive quarters. This weakness in the European economy is affecting not only exports within the euro area but also those bound for outside the area, and has started to affect global trade and economic growth through global supply chain networks. In addition, emerging economies, which had been hoped to drive global economic growth, are lacking momentum. As for the Chinese economy, exports to Europe – which make up a large share in China’s total exports – have declined, the effects of excess investment in the BIS central bankers’ speeches wake of the Lehman shock are starting to be felt, and inventory adjustments in a wide range of areas, including materials industries, have been more prolonged than expected, though some economic indicators have shown signs of improvement very recently. Partly against the background of weakness in final demand in Europe and China, the pick-up in the NIEs and the ASEAN economies has moderated, particularly in exports and business fixed investment in manufacturing in the corporate sector. Outlook for overseas economies With regard to the outlook for overseas economies, the current deceleration phase is likely to continue for the time being, but we expect that against the background of a sustainable recovery in the U.S. economy and a pick-up in the Chinese economy the global economy will gradually emerge from that phase and enter a moderate recovery thereafter. Uncertainty about the outlook for overseas economies, however, is not insubstantial, including the timing of economic recovery. Attention should continue to be paid to the possibility that the European debt problem may become more serious. While the U.S. economy continues to be on a moderate recovery trend, the momentum toward recovery warrants careful monitoring given that uncertainty about the fiscal policy outlook, in particular with regard to the “fiscal cliff”, remains significant. As for the Chinese economy, improvement in the supply and demand balance may require considerable time, especially in materials industries, where there is excess production capacity. Moreover, Japan-China relations have already started to affect a number of areas and there is concern that they may have wider implications for Japan’s economy. Although global financial markets were unstable until this summer, since then, investors’ risk aversion triggered by the European debt problem has abated somewhat, partly owing to the fact that European authorities have carried out a range of policy measures. Nevertheless, particular attention needs to be paid to developments in financial markets, as fiscal and economic structural reforms in Spain and Greece are still underway. II. Recent developments in Japan’s economy Weakening economic activity I will now explain recent developments in Japan’s economy. In the first half of 2012, Japan’s economy registered high growth: real GDP in January–March grew at an annual rate of 5.2 percent as domestic demand remained firm, mainly supported by both public and private reconstruction-related demand. However, in July–September, GDP growth turned negative for the first time since October–December 2011, showing an annual decline of 3.5 percent. Reflecting the deceleration in overseas economies, exports and industrial production have decreased. This weakness in exports and industrial production has started to affect domestic demand, which has remained firm thus far. For instance, business fixed investment in the manufacturing sector has shown some weakness, mainly due to the deceleration in overseas economies. Going forward, we need to remain vigilant as to whether there are any signs of firms delaying business fixed investment. In the manufacturing sector, the yearon-year rate of change in the number of new job offers has been negative since June 2012; moreover, overtime hours worked in the economy overall have also been decreasing somewhat, led by a decline in the manufacturing sector. Private consumption has lost some momentum, partly due to the decline following the expiry of subsidies for the purchase of environmentally friendly cars. On the whole, domestic demand is expected to remain resilient, mainly supported by reconstruction-related demand in a broad sense, including investment related to disaster prevention and energy. It is, however, unlikely to increase at a pace that will offset the BIS central bankers’ speeches weakness in exports. Owing to these developments, the Bank judges that Japan’s economy as a whole has been weakening somewhat. As for prices, the year-on-year decline in the consumer price index (CPI, all items less fresh food) peaked at a rate of 2.4 percent in August 2009 after the Lehman shock. Since then, the aggregate supply and demand balance – which shows the rate of utilization of labor and fixed capital – has been improving moderately and the year-on-year rate of decline in the CPI has been shrinking steadily since end-2009 and recently has been around 0 percent. Outlook for Japan’s economy Based on the aforementioned developments in overseas demand, exports and industrial production are expected to continue decreasing and Japan’s economy as a whole to remain relatively weak for the time being. With the economy weakening somewhat, the Bank judged it appropriate to undertake additional monetary easing and at the Monetary Policy Meeting on October 30 decided to further enhance its monetary easing for the second month in a row, which I will elaborate on shortly with regard to the policy decisions. The Bank believes that together with the cumulative effects of earlier policy measures and the effects of the government’s efforts to strengthen Japan’s growth potential, the latest decision to implement monetary easing will prevent the economy from deviating from its course of returning to a sustainable growth path with price stability. As overseas economies gradually emerge from the deceleration phase, exports and industrial production are expected to start increasing and the economy as a whole to strengthen as spending activity gains momentum. In the October 2012 issue of the Outlook Report, the Bank’s median projection for Japan’s annual real GDP growth rate is 1.5 percent for fiscal 2012, 1.6 percent for fiscal 2013, and 0.6 percent for fiscal 2014. This projection takes into account the front-loaded increase in demand prior to the consumption tax hike and the subsequent decline. Excluding these effects, the projected growth rates for fiscal 2013 and 2014 would be around 1–1.5 percent. This outlook entails a number of uncertainties and there are both upside and downside risks. Under the current circumstances, however, we should be particularly mindful of the downside risks. Specifically, close attention needs to be paid to the possibility that a further prolonged deceleration in overseas economies may delay the recovery in exports and industrial production, thus exacerbating the negative effects on domestic demand. Next, I would like to discuss the outlook for the CPI. Excluding the direct effects of the consumption tax hike on prices, the year-on-year rate of change in the CPI is expected to hover around 0 percent for the time being and start rising gradually thereafter reflecting the improvement in overall economic activity, such as increases in corporate profits and employment as well as a pickup in wages. The median projection of the year-on-year rate of change in the CPI in the October issue of the Outlook Report is –0.1 percent for fiscal 2012, 0.4 percent for fiscal 2013, and 0.8 percent for fiscal 2014, excluding the direct effects of the tax hike. It thus appears likely that the year-on-year rate of change in the CPI will move steadily closer toward the Bank’s “price stability goal in the medium to long term” for the time being of 1 percent. Compared with the projections in the July interim assessment, these projections represent a downward revision. The reason for the downward revision is that the improvement in the aggregate supply and demand balance – reflecting the downward revision of the economic outlook – is expected to be delayed and that crude oil prices were corrected downward. Nevertheless, despite the downward revision, the Bank’s CPI projections are still higher than those of economists in the private sector. In my view, the difference between the Bank’s projections and private sector economists’ projections is due to differences in the extent to which prices are seen to respond to changes in the aggregate supply and demand balance. The projections by private sector economists tend to strongly reflect developments in the mid-2000s, when prices failed BIS central bankers’ speeches to respond commensurately with the improvements in the aggregate balance. In fact, even though the economy registered moderate growth during this period, the inflation rate hardly picked up. This was a period when the excesses in production capacity remained unresolved, price competition among firms was even severer against the backdrop of subdued growth in the domestic market reflecting the aging of and decline in the population, and there was a substantial increase in cheap imports – from emerging economies such as China – that competed with domestic products. Increases in goods prices were also constrained by efforts by firms to restrain wages against the backdrop of an increase in global competition. Furthermore, property prices continued to decline at a rapid pace, and rents – which make up about 20 percent of the CPI components (all items less fresh food) – started to decline, keeping a lid on any upward pressure on overall CPI inflation. In contrast with that period, cheap imports from China today are not so conspicuous as to exert sizable downward price pressure and the resolution of excess production capacity, even if only at a gradual pace, is also making progress. Moreover, it is increasingly possible to see cases where firms have succeeded in differentiating their goods and services in response to the aging of and decline in the population and customers are showing interest in high value-added goods with relatively high prices; thus, there are forces that make it relatively easier for firms to raise prices. In addition, the declining trend in property prices has finally come to a halt and rents are expected to do the same, albeit with some lag. Taking recent changes into account, the year-on-year rate of change in the CPI in the baseline scenario in the Outlook Report is expected to start rising gradually as the aggregate supply and demand balance improves. However, it is also important to note that the changes that I mentioned are not that strong yet and remain vulnerable to external shocks. We therefore continue to remain vigilant to the downside risks. III. First program: asset purchase program The two stages of the transmission mechanism of monetary easing Let me now move on to the Bank of Japan’s conduct of monetary policy. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation as early as possible and returning to a sustainable growth path with price stability. Based on this recognition, the Bank has been pursuing aggressive monetary easing. The transmission of monetary easing can be divided into two stages. The first stage is the transmission of monetary easing effects from the realm of monetary policy to the financial environment in which firms and households can raise sufficient funds at low interest rates. The second stage is the transmission of effects from the financial conditions to economic activity and prices; in other words, the extent to which firms and households actually take advantage of the accommodative financial conditions to actively increase their investment and spending. In the following, I will discuss the role of the Bank’s two programs in terms of these two stages. Accommodative financial conditions In its Monetary Policy Meeting on October 30, the Bank decided to increase the size of the Asset Purchase Program substantially. This increase is a step that targets the first stage of the transmission mechanism. The Program was introduced in October 2010, starting off with a size of about 35 trillion yen, and the increased purchases were scheduled to be completed at the end of 2011. Since then, the size of the Program has been increased repeatedly and the timeframe has also been extended. In September and October 2012, the Bank took bold steps to further increase the size of the Program – each time by about 10 trillion yen respectively. Consequently, the Program has reached the substantial amount BIS central bankers’ speeches of about 91 trillion yen, and the timeframe has been extended to the end of 2013. The aim of the Program was to generate accommodative financial conditions in a situation where the Bank’s target rate was already at virtually zero percent, by encouraging a decline in longerterm market interest rates and a reduction in risk premiums through the purchase of not only Japanese government bonds (JGBs) and treasury discount bills (T-Bills) but also of various types of risk assets, including CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). Since the introduction of the Asset Purchase Program, financial conditions in Japan have become extremely accommodative both in historical and international comparison. In this sense, we believe that the Program has already achieved its intended effects. To be specific, in terms of firms’ funding costs, both short-term and long-term average interest rates on new loan contracts have hit 1 percent – an unprecedented level. In terms of households’ borrowing costs, 35-year fixed mortgage rates have fallen below 2 percent. Moreover, financial institutions’ lending attitude remains accommodative, issuing conditions for CP and corporate bonds are also generally favorable, and, overall, an environment has been maintained in which households and firms can feel secure that they can gain access to funds. Moreover, the Bank’s aggressive easing has mitigated the negative effects stemming from the appreciation of the yen and has fended off an even greater appreciation. Against the strong headwinds generated by the Great East Japan Earthquake and the European debt problem, extremely accommodative financial conditions have been firmly maintained. As part of the Asset Purchase Program, the Bank has stated its commitment to maintaining powerful monetary easing to achieve so-called policy duration effects. Specifically, the Bank has clarified that for the time being it aims 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 Program mainly through the purchase of financial assets. The Bank is determined to continue with this powerful monetary easing until it judges the 1 percent goal to be in sight. As I mentioned, the October issue of the Outlook Report notes that in fiscal 2014 it appears likely that the year-on-year rate of increase in the CPI will move steadily closer toward the Bank’s “price stability goal in the medium to long term” for the time being of 1 percent. So far, however, we have not come to the conclusion that the 1 percent goal is in sight. While the Program’s intended timescale for completing the increase is currently set for the end of 2013, given the commitment it has made, the Bank will continue to operate the Program beyond that date. IV. Second program: loan support program Making use of accommodative financial conditions While the creation of accommodative financial conditions represents the first stage of the transmission of monetary easing, the second stage consists of the extent to which a wide range of economic entities actually make use of such accommodative financial conditions. At present, the average interest rate paid by firms has fallen to nearly 1.5 percent. This is extremely low compared with firms’ return on assets (ROA), which has been around 3 percent. Firms are in a position to raise ample funds at interest rates substantially below their rates of return. Thus, at first glance, it seems as though firms only need to borrow some funds and invest them in order to make a profit; yet, this is not necessarily the case. Rather, they are faced with a situation where they have little confidence that if they do borrow funds they will actually be able to sell their products or services and make sufficient profits. Put differently, stagnant growth expectations have been preventing firms from being more aggressive in their business activities, and under these circumstances the accommodative financial conditions are not fully made use of. BIS central bankers’ speeches In order to overcome this sense of stagnation, we need to make efforts to strengthen the growth potential of Japan’s economy. As such efforts proceed and growth expectations pick up, firms’ profit prospects will improve, the expected rates of return on new investments will increase, and firms will become more proactive in their spending such as on investment. Once such a virtuous circle has taken hold, the accommodative financial conditions will have even stronger effects, and the virtuous circle will become more sustainable. This is what we aim to achieve at the second stage of the transmission mechanism of monetary easing. In terms of creating a favorable business environment, the government also plays an important role. On October 30, 2012, the government and the Bank of Japan released a joint statement with the title “Measures Aimed at Overcoming Deflation” in order to state clearly the shared understanding of their respective roles to overcome deflation. This statement reconfirms the importance of the government’s role in creating a favorable business environment. The Bank strongly expects the government to generate new demand by vigorously promoting measures – including decisive regulatory reform – for strengthening Japan’s growth potential, based on the government’s recognition that reforming the economic structure predisposed to deflation is essential in order to overcome deflation. Establishment of the framework for the “stimulating bank lending facility” From the perspective of boosting the second stage of the transmission mechanism of monetary easing, the Bank in 2010 introduced the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth (I called it the Growth Foundation Strengthening Facility or GFSF in my previous speeches) in order to make its utmost contribution as the central bank. This facility enables the Bank to provide long-term funds at a low interest rate to financial institutions carrying out lending and investment that contribute to Japan’s economic growth. Moreover, for a central bank, this is an extraordinary measure in the sense that it directly influences the lending activity of financial institutions. However, because the intention of the policy has been widely understood, I believe that the facility has been able to generate some successful outcomes. It is also heartening that this facility has served as a trigger for a wide recognition of the importance of strengthening the economy’s growth potential. Further to the introduction of this facility, the Bank on October 30, 2012 decided to establish the framework for the Fund-Provisioning Measure to Stimulate Bank Lending (I will call it the Stimulating Bank Lending Facility or SBLF hereafter) with a view to promoting aggressive action by financial institutions and helping to stimulate proactive credit demand by firms and households. Under this facility, the Bank will provide long-term yen-denominated funds at a low cost to financial institutions, at their request, up to an amount equivalent to the net increase in their lending. The total amount of funds provided by the Bank will be “unlimited” – that is, there shall be no upper limit. Financial institutions’ lending eligible under the SBLF can be either yen-denominated or foreign currencydenominated. With economic globalization continuing, the growth potential of financial institutions and firms is closely linked to their overseas activities. The Bank therefore judged that encouraging lending by financial institutions – irrespective of the currency involved – would be an effective means to boost the growth of Japan’s economy, and that strengthening financial institutions’ overseas activities would help to support Japanese firms with growth potential from the financial side. Moreover, increasing lending will enhance the profit base of financial institutions themselves in the medium to long term and thus is consistent with what they should be aiming for. In fact, partly because they have shown steady achievements in their business matching activities, the outstanding amount of financial institutions’ loans has recently been increasing at a moderate pace. Both the newly-introduced SBLF and the existing GFSF aim to encourage further use of accommodative financial conditions in Japan by supporting financial institutions’ efforts. In BIS central bankers’ speeches that sense, the two facilities are complementary to each other. Specifically, the SBLF intends to support the economy overall from the financial side by encouraging financial institutions to increase their lending and firms and households to increase their borrowing to engage in proactive economic activities. On the other hand, the GFSF mainly aims at playing a catalytic role in encouraging firms and financial institutions to proceed with efforts to strengthen the economy’s growth potential. The Bank decided to call the combination of the SBLF and the GFSF the “Loan Support Program”. Under the Loan Support Program, it aims at strengthening the second stage of the transmission mechanism of monetary easing by letting the two facilities achieve their intended consequences. Furthermore, it expects that coupled with the stimulative effects of the Asset Purchase Program the effects of monetary easing as a whole will be amplified. Looking at the last 12 months, the amount of lending by those banks and shinkin banks holding current accounts at the Bank that saw a rise in their lending increased by a total of approximately 15 trillion yen. This implies that under the new facility, the SBLF, those banks are entitled to receive funds of up to approximately 15 trillion yen from the Bank. Together with the 5.5 trillion yen from the GFSF, the total size of the Loan Support Program will be approximately 20 trillion yen. If financial institutions manage to increase their lending more aggressively, the total size of the Program will exceed 20 trillion yen. Furthermore, adding the Asset Purchase Program and the Loan Support Program together, the total size of these programs will easily exceed 110 trillion yen. Given that Japan’s nominal GDP in 2011 was 468 trillion yen, the size of these programs is equivalent to almost a quarter of GDP. This shows that the monetary easing undertaken by the Bank at present has reached a level unprecedented in the past. We strongly expect that financial institutions’ efforts to increase their lending will lead to an expansion of the total amount of fresh funds supplied to the economy. To this end, the Bank is currently in the process of working out the details of the new facility, the SBLF, to make it easy for financial institutions to use. We expect to release the details before the end of the year and start operation of the facility as soon as possible. Because of time constraints, I discussed the Bank’s monetary policy focusing on these two programs. The message that I wish to emphasize once again is that the Bank has been and will always be ready to take appropriate and decisive action when the economy strays too far from the baseline scenario of the outlook for economic activity and prices or when risks to that scenario materialize. Going forward, in order to achieve its price stability goal for the time being, the Bank is determined to pursue its aggressive monetary easing, making full use of the new policy measures. Concluding remarks Let me conclude my speech today by touching on the economy of Niigata Prefecture. In my speech, I stressed repeatedly the importance of making efforts to strengthen the economy’s growth potential in order to overcome deflation. Looking at firms based in Niigata, there are many locations where skills to make top products have been nurtured and accumulated over the years. Even in the midst of fierce competition with overseas firms, many firms have succeeded in maintaining leading market shares either at home or abroad on the back of these skills and using know-how on how to expand sales channels. This shows that firms have been making incessant efforts toward strengthening growth potential in the face of adversity such as the global financial crisis. I have full respect for these efforts. In addition, while Niigata is one of the most natural resource abundant regions in Japan – for example in terms of oil and natural gas deposits – it has long been involved in promoting renewable sources of energy. Initiatives aimed at commercializing solar power generation on a large scale at solar parks in the “snow country”, where daylight hours in winter are BIS central bankers’ speeches short, have started to bear fruit and power generation has commenced. Reflecting the experience after the Great East Japan Earthquake last year, the utilization of renewable energy and the use of environmentally friendly cars and home appliances have been accelerating on a national basis. Given that other countries in the world are likely to face energy constraints in the future, Niigata’s experience and accumulated know-how in this field should stand it in good stead to benefit from the first mover advantage. Looking back at the past year, a major piece of national news was that for the first time in 36 years, crested ibis chicks hatched in the wild on Sado Island in Niigata Prefecture. The crested ibis is registered as a special natural treasure in Japan and the hatching of the chicks is happy news. It is hoped that such happy news can also soon be heard on the economic front. The Bank will continue to make every effort as a central bank and do its utmost to help your initiatives. Thank you. BIS central bankers’ speeches
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Keynote speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Special Panel on "Property markets, financial stability, and macroprudential policies", at the Allied Social Science Associations - American Real Estate & Urban Economic Association Annual Meeting, San Diego, 4 January 2013.
Kiyohiko G Nishimura: Property bubbles and economic policy Keynote speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the Special Panel on “Property markets, financial stability, and macroprudential policies”, at the Allied Social Science Associations – American Real Estate & Urban Economic Association Annual Meeting, San Diego, 4 January 2013. * * * Property market bubbles have long been recognized as an important risk to economic stability. Although not all property bubbles lead to financial crises, there are malign bubbles that do indeed trigger significant financial stresses and cause economic crises, such as the US housing bubble of the 2000s. In this presentation, I argue that demographic trends are one of the key drivers of the property price movements we have observed over the past few decades. In particular, I argue that a growing young population increases the likelihood of a property bubble. The increased demand for property from a growing young population is likely to induce the institutional change of a loosening of financial laws and regulations that pushes up prices further, thereby fueling a malign price bubble. (These institutional factors will be discussed in greater detail by my fellow panelists Frank Warnock and Tim Riddiough.) In contrast, the negative effects of the bursting of a price bubble are all the more pronounced where there is an ageing population. Macroprudential or institutional policies therefore become important in responding to a malign property bubble. (This will be the subject of the presentation by Ken Kuttner.) However, I believe that the issue is not limited to questions of the technical effectiveness of various macroprudential policies, but highlights the very fact of the “procyclicality” of institutional changes in laws and regulations induced by demographic change. From this discussion I will draw three policy implications: firstly, the need, to recognize the significant effects of demographic trends, secondly, to avoid too loose a policy in the demographic bonus phase, and thirdly, to avoid too strict a policy in the demographic onus phase. In the final part of this presentation, I will discuss property price indexes, and outline an attempt to obtain relevant price information in a timely manner. Timely and accurate data on property prices is of utmost importance in responding to a property bubble, especially in emerging markets. (Yongheng Deng will discuss this issue in the context of China.) 1. Demographic trends and property markets Demographic trends and malign property bubbles; cross-country evidence Let me first explain why demographic trends are important using a series of charts depicting the recent bubble episode in the advanced countries. In these charts, I juxtapose, first, the ratio of working-age population to the rest (the inverse dependency ratio), second, the real property price index, and third, total loans in real terms. 1 In the United States (Chart 1.1), we have two peaks in the working-age population ratio. And the real property price index, which is the real house price index, seems to have two peaks, roughly coinciding with the demographic change. It is the second peak which triggered the financial crisis of 2008. The first peak coincided with the S&L problem, which had a far less The figures for the United States, Japan and China are taken from Nishimura, K. G., “How to Detect and Respond to Property Bubbles: Challenges for Policymakers,” in Heath, A., F. Packer, C. Windsor, eds., Property Markets and Financial Stability, Sydney: Reserve Bank of Australia, 2012, pp.292–301. The figures for the other countries are constructed in a similar way to those for these three countries. BIS central bankers’ speeches severe effect on the economy. The difference between the two lies in the difference in the total loans. The level of the real total loans in the first peak was high, but far lower than in the second peak that triggered the financial crisis. A remarkably similar picture is found in Japan, where the second peak around 1990 is a malign bubble that triggered a long period of stagnation (Chart 1.2). In Europe, we have two groups. The first group, including the United Kingdom (Chart 2.1), Spain (Chart 2.2), and Ireland (Chart 2.3), had a similar experience to that of the United States and Japan. The second group, including Germany (Chart 3.1) and France (Chart 3.2), tells a different story: their working population ratio, property prices, and real loans peaked at different times. And it is the first group, in Chart 2, which suffered property bubbles triggering financial distress, most severely in Ireland and Spain, and to a lesser extent in the United Kingdom. What lessons can we learn from this rather cursory examination of recent history? It shows that, if a demographic change, a property price bubble, and a steep increase in loans coincide, then a financial crisis seems more likely. Malign property bubbles: interplay of demographic trends and institutional factors Demographic trends have a significant effect on property prices, especially their land component. 2 In the population dividend phase, young baby boomers want to buy more land and save more real money for their retirement. Since the supply of land is physically limited, the real price of land will go up. Similarly, if nominal money supply is held constant, the “price” of real money holdings, which is the inverse of the price level, should also go up, implying deflation. Being mandated to maintain price stability, the central bank is then likely to increase nominal money to keep prices stable. The result is an increase in property prices while general price levels remain stable. 3 The story, however, does not end there. Property markets are also influenced heavily by institutional factors. The supply of land is regulated by the government in many countries, typically in the form of zoning. Housing finance systems are heavily dependent on financial laws and regulations. 4 Property markets are subject to high transaction costs, which may change as a result of financial innovation. 5 Any change or even prospect of change in these institutional factors may drastically change the dynamics of property prices, leading to a considerable deviation from the underlying fundamentals, that is, to a property bubble. In fact, in the population dividend or bonus phase, when baby boomers’ demand for property is strong, the demand for institutional change is also strong, favoring easier acquisition of property. The government is likely to come under political pressure to loosen financial laws and regulations, which in turn fuels expectation of further loosening. These changes, and the prospect of change, induce credit expansion to finance property acquisition and push up property prices further and far beyond their fundamental value given the initial institutional framework. The price hike caused by such institutional changes may even induce overly optimistic expectations of the “this-time-is-different” type about property markets and prices. See, for example, Takáts, Előd (2012): “Aging and house prices,” Journal of Housing Economics, vol 21, no 2, June, pp 131–41, and Nishimura, Kiyohiko G. (2011): “Population ageing, macroeconomic crisis, and policy challenges,” Panel discussion at the 75th Anniversary Conference of Keynes’ General Theory, University of Cambridge, 19–21 June 2011. See Nishimura, K. G., and E. Takáts, “Ageing, Property Prices, and Money Demand,” Working Paper no. 385, Bank of International Settlements, September 2012. See Warnock, F. E., and V. C. Warnock, “Developing Housing Finance Systems,” in Heath et al. ibid., 49–67. Packer, F., and T. Riddiough, “Securitization and the Commercial Property Cycle,” in Heath et al. ibid., 143–190. BIS central bankers’ speeches Thus, the demographic condition of population dividend or bonus is fertile ground for malign property bubbles. Population ageing and declining long-term per capita growth So far, I have discussed the formative stage of malign bubbles. Then, what happens when a malign bubble bursts? Here again, demographic trends are important and likely to influence the adjustment process significantly. As is often argued, the economy has to endure a period of lower growth after a malign bubble bursts. Chart 4 shows the rolling ten-year average of the per capita GDP growth rate of advanced countries. After the collapse of the bubble, the Japanese per capita rate plunged from above 3 to around 1. It is remarkable to note that the per capita GDP growth of the United States and major European countries also fell almost uniformly to around 1 after the collapse of the their bubbles (except for Italy, where the rate has fallen even further to become negative). Debt overhang and resulting deleveraging are often cited as the major culprits of this substantially lower growth. The next two charts suggest more than that and point to the possible importance of demographic trends. They juxtapose the working-age population ratio (inverse dependency ratio) and the long-run per capita growth rate, which is the average per capita growth rate of the past ten years, for the United States (Chart 5.1), Japan (Chart 5.2), the United Kingdom (Chart 6.1), Spain (Chart 6.2) and France (Chart 6.3). These figures suggest a possible link between demographic trends and long-term per capita growth, which is determined by efficiency in production. Population ageing, which we observed first in Japan and now in the United States and European countries, may affect factor productivity and long-term efficiency in the economy as a whole. For example, population ageing reduces the mobility of workers and entrepreneurs between regions and industries. Population ageing also changes the composition of consumer demand, and the vast difference among senior citizens in terms of wealth and experience reduces the effectiveness of mass-marketing to create demand. 6 This means many advanced economies experiencing a malign bubble and population ageing at the same time face doubly downward pressure from debt overhang and population onus. 2. Policy implications Awareness of the significant effects of demographic trends Let me now turn to the policy implications of what I have examined. The first lesson from the experience of the advanced economies is to be aware of demographic trends. In particular, we should take into account that the likelihood of malign property bubble formation is much greater in the population dividend or demographic bonus phase, while the negative impact of the collapsing bubble is far severer in the phase of the burden of an ageing population, or demographic onus. This is particularly important in some emerging economies. Chart 7 shows the situation in Brazil (7.1), China (7.2) and Korea (7.3). In Brazil, the peak of the working age population ratio is a decade away, but house prices and credit expansion are skyrocketing toward it, indicating the possible risk of a future malign bubble. The possible risk could be seen in China and Korea, where the working-age population ratio is likely to peak in a few years and credit expansion continues. Moreover, the size of population dividends is much greater and the future decline of the working-age population ratio is much more pronounced in these two See Nishimura, K. G., “Demographic Transition, Impact of ICT, and Globalization: A Long View of the Post-Crisis World,” Speech at the Central Bank of the Republic of Turkey, August 28, 2012. BIS central bankers’ speeches countries than in Brazil and the advanced countries in Charts 1 to 3, suggesting demographic change will have an even greater impact. Of course, the correlation between demographic factors and property bubbles remains loose, as exemplified by the German experience. However, considering the imminent grave consequences of a malign property bubble under the burden of an ageing population, it is advisable for policy makers to take precautions against the possible danger. Avoiding excessive loosening of a policy in the demographic bonus phase The recent bubble episodes have shown us that, in the population dividend or bonus phase, when demand for property increases substantially, financial laws and regulations tend to become loose, thereby fueling property price bubbles. 7 In other words, financial laws and regulations and government policies are markedly “procyclical”, though here the cycle is much longer than business cycles. The financial innovation of subprime RMBS is surely one example. So the second lesson is that we should avoid an excessive loosening of financial regulations and government policies in the demographic bonus phase. Here macroprudential policies become important, which rely on measures such as LTV and DTI requirements. 8 Unfortunately however, I find most discussions about macroprudential policies are concerned only with taming overly optimistic expansion of credit and fund flows, while they fail to give sufficient attention to the often “procyclical” regulatory changes that trigger such expansion. Thus, I still have strong reservations over the effectiveness of some macroprudential measures in a truly malign bubble, since such measures may simply mean temporary halting of the expansion and thus amount to “kicking the can down the road”. 9 Avoiding excessive tightening of a policy in the demographic onus phase Next, what is the lesson for the collapsing stage of a bubble? Adjustment is still under way, even in Japan after more than two decades since the 1990 bubble burst. However, one thing is clear: adjustment is long and severe when the economy is under the burden of an ageing population, or in the demographic onus phase. It is also becoming evident that there is no quick fix for the problem and no quick return to the “old normal” of the population bonus phase. Policy makers now face dual problems: they have to minimize the likelihood of another malign bubble in the future, and at the same time they have to minimize the current distress caused by the past bubble. Future bubble prevention usually leads to significant tightening of once-loose regulations and government policies toward banking and housing finance systems. The thrust of strict regulations is fueled by popular anger against the beneficiaries of the past malign bubble. At the same time, however, we should be aware that we are in a phase of demographic onus, with lower demand for property than in the demographic bonus phase of decades ago. This means regulatory measures appropriate in the population bonus phase may be too strict in the population onus phase. So we must avoid too strict a policy in the population onus In fact, the regulatory changes of 2004 (the so-called Bear Sterns exemption and the regulatory change with respect to Fannie Mae and Freddie Mac) caused unprecedented rapid expansion of credit, becoming a precursor of the financial crisis. See Nishimura, K. G., “What Should we Learn from the Eurozone Crisis – A Regulatory-Reform Perspective,” Speech at the Institute of International Bankers 2012 Annual Washington Conference, March 5, 2012. See Kuttner, K., and I. Shim, “Taming the Real Estate Beast: The Effects of Monetary and Macroprudential Policies on Housing Prices and Credit,” in Heath, et al. ibid., 231–259. For more detailed discussion on macro-prudential policies in the case of the Japanese property bubble, see Nishimura, Kiyohiko G. (2011) “Macroprudential Lessons from the Financial Crisis: A Practitioner’s View,” in: Kawai, Masahiro. and Eswar Prsard (eds.) Asian Perspectives on Financial Sector Reforms and Regulation: Washington, D.C., Brookings Institution Press, 180–195. BIS central bankers’ speeches phase, and avoid regulatory and policy “procyclicality” in the downward direction. Moreover, we should also recognize that a severe balance-sheet adjustment under population ageing hampers the effectiveness of conventional policy tools. 10 In addition, seemingly overly pessimistic expectations aggravate the problem of policy effectiveness. Thus, policy makers have to perform a subtle balancing act between long-run crisis prevention and immediate crisis response. 3. Property price indexes as the foundation of policy Let me now turn to the issue of data and statistics as the foundation of policy. Unfortunately, the current state of our knowledge about property markets is still limited, especially in constructing property price indexes that are reliable (R), accurate (A), timely (T), and easy (E) to understand – what I call the “RATE” requirement. Thus, property prices were identified at the November 2009 G20 Meeting as one of the crucial data gap issues. To rectify the problem, Eurostat is taking the lead in drafting a Handbook on Residential Property Price Indices under the aegis of the Inter-Secretariat Working Group on Price Statistics. 11 With respect to accuracy, the RRPI Handbook (4th draft) recommends hedonic price indexes, especially in countries where transactions are limited and repeated sales may involve sampling biases. Most emerging economies, including China, are in this category, as well as many advanced countries like Japan. 12 With respect to timeliness, there has been promising progress. Note that for a policy maker, timely information is as important as, or in some cases more important than, reliable and accurate information. According to this criterion, existing transaction-based property price indexes, though accurate, are not helpful in immediate policy making, since they inevitably lag far behind market movements. For example in Japan (Chart 8), it typically takes 10 weeks from posting in the market to negotiation, 5.5 weeks from negotiation to actual transaction, and 15.5 weeks from transaction to being recorded in the government data base. In addition, extra weeks are needed for data collection and compilation, so that the lag is likely to amount to almost a year. First asking price data are timely but not accurate (because they are biased), while transaction price data are accurate but not timely, posing a dilemma. However, there is an important way around this dilemma. Using previously-owned condominium prices in Tokyo, my collaborators and I are able to show that if a hedonic quantile-regression procedure of quality adjustment is applied to both first asking price data and transaction price data, the resulting price distribution is almost identical (Chart 9). 13 This implies that if hedonic quantile-regression quality adjustment is appropriate, which is likely, we can use first asking Not only does the conventional policy of controlling the overnight interbank rate turn out to be ineffective because of the zero lower bound, but the unconventional policy of asset purchases is also becoming less effective in altering firms’ and households’ financial conditions as the long rates themselves move down to a very low level. The Bank of Japan’s funding facilities for financing economic growth and the Bank of England’s funding for lending scheme are new types of unconventional policy aimed at coping with this problem. See Nishimura, K. G., “Funding for Financing Economic Growth – A Schumpeterian Perspective,” Remarks at the Global Interdependence Center Conference on The Global Financial Crisis: Lessons from Japan, Tokyo December 3, 2012. http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/methodology/owner_occupied_housing_hpi/ rppi_handbook. Deng, Y., J. Gyourko, and J. Wu, “Land and Housing Price Measurement in China,” in Heath, et. al. ibid., 13–43. Shimizu, C., K. G. Nishimura, and T. Watanabe (2011) “House Prices at Different Stages of the Buying/Selling Process,” Working Paper no. 69, Research Center for Price Dynamics, Institute of Economic Research, Hitotsubashi University. BIS central bankers’ speeches price data to construct a reliable proxy of quality-adjusted transaction price distribution. Thus, we get timely and reliable quality-adjusted price data through this procedure. I will stop here for the discussions of other panelists. 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Speeches by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the Bank of Italy and at the Eurasia Business and Economics Society Conference, Rome,
Sayuri Shirai: Japan’s monetary policy in a challenging environment Speeches by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the Bank of Italy and at the Eurasia Business and Economics Society Conference, Rome, 11–12 January 2013. * I. * * Introduction It is indeed a great honor to have this opportunity to address you today. In my presentation, I would like to focus on Japan’s macroeconomic performance, monetary policy, and the environment surrounding the conduct of monetary policy. Some of the issues I will raise today – such as population aging and associated macroeconomic and structural issues – are traditionally regarded as long-term issues for central banks, and they thus tend to be treated as issues beyond the framework of monetary policy. Nonetheless, a number of European countries, such as Italy and Germany, are currently facing a rapidly aging population in a similar manner to Japan. Therefore, I believe that those issues will be actively debated in Europe in the near future as factors affecting the conduct of monetary policy. For this reason, deepening the understanding of Japan’s experience may provide useful inputs, especially for countries whose economies have entered a mature stage. Cultivating a more profound insight into Japan’s experience may also promote innovative ways of thinking about the conduct of monetary policy. Let me briefly outline the content of this presentation. The main purpose of my talk is to describe the accommodative monetary policy that the Bank of Japan (hereafter the Bank) has been conducting for almost all of the past two decades since its first cut in the policy rate in 1991 in response to the bubble burst in real estate and stock prices. Owing to the limited time available, I would like to shed light on two types of nonstandard monetary easing adopted by the Bank under the zero lower bound on nominal interest rates: (1) the first round of monetary easing – the so-called quantitative easing (QE) during 2001–06; and (2) the second round of monetary easing – the so-called comprehensive monetary easing (CME) from 2010 until the present. The final part of my presentation will focus on structural issues and associated macroeconomic performance. The issue of the effectiveness of the conduct of monetary policy in the current challenging environment will also be explored. I am very much looking forward to active discussions with you after my presentation. II. First round of monetary easing under the quantitative easing (QE) policy (2001–06) Let me start my presentation by providing you with a brief summary of the economic performance since the 2000s and the experience under QE of 2001–06. A. Framework for the QE policy Before falling into a prolonged mild deflation phase, Japan experienced the collapse of the bubble in real estate and stock prices in the early 1990s, and the subsequent financial crisis in the second half of the 1990s. Over the same period, Japan suffered from a prolonged recession and negative output gap notwithstanding several short-lived recovery phases (Chart 1). The growth rate of the headline consumer price index (CPI) and core CPI (defined as all items except fresh food) gradually dropped and shifted to a continuous modest decline from 1998 (Chart 2). Moreover, the economy was adversely affected by the bursting of the U.S. IT bubble in 2000. Exports and production dropped sharply in early 2001, while CPIbased price changes remained in negative territory. Under this environment, the Bank adopted a new monetary easing framework – the so-called QE policy – in March 2001 with a view to stemming the continuous price decline and setting BIS central bankers’ speeches the basis for sustainable economic growth.1 This unique policy was a nonstandard monetary policy since it was introduced in the presence of a virtually zero uncollateralized overnight call rate or very short-term money market interest rate.2 It consisted of the following three main elements. First, the main operating target was shifted from the policy rate (uncollateralized overnight call rate) to the current account balance at the Bank – a transformation from interest rate targeting to reserve targeting. The target balance was then increased gradually by expanding excess reserves (Chart 3). To be precise, the target amount was raised nine times from the initial 5 trillion yen (which is higher than the required reserve level of 4 trillion yen) to around 30–35 trillion yen in January 2004 in response to the deteriorating economy. The same target amount was then maintained until the end of the QE policy. The attempt was made to achieve this reserve target mainly through money market operations with various maturities of one year or less. Theoretically, this measure, which led to an expansion of the Bank’s balance sheet (or the monetary base), was supposed to affect the financial and capital markets through the following: (1) the portfolio rebalance effect (lowering the risk premiums of financial assets that are imperfect substitutes for the monetary base); and (2) the signaling effect (lowering the expectations for the future path of short-term interest rates), as indicated in Chart 4. The portfolio rebalance effect refers to the channel through which expansion of the Bank’s balance sheet helps reduce the risk premiums of riskier assets, thereby inducing financial institutions and investors to invest more actively in those assets. This action may raise their prices, thus indirectly stimulating business fixed investment and consumption – and hence general prices. The signaling effect refers to the situation in which a central bank sends out a signal to the market through an expansion of the balance sheet, which leads to expectations that the future path of short-term interest rates will remain low for a longer period. Since central banks can control the future path of short-term nominal interest rates, the expansion of the balance sheet signals the Bank’s future monetary policy conduct. Such expectations then affect various expectations for longer-term interest rates and the yields of other financial assets in the financial markets. Second, the Bank made a clear commitment to maintaining this policy until the condition of the core CPI registering “stably 0 percent or a year-on-year increase” was met.3 This innovative monetary policy tool is nowadays often referred to as “forward guidance.” Theoretically, this policy is supposed to lower future short-term interest rates through the signaling effect – by promoting market expectations that the virtually zero interest rate will be maintained for some time in the future even after economic conditions improve.4 Previously, the uncollateralized overnight call rate (targeted policy rate) was lowered to 0 percent in February 1999 to cope with deteriorating economic conditions and deflation risk. The zero interest rate policy was then abandoned, and the policy rate was raised to 0.25 percent in August 2000 with a view of reduced deflationary pressures driven by weak demand. In February 2001, the increase in the policy rate ceased, and it was lowered to 0.15 percent. Under the QE policy, the uncollateralized overnight call rate stayed at around 0 percent owing to the ample liquidity provision. To be precise, the interest rate under the QE policy declined to 0.001 percent – a level even below the 0.02-0.03 percent that prevailed during the zero interest rate policy. The forward guidance was clarified further in October 2003 by introducing two exit conditions: (1) the most recently published core CPI registers 0 percent or above and such a tendency is confirmed for over a few months; and (2) the projected core CPI does not register below 0 percent. These conditions were regarded as necessary so that there may be cases that the Bank will judge it appropriate to continue with QE even if these two conditions are fulfilled. See Eggertsson, Gauti B., and Michael Woodford, “The Zero Bound on Interest Rates and Optimal Monetary Policy,” Brookings Papers on Economic Activity, 1, pp. 139-211, 2003; and Reifschneider, David, and John C. Williams, “Three Lessons for Monetary Policy in a Low-Inflation Era,” Journal of Money, Credit and Banking, 32 (4) Part 2, pp. 936-66, 2000. BIS central bankers’ speeches Third, it was decided to increase the outright purchase of (long-term) Japanese government bonds (JGBs) if deemed necessary to facilitate meeting the targeted current account balance at the Bank. Indeed, the amount of JGBs purchased rose steadily. Theoretically, this measure aims at altering the composition of the Bank’s balance sheet without changing its size and is sometimes referred to as a “credit easing” policy. Like measures to expand the current account balance at the Bank, the expected effects could be decomposed into the portfolio rebalance and signaling effects. In practice, though the increase in the current account balance at the Bank was mainly conducted through relatively short-term market operations, this measure was regarded as an additional tool to ensure that the targeted balance would be met. B. Economic recovery setting the stage for exit from the QE policy Over the same period of 2001–06, expansionary economies overseas contributed to an increase in Japan’s export growth. Thus, Japan’s economy was finally able to enter a recovery phase after the trough in January 2002. Corporate profits grew during this period despite the rise in imported crude oil prices and other material prices. Reflecting growing production capacity constraints caused by active production activities, business fixed investment – especially in the export manufacturing sector – recorded high growth; however, the level of investment remained below the scale of cash flow. Household income rose moderately owing to an increase in employment, but also partly thanks to a moderate perworker nominal wage increase (driven mainly by rising working hours), an increase in dividend income, and the rise in stock prices, thereby supporting consumption activities. The economy was recovering steadily after the beginning of 2002, and the recovery trend was getting stronger (Chart 1). It seemed that the economic growth would continue for the foreseeable future. It was clear that the main engine for the growth was exports and associated domestic business fixed investment activities, which had been supported by favorable worldwide economic growth and the depreciation of the yen. The yen’s depreciation, especially vis-à-vis the U.S. dollar and the euro, was promoted mainly by the growing yen carry trade (selling yen and buying foreign currencies) in the face of interest rate differentials and the risk-taking behavior of investors (Chart 5). This view is consistent with the fact that both large and small and medium-sized firms in the manufacturing sector indicated more favorable sentiment over business conditions than their counterparts in the nonmanufacturing sector. Regarding price developments, the core CPI – having moved into negative territory since the late 1990s and remained more or less in a mild deflation phase – finally turned positive toward late 2005 (Chart 2). This was followed by larger increases after the beginning of 2006.5 Several firm-based surveys indicated that companies faced very strong capacity constraints in terms of capital stock and employment, which suggested that the negative output gap had mostly been eliminated (Chart 1). Since the economy was expected to expand at a pace above its potential, it was thought that the output gap would likely become positive and then widen moderately. One concern was that unit labor costs (ULCs) continued to decline since increases in hourly productivity had been large. However, wages began to increase in 2005 in the presence of a tighter supply and demand balance of labor over a relatively wide range of industries, while the rate of productivity increase was expected to slow down in the prolonged stage of economic recovery. Thus, it was projected that in the near future, ULCs would stop declining and start increasing moderately. Moreover, various To be precise, the core CPI growth rate turned positive in November 2005, and the rate for January 2006 announced in early March was 0.5 percent (though that of the headline CPI remained in negative territory over the same period of 2005 and shifted to a positive 0.5 percent in January 2006). However, these figures were retroactively adjusted downward, and the previously positive figures fell into negative territory in August 2006, when the base year for the CPI was shifted from 2000 to 2005. The scale of downward adjustment was greater than with the past trends and was thus beyond the projected one. BIS central bankers’ speeches surveys indicated that firms and households were adjusting inflation expectations upward for both the short term and the medium to long term. Like other advanced countries, Japan had been witnessing the phenomenon of the rate of increase in the CPI becoming less sensitive to changes in the output gap over recent years – the so-called flattened Phillips Curve. Nonetheless, the Bank assessed that the CPI inflation was likely to rise gradually based on the already-mentioned considerations: (1) an expected further improvement in the output gap; (2) expected tighter labor market conditions, partly as a result of growing economic activity; and (3) rising inflation expectations of firms and households. The increase in international commodity prices and the yen’s depreciation also contributed to the rising inflation prospects. Based on these observations, it was expected that the uptrend in the CPI would probably be achieved, even though those movements would be partially offset by downward pressures stemming from intense competition among domestic firms, intensified cross-border competition under deepened globalization, and advances in information and telecommunication technology. The growth rate of the core CPI was thus estimated to be within the range of 0–1 percent in fiscal 2006 and would approach the level of slightly below 1 percent in fiscal 2007. In March 2006, the Bank thus concluded that it was time to exit the QE policy since the conditions laid out in the commitment had been fulfilled.6 Therefore, the decision was made to reintroduce the standard uncollateralized overnight call rate as an operating target for money market operations instead of the outstanding balance of current accounts at the Bank. Also, the new target for the uncollateralized overnight call rate was set at effectively 0 percent. At the same time, the Bank adopted a new framework for the conduct of monetary policy by setting the “understanding of medium- to long-term price stability.” This is the level of the CPI inflation rate currently recognized as price stability by each member of the Policy Board of the Bank. An agreement was made among board members that a range of such an inflation rate would remain approximately between 0 and 2 percent with the median of 1 percent. It was also agreed that the rate would be reviewed annually. You may wonder why the range of inflation was lower than that of many other advanced countries. This is because the Bank found it important to take into account past price movements: namely, the average rate of inflation over the previous few decades had been lower than that of major overseas economies and had been low even during the bubble period of the 1980s. In addition, Japan had experienced a prolonged period of lower rates of inflation since the 1990s. Under such a low inflation environment, it was regarded as likely that the rate of inflation at which households and firms perceived price stability would also be low. After March 2006, the level of interest rates turned positive as a result of the Bank’s decision to raise the policy rate twice in light of favorable developments in economic activity and prices: from 0 percent to 0.25 percent in July 2006, and further to 0.5 percent in February 2007. This level of the policy rate was maintained until October 2008. C. Was the QE policy effective? This unique monetary policy contributed to rapid expansion of the monetary base, both in terms of the absolute amount and as a percentage of GDP. After the size of the monetary base was expanded from 38 trillion yen in 1990 (9 percent of GDP) to 65 trillion yen (13 percent of GDP) just prior to initiation of the QE policy, it further swelled to 110 trillion yen Since the core CPI growth rate (before the adjustment) registered positive from November 2005 through January 2006 and given the already-mentioned assessment over economic and price developments, it was judged that the conditions appeared to have been met. BIS central bankers’ speeches (22 percent of GDP) by March 2006. The scale of monetary accommodation contrasted with that in the United States and the euro area at that time (Chart 6). Empirically, the effects of the QE policy can be examined by decomposing the transmission mechanism into the following two stages: (1) the transmission mechanism from monetary easing to financial and capital markets (first stage); and (2) the transmission mechanism from the first stage to the real economy and prices through financial and capital markets (second stage). This is conceptualized in Chart 7. Ugai (2006)7 summarizes existing empirical analyses of the QE policy related to the first stage by focusing on the aforementioned three features of that policy: (a) the effect of expanding the size of the Bank’s balance sheet (or the monetary base) by increasing the current account balance at the Bank; (b) the effect of the forward guidance policy on the expected future path of short-term interest rates; and (c) the effect of altering the composition of the Bank’s balance sheet by increasing the purchases of JGBs (Chart 4). To summarize the research results, the effect of the QE policy was traced mainly through the forward guidance policy by pushing the yield curve downward (namely, through the signaling effect). The portfolio rebalance effect meanwhile had mixed results, depending on the types of assets. In particular, the purchase of JGBs had little impact on lowering risk premiums. However, some research analyses demonstrated the presence of the portfolio rebalance effect through the channel of cross-border capital flows. Namely, the QE policy induced capital outflows, whose funds were then reinvested in Japanese stocks by foreign hedge funds, and they contributed to raising those stock prices. With regard to the second stage, a small number of empirical studies have examined the impact of QE on macroeconomic performance. Some demonstrated that an expansion of the Bank’s balance sheet had a limited impact on aggregate demand and prices; other studies showed that there was a statistically significant positive impact of QE on industrial production, but no statistically significant impact was found on the core CPI.8 The overall assessment of the QE policy was made by the then Bank Governor Fukui in 2006.9 First, the policy stabilized the financial system through the ample liquidity provision at a time when there were strong concerns over its stability. The ample liquidity provided by the Bank met rising liquidity demand by financial institutions, and it thus successfully avoided a repetition of the large-scale credit crunch that occurred during the 1997–98 financial crises. Second, the policy created and maintained a very accommodative environment that supported the recovery of Japanese firms through the commitment to continue zero interest rates. In particular, bank lending rates and interest rates on corporate bonds continued to decline as a result of the flattening of the yield curve as well as the gradual decrease in credit risk premiums. Meanwhile, the Bank stressed that a side effect of the QE policy was shrinkage of the interbank markets owing to fewer arbitrage transactions and reduced demand for fund-raising from the market. This led to a decline in credit lines among financial institutions and a cut in resources allocated to the interbank market business within financial institutions. The function of the interbank market appears to have been impaired. Moreover, it was clear that such an accommodative monetary policy could not promote active lending activities by banks (Chart 8). This was mainly attributable to the size of See Ugai, Hiroshi, “Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses,” Bank of Japan Working Paper Series No. 06-E-10, 2006. See Adachi, Seiji, “Yen no Ashikase,” Toyo Keizai Inc., 2007; and Fujiwara, Ippei, “Evaluating Monetary Policy When Nominal Interest Rates Are Almost Zero,” Journal of the Japanese and International Economy, Vol. 20 (3), pp. 434-53, 2006. See Fukui, Toshihiko, Opening remarks at the conference organized by the Institute for Monetary and Economic Studies entitled “Financial Markets and the Real Economy in a Low Interest Rate Environment,” 2006. BIS central bankers’ speeches negative shocks triggered by the bursting of the bubble and their subsequent impact on the financial system. Policies for dealing with the deteriorating balance sheets of financial institutions caused by ample nonperforming loans were very slow; this was partly because there was hope for a reversal of the real estate and stock price decline, which would remove the possibility of a financial crisis or stagnation of the economy. Even at a later stage, when experts finally agreed on the need to provide public support for financial institutions, measures to inject public funds into those institutions met with public opposition (Shirakawa 2012).10 At the same time, the drag on aggregate demand was severe owing to the balance sheet problems of firms and three types of excesses – employment, investment, and debt. Nonetheless, it was pointed out that the liquidity provided by the Bank exerted a small, but still positive, effect on banks’ lending activities (Bowman et al. 2011).11 III. Second round of monetary easing under the comprehensive monetary easing (CME) policy (2010 to the present) That was a brief summary of how the Bank coped with difficult economic situations in around the first half of the 2000s. The next issue is the Bank’s most recent policy framework – the CME policy that has been adopted since October 2010. But before addressing that issue, I would like to talk about how the Bank reacted to the global recession triggered by the Lehman shock in September 2008 prior to the introduction of the CME policy. A. Quick ending of the normalization period of monetary policy Global economic conditions deteriorated sharply after autumn 2008 with the intensification of turmoil in the U.S. and European financial systems as well as in global financial markets. Exports decreased significantly owing to a sharp downturn in overseas economies. Business fixed investment also declined substantially, which reflected the deterioration in corporate profits and financial conditions. Moreover, the yen began to appreciate against the U.S. dollar in summer 2007 with the weakening of the global risk appetite and the unwinding of the yen carry trade (Chart 5). As a result, the nominal exchange rate of the yen shifted drastically. In the household sector, private consumption weakened against a backdrop of deterioration in consumer sentiment and in the employment and income situation. Therefore, it seemed likely that the economic growth rate for 2008 would deteriorate. Meanwhile, the headline and core CPIs rapidly increased in summer 2008, which was due mainly to the surge in commodity prices. Thereafter, the effects of commodity prices gradually waned, and the headline and core CPIs started to moderate by late 2008. Against this background, a series of accommodative monetary policy measures was adopted. First, the level of the policy rate was lowered twice: from 0.5 percent to around 0.3 percent in October 2008 and further to around 0.1 percent in December 2008. Thus, a period of raising the policy rate was sustained only during 2006–08. Similarly, the interest rate applied to the complementary lending facility (a backstop to provide liquidity to financial institutions) was cut from 0.75 percent to 0.5 percent in October 2008, and further to 0.3 percent in December 2008.12 In October 2008, the complementary deposit facility was established and the interest rate applied to excess reserves was set at 0.1 percent. See Shirakawa, Masaaki, “Deleveraging and Growth: Is the Developed World Following Japan’s Long and Winding Road?,” Lecture at the London School of Economics and Political Science, 2012. See Bowman, David, Fang Cai, Sally Davies, and Steven Kamin, “Quantitative Easing and Bank Lending: Evidence from Japan,” International Finance Discussion Papers No. 1018, Board of Governors of the Federal Reserve System, 2011. After the interest rate applied to the complementary lending facility was lowered from 0.25 percent to 0.1 percent in September 2001, the same rate was maintained during the QE policy. It was then raised to 0.4 percent in July 2006 and further to 0.75 percent in July 2007 in accordance with an increase in the policy rate. BIS central bankers’ speeches Second, the Bank newly adopted a three-month funds-supplying operation at the fixed target interest rate (0.1 percent) against pooled collateral up to a total amount of 10 trillion yen in December 2009. This operation aimed at promoting a further decline in longer-term interest rates in the money market. In March 2010, the amount of this operation was raised to 20 trillion yen. In August 2010, an additional six-month funds-supplying operation was introduced with the maximum amount of 10 trillion yen. Thus, the total amount provided under this operation reached 30 trillion yen. Third, the “Special Funds-Supplying Operations to Facilitate Corporate Financing” was established in December 2008 to ensure stability in the financial markets and facilitate corporate financing. The Bank provided financial institutions with an unlimited amount of funds over the fiscal year-end against the value of corporate debt pledged as the standing eligible collateral at a policy rate. It was extended three times and the implementation period ended in March 2010. Corporate bonds and CP were also purchased in 2009. Fourth, the expression of the “understanding of medium- to long-term price stability” (introduced in March 2006) was clarified further in December 2009 by eliminating the possibility of 0 percent rate of price change. Namely, the expression was changed to “in a positive range of 2 percent or lower with a midpoint of around 1 percent.” This measure aimed at removing public concern that 0 percent inflation would be tolerated by the Bank. B. Framework for the CME policy After the Lehman shock, overseas economies temporarily leveled out and showed a sharp recovery from the second half of 2009 thanks to active fiscal and monetary policies adopted collectively by major economies. However, the pace of growth began to slow somewhat after mid-2010, mainly because of the waning demand-boosting effects of fiscal policy measures. Moreover, global investors became increasingly risk averse in 2010 as the sovereign debt problem in some peripheral European countries grew into a focus of concern and uncertainty heightened over the outlook for the global economy, especially in the United States. Consequently, credit spreads on corporate bonds mainly in the United States and Europe have widened since 2010, and stock prices in many countries, including Japan, became unstable. With regard to Japan’s economy, signs of a moderate recovery were evident in 2009, but the pace began slowing down as the growth in exports and production decelerated in mid-2010. The slow pace of recovery was also expected in the near future due to the continued slowdown in overseas economies, the ending of demand-boosting fiscal policy measures to promote expenditure on durable consumer goods, and the continued appreciation of the yen. The yen continued to appreciate since it has been viewed as a relatively safe currency (Chart 5). Given this background, the Bank introduced the CME policy in October 2010. This policy comprises the following three pillars. First, the guideline (or targeted policy rate) for money market operations was changed from “around 0.1 percent” to “around 0–0.1 percent.” This policy could be regarded as a virtually zero interest rate policy. In addition, the interest rate applied to the complementary lending facility was maintained at 0.3 percent and that to the complementary deposit facility at 0.1 percent. Second, the Bank newly introduced the forward guidance policy and made the commitment to a zero interest rate policy being maintained until the price stability defined under the “understanding of medium- to long-term price stability” was in sight.13 The expression describing price stability was maintained as in a positive range of 2 percent or lower with a This commitment will be pursued under the condition that no problem is identified when examining risk factors, including the accumulation of financial imbalances. The same condition applies to all other revised commitments. BIS central bankers’ speeches midpoint of around 1 percent. In February 2012, an important decision was made to revise this framework in two steps. The first step was to introduce “the price stability goal in the medium to long term,” which would be “within a positive range of 2 percent or lower,” while setting the goal “at 1 percent for the time being.” The definition of this goal was to be examined in principle once every year. The second step was to strengthen the forward guidance policy by committing to the CME policy through the virtually zero interest rate policy and the Asset Purchase Program, which I will describe later, until the Bank judged that the 1 percent goal was in sight. I believe that these changes constitute a considerable departure from previous practices for two reasons. One is because medium- to long-term price stability is now defined as a “goal” and is uniformly set through the consensus of all members of the Policy Board. Previous price stability was defined as an “understanding” in a manner that embraced differing views of price stability by each member, or it was simply a collection of the board members’ various views. The other reason is that at both the market and individual level, the word “goal” may be viewed as a sign of stronger action on the part of the Bank than the word “understanding” would suggest, even though the Bank’s determination to conquer mild deflation is intact. It is true that some people regarded the term “understanding” as being too passive, and it did not indicate positive action by the Bank. For this reason, these changes accompanied the decision to increase the total size of the Asset Purchase Program by 10 trillion yen, partly to demonstrate the Bank’s strong commitment and also to ensure the path toward economic recovery. I take the view that these actions helped promote public understanding of the Bank’s determination to overcome mild deflation. Third, the Bank introduced the Asset Purchase Program to promote the decline in longerterm interest rates and various risk premiums. The assets to be purchased under the program covered JGBs (with a remaining maturity of one to three years),14 treasury discount bills (T-Bills), commercial paper (CP), corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). The existing three- and six-month fundssupplying operations are still in effect. The total outstanding amount of assets to be purchased and funds-supplying operations (hereafter called simply the amount of the Asset Purchase Program) was initially set at about 35 trillion yen, and it was decided to meet the target by the end of 2011. Since then, monetary easing has been repeatedly strengthened. The total amount of the program was increased eight times from the initial 35 trillion yen to the current target of 101 trillion yen (to be completed by the end of 2013), as shown in Chart 9. During 2012, the program was expanded five times (February, April, September, October, and December). The increase has been conducted mainly through the purchase of JGBs (from an initial 1.5 trillion yen to 44 trillion yen) and T-Bills (from an initial 2 trillion yen to 24.5 trillion yen). C. What are the differences between the QE and CME policies? The CME policy differs from the QE policy in several ways. First, the Asset Purchase Program covers a wider range of financial assets than those of the QE policy and those of other central banks with nonstandard monetary policies. This reflects the view that the direct purchase of various financial assets may encourage the further decline in longer-term interest rates and risk premiums through possibly greater portfolio rebalance and signaling effects (Chart 10). Second, the CME policy directly aims at lowering longer-term interest rates and risk premiums through an emphasis on asset purchases – the asset side of the Bank’s balance sheet. This is a sharp contrast from the QE policy, where the main focus was on the size of In addition to the Asset Purchase Program, the Bank regularly purchases JGBs (with the remaining maturity of up to 30 years, including that of one year or less) at the rate of 21.6 trillion yen per year to counterbalance the increased amount of banknotes in circulation. BIS central bankers’ speeches the current account balance at the Bank – the liability side of the Bank’s balance sheet. It is important to note that the volume of the current account balance is less emphasized here than in the QE policy. Instead, with the CME policy it is important to examine whether there is room for further monetary easing by encouraging a further decline in longer-term interest rates and risk premiums. Thus, the size of excess reserves is no longer a target and is endogenously determined as a result of market operations. Third, the positive interest rate of 0.1 percent applied to the complementary deposit facility (introduced in October 2008) remains under the CME policy, while the policy target was set in the range of around 0–0.1 percent. This differs from the QE policy, where no such a facility was present under the zero short-term interest rate environment. The Bank pays an interest rate of 0.1 percent on banks’ excess reserves with the Bank for several reasons. First, as pointed out earlier with respect to the assessment of the QE policy, shrinkage of the interbank markets may generate a situation in which financial institutions are unable to raise funds promptly from the markets when most needed. As a related issue, since this interest rate forms the floor for interbank market interest rates, the Bank is able to smoothly provide sufficient liquidity to the market without causing large fluctuations in the interbank market rates. Moreover, as a future issue, it has also been pointed out by Svensson (2012)15 that maintaining such a deposit facility interest rate makes it easier for a central bank to conduct an exit strategy smoothly by containing excessive inflation risks within the phase of economic recovery. If such a rate already exists, a central bank may be able to raise the deposit facility interest rate, thereby leading to higher interbank market interest rates even if there are ample excess reserves. However, positive aspects related to removing the interest rate have been pointed out. For example, a positive impact on the yen’s depreciation could be expected by further lowering short-term interest rates. One issue over which there is a lack of clarity concerns the impact of removing the deposit facility interest rate on financial institutions’ lending behavior. There is a view that removing such an interest rate may increase their lending since there is no gain from placing excess reserves with the Bank. On the other hand, it has been stressed that such removal would lower financial institutions’ profitability and thus rather stifle the incentive to take credit risks by increasing lending activities. Such pros and cons related to the deposit facility interest rate need to be better understood and properly discussed in light of the impact on overall economic and price movements. Similarly, the Federal Reserve applies a positive interest rate on the deposit facility at 0.25 percent while the target policy rate is set in the range of 0–0.25 percent. This is a possible reflection of maintenance of the interbank market function being regarded as essential in the United States. Meanwhile, the European Central Bank (ECB) dropped the deposit facility interest rate from 0.25 percent to 0 percent in July 2012 while lowering the interest rate charged on marginal refinancing operations from 1 percent to 0.75 percent. This can probably be attributed to the limited adverse impact of such a rate cut on the interbank market given that financial institutions already depend heavily on central bank liquidity provisions; this is a result of the segmented, malfunctioning interbank market in the euro area since the deepening of sovereign debt problems. D. Is the bank’s framework different from inflation targeting? Globally, a number of central banks adopt inflation targeting, such as those in Canada, New Zealand, Norway, Sweden, and the United Kingdom. It is widely known that inflation targeting actually refers to flexible inflation targeting for these countries, as clarified by Dr. Lars E.O. Svensson, the distinguished scholar in the field of finance theory and deputy governor See Svensson, Lars E. O., “Practical Monetary Policy: Examples from Sweden and the United States,” NBER Working Paper Series No. 17823, 2012. BIS central bankers’ speeches of the Riksbank in Sweden. Flexible inflation targeting is different from the original strict interpretation of inflation targeting, which focuses solely on price stability. Flexible inflation targeting refers to the conduct of monetary policy that attempts to choose a policy rate path such that the corresponding forecasts for inflation and output gap (or other resource utilization measures) seem best for stabilizing inflation around the inflation target and output gap around a sustainable level. Thus, rather than simply achieving the inflation target at any cost, flexible inflation targeting aims to attain a better balance between securing inflation stability and reducing negative output gap. In this sense, achieving the inflation target will be attempted in the medium to longer term by taking into account various shocks that occur unexpectedly and considering their impacts on economic growth performance. Namely, monetary policy is conducted flexibly. Moreover, the global financial crisis has woken central banks to the fact that adhering to inflation targets was unable to avoid the financial crisis triggered by the Lehman shock. Thus, there is an increasingly shared view among central banks that attending to financial imbalances is an important element in conducting monetary policy. For these reasons, flexibility in monetary policy is stressed under the current flexible inflation-targeting framework, in which a number of central banks permit deviation of actual inflation from inflation targets. Sometimes, such deviations can last quite a long time. The Bank does not adopt an inflation-targeting framework, but it conducts monetary policy flexibly in the manner of a central bank under a flexible inflation-targeting framework by taking into account the impact on economic growth performance and financial imbalances. There are a number of other similarities between its policies and such a framework. First, the medium- to long-term price stability goal is set within a positive range of 2 percent or lower. This indicates that the numerical goal of 2 percent (the level of inflation often adopted as an inflation target under the flexible inflation-targeting framework) is not rejected, but the range of inflation is broad to allow consensus among board members holding differing views. The short-term goal was set at 1 percent for two main reasons: (1) to take into account past price movements (or price perceptions among households and firms); and (2) to accommodate the view that a longer-term goal could be achieved in conjunction with efforts to strengthen potential economic growth by various constituents, including the government, the Bank, financial institutions, and firms. If such collective efforts bear fruit, it is very possible to achieve the inflation rate above 1 percent. Regarding the medium- to longterm price stability goal, Mr. Shirakawa, the governor of the Bank and chairman of the Monetary Policy Meeting, gave instructions at the meeting in December 2012 that the definition of price stability as well as its numerical expression could be discussed at the next meeting in January, as almost a year would pass since the price stability goal was introduced in February 2012. Second, the Bank makes a strong commitment to maintaining the CME policy with the aim of achieving the 1 percent goal. Since this is a promise to markets and individuals, the degree of the Bank’s determination to cope with current economic difficulties is no different from that of other central banks in adopting flexible inflation targeting. However, if such an intention is not well received, the Bank may need to seek better communication strategies. Third, the Bank and other central banks have defined their perspectives on economic growth and general prices for the next few years by means of regular reports. In the case of the Bank, the report called the “Outlook for Economic Activity and Prices” is published twice a year (April and October) and describes the baseline scenario and examines the likelihood of this scenario coming about. In addition, the report analyzes whether the Japanese economy is likely to return to a sustainable growth path with price stability in the longer run. At the same time, the Bank examines the risks related to the conduct of monetary policy (i.e., financial imbalances, uncertainty related to global demand, and tail risks arising from other countries). The medium-term review over those prospects is conducted in January and July each year. BIS central bankers’ speeches Fourth, as a related issue, it should be noted that both the Bank and other central banks under flexible inflation targeting adopt an inflation forecast approach, not an actual inflation approach in conducting monetary policy. This reflects the fact that “current” inflation is essentially predetermined by the following: (1) previous decisions by firms and households; (2) past wage contracts; and (3) several shocks and other factors (such as value-added tax [VAT] and sales taxes). Thus, central banks have imperfect control over “actual” inflation, as explained by Dr. Svensson (1996).16 Moreover, both markets and individuals may find it difficult to monitor and evaluate monetary policy, since the impact of monetary policy appears with a lag of about one and a half to two years depending on economic circumstances and thus they have to wait that length of time before any proper evaluation can be made. For these reasons, the reality is that central banks can affect only future inflation or an inflation forecast – not actual inflation, as Dr. Svensson pointed out. And such an inflation forecast becomes an intermediate target toward achieving the inflation target (or goal). The main point here is to bring the inflation forecast closer to the inflation target (or goal) within a certain period. In this sense, the expression used by the Bank for describing the forward guidance policy – maintaining the CME policy until the Bank judges that the “1 percent goal is in sight” – could be interpreted as adopting an inflation forecast approach. This inflation forecast approach is a standard approach adopted by many central banks around the world. However, some people regard the term “in sight” as having a passive connotation and not signaling the Bank’s strong determination to achieve that 1 percent goal. Thus, how to signal the Bank’s intention correctly to the market and the general public could be one of the issues for further discussion. E. Was the CME policy effective? The CME contributed to a large expansion of the monetary base and exceeded the maximum level observed during the QE period of 2001–06 (Chart 6). Please recall that the Bank had already expanded the size of the monetary base significantly since the 1990s by conducting a series of accommodative monetary policy measures in response to various negative shocks. Thus, the size of the monetary base as a percentage of GDP was already higher than those of the United States and the euro area when the Lehman shock occurred. In response to the financial crises, the United States and the euro area injected massive liquidity to the market. Japanese financial institutions, on the other hand, avoided the financial crisis this time owing to the relatively sound balance sheets after having experienced the crisis in the 1990s. Nonetheless, the size of the monetary base expanded under the CME and currently exceeds 26 percent of GDP – higher than those of the United States (17 percent of GDP) and the euro area (18 percent of GDP). In the current very accommodative monetary environment, domestic financial markets have remained favorable. In the money market, the overnight call rate remains at extremely low levels. Interest rates on term instruments and lending rates have declined further (Chart 11). As a whole, firms’ funding costs through bank loans and the issuance of CP and corporate bonds have declined to record low levels. Moreover, long-term bond yields have been declining steadily. In particular, the yields on JGBs up to three years have declined and flattened. Furthermore, the financial market remained resilient after the Great East Japan Earthquake of 2011, partly because the Bank reacted quickly with a prompt injection of massive liquidity to the financial system in order to preempt possible deterioration in investors’ confidence. By means of an event study, it has been empirically demonstrated that the CME policy has a positive impact on financial markets. Following the monetary easing events, that study See Svensson, Lars E. O., “Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets,” NBER Working Paper No. 5797, 1996. BIS central bankers’ speeches determined that the yields on JGBs declined across all maturities. Similarly, corporate yields decreased across investment grades, and bond issuances also improved. The prices of J-REITs surged. The Bank’s monetary easing fended off a further appreciation of the yen and supported stock prices. Most of the impact on financial markets arose from the announcement of new easing measures, rather than from subsequent actual purchases. This suggests that investors tend to price the expected impact of the Bank’s subsequent operations or purchases immediately upon an announcement being made.17 Meanwhile, firms’ demand for external funds remains weak in the presence of improved cash flow and limited domestic and foreign demand. The amount of outstanding bank loans in the private sector has recently showed an increase, though at a very moderate pace (Chart 8). During the previous QE period, it was viewed that banks’ lending activities remained sluggish mainly because of the balance sheet problems of banks and firms. However, even after the soundness of their balance sheets was restored and financial institutions’ lending attitude became favorable, lending activities remained moderate. This mainly reflects a shortage of credit demand arising from sluggish economic activities and could be partially attributable to the structural issues that I would now like to discuss. IV. Structural issues related to the conduct of monetary policy In this final section, I would like to point out some structural changes that have been affecting the environment surrounding the conduct of monetary policy as well as the Bank’s efforts to cope with the various issues. A. Structural issues affecting macroeconomic performance To begin with, demographic changes are one of the most important ongoing structural issues that Japan faces. Globally, Japan is taking the lead in dealing with demographic trends and associated macroeconomic issues. It is well known that Japan has faced a decline in its working-age population (15–64 years) in absolute terms since the mid-1990s. The trend of a declining total population began in 2011 (Chart 12). As a result, Japan has become the most advanced aging society in the world. The rapid reversals in the growth rates of the workingage population and total population seem unprecedented at the global level. Why are Japan’s demographic changes occurring so fast and taking the lead in the world? This situation is due to a low level of the fertility rate, limited migration inflows, and longevity being simultaneously present. Let us look first at the total fertility rate (average number of children that would be born to a woman over her lifetime). Chart 13 shows that there is a sharp difference between Japan (1.39) and the United States (2.01). Though the rates of Germany (1.39) and Italy (1.41) are comparable to that of Japan, some advanced European countries have higher rates, as exemplified by France (2.03), the United Kingdom (1.98), Sweden (1.98), and Finland (1.87). In Asia, some economies have total fertility rates that are even lower than Japan’s; they include South Korea (1.22), Singapore (1.15), Hong Kong (1.11), and Taiwan (0.90). So Japan is not unique in terms of its low fertility rate. However, the reason for Japan taking the lead in demographic changes arises from a low net migration rate and the rapid growth of the elderly population. The net migration rates (defined as the difference between immigrants and emigrants divided by 1,000 inhabitants) are very high in Singapore (15.62), Italy (4.67), and the United States (3.62). Although the rate in Germany (0.71) is relatively low, it exceeds Japan’s (0). With regard to aging, the elderly dependent ratio – defined as the ratio of the elderly population (aged 65 years and above) to the working-age population – in Japan has been quickly rising (Chart 14). The ratio is higher than that of other economies, such as Germany See for example Lam, W. Raphael, “Bank of Japan’s Monetary Easing Measures: Are They Powerful and Comprehensive?,” IMF Working Paper WP/11/264, 2011. BIS central bankers’ speeches and Italy, whose rate of aging is faster than in other European countries. This reflects the fact that Japan’s life expectancy at birth is greater than in other countries (Chart 15). Moreover, the ratio of the elderly population to the total population (the elderly population ratio) is the highest in Japan (23 percent), followed by Germany and Italy (20.6 percent each). These levels are much higher than in France (17 percent) and the United States (13 percent). Also, Japan’s elderly population ratio is much higher than the aforementioned Asian economies whose total fertility rates are low: Hong Kong (13 percent), South Korea (11 percent), Taiwan (11 percent), and Singapore (9 percent). This is why aging issues tend to be regarded in Asia (excluding Japan) as being on the future structural agenda in spite of frequently reported articles and growing awareness. It is clear that the main issue for Japan is how the society will cope with the rapidly declining rates of its working-age and total populations (charts 16 and 17). Though Germany follows Japan with regard to declining trends in working-age and total populations, those trends could be partially mitigated by net immigration flows. Moreover, it has been noted that there is no sign of a decline in the working-age and total populations in the United States. In other words, it may not be appropriate to compare Japan with the United States when the impact of demographic changes on the macroeconomic performance or the environment surrounding the conduct of monetary policy is being examined. B. Why are structural issues so important for the conduct of monetary policy? The following question naturally occurs: how do demographic changes affect Japan’s macroeconomic performance? In answering that question, let us first examine Japan’s economic growth trend. Demographic changes – especially the decline in the working-age population – have been depressing Japan’s potential growth and thus its actual economic growth over the past decade (Chart 18). The impact of these changes occurs in various ways, including a direct decrease in the labor force, slow growth in labor productivity, and a shift in the consumption structure from manufacturing to nonmanufacturing. Moreover, demographic changes affect the economic growth performance by contributing to sluggish expectations for economic growth (namely, slow sales market growth expected domestically by firms and limited income growth expected by households), and reduced demand for business and residential investment (Chart 19).18 Therefore, it is essential for Japan to raise productivity growth (namely, the rate of per-worker growth in real GDP), which mitigates the negative impact of growth in the labor force (Chart 18) and, simultaneously, find ways to cope with the rapid pace of demographic changes. In addition to economic growth, Japan’s output gap has remained negative for almost the entire period since the mid-1990s (Chart 1). Generally, the negative output gap (excess supply) is regarded as being caused by cyclical factors or temporary shocks to the economy, such as natural disasters. Indeed, the output gap has deteriorated following a series of domestic and external shocks, such as the collapse of the asset bubble in the early 1990s, the Japanese financial crisis and East Asian currency crises in the second half of the 1990s, the collapse of the IT bubble in the United States during the early 2000s, the global financial crisis of 2008, the European sovereign debt problems since 2010, the Great East Japan Earthquake and Thailand floods of 2011, and the spreading effects of recent developments in the relations between Japan and China. Except for a short period, this series of shocks has prevented the negative output gap from narrowing quickly to positive territory. See Shirai, Sayuri, “Have Demographic Changes Affected Japan’s Macroeconomic Performance? – Some Implications for Monetary Policy –,” Speeches at the Bank of Finland, the Riksbank, and Stockholm University, Bank of Japan, 2012; and Shirai, Sayuri, “Demographic Changes in Asia and Japan’s Economic and Financial Developments,” Summary of a Speech at a Meeting with Business Leaders in Kumamoto, Bank of Japan, 2012. BIS central bankers’ speeches In addition, structural issues have also contributed to the long-standing negative output gap. Some may argue that the output gap is likely to shrink quickly if firms adjust their production plans in response to a shortage in demand. However, this may not necessarily be the case in Japan. Let us imagine an economy in which firms in existing, declining industries survive despite declining demand and profitability and do not rapidly adjust their business models to cultivate newly emerging or potentially large markets (i.e., goods and services related to the elderly population, medical treatment, pharmaceuticals, robotics, and energy). Such structural rigidity may be sustained because of various regulations, a lack of adequate support in developing new industries, and slow corporate responses. In such a case, the negative output gap is likely to persist in existing industries, while newly emerging or potentially large markets do not promptly develop to stimulate new demand (and possibly, generate a positive output gap). This may lead not only to a persistent negative output gap, but also to sluggish economic growth even after the output gap has been eliminated. Furthermore, the phenomenon of long-standing mild deflation could be associated with such structural issues. To conquer deflation, it is essential to mitigate these structural issues and give rise to the following situations: (1) a permanent shift of the output gap from negative (excess supply) to positive (excess demand); (2) a rise in expectations for future economic growth that lead to higher inflation expectations; and (3) stable income and wage growth without adversely affecting firms’ competitiveness and profitability. Though those situations are interrelated, an improvement in expectations for economic growth – as described in situation (2) – may be essential since it could exert a favorable effect in both situation (1) and situation (3), thereby setting the stage for stable price increase (charts 19 and 20). C. Banks’ efforts to stimulate potential economic growth and credit demand In the light of this situation, the Bank has been examining how monetary policy could contribute to mitigating the structural issues and associated macroeconomic performance. With a view to promoting potential growth from the perspective of monetary policy, the Bank introduced a new facility called the Growth-Supporting Funding Facility in 2010 (Chart 21). This facility aims at providing financial institutions with longer-term funds (with a maturity of one year, but this can be rolled over up to three times). The interest rate is low – currently 0.1 percent. The funds will be provided to financial institutions based on their applications for loans and investment extended by them in growth-oriented sectors. The maximum amount of funds available under this facility is 3.5 trillion yen. Under this facility, the Bank also provides separate funds for financial institutions if they perform asset-based lending ([ABL] up to 500 billion yen) and small-lots investments and loans (up to 500 billion yen). Moreover, U.S. dollar lending is provided by using the U.S. dollar reserves held by the Bank (up to 12 billion U.S. dollars). In October 2012, the Bank decided to establish the framework for the Stimulating Bank Lending Facility by way of supporting active lending activities by financial institutions, thereby stimulating credit demand by firms and households (Chart 21). This facility, which will be introduced in 2013, will provide long-term yen-denominated funds at a low cost (0.1 percent) to financial institutions up to an amount equivalent to the net increase in their lending to firms and households. With this new facility, the coverage of eligible loans extended to financial institutions is wider than with the Growth-Supporting Funding Facility. The duration of each loan will be one, two, or three years, and it will be possible for the loans to be rolled over for up to four years. The total amount of funds provided by the Bank will be unlimited. Financial institutions eligible for loans under this facility include foreign branches of domestic financial institutions and both their yen-denominated and foreign currency-denominated lending can be covered. This reflects the view that the growth potential of financial institutions and firms is closely linked to their overseas activities in this globalization era and that their enhanced competitiveness would indirectly boost the growth of the Japanese economy. Given that the actual annual increase in loans extended by financial institutions amounted to 15 trillion yen, it is possible that this facility could invite more than that amount. The Bank designated this BIS central bankers’ speeches facility, together with the aforementioned growth-supporting funding facility, the Loan Support Program. Both facilities will be maintained until the end of March 2014. V. Conclusions Finally, I would like to stress that I remain optimistic that the issues of low potential economic growth, negative output gap, and mild deflation can be overcome in the medium term. This is because many Japanese firms are striving to become more innovative and competitive in addition to exploring new sources of demand, both at home and abroad. With their high technology level and experience, I believe Japanese firms can take the lead in developing innovative, higher value-added goods and services in such areas as robotics, medical treatment and elderly care, medical supplies, biotechnology, and energy. Many newly developed goods and services are likely to contribute to creating a more convenient, comfortable life for the elderly. Such business opportunities can also be explored globally – especially in Europe, where the pace of aging is rapidly progressing, and in Asia’s highincome aging economies. The competitiveness of Japanese firms is likely to be strengthened further if a more business-friendly environment is created. The Bank will continue to support the business community by ensuring an accommodative monetary environment and providing long-term funds through financial institutions. The Bank recognizes that Japan’s economy faces the critical challenge of overcoming deflation as early as possible and achieving sustainable growth with price stability. Meanwhile, I will continue to devote myself to considering how the Bank can best respond to the current challenging environment without being biased in advance to possible measures. In addition, I would like to make greater efforts to improve the communication strategies in order to facilitate an understanding of the Bank’s monetary policy both in Japan and abroad. Thank you very much for your kind attention. 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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan National Press Club, Tokyo, 25 January 2013.
Masaaki Shirakawa: The roles, missions and challenges of the central bank Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Japan National Press Club, Tokyo, 25 January 2013. * * * Introduction Today, I am very pleased to appear before the venerable Japan National Press Club. The first public speech that I gave as the Governor of the Bank of Japan was at this venue, just one month after my appointment. We have experienced many things in the five years since then, and central banks around the world, including the Bank of Japan, seem to be going through the most turbulent times. Looking back on the spring of 2008, I still remember my hesitation to embrace a view expressed during a meeting between G-7 finance ministers, central bank governors, and major financial institutions – held on the day after my appointment – that the worst might be over. In fact, one of the largest U.S. investment banks, Lehman Brothers, went bankrupt in September of that year. This led to extremely high stress levels in international financial markets, and global economic activity fell off the cliff. The last months of 2009 saw the European debt crisis, which was to subsequently intensify in waves, erupt in Greece. The financial crises that occurred around the globe strengthened the risk-averse attitude of investors, leading to heightened demand for the yen as a safe haven. Accordingly, the yen’s exchange rates staged a turnaround from a depreciating trend into 2007, and the yen appreciated rapidly. Furthermore, in March 2011, we experienced a most tragic disaster – the Great East Japan Earthquake. Needless to say, these events affected Japan’s economy in the most profound manner. Meanwhile, in a slightly different vein but just as important as these three events is the rapid aging of the population that Japan’s economy is experiencing, and the procrastination relative to making the necessary adjustments to this situation is giving rise to various vexing issues, including the decline in growth and deterioration in government finances. Central banks around the world, including the Bank of Japan, have done everything they can in response to these events. When faced with a potential breakdown of market functioning, the time-honored course of action for central banks is to act as the “lender of last resort”. Following this principle, central banks made every effort to stabilize financial markets and the financial system, thereby averting a repeat of the Great Depression of the 1930s. Nevertheless, given the enormity of debt incurred during the global credit bubble preceding the crisis, global economic recovery remains anemic more than four years after the collapse of Lehman Brothers. In metaphorical terms, one could say that, even if the acute symptoms of the crisis are cured, we have not been able to put behind us the chronic symptoms arising from paying off excessive debt. Looking at monetary policy, short-term interest rates are effectively at zero in many developed economies, including Japan. Central banks’ liquidity provision and balance sheets have also expanded to unprecedented levels. In addition, they are expanding the range of assets they would buy. The Bank of Japan is buying not only government securities, but also risk assets such as commercial paper, corporate bonds, exchange-traded funds, and real estate investment trusts. In spite of mobilizing these measures – the so-called non-traditional policy measures by central banks of developed economies including the Bank of Japan – economic recovery is far from satisfactory, as I noted a moment ago. Issues differ from one economy to another. For example, the United States and Europe are suffering from high unemployment. The unemployment rate in the euro area stands at 11.8 percent, and in the United States, despite coming down from its peak, the rate is at 7.8 percent. In the case of Japan, the unemployment rate had risen only modestly, and is relatively low compared with BIS central bankers’ speeches Europe or the United States, standing at 4.1 percent. On the other hand, inflation in Japan is low, and the year-on-year rate of change in the consumer price index (CPI) is around 0 percent. Japan has not shaken off deflation. Meanwhile, in all developed economies the importance and long-term benefits of fiscal consolidation and structural reforms aimed at enhancing competitiveness are appreciated, but their implementation tends to lag, reflecting pains that initially accompany these items. Against this backdrop, demands and expectations on central bank policies are more heightened than ever. As you know, the debate on monetary policy has never been so lively as that seen in recent months. In addition, the Bank of Japan introduced additional steps at this week’s Monetary Policy Meeting to provide monetary accommodation in a decisive manner – namely, the “price stability target” and the “open-ended asset purchasing method”. The Bank also issued a joint statement with the government on strengthening policy coordination. Although I am aware of the fact that your interest in these measures is running high, I have already explained them in detail at the press conference following the Meeting and elsewhere. In view of this, my speech today carries the title “The Roles, Missions, and Challenges of the Central Bank”. I will spend about two thirds of my allotted time talking about what a central bank is and the remaining one third on the Bank’s most recent decisions; hopefully, this will enhance the public’s understanding of the decisions in a broader context. It would be my greatest pleasure if, by describing the essence of central banking, I could succeed in providing any useful input for people who are contemplating issues related to monetary policy and the Bank. I. Four episodes illustrating the role of the central bank Now, what does a central bank do? In order to answer this question, I would like to start by referring to three well-known quotes on central banking. The first is by the U.S. comedian Will Rogers, who enjoyed enormous popularity in the 1920s and 1930s. He compared central banking with the fire and the wheel, calling these the three greatest inventions of mankind. It may be a bit of an exaggeration to count central banking as one of the three great inventions, but the quote conveys how important the central bank is to the lives of people. The second quote is from William McChesney Martin, who served as the Chair of the Board of Governors of the Federal Reserve System for nearly 20 years in the 1950s and 1960s. He said that the role of the central bank is to “[take] away the punch bowl just when the party is getting good”. The third quote is from Helmut Kohl, the German Chancellor who oversaw the reunification of East and West Germany. “As the Federal Chancellor, I sometimes have a problem with the Bundesbank. As a citizen, I’m glad that it exists.” The last two remarks refer to the role of the central bank, relating this to its independence. Instead of using these figurative remarks, one could approach the question from a systematic angle and say that the central bank pursues “price stability” and “financial stability”. Looking at central bank laws around the world, the objectives of the organization written into them reflect the historical influences at the time of their adoption, and tend to be more complex and somewhat ambiguous in older laws. Nevertheless, the overwhelmingly prevailing trend over the last 20 years, including the Bank of Japan Act, is to establish two pillars: “price stability” and “financial system stability”. I also believe that the pursuit of these two is the fundamental role of the central bank. At the same time, these abstract ideas alone cannot give a good idea of what role the central bank is actually playing in the economy. Having said this, in the following sections, I will try to illustrate the roles and missions of the central bank by looking at specific episodes from the last five years. I will attempt to take up as many aspects of a central bank’s operations as possible. The episodes are the Lehman shock, the European debt crisis, the Great East Japan Earthquake, and the rapid aging of Japan’s economy. BIS central bankers’ speeches Lehman shock Let me begin with the collapse of Lehman Brothers in September 2008, which sent huge shockwaves throughout the global financial market. This event showed that real economic activities are significantly affected by impairment of the financial system. The stability of the financial system is akin to the air around us, although its importance is usually taken for granted. Nonetheless, it is one of the most important factors in the smooth functioning of the economy. This episode demonstrated the many roles played by central banks. The first and most evident was their role as the “lenders of last resort”. The Bank of Japan also acted promptly as the lender of last resort. In Japan, the problem was most acute in the funding market for U.S. dollars. In a very short period of time, both financial institutions and non-financial firms were finding it difficult to secure dollar funds. Perceiving this problem, the Bank also supplied dollar funds in the Japanese market – the dollars being obtained from the Federal Reserve through foreign exchange swap arrangements. The yen interbank market, meanwhile, was relatively stable, but as the conditions in the commercial paper and corporate bond markets rapidly deteriorated, reflecting concerns over credit risk, the Bank decided to purchase commercial paper and corporate bonds in the market. This was an unusual action for a central bank, in that it resulted in the bank incurring credit risk of individual firms. The second role, which may not be glamorous but which I wish to emphasize, was the central banks’ catalytic role in improving the payment and settlement systems. For example, six years before the Lehman shock, in September 2002, a system was introduced that linked the two settlement legs of foreign exchange transactions, e.g., the dollar and yen legs in the case of settling dollar-yen trades. The disruptions in the financial markets caused by the collapse of Lehman Brothers would have been much larger if such a system were not in place before the event. Central banks, including the Bank of Japan, played a leading role in the six years leading up to the launch of the system. The third role was to prevent bubbles and ensure the stability of the economy and financial system. Looking at the economic stagnation after the Lehman shock, one is confronted with the question of why an extraordinary credit bubble was allowed to form into the middle of 2000s, which was the root cause of the global financial crisis. In this regard, it is often said that the policy responses of the Federal Reserve after the bursting of the bubble were more aggressive than those of the Bank of Japan. Nevertheless, when one examines the economic performance of the United States and Japan over the six years after the bursting of their respective bubbles, recovery in the United States in terms of real GDP is more sluggish than that of Japan in the 1990s. A precise comparison of economic performance is beside the point. The important lesson from the experiences of the two economies is that, when borrowing by firms and households ballooned, resulting in a credit bubble, the consequences were quite serious. When a bubble bursts, firms and households are forced to prioritize their debt pay-downs. In the case of this particular episode, this resulted in reduced investment and consumption, depressing economic activity more generally, and brought about a prolonged period of low growth. It may seem unbelievable in hindsight, but the overwhelmingly prevailing view overseas, before the collapse of the most recent credit bubble, especially among the members of academia and policy makers in the United States was that aggressive monetary policy could adequately deal with the consequences of the collapse of bubbles. In other words, “mopping up” after the fact was regarded as important. The reason why monetary policy remained loose during the bubble was partly because prices were stable. This was the case both for the United States and Japan. In Japan, prices rose by only fractions of 1 percent in 1987 and in 1988. While it was true that credit was expanding and asset prices were rising rapidly, there was no recognition of the risk that economic stability in the long term could be compromised through such accumulating imbalances. Of course, the causes of bubbles are complex, and sometimes can only be attributed to people jumping on the bandwagon. Bubbles do not result solely from monetary easing, and they cannot be completely prevented through good financial regulation and BIS central bankers’ speeches supervision. Having said that, I must also stress that appropriate monetary policy, as well as adequate regulation and supervision, do have important roles to play in preventing bubbles or an excessive build-up of debt. In this regard, what I find notable is that there was a remarkable shift in conventional wisdom regarding bubbles and monetary policy over the course of just five or six years. Furthermore, I feel that we tend to forget the fact that bubbles and financial crises have happened repeatedly. One must, therefore, remain humble when taking the wheel of policy. European debt crisis The second event that I wish to take up is the European debt crisis. As we know, this crisis emerged following the extensive revision of past fiscal balance statistics by the Greek government. Adding to the three roles of the central bank that I have just mentioned regarding the Lehman shock, there are a few facts and lessons to be learned with respect to the European debt crisis regarding the relations and interactions between the central bank and markets, governments, and society at large. The first is the importance of fiscal prudence. While it was widely viewed that confidence in fiscal sustainability would be essential to maintaining confidence in the currency, the European debt crisis demonstrated that fact in real time. When government finances become unsustainable, the options to correct this are, conceptually, fiscal consolidation, default of government debt, or inflating away the real value of debt. If the government defaults, or if it will not pay its debts, financial institutions that hold government debt would see their capital eroded, and in the extreme, people would lose confidence in the safety of bank deposits, which are debts of banks. Even if the situation does not deteriorate that far, banks would cut back on lending to the private sector and the real economy would suffer as a result. If the central bank would then buy government debt in order to prevent such damage, the consequent excessive issue of money would result in inflation. In all the cases, the value of the currency would be impaired. In sum, confidence in the currency hinges on the prudent management of government finances over the medium to long term. The second is the appropriate distance between the central bank and financial markets. The fluctuations in government bond yields since the introduction of the euro starkly illuminate this issue. In the euro area, there was an expectation that the economic fundamentals of the member countries would converge through the introduction of the single currency. Accordingly, the government bonds of the member countries quickly came to enjoy terms of issuance mirroring those of Germany. For over ten years, bond yields for the peripheral economies, including Greece, Ireland, and Portugal, remained at the same level as that of Germany. However, when the yields began to rise, they did so significantly. Looking at the yield spread over Germany, while the Greek spread may be a little extreme, the Spanish spread was just 0.7 percent three years ago. At its widest, this reached 6.4 percent in late July 2012 and now stands at 3.5 percent. Even if I will have to reserve my judgment on what the normal spread is, the experience shows that confidence – the determinant of spread – is fragile. Third, there is the issue of the interaction between central bank actions and society at large. Since the beginning of the crisis, market sentiment repeatedly shifted between optimism and pessimism. When tensions arose, the European Central Bank (ECB) supplied funds to the market so as to stabilize financial markets. When those actions succeeded in mitigating the tensions, there was a loss of momentum regarding reforms that were discussed under market duress. As a result, tensions returned and the ECB had to inject more liquidity. This was repeated over the last three years. Liquidity injection by the ECB is a policy to “buy time”. Structural reforms in the economy and government finances must be pursued during the bought time. This is a difficult balancing act, in which the central bank must maintain the stability of the economy and the financial system while keeping enough momentum in society for implementing reforms. BIS central bankers’ speeches These experiences and lessons from the European debt crisis seem to offer rich material for us in Japan to contemplate regarding the role of the central bank. Great East Japan Earthquake The third event to examine when considering the role of the central bank is the tragic Great East Japan Earthquake. The earthquake confirmed the vital role played by the central bank in maintaining the essential physical integrity of the financial system infrastructure. Confidence in the central bank faces a severe test when a disaster strikes, and in order to pass that test, the bank must succeed in guarding the physical in addition to the functional stability of the financial system and the markets of the economy. As we know, the tremor struck just before 3PM on a Friday, as financial institutions were winding down the week’s business. As a result, there was very little remaining activity in the market, but the Bank took steps to ensure that all settlement of yen funds for the day would be completed without any disruption. On the following Monday, the Bank cut short its Monetary Policy Meeting to one day, and with a view to preventing negative effects on the real economy from the deterioration in business confidence and heightened risk aversion in financial markets, decided to increase its purchase of financial assets (mostly riskier assets). It also supplied ample funds to the market to prevent disruptions in the financial markets. The offer of funds amounted to 21.8 trillion yen on that Monday alone. Meanwhile, the BOJ-NET, which is the backbone of the Japanese payments system, functioned without a hitch. Furthermore, the Bank took care to make sure that damaged banknotes and coins – for example, those swept away by the tsunami and soaked in water – could be exchanged as quickly as possible by setting up temporary exchange desks and sending extra staff to the stricken areas. In a country like Japan, which is prone to earthquakes, it is important to maintain the physical integrity of infrastructure. The Bank believes that it was able to discharge its responsibilities in the wake of the earthquake. The Bank has deployed significant resources to this end. It is now in the process of further enhancing its business continuity planning, including responses to potentially deadly earthquakes in the South Sea Trough and in the Tokyo area. Rapid aging of Japan’s population The last theme I’ll use to illustrate the role of central banking is the rapid aging of Japan’s population. The reason why I look at aging in relation to the role of central banks is because it offers insights into the implications of the potential growth rate, which is a given in the short term with respect to the conduct of monetary policy. Economic developments determined by the supply side of the economy and other real factors are beyond the direct control of the central bank. While the central bank hopes to positively influence the supply side through bringing about a stable financial and economic environment, monetary policy tries to influence prices and economic activity through acting upon the demand side – the spending decisions of economic agents. When demand lies below the potential of the economy, there is a negative output gap. When demand lies above the potential of the economy, there is a positive output gap. Currently, the negative output gap in Japan is about 2 percent, and during the process of closing this gap, growth will accelerate. When the gap is closed, growth will be in line with the increase in the potential of the economy – in other words, the potential rate of growth. The problem faced by Japan’s economy is that this potential growth rate is gradually declining. To a large part, this decline is brought about by aging, which is progressing at a speed heretofore unequaled by any other economy. The aggregate economic activity of an economy is determined by the number of people working and the amount of output produced by each working person, i.e., value added per worker. In the case of Japan, if one assumes that the present rates of labor participation for gender and age will remain stable, the numbers of workers will decline at an annual rate of –0.6 percent during the 2010s. In other words, from the perspective of the number of workers, real GDP is going to decline at an annual rate of –0.6 percent. This is a very strong headwind. Meanwhile, looking at the rate of increase in value added per worker, the average for G-7 economies over the last 20 years is 1.3 percent. For Japan, the figure is 1.5 percent for the relatively BIS central bankers’ speeches good times between 2000 and 2008. These numbers enable us to make a calculation of the potential growth rate, which is below 1 percent. I do not wish to say here that low growth is inevitable. Demography cannot be changed quickly. Nevertheless, it is possible to raise the growth potential by changing the many elements that can be influenced by deliberate actions. First of all, the number of workers can be increased by raising the labor participation rate of women and elderly people. For example, if by 2030 the participation rate of women increases to the level now seen in Sweden, the participation rate of the 60 to 64 age group is raised to the current level of the 55 to 59 age group, and there is an in-line increase in participation by people aged 65 and older, the labor supply during the 2010s will increase by 0.2 percent annually, not –0.6 percent as I mentioned a short while ago. Meanwhile, in order to accelerate the increase in the value added per worker, it is essential to develop goods and services that are in demand both domestically and abroad, and build successful businesses on them. For example, in terms of cultivating domestic demand, businesses must, in a timely manner, provide services that fulfill new potential demand arising from aging. In order to encourage businesses to take up such a challenge, there is a need to aggressively create a more favorable environment through such means as deregulation, for example. If growth potential is enhanced through these efforts, the business outlook will improve and inflation will gradually become higher. II. Overcoming deflation as early as possible and achieving sustainable growth with price stability Following these views on the roles of the central bank, let me now turn to the challenges faced by central banks. Of the many challenges, the greatest for Japan and hence the Bank of Japan is obviously to overcome deflation as early as possible and return to the sustainable growth path with price stability. The Bank realizes the utmost importance of meeting this challenge, and thus has pursued aggressive monetary easing. There are two elements to the Bank’s decision at the Monetary Policy Meeting held earlier in the week. “Price stability target” and the “open-ended asset purchasing method” The first is the introduction of the “price stability target”, at 2 percent. The Bank recognizes that the inflation rate consistent with price stability on a sustainable basis will rise as efforts by a wide range of entities toward strengthening competitiveness and growth potential of Japan’s economy make progress. Based on this recognition, the Bank sets the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI. Under the price stability target specified above, the Bank will pursue monetary easing and aim to achieve this target at the earliest possible time. Taking into consideration that it will take considerable time before the effects of monetary policy permeate the economy, the Bank will ascertain whether there is any significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances. The second element is the introduction of the “open-ended asset purchasing method”. The Bank will pursue aggressive monetary easing, aiming to achieve the above-mentioned price stability target, through a virtually zero interest rate policy and purchases of financial assets, as long as the Bank judges it appropriate to continue with each policy measure respectively. As the Bank has already announced, the size of the current Asset Purchase Program is set to increase by nearly 40 trillion yen over the course of this year. Furthermore, the Bank has introduced from the beginning of this year a scheme to provide financing to financial institutions, up to the amount of net increases in lending at each financial institution. More than 15 trillion yen would be provided through this scheme by the spring of 2014. Meanwhile, with respect to the Asset Purchase Program, after completing the current purchasing method, from January 2014, the Bank will introduce a method of purchasing a certain BIS central bankers’ speeches amount of financial assets every month without setting any termination date. The outlook just published by the Bank for the CPI inflation rate for the 2014 fiscal year is 0.9 percent excluding the effects of the increase in the Consumption Tax rate. From the beginning of 2014, for some time, the Bank will buy financial assets totaling about 13 trillion yen every month, including 2 trillion yen in long-term Japanese government bonds. Consequently, the size of the Asset Purchase Program alone will increase by about 10 trillion yen over the course of 2014, and the size of the Program is expected to stay at that level from then on. The Bank will thus provide strong monetary stimulus without interruption. Achieving the target A few moments ago, I explained that the Bank recognized that the inflation rate consistent with price stability on a sustainable basis would rise as efforts by a wide range of entities toward strengthening competitiveness and the growth potential of Japan’s economy made progress, and, based on this, the Bank decided to set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI. Looking back at historical rates of inflation, the average year-on-year inflation rate, even during the bubble years – the latter half of 1980s – was 1.3 percent. If one takes the average between 1985 and 2011, the average inflation rate was 0.5 percent. In order to bring about sustainable growth with price stability, I believe that serious efforts from a wide range of entities are essential. As I noted in relation to the rapid aging of the population, it is not appropriate to become pessimistic regarding the possibility of raising the growth potential. Indeed, quite often we see comparisons of current real GDP levels with that before the Lehman shock, and find that Japan, like many European economies, is still undershooting the level of GDP seen in 2007. In contrast, when one looks at the current per capita real GDP, major economies including the United States are still below 2007 levels, but Japan’s output loss is relatively small. Furthermore, in terms of the rates of increase in GDP per worker, while the U.S. and European economies have not regained 2007 levels, Japan has surpassed its 2007 level. In other words, Japan realizes low growth as an economy because its workforce is declining, but each Japanese worker is contributing more to increasing output at a faster pace than U.S. or European workers. This shows that not only is it inappropriate to become excessively pessimistic, we should actually be more confident about our potential. If I may add a few words on the recent joint statement between the Japanese government and the Bank of Japan regarding the strengthening of policy coordination, there is a clear recognition of the role that each entity will play: the Bank will pursue aggressive monetary easing and the government will formulate and promote measures for strengthening competitiveness and the growth potential of Japan’s economy. It also states that the government and the Bank will work together to overcome deflation early and achieve sustainable economic growth with price stability. This is very significant. The importance of flexibility in monetary policy The decision on the “price stability target” by the Bank was both a decision on a “target” and a flexible inflation targeting framework. As such, let me also explain the latter element. Obviously, the effects of monetary policy permeating economic activity and thereafter prices require a considerable and variable time lag. The conduct of monetary policy has to be flexible by examining various risk factors, including those related to financial imbalances, in addition to the assessment of current developments and outlook for economic activity and prices, from the perspective of achieving sustainable growth with price stability. Such understanding has been widely shared around the globe; particularly, in the aftermath of the global financial crisis, major economies of the world have come to emphasize flexibility in the conduct of monetary policy – by, for example, publicly articulating the importance of paying due attention to financial system stability. Over the last year, there has been an increasing awareness of such understanding in Japan as well. In such circumstances, it is judged transparent and appropriate to use the expression, “target”, in order to explain the Bank’s thinking on price stability. BIS central bankers’ speeches The purpose or principle of monetary policy by the Bank is clearly stated in the Bank of Japan Act – namely, it is “achieving price stability, thereby contributing to the sound development of the national economy”. Obviously, therefore, the Bank will manage monetary policy as guided by this aim and pursue the new price stability target set under this aim. With a view to achieving sustainable growth with price stability, the Bank will examine the current state of the economy and prices and the outlook thereof, and ascertain whether there is any significant risk, including financial imbalances. Such a policy framework is the same as those currently adopted by many other central banks. In this regard, if one is to call this “flexible inflation targeting”, the Bank’s framework may be regarded as such. Looking at the practices of overseas central banks, irrespective of the adoption of inflation targeting, no specific date has been set for achieving price stability. The Bank’s view on price stability is based on a similar understanding in that the Bank aims to achieve price stability on a sustainable basis. The Bank is implementing the easing measures that I have just explained, and aims to achieve the target at the earliest possible time. The effects of easing will be amplified and brought forward if and when firms and other economic agents aggressively take advantage of the accommodative financial conditions. Nevertheless, it is not possible at this juncture to accurately predict how and when that would happen. In addition, considering that Japan has a prolonged experience of low inflation, it also is not possible to foresee the potential changes in the behavior of firms and households as the year-on-year rate of increase in the CPI accelerates. Furthermore, the severity of the government’s fiscal problems makes it difficult to gauge the reactions of domestic and overseas financial markets. The Bank is fully committed to pursuing achievement of the target as early as possible, under the aim stated in the Bank of Japan Act, i.e., “achieving price stability, thereby contributing to the sound development of the national economy”. In my view, this policy stance of the Bank’s is consistent with the prevailing views of the Japanese people. For example, looking at the results of the Opinion Survey on the General Public’s Views and Behavior, which is conducted by the Bank on a quarterly basis, the desirable “price stability” for most of the population is a state where prices would rise gradually, reflecting the steady improvement of the economy in a balanced manner, accompanied by increases in employment and wages and improvements in corporate profitability. In other words, Japan must return to a path of sustainable growth with price stability. The last words: organizational aspects of the central bank Today, I have dwelled on the roles of the central bank and the most recent decisions by the Bank. Before concluding, let me make a few points on the basis for the central bank to appropriately discharge its responsibilities, referring to some issues that are often outside the public’s awareness. In particular, I would like to look at the organizational aspects of the central bank. At every firm, at every organization, business is carried out by individual people, and the corporate culture – including the tacit knowledge formed through tradition and the interactions of members – is most important. There are four aspects that I wish to note. Firstly, a central bank is a bank. Accordingly, the day-to-day banking operations are very important. Monetary policy, including the asset purchases that I have explained, is dependent on banking operations such as settlement services, management of haircuts, etc. These banking operations are not simple and mechanical affairs. It is often said that “the devil is in the details”, and the knowledge and feel for banking operations is essential to understanding subtle financial developments. This is all the more so in times of crises. Secondly, in a point related to the importance of the banking operations that I have just mentioned, the management of policies – both monetary and financial system stability policies – must fully mobilize the information and intuition obtained from all corners of the broad central banking functions. Unfortunately, the importance of the wide-ranging functions BIS central bankers’ speeches of the central bank is not widely recognized. In fact, media attention on the Bank is concentrated on monetary policy. While monetary policy is indeed important, this is only one piece of the many functions performed by the central bank for the purpose of maintaining the stability of the economy and the financial system. Looking at the allocation of time in my day-to-day schedule as governor, and also at the headcount for various functions, I feel that these functions as a whole are contributing to maintaining the stability of the economy and the financial system. With the increasing emphasis placed on macroprudential policy following the Global Financial Crisis, many central banks are vested with macroprudential policy by themselves or with other institutions. This reflects not only the fact that the central bank is connected to various aspects related to finance, including the macroeconomy, financial markets, financial institutions, and payments and settlements infrastructure, but also the fact that the bank is sensitive to information that is obtained from those connections. Thirdly, the central bank must stick to a constant learning process in the broadest sense. Looking at what happened over the course of the last 25 years, including the formation and bursting of the bubble, financial crisis, deflation, and rapid aging, few economies had initially correctly realized the significance of these developments. Nevertheless, it eventually became evident that such changes in the environment had profound effects on the economy. In this regard, the central bank must always be sensitive to the changes in the economy and financial markets, and be humble enough to listen to people with different viewpoints and opinions. Considering that the central bank must make decisions that affect the lives of many people in a world full of uncertainties, the importance of humility cannot be overstated. Lastly, a global perspective is essential. While it may sound obvious in a world of globalizing economies and finance, I again stress this point here. A global perspective means not only that what happens overseas will affect Japan, but also that what happens in Japan will affect other economies. In hindsight, Japan has faced many problems ahead of other developed economies – for example, the bursting of the bubble and the financial crisis and subsequent low growth and rapid aging. The Bank of Japan has been trying to explain to the outside world its experiences and the lessons to be garnered from them, but it was not easy to convince the overseas audience until the bubbles burst in the United States and in Europe, and even now, I have a feeling that our points are not fully driven home. Japan and the Bank must put more efforts into this, in terms of global intellectual exchanges. Last year, the Bank of Japan reached 130 years old. Over its long history, the operations of the Bank have changed and it now faces new challenges. In any case, the Bank aims to contribute to the stable and sustainable development of Japan’s economy through achieving the stability of prices and the financial system. Thank you for your attention. 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, Nagasaki, 31 January 2013.
Hirohide Yamaguchi: Path to overcoming deflation and decisive additional steps in monetary accommodation Speech by Mr Hirohide Yamaguchi, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Nagasaki, 31 January 2013. * * * Introduction Thank you for giving me an opportunity to exchange views with administrative and business leaders in Nagasaki. And I express my gratitude to everyone for your cooperation in various business operations of the Bank of Japan’s Nagasaki branch. At the Monetary Policy Meeting held last week, the Bank of Japan took additional steps to provide monetary accommodation decisively toward overcoming deflation as early as possible and achieving sustainable economic growth with price stability, and decided on three things. First, the Bank decided to introduce a 2 percent “price stability target.” Second, the Bank decided to introduce an “open-ended asset purchasing method” under the Asset Purchase Program. Third, the Bank decided on the joint release of a statement with the Government titled “Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth.” Today, before exchanging views with you, I will first talk about the current state and the outlook for economies at home and abroad, followed by the thinking behind the recent monetary policy decision by the Bank. I. Overseas economic developments: brightening overseas economies Let me first state briefly the view on Japan’s economy. Japan’s economy remains relatively weak. While such situation will likely continue for the time being, thereafter, Japan’s economy is expected to return to the moderate recovery path toward the middle of the year as domestic demand remains resilient and overseas economies emerge from the deceleration phase and increase their brightness. Let me explain the background. Let me start with the developments in overseas economies. Looking back at the developments over the past year, the European debt problem was aggravated up to the summer. Its adverse effects spread over globally through a decline in trade and a deterioration in business sentiment, and, since the summer, many countries have moved deeper into a deceleration phase. While overseas economies have been remaining in a deceleration phase, recently, a silver lining has started to be seen mainly in the United States and China. Developments in the European economy By region, the European economy continues to be in a moderate recession phase with continued fiscal austerity and tight financial conditions on the back of a debt problem. Deterioration in business and household sentiment has spread not only to southern European countries that have been burdened with the debt problem but also to core European countries, including Germany and France. As a result, firms’ business fixed investment has decreased and weakness in private consumption, particularly of durable goods like automobiles, has become pronounced. Meanwhile, the policy authorities’ responses to the debt problem have made some progress since last summer. Broadly speaking, there were four moves. First, the European Central Bank established a new scheme that allowed for purchases of an unlimited amount of government bonds within the euro area under certain conditions. Second, the framework for supporting Greece was maintained tentatively and support to Spain’s banking sector was BIS central bankers’ speeches implemented. Third, the European Stability Mechanism, a permanent support fund for the countries in the euro area, started to operate. And fourth, the establishment of a single banking supervisory mechanism in the euro area was agreed on. As a result of those policy responses, the risk of a panic dispatched from Europe spreading to the global economy mainly through turmoil in global financial markets seems to have subsided considerably. As for the outlook for the European economy, as belt-tightening fiscal management will continue, a moderate recession might continue for the time being, but eventually the European economy will emerge from the recession phase starting from a pick-up in exports, mainly in core countries like Germany. Developments in the U.S. economy The U.S. economy has been recovering moderately. Up to the end of last year, business sentiment became cautious and business fixed investment slowed on the back of uncertainties associated with the so-called “fiscal cliff,” which refers to the concurrent expiration of past tax cut measures and a reduction in fiscal spending at the beginning of this year. Nevertheless, even against such a backdrop, supported by an improvement in labor and income conditions and the low interest rate environment, housing investment has been picking up and private consumption, particularly car sales, has continued to recover. Hereafter, with the “fiscal cliff” being barely averted, business sentiment is expected to improve and business fixed investment is also expected to recover. It is also likely that private consumption and housing investment will continue improving, supported mainly by the accommodative financial environment. As a result, the U.S. economy will continue to follow a moderate recovery path and is expected to become a driving force of the global economy. Developments in the Chinese economy A silver lining has also been seen in the Chinese economy. While inventory adjustment pressure, particularly in the material industry, has been persisting and an increase in production has not yet restored a clear increasing trend, private consumption has remained firm on the back of favorable labor and income conditions. Exports have been showing signs of recovering, albeit with fluctuations. Infrastructure investment has recently been increasing partly due to the policy authorities’ prop-up measures, and a slowdown in an increasing trend in fixed asset investment as a whole has come to a halt. Business sentiment, particularly in the manufacturing sector, has been improving. From a longer- term perspective, the Chinese economy is in a transition phase from high growth to stable growth, and there remains uncertainty whether a smooth transition could be made. Having said that, as for the immediate future, in addition to policy effects both from the fiscal and monetary fronts, inventory adjustment is likely to progress, supported by firm domestic demand, and exports are also expected to pick up, and thus the recovery trend in the Chinese economy will gradually become pronounced. Developments in the NIEs and ASEAN economies At present, partly due to stagnant exports to Europe and other countries, the pick-up in the NIEs and the ASEAN economies has moderated. However, as for the outlook, if the global economy increases its brightness led by the United States and China, exports will gradually pick up and the pace of recovery will likely accelerate. Developments in global financial markets Meanwhile, the global financial markets have considerably restored stability. Global investors have gradually become ready to take risks. Behind that are (a) in the United States, amid a continuing moderate recovery, the “fiscal cliff” has been barely averted, (b) in Europe, progress has been seen in policy responses with regard to the debt problem, and (c) in the BIS central bankers’ speeches Chinese economy, a silver lining has gradually started to be seen. Against such a backdrop, stock prices in the United States and Europe bottomed out last summer and have been rising. As investors have turned ready to take risks, yields on southern European countries’ government bonds have declined substantially. In the foreign exchange market, the euro has been bought back and the yen has been depreciating. Outlook for overseas economies To summarize the above, overseas economies will gradually emerge from the deceleration phase and turn to a moderate recovery, with the United Stated and China being driving forces. Of course, we cannot keep our eyes off the developments in the European debt problem. Whether the recovery in the U.S. economy will continue while overcoming the fiscal problem requires caution. As the Chinese economy is burdened with various problems, I will not say there is no uncertainty whether the economy will make a smooth transition to a recovery path. Those uncertainties continue to warrant thorough attention. II. The current state and outlook for Japan’s economy: path to moderate recovery Current state of Japan’s economy Let me turn to the developments in Japan’s economy. At present, Japan’s economy remains relatively weak. While the economy registered somewhat a high annual growth rate of about 3 percent in the first half of 2012 mainly supported by increases in reconstruction-related demand, exports and industrial production declined substantially in the second half due to a deceleration in overseas economies. As capital goods and parts account for a large part of exports and industrial production in Japan, if demand for those goods decline due to weakening activity in the manufacturing industry worldwide, the resultant effects will tend to be large. A substantial decline in exports to China, particularly automobile exports, due to the effect of Japan-China relations, also added to the decline, mainly in exports. As for other effects of Japan-China relations, there has been a large decline in the number of incoming foreign tourists. I have heard that this region has also been affected. Against such a backdrop, there has been an increasing downward revision in the prospects for corporate profits and business sentiment has become cautious. While business fixed investment in the non-manufacturing sector has been firm, there have been increasing moves, particularly in the manufacturing sector, to defer business fixed investment, and thus the overall investment has become somewhat weak. In terms of employment and income, particularly in the manufacturing sector, the number of new job offers declined substantially and overtime work has also been decreasing. In such a way, the deceleration in overseas economies has spread over not only to exports and production but also to domestic demand and employment. While there have remained effects of the decline following the expiry of subsidies for the purchase of energy-efficient cars, private consumption as a whole, particularly service consumption, has remained resilient. One reason why private consumption maintains resilience might be the underlying support by demand of the elderly. Households headed by 60 years or older account for more than 40 percent in private consumption. In the meantime, public investment, particularly reconstruction-related investment, has been increasing and housing investment has been picking up partly due to the rebuilding of disaster-stricken houses. While such resilience in domestic demand has not offset all the effects of deceleration in overseas economies, it has nevertheless been an element steadily underpinning Japan’s economy. Outlook for Japan’s Economy With regard to the outlook, as I mentioned at the outset, Japan’s economy is expected to remain relatively weak for the time being, and thereafter, it is expected to return to the BIS central bankers’ speeches moderate recovery path toward the middle of the year as domestic demand remains resilient and overseas economies gradually increase their brightness. As a recovery is the one following some periods of relatively weak developments and the pace will be moderate, firms might have difficulty realizing an economic recovery. However, there is a good possibility that “with hindsight the first half of 2013 was the turning point.” As mentioned earlier, there is a silver lining in overseas economies and, in particular, it is encouraging that the U.S. economy is on a recovery trend. In addition, the recent developments in the yen exchange rate will gradually underpin exports. In domestic demand, public investment is likely to continue to be on an increasing trend and housing investment likely to also continue to pick up. In the not distant future, business fixed investment will likely return to the moderate uptrend partly due to investment related to disaster prevention and energy. Private consumption is likely to remain resilient as a trend, with the effects of the decline following the expiry of subsidies for the purchase of energy-efficient cars subsiding. Prices On the price front, the year-on-year rate of change in the consumer price index (CPI) excluding volatile food is around 0 percent. For the time being, it is expected to turn negative due to the reversal of the previous year’s movements in energy-related and durable consumer goods, and thereafter, is likely to be around 0 percent again for some time and then gradually increase its rate of change with economic recovery. Taking into account such developments in economic activity and prices, the Monetary Policy Meeting last week examined the outlook for economic activity and prices for the next two years. Looking at the median of the Policy Board members’ forecasts, the real GDP growth rate, following +1.0 percent in fiscal 2012, is somewhat high at +2.3 percent for fiscal 2013, partly due to a surge in consumer spending prior to the consumption tax hike. In fiscal 2014, while there will be some reversal developments, the growth will be +0.8 percent exceeding the potential growth rate. The year-on-year rate of change in CPI excluding volatile food, following –0.2 percent in fiscal 2012, is forecasted to gradually increase the rate of change, with +0.4 percent in fiscal 2013, and, on the basis of excluding the effects of the consumption tax hike, +0.9 percent in fiscal 2014. The reason the Bank set 2 percent as the “price stability target” is, that the achievement of 1 percent – a goal for the time being set by the Bank – has come into sight in fiscal 2014, and that it has judged necessary to clarify its next target. I will later explain again such line of thinking. III. Thinking behind the recent policy decisions: decisive additional steps in monetary accommodation Let me explain the Bank’s monetary policy conduct. As I mentioned at the outset, at the Monetary Policy Meeting last week, the Bank took additional steps to provide monetary accommodation decisively toward overcoming deflation as early as possible and achieving sustainable economic growth with price stability. Specifically, first, the Bank has set the “price stability target” at 2 percent in terms of the year-on-year rate of change in the CPI, and second, aiming to achieve the target at the earliest possible time, introduced the “open-ended asset purchasing method” under the Asset Purchase Program. And third, the Bank clarified its posture that it will strengthen policy coordination with the Government and work together. Introduction of “Price Stability Target” To begin with, let me talk about the Bank’s decision to set 2 percent in terms of the year-on-year rate of change in the CPI as the “price stability target.” Japan’s economy has been in deflation for a long period. Behind that not only cyclical factors but structural factors have been at play. Amid substantial changes of the environment for Japan’s economy, such as rapid ageing and globalization, Japan has fallen behind in BIS central bankers’ speeches adapting to those changes, and, as a result, the growth rate has been on a downtrend and firms’ and households’ medium- to long-term growth expectations have also declined. Amid low growth expectations, firms have sought to survive with cost cutting and price competition. In doing so, adjustment has been made mainly in wages and working hours, which exerted successive downward pressure on prices in Japan’s economy. To put it another way, if such structure can be converted, it becomes possible to overcome deflation. The bottom line is, it is necessary to restore the flexibility and adaptability of Japan’s economy and unlock its potential, and thereby raise firms’ and households’ growth expectations. In my view, now is the “window of opportunity” toward overcoming deflation. There is a prospect that the U.S. and the Chinese economies, which have substantial effects on Japan’s economy, will return to the recovery path. Against such a backdrop, as I mentioned earlier, the possibility of Japan’s economy, which has been stagnant since last year, to return to the moderate recovery path toward the middle of the year has been increasing. Also, in our outlook for economic activity and prices, the possibility for the year-on-year rate of change in the CPI excluding volatile food to reach 1 percent in 2014 has gradually come in sight. Under such changes, if the inflation rate actually rises, people’s inflation expectations are also likely to increase. We should not miss this “window of opportunity.” Based on such line of thinking, the Bank has further enhanced its past line of policy of “setting a goal at 1 percent for the time being” and set 2 percent as the “price stability target.” Under the target, the Bank will pursue monetary easing aggressively and aim to achieve the target at the earliest possible time. With regard to such monetary policy conduct of the Bank, we have sometimes been asked whether the Bank has adopted the so-called “inflation targeting.” In that regard, looking at the monetary policy conduct of other countries which have actually adopted “inflation targeting,” for example, the United Kingdom, the Bank of England conducts flexible monetary policy which takes into account not only developments in prices but also those in other areas, including the real economy and asset prices. The Bank’s decision this time of “price stability target” is the same as the one many central banks are currently adopting, and it is generally called “flexible inflation targeting.” Within such monetary policy framework the Bank intends to make as decisive policy responses as ever while steadily examining the situation of economic activity and prices. Introduction of “Open-Ended Asset Purchasing Method” Next, how to pursue aggressive monetary easing. In particular, let me explain the newly introduced “open-ended asset purchasing program.” The Bank will pursue aggressive monetary easing, aiming to achieve the “price stability target,” through a virtually zero interest rate policy and purchases of financial assets, as long as the Bank judges it appropriate to continue with each policy measure. Purchases of financial assets mean to purchase a wide range of financial assets, including government bonds, corporate bonds, CP, exchange-trade funds (ETFs), and real estate investment trusts (REITs), from the market through a program called “Asset Purchase Program.” Through the purchases, the Bank aims at encouraging a decline in longer term interest rates and narrowing the risk premiums, thereby facilitating firms’ and households’ funding at a low cost. In actually purchasing financial assets, the Bank used to set the goal of an outstanding purchased amount at a particular point of time in the future, like “about 101 trillion yen by the end of 2013.” This time, the Bank has decided to purchase a certain amount of financial assets every month without setting any termination date because the Bank judged that it could clearly show its intention to continue purchasing financial assets toward achieving the newly introduced “price stability target.” Specifically, after completing the current purchasing method, from January 2014, the Bank will, for some time, purchase every month about 13 trillion yen, 2 trillion of which is Japanese government bonds, of financial assets. As a BIS central bankers’ speeches result, the total size of the Asset Purchase Program will be increased by about 10 trillion yen to about 111 trillion yen in 2014 and is expected to be at least maintained thereafter. About the new asset purchasing method, we have sometime been asked “As you have introduced a new method, why don’t you start purchases immediately rather than waiting until the beginning of next year?” A clear answer would be that the Bank already decided on a massive fund provision of more than 50 trillion yen this year. To elaborate on that, the amount outstanding of the “Asset Purchase Program” now stands at about 65 trillion yen and, by pursuing the already decided purchases, it will increase by about little less than 40 trillion yen by the end of the year. In addition, the Bank introduced last October a framework called “Stimulating Bank Lending Facility,” within which the Bank provides funds to financial institutions for the entire amount of a net increase in lending. I will talk about the thrust of the facility later. The fund-provisioning under the facility is expected to reach more than 15 trillion yen in about a year, based on the recent lending data. Putting those together, the Bank will make a new massive fund-provision of more than 50 trillion yen in about a year. On top of those purchases and fund-provisioning, from the beginning of next year, the Bank will purchase about 13 trillion yen of financial assets every month. As just described, the Bank intends to aggressively pursue monetary easing in a continuous manner, and judged that, by being committed to continuing such massive fund-provisioning next year onward at this stage, it would like to make the already accommodative financial conditions further accommodative. There has also been the opinion that, for the “decisive additional steps in monetary accommodation,” a net increase in the Program’s total size of about 10 trillion yen might be insufficient. On that point, we would like to be assessed in relation to the Bank’s strong posture to pursue monetary easing in a continuous manner from this year to next year onward, as I have just mentioned. Toward achieving the “price stability target” as early as possible, from the beginning of next year onward, the Bank will purchase financial assets without setting any termination date. The total size of the Asset Purchase Program will be increased by about 10 trillion yen in 2014 and is expected to be at least maintained at that high level thereafter. Such commitment by the Bank will be a substantially stepped-up policy posture. Of course, with regard to the future management of the Program, it could be the case that further accommodation will be pursued, while examining the situation of economic activity and prices, if necessary. Strengthening policy coordination between the Government and the Bank This time, the Government and the Bank decided and released the “Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth.” In the statement, the Bank stated that it set the “price stability target” at 2 percent and, under the target, would pursue monetary easing to achieve the target at the earliest possible time. The Government expressed that it would formulate measures for strengthening the competitiveness and growth potential of Japan’s economy, and promote them strongly, as well as steadily promote measures aimed at establishing a sustainable fiscal structure. As the possibility of Japan’s economy returning to the recovery path in the not distant future and the year-on-year rate of change in the CPI excluding volatile food reaching 1 percent in fiscal 2014 has come into sight, the Bank has considered that it would be highly significant to seize the “window of opportunity” and that it would be highly significant if the Government and the Bank work together and make concerted efforts to overcome deflation and achieve sustainable economic growth. As mentioned earlier, the Bank will pursue monetary easing aggressively with the aim of achieving the “price stability target.” In doing so, it is important to steadily ensure the market credibility of fiscal management. The Bank currently holds a large amount of government bonds and will still pursue large-scale government bond purchases. While Japan’s fiscal conditions are in a severe state, compared with other countries, yields on government bonds BIS central bankers’ speeches have been at historic low levels. In our view, such situation suggests that market credibility of fiscal management has been ensured. Nevertheless, taking into account the experience of Europe and others, we need to be aware that the market’s view could change rapidly. Once credibility of fiscal management wavers, the effects of monetary policy may even be eroded by a rise in interest rates. In addition, there is a risk that, through adverse effects on business performance of financial institutions, which hold government bonds, and eventually on the financial system, financial and economic stability might be impaired. In the joint statement, the government referred to fiscal management and clearly stated that “in strengthening coordination between the Government and the Bank of Japan, the Government will steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management.” That is an important point in the Bank’s pursuit of aggressive monetary easing. IV. Initiatives to utilizing accommodative financial conditions In concluding the explanation of monetary policy, let me talk about the relationship between monetary easing and firms. Thanks to the Bank’s monetary easing, at present, banks’ lending rates have declined to a historic low level of around 1 percent both for a short-term and a long-term. Financial institutions have been maintaining their active lending stance and firms and households can quite easily borrow money from financial institutions. If firms and households make better use of such accommodative financial conditions, the Bank’s monetary policy effects will become larger and overcoming deflation as well as sustainable growth with price stability will be achieved earlier and more surely. For firms and households to thoroughly utilize accommodative financial conditions, what kind of situation does it refers to? Presumably, it is to create a situation in which, for firms, they can foresee profits by borrowing funds and investing the funds, and for households, they can take out housing loans without concern about future income conditions. I might have to repeat this several times, but, at present, as positive developments have been generated, including developments in economic activity at home and abroad, the Government’s policy measures, and ensuing developments in foreign exchange and stock markets, which offers a “window of opportunity” to build up economic entities’ momentum to utilize the current situation. Financial conditions are quite accommodative and the Bank will continue to promote monetary easing aggressively. We are looking forward to positive actions by firms. For financial institutions that have contact with firms, while thoroughly knowing that they have been aggressively making efforts, we would like to ask the institutions to further make efforts to encourage firms’ positive actions and to tap new fund demand. In that regard, the Bank itself will provide support as a central bank as much as possible. At present, with a view to being a catalyst for firms and financial institutions to promote efforts toward strengthening growth potential, the Bank has a framework of “the fund-provisioning measure to support strengthening the foundations for economic growth.” It is the framework in which the Bank provides low interest rate and long-term funds to financial institutions providing loans to or investing in wide-ranging areas that contribute to the growth of Japan’s economy, such as medical and nursing care, environment and energy, agriculture, forestry and fisheries, and tourism. The Bank has prepared 5.5 trillion in a total amount of the framework and already about 4 trillion yen has been used. In addition, as I briefly mentioned earlier, last October, with the view to promoting financial institutions’ aggressive action and helping increase proactive credit demand of firms and households, the Bank introduced a new framework of “Stimulating Bank Lending Facility.” Under the facility, in 15 months through end-March 2014, if financial institutions increase net lending, the Bank will provide an unlimited amount of long-term funds at a low interest rate for the net increase. In thoroughly utilizing the accommodative financial conditions, the Bank will continue to use its ingenuity, seeing whether there is anything that can be done further as a central bank. BIS central bankers’ speeches Concluding remarks As time is running out, let me conclude my speech by touching on the economy of Nagasaki Prefecture. Nagasaki Prefecture, as a region that has been open to the world since ancient times, has played a major role in formulating Japan’s culture and modernization as well as nurturing a unique regional culture. It is blessed with nature like beautiful coast lines as well as ample tourism resources such as hot springs and agricultural and marine products, receiving many tourists from home and abroad. As a move to further enhance the attractiveness of Nagasaki, last August, the construction of the railway between Isahaya Station and Nagasaki Station of the Nagasaki route of the Kyushu Shinkansen line began with an aim of completion in 2022. I have heard good news that, last October, Nagasaki City was chosen as one of the world’s top three nightscapes along with Monaco and Hong Kong at “Nightscape Summit 2012 in Nagasaki.” Meanwhile, the population, particularly in remote islands, has been declining, and, above all, the prefecture is faced with a great challenge of the continuing exodus of young people to other prefectures. Needless to say, that is the epitome of a challenge Japan as a whole is faced with. In response, the prefectural administration has been making aggressive efforts to utilize a location advantage, including a diversity of remote islands and a friendly relationship with overseas, as well as to incorporate the vitality of Asian countries like South Korea and China. In promoting such projects, I have heard that “Nagasaki Summit,” which is a venue for industry-academia-government collaboration, has also been playing a critical role. Turning to the financial front, local financial institutions, through collaborating with the administration and universities, have been supporting the establishment and nurturing of local firms’ new business and business revitalization of troubled firms. Several of these institutions have been participating in the Bank’s “fund-provisioning measure to support strengthening the foundations for economic growth.” As “Stimulating Bank Lending Facility” will start, I strongly hope that local institutions could make the most of the facility. As I have just mentioned, in Nagasaki Prefecture, the fruits of the efforts toward incorporating external demand and tapping domestic demand have been steadily accumulated, and that will not only be the foundations for Nagasaki Prefecture’s future development, but also be a precious asset for Japan as a whole and, further, for Asian countries which are bound to be faced with similar challenges in the not-so-distant future. The Bank expects your various efforts and will continue to provide support as much as possible as a central bank. BIS central bankers’ speeches
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Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Gunma. 6 February 2013.
Takehiro Sato: Recent developments in economic activity, prices and monetary policy Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Gunma. 6 February 2013. * I. * * Introduction At the Monetary Policy Meeting (MPM) held on January 21 and 22, 2013, the Policy Board of the Bank of Japan decided to take additional steps to provide monetary accommodation decisively. Specifically, the Bank decided to introduce (1) the “price stability target” set at 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) and (2) the “open-ended asset purchasing method” (i.e., to purchase assets without setting any termination date) under the Asset Purchase Program. The Bank also decided to release a joint statement with the government (Chart 1). As was already noted in the statement on monetary policy released on January 22, 2013, I voted against the 2 percent price stability target. However, since policy decisions are made by majority vote of the Policy Board members at the MPM, the aforementioned decisions at the January MPM were made accordingly. In my remarks today, I will reflect on the conduct of monetary policy in the future, taking note of the measures to achieve the 2 percent “price stability target” that has just been introduced. II. Recent conduct of monetary policy A. From the “price stability goal in the medium to long term” to the “price stability target” The “price stability target” – introduced by the Bank as a numerical value – is set at 2 percent in terms of the year-on-year rate of change in the CPI. This target replaces the “price stability goal in the medium to long term” introduced by the Bank in February 2012, which the Bank had judged 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 1 percent for the time being. The major changes to the expressions regarding price stability from February 2012 are as follows. First, the Bank deleted the phrase “medium to long term”; and second, the Bank changed its wording from “goal” to “target” The changes reflect a situation in which awareness of the importance of flexibility in the conduct of inflation-targeting policy has been increasing. More specifically, even inflation-targeting countries do not change their monetary policy stance mechanically in accordance with their target inflation rates (Chart 2). This reflects lessons learned from bitter experience in the past, when many credit bubbles grew under the perception that prices had been stabilized, which created a large downswing in economic activity and prices after the bubbles burst. In addition, especially after the Lehman shock, many major countries have emphasized flexibility in the conduct of monetary policy by, for example, publicly articulating the importance of paying due attention to financial system stability (Chart 3). Given these developments, the phrase “medium to long term” is no longer necessary and the difference between a “goal” and a “target” is no longer a substantive issue. B. Why has the price stability target been set at 2 percent? As indicated in the statement on monetary policy released on January 22, 2013, the Bank recognizes that an inflation rate consistent with price stability on a sustainable basis will rise BIS central bankers’ speeches as efforts made by a wide range of entities toward strengthening the competitiveness and growth potential of Japan’s economy make progress (Chart 4). The 2 percent target looks rather high, given the current rate of inflation/deflation. However, the Bank decided that it was appropriate to set the target before confirming the product of the efforts made by a wide range of entities to strengthen the competitiveness and growth potential of the economy. The expected inflation rate of households, firms, and financial markets has been formed based on the past inflation rate that has been consistently lower than in other countries (Chart 5). As efforts made by the government, the Bank, and the private sector toward strengthening the growth potential of the economy make progress, the inflation rate will gradually increase and the expected inflation rate of households, firms, and the markets will likely rise accordingly. Furthermore, by setting a challenging target of 2 percent, the Bank expects to influence the expectations of a broad range of economic entities and to promote efforts toward strengthening the competitiveness and growth potential of the economy, thereby influencing the expected inflation rate of households, firms, and the markets. At the same time, should prices overshoot 2 percent, the Bank should be able to anchor the expected inflation rate by clarifying its target, and this will contribute to the achievement of price stability on a sustainable basis. Nevertheless, it is important for the Bank to continue to ensure credibility in its conduct of monetary policy in order to anchor the year-on-year CPI inflation rate at 2 percent. As the Governor of the Bank mentioned at his regular press conference after the January MPM, I dissented from setting the 2 percent price stability target with another Policy Board member, Mr. Takahide Kiuchi, for the following reasons. First, a 2 percent CPI inflation rate far exceeds the pace of price growth that is considered to be consistent with price stability on a sustainable basis. Second, it might impair the credibility of monetary policy to set the target before the efforts made by a wide variety of entities toward strengthening the growth potential of the economy achieve progress. However, as I explained at the beginning of my remarks today, I am in a position to execute the Bank’s policy decisions and responsible for their execution as a member of the Policy Board. The Policy Board members, including myself, are now facing the challenge of achieving the 2 percent price stability target as well as raising the credibility of the Bank’s goal. C. An inflation rate of 2 percent was very high in japan in the past What is the implication of the 2 percent inflation rate in Japan? Following the two oil shocks in the 1970s and 80s, an inflation rate above 2 percent in the Japanese economy was rather unusual. The times when the inflation rate exceeded 2 percent are generally regarded as periods when the Japanese economy confronted a difficult situation on the whole (Chart 6). Excluding the effect of consumption tax hike, the economy did not experience an inflation rate above 2 percent in the last quarter-century except for the period from April 1990 through December 1992 – when Japan faced a residual effect from the asset bubble economy in the late 1980s – and the period from July through September 2008 – just before the Lehman shock occurred. While the former period was marked by demand-pull inflation, this was due to the residual effect of the abnormal elevation of asset prices, whose collapse had produced the financial crisis of the late 1990s. This became a major cause of the protracted stagnation of the Japanese economy. The latter period was a time of typical cost-push inflation, which resulted in an outflow of purchasing power due to deterioration in the terms of trade and lowered the national economic welfare. Therefore, defining and aiming at an inflation rate that has rarely been achieved in the past two decades as the inflation rate consistent with price stability on a sustainable basis not only forces a substantial change in the Bank’s way of thinking but also imposes a challenge. As for the numerical expression for price stability, the Bank had not specified it up until the mid-2000s. In October 2000, shortly after lifting the zero interest rate policy, the Bank BIS central bankers’ speeches released a document titled “On Price Stability”, in which it concluded that “it is not deemed appropriate to define price stability by numerical values”1 It was only in March 2006 that the Bank for the first time began employing a numerical expression for price stability: it indicated the level of inflation within the range between 0 and 2 percent as a union of ranges of inflation rates that each member of the Policy Board understood as being consistent with price stability over the medium to long term – namely, the “understanding of medium- to longterm price stability”2 It was about six years later that the Bank in February 2012 introduced “the price stability goal in the medium to long term” – rolling out a specific numerical expression that could represent the consensus among all the Policy Board members as the inflation rate judged to be consistent with price stability sustainable over the medium to long term, instead of presenting the union of ranges of inflation rates of each Policy Board member.3 In the meantime, the Japanese economy has remained in a mild deflationary situation, although the degree has varied with time. The major reason why the Bank required time to formulate a numerical expression for price stability was due to the lack of a decisive measure to elevate the inflation rate under the constraints of the zero lower-bound on the nominal policy interest rate. While an inflation-targeting policy is generally assumed to be a framework for containing a higher inflation rate within the targeted level in overseas economies, it has long been recognized in Japan as a measure for raising the extremely low inflation rate to the targeted level. However, monetary policy conduct in a time of deflation is much more difficult than that under inflation, as expressed by the metaphor of “pushing on a string”. At a time when Japan faces rising headwinds such as population aging and population decline, setting the price stability target at 2 percent is rather challenging. A decline in the total working population at an annual rate of a little less than 1 percent is expected to continue. This implies that Japan’s GDP will drop at an annual rate of a little less than 1 percent, if nothing is done to overcome the headwinds. In such circumstances, in order to raise the output gap to a level that is consistent with the 2 percent inflation rate, it is necessary to boost demand by promoting further progress to strengthen the economy’s growth potential. Furthermore, we will have to face the reality of the flattening of the Phillips curve – the slower responsiveness of prices to the improvement of the output gap – due to globalization and the progress in IT (Chart 7). Thus, the achievement of the price stability target becomes increasingly challenging. D. The need for a recovery in wages And yet, why has the Japanese economy consistently failed to exit from deflation for more than a decade? During the early phase of deflation in the late 1990s, this was mainly due to the substantial fall in asset prices, the subsequent credit crunch caused by the financial crisis, and the preservation of excess supply caused by the delay of firms with poor productivity in exiting the market. However, since the Japanese economy has already overcome problems in its financial system, deflation since the mid-2000s has entered a new phase. Stagnant wages have become the main factor behind deflation. Prices of goods and services are affected by the cost of production. Assuming that the cost of production consists of personnel expenses and material costs, many of the latter are determined through cross-border competition. Therefore, their price fluctuations – excluding volatility due to developments in the foreign exchange markets – should equally affect the entire global economy, and thus material costs cannot be the main reason why Japan is the See http://www.boj.or.jp/en/announcements/release_2000/k001013a.htm/. See http://www.boj.or.jp/en/announcements/release_2006/mpo0603a.htm/. See http://www.boj.or.jp/en/announcements/release_2012/k120214b.pdf. BIS central bankers’ speeches only advanced economy suffering from deflation. The real cause is another factor affecting the cost of production, namely, wages. In fact, consumer prices and wages are closely correlated (Chart 8). About half of the components of the CPI are services in terms of weight, and prices of services are generally synchronized with wages in the services industry (Chart 8). This industry is labor intensive, and prices of services are easily affected by developments in wages. Accordingly, in aiming at the 2 percent price stability target in terms of the year-on-year rate of change in the CPI, it is vital, above all, to seek a recovery in wages. However, the level of annual nominal compensation of employees in the “National Accounts” dropped by more than 10 trillion yen after the Lehman shock and has shown virtually no sign of recovery (Chart 9). In order for a recovery in wages to occur, it is important that firms maintain their labor share of income distribution when they achieve an increase in their corporate profits, the source of wages. In fact, there was an opportunity in Japan for wages to recover in the mid-2000s. This occurred when the global economy overheated – triggered by growing demand in emerging economies and supported partly by the credit bubble. At this time, many firms, especially those in manufacturing, posted record highs in their corporate profits and were expected to increase their distribution of corporate profits to employees. However, they placed a higher priority during this period on accumulating internal reserves, and thus the labor share of income distribution fell (Chart 9). As major labor unions did not strongly oppose this distribution policy, wages scarcely improved. Currently, given the situation in which firms face what have been called the “six headwinds”,4 the profits enabling firms to boost distribution are unlikely to rise, even if management wishes to increase the distribution to employees. This is due partly to the significant decline in the competitiveness of some sectors of manufacturing and the resultant halt in improvement in corporate profits, the source of wages. E. Differences in employment adjustment between the United States and Japan The difference in employment adjustment between the United States and Japan has some effect on developments in wages. In the United States, when firms decide to adjust their employment policy, they aggressively reduce the number of employees instead of wages, which often results in a rapid retreat from unprofitable businesses. As a result, nominal wages continue to grow at a rate of about 2–4 percent irrespective of the phase of the economic cycle, and the U.S. economy is unlikely to fall into deflation since excess supply is unlikely to continue. If we consider the Phillips curve – with the unemployment rate on the x-axis and the rate of wage inflation on the y-axis – we reach a similar conclusion (Chart 10). On the other hand, under the employment practice in Japan it is difficult to aggressively reduce the number of employees while maintaining the nominal wage growth in an economic recession. On the other hand, Japan’s unemployment rate is comparatively stable partly due to the difference in labor regulations between the two countries, but the sensitivity of wage inflation to the unemployment rate is rather high. This makes employment adjustment through dismissal relatively limited even during a recession in Japan, and such employment adjustment, if any, tends to be executed mostly through wage reduction. Consequently, in Japan consolidation and reorganization of unprofitable businesses tend to take longer and the share of labor in income distribution tends to remain at a high level, and this slows the economy’s metabolism and allows excess supply to be preserved easily. In Japan the cost of employment adjustment is shared widely among workers, and this type of employment practice may be one of the main factors making it difficult for the economy to exit from deflation. The headwinds in Japan are generally characterized as (1) yen appreciation; (2) comparatively high corporate taxes; (3) delay in the creation of free trade agreements (FTAs); (4) tight labor regulations such as limitations on the employment of dispatched workers; (5) tighter environmental regulations; and (6) power shortages. BIS central bankers’ speeches Going forward, if we see supply-demand conditions tighten in the labor market with economic expansion in Japan, can we expect wages to rise in line with the correlation I have mentioned? It might sound pessimistic, but such may not be the case, as some firms in Japan have recently begun to lose their competitive edge and profit-making ability. This might reflect a gradualist approach to the streamlining of industries and unprofitable businesses, whose expected growth rates have worsened. The current situation in Japan – where the pricing power of firms has weakened and firms cannot pass on the rise in purchase prices to selling prices – clearly reflects this decline in Japanese firms’ competitiveness (Chart 11). At any rate, as the Bank aims at the 2 percent price stability target, greater fundamental strength of the economy is needed to generate a wage increase of approximately 4 percent. To this end, a wide range of entities is expected to redouble efforts to strengthen the competitiveness and growth potential of the economy. F. What the central bank can do What kind of contribution can the Bank make from the monetary policy side, in order to achieve the 2 percent price stability target? A well-balanced price hike should materialize in a situation where general prices rise in tandem with wages, as the result of a rising level of total economic activity and subsequent improvement in the output gap. Furthermore, such a price hike must be sustainable. Although the Bank has announced that price stability can be achieved through the efforts by a wide range of entities to strengthen the competitiveness and growth potential of the economy, both the government and the Bank have also been working to address the issue. At the same time, it is difficult to think that the 2 percent price stability target will be achieved merely by enhancing ongoing policy initiatives, and therefore both the government and the Bank must tackle this issue with much greater vigor. Generally speaking, when an economy faces a deflation trap with the constraints of the zero lower-bound on the nominal policy interest rate, the plausible channels for economic stimulation and achieving a price recovery are (1) the channel through foreign exchange rates and (2) the channel through asset prices. In terms of the former, the Bank decided at the December MPM to increase the purchases of treasury discount bills (T-Bills) and Japanese government bonds (JGBs). The Bank considers that a stronger indirect influence on foreign exchange rates will be achieved from a further decline in interest rates – narrowing or reversing the interest rate differentials between Japan and other countries – while continuing with the payment of interest on excess reserve balances at 0.10 percent. The Bank’s decision at the January MPM to take additional steps to provide monetary accommodation by introducing the open-ended purchasing scheme will further strengthen this influence. Regarding this latter policy initiative, the Bank formally launched the Loan Support Program at the December MPM to vigorously support the increase in private bank lending in terms of fund provisioning. This policy initiative relies on the efforts of private banks to boost lending, and what the Bank can do is to support these efforts by the private sector. In a situation where demand for funds has been weak for a long period of time and there is no bottleneck in the availability of funds at private banks, it has been widely observed that the effects of such a policy will be limited. Nevertheless, if such an increase in bank lending promotes real economic activity and transactions in the asset markets, some positive impact can be expected on general prices through an increase in asset prices. In particular, once upward momentum starts accumulating in the economy, the effects of the policy initiative are likely to be more pronounced. In addition, if private-sector lending promotes cross-border capital expenditures or mergers and acquisitions by firms and banks, this will indirectly induce depreciation of the yen. At any rate, I would like to emphasize the importance of exerting indirect influence on the foreign exchange markets and asset markets mainly by facilitating a further decline in interest rates. BIS central bankers’ speeches G. Policy measures indirectly influencing foreign exchange rates under the zero interest rate During the quantitative easing period from March 2001 through March 2006, the effects of monetary easing were likely to appear through depreciation of the yen, since Japan was the only country that had adopted a zero interest rate policy (Chart 12). From the time of the Lehman shock up to the present, however, the Bank’s efforts have had limited effectiveness, given that interest rate differentials between Japan and other advanced countries have narrowed in a situation where central banks in these countries have started to adopt the zero interest rate policy as well. Nevertheless, I believe that the interest rate channel might work in this situation, albeit to a limited extent. For example, the 3-month T-Bill rate, which had been consistently higher than that in the United States, marked a recent low of 0.093 percent, edging close to the rate in the United States, reflecting the Bank’s large-scale purchasing of T-Bills as part of the Asset Purchase Program even though the Bank maintained the interest on excess reserves at 0.10 percent. A favorable tailwind is also apparent in signs of change in U.S. monetary policy. For example, in December 2012 the Federal Open Market Committee (FOMC) discussed decreasing the size of its asset purchase or suspending it in the course of 2013. Against the background of such developments, the Bank is closely monitoring the extent to which both short and long-term interest rates may decline further while continuing to employ the Asset Purchase Program. Meanwhile, steadily increasing the amount outstanding of the Asset Purchase Program is no easy task. If the asset purchases under the Asset Purchase Program are conducted smoothly as planned, the amount outstanding of the program is expected to surpass 100 trillion yen from the current 65 trillion yen by the end of 2013 (charts 13 and 14). The provision of such a large amount of funds is unprecedented for the Bank, and there is a risk that it will be unable to increase the amount outstanding of the Asset Purchase Program smoothly if private banks grow reluctant to boost excess reserves at the Bank to avoid balance-sheet expansion due to their financial strategy or other reasons such as corporate governance. It is probably the case that, in increasing the amount outstanding of the Asset Purchase Program, whether private banks submit bids for the Bank’s asset purchases depends greatly on interest rate levels. Some events might be beyond the scope of expectations in an unprecedented situation, but the Bank aims to steadily increase the amount outstanding of the Asset Purchase Program by adjusting the program in a flexible manner. H. Is a substantial increase in risky asset purchases a viable option? On the other hand, it has been argued that the Bank should substantially increase its purchase of risky assets. In line with its comprehensive monetary easing in October 2010, the Bank has been purchasing risky assets such as corporate bonds and CP and – with government approval – exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). Among major central banks, the Bank is the only central bank that purchases such risky assets for its own account. However, the Bank’s intention in this operation is not to employ large-scale intervention in the asset markets but to work as a catalyst for the financial markets. Some argue that it is a viable option for the Bank to increase such purchases substantially by intervening in the markets on a large scale. I consider the efficacy of this sort of policy initiative to be doubtful, as it contains the risk of eroding the Bank’s capital base. If the prices of risky assets held by the Bank declined and the Bank incurred a loss, this would result in a reduction in its payments to the national treasury. If the size of the risky assets was sufficiently large compared with the size of the Bank’s net capital, the Bank might fall into capital deficiency. The first outcome, reduction of payments to the national treasury, would be equivalent to an increase in fiscal spending, and because of this risk the Bank must obtain authorization from the government based on Article 43 of the Bank of Japan Act in order to purchase ETFs and J-REITs. The second outcome, capital deficiency, could lead to a larger issue, affecting the credibility of the Bank and the BIS central bankers’ speeches yen as well as the autonomy of monetary policy, if the Bank asked the government for recapitalization or compensation for its loss. Given these issues, whether the Bank should substantially increase risky asset purchase from the current limit is a matter that involves not only the Bank but also the government. It might therefore be effective to set ex ante policy rules for loss sharing, in order to prevent purchases of risky assets from influencing the autonomy of the Bank’s monetary policy. I. Are foreign bond purchases a viable option? At a press conference in July 2012 after becoming a Policy Board member, I remarked that foreign bond purchases might be an option for the Bank but a number of conditions must be met. For example, the Bank of Japan Act stipulates that the Bank may buy or sell foreign exchange solely as an agent of the government (Article 40); therefore, the Bank cannot make any subjective policy decisions to secure the stability of the yen (Chart 15). Can the Bank then purchase foreign bonds if it receives government authorization pursuant to Article 43 of the Bank of Japan Act – as in cases of ETF and J-REIT purchases? As stipulated in Article 40 of the Bank of Japan Act, the Bank is not allowed to buy or sell foreign exchange for the purpose of intervening in the yen market. Therefore, regardless of Article 43, it is natural to consider that the Bank cannot purchase foreign bonds for such a purpose. In that case, what about purchases by the Bank of a fixed amount of foreign bonds on a regular basis as part of money market operations? This too risks contravening Article 40, if the purpose of such purchases is considered to manipulate the foreign exchange markets. Because of the legal restriction I have mentioned, the Liberal Democratic Party (LDP) made an election pledge in December 2012 that it would establish a joint fund by the public and private sectors to purchase foreign bonds. The net impact on the economy would be basically the same whether the government or the Bank bought foreign bonds, and therefore I think that the Bank itself need not assume the dominant role in conducting such purchases. However, it might pose a problem in terms of currency diplomacy; therefore, close coordination with foreign currency authorities is indispensable in order to achieve consensus. J. Economic welfare would not improve if a price hike is simply driven by the yen’s depreciation Even if the yen depreciates against the U.S. dollar by 10 percent, I estimate that the rise in Japan’s CPI would be far short of 1 percent, even if the accumulation of its effect for several years is taken into account. Therefore, if the core CPI – now around 0 percent – is to be raised to 2 percent solely through depreciation of the yen, a substantial depreciation is needed, and this does not seem practical. Many uncertainties remain if such a substantial depreciation of the yen is to take place through the conduct of interest rate policy. Even if it were possible, it might raise a number of issues in terms of currency diplomacy. Furthermore, a hike in import prices and deterioration in the terms of trade would cause an outflow of purchasing power. Thus, even if the inflation rate rose, it would be largely superficial and gross domestic income (GDI) as well as gross national income (GNI) would decrease; as a result, people would not feel that the economy had overcome deflation (Chart 16). In sum, although the impact of developments in exchange rates on prices is substantial, pursuing a high price stability target of 2 percent solely through the exchange rate channel is not a balanced option. What should be aimed for is a rise in prices that accompanies an increase in income. However, it should be noted as well that underestimating the economic-stimulus effects of the ongoing depreciation of the yen on the asset markets is to take an unbalanced view. The asset markets, especially domestic stock markets, have underperformed compared to overseas markets due to the effects of the overappreciation of the yen, which has appreciated by about 40 percent in terms of the nominal effective exchange rate since the Lehman shock. Recently, however, in the process of correction of the yen’s overappreciation, the valuation of domestic stock prices has been revised, and the asset markets have become BIS central bankers’ speeches buoyant after a long period of inactivity. As I mentioned earlier, the recovery in asset prices could lead to an improvement in the output gap and in turn a rise in prices, by strengthening the risk tolerance of firms and households and then raising the level of total economic activity. Therefore, I would like to continue to draw attention to the channel in which monetary policy indirectly exerts influence on foreign exchange rates. III. Recent economic activity and prices A. Outlook for the global economy According to the latest global economic outlook released by the International Monetary Fund (IMF) in January 2013, the global economy is expected to grow moderately at 3.5 percent and 4.1 percent in 2013 and 2014, respectively, and these growth rates are almost the same as or slightly above the average of the past three decades of 3.4 percent (Chart 17). In the recent past, this outlook had been revised downward mainly due to the worsening of the European debt problem and the deceleration of the Chinese economy. However, the global economy has not become subject to a considerable downward revision since summer 2012, because (1) the U.S. economy remained comparatively albeit modestly firm, (2) the tail risk receded substantially in Europe thanks to a variety of policy developments, and (3) the Chinese economy bottomed out. It is still uncertain, however, whether the global economy will return to its 4 percent growth path, which is above the average of the past three decades, in line with the IMF’s outlook. While there are many reasons for the uncertainty, the main one is that the global economy is still in the phase of balance-sheet adjustment following the bursting of credit bubbles that expanded in the late 2000s, and therefore the adjustments in both the public and private sectors are likely to dampen economic performance as a whole. B. Balance-sheet adjustment is still on track If we review the long-term developments in the private-sector debt of major economies (as a percentage of nominal GDP), we can see that the debt’s expansion and subsequent adjustment are synchronized on a global basis. Very roughly, we can observe credit cycles with ten years of expansion followed by ten years of adjustment (Chart 18-1). In the 1980s, the credit cycle was in an expansion mode with a few exceptions, and the 1990s were a period of adjustment followed by expansion again in the 2000s. Because of the global financial crisis following the Lehman shock in 2008, the expansion of private-sector debt has come to an end, and we are now in an adjustment phase on a global basis. As evident from developments in the U.S. household sector, the adjustment of excess capital stock is only halfway complete. Meanwhile, regarding the total of private- and public-sector debt, the degree of fluctuation is smaller, and a major phase of deleveraging has not been observed except for Canada in the 1990s (Chart 18-2). This probably reflects the fact that when the private sector deleverages, public-sector debt expands. Looking at the long-term developments in total debt, which includes both private- and publicsector debt – with the latter on a net basis – we find that (1) the debt ratio rose in many countries in the 1980s; (2) it stabilized in the 1990s as a whole; and (3) it rose in the 2000s led by Spain, the United States, and the United Kingdom, followed by Japan from around 2005. In addition, it should be pointed out that Japan does not stand out from the other countries if we look at the level of the public-sector debt on a net basis, unlike the case on a gross basis. The fact that debt in the private and public sectors tends to have a negative correlation, and that the total debt is downwardly sticky has an implication for the relation between the debt and economic growth. In countries such as Japan, the United States, the United Kingdom, and Spain, the debt overhang in households, firms, and/or the government seems to be at a threshold point at which the debt will exert a severe restriction on the economy. Therefore, in BIS central bankers’ speeches considering the outlook for the global economy, it must be borne in mind that the high level of total debt could remain a major impediment to global economic development. C. The Japanese economy is expected to return to a moderate recovery path The Japanese economy has shown some weakness since April 2012 mainly in manufacturing, because the European economy has receded and growth in the Chinese economy has slowed, and because domestic demand has been insufficient to offset the weakness in overseas demand. Although the trend of exports is still downward, the rate of decline has moderated compared to the situation during the July–September quarter of 2012. This movement is consistent with recent developments in the global Purchasing Managers’ Index (PMI), which reflect the pick-up in the U.S. and the Chinese economies. Reflecting signs that the fall in exports has bottomed out, production in manufacturing is thought to be bottoming out as well (Chart 19). Looking at domestic demand components such as private consumption, the negative impact of the ending of environmentally friendly car subsidies has recently diminished, and consumption remains resilient despite several negative factors affecting income such as the decrease in winter bonuses (charts 20 and 21). The employment condition in the manufacturing sector still looks bad, but the negative spiral of weakness in manufacturing is not expected to spill over into the nonmanufacturing sector. In these circumstances, business fixed investment, which has recently shown some weakness on the whole, is projected to turn to a moderate increasing trend (Chart 22). According to the production forecast survey by the Ministry of Economy, Trade and Industry (METI), it is becoming harder to identify the basic trend of production due to quirks in the seasonal adjustment unique to the January–March quarter and the Chinese New Year holidays in February. Nevertheless, at a minimum production is unlikely to show a further substantial decline. As overseas economies are somewhat more likely to return to a moderate growth path – unlike in the period up to summer 2012, when there were high tail risks – and the domestic economy is expected to enjoy the impact of fiscal stimulus measures, some degree of economic improvement is expected from the April–June quarter onward, though it should be temporary. Although care should be taken to avoid undue optimism, the economic recession that began in April 2012 seems to have ended in November, resulting in a “mini-recession” of eight months. Still, due attention should continue to be paid to tail risks, as it is difficult to foresee the effects of the fiscal drag in the United States even after the temporary resolution of issues related to the fiscal cliff and the debt ceiling, and it is possible that risk aversion will reintensify worldwide depending on developments in political events such as elections in Europe. In addition, the recovery path of the global economy should be fundamentally moderate, as a result of the adjustment of excess debt that has been accumulated globally, as I mentioned earlier. Given all these developments in demand both at home and abroad, in the recently conducted interim assessment of the October 2012 Outlook for Economic Activity and Prices, growth prospects are projected to be somewhat lower for fiscal 2012 but higher for fiscal 2013 compared with the October forecasts (Chart 23). As for prices, the inflation rate for the core CPI (all items less fresh food) is currently around 0 percent on a year-on-year basis. Going forward, several factors are likely to affect price movements. One is the increased price competition in nondurable goods such as processed food among supermarkets, which renders the price trend somewhat weak. Another is the expected decline in the index due to the reversal of developments in energy prices, which surged last year, and in durable consumer goods prices, whose rate of decline slowed reflecting the change in the survey specifications that was made around the same time last year. Furthermore, the widening of the negative output gap caused by the earlier weak economic activity is likely to adversely affect price developments going forward with some time lag. All these factors are likely to increase the negative year-on-year margin of the core CPI inflation rate. The Bank has just set the 2 percent price stability target, but the outlook for prices is highly unfavorable for the time being. BIS central bankers’ speeches Even so, the recent depreciation of the yen and changes in asset prices, such as the rise in stock prices, are expected to positively affect price developments through the improvement in the real economy. At any rate, it is important to foster a proactive effect on the real economy by fully implementing not only monetary policy but all available measures. IV. Concluding remarks I would like to conclude this speech by briefly touching on the economy of Gunma Prefecture. The pick-up in the prefecture’s economic activity has come to a pause, and its economy remains more or less unchanged, owing to the prolonged deceleration in overseas economies. Compared with other prefectures in Japan, however, economic conditions in the prefecture are favorable on the whole, led by a healthy transportation equipment industry. As for the outlook, Gunma Prefecture’s economy is likely to pick up moderately again as overseas economies start recovering and as exports increase. The prefecture enjoys a strong industrial foundation, with regional characteristics such as a very low vulnerability to natural disasters including earthquakes, bountiful water resources, and good access to the Tokyo metropolitan area. Due mainly to vigorous promotion by the prefectural government and cities of the advantages of Gunma Prefecture as a convenient site for corporate back-up facilities, the number and area size of new factories in the prefecture have reached the highest levels in Japan for the past several years. Furthermore, Gunma Prefecture has great potential in the area of tourism. The prefecture enjoys ample resources including rich natural surroundings such as the famous Oze Marsh, historic and cultural assets such as the Tomioka Silk Mill – which has applied to join the World Heritage List – and the major hot spring resorts of Kusatsu, Minakami, Ikaho, and Shima. Regional efforts have been made to attract more tourists to the prefecture from all over Japan and abroad. I hope that these and other efforts will promote even further the development of tourism in Gunma Prefecture. 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Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Executive Member Meeting of the Policy Board of Nippon Keidanren (Japan Business Federation), Tokyo, 28 February 2013.
Masaaki Shirakawa: Toward strengthening the competitiveness and growth potential of Japan’s economy Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Executive Member Meeting of the Policy Board of Nippon Keidanren (Japan Business Federation), Tokyo, 28 February 2013. * * * Introduction It is a great honor to have this opportunity to address the executive member meeting of the Policy Board of Nippon Keidanren today. Before I start, let me express my deepest appreciation for the information and views on current developments in economic and financial activities as well as on policy conduct provided to us by all the member firms. Today’s speech is the last one I will give as Governor of the Bank of Japan. However, it was not difficult for me to decide today’s main topic, “toward strengthening the competitiveness and growth potential of Japan’s economy”, because it is the most pressing issue for Japan at present. It is also a very important theme for the Bank of Japan. As you know, at the Monetary Policy Meeting in January, the Bank decided to introduce a “price stability target” and set it at 2 percent.1 This target was introduced based on the recognition that progress would be made by a wide range of entities in their efforts toward strengthening the competitiveness and growth potential of Japan’s economy (Chart 1). For this reason, it is extremely important in conducting monetary policy whether such efforts will actually make progress. In the following, I would like to talk about this theme while paying due regard to the perspectives of macroeconomics, corporate behavior, and economic policymaking. I. The aim of economic policy While there has been active discussion regarding the conduct of economic policies in Japan, I will first consider the aim of economic policy and the kind of situation we expect Japan’s economy to attain. Needless to say, the ultimate aim of economic policy is to raise the living standard of each citizen. While there is no single indicator for gauging people’s quality of life, if we were to put this in approximate terms, the key aim of macroeconomic policy is to raise the per capita consumption level, or to raise the real gross domestic product (GDP), which is closely related to the former, in a sustainable manner (Chart 2). Having said this, a more detailed discussion is necessary when considering the various options regarding economic policy on the basis of the situation facing Japan’s economy. First, there is a need to consider the effects of the decline in the labor force due to the rapid aging of Japan’s population. Japan’s current real GDP remains below the level seen prior to the Lehman shock. Looking at per capita real GDP figures, the drop for Japan is relatively small compared with countries such as those in Europe (Chart 3). Furthermore, in terms of the level of real GDP per working-age person, Japan has exceeded the pre-crisis level, which is a better performance than that of the United States. While “population decline” is one of the clichés used in discussing Japan’s economy, this fundamental fact is oftentimes disregarded when discussing economic developments. Of course, figures do not differ significantly within short time periods of a quarter or a year, but when considering Japan’s For details on decisions made at the Monetary Policy Meeting on January 22, 2013, including the introduction of the “price stability target”, please see Masaaki Shirakawa, “The Roles, Missions, and Challenges of the Central Bank” (Speech at the Japan National Press Club in Tokyo), January 25, 2013. http://www.boj.or.jp/en/announcements/press/koen_2013/data/ko130130a.pdf BIS central bankers’ speeches economic policy in the medium to long term, it is important to think in terms of changes in per capita or per worker data. Second, we need to take account of the progress in economic globalization. Specifically, it is necessary to look not only at real GDP but also at real gross national income (GNI). Real GNI is a concept of income that results from making the following two adjustments to real GDP. One source of adjustment is the overseas income of Japanese nationals. Looking at figures for 2012, overseas income amounts to 14.3 trillion yen – that is, 3.0 percent of nominal GDP. In recent years, profits from outward direct investment have been increasing in addition to profits from outward portfolio investment (Chart 4). The other source of adjustment is the change in real purchasing power due to changes in the foreign terms of trade. Japan’s terms of trade have been deteriorating in recent years, mainly due to the rise in commodity prices against the background of high growth in emerging economies. Trade gains/losses – in other words, real purchasing power arising from changes in the terms of trade – have thus been on a declining trend (Chart 5). Terms of trade undergo changes, not only due to commodity prices but also in response to the pricing power of Japanese firms through the non-price competitiveness of exports. Fluctuations in foreign exchange rates, for example depreciation of the yen, will raise real GDP through an increase in exports but may at times adversely affect trade gains/losses. Effects on real GNI depend on the net result that takes into account these two adjustments (Chart 6). Setting 2000 as the base year, real overseas income increased by about 2.5 times in 2012, pushing up real GDP for 2012 by 1.9 percent compared with that in 2000. On the other hand, the trade gains pushed real GDP downward by 5.8 percent. Third, another topic for discussion is how to treat nominal GDP and real GDP in considering economic policy. On this point, both of these increase when the economy grows in a sustainable manner, suggesting that the direction of medium- to long-term policy is not all that different depending on which figure we take into account. What I must mention here is the cause-and-effect relationship between the two. The basic causal relationship is that, as real GDP rises, the output gap tightens and prices subsequently rise, resulting in a rise in nominal GDP (Chart 7). There are situations, of course, where prices fluctuate first, as seen during the time of the oil crises. In such a situation, however, economic conditions deteriorate, and this is different from what we wish to see. What we are trying to achieve through economic policy is to raise real GDP, as a result of which nominal GDP will rise. In relation to this, the results of the Opinion Survey on the General Public’s Views and Behavior that the Bank conducts on individuals on a quarterly basis provide some interesting findings. The survey results reveal that approximately 80 percent of the respondents – irrespective of their sex, age, and occupation – have consistently viewed the price rise as “rather unfavorable” throughout the past surveys (Chart 8). Underlying the survey results is the concern that wages may not rise even if prices rise. A considerable portion of the Japanese public is not simply looking for a situation in which prices rise. In the phrase “overcoming deflation”, people are looking for a situation in which one’s salary rises, employment is secured, and profits increase; in other words, a situation characterized by a well-balanced improvement in economic conditions and consequent rise in prices. The fourth point involves the problem of how to distribute the fruits of economic growth. While market mechanism plays a key role in order for the economy to grow, this requires a perspective of society as a whole that accepts such mechanism at large. On this point, the situation surrounding income distribution is one of the crucial factors. In the United States, during the period of economic expansion preceding the Lehman shock – from 2002 to 2007 – the real incomes of the highest-income households in the top 1 percentile increased by 86 percent and household average income increased by 20 percent. In contrast, the “median” household income – that is, the income that represents the middle of a series of all household incomes arranged in order of size – increased only by 10 percent, which amounts to just half the growth of the average income (Chart 9). The situation surrounding income distribution partly depends on the proportion of the elderly that does not have any earnings, BIS central bankers’ speeches and reviewing this through a single indicator can therefore be challenging. Japan’s case may not be as extreme as that in the United States. Nevertheless, awareness of the need to achieve well-balanced economic growth, especially for the middle class, has increased around the globe. II. The need to strengthen competitiveness and growth potential Bearing these issues related to the aim of economic policy in mind, let me now move on to the need to strengthen competitiveness and growth potential.2 Looking at developments in a country’s economic growth rate over the longer term, factors affecting it can be broken down into real or supply-side factors – namely, capital stock, labor force, and technological innovation. Explaining this within the framework of so-called growth accounting, the growth rate can be broken down into growth in the number of workers and that of value-added per worker, in other words, the labor productivity growth rate (Chart 10). Mechanically estimating future growth in the number of workers, based on the assumption of the most recent labor participation rate by gender and age, the number of workers in Japan will change at a rate of –0.6 percent per annum in the 2010s and –0.8 percent in the 2020s. Meanwhile, the labor productivity growth rate for the years 2000 through 2008 – a period characterized by relatively favorable economic conditions – was 1.4 percent on an annual basis. Adding this to the aforementioned growth in the number of workers, the average growth will become 0.8 percent for the 2010s and 0.6 percent for the 2020s. This will merely amount to maintaining positive growth over the next two decades. Japan’s economy faces a considerably strong headwind in the form of a decline in the labor force, and we need to more seriously acknowledge its implications. Raising the labor productivity growth rate further will alleviate the problem, of course. Japan has achieved a growth rate slightly exceeding the average for the G-7 countries for the past 10 years, however, and it is not very plausible to think that we can raise it by 1 percent or more at once (Chart 11). At any rate, raising Japan’s growth potential continuously into the future requires work, especially strenuous work, on both the number of workers and the labor productivity growth rate. While efforts by a wide range of entities are necessary in such case, the main actors here, above all, are private firms. The corporate sector has consistently had a savings surplus, together with households, since 1998 (Chart 12). A significant savings surplus by the corporate sector is a phenomenon now observed outside of Japan as well: it has spread to major advanced countries since the start of the 2000s. In terms of the amount of savings surplus relative to GDP, figures for the United Kingdom, Japan, and the United States are 6.1 percent, 4.6 percent, and 4.1 percent, respectively. The most significant underlying cause of this savings surplus is the lack of attractive investment opportunities at home amid expanding investment opportunities in the emerging markets. Recently, other causes have also been pointed out, including the securing of funds to offset additional costs that may arise from a lack of funds for corporate pensions mainly resulting from a decline in interest rates. I presume that in your day-to-day decision making, you cannot muster enough confidence to invest at home despite having ample liquidity on hand (Chart 13). In fact, on-hand cash and deposits at Japanese firms has been increasing steadily: the proportion of Japanese firms listed on the First and Second Sections of the Tokyo Stock Exchange (TSE) holding cash and deposits exceeding the amount of interest-bearing debt – in other words, firms without net external borrowings – has recently become as high as 43 percent. The importance of strengthening growth potential and of the supply side is something many central banks emphasize. Please see, for example, Speech given by Mervyn King, Governor of the Bank of England, at the CBI Northern Ireland Mid-Winter Dinner, Belfast, 22 January 2013. http://www.bankofengland.co.uk/ publications/Documents/speeches/2013/speech631.pdf BIS central bankers’ speeches Of course, firms’ ample on-hand liquidity itself is reasonable up to some level, taking into account experiences such as the post-bubble financial crisis and the aftermath of the failure of Lehman Brothers – that is, the shortage of U.S. dollar funds and the decline in the functioning of the CP market. The current level of on-hand liquidity, however, appears to go well beyond the amount of such precautionary demand. As for the use of excess funds, there are only three options: making real or financial investments at home and abroad; disbursing funds to employees in the form of wages; and returning them to stockholders through dividend payments and share buybacks. The economy will not see positive outcomes unless some kind of change is brought about to the increased liquidity via one of the aforementioned routes. In that sense, it is extremely important to change the business environment, thereby modifying firms’ incentives. That is why in achieving sustainable growth with price stability, efforts toward strengthening the competitiveness and growth potential of Japan’s economy are necessary as much as monetary policy is indispensable in this regard. III. Outline of the course of future measures Next, I would like to outline the course of future efforts toward strengthening the economy’s competitiveness and growth potential. Capturing increasing overseas demand The first course is to capture increasing overseas demand in the form of expanding Japanese firms’ overseas business activities. It is inappropriate to negatively describe such efforts as the “hollowing-out” of industries in an environment where overseas economies – mainly emerging economies – have grown much faster than Japan. With regard to international division of labor, while manufacturing and assembly overseas expands, increasing the export of intermediate goods from Japan and reinforcing domestic R&D activity, whose value-added is relatively higher, will contribute to raising Japan’s real GDP. In addition, if surplus funds that have accumulated in the corporate sector are being used for overseas investment with high returns, the benefit of such investment will be passed back to Japan in the form of interests and dividends. This will not directly contribute to raising real GDP, but it does raise real GNI. While globalization of the economy continues, it is deemed imperative to make balanced efforts as a nation by combining domestic production with exports as well as with foreign direct investment, or local production overseas. Indeed, overseas investment by Japanese firms has been increasing, especially in Asia. Such a trend has spread from large manufacturing firms to nonmanufacturing ones, as well as small and medium-sized enterprises (Chart 14). Nevertheless, the outstanding amount of Japan’s foreign direct investment remains at a low level compared with that of other advanced countries (Chart 15). Similarly, in terms of the profitability of foreign investment, which is the combination of portfolio investment and direct investment, Japan falls a little behind countries such as the United States, partly because of its small share of direct investment, which has a high rate of return (Chart 16). Huge potential demand exists in emerging economies, particularly Asia, in the area of building core infrastructure for transportation systems, energy supply, and communication systems. According to the estimates of the Asian Development Bank, such demand will amount to approximately 8 trillion U.S. dollars from 2010 to 2020 (Chart 17). There are ample business opportunities for Japanese firms to make use of their globally recognized cuttingedge technologies and wealth of experience – such as upgrading metropolitan infrastructure and implementing environmental and energy-saving technologies, as well as deploying factory automation systems to address labor shortages and wage rises – that have been nurtured in Japan over the years. It has become increasingly apparent that Japanese firms in such sectors as retail, healthcare, and education, which have focused mainly on the domestic market, are able to formulate sweeping business strategies in large Asian markets, where consumer demand is increasing briskly as these countries’ middle-income populations continue to expand. BIS central bankers’ speeches Responding to the aging population The second course is to respond to the rapidly aging population. The long average life expectancy of the Japanese people implies that health, the condition most vital to well-being, is being fulfilled at a high level. Having said that, it is necessary to adjust the economic structure and social infrastructure as the population continues to age. Otherwise, it becomes difficult to maintain the current high quality of life. While this is sometimes misunderstood, the demographic change of population aging itself is not triggering the problem for Japan’s economy; the real issue is that Japan’s economic structure and social infrastructure have not sufficiently caught up with such demographic changes. The aging of the population brings about various changes to the economy. First, it will become a downside factor for economic growth via the economy’s supply side – namely, a decline in the labor force. In order to counter this trend, it is most important to increase labor participation, particularly of the elderly and women.3 The labor participation rate of 60–69 year-olds has increased continuously over the last few years (Chart 18). The labor participation rate of women is also increasing, but remains at a relatively low level compared with other advanced economies (Chart 19). Aging will also substantially change the demand structure of the economy. The area of medical and nursing care is one worth mentioning. In the United States, the elderly population aged 65 and older increased by 13 percent in the ten years from 2000, and as a result, the expenditure in medical and nursing care rose by 82 percent. By contrast, in Japan, while the elderly population increased by 29 percent, such expenditure only rose by 17 percent (Chart 20). In relation to this, it has often been pointed out that, in Japan, due to a number of regulations and a shortage in the workforce, sufficient service in this sector has not been provided relative to demand. While one should be mindful of the fiscal implications, appropriate system design and regulatory reforms are likely to turn the potential demand in medical and nursing care, as well as in medical equipment and infrastructure, into actual demand. At the same time, medical and nursing care could become one of the most promising domestic employers as Japanese firms expand their overseas operations (Chart 21).4 Population aging also brings about an expansion in demand in the housing market. For the child-raising generation, potential demand for larger housing is believed to be high, but such demand has not been satisfied, particularly in the metropolitan areas. On the contrary, members of the elderly generation continue to live in large houses that had been acquired during their working age. Indeed, in Japan, the share of second-hand dwellings in the total housing market (i.e., combining new and second-hand dwellings together) is only 12 percent, far less than the 79 percent in the United States and 86 percent in the United Kingdom (Chart 22). Once the housing market is reorganized, potential demand for housing will be cultivated by meeting the different needs in different stages of life, and this will eventually invigorate related markets, such as electric home appliances and other household items, as well as remodeling. Change is also desirable on the financial front. It is often pointed out that, in Japan, household financial assets are concentrated in cash and deposits. This partly reflects that the share of residential assets, that is, real assets with large price fluctuations and low liquidity, among total household assets tends to be high (Chart 23). If household assets start flowing into financial assets other than cash and deposits, we might enjoy an increase in the supply of long-term risk money. For details on the importance of raising the labor participation rate of women, please see Chad Steinberg and Masato Nakane, “Can Women Save Japan?” IMF Working Paper 12/248. International Monetary Fund, 2012. http://www.imf.org/external/pubs/ft/wp/2012/wp12248.pdf In the United States since 1990, while the number of employees in manufacturing has decreased by about 6 million, mainly due to an acceleration in the shift of production overseas, that in the healthcare industry has increased by 6 million. BIS central bankers’ speeches Promoting smooth transfer of resources The third course is to promote the smooth transfer of resources. In the medical care and housing areas that I just talked about, not a shortfall in demand but the mismatch between demand and supply has become the essence of the problem in the sense that potential demand and actual supply do not correspond to each other. In recent years, sales of pre-packaged tours to the elderly and sales in health-related industries have shown marked increases. This suggests that firms have succeeded in cultivating potential demand by making efforts to develop new products through shifting their human resources and capital to those businesses. Changes will surely create new demand and promote the introduction of new goods and services. It is imperative to realize the optimal resource allocation by shifting labor and capital resources within a firm, as well as among firms, industries, and regions, in accordance with a changing demand structure. In short, the metabolic process is also crucial in achieving economic growth. Looking at the founding years of the top 300 firms in terms of market capitalization, there are more firms with long corporate histories in Japan than in the United States (Chart 24). This is evidence that firms themselves have made efforts to self-transform and have successfully managed to cope with a series of environmental changes. It can also be said that dynamism is absent in terms of birth of firms. Changes are surely taking place, however. For instance, looking at developments in the stock market after the Lehman shock, comparatively small firms have recently been performing relatively well (Chart 25). The number of initial public offerings – which showed a large decline in recent years – is gradually on a recovery trend, and such movements are now also being observed outside large metropolitan areas. I am quite encouraged by this development. IV. Regulatory and institutional reforms, corporate governance reform, and social values So far, I have talked about the outline of the measures toward strengthening competitiveness and growth potential. In principle, this should happen in an economy as a result of individual firms’ rational choice. The fact that this is not happening in reality must be the result of economic, institutional, or social factors. Accordingly, there is a need to improve the economic environment, i.e., remove those obstructing factors. Regulatory and institutional reforms First, there needs to be an improvement, promoted by the government, in the environment that will serve to back firms’ efforts aimed at bringing about change. More specifically, it is necessary for the government to carry out bold regulatory reform in order for firms to broaden the areas in which they may embark on new challenges, and to make institutional improvements to the labor market so as to allow workers to move more smoothly into businesses and industries with high growth potential. In order to avoid an increase in excessive social friction arising from responses to changes in the economic environment, it is also necessary to provide support for career changes and to enhance the safety net. Corporate governance reform Second, it is necessary to ensure the appropriate functioning of corporate governance by stockholders and investors.5 On this issue, Germany is a good source of reference. Until the For details on the effects of various legal institutions including corporate governance on corporate profits, please see Nobuyuki Kinoshita, “The Institutional Background to Characteristics of Japanese Firms’ including Low Profitability” (available only in Japanese), IMES Discussion Paper Series 2012-J-12, Institute for Monetary and Economic Studies, Bank of Japan, 2012. http://www.imes.boj.or.jp/research/papers/ japanese/12-J-12.pdf BIS central bankers’ speeches beginning of the 2000s, Germany was named as a country putting off essential structural reforms, and the country indeed suffered from slow economic growth in the first half of the 2000s. Under such circumstances, however, it engaged in various reforms surrounding corporate activity, including institutional reforms that allowed for flexible adjustments to employment as well as enhanced information disclosure to investors. On this point, Japan falls behind Germany, especially when it comes to reforming enterprise law in such areas as corporate rehabilitation, as well as mergers and acquisitions. This is said to hinder dynamic corporate restructuring, thereby eroding the international competitiveness of industries across the board. It is also said that such an environment has accentuated the anxiousness over legal liquidation or removed the fear of being taken over, and encouraged to some extent the excessive accumulation of cash and deposits at firms. Social values Third, society needs to face possible trade-offs between stability and change. Japan has been somewhat dominated so far by a perspective that stressed the importance of stability. The method of adding gradual “improvements” to one’s company’s products in accordance with consumer needs in the existing domestic market can be considered a business management style that puts importance on stability. Merely making improvements focused on the domestic market amid a population decline, however, carries the risk of the economy falling into a shrinking cycle. Corporate profits will suffer even more in the long term if firms continue to keenly compete in terms of prices while maintaining their commitment to securing employment. If I may make a sweeping generalization, firms are facing a judgment call of choosing between “improvement”, which represents continuity, and “innovation”, which represents discontinuity. If the shock against the economy is temporary, there may be a point to overcoming any difficulties in the immediate future via “improvements”, thus prioritizing stability in the long term. Confronting long-lasting shocks such as globalization and population aging by means of the same “improvement” as before, however, may delay responses to significant changes. Reform cannot proceed without public consensus. Bringing about innovation requires firms’ willingness to take on challenges as well as the transfer and reallocation of necessary resources. Frictions may well be experienced in the process. While this is not necessarily an issue with one indisputable solution, if environmental change is long-lasting, I find it extremely important for society as a whole to accept such changes and adopt a view that encourages any and all efforts to take on new challenges, in order to successfully carry out reforms toward strengthening growth potential. V. Relationship with prices So far, I have talked about the efforts to strengthen the economy’s competitiveness and growth potential. Next, getting slightly off track, I will touch upon the relationship between economic growth and prices. The year-on-year rate of change in the consumer price index (CPI) is currently around 0 percent, but is expected to reach 0.9 percent in fiscal 2014, according to the Bank’s forecasts. This is based on the view that Japan’s economy will continue to grow above its potential growth rate and the output gap will be filled, assuming that overseas economies moderately improve. However, considering the fact that the output gap has narrowed significantly compared with its peak, and given the sensitivity of prices to the gap, the closing of the gap alone will not allow us to reach the target of 2 percent right away. What is the general image of an economy that achieved 2 percent inflation, and what is the mechanism behind the process leading up to this state? In theory, one can come up with several cases. The first involves a push from rising import prices as a result of the yen’s depreciation or rising international commodity prices. The second is related to rising wages. In the medium to long term, wages and prices are closely correlated. The third sees rising inflation BIS central bankers’ speeches expectations. Finally, the fourth corresponds with rising growth expectations of firms and households. Which case are we looking for? In the case where import prices push up inflation, household real income is squeezed. The ideal situation is that a rise in wages, a rise in inflation expectations, and a heightening of firms’ and households’ growth expectations take place at the same time. What should be noted here is the relationship between wages and prices. One of the main factors behind low inflation rates in Japan relative to other economies is Japan’s employment practice. Specifically, Japanese society since the second half of the 1990s has prioritized securing employment, and it effected reductions in costs largely by cutting back wages; consequently, prices fell (Chart 26). Looking at development patterns of corporate profits, wages, and prices during economic recovery phases, these three indicators moved together in the same direction during the high-growth era in the 1970s (Chart 27). At present, neither wages nor prices have changed materially even in the economic recovery phase, as corporate profits have acted as a buffer to absorb shocks, with the labor distribution rate rising during economic recession phases and declining during recovery periods. The primary cause for this is the decline in firms’ profitability, which in turn reflects the decline in the potential growth rate. On this point, looking at the relationship between medium- to long-term inflation expectations and potential growth rates, there is a clear positive correlation in Japan (Chart 28). If firms’ and households’ growth expectations improve, this will have a positive effect on wages and prices in a sustainable manner. Consequently, “deflationary expectations” that had taken hold over a prolonged period will fade away. VI. The will to reform While it generally has been recognized that there is a need to work toward strengthening competitiveness and growth potential, and that meeting these challenges is essential in overcoming deflation and achieving sustainable growth with price stability, why is it that such efforts have not made progress? On this point, the key lies in the sense of urgency regarding the need for reform. The problems currently facing Japan’s economy, namely, the rapid aging of the population and accompanying issues, are not temporary. They are steadily affecting the economy in the manner of a chronic illness. Deterioration of fiscal conditions is a textbook example of such problems. In order to maintain fiscal sustainability, it is necessary to reform the structure of expenditures and revenues as well as strengthening growth potential. Unless the growth rate rises, a modest increase in the rate of inflation alone will barely improve the fiscal balance. While such chronic symptoms exist in Japan, acute ones have not appeared. The biggest reason for this lies in the fact that Japan holds a massive amount of external net assets reflecting the current account surplus that has continued over a prolonged period. Because of this, Japan tends to experience inflows of capital that search for a safe haven, even in the event of a global economic shock, and enjoy stable long-term interest rates while facing an appreciation of the yen. Japan has not experienced any sell-off of its currency in a crisis. In this regard, I would like to make reference to recent developments in financial markets. The keywords to understanding movements in the global financial markets over the last several years are risk-on and risk-off. When faced with a great amount of uncertainty about the future, investors stay away from risks – in other words, they become risk-off – but when such uncertainty is judged small, they become risk-on (Chart 29). The basic background to the yen’s appreciation that lasted until summer 2012 was investors’ preference for safe assets as the European debt problem intensified. Indeed, it was in late July that the yen hit its recent peak in the nominal effective exchange rate and the Spanish and Italian sovereign rates reached the most elevated levels. After that, a variety of safety valves to cope with the European debt problem were put in place in Europe and the fiscal cliff was avoided in the United States. Against the background of these developments, global investors’ risk aversion has substantially receded. Broadly speaking, the yen’s recent depreciation and rise in stock BIS central bankers’ speeches prices in Japan are also taking place amid such changes in those investors’ risk aversion. Put differently, investors’ attitude toward risk may influence market conditions. I believe this could be easily understood by looking back at the fact that yields on government securities of member states of the euro area had remained at practically the same levels for nearly ten years. What ultimately drives market developments is economic fundamentals. Over the last 15 years in Japan, there were several phases when the yen depreciated. Although exports and production increased during those phases, we regrettably did not succeed in raising the potential growth rate (Charts 30 and 31). The important thing is to make use of the current favorable conditions and make steady efforts to strengthen the competitiveness and growth potential of the economy. VII. Conduct of monetary policy by the Bank of Japan Lastly, I would like to go over the recent monetary policy measures by the Bank of Japan. As I mentioned at the outset, the Bank recognizes that the inflation rate consistent with price stability on a sustainable basis will rise as efforts by a wide range of entities toward strengthening competitiveness and growth potential of Japan’s economy make progress. Based on this recognition, at the Monetary Policy Meeting held in January, the Bank set and announced the “price stability target” at 2 percent in terms of the year-on-year rate of change in the CPI. As stated 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”. Put differently, the Bank aims at achieving price stability with which Japan’s economy will grow in a sustainable and balanced manner, and under such a principle, the Bank has been pursuing aggressive monetary easing with the aim of achieving this price stability target at the earliest possible time. The Bank, under the Asset Purchase Program, will additionally purchase financial assets amounting to about 36 trillion yen, mainly JGBs, by the end of this year. Furthermore, from January 2014 onward, it will purchase about 13 trillion yen worth of assets, 2 trillion yen of which will be JGBs, every month without setting any termination date. The Bank is committed to pursuing, without loosening the reins, aggressive monetary easing with the aim of achieving the “price stability target”. Efforts by the government, in parallel with appropriate monetary easing measures, are important in order to overcome deflation early and achieve sustainable growth with price stability, for the following reasons. First of all, if the government’s efforts to strengthen competitiveness and growth potential make progress, economic agents will take further advantage of the accommodative financial conditions and the effects of monetary easing will be increasingly amplified. At present, money, or liquidity that the Bank has been supplying, is increasing significantly; however, prices have not been responding accordingly (Chart 32).6 Private financial institutions have been increasing their government bond holdings rather than lending (Chart 33). On this point, the government has stated its intention to advance structural reform of the economy by making use of all possible decisive policy actions, including carrying out bold regulatory and institutional reforms. The Bank expects that forceful efforts will be forthcoming in this regard. Meanwhile, the Bank itself has established a “Loan Support Program” through which to encourage proactive efforts by firms and financial institutions, using the levers of finance.7 On this point, Chairman Bernanke of the Federal Reserve stated during the press conference on December 12, 2012 that “there’s no effect on inflation expectations from the size of our balance sheet”. For details, please see Federal Reserve Board, “Transcript of Chairman Bernanke’s Press Conference”, December 12, 2012. http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20121212.pdf The Bank established the “Loan Support Program” by integrating the “Growth Supporting Funding Facility” introduced in June 2010 and the “Stimulating Bank Lending Facility” introduced in October 2012. BIS central bankers’ speeches Together with the aforementioned Asset Purchase Program, the Bank will supply additional funds amounting to over 60 trillion yen in the next two years. The amount outstanding will exceed 130 trillion yen, which is about 30 percent of nominal GDP (Chart 34). While monetary easing by the central bank has a stimulating effect on current economic conditions by bringing forward tomorrow’s demand to today, so to speak, such effect will wane once it becomes tomorrow and unless demand for the day after is brought forward. At any rate, the size of the demand brought forward depends on future growth potential. This makes efforts to raise the potential growth rate itself all the more important. If such efforts by the Bank on the financial side and those by the government to strengthen the growth potential could instigate a virtuous cycle and bring about synergies, the policy effects are likely to be amplified. Second, in order to pursue aggressive monetary easing, ensuring confidence regarding fiscal policy is also important. As part of its monetary easing, the Bank has been purchasing a substantial amount of government bonds. Given the severe fiscal conditions, however, if such purchases were regarded as monetizing government debt in the markets at home and abroad, there is a risk that long-term interest rates would rise. In particular, if efforts to strengthen the growth potential do not make progress and the Bank’s holding of JGBs continues to increase, that risk becomes more imminent. Were this to occur, not only would the effects of monetary easing weaken, but there would also be adverse effects on the real economy through the impacts on the businesses of financial institutions holding a large amount of government bonds.8 In that sense, discipline is expected of both the government and the Bank. Discipline within the Bank is stipulated by the purpose imposed on the central bank, that is, contributing to sustainable growth through price stability and financial system stability. Meanwhile, the government is required to uphold fiscal discipline. On this point, the government stated clearly that it “will steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management”. Once credibility is eroded and the economy falls into a state of confusion, there will be limited room for maneuver by the central bank. Economists generally refer to this kind of situation as “fiscal dominance”. In order to prevent such a situation from materializing, it is important to engage in efforts to achieve fiscal reform, thereby maintaining fiscal discipline in the medium to long term. Final remarks While there is active discussion regarding the conduct of economic policy in Japan, I personally feel there is a need to earnestly discuss what it is that we truly want to achieve when referring to “overcoming deflation”, and what it is that we must carry out in order to accomplish this. The opportunity is right in front of us now. Once we find what we want, we must take action. The Bank will continue to do its utmost toward overcoming deflation early and achieving sustainable growth with price stability. The purpose of the central bank is to lay stable economic and financial foundations that support the sustainable growth of the economy.9 In doing so, it goes without saying that the Bank will thoroughly examine the outlook for economic activity and prices and risk factors to sustainable growth. Independent central On the relationship between fiscal sustainability and financial system stability, as well as price stability, 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 For more on this point, please see Masaaki Shirakawa, “The Roles, Missions, and Challenges of the Central Bank” (Speech at the Japan National Press Club in Tokyo), January 25, 2013. http://www.boj.or.jp/ en/announcements/press/koen_2013/data/ko130130a.pdf BIS central bankers’ speeches banks are obviously expected to explain the effects as well as costs of measures in the longer term. I believe this is what accountability means. As the experience of the global credit bubble in the mid-2000s suggests, time and again, the seeds of new problems and unexpected crises have already been sown as authorities respond to a problem. This provides us with a renewed sense of awareness of the importance of humility to learn from history and of stability from a medium- to long-term perspective. The Bank of Japan will continue to listen to a variety of views and conduct monetary policy appropriately on the judgment and under the responsibility of its Policy Board with the aim of overcoming deflation early and achieving sustainable economic growth with price stability. I ask for your continued support. 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 BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches 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, Kochi, 20 February 2013.
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, Kochi, 20 February 2013. * * * I. Recent financial and economic developments A. Overseas developments 1. Global financial markets I would like to start with developments in global financial markets and overseas economies, which affect Japan’s economy. Against the backdrop of the European debt problem, some nervousness continued to be seen in global financial markets through summer 2012, but the tail risk of a potential disintegration of the euro, which some had feared at one time, has receded since the autumn. This is because gradual progress has been made in discussions and measures for further strengthening and restructuring the euro area to form an economic and financial union with greater stability. Steps include (1) the introduction of the modalities for undertaking Outright Monetary Transactions (OMTs) by the European Central Bank (ECB), which have created a safety valve in government bond markets, especially in peripheral countries such as Spain and Italy; and (2) an agreement to establish a single banking supervisory mechanism in Europe to ensure the stability of the European financial system. More recently, it emerged that the amount of early repayments under the ECB’s 36-month longer-term refinancing operations (LTROs), implemented in early 2012 in response to the crisis, turned out to be larger than markets expected, suggesting that the financial system is regaining stability. Meanwhile, in the United States the “fiscal cliff” has been avoided and investors’ risk aversion has been abating. Nevertheless, as these factors contain numerous inherent uncertainties, market developments require continued attention. 2. Overseas economies Under these circumstances, the extent of deceleration in many overseas economies became more pronounced through summer 2012 due in part to the anxiety in global financial markets reflecting concern over the European debt problem. Overseas economies remained in a deceleration phase thereafter, but at present, while the euro area economy remains stagnant, the U.S. and Chinese economies show some positive developments. As for the outlook, assuming that global financial markets remain stable on the whole, overseas economies are expected to gradually emerge from the deceleration phase and turn to a moderate recovery. 3. Euro area economy By region, economic activity in the euro area has been receding slowly. Given the continued adverse feedback loop in peripheral countries among the fiscal situation, the financial system, and economic activity, business and household sentiment has become cautious. Because fiscal austerity measures will continue, economic activity is expected to continue receding slowly for the time being. However, while tensions in financial markets have been easing, business sentiment has shown signs of improvement in core countries such as Germany. Regarding the outlook, as economies outside the euro area pick up, economic activity in the euro area – particularly in the core countries – is likely to gradually emerge from the deceleration phase, led by exports. BIS central bankers’ speeches 4. U.S. economy The U.S. economy continued to recover at a moderate pace, particularly in the household sector, supported by accommodative financial conditions. Although some weakness can be seen in household sentiment due to the effects of the expiration of the payroll tax cut at the beginning of 2013, the employment situation has been improving, albeit modestly, and private consumption has been firm, as evidenced by continued brisk car sales. Housingrelated investment has also continued to show signs of picking up, albeit at a depressed level. Because the fiscal cliff was avoided, reducing the risk of a sharp fiscal tightening, business sentiment has been improving, and consequently, the deceleration in business fixed investment is coming to a halt. The U.S. economy is likely to continue recovering, supported by accommodative financial conditions. Nevertheless, the pace of recovery is likely to remain only moderate for the time being, reflecting the lack of momentum in external demand as well as continued downward pressure from the fiscal side. 5. China’s economy, and the NIEs and the ASEAN economies With regard to emerging countries, the Chinese economy has been regaining stability on the back of firm domestic demand. Domestic demand as a whole has been firm, as evidenced by the uptrend in infrastructure investment and retail sales. There are also signs of a bottoming out in exports and imports. Reflecting these developments in demand at home and abroad, industrial production has also been stabilizing. As for the outlook, domestic demand is expected to remain firm, partly due to the effects of policies taken since mid-2012 such as monetary easing and the front-loading of public works projects. Under these circumstances, as inventory adjustments make progress and exports gradually pick up, the recovery of the Chinese economy is likely to become more pronounced. However, since China’s new administration has launched a policy emphasizing “quality-based” growth and targeting well-balanced growth, the pace of economic growth in China is expected to be restrained relative to the high growth in the mid-2000s. The NIEs and the ASEAN economies are picking up only moderately, led by the corporate sector, but are expected to gradually regain momentum underpinned by firm private consumption. B. Japan’s economy and prices 1. Economic activity I will now explain the current state of, and outlook for, Japan’s economy given the overseas economic developments I have just outlined. Japan’s economy picked up rapidly following the plunge caused by the Great East Japan Earthquake, which struck just as the economy was recovering from the Lehman shock, and it posted relatively high growth in the first half of 2012. In the second half of 2012, however, the economy as a whole was relatively weak as exports and industrial production dropped sharply due to the effects of the deceleration in overseas economies. However, this downward momentum has recently been coming to an end. Specifically, the pace of decrease in exports has been moderating in a situation where some signs of picking up have been observed in overseas economies, particularly in the United States and China. In addition, private consumption has been resilient, and the effects of the decline in car sales due to the ending of subsidies for purchasers of environmentally friendly cars have fallen off. Meanwhile, public investment has continued to increase, and housing investment has generally been picking up. With regard to the outlook, as the effects of various economic measures underpin domestic demand and overseas economies emerge from the deceleration phase, exports and industrial production are likely to start picking up, and these improvements are likely to feed through into business fixed investment and private consumption. In addition, recent movements in foreign exchange rates are likely to contribute to the underpinning of exports and corporate profits. Under these circumstances, Japan’s economy is likely to more or less level off for the time being and subsequently return to a moderate recovery path toward mid-year. BIS central bankers’ speeches The economic growth rate in fiscal 2013 is expected to be relatively high, mainly owing to the effects of various economic measures and foreign exchange rate movements. Although the economic growth rate is likely to decrease mainly due to a decline in demand following the front-loading of consumption prior to the consumption tax hike, growth is expected to remain above potential in fiscal 2014. In the Bank of Japan’s interim assessment in January 2013, the median of the Policy Board members’ forecasts for Japan’s real GDP growth rate is 2.3 percent for fiscal 2013 and 0.8 percent for fiscal 2014. 2. Prices Next, I will talk about price developments. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is around 0 percent. For the time being, it is expected to turn negative due to the reversal of the previous year’s rise in energy prices and of the movements in durable consumer goods, and thereafter, it is likely to be around 0 percent again. However, in the somewhat longer term, the rate of change is likely to turn positive as the aggregate supply and demand balance improves due to the recovery of Japan’s economy, and is expected to gradually rise in fiscal 2014. In the Bank’s interim assessment in January 2013, the median of the Policy Board members’ forecasts for the year-on-year rate of increase in the CPI (all items less fresh food; excluding the direct effects of the consumption tax hike) is 0.4 percent for fiscal 2013 and 0.9 percent for fiscal 2014. C. Uncertainty surrounding the outlook The baseline scenario for Japan’s economy described thus far is subject to both upside and downside risks. Risk factors that particularly warrant close attention are developments in overseas economies and uncertainty with regard to firms’ and households’ medium- to long-term growth expectations. With regard to overseas economies, remaining uncertainty over the European debt problem and future developments in the relations between Japan and China require due attention. As for the Chinese economy, whether it will succeed in making a smooth transition to stable growth is a key issue. The economy is likely to face various structural changes, including in labor supply and demand conditions following the reduction of excess capacity in the manufacturing sector and surplus labor in rural areas, as well as in the supply and demand conditions for resources. Attention therefore needs to be paid to the risk that these changes will impose constraints on the Chinese economy. On the other hand, the so-called shale revolution in the United States may buoy up the U.S. economy through declines in energy and materials prices. With regard to the Japanese economy, various economic measures will likely boost its growth rate for the time being; in the meantime, however, there is uncertainty over the extent to which the economic measures can promote a virtuous circle in which firms’ and households’ medium- to long-term growth expectations rise as a result of progress in regulatory reforms. As for prices, attention needs to be paid to the possibility that materialization of the aforementioned risks to economic activity could exert considerable effects on developments in prices, including the supply and demand balance. II. Monetary policy under the “price stability target” Next, I would like to turn to the Bank’s conduct of monetary policy under the current economic and price situation. In order for Japan’s economy to overcome deflation as early as possible and return to a sustainable growth with price stability, the Bank has been pursuing aggressive monetary easing. At the Monetary Policy Meeting held on January 21 and 22, 2013, the Bank took decisive additional steps to provide monetary accommodation. Specifically, the Bank decided to introduce (1) the “price stability target” in place of the “price stability goal in the medium to long term”, and (2) the “open-ended asset purchasing method” under the Asset Purchase Program. Furthermore, the Bank released “Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth” with the BIS central bankers’ speeches government. In addition, by providing strong support to lending by financial institutions, the Bank is making efforts to ensure that firms and households make use of the accommodative financial conditions. In what follows, I will explain the aim of, and thinking behind, the Bank’s policy measures. A. Introduction of the “Price Stability Target” of 2 percent 1. What is “price stability”? I would now like to explain the details of the “price stability target”. The Bank conducts monetary policy based on the principle that monetary policy shall be aimed at “achieving price stability, thereby contributing to the sound development of the national economy”. On this basis, I would like to explain the price developments under which the Bank perceives “price stability” and the reasons for setting the target at 2 percent in terms of the year-on-year rate of change in the CPI. “Price stability” is defined conceptually as a state where various economic agents may make decisions regarding such economic activities as consumption and investments without being concerned about the fluctuations in the general price level, and this must be achieved on a sustainable basis. The Bank considers “price stability” to be a situation in which the economy improves in a balanced and sustainable manner, accompanied by increases in employment, wages, and corporate profits, and prices rise moderately as a result. To put it simply, what the Bank is aiming to achieve with the “price stability target” is to create an environment in which corporate profits and wages rise in a sustainable manner that primarily reflects increases in productivity. For example, when import prices rise, this may push up the inflation rate, but such an increase in inflation is not accompanied by an improvement in the economy because the terms of trade will deteriorate and real income of households and firms will fall. This is not the type of inflation the Bank aims to achieve. In Japan, given that inflation has been hovering at a low level of close to 0 percent year on year for a prolonged period, low inflation expectations have become entrenched in firms’ and households’ decision making. Given this, the “price stability target” of 2 percent may be seen as somewhat high. However, as I explained earlier, the year-on-year rate of change in the CPI is projected to move closer to 1 percent through fiscal 2014 supported by a recovery in the economy. If, in this situation, efforts by a wide range of entities to raise the competitiveness and growth potential of Japan’s economy bear fruit and firms’ and households’ inflation expectations rise as a result, the inflation rate consistent with price stability on sustainable basis will rise as well after fiscal 2014. The Bank will continue to provide support from the financial side through measures to pursue aggressive monetary easing and support strengthening the foundations for economic growth in order to underpin the signs of recovery currently seen. The Bank will do its utmost so that the CPI will rise steadily to the target of 2 percent and that the target will be achieved at the earliest possible time. 2. Inflation mechanism Now, I would like to briefly explain the mechanism through which the inflation rate rises. From a somewhat long-term perspective, there is a mild positive correlation between the rate of increase in the CPI and the aggregate supply and demand balance. If, as a result of an improvement in the economy, aggregate demand in the economy as a whole increases relative to production capacity and, therefore, the balance between aggregate supply and demand improves, the rate of increase in the CPI will rise with a time lag of several quarters. Since the mid-1990s, Japan’s economy has tended to face a shortage of aggregate demand and the rate of change in the CPI (all items less fresh food) has been on a moderate declining trend since the latter half of the 1990s, with the exception of 2007 and 2008. The aggregate supply and demand balance reached nearly minus 8 percent after the Lehman shock, and although it has recently narrowed to about minus 2 to 3 percent, upward BIS central bankers’ speeches momentum on prices has not been sufficiently strong. This shortage of demand reflects not only cyclical factors but also structural ones. As a result of globalization and the unparalleled decline in the birth rate and aging of the population, the environment surrounding Japan’s economy has changed dramatically but economic structures have been slow to adapt. As a consequence, economic growth has declined as a trend, lowering growth expectations, which in turn has led to a chronic shortage of demand. Due to this shortage, many firms have cut costs, mainly by reducing wages. Despite these efforts, however, corporate profits have not increased because fierce price competition has prevented firms from raising prices on their goods. Consequently, unable to foresee a clear improvement in profits, firms have inevitably turned cautious about increasing fixed investment, employment, and wages. 3. Importance of strengthening the growth potential In order to overcome this situation, it is essential to strengthen the growth potential of the economy to raise firms’ and households’ medium- to long-term growth expectations and to resolve the chronic shortage of demand. Because it is impossible to halt the decline in the birth rate and the aging of the population in the short run, a prerequisite for strengthening the growth potential of the economy is to secure the labor force and raise the value added per worker (value-added productivity). In order to secure the labor force, it is important to (1) make the labor market more flexible, and (2) make it easier for labor to move from one industry to another and for women and the elderly to participate in the labor market. If the situation remains unaddressed and the labor force continues to decline, this will push down Japan’s annual economic growth rate in the 2010s by approximately 0.6 percentage point. This population issue is not unique to Japan. China’s labor force also started to decline in 2012, giving rise to a sense of crisis. A shrinking labor force is a problem that many other advanced and emerging countries will face in the near future. In Japan, it is estimated that if the labor force participation rate of women were to rise to the level of Sweden by 2030 and that of the elderly (those aged 60 and over) were also to rise, the Japanese labor force would increase at an annual rate of 0.2 percent in the 2010s. As for the employment of the elderly, in view of the gradual rise in the pensionable age of the national pension to 65, starting in April 2013 it will be mandatory for firms to provide employment to elderly workers who wish to keep working. Given that Japan succeeded in shifting from a retirement age of 55 to 60 toward the 1980s, it should be possible to create a society in which it is normal to work until the age of 65 or beyond through institutional reforms and changes in the way people work. To raise value-added productivity, it is necessary to build an economic environment where innovations in a broad sense – including the development of new business models – can be achieved more easily. Recently, firms have been making active efforts in a wide range of areas to capitalize on social changes, including business focusing on the elderly, the environment and energy, and information and telecommunications. If firms accelerate efforts on these fronts and reorient their strategies from concentrating on price competition to competition based on new goods and services, and if this is accompanied by increases in the labor force and value-added productivity, firms’ and households’ medium- to long-term growth expectations should rise amid vigorous economic activity. B. Fostering more accommodative financial conditions: maintaining a virtually zero interest rate policy and increasing asset purchases I will now explain the Bank’s powerful monetary easing measures to achieve the “price stability target” of 2 percent. The Bank is pursuing aggressive monetary easing through its commitment to continue with a virtually zero interest rate policy and purchases of financial assets for as long as the Bank judges appropriate. Through the Asset Purchase Program established on its balance sheet, the Bank purchases various financial assets – such as Japanese government securities (JGSs), CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) – and conducts the fixed-rate funds-supplying operation against pooled collateral. The program is aimed at encouraging BIS central bankers’ speeches declines in longer-term interest rates and various risk premiums to foster more accommodative financial conditions for firms and households to raise sufficient funds at low interest rates. The size of the Asset Purchase Program, which was set at about 35 trillion yen at the time of its establishment in October 2010, has successively been increased, and the amount outstanding of the program was about 65 trillion yen at the end of December 2012. The Bank will continue to significantly increase the amount outstanding of the program until it reaches about 101 trillion yen by the end of December 2013. In addition, the Bank decided at the Monetary Policy Meeting held on January 21 and 22, 2013 to introduce, after completing the current purchasing method, a method of purchasing a given amount of financial assets every month without setting any termination date. Specifically, from January 2014, the Bank will conduct purchases of financial assets totaling about 13 trillion yen each month for some time. As a result, the amount outstanding of the Asset Purchase Program will be increased further by about 10 trillion yen in 2014 – to about 111 trillion yen – and is expected to be maintained thereafter. C. Strengthening policy coordination between the government and the bank On January 22, 2013, the Bank released “Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth”. The Bank announced that it was setting the “price stability target” at 2 percent in terms of the year-onyear rate of change in the CPI, and that, under this target, it would pursue monetary easing and aim to achieve this target at the earliest possible time. The Bank stated that it would ascertain whether there was any significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances. The government, on the other hand, announced that it would formulate and strongly promote measures for strengthening the competitiveness and growth potential of Japan’s economy, and steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management. The government plays a crucial part in strengthening the growth potential of the economy. Specifically, strengthening the growth potential hinges on the cumulative efforts of firms and financial institutions to create and expand new business. In this context, the government plays a pivotal role in fostering, through regulatory and institutional reforms, an environment that encourages the private sector to take on new challenges. While the Bank continues to pursue aggressive monetary easing through measures such as large-scale purchases of JGSs, Japan’s fiscal imbalances – among the most serious in the world – could hamper the effects of monetary easing. If the credibility of Japan’s fiscal management were to falter, interest rates would likely rise, thereby making fiscal management more difficult and undermining the effects of monetary easing. In order to fully ensure the effectiveness of monetary easing, it is important for the government to ensure market credibility of fiscal consolidation. In this regard, the joint statement has profound significance in showing that the government and the Bank have clearly acknowledged each other’s roles and that they will work together to overcome deflation and achieve sustainable economic growth. D. Making use of accommodative financial conditions: providing a boost through the loan support program Given the Bank’s aggressive monetary easing I described earlier, financial conditions in Japan are extremely accommodative both in historical and international comparison. To be specific, in terms of firms’ funding costs, both short- and long-term average interest rates on new loan contracts have hit 1 percent – an unprecedented level. In terms of households’ borrowing costs, variable mortgage rates are below 1 percent and even 35-year fixed mortgage rates are around 2 percent. Moreover, financial institutions’ lending attitude remains accommodative, issuing conditions for CP and corporate bonds remain favorable on BIS central bankers’ speeches the whole, and an environment has been maintained in which households and firms can feel secure that they can gain access to funds. Meanwhile, even at a time when there were strong headwinds generated by the Great East Japan Earthquake and the European debt problem, extremely accommodative financial conditions have been firmly maintained. In order for Japan’s economy to achieve sustainable growth with price stability, it is important that firms and households actually make use of the accommodative financial conditions for funding and increase investment and spending, which in turn will lead to an improvement in the aggregate supply and demand balance. As for recent developments in credit demand, although firms have shown signs of increasing their demand mainly for working capital and funds related to mergers and acquisitions, business fixed investment has been financed from cash flows, indicating that accommodative financial conditions have not been used to the fullest possible extent. To promote full use of the accommodative financial conditions, the Bank has established the Loan Support Program, consisting of the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility) and the fund-provisioning measure to stimulate bank lending (hereafter the Stimulating Bank Lending Facility). These facilities are offered for your use. 1. The growth-supporting funding facility The Growth-Supporting Funding Facility was introduced with the aim of supporting the flow of funds to areas with growth potential. With this facility, the Bank provides long-term funds at a low interest rate to financial institutions for their lending and investment to areas that are expected to contribute to strengthening Japan’s growth potential, such as medical and nursing care; environment and energy; agriculture, forestry, and fisheries; and tourism. In addition to the lending arrangement under the main rules, the Bank has established special rules for a lending arrangement through which it extends loans to financial institutions for their equity investments and asset-based lending (ABL). In ABL, assets such as accounts receivable and inventories are used as eligible collateral. Moreover, the Bank has established special rules for another lending arrangement for small-lot investments and loans as well as for a U.S. dollar lending arrangement of 12 billion U.S. dollars – equivalent to 1 trillion yen – using the U.S. dollar reserves already held by the Bank, for foreign currencydenominated investments and loans. The total size of these lending arrangements making up the Growth-Supporting Funding Facility was set at about 5.5 trillion yen, of which nearly 4 trillion yen has already been disbursed by the Bank. The amount of lending and investment actually provided by financial institutions using this facility greatly exceeds the amount of loans disbursed by the Bank. This indicates that the Bank’s measures have been producing positive effects as a catalyst. 2. The stimulating bank lending facility In October 2012, the Bank introduced the Stimulating Bank Lending Facility with the aim of prompting financial institutions to take a more active stance and stimulating greater proactive credit demand of firms and households. With this facility, the Bank will provide long-term yen-denominated funds at a low cost to financial institutions that have increased their lending, at their request, up to an amount equivalent to the net increase in their lending for a period of 15 months until the end of March 2014. The lending, based on which the net increase is calculated, can be either yen-denominated or foreign currency-denominated. While it may be extraordinary for a central bank to support lending – particularly foreigncurrency denominated lending – to firms located overseas or lending by domestic financial institutions’ overseas offices, Japanese firms’ international operations as well as financial institutions’ activities to provide funds for such operations are essential in capturing global demand, so that the Bank’s measure to support such lending contributes to strengthening Japan’s growth potential. Based on recent lending data, the amount of funds provided through the Stimulating Bank Lending Facility is expected to reach more than 15 trillion yen by the end of March 2014. BIS central bankers’ speeches E. Quantitative aspects of monetary easing The Bank will provide a massive amount of funds exceeding 50 trillion yen by the end of March 2014 under the Asset Purchase Program and the Loan Support Program, and the amount outstanding of these programs will exceed 120 trillion yen. Looking at the amount of funds disbursed by the Bank in terms of the monetary base, the ratio relative to nominal GDP in Japan is currently about 27 percent, the highest level among the advanced economies. When considering the additional funds of more than 50 trillion yen to be provided, the ratio will rise further by more than 10 percentage points to almost 40 percent. As these figures show, the Bank will proceed with unprecedentedly massive monetary easing this year. On this basis, it will continue to closely examine the financial and economic environment, and make policy decisions in a timely and appropriate manner. If the large amount of funds provided at low cost on the basis of these accommodative financial conditions is utilized effectively and invigorates corporate activity, this should bring an improvement in firms’ profit prospects and an increase in the expected rate of return on new investment. Once such a virtuous circle has taken hold, the accommodative financial conditions will have even stronger effects, and the virtuous circle will become more sustainable. As mentioned earlier, “price stability” is achieved in a situation in which the economy improves in a balanced and sustainable manner, accompanied by increases in employment, wages, and corporate profits, and prices rise moderately as a result. The Bank will do its utmost to fulfill its responsibility to achieve the “price stability target”. BIS central bankers’ speeches
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Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kanagawa, 28 February 2013.
Takahide Kiuchi: Recent developments in economic activity and prices and future monetary policy Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kanagawa, 28 February 2013. * * * I. Current situation of overseas economies and their prospects for a moderate recovery A. Easing of tension in global financial markets I would like to start my speech with a look at overseas economies. Developments in global financial markets continue to require vigilance, especially in terms of the European debt problem and the fiscal problem in the United States. Nevertheless, tension in the financial markets has eased significantly since around autumn 2012, as evidenced by the repurchasing of risk assets such as currencies of emerging economies and stocks and the selling of advanced economies’ government bonds and the yen, which had been purchased as a safe currency. Three things seem to be at work in the background to these developments. First, in Europe and the United States, a decline has occurred in tail risks – risks with a low probability of materialization but a devastating impact if they materialize. This reflects the fact that in Europe the possibility of disintegration of the euro has fallen significantly, supported by (1) the approval of new disbursement of financial assistance to Greece, (2) some progress achieved in fiscal consolidation and economic structural reforms by peripheral European countries such as Portugal and Spain, and (3) the introduction of safety valves such as the European Stability Mechanism (ESM). In addition, at the beginning of 2013 the United States avoided the “fiscal cliff,” a state in which the expiration of largescale tax cuts and substantial fiscal spending cuts threatened to occur simultaneously. Second, investors’ confidence has returned due to expectations regarding policy measures, as central banks in advanced economies such as the United States and Europe as well as Japan have conducted aggressive monetary easing. Third, expectations have grown that the global economy will pick up, as the U.S. and Chinese economies have firmed since autumn 2012. B. Gradual pick-up in overseas economies from a deceleration phase While overseas economies remain in a deceleration phase as a whole, signs of a pick-up have been observed. The U.S. economy has been on a moderate recovery trend. Business sentiment that had been cautious due to concerns over the fiscal cliff has improved somewhat, and business fixed investment has shown signs of a pick-up. In the household sector, firmness in housing investment and car purchases has become pronounced partly due to the effects of the decline in long-term interest rates. As for the outlook, the recovery trend in the U.S. economy is likely to gradually strengthen in the latter half of 2013, as the effects of expiration of tax cuts wane and uncertainties diminish in regard to fiscal spending cuts and the debt ceiling problem. Economic activity in the euro area remains weak. From the latter half of 2013, however, economic activity is likely to gradually recover particularly in core countries such as Germany and France. This is because (1) disturbances in financial markets have been diminishing; (2) the degree of fiscal austerity, while continuing, has eased somewhat; and (3) the competitiveness of peripheral countries’ exports has begun to recover with the progress in structural reforms, including reductions in labor costs. The Chinese economy has been generally picking up since autumn 2012, as the government’s expansionary fiscal measures centered primarily on infrastructure investment and monetary easing measures have been producing positive effects. The real GDP growth BIS central bankers’ speeches rate in the January-March quarter of 2013 is expected to recover to the 8.0–9.0 percent level for the first time in a year. In these circumstances, looking at the outlook for the global economy as a whole, the real GDP growth rate is expected to accelerate moderately from 3.2 percent in 2012 to 3.5 percent in 2013 and 4.1 percent in 2014, according to the latest World Economic Outlook released by the International Monetary Fund (IMF) in January 2013. If the global economy – led by emerging economies – registers growth rates as projected, the rates will be above the historical long-term average. II. Current situation of Japan’s economy and its prospects, with the key factor of a pick-up in overseas economies A. Leveling out of Japan’s economy Japan’s economy remained relatively weak during the latter half of 2012, as exports and production decreased significantly due mainly to the deceleration in overseas economies, which in turn adversely affected domestic demand such as business fixed investment in the manufacturing industry. However, recent developments show that the pace of decrease in exports has been moderating and production appears to have stopped decreasing. Based on these developments, at the Monetary Policy Meeting (MPM) held on February 13 and 14, 2013, the Bank of Japan revised upward its basic assessment of the domestic economy, from an assessment that the economy remained relatively weak to an assessment that it appeared to have stopped weakening. The leveling out of production is mainly attributable to three factors. First, the effects of the ending of subsidies for purchasing energy-efficient cars, which temporarily exerted strong downward pressure on car production, have fallen off. Second, the effects of the recent developments in the relations between Japan and China, which dealt a serious blow particularly to exports of cars and related items, have eased somewhat. And third, the pace of decrease in exports has been moderating as overseas economies such as the United States and China have shown some signs of picking up. Nevertheless, while exports are showing some signs of leveling out, it is necessary to closely monitor whether a clear increase will occur in exports, which are expected to become the driving force of a fullfledged economic recovery. Consequently, uncertainty remains over how Japan’s economy will achieve a full-fledged recovery. B. Effects of fiscal policy measures, the depreciation of the yen, and the rise in stock prices Japan’s growth rate for 2013 is expected to rise relatively steadily, in line with the accumulation of temporary boosting effects of various policy measures. First, the implementation of the supplementary budget for fiscal 2012 of about 20 trillion yen is expected to have an effect, particularly in public investment, from the April-June quarter of 2013 onward. Second, the recent developments in foreign exchange rates and stock prices – supported in part by expectations for the new administration’s economic and fiscal policies as well as for the Bank’s enhancement of monetary easing – are expected to gradually have positive effects mainly in exports and private consumption. Third, a front-loaded increase in demand prior to the hike in the consumption tax scheduled in April 2014 is likely to take place particularly in demand for housing and durable consumer goods. According to the median of the forecasts of the majority of the Bank’s Policy Board members in the interim assessment of the October 2012 Outlook for Economic Activity and Prices, released in January 2013, the real GDP growth rate is expected to be 1.0 percent for fiscal 2012, accelerate to 2.3 percent for fiscal 2013, and decline to 0.8 percent for fiscal 2014 even after accounting for the effects of the consumption tax hike. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is expected to rise BIS central bankers’ speeches gradually reflecting an improvement in the output gap as a result of the economic growth rate continuing to exceed the potential growth rate. As for the median of the forecasts, the yearon-year rate of change in the CPI is projected to be minus 0.2 percent for fiscal 2012, 0.4 percent for fiscal 2013, and 0.9 percent for fiscal 2014 excluding the direct effects of the consumption tax hike. Meanwhile, with regard to risk factors, attention should be paid to the prospects for the European debt problem, the momentum toward recovery for the U.S. economy, the possibility of emerging and commodity-exporting economies making a smooth transition to a sustainable growth path, and the effects of the recent developments in the relations between Japan and China. With these factors taken into consideration, a high degree of uncertainty remains concerning Japan’s economy. III. Downside risks to the economic outlook A. Weak recovery of overseas economies With respect to the aforementioned baseline scenario of the outlook for economic activity and prices in Japan, I consider the downside risks to be rather large. The greatest concern arises from the possibility of the deceleration in overseas economies. Although overseas economies are likely to gradually emerge from their current deceleration phase, the sustainability of their recovery will likely remain unpredictable. In the United States, housing investment and private consumption are expected to be the driving force of the pick-up in the economy in the short run; if the recent uptrend in long-term interest rates strengthens suddenly, however, this could adversely affect funding for housing investment and car purchases. Attention should also be paid to the risk that the persisting uncertainty over fiscal policy could exert downward pressure on the U.S. economy with an influence on public sentiment. With regard to the euro area, it is necessary to remain continually vigilant against the risk that financial markets could suffer renewed disturbance if political and social instability hinders fiscal consolidation and economic structural reforms and if slow progress in coordinating national interests hampers Europe’s ongoing integration such as the formation of fiscal and banking union. In addition, since banks’ lending attitudes have not shown signs of easing, there is a risk that funding constraints could prevent the economy from emerging from the deceleration phase for a long time. As for China, the government’s policy stance is the focus of attention. Because aggressive fiscal measures adopted after the Lehman shock left many issues unresolved – such as excessive capital stock and an overheating in the real estate market – China’s previous administration had remained cautious about public spending despite a decelerating economy. The current administration also appears to be maintaining a cautious stance. In addition, the Chinese government remains vigilant against (1) a rise in the inflation rate, (2) an upturn in major cities’ housing prices, which the previous administration had sought to contain, and (3) a rapid expansion in shadow banking such as trust business, where personal assets are flowing in to gain high returns. The possibility should therefore not be ruled out that the government will reverse its accommodative stance on fiscal policy. In terms of monetary policy, the People’s Bank of China has indicated its intention of placing top priority on controlling inflation. Moreover, in response to the expansion in bank lending in January 2013, the authorities have reportedly instructed large banks to constrain lending. The authorities have stated their intention of strengthening risk management associated with shadow banking, in which case there is a risk that infrastructure investment and real estate investment will be significantly suppressed. B. Continuation of a large negative output gap in the major economies Aside from the short-term downside risks I have mentioned, there is concern over the medium to long term: it could take time before the U.S. and European economies, as well as BIS central bankers’ speeches the Chinese economy, overcome the aftereffects of the credit bubble. Similar to what occurred in Japan, firms will likely continue their cautious stance on employment and households’ medium- to long-term income expectations are likely to weaken in view of the persistently high unemployment rate, causing the economies to lag behind in achieving a self-sustaining recovery with an expansion of employment and income. What I wish to highlight here is that since the Lehman shock, the output gap – which indicates the aggregate demand and supply balance – has been largely negative across the advanced economies. According to the Organisation for Economic Co-operation and Development (OECD), the output gap in the advanced economies, after having reached minus 4.0 percent of GDP in 2009, is expected to exceed minus 3.0 percent in 2013, at minus 3.3 percent. In the OECD’s projections for the output gap as of November 2012, the output gap of Japan is minus 2.1 percent for 2013, but that of the United States and of the euro area is substantially more negative. The large negative output gap in the advanced economies indicates a prolonged excess in production capacity and labor in the aftermath of the credit bubble, appearing in the form of balance-sheet adjustments. This type of situation causes firms to post lower profits and further restrain investment, and causes households to lower their income expectations and restrain consumption, exerting downward pressure on the already-declining inflation rate. With this situation spreading widely in the major economies, which are Japan’s main export destinations, considerable uncertainty will inevitably remain over Japan’s export environment in the long run. C. Expansion of trade deficit and financial market stability With regard to the downside risks to Japan’s economy, due attention should be paid to the continued trend in the expansion of trade deficit and its effects on financial markets. As I mentioned, Japan’s economic growth rate is expected to rise relatively smoothly for the time being, but the recovery of overseas economies could lack momentum. In addition, imports of raw materials are expected to remain at a high level. This situation could cause Japan’s trade deficit to expand. An expansion of the trade deficit causes the yen to depreciate mainly through changes in the supply-demand balance in foreign exchange markets. This could then destabilize financial markets, because not only a buoyant economy and a rise in import prices but also a reduction in surplus funds in the domestic markets cause long-term interest rates to rise. Attention should therefore be paid to the effects of the expansion of trade deficit on financial markets as well as economic activity. Furthermore, long-term interest rates could rise if credibility of the conduct of fiscal policy is undermined. The rise in long-term interest rates could significantly affect Japan’s economy, and depending on the degree of the rise, could also affect the economy by greatly aggravating instability in the banking system. Long-term interest rates in Japan have been stable so far, and this may be regarded as evidence that the credibility of fiscal policy is being maintained. However, given that unexpected events may trigger sudden and nonlinear changes in market sentiment, as experienced with the European debt problem, it is necessary to continue careful monitoring to identify the changes as risk factors. IV. Developments in prices and wages in Japan and their characteristics Before I move onto my next topic of monetary policy conduct, I would like to discuss developments in prices and wages in Japan, which are closely linked to my topic, and give my personal view on the background to the prolonged deflation. A. Historical developments in Japan’s inflation rate and a comparison with other major economies Since the 1980s, Japan’s inflation rate has remained at a consistently low level, unlike the case of other major economies. According to the OECD, during the decade from 1985 to BIS central bankers’ speeches 1995, the year-on-year rate of change in the CPI in the G-7 countries was 3.3 percent on average, while in Japan it was 1.4 percent. For the 15 years thereafter, from 1996 to 2011, the year-on-year rate of change in the CPI in the G-7 countries was 1.9 percent on average, while in Japan it was minus 0.1 percent. The difference between the averages of Japan’s inflation rate and those of the G-7 countries remained mostly unchanged: approximately 1.9 percent for the first ten years from 1985 and around 2.0 percent for the 15 years thereafter, when Japan’s economy fell into deflation. This indicates that, during the 25 years as a whole, Japan and the other major economies generally experienced a long downtrend in their inflation rates. I see in this the possibility that Japan’s deflation might have been brought about by the downtrend in global inflation. In particular, a large negative output gap – a state of excessive supply – continues to be seen in the major economies since the Lehman shock, on the back of balance-sheet adjustments in the aftermath of the credit bubble. This has created an environment where the inflation rate is subject to downward pressure, and such developments overseas could also be considered to have exerted downward pressure on price developments in Japan. B. Major factor behind the difference between inflation rates in Japan and the United States: the service sector I would also like to compare and examine price developments in Japan and abroad. For example, if we compare price developments in Japan and the United States, in Japan the year-on-year rate of change in the CPI was minus 0.2 percent on average between 1997 and 2011, while in the United States it was 2.4 percent, resulting in a gap of 2.6 percentage points. The major factor behind this was a difference in the contribution of prices of services less rent, which accounted for about one-third of the 2.6 percentage point gap, or 0.9 percentage point. When rent was included, services prices accounted for almost twothirds of the gap, or about 1.7 percentage points. In my view, the fact that services prices are typically susceptible to developments in wages may indicate the reason why Japan’s price structure is prone to deflation and suggest how deflation can be overcome. C. Relationship between the potential growth rate, wages, and prices As seen earlier, according to the OECD, since 2009 – when the negative output gap expanded worldwide due to the effects of the Lehman shock – the negative output gap in Japan has not been particularly large compared with other major economies, and this suggests that the level of the output gap does not solely determine the level of the inflation rate. In considering the cause of deflation in Japan, attention should therefore be paid to the supply-side factors, such as the rate of increase in labor productivity and the economy’s potential growth rate. In Japan, there is a relatively strong correlation between the potential growth rate per capita and medium- to long-term inflation expectations. This relationship is considered to reflect the customary practice prevailing between employers and employees: when medium- to longterm growth expectations declined after the bursting of the economic bubble, Japanese firms tended to adjust wages rather than employment, and workers tended to accept such adjustments. Although Japan has experienced prolonged deflation that is unprecedented among major economies, its unemployment rate has remained very low relative to other economies and the employment situation has shown outstanding stability. In the United States, on the other hand, employment has fallen but declines in wages and prices have remained quite limited amid economic deterioration. These contrasts show how means of adjustment in the labor market differ between Japan and the United States. With these points taken into account, an end to deflation and a further rise in Japan’s inflation rate require efforts to strengthen the growth potential to raise the economy’s potential growth rate and subsequently boost growth expectations. Such improvements are expected to result BIS central bankers’ speeches in an increase in services prices through a rise in the rate of wage increase. However, if wages increase unaccompanied by a strengthening in the growth potential and a rise in productivity, this will depress corporate profits, which in turn could restrain business fixed investment and hamper steady economic growth. The possibility of a resultant deterioration in the employment and income situation is a matter of concern. On the other hand, if the inflation rate increases while the growth potential does not strengthen and wage inflation remains unchanged, the general standard of living will fall in real terms. In sum, the economic condition to be sought is a balanced increase in wages and prices on the basis of a strengthened growth potential. V. Current and future conduct of monetary policy A. Decisions made at the MPM held on January 21 and 22, 2013 At the MPM held on January 21 and 22, 2013, the Bank decided to take additional steps to provide monetary accommodation decisively by introducing two measures: the “price stability target” of 2 percent in terms of the year-on-year rate of change in the CPI; and the “openended asset purchasing method” for the Asset Purchase Program (hereafter the Program). In addition to these two measures, another important decision was the strengthening of policy coordination between the government and the Bank. The Bank, together with the government, decided and released “Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth.” The Bank had previously adopted a “price stability goal in the medium to long term,” judged 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 set a goal at 1 percent for the time being. As I will explain in detail later, the Bank replaced this goal with the “price stability target” of 2 percent for the following reasons. First, there is an increasing awareness among the general public that even if the Bank were to use the term “price stability target” it would not conduct monetary policy in an automatic manner in pursuit of a certain inflation rate. And second, as progress is achieved through efforts by a wide range of entities – such as those by the government to strengthen the competitiveness and growth potential of Japan’s economy – an increase is likely to occur in the inflation rate at which firms and households perceive price stability – the basis for their economic activity. There is uncertainty with regard to how the strengthening of the growth potential of Japan’s economy will proceed, but the Bank expects the setting of this very ambitious target to have the secondary effect of encouraging efforts by a range of entities. In this regard, the “price stability target” of 2 percent could serve in a sense as a kind of “slogan” for the general public in the revitalization of Japan’s economy. Moreover, the Bank has introduced the “open-ended asset purchasing method” without setting any termination date, to clearly show its strong determination to achieve the “price stability target” of 2 percent, which it considers will result in greater policy effects. Under the current purchasing method – which makes a commitment in terms of the future level of the total size of the Program – the total size of the Program will be increased to 101 trillion yen by end-2013 from 65 trillion yen at end-2012, as had been planned earlier. From January 2014 and for some time, the Bank will purchase about 13 trillion yen in financial assets, including about 2 trillion yen of JGBs, every month without setting any termination date. B. The Bank’s price stability target and its importance Next, I would like to discuss in more detail the inflation targeting system, looking at examples of overseas systems. Article 2 of the Bank of Japan Act 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.” This tells us that achieving price stability is the precondition for the sound development of the national economy and that the sound development of the national economy – which deeply impacts public welfare – is the ultimate target of the monetary policy conduct. Based on this thinking, in policy conduct BIS central bankers’ speeches aimed at achieving the price stability target, it is most important to aim at contributing to the stability and development of the economy in the medium to long term, and to carefully conduct policy while monitoring the soundness of the financial system. At the same time, it must be noted that policy conduct aimed at guiding the inflation rate to the target in an automatic manner in fact entails the risk of hampering medium- to long-term economic stability. C. Flexible inflation targeting system The introduction of an inflation target by the Reserve Bank of New Zealand in 1988 was a first among the central banks of the major economies, followed by the central banks of Canada and the United Kingdom. In New Zealand, the central bank aimed at the target rigidly in the beginning, but later it was recognized that this rigidity was destabilizing the economy. For this reason, the introduction of an inflation target was deferred by the central banks of Japan, the United States, and other major economies in Europe. Subsequently, however, central banks adopting an inflation target have made adjustments to boost flexibility. Many of the central banks have not specified the timing for achieving the target. Even the Bank of Canada – which specified the term for achieving the target as “typically within a horizon of six to eight quarters” – allows adjustments in the length of the term depending on developments in economic activity and prices to ensure the target’s flexibility. As a result, central banks in major economies are at present conducting policy aimed at achieving sustainable growth with price stability while assessing the current developments and outlook for economic activity and prices as well as examining various risks, including those stemming from the accumulation of financial imbalances. This policy framework is often referred to as the flexible inflation targeting system. The price stability target adopted by the Bank of Japan is based on the same thinking. The Bank has clarified that it will aim to achieve this price stability target of 2 percent “at the earliest possible time.” The intention behind this clarification is that, as discussed earlier, in achieving an inflation target it is important – from the viewpoint of ensuring medium- to long-term stability of the economy – to secure flexibility in the policy conduct while carefully ascertaining risks arising from, for example, the accumulation of financial imbalances. The Bank will aim to achieve the target “at the earliest possible time” on this basis. In other major economies, central banks have introduced inflation targets with the aim of containing rising inflation and reinforcing their independence from the government by ensuring the transparency of their policy conduct. The Bank of Japan, on the other hand, has introduced the price stability target in an attempt to overcome deflation. This point differs from the inflation targets of other central banks, and therefore the Bank’s action may be regarded as an unprecedented endeavor. D. Votes at the MPMs held in January and February So far, I have explained the decisions made at the MPM held on January 21 and 22, 2013. At the meeting, I voted against the introduction of the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI. The main reasons for my vote have already been outlined in the minutes of the MPM, which were released on February 19. Although my remarks here will thus repeat them, I would like to briefly review the three reasons outlined in the minutes. First, while the inflation rate consistent with sustainable price stability pursued by the Bank is considered to be largely affected by the general public’s current perception of price developments, 2 percent in terms of the year-on-year rate of change in the CPI had rarely been achieved in the past two decades, and based on the general public’s current perception of price developments that is built on such past experience, the 2 percent inflation rate is considerably higher than the inflation rate that is considered at this point to be consistent with sustainable price stability. Second, this suggested that, even if the central bank were to set 2 percent inflation as a target, this alone is highly unlikely to substantially influence inflation expectations. Third, efforts by a wide range of entities toward strengthening the growth potential of Japan’s economy are essential in order to achieve the BIS central bankers’ speeches 2 percent target, but if the 2 percent target were set before such efforts made progress and the effects of these efforts were confirmed, this could impair the credibility of monetary policy due to considerable uncertainty regarding achievement of the target. For these reasons, I judged that the Bank’s commitment to do its utmost to achieve the target of 1 percent in terms of the year-on-year rate of change in the CPI for the time being would further enhance the policy effects and be more appropriate in the current situation. Subsequently, at the MPM held on February 13 and 14, I voted for the public statement that included the following sentence: “the Bank has set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI.” I still hold the view that it is not an easy task to achieve the price stability target of 2 percent. Neither is there a significant change in the general public’s perception of price developments at present. However, in line with the recognition that a range of entities, including the government and the private sector, will fulfill their respective roles to overcome deflation, I considered that financial market developments after the introduction of the price stability target of 2 percent appeared to reflect expectations for the Bank’s monetary policy and the government’s various policy measures, and that it was important to further increase credibility regarding the Bank’s decision on the price stability target of 2 percent from the viewpoint of overcoming deflation. While monitoring the effects of monetary policy and their spread through the economy, the Bank will conduct policy aimed at achieving this target in a responsible manner, by carefully communicating its policy intentions and considering a decisive action for additional monetary easing as necessary. E. The Bank’s policy stance on achieving the 2 percent price stability target In my opinion, the Bank’s decision to introduce the open-ended asset purchasing method with the aim of achieving the 2 percent price stability target indicates that asset purchases through market operations will continue to form the core of the Bank’s policy to enhance monetary easing. Specifically, this decision is based on the idea that the Bank will give greater consideration to producing policy effects by affecting market prices, which is what the comprehensive monetary easing policy has been aiming for. This means encouraging a decline in longer-term interest rates and a reduction in risk premiums and thereby ensuring financial conditions that allow firms and households to raise funds at low cost. There seems to be a range of views in financial markets currently on the feasibility of the 2 percent price stability target. If any doubt arose in the markets over the Bank’s stance on achieving the target, this could reduce the policy effects. Therefore, with a view to avoiding such a situation and continuing to clearly show the Bank’s strong determination to achieve the target, it is important to steadily conduct asset purchases under the Program in a sustainable manner and thereby produce the intended policy effects. In this regard, I will discuss three points: steadily increasing the amount outstanding of the Program; strengthening coordination with the government and maintaining fiscal consolidation; and communication to the public to gain understanding of the Bank’s policy intention. F. Issues regarding the operation of the asset purchase program First, let me mention an issue concerning the payment of interest under the complementary deposit facility, or the payment of interest on excess reserve balances of financial institutions’ current accounts at the Bank. This issue needs to take into account the fact that undersubscription – that is, aggregate bids falling short of the Bank’s offers – has been occurring frequently in the fixed-rate funds-supplying operation against pooled collateral since the turn of the year. Generally speaking, as the degree of monetary easing is enhanced, financial institutions’ demand for liquidity will be met sufficiently, thereby reducing their need for funds provided by the Bank; consequently market participants will have a reduced incentive to submit bids for the Bank’s market operations. Moreover, the bidding activity for market operations is affected by not only the supply and demand conditions of market participants’ funds but also various events and speculation in the markets. Therefore, BIS central bankers’ speeches with regard to financial institutions’ current accounts held at the Bank, the balances of which change along with the Bank’s asset purchases, careful deliberation is necessary in discussing the lowering or the abolishment of the payment of interest on excess reserve balances of the current accounts. Since such a move would affect financial institutions’ incentive to hold excess reserves at the Bank, the costs and benefits should be assessed while taking into account the sustainability of asset purchases under the Program. Second, it should be noted that the remaining maturity of JGBs to be purchased under the Program is currently one to three years. This takes into account the fact that the average financing term used by Japanese firms is around three years. On this point, some market participants, for example, have called for extending the remaining maturity of the JGBs to be purchased under the Program. Some have noted the importance of enhancing policy effects by encouraging a decline in longer-term interest rates, and others have mentioned the need to conduct asset purchases under the Program smoothly and to ensure the sustainability of the purchases. And third, the Bank purchases risk assets – namely, CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) – for the purpose of encouraging a decline in risk premiums in the markets, while paying due attention to the potential cost of impairing the Bank’s balance sheet. On this point, some market participants have stated that the Bank should increase the amount of risk assets it purchases. In this regard, in deliberating on the possibility of either extending the remaining maturity of JGBs to be purchased under the Program or increasing the amount of risk assets to be purchased, it is essential for the Bank to carefully assess costs and benefits in light of its policy objective of achieving the 2 percent price stability target, while giving due consideration to the two points mentioned earlier: ensuring the sustainability of asset purchases under the Program and producing the intended policy effects. G. Importance of strengthening coordination with the government and maintaining fiscal consolidation The joint statement indicates that the Bank sets the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI, and under the target it will pursue monetary easing and aim to achieve this target at the earliest possible time. At the same time, the government will formulate measures for strengthening the competitiveness and growth potential of Japan’s economy, and promote them strongly, as well as steadily promote measures aimed at establishing a sustainable fiscal structure. In order for the Bank to pursue powerful monetary easing with the aim of achieving the 2 percent price stability target, it is important for the credibility of fiscal management to be firmly ensured in the financial markets. In this regard, it is worth noting the obvious: the policy coordination mentioned in the joint statement does not indicate “monetization,” that is, the central bank’s financing of the government’s fiscal deficit. The firm guarantee by law in many countries of a central bank’s independence is the result of bitter experience. Specifically, the underwriting of government securities by central banks during wartime led to a substantial expansion of government debt, which became a burden for future generations. This underwriting also accelerated inflation and destabilized financial markets and the financial system, which seriously degraded people’s living conditions. Japan experienced sharp inflation immediately after the end of World War II, and in response the yen was revalued and a freeze on bank deposits was imposed. While the number of people who actually experienced these events is gradually declining, one of the vital roles of a central bank is to continue to provide a warning about the dangers of monetization based on the lessons of history. In addition to preventing monetization at all costs, it is essential to avoid even the emergence of mere doubt in financial markets as to whether the Bank’s action could be considered monetization. If such doubt should emerge, the credibility of fiscal policies would be BIS central bankers’ speeches undermined to a substantial degree and a fiscal crisis could occur, which in turn would inflict considerable damage on economic activity, together with a crisis in the financial system. It should be recognized that, in such a case, the quality of people’s lives would be significantly impaired. In addition to the joint statement in which the government clarified its stance of emphasizing fiscal discipline, the Cabinet decided the fiscal consolidation target, which aims at halving the primary balance deficit relative to GDP by fiscal 2015 from the fiscal 2010 level and achieving a surplus by fiscal 2020. It appears that these moves will contribute to containing the risk that concern over monetization will emerge in financial markets. If the government’s determination regarding fiscal consolidation spreads further in the markets – through its communication about the consistency between the supplementary budget for fiscal 2012 and the medium-term fiscal consolidation policy as well as the path to achieving fiscal consolidation – this will give the Bank more room to proceed with purchasing government securities without causing concern over monetization. This would also help achieve the 2 percent price stability target. H. Importance of communication to the public to gain understanding of the Bank’s policy intention With a view to strengthening the policy coordination between the Bank and the government, it is important to deepen the public’s understanding of the Bank’s thinking on the conduct of monetary policy and its specific actions. The Bank considers it essential to make its utmost efforts to this end. To my understanding, the issues that need to be explained thoroughly to deepen the public’s understanding are as follows. First, as the principle of the conduct of monetary policy, it is important that the policy should aim at achieving price stability, thereby contributing to the sound development of the national economy. Second, regarding the effects of monetary policy on price developments, I continue to attach importance to the transmission mechanism in which monetary policy influences demand, thereby encouraging the improvement in the output gap; in this regard, the transmission mechanism in which monetary policy underpins inflation expectations is also noteworthy. And third, I consider that the medium- to long-term trend in inflation rates is largely determined by supply-side factors, such as the growth rate of productivity and the potential growth rate of the economy, or in other words, by the growth potential of the economy. I. Function of Policy Board members in making monetary policy decisions In the remainder of my remarks, I will briefly touch on the central bank committee system in which monetary policy decisions are made as a result of deliberations among committee members, rather than by any one individual. The Bank of Japan Act stipulates that the Policy Board shall be established, composed of nine members – the Governor, two Deputy Governors, and six Members of the Policy Board. It also stipulates that matters concerning monetary policy shall be decided by the Policy Board. This type of committee system is currently adopted by not only the Bank of Japan but also other major central banks. In his book The Quiet Revolution: Central Banking Goes Modern, Alan S. Blinder, a former vice chairman of the Board of Governors of the Federal Reserve System, positively assessed the advantage of group decision making by policy committee on the basis of certain assumptions. He pointed to two developments behind the spread of the committee system: the worldwide trend of increased central bank independence from the government; and growing recognition of the system’s success in the United States and Germany, where it had been introduced as a pioneering effort. He also noted that decision making by members of a committee could help avoid certain risks associated with decision making by a single individual and thereby generate better outcomes. In the vote taking, each member of the Bank of Japan’s Policy Board is given an equal vote and makes a judgment independently. The split vote that occurred at the January 2013 MPM demonstrates that each member’s autonomy is respected. This is also reflected in the BIS central bankers’ speeches provisions of the Bank of Japan Act that the members of the Policy Board shall be appointed by the Cabinet, subject to the consent of the House of Representatives and the House of Councillors, and shall not be dismissed against their will during their terms of office of five years, except in special cases such as becoming incapable of carrying out their duties due to mental or physical disorder. At the same time, we the Policy Board members conduct our daily duties by fully recognizing the responsibility that we – who are not chosen by election – are granted considerable authority to make monetary policy decisions, which significantly affect people’s lives. Therefore, in order to maintain and enhance the public’s trust, I believe that it is vital to further enhance the transparency of the conduct of monetary policy – that is, communication to the Diet and the public by thoroughly explaining the Bank’s thinking on the conduct of monetary policy. We are also listening with all due respect to the government’s and public’s opinions on monetary policy conduct and working to incorporate them into policymaking, and I regard today’s meeting as one such opportunity for this. BIS central bankers’ speeches
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Statement by Mr Haruhiko Kuroda, Governor of the Bank of Japan, before the Committee on Financial Affairs, House of Representatives, Tokyo, 26 March 2013.
Haruhiko Kuroda: The Bank of Japan’s Semiannual Report on Currency and Monetary Control Statement by Mr Haruhiko Kuroda, Governor of the Bank of Japan, before the Committee on Financial Affairs, House of Representatives, Tokyo, 26 March 2013. * * * 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 first half of fiscal 2012 on December 7, 2012. 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 First, I will explain economic and financial developments in Japan. Japan’s economy has remained relatively weak since summer 2012 mainly against the background of the deceleration in overseas economies, but some positive signs have recently been observed. The Bank currently assesses that the economy has stopped weakening. Three factors can be pointed out as underlying developments behind this change in the economic situation. First, overseas economies – the U.S. and Chinese economies in particular – have begun to show signs of emerging from their deceleration phase. The U.S. economy has been on a moderate recovery trend with increasing firmness, while the balance-sheet repair weighing on the economy has gradually been mitigated. Private consumption has been increasing moderately and housing investment has been showing clear signs of picking up, as the employment situation follows an improving trend. Business fixed investment, which had been constrained, shows signs of picking up. The Chinese economy, albeit with some fluctuations in exports, appears to be emerging from its deceleration phase supported by firm domestic demand, with firmness in private consumption and rises in infrastructure investment. Meanwhile, economic activity in Europe continues to recede slowly as business fixed investment and private consumption have been declining partly due to the effects of fiscal austerity and the tightening of financial conditions, although further deterioration in business and household sentiment is coming to a halt. Second, business and household sentiment has been improving mainly on the back of the recent depreciation of the yen and the rise in stock prices. In global financial markets, investors’ risk aversion remains abated, partly due to progress made in policy responses regarding the European debt problem since last summer and to the fact that the U.S. “fiscal cliff” at the beginning of this year was avoided. Nevertheless, developments including the situation surrounding the European debt problem – particularly discussions on the support package for Cyprus and developments in Italy following the general election – require continued attention. Third, factors that had been exerting downward pressure on the economy, such as the effects of the decline in car sales due to the ending of subsidies for purchasers of environmentally friendly cars and the effects of the recent bilateral relationship between Japan and China, have fallen off or diminished. Under these circumstances, exports appear to stop decreasing. Business fixed investment has shown some weakness on the whole, although resilience has been observed in nonmanufacturing. In contrast, public investment has continued to increase, and housing investment has generally been picking up. Private consumption has remained resilient, BIS central bankers’ speeches supported mainly by demand from the elderly. Reflecting these developments in demand both at home and abroad, industrial production has stopped decreasing. With regard to the outlook, the pick-up in Japan’s economy is expected to become more evident around mid-2013, mainly against the background that domestic demand remains firm partly owing to the steady implementation of various economic measures and that overseas economies gradually emerge from the deceleration phase. Financial conditions in Japan are accommodative. In terms of interest rates, the overnight call rate has remained at an extremely low level, and firms’ funding costs have been hovering at low levels. With regard to credit supply, firms have continued to see financial institutions’ lending attitudes as being on an improving trend. Issuing conditions for CP and corporate bonds have remained favorable on the whole. As for credit demand, firms have shown signs of increasing their demand mainly for working capital and funds related to mergers and acquisitions. In these circumstances, firms have retained their recovered financial positions on the whole. On the price front, the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) is around 0 percent. For the next few months, it is expected to turn negative due to the reversal of the previous year’s movements in energy-related and durable consumer goods. Thereafter, however, the year-on-year rate of change in the CPI is expected to start a moderate increasing trend as the aggregate supply and demand balance continues a moderate improving trend with Japan’s economy on a moderate recovery path. There remains a high degree of uncertainty concerning Japan’s economy, including the prospects for the European debt problem, the momentum toward recovery for the U.S. economy, the possibility of emerging and commodity-exporting economies making a smooth transition to the sustainable growth path, and the effects of the recent bilateral relationship between Japan and China. Recent developments in financial markets appear to assume that the global economy will emerge from the deceleration phase and pick up. The Bank will continue to carefully examine whether the uncertain factors surrounding the global economy will be dispelled smoothly. II. Conduct of monetary policy Next, I will explain the Bank’s conduct of monetary policy. Japan’s economy has suffered from deflation for nearly 15 years. This is an extraordinary situation even on a global scale. A vicious cycle – where a decline in prices causes wages and profits to contract, thereby reducing investment and consumption, consequently leading to a further decline in prices – has been causing a deterioration in Japan’s economy. Overcoming deflation at the earliest possible time is the most critical issue facing Japan’s economy. Ensuring price stability is the mandate of the central bank, and the role of the Bank in overcoming deflation is extremely important. The Bank has engaged in a wide range of efforts – from implementing the zero interest rate policy and the quantitative easing policy, to pursuing monetary easing consisting of comprehensive monetary easing, ensuring financial market stability, and providing support to strengthen the foundations for economic growth in more recent years – but fallen short of overcoming deflation. There are many factors – both at home and abroad – exerting downward pressure on prices in Japan: an increase in cheap imports from overseas, increased distribution efficiency mainly due to deregulation, and the consequent low-price strategies of firms as well as an increased preference among households for low prices. Notwithstanding these factors, it is the Bank’s mandate as the central bank to achieve price stability by addressing them. Indeed, no other country in the world is undergoing such a prolonged period of deflation. The government announced, for overcoming deflation and achieving economic revitalization, a “three-pronged strategy” – consisting of bold monetary policy, flexible fiscal policy, and a growth strategy that BIS central bankers’ speeches encouraged private sector investment – and swiftly undertook responses including the emergency economic measures. An upturn in stock prices was recently observed, as a positive response to such efforts and in expectation of an economic recovery. Of particular significance is the joint statement released this January, in which the government and the Bank clearly set their respective tasks and announced their determination to accomplish those tasks with responsibility. This marks a significant step toward overcoming deflation and achieving sustainable economic growth. The Bank introduced a “price stability target” of 2 percent in terms of the year-on-year rate of change in the CPI, and decided that under the price stability target it would pursue monetary easing and aim to achieve this target at the earliest possible time. The Bank believes that the achievement of this target, without delay, is its mission of utmost importance. So far the Bank – with a view to overcoming deflation – has been purchasing a variety of assets such as sovereign debt as well as corporate bonds, CP, exchange-traded funds (ETFs), and real estate investment trusts (REITs). While such purchases go beyond the domain of traditional central bank operations, the scale and type of assets to be purchased have not been sufficient to materialize a strong commitment to achieving 2 percent inflation at the earliest possible time. We need to pursue bold monetary easing both in terms of quantity and quality. Moreover, given that there is little room for the interest rate to decline, it is imperative to work on market expectations in the conduct of monetary policy. Through communication with the market, we need to make clear that we have adopted the uncompromising stance that we will do whatever is necessary to overcome deflation. Furthermore, ensuring cooperation with the government is also important. The effect of monetary policy will be reinforced by maintaining consistency with the government’s economic policies. According to the joint statement released by the government and the Bank, they will strengthen their policy coordination and work together in order to overcome deflation early and achieve sustainable economic growth with price stability. The government will flexibly manage fiscal policy, formulate measures to strengthen the growth potential and competitiveness of Japan’s economy, and promote measures aimed at achieving fiscal consolidation in the medium to long term. For its part, the Bank will on its own responsibility pursue monetary easing with a view to achieving the price stability target at the earliest possible time. Parallel to monetary easing, if the government can take initiatives to create real demand and improve wages and employment through the expansion of consumption and investment, this is expected to contribute to generating a virtuous cycle that will eventually lead to price increases. To avoid an increase in interest rates on the back of declining confidence in fiscal management, it is also important to take measures aimed at achieving fiscal consolidation in the medium to long term. We expect the government to take appropriate actions in line with the joint statement. For the future conduct of monetary policy, we will continue to examine the most effective policy measures, at the Monetary Policy Meetings, by making full use of the Bank’s resources, while assessing the effect on the market through the examination of economic and price developments. BIS central bankers’ speeches
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Speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Tochigi, 11 March 2013.
Koji Ishida: Recent economic and financial developments Speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Tochigi, 11 March 2013. * * * I. Economic activity and prices A. Recent financial and economic developments 1. Overview I would like to start by looking at recent developments in the global economy. The global economy plunged following the Lehman shock in 2008, but moved subsequently toward recovery. Since mid-2011 however, it has decelerated following the outbreak of the European sovereign debt crisis triggered by the fiscal problem in Greece. Thereafter, as the debt problems in major economies such as Spain and Italy also worsened, the euro area economy entered a severe recession and the real GDP growth rate for the area turned negative in 2012. In addition, the growth rate declined for the Chinese economy, which exports a great deal to Europe, and emerging and commodity-exporting economies in general were seriously affected. In these circumstances, Japan’s economy has inevitably undergone significant adjustments since summer 2012, such as in the form of a decrease in production and curbs on business fixed investment due to a drop in exports. The problems in the euro area have shown signs of stabilizing, reflecting progress made since the latter half of 2012 in establishing frameworks to avert a crisis. Examples include the introduction of a program called Outright Monetary Transactions (OMTs), through which the European Central Bank (ECB) purchases government bonds issued by euro area countries facing financial difficulties, and the start of the operation of the European Stability Mechanism (ESM). In this situation, markets outside the euro area have begun to factor in the bottoming out of respective economies. The International Monetary Fund (IMF) has projected that the global economy will recover in 2013 and 2014, having bottomed out in 2012. 2. European economy The euro area economy, which is considered to have triggered the global economic slowdown in 2012, remains in a moderate recessionary phase. Private consumption in the euro area has been on a downtrend since 2011 against the backdrop of the debt problems. Car sales have been particularly weak. Looking at exports and production, exports to outside the area had been solid, primarily in Germany with its competitive edge, owing in part to the depreciation of the euro to date. However, these exports have more recently shown sluggish growth due to the deceleration in the global economy. As a result, production, which had already been stagnant due to weak consumption in the euro area, has declined further. However, with the pick-up in the global economy, there are indications of a halt in the deterioration of business sentiment – a leading economic indicator – and some positive developments in other economic indicators. Even so, given that some peripheral European countries need to continue to implement fiscal austerity measures, the European economy as a whole is highly likely to remain sluggish for the time being. The fundamental cause of the European sovereign debt crisis and the current economic stagnation presumably lies in the imbalance between individual economies in the euro area. National currencies were unified into the single currency of the euro despite disparities in the economic strength of the countries involved, but sovereignties over fiscal and other national affairs have not been unified. In these circumstances, peripheral European countries experienced an economic boom, as their previously high interest rates converged toward the low level of Germany’s interest rates following the currency union and their funding from BIS central bankers’ speeches global capital markets became easier at low cost. Subsequently, peripheral European countries ran current account deficits, and their deficits were covered by investment and borrowing from the private sector mainly in the core euro area countries. Moreover, peripheral countries allowed labor costs to rise, causing a widening gap in competitiveness with euro area countries that enjoyed high productivity, such as Germany. The funding conditions have deteriorated for financial institutions in the peripheral European countries burdened with the debt problems, since the problems have worsened amid a global increase in awareness of credit risk arising from interbank funds transactions in the wake of the Lehman shock. This implies that it has become difficult for peripheral European countries’ current account deficits to continue to be financed with funds from other countries’ private sectors. From 2011 through the first half of 2012, the debt problems in the euro area not only raised tensions in global financial markets but also exerted significant downward pressure on the global economy as a whole. Since the latter half of 2012, however, the situation has shown signs of stabilizing reflecting the implementation of a number of measures to avert a crisis, as I mentioned earlier. Nevertheless, since the economic imbalance in the euro area that lies at the root of the crisis has not yet been resolved, due attention should continue to be paid to the possibility that some events might cause a crisis to recur. I see the risks to the outlook for the European economy as still tilted sharply to the downside. 3. U.S. economy Next, I will discuss the U.S. economy. Although the Lehman shock originated in the United States, the U.S. economy has regained momentum since the plunge and has been growing at an average annual rate of around 2 percent. In the October–December quarter of 2012, the real GDP growth rate slowed due to negative contributions from inventory investment and government spending, but domestic final private demand items, such as private consumption and housing investment, maintained their uptrend. With regard to business sentiment, the business sentiment index for the nonmanufacturing sector has stayed firm. Meanwhile, the index for the manufacturing sector fell temporarily to around the breakeven point of 50 reflecting the deceleration of the euro area and Chinese economies together with the “fiscal cliff” problem in the United States, but it has recently been recovering. As for the outlook, assuming that uncertainties arising from fiscal and other problems are gradually dispelled, I expect that business sentiment in the manufacturing sector will gradually pick up, and that, as a result, production and business fixed investment will gain momentum. As for the employment situation, the unemployment rate, which had remained between approximately 4 to 6 percent, jumped to around 10 percent after the Lehman shock occurred. In the four years thereafter, the unemployment rate fell back only to slightly below 8 percent. Compared with the loss of about 9 million jobs, new jobs created totaled only about 6 million despite an increase in the working population. However, as the number of employees has been steadily rising, the employment situation is improving as a trend. With regard to developments in the household sector, car sales have recovered considerably and housing prices, which had bottomed out, are starting to rise, albeit moderately. The number of housing starts is still around half of the level seen before the bursting of the housing bubble but is increasing moderately. Viewed from another angle, the current low level means that there is still ample room for growth. The Lehman shock was caused by the formation and bursting of the U.S. housing bubble, so it is expected to take a long time before the excess debt in the household sector that was created during the bubble’s formation is resolved. This balance-sheet problem in the household sector, coupled with downward pressure arising from the fiscal side, has probably held down U.S. economic growth to around 2 percent, although the growth rate without these negative factors would have been essentially somewhat higher. The ratio of household debt BIS central bankers’ speeches to disposable income has been declining after rising sharply during the bubble period. Although the ratio remains at a high level, it is converging toward the trend line. If the recent rise in housing prices continues, the balance-sheet problem is expected to ease, leading to more vigorous household spending activity due to the wealth effects. The U.S. economy has been confronted with a very serious problem of the fiscal cliff. The fiscal cliff refers to a state in which the expiration of various tax cuts – namely, those introduced by the administration of former President George W. Bush and those carried out after the Lehman shock – and the implementation of automatic spending reductions threatened to occur simultaneously at the start of 2013. Given the extremely large scale of the tax cuts and spending reductions, there were concerns that the fiscal cliff could exert strong downward pressure on the economy, depending on how it was dealt with. Concerning the expiration of the tax cuts, a compromise was recently reached to extend some of them. However, a resolution was not achieved before the new deadline of March 1, 2013 for automatic spending reductions, and spending reductions have begun. As a series of problems lie ahead – such as the expiration of the provisional budget on March 27, 2013 and of the suspension of the federal debt ceiling by mid-May – the fiscal issues could still turn out to be a major destabilizing factor for the U.S. economy. It is expected that a compromise will eventually be reached over these problems. In any case, it is inevitable that U.S. economic growth will be restrained in the first half of 2013 given the negative factors on the fiscal front, such as tax increases and spending cuts. However, economic growth should accelerate gradually in and beyond the middle of 2013, when the effects of the problems are likely to subside. In this case, U.S. long-term interest rates may rise gradually, which may in turn affect long-term interest rates in Japan and the U.S. dollar-yen exchange rate. Accordingly, close monitoring of future developments is required. 4. China’s economy, and the NIEs and the ASEAN economies With regard to the Chinese economy, the Chinese authorities implemented tightening measures, such as those to restrain the increase in real estate transactions and curb public investment, due to concerns that the massive economic stimulus measures that had followed the Lehman shock could cause an acceleration in inflation and a surge in asset prices. Because the decline in China’s exports to Europe was combined with the effects of the tightening measures, downward pressure on the Chinese economy grew as a whole. However, since summer 2012 the authorities have partly revised their policy stance, and the conduct of monetary policy has become rather accommodative. In these circumstances, the Chinese economy has recently been picking up, supported also by expectations of a recovery in the global economy. Private consumption has been firm on the back of a favorable employment and income situation. As for fixed asset investment, the pace of increase has slowed, reflecting excessive production capacity of materials and slower growth in exports in the manufacturing sector, but this slowdown in investment has recently been coming to a halt due to recoveries in public investment and real estate investment. Business sentiment in the services sector has been firm, and that in the manufacturing sector has started improving as business conditions have recently turned for the better. China’s exports have started to recover after bottoming out in the July–September quarter of 2012. A drop in exports to Europe, which account for a large share of China’s overall exports, has been counterbalanced by increases in exports to other destinations. In 2012, the share of exports to the United States surpassed that of exports to Europe. As for the outlook, although some uncertain factors remain, I expect that the growth rate of the Chinese economy will gradually rise and succeed in reaching somewhere between 8 and 8.5 percent for the year. The pace of pick-up in the NIEs and the ASEAN economies remains moderate as business fixed investment, particularly in the NIEs, has been sluggish. As for the outlook, however, if BIS central bankers’ speeches the prospects for the global economy brighten – led by the U.S. and Chinese economies – the pace of recovery in the NIEs and the ASEAN economies is likely to increase, supported by a gradual pick-up in exports and firm domestic demand. 5. Current state of Japan’s economy Thus far, I have talked about developments in overseas economies. Let me turn now to Japan’s economy. Japan’s economy, which had been recovering steadily from the plunge following the Lehman shock in 2008, was significantly affected by the Great East Japan Earthquake of March 11, 2011. Thereafter, flooding in Thailand temporarily acted to brake Japan’s economic growth, but relatively high growth was achieved during the first half of 2012 due partly to a rebound from the plunge, inventory restocking, and heightened demand for rebuilding. Nevertheless, as the second half of 2012 began exports and production decreased sharply, reflecting the deceleration in the global economy due to the worsening of the European debt problem and the slowdown in the Chinese economy. The real GDP growth rate for the July–September quarter of 2012 was minus 0.9 percent on a quarter-on-quarter basis and minus 3.7 percent on an annualized basis. However, that for the October–December quarter was 0 percent on a quarter-on-quarter basis and 0.2 percent on an annualized basis, and Japan’s economy seems to have stopped weakening recently, in a situation where overseas economies have shown signs of picking up, as I mentioned earlier. However, the pace of improvement in Japan’s exports seems somewhat slow compared with developments in overseas economies. This is attributable to a degree to the drop in exports to China, reflecting in part the recent developments in the relations between Japan and China, but it is largely attributable to the sluggish exports of capital goods and parts, which are a major category of Japan’s exports along with automobiles. In this regard, the sluggishness in exports of capital goods and parts is strongly affected by the fact that sentiment in the manufacturing sector has deteriorated worldwide amid the current phase of global economic deceleration, causing firms to take a cautious stance toward business fixed investment. If a recovery trend in overseas economies becomes clear and production starts increasing, firms will regain their appetite for business fixed investment, raising the level of Japan’s exports. I have discussed overseas demand. Now, looking at domestic demand, public investment, in terms of the amount of public construction completed, has continued to increase since around the end of 2011, primarily in that related to reconstruction following the earthquake disaster. Public investment is expected to continue trending upward, supported by the effects of various economic measures. Business fixed investment has shown some weakness on the whole, as that in the manufacturing sector has declined due to the drop in exports and production, although resilience has been observed in investment in the nonmanufacturing sector. On the other hand, private consumption remains resilient and the effects of the decline in car sales due to the ending of measures to stimulate demand for automobiles have fallen off. Private consumption is expected to remain resilient as a trend. Attention, however, needs to be paid to the fact that the income situation cannot necessarily be regarded as firm, given that summer and winter bonus payments in 2012 were below the previous year’s levels and non-scheduled cash earnings have also declined. Meanwhile, housing investment has generally been picking up, supported in part by reconstruction of disaster-stricken homes. It is expected to continue to do so, as a front-loaded increase in demand prior to the consumption tax hike is likely to occur. Recently, stock prices have been rising and the yen has been depreciating. A number of factors have been pointed out as the background to these developments, including (1) abating tensions in the global financial markets due to a settling down of the European sovereign debt crisis for the time being and the reduced threat of the fiscal cliff; (2) expectations for the outlook for the U.S. and Chinese economies; and (3) the widening of Japan’s trade balance deficit and a sharp fall in the current account surplus. Rising BIS central bankers’ speeches expectations in regard to the policy conduct of the government and the Bank of Japan are also a large factor. In these circumstances, business and household sentiment has improved significantly. As overseas economies recover, Japan’s economy is expected to return to a solid recovery path as well. In this situation, it is particularly important that the improved business and household sentiment be maintained to ensure strong momentum for recovery. B. Outlook for Japan’s economic activity and prices Next, I will talk about the outlook for Japan’s economic activity and prices. Semiannually, in April and October, the Bank releases the Outlook for Economic Activity and Prices, known as the Outlook Report, in which it presents its outlook for economic activity and prices for the next two years, carefully assesses upside and downside risks, and summarizes its thinking on the conduct of monetary policy. Then, in January and July, the Bank makes interim assessments of the outlook laid out in the Outlook Report. According to the interim assessment made in January 2013, the Policy Board members’ baseline scenario for Japan’s economy is that it is expected to level off more or less for the time being, and thereafter it will return to a moderate recovery path as domestic demand remains resilient, partly due to the effects of various economic measures, and as overseas economies gradually emerge from the deceleration phase. As for prices, the year-on-year rate of change in the consumer price index (CPI) is expected to turn negative for the time being, due to the reversal of the previous year’s movements in energy-related and durable consumer goods, and thereafter it is likely to be around 0 percent again. The year-on-year rate of change in the CPI is expected to then start rising moderately as the aggregate supply and demand balance improves. Specifically, the median of the Policy Board members’ forecasts for Japan’s real GDP growth rate is 2.3 percent for fiscal 2013 and 0.8 percent for fiscal 2014. The median of their forecasts for the year-on-year rate of change in the CPI is 0.4 percent for fiscal 2013 and 2.9 percent for fiscal 2014 – or 0.9 percent excluding the direct effects of the consumption tax hike. While this outlook entails various risks, the Bank also presents the Risk Balance Charts, which show the probability distribution of the forecasts taking into account such upside and downside risks. According to this distribution, the upside and downside risks to the outlook are broadly balanced. Thus far, developments in Japan’s economic activity and prices have been in line with this outlook. II. Monetary policy Now, I will outline the Bank’s current conduct of monetary policy, based on the current state of Japan’s economy and the future outlook just described. At the Monetary Policy Meeting (MPM) held on January 21 and 22, 2013, the Bank took additional steps to provide monetary accommodation decisively to overcome deflation early and achieve sustainable economic growth with price stability. It also introduced the “price stability target” of 2 percent in terms of the year-on-year rate of change in the CPI. A. Introduction of the “Price Stability Target” In this regard, I would first like to talk about the “price stability target” of 2 percent. In February 2012, the Bank judged that the inflation rate consistent with price stability sustainable over the medium to long term was in a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI, and set the “price stability goal” at 1 percent for the time being. With the aim of achieving this goal, the Bank has been pursuing monetary easing. BIS central bankers’ speeches In January 2013, however, as a replacement for this 1 percent goal, the Bank set the “price stability target” of 2 percent. As mentioned earlier, the median of the Policy Board members’ forecasts for the year-onyear rate of change in the CPI excluding the direct effects of the consumption tax hike is 0.9 percent for fiscal 2014. This figure is the average for fiscal 2014, and under this forecast it is projected that the rate of change will reach 1 percent on a monthly basis at around the end of fiscal 2014. Given this situation, with the aim of better ensuring the overcoming of deflation, the Bank decided to work to achieve the target of 2 percent thereafter. Since the 1980s, except for the period immediately after the bursting of the bubble, the yearon-year rate of change in the CPI in Japan remained consistent, at a level below 2 percent. There has been a delay in adjusting Japan’s economy in response to structural change such as rapid population aging and increasing globalization, and as a result the potential growth rate as well as firms’ and households’ medium- to long-term expectations for growth have been declining. In these circumstances, a chronic shortage of demand has been observed and therefore the negative output gap has had less of a tendency to narrow. In this situation, firms have committed to cutting costs to survive competition while maintaining employment, and this has also exerted continued downward pressure on wages. These overall developments have led to the persistent downward pressure on prices. To overcome deflation, it is necessary to reverse this vicious cycle by responding appropriately to structural change, and raising firms’ and households’ medium- to long-term expectations for growth. The price stability target of 2 percent is significantly high considering the long-term developments in Japan’s price situation, but if the general public’s expectations for growth of the economy heighten – causing the actual inflation rate to rise – the public’s expectations for inflation can also be expected to increase. I believe that the achievement of the price stability target of 2 percent can be highly expected, if – in parallel with the pursuit of aggressive monetary easing by the Bank – efforts by a wide range of entities toward strengthening the competitiveness and growth potential of Japan’s economy make progress. B. Introduction of the “Open-Ended Asset Purchasing Method” As I have explained, the Bank will pursue aggressive monetary easing, aiming to achieve the “price stability target”. Specifically, the Bank decided at the MPM held on January 21 and 22, 2013 to (1) continue with a virtually zero interest rate policy and purchases of financial assets for as long as the Bank judges it appropriate to continue with each respective policy measure and (2) introduce the open-ended asset purchasing method for purchases of financial assets from January 2014. The Bank purchases various financial assets – such as government securities, corporate bonds, CP, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) – from the markets through the Asset Purchase Program, and aims to encourage a decline in longer-term interest rates and a narrowing of risk premiums. The Bank set the size and term of the Asset Purchase Program as about 101 trillion yen by the end of 2013. After completing the term for the current purchasing method, from January 2014, the Bank will for some time purchase financial assets totaling about 13 trillion yen every month without setting any termination date. This new method was introduced because the Bank judged that it could clearly show its intention to continue purchasing financial assets toward achieving the newly introduced “price stability target”. C. Fund-provisioning measure to stimulate bank lending The Bank has been continuing with the virtually zero interest rate policy and providing ample funds to the money market, and the effects of its monetary policy will become stronger if firms and households make greater use of the current extremely accommodative financial conditions. BIS central bankers’ speeches From this viewpoint, the Bank formally launched the fund-provisioning measure to stimulate bank lending (the Stimulating Bank Lending Facility) in December 2012 with the aim of promoting financial institutions’ aggressive action and helping stimulate the proactive credit demand of firms and households. With this facility, the Bank will provide long-term funds at a low interest rate to financial institutions that have increased their lending, at their request, up to an amount equivalent to the net increase in their lending, with no upper limit to the total amount of funds to be provided by the Bank under this facility. In June 2010, prior to the establishment of this facility, the Bank introduced the fund-provisioning measure to support strengthening the foundations for economic growth (the Growth-Supporting Funding Facility). The Bank has prepared a framework consisting of 5.5 trillion yen in total – including loans in U.S. dollars – and nearly 4 trillion yen has already been used. D. Strengthening policy coordination between the government and the bank On January 22, 2013, in line with the further pursuit of aggressive monetary easing I have just described, the government and the Bank released “Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth”. In the statement, the Bank announced that it would pursue monetary easing and aim to achieve the “price stability target” of 2 percent at the earliest possible time. Concurrently, the government announced that it would not only flexibly manage macroeconomic policy but also strongly promote measures for strengthening the competitiveness and growth potential of Japan’s economy as well as steadily promote measures aimed at establishing a sustainable fiscal structure. As mentioned earlier, the growth strategy – which aims at restoring the flexibility and adaptability of Japan’s economy and raising its potential – is extremely important for Japan. Furthermore, Japan’s fiscal situation is very severe compared with other countries. Although yields on Japanese government bonds (JGBs) are stable at a historically low level, this is simply because the credibility of Japan’s fiscal management in financial markets has been ensured. If such credibility were to falter, interest rates would rise substantially, undermining the effectiveness of monetary policy as well as increasing the loan burden on individuals and firms, and inflicting damage on the business conditions of financial institutions with JGB holdings. The economy would naturally be affected adversely. These developments would also increase interest payments on JGBs and subsequently lead to a worsening fiscal situation. Such a case must be avoided. This necessity is made apparent by the recent situation in the euro area. The Bank has been purchasing a large amount of government securities and will continue to do so. In order for the Bank to proceed with massive monetary easing, it is extremely important to steadily promote measures aimed at establishing a sustainable fiscal structure. As I have described, the Bank will work together with the government and do its utmost to overcome deflation early and achieve sustainable economic growth with price stability. BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the Yomiuri International Economic Society, Tokyo, 12 April 2013.
Haruhiko Kuroda: Quantitative and qualitative monetary easing Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the Yomiuri International Economic Society, Tokyo, 12 April 2013. * * * Introduction It is a great honor to be invited to this meeting hosted by the Yomiuri International Economic Society today. This is my first speech as Governor of the Bank of Japan. Today, I would like to explain the “Quantitative and Qualitative Monetary Easing” that we decided to embark on last week. I. Basic thinking When I was appointed as the governor, I had the following basic thinking in mind. The first is that we should do whatever is necessary to overcome deflation, which has been causing a deterioration in Japan’s economy for nearly 15 years. The Bank of Japan has engaged in a wide range of monetary easing efforts – including the implementation of the zero interest rate policy, the quantitative easing policy, and comprehensive monetary easing. Despite its cumulative efforts, there have been no easily derived concrete results, and I have felt strongly that we should make all-out efforts to utilize every possible resource bestowed upon the Bank, rather than to adopt an incremental approach – or, put differently, to adopt gradualism. The second point is the importance of committing strongly and clearly that the Bank is responsible for achieving the price stability target. At the Monetary Policy Meeting held in January, the Bank – on its own judgment – set the price stability target at 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) and made a groundbreaking commitment to achieve that target at the earliest possible time. Regarding the time frame for achieving the target, looking at other economies, many central banks have been making efforts to achieve the price stability in the medium term, with a time horizon of about two years for the effects of monetary policy to permeate the economy. I have found it appropriate for Japan’s economy as well to make a commitment with a time horizon of about two years. The third point is to convey the Bank’s strong policy stance to markets and economic entities with clarity and intelligibility, thereby dramatically changing the expectations of market participants as well as firms and households. During the course of 15 years of deflation, the public’s behavior has been based on the assumption that prices would either decline or be unlikely to rise. It is necessary to eliminate deflationary expectations through the Bank’s strong commitment and intelligible explanation. And lastly, we should enter a new phase of monetary easing both in terms of quantity and quality in order to underpin such a commitment. There is a reason to emphasize the qualitative aspect of monetary easing along with its quantitative aspect. While the Bank of Japan and other central banks in advanced economies have almost exhausted further declines in short-term interest rates, they now engage in policies to increase the size of their balance sheets as part of unconventional policy measures. There is now a broad consensus with regard to the effect of balance sheet expansion. That is, the central banks’ purchases of government bonds and other assets from the markets have the effect of encouraging further declines in long-term interest rates and lowering risk premia of asset prices by absorbing risks – such as the one stemming from interest rate fluctuations. Consequently, it becomes important to determine not only how much liquidity to supply but also how to supply that quantity. Even with the same amount of liquidity, purchasing short-term T-Bills produces different effects than in the case where the Bank purchases other assets such as long-term BIS central bankers’ speeches JGBs and risk assets like exchange-traded funds (ETFs). Thus, it is important to work on two aspects of monetary easing, both in terms of quantity and quality. II. Introduction of the “Quantitative and Qualitative Monetary Easing” With this basic set of views, I assumed the governorship and attended the Monetary Policy Meeting on April 3 and 4. Following discussion with other Policy Board members and taking into account the staff view regarding practicalities, we came to a conclusion. The name of the quantitative and qualitative monetary easing that we introduced this time speaks for itself. This is indeed a new phase of monetary easing both in terms of quantity and quality. Strong and clear commitment First, the Bank decided – as I mentioned earlier – to convey a strong and clear commitment. The Bank clearly announced in a statement that “[it] will achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years.” This is the decision of the Bank’s Policy Board – namely, it expresses the will of the Bank as an institution. New phase of monetary easing both in terms of quantity and quality Next, the Bank decided to embark on the quantitative and qualitative monetary easing as a means to underpin this commitment. Concretely, with a view to pursuing quantitative monetary easing, the Bank decided to change the main operating target for money market operations from the uncollateralized overnight call rate (i.e., interest rates) to the monetary base (i.e., quantity) and conduct money market operations so that the monetary base will increase at an annual pace of about 60–70 trillion yen. The monetary base is the currency supplied to the economy as a whole by the Bank; more specifically, it is the sum of banknotes and coins in circulation and financial institutions’ current account deposits at the Bank of Japan. As of end-2012, its amount outstanding was 138 trillion yen, and it is expected to reach about 200 trillion yen at end2013 and 270 trillion yen at end-2014. It will almost double in two years. This accounts for nearly 60 percent of nominal GDP, far above the levels of any other advanced economies. As a means to increase the monetary base, the Bank decided to purchase JGBs so that its holding of their amount outstanding on the Bank’s balance sheet will increase at an annual pace of about 50 trillion yen. Consequently, the Bank’s holding of JGBs will be increased from 89 trillion yen at end-2012 to 190 trillion yen at end-2014. In short, it will more than double in two years. The monthly flow of JGB purchases is expected to become 7+ trillion yen, because the Bank needs to compensate for JGBs redeemed. In terms of quality, in increasing the purchases of JGBs, those with all maturities including 40-year bonds will be made eligible for purchase, and the average remaining maturity of the Bank’s JGB purchases will be extended from slightly less than three years at present to about seven years – equivalent to the average maturity of the amount outstanding of JGBs issued. We intend to strengthen the working of monetary easing on the economy and prices by encouraging a further decline not only in shorter-term interest rates but also in those across the yield curve. Furthermore, with a view to lowering risk premia of asset prices, the Bank will purchase ETFs and Japan real estate investment trusts (J-REITs) so that their amounts outstanding on the Bank’s balance sheet will increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. Intelligible monetary policy In the implementation of the quantitative and qualitative monetary easing, as mentioned earlier, we have taken account of the need to present our policy stance intelligibly to markets as well as firms and households. BIS central bankers’ speeches Until last week, the Bank’s purchases of JGBs had been conducted according to the following two types of operations: one under the Asset Purchase Program introduced in October 2010 and the other for facilitating money market operations, often referred to as Rinban operations. This reflects the Bank’s various efforts to tackle challenges in response to changes in economic circumstances. In fact, these types of operations, reflecting their objectives, had differed in terms of the purchasing methods used. However, this framework was somewhat complicated and entailed a problem that the Bank’s serious efforts to combat deflation by monetary easing were rather difficult for the market and the public to understand. Based on such recognition, the Bank has terminated the Asset Purchase Program and synthesized purchasing methods of JGBs. Moreover, it has decided to express the target of JGB purchases as a net increase in its JGB holdings – namely, at an annual pace of about 50 trillion yen. We believe that these changes will facilitate understanding of the Bank’s intention with regard to monetary easing in a straightforward manner. As I mentioned earlier, the Bank decided to adopt the monetary base as an indicator for quantitative easing. This also reflects our judgment that the monetary base – the total amount of currency that the Bank supplies to the economy as a whole – will be the most appropriate indicator for conveying the Bank’s aggressive stance on monetary easing to the public. Continuation of monetary easing The Bank will continue with the quantitative and qualitative monetary easing that I have explained thus far, “aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner.” Obviously, there will be both upside and downside risks to economic activity and prices going forward. The Bank will examine those risks carefully and will not hesitate to make adjustments as appropriate, should circumstances warrant. One may ask, why is there a connection between what I have just mentioned and a time horizon of about two years? In our view, the latest decisions include all the necessary measures to achieve the 2 percent target with that time horizon. Nonetheless, it is not appropriate to say that the monetary easing will only last for two years. The economy entails uncertainty, and there is always a degree of latitude in people’s expectations; for example, some people may not share the view that the inflation rate will reach 2 percent in two years. For everyone – including those who are somewhat skeptical – to be convinced that sufficient monetary easing will be implemented, it is appropriate to state that the Bank will continue with monetary easing, aiming to achieve the price stability target of 2 percent, “as long as it is necessary.” Making such a commitment will, in the end, further ensure the achievement of the target in two years. I also want to elaborate on the meaning of “as long as it is necessary.” The Bank does not believe 2 percent inflation achieved at a certain point in time is enough; rather, it believes 2 percent inflation should be maintained in a stable manner. Therefore, even if the inflation rate hits 2 percent at some point, the Bank could continue with the quantitative and qualitative monetary easing if it is judged necessary to do so in order to maintain that rate in a stable manner. The opposite could also be true. In short, analyzing the fundamental movement of prices, the Bank intends to continue with monetary easing, as long as it is necessary. III. Effects of the “Quantitative and Qualitative Monetary Easing” Transmission channels of monetary easing effects I will next explain the mechanism of achieving the 2 percent target under the quantitative and qualitative monetary easing. The Bank expects that the effects of monetary easing will permeate the economy and influence prices primarily through three channels. BIS central bankers’ speeches First, the purchases of JGBs, ETFs, and J-REITs will encourage a further decline in longerterm interest rates and lower risk premia of asset prices. This will raise firms’ credit demand through a decline in funding costs. Second, as a result of the Bank’s massive purchases of JGBs, both investors and financial institutions investing in JGBs are expected to shift from JGBs to such risk assets as stocks and foreign-denominated bonds and/or to increase lending within their portfolios. In economic textbooks, this is referred to as a portfolio rebalancing effect. The extension of the average remaining maturity of JGB purchases reflects our understanding of such an effect. Third, the commitment to achieve the price stability target at the earliest possible time and the continuation of the new phase of monetary easing are thought to drastically change the expectations of markets and economic entities. This is what I referred to earlier as the elimination of deflationary expectations. A rise in the expected inflation rate will not only influence actual prices but also stimulate private demand through a decline in real interest rates. Developments in economic activity and prices Looking at recent developments in economic activity and prices, it seems that the conditions are being prepared to demonstrate the effects of the quantitative and qualitative monetary easing through the three transmission channels that I just mentioned. Indeed, Japan’s economy has shown some bright signs of picking up. Going forward, we expect the economy to return to a moderate recovery path against the background of firm domestic demand and a pick-up in growth rates of overseas economies. In recent months, conditions in financial markets have significantly turned favorable due to the abatement of global investors’ risk aversion and expectations for domestic policies. The year-on-year rate of change in the CPI has recently been at around 0 percent or slightly negative, but looking to the future, it is expected to turn positive and start picking up, mainly reflecting the improvement in the aggregate demand and supply balance. Looking at breakeven inflation rates – using the information content in inflation-indexed bonds – and the results of economists’ and households’ surveys, we have increasing evidence that inflation expectations are starting to rise. Behind this are expectations for policies including monetary policy. This indicates that policies can move expectations. The Bank expects that the quantitative and qualitative monetary easing will support, in a timely manner, the positive movements that have started to appear in economic activity and financial markets, contribute to a further pick-up in inflation expectations that appear to have risen, and lead Japan’s economy to overcome deflation that has lasted for nearly 15 years. IV. Some points of discussion in the monetary policy conduct After the announcement of this time’s decision, some wonder if the Bank can carry out the quantitative and qualitative monetary easing while others say that it has gone too far. In addition, we often receive questions about the relationship between monetary policy and other policies conducted by the government. In the final part of my remarks, I wish to answer some of these questions. Execution of the quantitative and qualitative monetary easing The newly planned purchase of JGBs at an annual pace of 50 trillion yen is massive and goes beyond the conventional knowledge of market participants. In addition, the achievement of the monetary base of 270 trillion yen at end-2014 requires that financial institutions’ current account balances held at the Bank reach 175 trillion yen. Again, this is extremely large. Furthermore, the extension of the average remaining maturity from slightly less than three years to about seven years (i.e., allowing for a range of about six to eight years) necessitates the purchases of JGBs with longer maturity, including 20- and 30-year bonds. Such JGBs with super-long maturities are likely to be held to maturity by institutional BIS central bankers’ speeches investors and their market is not so active. Against this background, some market participants wonder if the Bank is able to purchase these JGBs in practice. To answer this question, we can do this, in principle, so long as the Bank purchases a wide range of JGBs through a competitive auction. I assure you that we will achieve our commitment. Having said so, however, such purchases by the Bank might not proceed smoothly because they go beyond the market’s convention. To start with, these measures are meant to encourage a further decline in interest rates; thus, effects on the market are inevitable to some extent. As the Bank wants to facilitate such operations, it is vital to have the cooperation of market participants, such as counterparties’ active bidding in the Bank’s market operations. The Bank has decided to set forums for enhanced dialogue with those market participants in order to exchange views pertaining to money market operations and market transactions in general. In fact, it has already initiated such dialogue with various market participants since last week. Relationship with financing the fiscal deficit Once the Bank embarks on the large-scale purchase of JGBs under the quantitative and qualitative monetary easing, some worry that this will result in financing the fiscal deficit. The JGB market remains stable, but if such purchases by the Bank were regarded as monetizing government debt, the JGB market might start destabilizing, raising long-term interest rates in a manner inconsistent with the real economy. This might not only offset the monetary easing effects but also have negative effects on Japan’s financial system and its economy as a whole. Of course, the JGB purchases under the quantitative and qualitative monetary easing are executed for the purpose of conducting monetary policy and not for the purpose of financing fiscal deficits. Moreover, in order to avoid a possible arousal of doubt regarding the Bank’s increasing purchases of JGBs as financing fiscal deficits, it is vital for the government to clearly show the future course of fiscal consolidation and steadily make progress to reform the fiscal structure. On this point, the government – in the joint statement released with the Bank in January – stated that “in strengthening coordination between the Government and the Bank of Japan, the Government will steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management.” We strongly expect the government to move on that front. Because the Bank synthesized the purchasing methods of JGBs this time, it temporarily suspended the so-called banknote principle. This principle indicates that the purchases of JGBs conducted for facilitating money market operations are subject to the limitation that the outstanding amount of long-term government bonds effectively held by the Bank be kept below the outstanding balance of banknotes issued. In reality, however, after the introduction of the Asset Purchase Program in 2010, the total amount outstanding of JGBs held by the Bank has already exceeded the outstanding balance of banknotes. Based on this recognition, the Bank has decided to temporarily suspend the banknote principle as it pursues the quantitative and qualitative monetary easing. In any case, let me reiterate that the Bank will not finance the fiscal deficit during or after the period of the quantitative and qualitative monetary easing, and this line of thinking will not change. Effect on exchange rate We also hear comments about the relationship between monetary policy and exchange rates against the background of the recent depreciation of the yen. On this point, we have no intention to conduct monetary policy targeting the exchange rate. The objective of the Bank’s monetary policy is, obviously, to pursue the stability of domestic prices. It is true that, when a central bank takes accommodative actions, there is a tendency for its country’s currency to depreciate. This, however, is merely a general observation, ceteris paribus. For instance, if the growth potential of the economy rises as a result of monetary BIS central bankers’ speeches accommodation as well as appropriate fiscal policy and the growth strategy, its currency could appreciate rather than depreciate. In any event, the Bank’s monetary policy is focused on achieving the domestic objective to lead Japan’s economy toward overcoming deflation. Achieving this goal will eventually provide the global economy with favorable effects. I believe that the international community shares a common understanding on these points. Three-pronged strategy (three arrows) At present, the government is determined to address challenges that Japan’s economy faces, including the overcoming of deflation, through the combination of three policy arrows – namely, bold monetary easing, flexible fiscal policy, and a growth strategy that promotes private investment. I think it is indeed an appropriate policy package. Achieving the price stability target of 2 percent at the earliest possible time, through the first arrow (i.e., monetary easing) is the role of the Bank of Japan. As I have explained to you today, the Bank will achieve this target under its own responsibility. In addition, parallel to monetary easing, if the government creates real demand and wages and employment improve through the expansion of consumption and investment, this is expected to contribute to generating a virtuous cycle that eventually will lead to a gradual pick-up in inflation. It is in this sense that the implementation of the other two arrows – namely, flexible fiscal policy for the time being and a growth strategy – will lead to raising the growth outlook, thereby contributing to the achievement of the price stability target more smoothly. We have high expectations that the government will make steady progress on these fronts. Concluding remarks For eight years before assuming the position of Governor of the Bank of Japan, I looked at Japan from overseas as President of the Asian Development Bank. No other country has suffered from deflation for nearly 15 years. Given that Japanese financial institutions, firms, and individuals play active roles in each Asian economy, I have often found it hard to accept the contrasting image at home and abroad. The world is eagerly waiting for Japan to overcome deflation and for Japan’s economy to recover its economic strength. I believe steady efforts toward achieving these goals will also lead Japan toward regaining its influence on the global society. Thank you. 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, Gifu, 18 April 2013.
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, Gifu, 18 April 2013. * * * Introduction Thank you for giving me this opportunity to exchange views with people representing Gifu Prefecture, who have taken time to be here despite their busy schedules. Allow me to also express my gratitude for your cooperation with the activities of the Bank of Japan’s Nagoya Branch. Today, I will review economic activity and prices in Japan, whose economy has stopped weakening and has shown some signs of picking up, and then discuss the Bank’s monetary policy. My concluding remarks will touch briefly on the economy of Gifu Prefecture. Following my speech, I would like to listen to your views on the actual situation of the local economy and to your candid opinions. I. Recent developments in economic activity and prices A. Economic activity through the end of 2012: firms’ defensive stance I would like to begin by looking back at developments in overseas economies and Japan’s economy over the past few years, through the end of 2012. The following two developments can be highlighted as the main features of this period. First, the outlook for overseas economies had been highly uncertain due to their prolonged deceleration. Even though several years had passed since the Lehman shock, overseas economies remained unable to emerge from the phase of post-crisis adjustment; that is, the chronic economic downturn. Subsequently, these economies were struck by multiple waves of significant shocks, including the worsening of the European sovereign debt problem and concern about a potential disintegration of the euro, as well as a delayed recovery in the employment situation and the fiscal problem in the United States. As a result, investors’ risk aversion and preference for safe assets heightened in global financial markets, and the yen’s appreciating trend continued. The downturn in overseas economies was also reflected in developments in the world economic growth rate (Chart 1). Second, reflecting such severe conditions in overseas economies and global financial markets, business activities in Japan, particularly fixed investment, became cautious. With a high degree of uncertainty regarding the outlook, Japanese firms focused on taking a defensive stance, holding back or postponing fixed investment while maintaining relatively high profits and internal reserves (Chart 2). At the same time, stock prices and the potential growth rate of Japan’s economy also remained depressed (charts 3 and 4). It must be noted that the continuation of such a defensive stance can cause deflationary sentiment to become firmly fixed and impair the economy’s growth potential. In order to make Japanese firms shift from such an excessively defensive stance and allow the economy to regain its growth potential, it is essential to put forward various regulatory and institutional reforms as well as a wide range of investment, such as in capital and human resources. In this regard, it is encouraging to see that Japanese firms’ growth expectations and appetite for fixed investment have been maintained. For example, according to the Cabinet Office’s Annual Survey of Corporate Behavior (Fiscal 2012), firms’ forecasts for real growth rates over the next three and five years, respectively, were at a level exceeding 1 percent and also above the current potential growth rate, which is estimated to be in the range of 0–0.5 percent. Moreover, with business fixed investment plans remaining solid, postponed BIS central bankers’ speeches investment projects are likely to have accumulated considerably, indicating that firms’ growth expectations remain resilient. Furthermore, business sentiment has started to pick up and corporate profit prospects have begun to improve, triggered by the correction in the yen’s appreciation and the rise in stock prices since the end of 2012. Although uncertainty regarding the world economy still exists, serious tail risks such as a potential disintegration of the euro have receded and the outlook for overseas economies has been on an improving trend. Reflecting these developments, firms are gradually beginning to enjoy an environment in which they can show their “animal spirits” – that is, their entrepreneurship – and carry out business fixed investment. B. Japan’s economy: showing some signs of picking up In these circumstances, Japan’s economy has finally stopped weakening and has shown some signs of picking up. Overseas economies remain in a deceleration phase on the whole, but the U.S. and Chinese economies are heading toward a pick-up. In this situation, Japan’s exports have stopped decreasing. As for domestic demand, business fixed investment continues to show some weakness on the whole, as the result of investment that is weak in manufacturing and solid in nonmanufacturing. In contrast, public investment has continued to increase, and housing investment has generally been picking up. Private consumption has been increasingly resilient. Reflecting these developments in demand both at home and abroad, industrial production has stopped decreasing and has shown some signs of picking up. With regard to the outlook, Japan’s economy is expected to return to a moderate recovery path, mainly on the assumption that domestic demand will remain resilient, partly due to the effects of various economic measures, and that growth rates of overseas economies will gradually pick up. To elaborate on this, exports are expected to pick up, led by the recovery in the U.S. and Chinese economies. As for domestic demand, it is expected that public investment will continue trending upward, supported by the effects of various economic measures, and that housing investment will continue to generally pick up. Resilience in private consumption is expected to increase gradually, assisted mainly by an improvement in consumer sentiment. Business fixed investment – a crucial factor of domestic demand – is projected to remain somewhat weak for the time being in manufacturing, but follow a moderate increasing trend thereafter, partly due to investment related to disaster prevention and energy. In these circumstances, it is anticipated that production will pick up. Japan’s economy is thus expected to gradually pick up. However, uncertainties remain over the economic outlook, such as downside risks associated with overseas economies, and I am paying greater attention to the downside risks. Meanwhile, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food has been slightly negative, due to the reversal of the previous year’s movements in durable consumer goods. As for the outlook, it is likely to remain slightly negative in the short run. This is because over the next few months, while weak economic recovery in 2012 would put downward pressure on prices, upward pressure from factors such as the depreciating trend of the yen is likely to be offset by the downward pressure brought about by the reversal of the rises in prices of televisions and crude oil in 2012. However, the year-on-year rate of change in the CPI is expected to return to around 0 percent, as the downward pressure caused by the reversal of price rises in 2012 subsides, and then become positive, assuming that the negative output gap narrows accompanied by a recovery in the economy. C. Path toward achieving the 2 percent price stability target I will next discuss the outlook for the somewhat longer term. In January 2013, the Bank decided to introduce the “price stability target” and take a decisive step forward to enhance monetary easing with the aim of achieving this target at the earliest possible time. One of the BIS central bankers’ speeches main reasons behind this decision is that it has become possible to envisage the path toward reaching the 2 percent target, in a situation where the achievement of 1 percent inflation in fiscal 2014 has come into sight in terms of the median of the Policy Board members’ forecasts of the year-on-year rate of change in the CPI. In what follows, I present a baseline scenario for the path toward achieving the 2 percent price stability target, focusing on several specific points. In creating a future scenario, it is necessary to take into account various factors, but I place particular importance on the following points. First, the world economy is expected to stabilize and grow through 2014. The latest projections by the International Monetary Fund (IMF) show that the growth rate of the world economy will increase gradually to around 4 percent through 2014 on an annual basis. In these projections, cautious views on the European economy are maintained, as represented by the forecast for 2013 of slightly negative growth, while steady recovery is expected in the U.S. economy and emerging economies in Asia. Second, as the world economy, especially the U.S. economy, recovers steadily, it is likely that investors’ risk-taking will continue to be active – the so-called risk-on – as a trend and that U.S. long-term interest rates will rise moderately. These factors will underpin the demand for risk assets as well as affect foreign exchange rates by putting pressure on the U.S. dollar to appreciate against the yen. Third, demand for business fixed investment in Japan, which has been restrained, will emerge as the world economy moves toward normalization and thereby reduces associated uncertainty. Developments since the end of 2012, such as an upturn in business sentiment and projected improvement in corporate profits, together with the effects of monetary easing by the Bank, will probably encourage firms to make positive efforts. Fourth, the potential growth rate of Japan’s economy is likely to increase moderately. Productivity will improve if business fixed investment is made and obsolete facilities and factories are replaced by ones equipped with new technologies. Moreover, if institutional and regulatory reforms are conducted in fields such as agriculture, energy, and medical care with a vigorous trade policy implemented, then efforts to strengthen the growth potential and competitiveness of the economy will progress further. In view of these prospective factors, it is reasonable to expect a moderate increase in the potential growth rate, which seems to be in the range of 0–0.5 percent at present. Fifth, the public’s inflation expectations will likely rise gradually. These expectations are affected by developments in actual inflation rates, the medium- to long-term trend of inflation rates, and the prospects for economic recovery. It is not unrealistic to assume a rise in the public’s inflation expectations if deflationary sentiment is dispelled, the actual inflation rate rises, and prospects for sustainable economic recovery become widely acknowledged under the 2 percent price stability target, together with the effects of monetary easing by the Bank. Let me briefly summarize what I have covered. The path toward achieving the 2 percent price stability target can be described as follows (Chart 6). First, the normalization of overseas economies will bolster the recovery trend in Japan’s exports and production, thereby increasing corporate profits. Second, the continued risk-on trend and gradual rise in U.S. long-term interest rates, as well as strong monetary easing by the Bank, will support accommodative financial conditions, reflected even in asset prices and foreign exchange rates. Third, this will encourage firms’ positive initiatives to make fixed investment and implement structural reforms, which will in turn bring a gradual rise in the potential growth rate of Japan’s economy. Fourth, on the expectation of sustainable economic recovery, firm household spending should be maintained and prices should gradually increase accompanied by the narrowing of the negative output gap. Fifth, the public’s inflation expectations will rise gradually, and in this situation the inflation rate is likely to rise above 1 percent during fiscal 2014 – more specifically, as of January 2013, the median of the Policy Board members’ forecasts of the year-on-year rate of change in the CPI for fiscal 2014 is BIS central bankers’ speeches 0.9 percent. And sixth, thereafter, in a situation where the virtuous circle of a five-stage path is maintained, economic recovery will be sustained and the public’s expected rate of inflation and the medium- to long-term trend inflation rate will likely increase further toward 2 percent. As a result, the actual inflation rate is projected to continue to rise, approaching the 2 percent price stability target. As illustrated, the 2 percent target will likely be achieved as the inflation rate rises in balance with a sustainable economic recovery. It should be noted that, during the 2003–2006 period, Japan experienced the same virtuous circle as the path I have just described. During this period, the prospect of resolving banks’ nonperforming-loan problem almost came into sight, and with the tailwind of recovery in overseas economies, there was progress in firms’ efforts to make arrangements to resolve the “three excesses,” in employment, capital stock, and debt, as well as in efforts to implement structural reforms and spend on new investment. These efforts were strongly supported from the financial side by policies implemented at that time, such as decisive monetary easing policy – namely, quantitative easing policy. Subsequently, the medium- to long-term trend inflation rate rose (charts 1–5). In short, during the 2003–2006 period, Japan experienced a virtuous circle of recovery in overseas economies, aggressive monetary easing, progress in structural reforms, a rise in the potential growth rate of the economy, and an increase in the medium- to long-term expected rate of inflation. Looking back at price developments during that period, prices were under downward pressure, mainly from the effects of adjusting excess labor, or reducing labor costs, and the inflow of inexpensive imported goods. Consequently, prices did not rise sufficiently to overcome deflation. This time, however, strong negative shocks to prices are unlikely to occur in addition. Therefore, if the virtuous circle I mentioned earlier does indeed begin to operate, prices are likely to swing upward. II. Monetary policy A. Conduct of monetary policy Let me now discuss the Bank’s efforts to enhance monetary easing. At the Monetary Policy Meeting (MPM) held on April 3 and 4, 2013, the Bank decided to introduce the “quantitative and qualitative monetary easing” in order to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years. Specifically, the Bank’s monetary easing consists of the following measures (Chart 7). First, with a view to pursuing the quantitative monetary easing, the Bank decided to change the main operating target for money market operations from the uncollateralized overnight call rate to the monetary base. On this basis, the Bank will conduct money market operations so that the monetary base will increase at an annual pace of about 60–70 trillion yen. Second, with a view to putting downward pressure on interest rates across the yield curve, the Bank decided to increase its purchases of Japanese government bonds (JGBs) and extend their maturity. That is, the Bank will purchase JGBs so that their amount outstanding will increase at an annual pace of about 50 trillion yen. In addition, the Bank decided that JGBs with all maturities including 40-year bonds will be made eligible for purchase, and the average remaining maturity of the Bank’s JGB purchases will be extended from slightly less than three years at present to about seven years – equivalent to the average maturity of the amount outstanding of JGBs issued. Third, with a view to lowering risk premia of asset prices, the Bank decided to purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at an annual pace of 1 trillion yen and 30 billion yen, respectively. BIS central bankers’ speeches Fourth, the Bank decided to continue with the quantitative and qualitative monetary easing, which consists of the above measures I have just explained, with the aim of achieving the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. The Bank will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. Fifth, the Bank decided to terminate the Asset Purchase Program and temporarily suspend the so-called banknote principle as it implements these measures. These measures are very drastic, and I would like to point out the main features, as follows. First, the Bank fundamentally reconstructed the framework of monetary policy, bearing in mind the importance of clearly communicating to the markets and the public its aggressive monetary easing stance to achieve the price stability target of 2 percent. To this end, the Bank first made a clear commitment to achieving the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years, and as a new framework for achieving this target, it introduced a new guideline for money market operations with the monetary base set as the main operating target. Second, the Bank had previously been strengthening its monetary easing gradually while examining the effects of easing. This time, however, it took all possible measures that were considered necessary at present. Third, the Bank took very drastic measures both in terms of the scale (quantity) and contents (quality) of its asset purchases. On the quantity side, the Bank will double the monetary base in two years – that is, it will conduct money market operations so that the monetary base will increase at an annual pace of about 60–70 trillion yen. The Bank will more than double the amount outstanding of its JGB holdings – an item that accounts for the largest part of the Bank’s balance sheet expansion – by purchasing JGBs at a level such that their amount outstanding will increase at an annual pace of about 50 trillion yen. As a result, the Bank will be purchasing JGBs on an exceedingly large scale: the monthly flow of JGB purchases is expected to exceed 7 trillion yen on a gross basis, which is an amount equivalent to about 70 percent of the monthly average of newly issued JGBs (Chart 8). On the quality side, the Bank will more than double the average remaining maturity of JGB purchases in order to exert stronger influence on longer-term interest rates in general. In addition, it will almost double the pace of ETF purchases to further lower risk premia of asset prices (Chart 9). It should be noted that the Bank decides and assesses at the MPMs paces of increase in the monetary base as well as JGB and ETF purchases on an annual flow basis, and if calculated on a stock basis, the monetary base and the amounts outstanding of JGBs as well as ETFs will double in two years. The ratio of the monetary base to nominal GDP is expected to increase to about 57 percent by the end of 2014. This not only stands out above the other advanced economies, but also is more than three times larger than the ratio before the Lehman shock. The Bank is fully aware that its massive JGB purchases and provision of the monetary base far exceed market expectations. Therefore, it is vital to have the cooperation of market participants, such as counterparties’ active bidding in the Bank’s market operations. In this regard, the Bank has set up forums for enhanced dialogue with those market participants in order to exchange views pertaining to money market operations and market transactions more generally. As part of such attempts, it held the first meeting for the purpose of exchanging views with market participants last week. B. Issues to be considered regarding the quantitative and qualitative monetary easing I will next present my views on several issues regarding the quantitative and qualitative monetary easing I have just mentioned. BIS central bankers’ speeches 1. Why was the monetary policy framework changed at this time? Ever since the price stability target of 2 percent was introduced in January 2013, I have been submitting a proposal for additional monetary easing – in the belief that it was necessary to demonstrate the Bank’s firmer determination to achieve the target at the earliest possible time – stating that “The Bank, aiming to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI, will continue with a virtually zero interest rate policy until it judges the achievement of the price stability target to be in sight. By doing so, as well as continuing with purchases of financial assets, the Bank will further pursue aggressive monetary easing.” At the same time, I also considered it necessary to change the framework of monetary policy, mainly because of the following. First, the operational burden of the Asset Purchase Program was increased, as seen in the frequently occurring undersubscription in the Bank’s fixed-rate funds-supplying operation against pooled collateral under the program. Second, if the Bank were to purchase longer-term JGBs in order to reduce such burden, this would require the consolidation of JGB purchases conducted through the program with those conducted for facilitating money market operations. Moreover, my consideration was that, if the Bank were to go so far as to change the monetary policy framework, the most effective timing would be after the installation of new leadership at the Bank. Through the discussion made at the April 3–4 MPM, I reached the conclusion that the measures for large-scale JGB purchases and their maturity extension were expected to generate stronger monetary easing effects than the proposal I had been submitting, in that they would further put strong downward pressure on the entire yield curve. Taking into account the associated costs and risks – which I will touch upon later – I voted for the introduction of the quantitative and qualitative monetary easing. 2. What kinds of transmission channels are assumed? The assumed transmission channels under the quantitative and qualitative monetary easing are as follows. The large-scale JGB purchases will create several transmission channels: (1) a channel to influence the entire yield curve; (2) one to influence asset prices such as stock prices and real estate prices; (3) one to induce portfolio adjustments by banks and institutional investors, such as increased demand for lending and risk assets; and (4) one to exert influence on inflation expectations. These channels are closely interrelated. For example, the first channel triggers the second and third channels, while the second and third channels reinforce each other (Chart 10).1 The main developments that are expected to occur through the channels I have mentioned are as follows. Through the first channel, firms’ and households’ borrowing costs will be reduced. Through the second channel, there will be a rise in firms’ capital raising and fixed investment, as well as in households’ consumption and net exports. Through the third channel, there will be a shift from investment in government securities to banks’ credit and investment in risk assets. Through the fourth channel, real interest rates will decrease and thereby underpin spending activity in the economy. As a result, we ultimately could expect to see positive effects transmit to developments in economic activity and prices. 3. What do we mean by “expectations”? In relation to the transmission effects I have just described, the measures decided at the April 3–4 MPM emphasize the influence on “expectations.” I will explain what these “expectations” mean. There are three types to consider. As a derivative of the third channel, we could expect a transmission channel through an “international spillover.” Specifically, as a result of international portfolio adjustments, if an inflow of funds occurs in foreign countries, such as through foreign bond investment, and revitalizes overseas economies, this would feed back as benefits to the domestic economy through a rise in demand overseas and an increase in profits of globally active firms. BIS central bankers’ speeches The first type is expectations for future monetary policy. The measures decided at the MPM presented the prospects for paces of increase in the monetary base and JGB purchases, as well as the time frame for continuing these actions. These in turn will increase the predictability of future polices, and thereby enhance the overall effects of the transmission channels I have mentioned. The second type is inflation expectations, which I pointed out in my earlier reference to the fourth transmission channel. The third type is expectations for a virtuous circle. Specifically, this refers to the expectations that a virtuous circle of future sustainable economic recovery and a rise in the inflation rate will emerge, as developments through the transmission channels become visible. As I described in the first half of this speech, if the scenario of aiming to achieve 2 percent CPI inflation will gradually materialize in line with the intended path, the public will actually sense this development and raise its level of confidence regarding the economic activity and price outlooks. Consequently, spending will increase due to a rise in expectations for income increases, together with a rise in the inflation rate and inflation expectations, which will in turn underpin and strengthen the virtuous circle of the economy as a whole. Taking account of each of these three aspects, I consider it important to influence expectations. 4. Why was the main operating target for money market operations changed to the monetary base? Under the quantitative and qualitative monetary easing, indicators that represent the direction of overall quantity could be the monetary base, the outstanding balance of current accounts at the Bank, and the size of the Bank’s balance sheet. Among them, the monetary base represents the amount of currency the Bank directly supplies – namely, the sum of banknotes in circulation and current account balances at the Bank – and is a clear concept in economics. The Bank judged it appropriate to introduce the monetary base as the main operating target for money market operations in order to communicate its policy stance clearly to the markets and the public as well as to enhance policy effects. Generally speaking, when the “quantity,” such as the monetary base, is used as a policy variable, controlling quantity could cause interest rates to fluctuate to some extent. The framework introduced at the April 3–4 MPM is highly distinctive in that it involves not only the control over the increase in the amount of currency, but also the decision on the purchases of financial assets such as JGBs and risk assets. In short, the new framework simultaneously pursues two channels: the general transmission channel triggered by low interest rates resulting from large-scale JGB purchases; and the channel exerting influence on inflation expectations by introducing control over the amount of currency. In doing so, the framework aims to convey a strong message to overcome deflation and further enhance policy effects.2 Let me note that, under this framework, the Bank becomes able to conduct more flexibly the operations for short-term assets, excluding JGBs and risk assets. As downward pressure will be put on the entire yield curve, interest rates with short-term maturities are likely to remain at very low levels. 5. Until when will the new monetary policy be continued? Under the price stability target, the Bank has made a commitment to achieving 2 percent inflation at the earliest possible time. It is not the case that the price stability target is fulfilled In the United States, in the 1979-1982 period, an operating procedure of controlling monetary aggregates called “non-borrowed reserve” targeting was adopted in order to curb high inflation at that time. This measure is considered to have played a role in conveying a strong message to eliminate high inflation by going so far as to change the operating procedure with the aim of achieving the objective of addressing the issue. As a result, inflation was curbed. BIS central bankers’ speeches once the targeted inflation is achieved at a single point in time. Rather, it is necessary to maintain the targeted level in a stable manner. Therefore, with a view to clarifying this purpose, the new framework is indicative of the Bank’s commitment that it will continue with the quantitative and qualitative monetary easing, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. This means that, even if the inflation rate reaches 2 percent at one point, if the Bank judges it necessary to maintain that situation in a stable manner, it will continue the quantitative and qualitative monetary easing, while the opposite is also true. Having said this, I believe that the Bank decided at the April 3–4 MPM all the necessary measures to meet its commitment to achieving the 2 percent price stability target at the earliest possible time, with a time horizon of about two years. 6. Are risks and costs considerable? It is true that the quantitative and qualitative monetary easing entails some risks. The markets may become unstable temporarily if risk-taking by some investors becomes excessive. The risks to the Bank’s balance sheet will increase, and it might take considerable time to exit from the monetary easing. However, I believe that the quantitative and qualitative monetary easing is indispensable to achieving the price stability target at the earliest possible time. Taking into account Japan’s current situation of protracted deflation, this measure should be pursued as long as benefits are considered to exceed costs, even if various risks are entailed. In the course of pursuing this measure, with a view to ensuring sustainable recovery in the economy, the Bank will carefully examine risk factors such as market conditions and developments in economic activity and prices. On this point, in the statement released on April 4, 2013, it is noted that the Bank will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. This contains the ideas presented in the statements released after the previous MPMs and in the joint statement with the government that the Bank will ascertain whether there is any significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances. The change of expression does not imply that the need to perceive risks has been reduced. 7. Is the alternative to the “banknote principle” necessary? At the April 3–4 MPM, the Bank decided to temporarily suspend the so-called banknote principle until it achieved the price stability target. However, it is not necessary to repudiate the underlying concept of the principle that the amount of banknotes in circulation – namely, the Bank’s long-term liabilities – should be backed by the purchasing of JGBs – that is, longterm assets. I understand that the Bank should resume the purchases in line with the banknote principle in the future. In order to prevent concerns over fiscal dominance from arising following the temporary suspension of the banknote principle, it is important for the government to ensure the market credibility of its stance toward achieving fiscal consolidation. In this regard, in the joint statement by the government and the Bank released in January, it is clearly stated that, in strengthening coordination between the government and the Bank, the government would steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management. I strongly expect that such efforts will make steady progress. 8. Summary of recent policy decisions The decisions made at the April 3–4 MPM have great significance. Under the framework of “comprehensive monetary easing,” which had been adopted for the past two and a half years, the Bank had been strengthening monetary easing through various unconventional measures while examining the effects of such easing. This has contributed to underpinning Japan’s economy, but the economy has failed to exit from a period of deflation. BIS central bankers’ speeches It should be noted that, because of this experience of the comprehensive monetary easing, the Bank could decide on a new policy of the quantitative and qualitative monetary easing at the April 3–4 MPM. It is true that the decision, which includes the purchases of JGBs on such an unprecedented scale, entails a certain degree of risk, but I am sure that this will produce effects that would more than offset such a risk. The Bank will strongly pursue the quantitative and qualitative monetary easing in order to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. At the same time, if regulatory and institutional reforms as well as economic growth policies implemented by the government make progress and the growth potential of the private sector increases, this will further enhance the effects of the quantitative and qualitative monetary easing. Initiatives in such areas are steadily being undertaken, and I have great expectations that further progress will be made. Concluding remarks: the economy of Gifu prefecture My concluding remarks will touch on the economy of Gifu Prefecture. In my view, monozukuri, or manufacturing, has long been a prosperous and key industry in Gifu Prefecture. For example, the proportion of workers in the manufacturing sector accounts for 24.1 percent, which is the fifth highest level in Japan. The current main manufacturing industries include transportation equipment such as motor vehicle parts and aircraft, electronic parts such as integrated circuit packages, and general machinery such as machine tools as well as molds and dies. At the same time, traditional local industries prevail throughout the prefecture, including (1) knives made in Seki City, which is recognized as the hub of Japanese cutlery production; (2) Mino paper, one of the best known types of Japanese paper, which is famous for its quality; (3) Mino ceramic ware, which accounts for about half of the dishware produced in Japan; and (4) Ichii Ittobori, yew wood carvings characterized by a fine grain. I believe that one characteristic of the prefecture is that such traditional craftsmanship has been passed on to current manufacturing industries – for example, of fine ceramics and health food such as royal jelly. In addition to this accumulation of traditional industries, Gifu Prefecture enjoys favorable geographical conditions. Situated in the center of Japan, it has good access in terms of transportation and distribution not only to the Tokai region, but also to the Tokyo metropolitan area and Kansai region. In recent years, an extension of the expressway network, including the Tokai-Kanjo Expressway, has further improved its accessibility. The prefecture’s other strengths are its hard ground, the low risk of tsunami, and its bountiful freshwater resources. Due to such advantages, the number of new factories in the prefecture has been ranked among the highest levels in Japan, at fourth and eighth place in 2011 and 2012, respectively. Investment in distribution centers is also prominent, with signs of remarkable future progress becoming evident. Through efforts to make use of these characteristics and advantages, as well as foster new areas with growth potential, I expect that further progress will be made in the prefecture with monozukuri. The Hida region, especially Takayama City, is well known as an international tourist destination that attracts a number of visitors not only from Japan but also overseas. This is the result of strenuous efforts made throughout the community, such as advertising campaigns overseas to invite tourists, a helpful visitor information center, informative brochures, and multilingual signposts. From 2011 to 2012, the number of tourists from abroad dropped because of the accident at the Fukushima nuclear power plant and the developments in relations between Japan and China. However, international tourists have been coming back of late. I expect that efforts to attract tourists both from Japan and overseas will further promote development of the tourist industry in the region. BIS central bankers’ speeches The Bank will continue to provide support as much as possible as the central bank, so that efforts in each economic sector of the prefecture will pay off. BIS central bankers’ speeches Note: Charts are based on data released prior to April 15, 2013. (Chart 1) World Economic Growth Rate % 6.00 5.00 4.00 3.00 2.00 1.00 0.00 -1.00 1996 97 99 2000 01 Source: IMF, “World Economic Outlook.” (Chart 2) Corporate Profits and Business Fixed Investment tril. yen Current profits Business fixed investment Source: Ministry of Finance, “Financial Statements of Corporations by Industry.” BIS central bankers’ speeches (Chart 3) Stock Prices (TOPIX) 2,000 1,800 1,600 1,400 1,200 1,000 2012. 1 2010. 1 2008. 1 2006. 1 2004. 1 2002. 1 2000. 1 1998. 1 1996. 1 1994. 1 Source: Bloomberg. (Chart 4) Potential Growth Rate of Japan’s Economy % 2.50 2.00 1.50 1.00 0.50 2012.1 2011.1 2010.1 2009.1 2008.1 2007.1 2006.1 2005.1 2004.1 2003.1 2002.1 2001.1 2000.1 1999.1 1998.1 1997.1 1996.1 1995.1 1994.1 0.00 Source: Bank of Japan. BIS central bankers’ speeches (Chart 5) Medium- to Long-Term Expected Rate of Inflation ％ Inflation expectations (6‑10 years ahead) Note: Figures for inflation expectations are based on the averages of the April and October results of the Consensus Forecasts, a survey conducted on private sector forecasters. Source: Consensus Economics Inc., “Consensus Forecasts.” (Chart 6) Path toward Achieving the 2 Percent Inflation Target Expected change in situation Effects on economic activity and prices (1) Normalization of overseas →Bolster the recovery trend in Japan's exports economies and production (2) Gradual increase in U.S. long- →Support accommodative financial conditions term interest rates (3) Business fixed investment and structural reforms (asset prices and foreign exchange rates) →Gradual rise in the potential growth rate (4) Expectation of sustainable →Gradual rise in prices with narrowing of the economic recovery output gap (5 )Rise in the public's inflation expectations (6) Virtuous circle of a five-stage path BIS central bankers’ speeches →1% inflation accompanied by (1) through →2% inflation with the rise in the trend inflation (Chart 7) Quantitative and Qualitative Monetary Easing (QQE) 1. Adoption of the monetary base control ● The monetary base will increase at an annual pace of about 60-70 tril. yen. 2. Increase in JGB purchases and their maturity extension ● With a view to encouraging a further decline in interest rates across the yield curve, the Bank will purchase JGBs so that their amount outstanding will increase at an annual pace of about 50 tril. yen. ● JGBs with all maturities will be made eligible for purchase, and the average remaining maturity of the Bank's JGB purchases will be extended from slightly less than 3 years to about 7 years -- equivalent to the average maturity of the amount outstanding of JGBs issued. 3. Increase in ETF and J-REIT purchases ● With a view to lowering risk premia of asset prices, the Bank will purchase ETFs and J-REITs so that their amounts outstanding will increase at an annual pace of 1 tril. yen and 30 bil. yen, respectively. 4. Continuation of the QQE ● The Bank will continue with the QQE, aiming to achieve the price stability target of 2%, as long as it is necessary for maintaining that target in a stable manner. ● The Bank will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. BIS central bankers’ speeches (Chart 8) Expansion in the Monetary Base and JGB Purchases tril. yen End-2014 270 tril. yen Monetary base Amount outstanding of the Bank's JGB holdings End-2013 200 tril. yen End-2014 190 tril. yen End-2012 138 tril. yen End-2013 140 tril. yen End-2012 91 tril. yen Projection BIS central bankers’ speeches (Chart 9) Balance Sheet Projections tril. yen End-2012 End-2013 End-2014 (actual) (projected) (projected) Monetary base JGBs CP 2.1 2.2 2.2 Corporate bonds 2.9 3.2 3.2 Exchange-traded funds (ETFs) 1.5 2.5 3.5 Japan real investment (J-REITs) estate trusts 0.11 0.14 0.17 Loan Program Support 3.3 Banknotes Current deposits Breakdown of the Bank's Balance Sheet Total assets others) Total liabilities (including and assets (including others) net BIS central bankers’ speeches (Chart10) Transmission Channels Quantitative easing: expansion in the monetary base Qualitative easing: expansion in JGBs and risk assets Increase in JGB purchases and their maturity extension Purchases of ETFs and J-REITs Channel Downward pressure on the entire yield curve Channel Lowering risk premia of asset prices Channel Portfolio adjustments by banks and investors Channel Inflation expectations Improvement of financial conditions （borrowing costs, bank credit, stock prices, etc.） Increase in expenditure (consumption, fixed investment, exports) Improvement of the output gap Decrease in real interest rates Increase in inflation expectations Increase in the CPI BIS central bankers’ speeches
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Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Executive Forum "Impact of the financial crises on central bank functions", hosted by the World Bank, Washington DC, 22 April 2013.
Hiroshi Nakaso: Financial crises and central banks’ “Lender of Last Resort” function Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Executive Forum “Impact of the financial crises on central bank functions”, hosted by the World Bank, Washington DC, 22 April 2013. * I. * * Introduction The financial crisis that originated in the United States spilled over into the global financial system in the summer of 2007, and its breadth and potency rapidly increased following the collapse of Lehman Brothers in the autumn of 2008. The crisis again reminded us of the inherent instability of the financial system and the vicious compounding of problems between the financial system and the real economy. In response, central banks around the world took action, including cuts in interest rates, the provision of ample liquidity, and so-called nontraditional or unconventional measures. Among these, the “lender of last resort” (LLR hereafter) function was the most critical that was carried out by central banks amidst the deepening crisis. The importance of the LLR function is underscored by history, and this time around, forceful actions by central banks contributed significantly to avoiding a meltdown of the global financial system and the collapse of real economic activity. The concept of LLR came to be widely recognized thanks to Walter Bagehot, who was the editor of the London Economist.1 According to his formulation, one of the most basic principles was that the central bank should be prepared to lend to any “solvent but illiquid” bank so as to prevent the unsettling of the financial system. This view came to be criticized in recent years by some contemporary economists. They thought that Bagehot’s principle was the offspring of an age when financial markets were not as sophisticated, and that it was no longer applicable in the current market environment where market participants have considerable ability to collect and process information. This view was founded on the belief that, in an efficient market, market participants should be able to distinguish clearly between solvency and liquidity issues confronted by their counterparties, which entailed that solvent banks would never face liquidity constraints, negating the need for the central bank to provide LLR functions to individual banks. Such an optimistic view, however, proved to be too cavalier. With the deepening of financial markets and globalization, the LLR function of central banks not only transmuted but also increased in importance. Today, in the time allotted to me, I will reflect on the experiences of the recent financial crisis, and begin by summarizing the changes in central banks’ LLR function. That will be followed by a discussion of a few issues pertaining to the LLR function that have become apparent. I will then conclude by reflecting on the roles the central bank should play in order to safeguard the stability of the financial system and the real economy. II. The transmutation of the LLR function The purpose of the LLR function is to prevent the manifestation of systemic risk, that is, the risk that a problem in one part of the financial system spreads to the whole system in a domino-like fashion. The classic description of systemic risk focuses on contagion, where a bank run could affect other domestic banks in the system through a decline in funding liquidity. In contrast, the recent financial crisis revealed that, in the light of deepening financial markets and globalization, systemic risk can (a) be magnified through mutually Walter Bagehot ([1873] 1924), Lombard Street: A Description of the Money Market, London: John Murray. BIS central bankers’ speeches reinforcing declines in funding and market liquidity; and (b) spill over across national borders and have a global dimension. Central banks’ LLR function has evolved in response, encompassing the roles of “market maker of last resort” (MMLR hereafter) and “global lender of last resort” (GLLR hereafter). MMLR From the summer of 2007, market liquidity dried up in the U.S. and European interbank market as the problems in the sub-prime mortgage sector spilled over into other sectors, which in turn increased the precautionary demand for liquidity and heightened counterparty risk. At the same time, investors’ risk appetite plunged, resulting in a decline in market liquidity not only in the securitization markets but also in markets for risky assets in general. Financial institutions that had accumulated such assets on their balance sheets were increasingly hard pressed to finance such positions even for the short term. With liquidity in the interbank market severely impaired, funding became ever more difficult, and financial institutions were forced into stepping up their sales of safe assets, whose markets remained relatively liquid. This, in turn, eroded the liquidity in the markets for relatively safe securities and prevented the functioning of repo markets that used those securities as collateral. It was a vicious cycle – a “market run” – where the decline in market liquidity impacted the funding liquidity of financial institutions, which then further eroded market liquidity (Chart 1). When market liquidity is impaired, markets will seriously struggle to perform their role of price discovery in line with fundamentals. In such an environment, central banks in the advanced economies first provided liquidity to the interbank market as an unwavering counterparty. In addition, they provided liquidity directly to market participants who were straining to obtain funding in the severely constricted capital markets. For example, the Federal Reserve introduced measures to provide funds to issuers of commercial paper (CP) and holders of asset-backed securities (ABS).Meanwhile, the Bank of Japan purchased CPs, asset-backed commercial papers, and corporate bonds in response to the rapid deterioration of market liquidity in those markets, which funded large non-financial corporations directly impacted by the financial crisis. In the euro area, when the sovereign spread of the so-called peripheral countries against Germany widened, the European Central Bank (ECB) purchased bonds issued by the peripheral countries through the Securities Markets Programme (SMP), judging that the widening of the spreads was due not to deteriorating solvency but to impairment of market liquidity. Such provision of liquidity by central banks, which in effect turned central banks into market makers, aided the recovery of market functioning. In this regard, central banks played the role of MMLR. GLLR When the intermediation functions of financial institutions are conducted solely in their home currency, home central banks can respond to liquidity crises through their LLR function. However, with the deepening of globalization, financial institutions have increasingly broadened their intermediation activities into non-home currencies, and as a result it has become increasingly difficult for central banks to put an end to liquidity crises on their own if financial institutions are confronted with liquidity issues in non-home currencies. In such cases, troubled financial institutions may not be able to obtain liquidity directly from the issuing central bank in a timely manner, due to operational constraints. During the recent financial crisis, U.S. dollar liquidity became an acute concern, especially among European financial institutions, which had expanded their dollar intermediation activities. Consequently, the ECB and the Swiss National Bank each entered into swap arrangements with the Federal Reserve to obtain dollars and provided dollars to financial institutions operating in the respective markets (Chart 2). After the collapse of Lehman Brothers, the scope of swap arrangements broadened, with other major central banks, including the Bank of England and the Bank of Japan, establishing swap arrangements with the Federal Reserve. In addition, when global financial markets came under heavy strain in BIS central bankers’ speeches 2011 on the back of the sovereign debt problems in Europe, six major central banks established bilateral liquidity swap arrangements, as a contingency measure, so that liquidity could be provided in each jurisdiction in any of their currencies, if needed. Such a provision of non-home currencies under central bank cooperation can be called GLLR. III. New issues regarding the LLR function The transmutation of the LLR function of central banks raises a set of new issues. In the following, focusing on MMLR and GLLR, I will discuss (a) the relationship between monetary and financial stability policies, (b) the limits to liquidity provision and support by governments, (c) the financial trilemma and cooperation among central banks, and (d) the relationship between foreign reserves policy and the GLLR function. Relationship between monetary and financial stability policies When one groups the functions of central banks into monetary policy and financial stability policy, MMLR falls under the heading of financial stability policy, if one emphasizes the aspect of mitigating systemic risk. At the same time, the function can be labeled as monetary policy, albeit of the non-traditional sort. Given that monetary policy works through the money and capital markets, the prolonged impairment of market functioning resulting from the erosion of liquidity will negatively impact the effectiveness of monetary policy. In this regard, efforts by central banks, acting as MMLR, to restore liquidity in the money and capital markets can be deemed as part of monetary policy. Instruments deployed as MMLR by central banks are complementary. Take for example the ECB’s case. In the euro area, as the area’s crisis deepened beginning in 2010, increasing selling pressure from non-domestic investors in the sovereign bond markets of the peripheral countries resulted in the fragmentation of financial markets within the currency area and impeded bank financing (Chart 3). In response, the ECB, through its operations, in particular the Longer-term Refinancing Operations (LTROs), provided funds in unlimited quantities to the financial institutions of peripheral countries, which had difficulties in funding themselves in the interbank market. In the meantime, the ECB worked to alleviate the fragmentation of financial markets through its purchases of peripheral sovereign bonds under the SMP. In the peripheral countries, financial institutions increased their holdings of domestic sovereign bonds and used such bonds as collateral when obtaining funds from the ECB. In this regard, the absence of either LTROs or SMP would have been detrimental to achieving the stability of the financial system and prices – or more precisely the effective transmission of monetary easing. In the same vein, in the United States, the Federal Reserve provided funds to primary dealers secured by agency bonds and agency mortgage-backed securities under the Primary Dealer Credit Facility and at the same time purchased the same securities. In this case, LLR and MMLR functions were complementary. These examples show that, in times of crises, the relationship between financial stability policy and monetary policy becomes more intertwined than ever. Non-traditional monetary policy measures adopted during the crisis are beneficial to the stabilization of the financial system. At the same time, measures adopted with a view to stabilizing the financial system maintain and reinforce the transmission channels of monetary policy. Given that both policies aim to influence the economy and prices through financial markets and financial institutions, not only are their effects complementary, but so are also their “inputs”: information and analyses provided for one policy may be employed to increase the effectiveness of the other. Having said this, as we saw during the euro area crisis, when a crisis develops as a result of a loss of liquidity in the sovereign bond market reflecting concerns over the solvency of the sovereign, other problems may arise. If the central bank attaches greater weight to the stability of the financial system, it has to continue purchasing government paper as MMLR and expand its balance sheet at the expense of increased uncertainty regarding the future path of prices. On the other hand, if the central bank chooses to avoid the expansion of its BIS central bankers’ speeches balance sheet and attaches greater weight to price stability, it may become difficult to restrain the decrease in the liquidity of the market for government paper, as the bank’s purchase of such paper is reduced. Thus, if such a tradeoff is to be avoided, trust in the sustainability of government finances is a prerequisite. Limits to liquidity provision and support by Governments In a situation where the central bank provides funds to a “solvent but illiquid” financial institution as LLR, the funding liquidity of that institution will be ensured. On the other hand, when the central bank steps in to provide liquidity as MMLR, market liquidity will not automatically improve. As a result, the central bank will face a difficult decision as to how far it is prepared to go. Depending on its own actions as MMLR, not only will those actions affect the stability of the financial system and the effectiveness of monetary policy, but they will also endogenously influence the central bank’s own financial soundness. If the central bank’s actions as MMLR are able to set in motion a process of reviving market liquidity, the market prices of the assets that the central bank had purchased or accepted as collateral will stabilize, thus safeguarding its equity capital. If, in contrast, the central bank attempts to defend its balance sheet – and hence the confidence in the central bank – and limit its capital exposure by holding back on liquidity provision as MMLR, market liquidity might continue to decline, which would, in turn undermine the value of the assets that the central bank had purchased or accepted as collateral, eventually risking a hit to its equity capital. An erosion of the central bank’s financial soundness resulting in a loss of its credibility may compromise its ability to implement monetary policy and ultimately the effectiveness of such policy. In addition, losses incurred by the central bank would hurt taxpayers as transfers to the government are reduced and its actions as MMLR would inevitably impinge upon microlevel resource allocation, which implies that they are quasi-fiscal measures (Chart 4). At the same time, however, it is also undesirable to see the central bank not acting sufficiently forcefully as MMLR in order to minimize hits on its balance sheet. In this context, when the Federal Reserve introduced the Term Asset-Backed Securities Loan Facility so as to restore liquidity in the ABS market, it was agreed that the U.S. government would shoulder losses up to a certain level. In the case of the Asset Purchase Programme of the Bank of England, this is based on the agreement that any losses will be borne by the U.K. government. In the case of the Bank of Japan, when it decided to embark on a program of purchasing corporate financing instruments in 2009, the Japanese government noted at the Monetary Policy Meeting that it intended to consult with the Bank of Japan in the context of closing its books at the end of accounting periods if the risks had materialized. The financial trilemma and cooperation among central banks With regard to the stability of the financial system under deepening globalization, an important perspective is provided by Schoenmaker: the “financial trilemma” (Chart 5).2 That view holds that it is impossible to simultaneously achieve financial stability, financial integration (capital mobility), and national financial policy. Let me apply this framework to the LLR function. If, against the background of deepening global financial integration, the LLR function of the central bank is confined to providing liquidity in the domestic currency – that is, its role is limited to national financial policy – stability of the global financial system cannot be achieved. Under a different combination, if financial stability is to be pursued with national financial policy (i.e., domestic currency LLR), financial integration – globalization – must be curbed through the regulation of capital flows. Alternatively, in order to attain financial stability under global financial integration, some sort of supra-national financial policy is Dirk Schoenmaker (2011), “The Financial Trilemma,” Economics Letters, 111, 57–59. BIS central bankers’ speeches necessary, including an international framework for financial regulation and supervision. GLLR realized through central bank cooperation might be regarded as an element of the safety net in the broad context of the third combination. There are many proposals for an international safety net other than central banks acting as GLLR. For example, one suggestion calls for the establishment by national central banks of credit lines in domestic currencies to the IMF – the IMF will then manage the money and provide liquidity to, and monitor the policies of, central banks in need of liquidity. Another scheme attempts to make use of SDRs. There is also a plan to collectively manage a pool of national foreign exchange reserves. All of these will require an agreement on cost allocation before they can become a reality. In view of the fact that liquidity and solvency tend to deteriorate in tandem during times of crisis, extending financing to troubled financial institutions, central banks, or governments carries credit risk. With regard to cost allocation when such risks materialize, given that risks to financial stability can easily cross borders and are therefore mutually dependent in a globalized financial system, there may be little disagreement on the view that some sort of international policy coordination is necessary. Nevertheless, reaching political agreement on concrete proposals for cost allocation is inherently difficult. At the same time, in order to persuade the public that the costs are appropriate, it is essential to establish mechanisms to ensure that any costs are minimized; in other words, it is essential that an effective system of regulation and supervision at a global level is put in place. The ongoing discussion over a banking union in the euro area is highly instructive in this regard. The relationship between foreign reserves policy and the GLLR function The figures for cross-border financing at banks in the advanced economies during the recent financial crisis reveal some interesting trends (Chart 6). First of all, in the second quarter of 2008, cross-border liabilities to banks shrank as transactions declined in the interbank market. In the following quarter (3Q), cross-border liabilities to non-banks fell, probably reflecting the reluctance of banks to maintain credit lines in the light of the shrinking interbank market and also the draw-downs of deposits by non-financials. Then, in the fourth quarter, liabilities to official monetary authorities dropped off. The liabilities exclude the U.S. dollar funds supplied to banks by central banks under the Federal Reserve swap facilities, and consist mainly of dollar deposits taken in from overseas monetary authorities managing their foreign exchange reserves. Before the crisis, monetary authorities of emerging market and commodity producing economies had built up significant balances of dollar deposits at banks, mostly European ones. This resulted in increasing liabilities to official monetary authorities at advanced economy banks, which trend was reversed as the crisis deepened. The withdrawal of foreign exchange reserve money by overseas authorities increased markedly, especially vis-à-vis European banks, after the collapse of Lehman Brothers in the autumn of 2008, and again towards the end of 2011, when the European sovereign crisis began to spill over into the financial system. Although overseas authorities did not pull the trigger, their actions were one element that exacerbated the disruption. It can be seen that the LIBOR-OIS spread, which is a signal of risk premiums in the short-term money markets, was closely correlated with the behavior of authorities. Looking at the ebb and flow of currency and deposits attributed to the management of foreign exchange reserves, authorities of emerging economies withdrew funds from financial institutions in 2008 and the second half of 2011, whereas the behavior of the authorities of advanced economies had not materially changed (Chart 7). The main reason for this behavior seems to be that, as international financial markets became increasingly unstable from the summer of 2007 and funds began to flow out of emerging markets, those authorities withdrew significant amounts of dollar deposits from advanced economy banks, where they had parked their foreign exchange reserves, and intervened in the foreign exchange market defending their currencies, selling dollars and purchasing domestic currency. The withdrawal by overseas authorities, mainly emerging market authorities, was massive, amounting to BIS central bankers’ speeches about $800 billion during 2008. A significant share of this was covered by the dollars provided under the central bank swap arrangements, the outstanding amount of which increased by about $500 billion in the corresponding period (Chart 8). It was perfectly rational for individual emerging market authorities to draw down their foreign exchange reserves in order to insulate their respective economies from the turbulence in international financial markets. Nevertheless, aggregated across emerging economies, such actions had the effect of reducing funding liquidity at banks of advanced economies. When this prompted more deleveraging by the banks, it resulted in further capital outflows from emerging market economies – the “fallacy of composition.” In other words, the pursuit of national financial policies to protect against the crisis exacerbated the instability of the entire financial system, which again underscores Schoenmaker’s “financial trilemma” (see previous Chart 5). IV. Concluding remarks Central banks’ LLR function is necessary because the world we live in is full of uncertainties. While the advances in financial and information technologies of recent years have enabled us to statistically and numerically describe developments in financial markets which were only understood intuitively before, these descriptions are inevitably approximations. Events that cannot be predicted through probabilistic methods or past experience do happen. There are black swans swimming around us. There is a need for backstops to prevent the whole system from disintegrating when a black swan appears, and the LLR function is one of them. In a financial landscape characterized by deepening globalization, where market-driven financial intermediation proliferates, it seems almost inevitable that the LLR function of central banks has to be broadened, if the stability of the financial system is to be maintained. During the recent crisis, as I have noted today, central banks have succeeded to some extent in meeting a number of challenges. Nevertheless, there are unresolved issues. While appropriate responses by individual central banks are no doubt important, it is essential to enhance the coordination and division of labor between central banks and governments as well as cooperation among central banks and fiscal authorities with a view to building an international safety net. Furthermore, the vantage point of crisis prevention is just as important as crisis response. One difficult issue here is that the existence of an LLR, and the growing role that central banks’ LLR function has come to play, could encourage excessive risk-taking by market participants; in other words, the issue of moral hazard needs to be taken into account. In this regard, one must stress the role played by regulation and supervision in order to prevent the accumulation of financial imbalances. It is also necessary to go another step forward and incorporate macroprudential perspectives in central bank actions. Given that globally relaxed monetary conditions are expected to be maintained for the near future, central banks must strive to answer how this is to be realized in the future conduct of their policy. We must also pay attention to the fallacy of composition in the global financial system. In the context of ever-growing global financial integration with free capital flows, individual central banks, in their pursuit of maintaining the stability of their domestic economies, have the choice of either conducting an independent monetary policy or focusing on the exchange rate (i.e., maintaining a fixed exchange rate). Whatever choice individual central banks make for themselves, the effects of their policies do not necessarily add up globally to guarantee the stability of the global economy (Chart 9). For example, if there are externalities to stabilization policies, such policies are likely to be synchronized across countries, which may amplify fluctuations in the world economy and destabilize the global financial system. The policy issues confronting central banks in this problem of “fallacy of composition” are probably more intractable than the trilemma described by Robert Mundell. Monetary policy in a globalized economy may also be affected by feedback loops in unexpected ways, since nationally granular foreign reserves policies (accumulation of precautionary reserves against BIS central bankers’ speeches capital flight) or national financial policies could amplify international capital flows or concentrate capital flows into economies with the laxest regulations. Such interactions between Mundell’s and Schoenmaker’s trilemmas would complicate the policy conundrum. “This time is different” has become synonymous with our follies. Nevertheless, we should not fall into the trap of defeatism. There are many things we can do to reduce the chances of another crisis. Although the bar is high for central banks in building up ideal and foolproof arrangements, we know that “even the longest journey begins with a single step” – a Japanese proverb equivalent to “Rome was not built in one day.” It is important to enhance coordination and cooperation among central banks and governments wherever possible, and such steps taken, however small, will enable us to eventually reach a goal that seems to be far away. 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 Haruhiko Kuroda, Governor of the Bank of Japan, at the International Conference on "The future of Asia", Tokyo, 24 May 2013.
Haruhiko Kuroda: Realizing the Asian century Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the International Conference on “The future of Asia”, Tokyo, 24 May 2013. * 1. * * Introduction Good morning. I am honored to be here today at the International Conference on the Future of Asia. In the 45 years of my career, I have moved from the Ministry of Finance to Hitotsubashi University, the Asian Development Bank, and now to the Bank of Japan. But wherever I have worked, my focus has been on Asia, and I have always cherished my ties with my Asian colleagues. From this standpoint, I will first briefly touch upon economic developments in Asia, then move to the thrust of my speech today, which is the challenges to realizing the Asian Century and how these may be addressed, and close with how Japan can contribute to these efforts. 2. Economic developments in Asia: factors driving growth While developed economies have experienced prolonged economic downturns since the Lehman Shock and the ensuing global financial crisis, Asia has maintained a higher growth rate than any other region in the world, albeit with some slowdown. In particular, the growth of ASEAN economies has been outstanding, with a boost in economic growth in 2012. I would like to point out three structural changes supporting the strength of the Asian economies. The first change is that the supply chain in Asia has been enhanced. An intraregional supply chain network, covering not just finished goods but also other areas of the supply chain ladder such as raw materials and intermediate goods, has been established by the relocation of firms, thereby underpinning the global competitiveness of the region. This integrated supply chain network would not have been possible without the second change I wish to point out, that is, trade liberalization, with the increase in FTA agreements between economies both inside and outside the region. This trade liberalization is most pronounced in the Korean and ASEAN economies. Intra-regional and cross-regional trade in ASEAN economies is growing much faster than the global average. The third change is closely linked to the other two changes: the autonomous expansion of domestic demand with the increase in income reflecting increased production activities in the region. The expansion of domestic demand can be seen as a result of the Asian economies’ rebalancing of their economic growth toward a more domestic-driven model from that based on foreign demand. In particular, the economic rebalancing in China to achieve “quality economic growth” deserves attention, as it is vital for China to maintain sustainable growth, and will have significant implications for all of Asia. It should be noted that these three changes are not mutually exclusive, but rather intertwined. The shift from “Factory Asia” (as a manufacturing base) to “Consumer Asia” (as a consumption center) is expected to change the nature of the supply chain, stimulate new demand in Asia, and foster new industries. 3. Realizing the Asian century: how to avoid the middle income trap Looking ahead 30 to 40 years, we may well expect Asian economies to be even more prosperous. The Asian Development Bank, where I was President until this spring, published a report titled Asia 2050: Realizing the Asian Century in 2011. The report forecasts that BIS central bankers’ speeches Asia’s GDP would comprise half of global GDP by 2050, which is about double the current share, on the condition that Asian economies maintain their momentum. However, the rise of Asia is by no means preordained. The path will not be easy and requires more than just doing more of the same. The report warns of another future if the region cannot tackle its daunting policy, institutional, and governance challenges in a timely manner. In this pessimistic scenario, the region could fall into a Middle Income Trap and become stuck with low growth rates. The concept of the Middle Income Trap originally pertained to resource-rich countries in Latin America and Africa that became middle-income economies by extracting and exporting their resources, but did not climb higher to become developed economies. Asian economies have risen from being low-income to middle-income, not just by depending on natural resources, but by utilizing their human resources in the form of abundant labor to manufacture and export goods. But the question is whether high and sustainable economic growth can be maintained after passing the Lewisian Turning Point, where surplus labor from the agricultural sector is absorbed into the industrial sector and upward pressure is exerted on industrial sector wages. There are only four Asian economies, other than Japan, that have joined the league of developed countries with per capita Gross National Income of more than 10,000 USD since World War II: South Korea, Taiwan, Hong Kong, and Singapore, often dubbed the Four Asian Tigers. This shows how much more difficult it is for a middle-income economy to become a developed economy than for a low-income economy to become a middle-income economy. The key lies in whether a middle-income economy has the ability to grasp its growth potential, and whether there are autonomous mechanisms in place to fully exploit its growth potential. I mentioned in the first part of my speech that the growth potential in Asia is high. With that in mind, in order to avoid the Middle Income Trap and realize high growth, Asian economies require not only robust macroeconomic policies, but also strenuous efforts to implement the necessary structural reforms in order to improve production inputs, such as labor, capital and technology, and to push their growth potential to new frontiers. The concrete measures will vary for each economy as they face a unique set of challenges, and each economy will have to make its own decisions. Nevertheless, there may also be common challenges such as liberalizing regulations so as to create an environment conducive to innovation, and strengthening economic governance in order to enhance transparency and social fairness. To add to this, improving education levels is crucial to making the best of human resources. I strongly believe Asia can overcome these challenges. 4. Enhancing regional cooperation in Asia In discussing the Asian Century, the question naturally arises as to how its realization would contribute to the stability of the region and the global economy. There are many issues that Asian economies should tackle together as one. Among constructive efforts, I would like to stress, as the governor of a central bank, the importance of regional financial cooperation. The stronger network among Asian economies and closer ties with the global economy in terms of trade and investment obviously has its merits, but it also increases the risk of contagion to stress events in other regions, such as financial crises. It is also important to avoid becoming the source of stress that might endanger the stability of the global economy and financial markets. In order to enhance resilience against shocks, as well as making the financial system more robust, it is important to build a regional financial intermediary system that is not solely dependent on foreign capital. In addition, enhancing the safety net as a backstop against a global financial crisis is also essential. BIS central bankers’ speeches Asian central banks and financial authorities are actively engaged in sharing insights by exchanging information and opinions, as part of their efforts to increase the effectiveness of financial supervision. We are also committed to promoting the local currency-denominated bond markets so that the abundant savings of Asian economies can be utilized effectively within the region. One positive step towards enhancing the region’s safety net is the current efforts to strengthen the Chiang Mai Initiative. If Asia succeeds in strengthening its own financial system, it can play an even more important role globally in designing new international financial architecture and discussing governance systems. 5. Conclusion: how can Japan contribute? To conclude, I would like to address the question, what can Japan do to contribute to the realization of the Asian Century? The answer to this question is not singular. As I mentioned earlier, Japan can contribute through trade, investment, and financial cooperation. Japan can also assert its identity as a member of the Asian region, to participate in the stronger regional ties and cooperation, through which Japan can achieve higher growth. This would be mutually beneficial for both Japan and other Asian economies. In its early-April Monetary Policy Meeting, the Bank of Japan introduced a new policy framework, Quantitative and Qualitative Easing (QQE), with the aim of achieving the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years. The Bank believes this will lead Japan’s economy to overcome the deflation that has lasted for nearly 15 years, and reinvigorate the economy, adding substance to Japan’s efforts to contribute to the realization of the Asian Century. BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2013 Spring Annual Meeting of the Japan Society of Monetary Economics, Tokyo, 26 May 2013.
Haruhiko Kuroda: Quantitative and qualitative monetary easing and the financial system – toward realisation of a vigorous financial system Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2013 Spring Annual Meeting of the Japan Society of Monetary Economics, Tokyo, 26 May 2013. * * * Introduction It is a great honor to be invited to the 2013 Spring Annual Meeting of the Japan Society of Monetary Economics. The Bank of Japan’s mission is to ensure price stability and financial system stability. To ensure price stability, the Bank introduced the “quantitative and qualitative monetary easing” at the Monetary Policy Meeting held on April 3 and 4, 2013. This was decided based on the Bank’s strong determination to do whatever is necessary to overcome the deflation that has persisted for the past 15 years. In terms of ensuring financial system stability, no major problems are observed at present in the financial system. However, financial institutions face the challenge of the continued decline in their profitability in their lending operations, which is the main source of their profits. Over the years, the situation has remained the same, in that the amount of credit risk borne by financial institutions – a barometer of financial intermediation via lending – has decreased and the amount of interest rate risk associated with bondholdings has accumulated. The Bank expects its quantitative and qualitative monetary easing to effect a major change in the current situation of the financial system. The transmission channels assumed in this policy – such as influence on the yield curve and risk premia as well as portfolio rebalancing – will work through the financial system. I believe that more vigorous financial intermediation will be necessary if the policy effect permeates through Japan’s economy and thereby increases positive economic activity. The process to overcome deflation is also the process for the financial system to recover its vigor. Today, bearing these points in mind, I will talk about the relationship between the quantitative and qualitative monetary easing and the financial system, and the thinking on the Bank’s conduct of prudential policy. I. Quantitative and qualitative monetary easing and the outlook for economic activity and prices Key features of the quantitative and qualitative monetary easing I will first briefly explain the quantitative and qualitative monetary easing. This policy has the following features (Charts 1 and 2). First is a strong and clear commitment. The Bank clearly announced that it would achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years. Second is introduction of a new phase of monetary easing both in terms of quantity and quality in order to clearly underpin such a commitment. The Bank decided to change the main operating target for money market operations from the uncollateralized overnight call rate (i.e., interest rates) to the monetary base (i.e., quantity) and conduct money market operations so that the monetary base will increase at an annual BIS central bankers’ speeches pace of about 60–70 trillion yen. To this end, the Bank will purchase Japanese government bonds (JGBs) so that its holding of their amount outstanding on its balance sheet will increase at an annual pace of about 50 trillion yen. In terms of quality, in increasing the purchases of JGBs, those with all maturities including 40-year bonds were made eligible for purchase, and the average remaining maturity of the Bank’s JGB purchases was extended from slightly less than three years to about seven years. Furthermore, the Bank decided to purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding on the Bank’s balance sheet will increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. Third is enhancement of the intelligibility of monetary policy. For instance, the Bank’s purchases of JGBs had been conducted according to two types of operations: one under the Asset Purchase Program introduced in October 2010 and the other for facilitating money market operations, often referred to as Rinban operations. The Bank decided to synthesize the two purchasing methods of JGBs and to express the target of JGB purchases as a net increase in its JGB holdings, instead of the total size of JGB purchases. We believe that these changes facilitate understanding of the Bank’s intention with regard to monetary easing in a straightforward manner. The Bank’s adoption of the monetary base as an indicator for quantitative easing also reflects our judgment that the monetary base will be the most appropriate indicator for conveying the Bank’s aggressive stance on the monetary easing to the public. Fourth is explicit indication of the Bank’s thinking on the continuation of monetary easing. The Bank will continue with the quantitative and qualitative monetary easing, “aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner.” Obviously, there will be both upside and downside risks to economic activity and prices going forward. The Bank will examine these risks carefully and will not hesitate to make adjustments as appropriate, should circumstances warrant. Transmission channels of the quantitative and qualitative monetary easing I will next explain the mechanism of achieving the 2 percent target under the quantitative and qualitative monetary easing (Chart 3). The Bank expects that the effects of monetary easing will permeate primarily through three channels. First, the purchases of JGBs, ETFs, and J-REITs will encourage a further decline in interest rates across the yield curve and lower risk premia of asset prices. This will raise firms’ credit demand through a decline in funding costs. Second, as a result of the Bank’s massive purchases of JGBs, both investors and financial institutions investing in JGBs are expected to shift from JGBs to such risk assets as stocks and foreign-denominated bonds and/or to increase lending within their portfolios, which can be described as a portfolio rebalancing effect. The extension of the average remaining maturity of JGB purchases reflects our understanding of such an effect. And third, the clear commitment to achieve the price stability target at the earliest possible time and the continuation of massive purchases of assets underpinning this commitment are thought to drastically change the expectations of markets and economic entities. A rise in the expected inflation rate will not only influence actual prices but also stimulate private demand through a decline in real interest rates. Outlook for economic activity and prices On April 26, 2013, the Bank published the Policy Board members’ forecasts for economic activity and prices for the projection period of three years – from fiscal 2013 to fiscal 2015 – in its Outlook for Economic Activity and Prices. I will now talk about the Bank’s outlook for economic activity and prices under the quantitative and qualitative monetary easing (Chart 4). BIS central bankers’ speeches Japan’s economy has started picking up. Looking ahead, it is expected to return to a moderate recovery path around mid-2013, mainly against the background that domestic demand remains resilient due to the effects of monetary easing as well as various economic measures, and that growth rates of overseas economies gradually pick up. Thereafter, while the economy will be affected by the front-loaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, it is likely to continue growing at a pace above its potential, as a trend, as a virtuous cycle among production, income, and spending is maintained. Specifically, the annual real GDP growth rate is projected to be around 3.0 percent for fiscal 2013 and around 1.5 percent for fiscal 2014 and fiscal 2015, above the potential growth rate considered to be around 0.5 percent. The year-on-year rate of change in the CPI has recently been at around 0 percent or slightly negative, but looking to the future, the rate of increase is projected to rise, reflecting factors such as the improvement in the aggregate supply and demand balance as well as the rise in medium- to long-term inflation expectations on the back of the change in expectations of economic entities, and it is likely to reach around 2 percent – the price stability target – toward the latter half of the projection period. II. Financial system stability Next, I will talk about the relationship between the quantitative and qualitative monetary easing and the financial system. I believe that, if the effect of this policy fully permeates through financial and economic activity, firms and households are likely to increase their positive demand for funds. In this sense, it is vital for the financial system to maintain stability and fundamental strength so that it can adjust to future changes in the situation and respond properly to the increased demand for funds. The Bank regularly examines the conditions of the financial system. It now judges that Japan’s financial system can properly perform the financial intermediation function to support future economic growth. There are two main reasons behind this judgment. Soundness of financial institutions: relationship between the amount of risks and capital The first reason is that financial institutions as a whole hold sufficient capital relative to the amount of risks they bear (Chart 5). Recently, financial institutions have steadily increased their capital, as they have continued to raise equity capital and accumulate retained earnings. The amount of risks has decreased moderately, especially credit risk and risk associated with stockholdings. Credit risk has declined because the growth in lending has been slow, reflecting prolonged deflation and sluggish economic activity, and corporate bankruptcies have remained at a low level. Moreover, the decline in risk associated with stockholdings resulted from steady efforts made by the banking sector to reduce strategic stockholdings. The proportion of stockholdings at major banks has decreased significantly – from 150 percent of their Tier I capital in around 2000 to about 40 percent of their capital recently. This reduction and enhancement of financial institutions’ Tier I capital have increased their capability to respond to a possible increase in demand for funds. Resilience of the financial system: macro stress testing The second reason is that the financial system as a whole seems to possess sufficient resilience against such shocks as a rise in interest rates and deterioration in economic conditions. Since the real economy and the financial system affect each other, a significant negative shock can be amplified beyond the first-round effects, as in the case observed in the latter half of the 1990s, when a vicious cycle occurred as the result of a more cautious lending stance, deterioration in economic activity, a subsequent increase in nonperforming BIS central bankers’ speeches loans (NPLs), and a further cautious lending stance. The Bank examines the resilience of the financial system by conducting stress tests with various adverse shocks, using a financial macro-econometric model that takes account of such a mechanism. The examination of the resilience against an interest rate rise is an important issue especially during the process of overcoming deflation and achieving the price stability target under the quantitative and qualitative monetary easing. In the April 2013 Financial System Report, the Bank estimated the effects on the financial system of a scenario in which interest rates rose by around 1–3 percentage points (Chart 6). Of course, we should bear in mind that such a quantitative analysis comes with many reservations and limitations, and that the estimation should be interpreted with some latitude. However, even if interest rates rise by this degree, as long as the rise is accompanied by improved developments in economic activity and prices, there are no major concerns over possible instability in the financial system, as financial institutions’ profits will be boosted, for example, by an increase in lending, improvement in interest rate margins on loans, and a rise in stock prices. On the other hand, if interest rates rise due to heightened concerns over fiscal conditions in the absence of improvement in economic conditions, positive effects such as an increase in lending or improvement in interest rate margins on loans are unlikely to occur, thereby inducing strong adverse effects on financial institutions, namely, the occurrence of unrealized capital losses on bondholdings. Although financial institutions have the capacity to absorb such adverse effects, this depends on the degree and pace at which the interest rates rise. To prevent concerns over fiscal sustainability from emerging, it is important for the government to steadily proceed with its initiatives on fiscal structural reforms. III. Low profitability of lending and challenges to enhancement of the functioning of financial intermediation As should be clear, the financial system does not face major problems in terms of stability and fundamental strength. Nonetheless, I believe that the current financial institutions’ financial intermediation cannot be described as full of vigor or dynamism. This is mainly because of the low profitability of lending. I will now discuss how the quantitative and qualitative monetary easing will affect the low profitability of lending and whether the problem of low profitability hinders the spread of the monetary easing effects. Low profitability of lending and the background Financial institutions’ lending stance used to be restrained due to limited capital when they were suffering from the NPL problem. At present, however, they are not under any restrictions in terms of financial strength with a sufficient amount of capital, and have taken an aggressive lending stance toward positive demand for funds. In fact, they have recently increased loans to large firms for mergers and acquisitions and acquisition of interest in natural resources, as well as real estate-related loans and overseas loans. Nevertheless, such activity is still limited. Loans to small and medium-sized firms have remained sluggish. Although financial institutions have advanced their initiatives to facilitate financing in recent years, improvement in the quality of their loan assets has been slow. The profitability of lending and interest rate margins on loans have remained on a long-term downtrend because of intense competition among many lenders to attract limited positive demand for funds and borrower firms that are top rated (Chart 7). Such a problem is basically a reflection of prolonged deflation, sluggish economic activity, and weak demand for funds. Therefore, if the effects of the quantitative and qualitative monetary easing permeate through Japan’s economy and stimulate positive economic activity, it is expected that loans will increase and the problem of low profitability and the BIS central bankers’ speeches issues related to the quality of loan assets will gradually be resolved. However, given the intense lending competition, it is unclear to what extent the supply and demand conditions should improve and demand for funds should increase for interest rate margins on loans to start improving. Toward enhancing financial institutions’ financial intermediation Financial institutions are expected to actively elicit positive activity from firms and households, instead of passively waiting for such activity, and to work to enhance their capability for financial intermediation. This will raise the added value of their financial intermediation, and enable them to secure borrower firms without competing to reduce interest rate margins on loans and increase their profits as a result. At the same time, from a macroeconomic perspective, enhancing the capability for financial intermediation will bring about favorable conditions for a virtuous cycle to operate between financial and economic activity. In this regard, financial institutions have worked to facilitate financing, corporate turnarounds, and firms’ business reconstruction. They have also sought to identify firms planning to launch operations in areas with growth potential and help these firms to increase their growth through various measures including the Bank’s fund-provisioning measure to support strengthening the foundations for economic growth. I believe that such efforts have steadily enhanced financial institutions’ capability for financial intermediation. Given the sluggish economic activity and deflation, despite the efforts made by financial institutions, it might have been difficult to discern the outcome of such efforts through, for example, an increase in loans or improvement in the quality of financial institutions’ assets. However, I am sure that these initiatives made by financial institutions to support firms – formulation and monitoring of corporate turnaround plans, provision of advice on improving financial conditions, and support of firms’ projects through corporate tie-ups and exploration of new markets – will steadily enhance the added value of financial services. I hope that financial institutions will further strengthen the ability in order to tap potential demand for funds and identify firms and business areas with high growth potential. The Bank will continue to support the lending operations of financial institutions mainly through the fund-provisioning measure to support strengthening the foundations for economic growth and the fund-provisioning measure to stimulate bank lending. The Bank has been exchanging views with and advising financial institutions, through its day-to-day offsite monitoring and on-site examinations, about enhancing credit screening and monitoring capabilities that are the basis for financial intermediation as well as increasing the ability to assess firms’ projects and improving arrangements for the support of firms. The Bank has also continued to conduct research on financial methods that will enhance the added value of financial intermediation – such as asset-based lending that uses movable assets or accounts receivable as collateral, new financial methods utilizing electronically recorded monetary claims, and business reconstruction – and has shared information with financial institutions through seminars. IV. Quantitative and qualitative monetary easing and prudential policy Next, I will talk about the relationship between the quantitative and qualitative monetary easing and the Bank’s prudential policy. The quantitative and qualitative monetary easing is a policy that encourages financial institutions and investors to take on risks and affects asset prices by influencing the yield curve and risk premia. On the other hand, prudential policy is a policy under which the Bank encourages financial institutions to strengthen and enhance their risk management and closely monitors any signs of financial imbalances in, for example, asset prices. Based on these, some people may question whether the quantitative and qualitative monetary easing BIS central bankers’ speeches and prudential policy conflict with each other or whether the Bank’s thinking on the conduct of prudential policy will change under the quantitative and qualitative monetary easing. However, I would like to emphasize that the quantitative and qualitative monetary easing and prudential policy do not conflict with each other and are consistent, and that the Bank’s thinking on the conduct of prudential policy remains unchanged. This thinking can be summarized into two points. First, although the Bank expects financial institutions to actively take on risks under the quantitative and qualitative monetary easing, its basic stance remains unchanged, in that it will urge financial institutions to appropriately manage the amount of risks they bear relative to their financial strength. Excessive risk-taking may not immediately cause problems but will eventually lead to instability in financial institutions’ business conditions and the financial system, and will not promote improvement in economic conditions in the long term. On the contrary, expansion of risk-taking is a favorable action to increase profits as long as risks are managed properly. As I mentioned, the Bank has been working to exchange views with and advise financial institutions through on-site examinations, off-site monitoring, and seminars about risk management and ways to enhance the institutions’ capabilities for financial intermediation and business reconstruction. And second, the Bank’s basic thinking about the overheating of asset prices and financial imbalances also remains the same. It is difficult to discern financial imbalances, but if the Bank judges that financial imbalances exist, it is necessary to take appropriate action. On the other hand, if a rise in asset prices is a reflection of the policy effects or improved outlook for the real economy, it will have positive effects on the real economy by means of the wealth effect. As far as is shown by a range of indicators and financial institutions’ behavior, there is no sign at this point of excessively bullish expectations in asset markets or in the activities of financial institutions. The financial system and developments in economic activity and prices affect each other. I would like to stress that the stability of these two should be compatible and they do not conflict with each other. Concluding remarks Today, I have talked about the relationship between the quantitative and qualitative monetary easing and the financial system. In the final part of my remarks, I will briefly touch on a topic that I have not yet mentioned today. I will raise two points that I consider of importance in enhancing the vigor and the functioning of the financial system. Diversification of the portfolio selection of households First is the importance of diversifying the portfolio selection of households. Much time has passed since the issue of a shift “from savings to investment” by households was a topic of interest, but the households’ stance of preferring safe assets has not yet changed. In this situation, the amount outstanding of deposits at financial institutions has continued to increase despite the low interest rates. The preference of Japan’s households can also be seen in their composition of financial assets, which is greatly biased toward safe assets compared with other countries. As a result, financial institutions have been facing the situation of an increase in funds available for investment amid the sluggish growth in lending. The gap between the amounts outstanding of deposits and loans at financial institutions (banks and shinkin banks) expanded from about 60 trillion yen at the end of 2000 to about 230 trillion yen at the end of 2012. The difference has been invested in securities, mainly in JGBs. It is natural for the proportion of JGB holdings to total assets to expand at financial institutions when the weight of fiscal financing in the overall economy has risen, increasing the amount outstanding of JGB issuance. However, looking at the financial system as a BIS central bankers’ speeches whole, it is desirable for households to diversify their selection of assets other than deposits in terms of the portfolio rebalancing. This will support financial institutions’ business conditions, in that it will increase fees and commissions through sales and management of risk assets held by individual customers. In this regard, some financial institutions have refocused on sales of financial products to individual customers, partly reflecting the introduction of the Individual Savings Account (ISA). Responses to stricter international financial regulations Second is the importance of appropriately responding to reforms of international financial regulations. Recently, financial regulations have been reviewed widely around the globe, given the experience of the Lehman shock and the European debt crisis. A massive amount of rulemaking is in progress, such as regulations on financial institutions’ capital adequacy ratios and leverage ratios, regulations on derivatives transactions, and establishment of a framework that enables the resolution of systemically important financial institutions. These deliberations on new regulations are based on a lesson from the experience of global financial crises, and they show the strong determination of financial authorities worldwide to establish a stable financial system to avoid another financial crisis. The global financial regulations will be reflected in regulations in each country including Japan, and Japan’s financial institutions will be subject to these regulations. Major financial institutions in Japan that conduct overseas operations will need to adjust to the local laws overseas. Introduction of new regulations entails a considerable increase in costs for financial institutions in the short term as they adjust to the new regulatory environments. Nevertheless, from a long-term perspective, it will further stabilize their profits by restraining their excessive risk-taking, and further strengthen the foundations for sustainable growth of the overall economy, thereby underpinning the development of financial institutions. The initiatives to establish global financial stability will continue into the future. I expect Japan’s financial institutions to actively take part in such initiatives. The Bank is determined to diligently join international discussions such as meetings of the Financial Stability Board and the Basel Committee on Banking Supervision. I would like to close my speech by noting that the Bank will do its utmost to overcome deflation at the earliest possible time and achieve a vigorous financial system. Thank you. BIS central bankers’ speeches Chart 1 Introduction of the "Quantitative and Qualitative Monetary Easing"  Strong and Clear Commitment The Bank will achieve the price stability target of 2% at the earliest possible time, with a time horizon of about 2 years.  Monetary base: Annual increase of about 60-70 tril. yen (x2 in 2 years).  Amount outstanding of JGB holdings: Annual increase of about 50 tril. yen (more than x2 in 2 years).  Average remaining maturity of the Bank's JGB purchases: Extended to about 7 years (more than x2 in 2 years).  Amount outstanding of ETF holdings: Annual increase of about 1 tril. yen (more than x2 in 2 years).  Amount outstanding of J-REIT holdings: Annual increase of about 30 bil. yen. Chart 2 Introduction of the "Quantitative and Qualitative Monetary Easing" Intelligible Monetary Policy  The Bank has terminated the Asset Purchase Program and synthesized purchasing methods of JGBs.  It has adopted the monetary base as an indicator for quantitative easing.  The Bank will continue with the quantitative and qualitative monetary easing, aiming to achieve the price stability target of 2%, as long as it is necessary for maintaining that target in a stable manner.  It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. BIS central bankers’ speeches Chart 3 Effects of the "Quantitative and Qualitative Monetary Easing" Chart 4 Forecasts of the Majority of Policy Board Members Note: 1. Figures in brackets indicate the median of the Policy Board members' forecasts (point estimates). BIS central bankers’ speeches Chart 5 1,2 Risks and Tier I Capital Chart 6 Effects of a Rise in Interest Rates on Tier I Capital Ratio1,2,3 BIS central bankers’ speeches Chart 7 Net Interest Margin 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 held by the Foreign Correspondents' Club of Japan, Tokyo, 28 May 2013.
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Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2013 Bank of Japan-Institute for Monetary and Economic Studies (IMES) Conference, hosted by the IMES of the Bank of Japan, Tokyo, 29 May 2013.
Haruhiko Kuroda: Opening remarks Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2013 Bank of Japan-Institute for Monetary and Economic Studies (IMES) Conference, hosted by the IMES of the Bank of Japan, Tokyo, 29 May 2013. * I. * * Introduction Good morning, ladies and gentlemen. It is my great honor to say a few words at the beginning of the 2013 BOJ-IMES Conference. On behalf of my colleagues at the Bank of Japan and myself, I would like to welcome all the participants from the academia, central banks, and international organizations. This year, we are going to tackle the issue of “Financial Crises and the Global Financial System.” It is no doubt a very familiar theme for all of you. In fact, we have discussed this topic time and again. Every time we faced an international financial crisis – we had far too many of them – the international financial system had to evolve in response, and that called for new ideas, or at least, new twists on old ideas. This was no easy task, as many of you, who were my colleagues in arms, would attest without any hesitation. Working on the front lines of international finance in the recurring process of turbulence and evolution of the global financial system, under many different hats, I have always struggled with seemingly intractable problems, such as large fluctuations in the exchange rate and huge swings in the flows of capital. In retrospect, past discussions and responses regarding the global financial system did not follow a straight line. We saw a series of trials and errors. Karl Popper, who was a philosopher of scientific methodology, mentioned that for the quest of the truth, “there is no more rational procedure than the method of trial and error.”1 Through repeated trials and errors in every past financial crisis, economics has actually accumulated new wisdom. As we face the formidable task of rebuilding the international financial system severely hit by the most recent financial crisis, our trials and errors from the past will certainly provide us with valuable insights. II. The role of the trilemma of international finance in the evolution of the global financial system In light of wisdom that has been accumulated so far, the starting point of discussion on the organization of a global financial system is the trilemma of international finance. As you know, the trilemma shows that no economy can simultaneously achieve the three goals of capital mobility, a fixed exchange rate, and independent monetary policy. Global financial systems were adopted under the constraints of this trilemma. When an adopted system became unsustainable, the result was a financial crisis, leading to the adoption of a new global financial system. This cycle was repeated many times over. Let me briefly turn to a few historical examples. At the end of World War II, the Bretton Woods system was introduced to solve several problems that had occurred during the interwar period, including competitive devaluations. With controls over capital mobility, this system allowed the simultaneous pursuit of independent monetary policy and the peg to the U.S. dollar, which was exchangeable with gold at a fixed rate. In the 1960s, against a background of deteriorating U.S. balance of payments, there were changes in the international financial environment: the amount of U.S. dollars held by non-residents increased and the Eurodollar market came into being and Popper, Karl, “Science: Conjectures and Refutations,” Conjectures and Refutations, Routledge and Kegan Paul, 1963. BIS central bankers’ speeches expanded. Under such circumstances, the U.S. gold reserves continued to flow out and as the world became more uneasy with the convertibility of the U.S. dollar, the Bretton Woods system was abandoned. Consequently, advanced economies maintained independent monetary policy, while adopting the floating exchange rate system and further liberalizing capital mobility. A few decades on, in the 1990s, currency crises hit a number of emerging economies, such as Mexico, Thailand, Indonesia, South Korea, Russia, and Brazil. Against a background of increasingly liberal capital mobility and the accompanying growth of capital account transactions, the principal driver of the crises was the unsustainable current account deficits in many of those economies with de facto U.S. dollar-pegged exchange rates. After the crises, the economies have pursued independent monetary policy and have increased the flexibility of their exchange rates, while upholding capital mobility. Moreover, taking into account the lessons of the currency crises, Asian emerging countries have significantly increased their foreign exchange reserves and have promoted regional financial cooperation, such as the Cheng Mai Initiative. In sum, the evolution of the global financial system to date is heavily influenced by the episodes of past financial crises, at the same time constrained by the trilemma of international finance. III. Issues for the rebuilding of a global financial system after the recent global financial crisis The recent financial crisis has had a great impact on the global financial system as much as or even more than past crises. In a world of deepening financial globalization, financial crises were usually associated with emerging economies and triggered by a sharp decline in the exchange rate. But this crisis was different in two respects. First, the epicenter of the recent crisis was in the advanced economies and the crisis spread out from there to many emerging economies. Second, the crisis was triggered and then amplified by the dysfunction of financial systems. Reflecting on these observations, I believe that the global financial community must, in its efforts to rebuild the global financial system, come to terms with two issues: capital controls and financial regulation and supervision. On capital controls, in the past currency crises involving emerging economies, there was some contagion between those economies. In contrast, in the recent financial crisis, stress that arose in the United States and the euro area was transmitted at once to many emerging countries, including those in Central and Eastern Europe and Latin America. One of the causes of such international transmission of the crisis is deemed to be financial globalization and the accompanying global upsurge of gross capital flows, which has led to increasing attention over prudential capital controls. Moreover, in recent years, the International Monetary Fund, which has long emphasized the benefits of capital mobility, has, at least partially, accepted the necessity of capital controls as a macro-prudential policy tool. Turning to the regulation and supervision of financial institutions for the purpose of maintaining the stability of the financial system, in the wake of the recent financial crisis, there is a globally renewed recognition of the importance of financial stability. Against that background, international meetings, like those of the G20, have discussed how financial regulation and supervision could be enhanced and harmonized internationally. Meanwhile, in the euro area, the discussion on a banking union is underway. In this context, the concept of “financial trilemma,” which has recently been proposed in the academia, seems to offer a useful viewpoint2. In the argument of financial trilemma, it is held that any economy cannot Schoenmaker, Dirk, “Financial Trilemma,” Economics Letters, 111 (1), 2011, 57–59. BIS central bankers’ speeches simultaneously achieve three goals of financial integration (capital mobility), financial stability, and national financial policy. IV. Conclusion Finding solutions to these two issues and building a new global financial system under the trilemma of international finance are no easy tasks. Even if we could establish a global financial system that is robust at this time, such a system is unlikely to last forever, given that a financial crisis beyond our imaginations may occur in the future. Having said this, it is by no means futile for us to examine the relevant issues and pursue a more robust global financial system. As history has shown, there were more than a few financial crises, and on each occasion, there were discussions on building a new financial system. The accumulation of wisdom in the process has been helpful for shaping the policy responses to subsequent crises and rebuilding of the financial system. Today, the global economy has not yet completely shook off the effects of the global financial crisis, even after five years since the onset of the crisis. Nevertheless, I am convinced that the great challenges posed by the crisis will give us new insights and help us create a new and better world. I hope that with all the distinguished participants from around the world exchanging their experiences and views, this conference will contribute to the accumulation of wisdom that is urgently needed for the current efforts to rebuild the global financial system and sure to be useful in the future when black swan events strike again. Thank you. BIS central bankers’ speeches
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the International Conference, organised by the Economic and Social Research Institute, Cabinet Office, Government of Japan, Tokyo, 31 May 2013.
Hiroshi Nakaso: Basic idea underlying “Quantitative and qualitative easing” Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the International Conference, organised by the Economic and Social Research Institute, Cabinet Office, Government of Japan, Tokyo, 31 May 2013. * * * Introduction Thank you for giving me an opportunity today to speak at the international conference organized by the Economic and Social Research Institute, the Cabinet Office, the Government of Japan. I. Introduction of “quantitative and qualitative monetary easing” Japan’s economy has been in a state of deflation for nearly 15 years. During the period, the economy has been trapped in a vicious cycle. Amid the continued decline in prices, corporate profits and wages were squeezed. Those induced business fixed investment, private consumption, and other economic activity to plunge. As a result, prices fell again. For Japan’s economy to get out of the vicious cycle and recover sustainably, it is critical first to overcome deflation, thereby turning the behavior of economic entities, such as firms and households, positive. In that regard, the biggest challenge Japan’s economy is faced with is to overcome deflation promptly. The Bank of Japan recognizes that its role is critical. With such recognition, the Bank introduced quantitative and qualitative monetary easing at the Monetary Policy Meeting held at the beginning of April. It aims to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in consumer price index at the earliest possible time, with a time horizon of about two years. With a view to pursuing quantitative monetary easing, the main operating target for money market operations was changed to the monetary base. On that basis, the monetary base and the Bank’s outstanding amount of JGB and ETF holdings will be doubled in two years. The average remaining maturity of the Bank’s JGB purchases has been extended more than twice as long. The policy clearly differentiates itself from the gradualism or incremental approach adopted in the past. Besides, the Bank is committed to continuing with quantitative and qualitative monetary easing, aiming to achieve the 2 percent price stability target, as long as it is necessary in maintaining that target in a stable manner. As quantitative and qualitative monetary easing requires a massive purchase of JGBs, we need to conduct purchases while monitoring the effects in the bond market. After quantitative and qualitative monetary easing was introduced and in the process of the market digesting its contents, there have been rises in the volatility of government bond yields. The Bank has been having close dialogue more than ever with market participants and taking firm action, including an adjustment of the “parameters” of the JGB purchase operations. Yesterday, the Bank released the outline of the outright purchases of JGBs for the time being. Specifically, it decided to increase the frequency of JGB purchases. While the amount to be purchased was left at approximately 7+ trillion yen per month in principle, it also decided to conduct such purchases in a flexible manner by taking account of market conditions in order to ensure that the effects of monetary policy permeate the economy. The Bank expects that these measures will lead to the stable formation of long-term interest rates by suppressing excessive rise in interest rates and heightened volatility. BIS central bankers’ speeches II. Outlook for economic activity and prices and the importance of expectations Let me next explain how the Bank considers economic activity and prices will develop under quantitative and qualitative monetary easing. I will explain in line with the baseline scenario of the “Outlook for Economic Activity and Prices” released by the Bank at end-April. First, the real economy. Japan’s economy has started picking up. As for the outlook, Japan’s economy is expected to return to the moderate recovery path around the middle of the year. On the back of that, domestic demand is expected to remain resilient and growth rates of overseas economies will gradually pick up. Thereafter, the economy will be influenced by a last minute surge in demand and its reversal decline at two scheduled consumption tax hikes. Despite that, with a virtuous cycle of production, income, and spending expected to be maintained, the economy is likely to continue growing above the potential growth rate of around 0.5 percent as a trend. Let me quote specific figures from the median of the Policy Board members’ forecasts. The growth rate is projected to be 2.9 percent for fiscal 2013, 1.4 percent for fiscal 2014, and 1.6 percent for fiscal 2015. On such growth rate projection, the output gap, which illustrates aggregate supply and demand balance, will gradually turn positive from the current level of about negative 2 percent. It will further widen to about 2 percent in the latter half of the projection period up to fiscal 2015. As for prices, the year-on-year rate of change in the consumer price index (for all items excluding fresh food) has been negative. Based on the economic projection I have just mentioned, it is expected to be on an uptrend. Main factors behind that are an improvement in aggregate supply and demand balance and a rise in the expected rate of inflation. It is likely to reach the “price stability target” of about 2 percent through the latter half of the projection period up to fiscal 2015. Specifically, the median of Policy Board members’ forecasts was 0.7 percent for fiscal 2013, 1.4 percent for fiscal 2014, and 1.9 percent for fiscal 2015. The Bank’s clear commitment to achieving the price stability target and quantitative and qualitative monetary easing that underpins the commitment are expected to lead to a rise in prices through three routes. First, an improvement in aggregate supply and demand balance. When growth beyond the potential growth rate is achieved, aggregate supply and demand balance will improve and the positive output gap will widen. Second, a rise in the medium- to long-term expected rate of inflation. The expected rate of inflation will be on an uptrend under quantitative and qualitative monetary easing and will gradually converge on the price stability target of about 2 percent. Third, an increase in import prices. Foreign exchange rate developments will put upward pressure on those prices for the time being. And on the assumption that international commodity prices will be on a moderate uptrend in tandem with the growth of the global economy, import prices are likely to continue rising. Of the three, the important key to achieving the price stability target under the current policy is the second route, namely, to raise the medium- to long-term expected rate of inflation. Let me explain the reason by using the so-called Phillips curve, which shows the relationship between aggregate supply and demand balance and the inflation rate. As mentioned, when growth beyond the potential growth rate is achieved, the positive output gap widens. As the gap widens, the inflation rate will rise along the positive slope of the Phillips curve. As deflation has continued for nearly 15 years, the Phillips curve itself has shifted downward. And its slope has become moderate, due partly to a decline in firms’ pricing power amid globalization. Given such shape of the current Phillips curve, the 2 percent price stability target cannot be achieved only by achieving a 2 percent positive output gap. One reason for the difference in the outlook for prices between the Bank and private institutions might be that many private institutions have based their outlook on the Phillips curve during the period of deflation. Therefore, to achieve the 2 percent price stability target at the earliest possible time, the Phillips curve needs to be shifted upward by an increase in the expected rate of inflation. Namely, it is necessary not only to improve aggregate supply and demand balance but also to firmly raise the expected rate of inflation by significantly changing “deflationary BIS central bankers’ speeches expectations” of economic agents, such as firms and households. A combination of those two will lead to the achievement of the price stability target at the earliest possible time. The Bank made a clear commitment to achieve the 2 percent price stability target at the earliest possible time, with a time horizon of about two years. As a means of underpinning the commitment, the Bank has embarked on a new monetary easing policy, that is, quantitative and qualitative monetary easing. We believe that the Bank’s strong commitment and decisive actions will significantly change the expectations among firms and households. Looking at the financial markets, market expectations appear to have started changing. Looking also at indicators that show the expected rate of inflation of the market and economic entities, some have suggested an increase. Positive moves have started to take place, driven by the Bank’s quantitative and qualitative monetary easing. In further pursuing the policy, we expect such moves to spread to firms and households, and deflationary expectations to be reversed. Those firms and households released from deflationary expectations are expected to make active investment and consumption by fully utilizing accommodative financial conditions. Such positive economic activity and a change in expectations will induce an improvement in the real economy and a rise in the expected rate of inflation, paving the way to the achievement of the 2 percent price stability target. Final remarks The government has set its economic policy with a combination of three-pronged strategy (three arrows). Namely, bold monetary easing, flexible fiscal policy, and a growth strategy to promote private investment. As for the first arrow of bold monetary easing, the Bank, aiming to achieve the price stability target, has introduced a new monetary easing policy of quantitative and qualitative monetary easing. Naturally, in meeting our price stability target, we do not want to see only consumer prices climbing to 2 percent. The price stability target we aim at should be achieved in a virtuous cycle in which the real economy improves in a balanced manner, accompanied by an increase in corporate profits, employment, and wages. If the government can effectively deliver two other arrows and create real demand, that would underpin the virtuous cycle. It would enable the Bank to achieve the price stability target more smoothly. The government has already started various initiatives, and I have high hopes for more to follow. At the same time, to continue with quantitative and qualitative monetary easing, it needs to be recognized by the public that the Bank’s purchase of JGBs is carried out solely to achieve the price stability target and not in any way to finance the fiscal deficit. To that end, it is critical to maintain fiscal credibility. The government and the Bank released a joint statement in January. The government clearly stated that it would steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management. We strongly expect the government to move on that front. The Bank of Japan Act stipulates that the principle of monetary policy conduct should “be aimed at achieving price stability, thereby contributing to the sound development of the national economy.” Overcoming the longstanding challenge of deflation and achieving sustainable growth with price stability conform with the principle. Japan’s economy has started picking up, and now is a great opportunity to overcome the challenge. I believe seizing the opportunity is our manifest mission. Thank you. 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, Asahikawa, 13 June 2013.
Sayuri Shirai: Japan’s economic activity, prices, and monetary policy – monetary policy in the past and present Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Asahikawa, 13 June 2013. * I. * * Introduction Good morning. It is a great honor to have this opportunity to visit Hokkaido and meet representatives of the city of Asahikawa. It is my first time to visit this place, so I am really looking forward to learning from you about this region through an exchange of views. In addition, I would like to express my sincere gratitude for your cooperation with the activities of the Bank of Japan’s local office in Asahikawa and Sapporo Branch. As you may know, the Bank introduced a new monetary policy called Quantitative and qualitative monetary easing (QQE) at the Monetary Policy Meeting (MPM) held on April 3 and 4, 2013. And I would like to examine this new policy here today. Let me first briefly outline the sequence of my speech. In the next section, Section II, I will explain the Bank’s outlook for economic activity and prices in Japan on the basis of the Outlook for Economic Activity and Prices (hereafter the Outlook Report). Then, I would like to consider QQE – whose expected effects are incorporated in the Outlook Report – by focusing on the main features of this new policy. In Section III, I will review the previous policy – Comprehensive monetary easing (CME) – to facilitate an understanding of the essence of QQE, and I will also introduce my related proposal, which was presented at the March MPM. In Section IV, I will discuss my views and suggestions on the Outlook Report. Following my speech, I am looking forward to receiving your candid opinions about the content of my speech as well as the situation of the local economy. II. Economic activity, prices, and the new monetary policy I will begin my presentation by describing the Bank’s outlook for economic activity and prices presented in the Outlook Report released in April. After that, I will explain the features of the new monetary policy and the transmission mechanisms. A. Outlook for economic activity and prices In the light of recent developments in economic activity and prices, Japan’s economy has been picking up. It is likely to return to a moderate recovery path around mid-2013, mainly against the background that domestic demand remains resilient due to the effects of monetary easing as well as various economic measures, and that growth rates of overseas economies gradually pick up. Thereafter, while the economy will be affected by the frontloaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, it is likely to continue growing as a trend from fiscal 2013 toward fiscal 2015, at a pace above its potential, as a virtuous cycle among production, income, and spending is maintained (Chart 1). Regarding prices, the year-on-year rate of change in the consumer price index (CPI; all items less fresh food) has recently been around 0 percent or slightly negative. The outlook for prices as measured by the year-on-year rate of change in the CPI – excluding the direct effects of the consumption tax hikes – is expected to follow a rising trend; as such, it will reflect factors such as the improvement in the output gap (the difference between actual and potential GDP) as well as the rise in medium- to long-term inflation expectations. According to the “median” of the Policy Board members’ forecasts, the CPI inflation is likely to reach about 2 percent toward fiscal 2015 (Chart 2). Chart 2 indicates the rate of change in prices BIS central bankers’ speeches with and without the effects of the consumption tax hikes.1 The output gap is expected to follow a moderate improving trend (Chart 3). Moreover, as a tightening of labor market conditions is expected to become evident, nominal wages are likely to see gradual upward pressure (charts 4 and 5). In addition, some indicators suggest a recent rise in medium- to long-term inflation expectations (Chart 6). These expectations are likely to continue on a rising trend under QQE and the pace of increase may accelerate – especially after the actual rate of price change turns from negative to positive this year, gradually converging to around the 2 percent target. Import prices are also expected to continue rising during the projection period (fiscal 2013–2015), reflecting upward pressure for the time being from developments in the foreign exchange market and assuming that international commodity prices will follow a moderate rising trend in line with global economic growth. B. Upside and downside risks to Japan’s economy With respect to the upside and downside risks to the Bank’s aforementioned baseline scenario for economic activity, the following five factors were examined: (1) developments in global financial markets; (2) performance of overseas economies; (3) firms’ and households’ medium- to long-term growth expectations; (4) the extent of the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hikes; and (5) fiscal sustainability in the medium to long term. Following a review by the Bank, these risks were assessed as being “balanced,” although uncertainty remained high, including that regarding developments in overseas economies (Chart 7). As for upside and downside risks specific to prices, the following uncertainties were examined: (1) developments in firms’ and households’ medium- to long-term inflation expectations; (2) the responsiveness of prices to the output gap; and (3) developments in import prices reflecting fluctuations in international commodity prices and foreign exchange rates. After the Bank examined these matters, it assessed that the risks on the price front as “largely balanced”; however, considerable uncertainty surrounds developments in medium- to long-term inflation expectations (Chart 7). Regarding these risk assessments, my personal views will be explained in Section IV. C. Quantitative and Qualitative Monetary Policy (QQE) Next, I would like to consider QQE, which was introduced at the MPM held on April 3 and 4. The aforementioned Outlook Report certainly reflects the projected effects of the new monetary policy. QQE was adopted after analyzing the effectiveness and limitations of the previous CME, and the aim was to maintain the 2 percent price stability target adopted in January 2013 under CME. This will be explained in detail in Section III. Here, I would like to examine the four main aspects related to QQE. Aspect 1: Increase in purchases of Japanese Government Bonds (JGBs) and extension of their maturities The first characteristic of QQE is the purchase of JGBs as the most important tool toward achieving the 2 percent price stability target at the earliest possible time. The integration of JGB purchases under a regular purchase operation (informally called the Rinban operation) with the Asset Purchase Program was finally achieved, as explained in Section III. Moreover, the average remaining maturity of the Bank’s JGB purchases was decided to be extended from the current level of slightly under three years (after integrating the two operations) to about seven years (six to eight years) by purchasing JGBs with maturities of up to 40 years; this was done to exert further downward pressure on the whole yield curve (Chart 8). The To measure the impact of the monetary policy, it is important to look at indicators other than the effects of the consumption tax hikes. This is because the impact of the tax hikes is effective only during the first year of implementation; it is thus temporary and should be analyzed separately from the effects of monetary easing. BIS central bankers’ speeches yearly pace of increase in the amount outstanding of JGBs held by the Bank was set at about 50 trillion yen, and it will continue over two years, thereby doubling the amount outstanding from the end of 2012 to the end of 2014 (Chart 9). I believe that these changes constitute a considerable departure from previous practices both in terms of “quantity” (based on the size of the program) and “quality” (based on the maturity length). Aspect 2: Increase in purchases of risk assets The second characteristic of QQE is an increase in the purchase of two risk assets – exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). Considering the market size and the risk volume borne by the Bank, the yearly purchase amount was set at 1 trillion yen and 30 billion yen, respectively, over two years. This would double the amount outstanding of ETFs from the end of 2012 to the end of 2014. Regarding CP and corporate bonds, it was decided to maintain the amounts outstanding of these holdings given the already low levels of risk premia (expected excess returns demanded by investors relative to safe assets) after the decision in January. Aspect 3: Emphasis on inflation expectations and adopting the “quantity” target Third, QQE emphasizes the expectations of markets, firms, and households – particularly medium- to long-term inflation expectations – as one of the most important channels for achieving the 2 percent target. This feature draws a clear line between QQE and the previous CME. If firms and households expect inflation to rise in the medium to long term, that may positively affect the current levels of sales prices and wages. Moreover, as long as the pace of increase in inflation expectations exceeds that in long-term nominal interest rates, long-term interest rates in real terms will decline and thus support an accommodative monetary environment. I will touch on the concept of inflation expectations later. Let me add a few more comments on this issue. As described in Section III, the Bank previously held the view that it might take some time to achieve the 2 percent target; this was because (1) firms and households are accustomed to past low-price movements and (2) collective efforts are necessary to strengthen potential economic growth and hence inflation expectations. I still take this view. The important point here, however, is that there is no time like the present. For example, the Japanese government has adopted stimulative measures in addition to making ongoing reconstruction efforts while expressing the clear determination to raise potential economic growth through various strategies. Expectations of stronger monetary easing since the end of 2012 have already favorably affected some markets, including the exchange rate, stock, and J-REIT markets. Firms and households have a more positive outlook for the economy. In this favorable environment, I believe that it may be possible to accelerate the pace of rise in medium- to long-term inflation expectations in a stable manner by adopting a bold monetary policy. At the same time, I honestly feel that the Bank should maximize its monetary easing measures to demonstrate its strong determination to conquer deflation. The next question is how to raise medium- to long-term inflation expectations. For this purpose, the Bank decided to change the main operating target for money market operations from the uncollateralized overnight call rate (i.e., interest rates) to the monetary base (i.e., “quantity”). There are several reasons for adopting the monetary base, which comprises cash (banknotes and coins in circulation) and reserve deposits (financial institutions’ current account deposits with the Bank). Using the monetary base, it is intuitively easier for the public and market participants to grasp the essence of monetary easing: an increase in the “quantity” can easily be connected to a large-scale supply of cash, thereby creating an image of inflation. In addition, the monetary base is often used in financial markets as a reference for measuring the scale of monetary easing across central banks. Moreover, the monetary base is a basic concept presented in macroeconomic textbooks, and so it is globally known. Finally, changing the main operating target effectively signals a change in the monetary policy framework. Thus, it was decided that the monetary base should rise at an annual pace BIS central bankers’ speeches of about 60–70 trillion yen over two years; this would double the amount outstanding from 138 trillion yen at end-2012 to about 200 trillion yen at end-2013 and further to 270 trillion yen at end-2014 (Chart 9). The last figure would account for nearly 60 percent of nominal GDP – far above the levels of other advanced economies. Aspect 4: Effective communication strategies The fourth characteristic of QQE is that the Bank uses the number “two” a great deal: 2 percent price stability target; a time horizon of about two years; doubling the monetary base and the amounts outstanding of JGBs and ETFs; and doubling the average remaining maturity of JGB purchases. The Bank does so to send a clear message about the new framework and its strong determination to achieve the 2 percent target. Indeed, positive reactions have been received both domestically and abroad regarding the clarity of the new communication strategy. Nonetheless, I personally believe that there is still room for improvement in terms of communication strategies, as described in Section IV. D. Transmission mechanism for achieving the 2 percent target under QQE Impact on economic activity and prices Regarding the transmission mechanism of monetary easing on economic activity under QQE, several channels have been considered. With the first channel, the purchase of assets continues to exert downward pressure on long-term nominal interest rates and the risk premia of risk asset prices (Chart 8). This channel would contribute to increasing firms’ business investment, households’ durable consumption and residential investment by (1) a decline in the funding cost of firms and households, (2) improvement in firms’ balance sheets, and (3) the wealth effect. With the second channel, the continuation of JGB purchases by the Bank may encourage financial institutions as well as institutional and individual investors to shift some of their portfolios to risk assets; they would do so in the process of adjusting some of their asset management policies away from deflation-oriented strategies. The so-called portfolio rebalance effect is intended to promote some degree of risk-taking among a wide range of financial institutions and investors, and it is necessary to energize Japan’s economy. Some of that risk money could be allocated to viable emerging, growing firms. The effects of the first and second channels are expected to be greater than those envisaged under the previous monetary easing policy, CME. Regarding the third channel, increases in medium- to long-term inflation expectations are expected to lead to a decline in long-term interest rates in real terms, thereby increasing business investment by firms as well as residential investment and consumption of durable goods by households. In addition, the anticipation of higher inflation may hasten these investment and consumption activities. These three channels may lead to an expansion of aggregate demand, an improvement in the output gap, and a rise in medium- to long-term inflation expectations, thereby raising the rate of price changes. Impact on long-term interest rates So far, I have explained the transmission mechanisms of monetary easing with regard to the impact on economic activity and prices. Now, I would like to review the impact of QQE from the viewpoint of long-term interest rates. Generally, it is widely known that long-term interest rates can be decomposed into two components: (1) the risk premia (such as term premium, liquidity premium); and (2) the expected path of short-term interest rates, as shown in Chart 8. Based on this understanding, the Bank’s JGB purchases are expected to generate downward pressure mainly on the risk premia and then on the expected path of short-term interest rates (this latter effect is called the ‘‘signaling effect’’). Moreover, the Bank’s commitment to continue with QQE as long as it is necessary for maintaining the 2 percent BIS central bankers’ speeches price stability target in a stable manner is also likely to enhance the downward pressure. Meanwhile, an improvement in the economic outlook and a gradual rise in medium- to longterm inflation expectations may lead to an increase in the expected path of short-term interest rates. This path may also be influenced by a rise in overseas long-term interest rates, which reflects improvement in overseas economies. The downward pressure is also observed in other countries, including the United States, which have purchased financial assets under the nontraditional monetary policy. Developments in long-term interest rates since the adoption of QQE reflect those downward and upward pressures. As for the outlook, even in the phase of intensified upward pressure, the continuation of the large-scale asset purchases is likely to maintain that downward pressure, and it may even reinforce that pressure with the cumulative growth of the amount purchased – in addition to the commitment to achieve the 2 percent target in a stable manner. These effects, together with a gradual rise in medium- to long-term inflation expectations, are likely to be reflected in long-term interest rates, which would eventually stabilize at levels consistent with the 2 percent price stability target. Moreover, the Bank continues to closely monitor market developments within a flexible operational framework and through discussions with market participants, and it expects that both short- and longterm interest rates will move largely on a stable path. E. Why are inflation expectations so important? To achieve the 2 percent target, it is important to consider the positive relationship between the rate of price change and the output gap – a relationship known as the Phillips curve. It is expected that the curve will steepen and shift upward as inflation expectations rise (Chart 10). As these expectations grow, firms may find it easier than before to reflect changes in the output gap and production cost in their sales prices, thereby contributing to a steepening of the Phillips curve. At the same time, an upward convergence of inflation expectations toward the 2 percent level is likely to shift the curve upward. Currently, there is active debate among Japanese economists as to whether the curve will shift upward as the Bank expects or remain flattened, since flattening of the curve is observed in many advanced economies. This issue will be addressed in Section IV. Factors contributing to flattening of the Phillips Curve In the case of Japan, some have pointed out that deregulation (for example, in distribution and telecommunications), intensified competition in the domestic and foreign markets as well as the financial crisis and associated plunge in domestic demand since the second half of the 1990s have exerted constant downward pressure on corporate margins and wages. Consequently, firms, supermarkets, and large discount stores began to set their sales prices according to their competitors’ – rather than in response to the output gap or cost developments. The active use of online shopping has also accelerated this kind of pricesetting behavior. The smaller the size of the firm, the lower is its capability to negotiate prices with its client firms, which makes it difficult to transfer the input cost to the final sales prices. This phenomenon is also evident in the Bank’s March 2013 Tankan (Short-Term Economic Survey of Enterprises in Japan). This can be referred to as firms’ price-setting behavior in a deflationary environment. Furthermore, medium- to long-term inflation expectations dropped sharply mainly in the 1990s (Chart 11). There is a view that the long-standing negative output gap (or demand shortage), limited structural reforms – particularly in various nonmanufacturing sectors – and slow supply responses extended the period of sluggish productivity growth. This helped lower the medium- to long-term growth expectations of firms and households, thereby depressing their inflation expectations (Chart 6). Moreover, it could be said that the prevalence of the zero lower bound, as explained in Section III, weakened the effectiveness of monetary easing and thus contributed to lowering medium- to long-term inflation expectations. BIS central bankers’ speeches Converging to the 2 percent medium- to long-term inflation expectations A number of other advanced economies successfully lowered their medium- to long-term inflation expectations from the high levels in the 1990s, and those expectations gradually converged to more or less 2 percent. Such a decline also coincided with a drop in actual inflation. There is a consensus among central banks that this phenomenon is closely associated with the establishment of central bank independence and the adoption of inflation targeting (or a framework to emphasize price stability). In the case of the United Kingdom, for example, the Bank of England (BOE) adopted inflation targeting in 1992, with the initial target being set in the range of 1–4 percent. The target was subsequently changed to 2.5 percent in 1997 and further to 2 percent in 2004.2 Chart 12 shows that the medium- to long-term inflation expectations in that country converged to around 2.5 percent in the 1990s and have been around 2 percent since 2004. For the United Kingdom and the United States, which have been successfully stabilizing those expectations at around 2 percent, the current view is that expectations should be maintained at the current stabilized level. This issue will be brought up again in Section III. Given that inflation expectations remain low in Japan, what the Bank is trying to do is to raise those expectations toward around the 2 percent level, which is comparable to that of other advanced economies. In this process, the Phillips curve could become steeper and shift upward as inflation expectations and firms’ price-setting behavior change. III. The previous Comprehensive Monetary Easing (CME) and my proposal at the March MPM A. What is a nontraditional monetary policy? So far, I have explained the outlook for economic activity and prices as well as the new monetary policy, QQE. After listening to my remarks, you may wonder why the Bank adopted QQE, which represents a drastic leap from the previously adopted CME. To understand the essence of QQE, it is necessary, I believe, to review the effectiveness and limitations of CME as well as the factors that contributed to adopting the 2 percent price stability target in January 2013 under CME. Moreover, I should explain clearly what factors and thoughts led to my proposal at the March MPM and how they are related to QQE. That thinking was substantially influenced by my having received many inquiries and responses from a wide range of people domestically and abroad. In general, monetary easing in a recessionary phase is conducted mainly through a reduction in a very short-term nominal interest rate – namely the policy interest rate. In the case of Japan, this refers to the uncollateralized overnight call rate. There are some cases, however, where the policy interest rate drops to nearly zero, leaving limited room for further decline. Japan faced this situation immediately after the collapse of Lehman Brothers in 2008.3 Under such a situation, CME attempts to create an accommodative monetary environment by exerting downward pressure on longer-term interest rates, which remain in positive territory despite the policy rate reaching nearly zero. For example, yields on JGBs often function as the benchmark for measuring the long-term fixed interest rates related to mortgages, loans, bonds, and so on. Therefore, downward pressure on JGB yields is likely to In 1997, the BOE achieved operational responsibility for setting interest rates and established the Monetary Policy Committee. Currently, inflation below 2 percent is judged to be just as bad as inflation above 2 percent. If actual inflation becomes more than 3 percent or less than 1 percent, the Governor of the BOE must write an open letter to the Chancellor, explaining the reasons for such a deviation and prescriptions for correcting it. Specifically, the Bank lowered its policy rate from around 0.5 percent to around 0.3 percent in October 2008 and further to around 0.1 percent in December 2008. BIS central bankers’ speeches contain funding costs, which makes it easier for firms and households to increase their economic activities. This policy – often called the nontraditional monetary policy under the zero lower bound on interest rates – is also applied by other central banks, such as in the United States and United Kingdom, where very short-term interest rates have declined to nearly zero. B. Basic features of CME Under CME, which was introduced in October 2010, the policy rate was lowered from around 0.1 percent to around 0–0.1 percent, which amounted to adopting the so-called virtually zerointerest rate policy. However, as already mentioned, the main element of CME was to generate downward pressure on longer-term interest rates by purchasing JGBs (and Treasury discount bills [T-Bills]), and not on short-term interest rates, which had already declined significantly. In addition to the impact on the funding cost, the JGB purchases were expected to generate downward pressure on the risk premia, thereby supporting the foundation of risk asset markets. In addition, the wealth effect and portfolio rebalance effect were considered. To enhance those effects, the Bank also purchased various risk assets directly. For this purpose, the Bank established the Asset Purchase Program (hereafter the Program) on its balance sheet to purchase various financial assets. The assets purchased under the Program covered JGBs (with remaining maturity from one to three years), T-Bills, CP, corporate bonds, ETFs, and J-REITs. The Bank concentrated its purchases of JGBs and T-Bills to exert downward pressure on longer-term interest rates in particular. The total amount outstanding of the Program was increased gradually from an initial 35 trillion yen to 65 trillion yen at end-2012. The amount was scheduled to expand further to 101 trillion yen by end-2013 and to 111 trillion yen by end-2014. Thereafter, the amount of 111 trillion yen was to be maintained for an undefined period of time (Chart 13). On the issue of the Program after 2014, I would like to provide some details. In January 2013, the Bank introduced the open-ended asset purchasing method, which was to start in early 2014. This meant that the Bank would purchase financial assets of about 13 trillion yen monthly – comprising about 2 trillion yen on JGBs, 10 trillion yen on T-Bills, and 1 trillion yen on CP and corporate bonds – without setting any termination date. Based on this monthly purchase, the amount outstanding of the Program was expected to rise by 10 trillion yen to 111 trillion yen in 2014. The amount outstanding of 111 trillion yen was scheduled to be maintained from 2015 onward since the quantity of monthly purchased JGBs and T-Bills would roughly meet their maturing totals.4 Regarding CP and corporate bonds, the amount of 1 trillion yen would be allocated from 2014 onward to roughly meet the maturing total. With my talking about the Program in this way, you may wonder whether the Bank attached more importance to the quantity of assets, rather than to exerting downward pressure on the yields and risk premia. Indeed, the Bank regarded both as equally important. In other words, although the Bank emphasized downward pressure on longer-term interest rates and the risk The amount outstanding of JGBs held by the Bank was scheduled to increase to 44 trillion yen by end-2013 and further to 48 trillion yen by end-2014. The amount of 48 trillion yen was scheduled to be maintained from 2015 onward. T-Bills are the second-largest assets held by the Bank, and the amount outstanding was scheduled to grow to 24.5 trillion yen by the end of 2013 and further to 30.5 trillion yen by end-2014. The amount of 30.5 trillion yen was scheduled to be maintained from 2015 onward. BIS central bankers’ speeches premia as the primary purpose of CME, in practice the Bank strengthened monetary easing by emphasizing the expansion of the quantity and committing to achieving that at any cost.5 C. Adopting the 2 percent price stability target In addition to introducing the open-ended asset purchasing method, an equally important policy decision was made in January 2013. Namely, the Bank finally adopted the 2 percent price stability target in terms of the year-on-year rate of change in the CPI, and it committed to pursuing monetary easing to achieve this target as early as possible. Why was the 2 percent target adopted? Before January 2013, the Bank’s view on price stability – expressed as the price stability goal in the medium to long term – was defined as being in a “positive range of 2 percent or lower”; the expression “1 percent for the time being” was also added. So why did the Bank not simply adopt the 2 percent target from the outset? This was because the expression had to cover diverging views (from lower to higher) of the Policy Board members with respect to the appropriate level of medium- to long-term inflation. Moreover, adopting such an expression was (1) to take into account past price movements (or price perceptions among households and firms); and (2) to accommodate the view that a longer-term goal could be achieved in conjunction with efforts to reinforce potential economic growth through various constituents, including the government, the Bank, financial institutions, and firms. These factors implied that it might take time to achieve the 2 percent target. Therefore, the numerical value of 2 percent was not excluded – even before January 2013. Nonetheless, I retrospectively take the view that the word “goal” (especially the connotation of the related term medo, which was adopted in the Japanese version) and the ambiguous references to the range held nuances of passiveness. As a result, the public and market participants were not sure whether the Bank was ultimately pursing the 2 percent level or a lower one and whether the Bank was firmly determined to overcome deflation. Against this background, the adoption of the 2 percent target in January 2013 was very important since it meant that these problems were finally eliminated. Furthermore, from the beginning of my appointment as a member of the Policy Board, I have consistently advocated that medium- to long-term inflation should be well above 1 percent. Therefore, I regard the adoption of the 2 percent target as a major achievement in the history of the Bank’s conduct of monetary policy. Why was the 2 percent value appropriate? Now, some of you may wonder why 2 percent was chosen as the medium- to long-term target. Conceptually, price stability should refer to a situation of zero inflation or no change in general prices. Why then should the Bank need to seek higher inflation? The main reason is that, as explained in Section II, 2 percent is a widely shared goal among many central banks in advanced economies as the medium- to long-term inflation target. The next question is thus why central banks should choose the value of 2 percent. It reflects the fact that central banks commonly believe it important to avoid the aforementioned zero lower bound situation, in which there is limited opportunity for a further decline in the policy rate. This approach was taken because the Bank wished to underline the difference from the Quantitative monetary easing (QE) policy adopted from 2001 to 2006, and it also reflects some lessons learned during that experience. Under QE, the size of reserve deposits – namely, the "quantity" of the liability of the Bank – was placed as the primary operational target; monetary easing was thus strengthened by expanding this quantity. Regarding the differences between QE and CME, please refer to my speech entitled "Japan's Monetary Policy in a Challenging Environment," Speeches at the Bank of Italy and the Eurasia Business and Economics Society Conference Held in Rome, Bank of Japan, 2013. BIS central bankers’ speeches Global discussions on the 2 percent target For your reference, I would like to briefly introduce recent global-level discussions on this issue. In 2010, Dr. Olivier Blanchard, Economic Counsellor and Director of the Research Department of the International Monetary Fund (IMF), pointed out that the U.S. economy had been facing the zero lower bound since the global financial crisis began in 2008 and that it was proving costly. If the U.S. economy had begun with higher average inflation and thus higher short-term nominal interest rates when entering the recession, the Federal Reserve could have lowered the interest rate more and thereby reduced the drop in output and deterioration of fiscal positions. Dr. Blanchard subsequently suggested that a higher inflation target up to about 4 percent could be pursued in normal times and that medium- to long-term inflation expectations should be anchored at that level – up from the current level of 2 percent. Moreover, new research results have been released on this issue, and they appear to support the higher inflation target.6 Recognizing this debate, at Chairman Bernanke’s press conference held after the Federal Open Market Committee in March 2013, one journalist raised the issue of increasing the inflation target from 2 percent to a higher level to allow a further decline in interest rates. The chairman then acknowledged that the U.S. economy faced the zero lower bound (despite the 2 percent goal) and stressed 2 percent inflation, not zero inflation, as the appropriate price stability goal. He said, “if you have zero inflation, you’re very close to the deflation zone, and nominal interest rates will be so low that it would be very difficult to respond fully to recessions. And so, historical experience has suggested that 2 percent is an appropriate balance between the cost of inflation and the cost [of the zero lower bound].”7 Moreover, as Dr. Blanchard and Chairman Bernanke observe, it is generally viewed that deflation is less desirable than inflation after considering the benefits and costs. If deflation is prolonged, the sales unit price and wages tend to decrease (or such a deflation expectation prevails), such that firms and households may find that funding costs are rising in real terms – notwithstanding very low long-term nominal interest rates. Consequently, investment and consumption activities supported by external funding could be discouraged, thereby possibly dampening economic growth. Moreover, in the context of Japan, deflation may lead to excessive appreciation of the yen, sluggish asset prices, and shortages in tax revenues; thus, a deteriorating fiscal balance results. D. Effectiveness and limitations of CME With regard to the effectiveness of CME, JGB yields and the risk premia dropped to a significant degree, which supported the economy. On the other hand, I have to admit that CME was not successful in conquering deflation – partly owing to a series of domestic and external situations, such as the Lehman shock, the European sovereign debt crisis, the Great East Japan Earthquake, and the Thailand floods of 2011, and the effects of developments in the relations between Japan and China. More importantly, I sensed that there was a growing opinion among the public and market participants that the 2 percent price stability target was not achievable with the previously announced monetary policy framework. This meant that For example, one study pointed out that the incidence and effects of the zero lower bound could be greater than previously estimated in the United States. Another study indicated that raising the inflation target in a liquidity trap could have an expansionary effect on output. Interestingly, Chairman Bernanke continued to comment on this matter by stating that the issue of an appropriate level for the inflation target was being debated in academic circles and that trying to quantify this target was an interesting question. He also acknowledged that hitting the zero lower bound has become more common, although it was a very rare event a few years ago (he appears to have referred to the aforementioned research results). These remarks give the impression that he does not exclude the idea of raising the inflation target if more research results point in this direction in the near future. BIS central bankers’ speeches the Bank’s framework was regarded as having limited credibility. My view is that the following three factors have contributed to the prevalence of such a perception. D–1. Complexity problem in the monetary policy framework: co-existence of the two operations First, the Bank’s monetary policy framework under CME gave an impression of complexity; consequently, the framework was not well understood compared with those of other central banks. In particular, I would like to stress that the most serious complexity problem arose from the fact that the purchase of JGBs was conducted through two types of operations: (1) one under the Program, and (2) the other as a regular JGB purchase operation (which, as noted earlier, is informally referred to as a Rinban operation). From the beginning of my appointment as a member of the Policy Board, I have repeatedly emphasized at the Bank that it should integrate these two operations to avoid unnecessary complexity as well as other problems, which I will now explain. A Rinban operation aims at purchasing JGBs (on the asset side of the Bank) according to an increase in the banknotes issued (on its liability side). An increase in the amount outstanding of JGB holdings under the Rinban operation was limited relative to that of the Program – despite the large amount outstanding of 65 trillion yen at end-2012. However, the Rinban operation purchased a wide range of remaining maturity from slightly less than one year up to 30 years. This differed substantially from the Program, under which JGBs were purchased with a remaining maturity of only one to three years. Furthermore, the maximum amount of JGB holdings under this operation was set at the amount outstanding of banknotes issued. The imposition of a cap on JGB holdings – often called the Banknote Principle – reflected two purposes: one was to provide the so-called growth currency (seicho tsuka in Japanese) and the other was to avoid the misperception of monetization. Issues from the viewpoint of ‘‘growth currency’’ With regard to the first purpose, the Bank positioned the Rinban operation as a means of providing growth currency so that this operation could be separated from that for monetary easing. The growth currency idea reflects the view that the amount outstanding of banknotes issued tends to rise in line with the size of the economy (i.e., nominal GDP). Since economic growth calls for a more or less proportionate growth in the amount outstanding of banknotes issued, those banknotes could be regarded as growth currency. Thus, banknotes could be considered a long-term liability of the Bank since they are related to the size of the economy; therefore, it was appropriate to purchase JGBs as a long-term asset according to the amount outstanding of banknotes issued. In such a situation, purchasing JGBs could be regarded as relatively “neutral” to short-term business cycles and price movements; it would therefore have a limited impact on the JGB market. In other words, the purchase of JGBs to fulfill this long-term purpose did not constitute an operation for monetary easing. Indeed, other central banks such as the Federal Reserve and BOE engage in purchasing their treasury securities (including long-term ones) in “normal” times as a counterpart to the increase in the amount outstanding of banknotes issued; thus, a regular purchase operation similar to that of Rinban is normally adopted elsewhere. However, it seems that such a viewpoint no longer prevails in the downturn triggered by the global financial crisis (Chart 14). I think this is because the recent increase in the amount outstanding of banknotes issued is caused by factors other than economic growth – specifically, aggressive monetary easing and its effects. For example, the declining opportunity cost of holding banknotes (and coins) caused by extremely low short-term interest rates may have led to higher demand for banknotes relative to the growth of the economy. This may lead to difficulty in differentiating the purchase of treasury securities between that corresponding to the increase in the amount outstanding of banknotes issued and that related to monetary easing. Since the global financial crisis began, the Federal Reserve and BOE have deviated from such an operation temporarily and have purchased BIS central bankers’ speeches treasury securities (and other assets) far beyond the amount outstanding of banknotes. Moreover, all those purchased assets are regarded as a result of monetary easing. In other words, other central banks have maintained the same purchasing method of regular operations by switching the purpose to an accommodative monetary policy and, in some cases, lengthening the maturity of the purchase operation. Issues from the viewpoint of “monetization” and complexity The Bank differentiated the JGB purchase under the Program from the regular Rinban operation, and it regarded the former only as a tool of ‘‘temporary’’ monetary easing. This action reflected the view that avoiding the misperception of monetizing the fiscal deficit was a priority. Since the establishment of the Program in October 2010, however, the duration of monetary easing has become longer, and the total amount of JGBs purchased under the two operations has already exceeded the amount outstanding of banknotes; this has virtually broken the Banknote Principle. In addition, the separation of the two operations has caused the problem of the true scale of monetary easing (as well as the average maturity length of JGBs purchased) to be underestimated by the public and market participants; this is in contrast to the actions of the Federal Reserve and the BOE, which covered the total amount of asset purchases. The Bank decided, therefore, in August 2011 to place a footnote describing the yearly amount of JGB purchases under the Rinban operation in the public statements on monetary policy whenever monetary easing was increased. Contrary to the initial purpose, however, inserting the footnote appears to have amplified perceptions of complexity without promoting an understanding of the Bank’s intention. Furthermore, the Bank occasionally explained to the public and market participants that its scale of monetary easing was similar to that of other central banks by comparing the size of the Bank’s balance sheet both in its absolute value and in terms of GDP. However, this behavior may have caused some kind of inconsistency since the balance sheet reflected the results of JGB purchases under the two operations – despite the Bank’s declaration that only the Program constituted monetary easing. To deal with this complexity and inconsistency, I therefore believed that there was a strong rationale for merging the two operations. For separate reasons, I also strongly believed that it was necessary to integrate the two operations when I started to consider a maturity extension of JGB purchases from the maximum three years to about five years in late 2012. This was because lengthening the maturity under the Program was likely to give a sense of overlap with the Rinban operation – given that, as of March 2013, the average maturity of the Rinban operation was about four years and that of the Program about two years. D–2. Monetary easing perceived as a piecemeal approach and lack of boldness The second factor contributing to the perception over limited credibility was related to the way the Bank conducted monetary easing. Since its introduction in October 2010, the size of the Program was increased nine times. If the total size of the increase under the Program is taken into account, it is fair to say that the Bank’s monetary easing was quite substantial (Chart 13). Nonetheless, the scale of increase undertaken each time was in the range of 5–10 trillion yen, and it seems that many people viewed such a piecemeal approach as lacking boldness. In addition, it was pointed out that the Bank’s communication strategy was not so effective, and the perception spread domestically and globally that the Bank was being passive in tackling deflation. Moreover, there are deep-rooted views that exiting accommodative monetary policies in the past – for example, the Zero interest rate policy in August 2000 and Quantitative monetary easing in March 2006 – was too early. Such past experiences appear to have added to the view that the Bank might not be determined to be a deflation fighter. BIS central bankers’ speeches D–3. Limitation of monetary easing under the program The third factor contributing to a perceived lack of credibility was associated with the eroding effectiveness of monetary easing under the Program. The intensified purchase of JGBs up to a maximum remaining maturity of three years has already flattened the yield curve within that maturity zone, leaving limited room for further decline. The next possible move could then be considered as extending the maturity beyond three years. We may then recall the case of extending the maximum maturity from two years to three years in April 2012. At that time, market expectations over the maturity extension preceded our decision – based on the observation that the increase in the committed amount under the Program was gradually getting harder to achieve. With such expectations, extending the maturity not only reduced the effectiveness of monetary easing, but it also generated a sense that the Bank was being passive with respect to monetary policy. Since the early part of this year, market expectations about the maturity possibly being extended to five years have emerged, and these mainly reflect a sense of deadlock under the Program. And such market expectations were already reflected in the yield curve. This experience suggested that it was necessary for the Bank to look for a completely different framework for purchasing JGBs. E. My proposal for integrating the two operations and monetary expansion As already mentioned, I was a long-term advocate of integrating the two operations for purchasing JGBs. Since last year’s MPMs, I have also raised this issue – in addition to the need for further monetary easing. Consequently, I decided to summarize my arguments as a single package and present it as an official proposal. The content of the proposal, which was presented at the March MPM, can be roughly summarized as follows: First, the maximum remaining maturity of JGB purchases under the Program should be extended to 30 years by integrating the operation under the Program with the Rinban operation to exert downward pressure on the whole yield curve. An extension of up to 30 years would likely facilitate the Bank’s operations, enhance the effectiveness of monetary easing, and signal its firm determination to overcome deflation. Second, the monthly purchase of JGBs should increase from the current 4 trillion yen (after integrating the two operations) to at least about 5 trillion yen; the open-ended asset purchasing method should be brought forward from early 2014 to the earliest possible date. In addition, my view was that the average remaining maturity of JGB purchases should be extended from the current level of slightly under three years (after integration) to over four years by increasing the purchase of JGBs with a remaining maturity of about five years. Regarding the zoning of the remaining maturity, I felt that it could be divided into the following four zones: up to three years; three to five years; five to ten years; and ten to 30 years. This was because the zones up to ten years include two years, five years, and ten years, whose maturity coincides with that of newly issued bonds, which tend to be more liquid than off-therun issues. However, since the scale of potential demand in each zone involves uncertainty, my proposal stated that such details should be determined based on input provided by the Bank’s staff. I was pleased to see integration of the Rinban operation with the Program finally being achieved under QQE in April. F. Similarities and differences between QQE and my proposal Common features between QQE and my proposal in March include the following: (1) placing JGBs as the most important financial asset purchased by the Bank in order to achieve the 2 percent price stability target as soon as possible; (2) an emphasis on exerting downward pressure on the whole yield curve; and (3) integration of the Rinban operation with the Program. However, there are differences in the size of the purchase. QQE concentrates on purchasing JGBs of about 50 trillion yen (on a net basis) annually over two years. Converting the yearly BIS central bankers’ speeches purchasing rate into the monthly pace and on a gross basis, QQE is scheduled to purchase 7+ trillion yen monthly over two years – much greater than the amount of at least 5 trillion yen to be purchased through the open-ended asset purchasing method, as suggested under my proposal. The monthly purchase rate of about 5 trillion yen was estimated based on the assumption that monetary easing would continue for longer. However, QQE attempts to achieve the 2 percent target at the earliest possible time and it includes a time horizon of about two years; thus, the purchase rate naturally becomes greater. Although I considered that the rate of about 5 trillion yen was a reasonable figure, after submitting my proposal in March, I began to believe that bolder action was necessary to send a strong signal about the Bank’s determination to achieve the 2 percent target. Furthermore, when QQE was introduced, I supported the monthly purchase rate of 7+ trillion yen based on two reasons. First, the amount appeared to hit the right balance between the amount under my proposal and about 10 trillion yen (which is roughly equivalent to the monthly issue of JGBs by the Ministry of Finance). If the amount had been closer to about 10 trillion yen, the market may have misunderstood this as an operation to monetize the fiscal deficit. Second, the scale of the operation is comparable to that of other central banks, including the Federal Reserve. In the past, the Bank’s monetary easing was not seen as bold as that of the Federal Reserve. Under QQE, the monthly purchase of JGBs by the Bank on a net basis amounts to about 4 trillion yen, whereas that of securities by the Federal Reserve is about 85 billion U.S. dollars (of which 45 billion U.S. dollars is accounted for by U.S. Treasury securities and 40 billion U.S. dollars by mortgage-backed securities [MBSs]). Given that Japan is about 40 percent the economic size of the United States (in terms of nominal GDP), Japan’s purchase amount is relatively large. In addition, extending the average remaining maturity of JGB purchases by the Bank to about seven years (six to eight years) has made it more or less comparable to that of securities purchases by the Federal Reserve (about nine years in the case of U.S. Treasury securities). IV. My views and proposals on the outlook report The Outlook Report mentioned in Section II attracted some attention among the public and market participants since it was the first time for the Bank’s views to be released since the introduction of QQE. Indeed, with the Outlook Report, the Bank introduced some changes to its structuring of reports, such as by adopting a compact style of writing. Nonetheless, several divergent opinions, including my own, were expressed at the MPM held on April 26. Here, I would like to explain my views on the Outlook Report along with the content of my proposal. A. Reasons for extending the projection period by one year Before proceeding, I would like to explain why the projection period was extended by one year to fiscal 2015 (i.e., a period of three years) in the April report. The most important point is that, at the MPM held on April 3 and 4, the Bank collectively agreed to achieve the 2 percent target (excluding the effects of the scheduled hikes in the consumption tax rate) at the earliest possible time, and it set a time horizon of about two years with the introduction of QQE (which constitutes a new phase of monetary easing in terms of quantity and quality in the era after the promulgation of the new Bank of Japan Law). In such a case, I believe it is a central bank’s obligation to indicate the projected timing for achieving the 2 percent target to the public and market participants. The median of the Policy Board members’ forecasts indicated that 2 percent inflation would be achieved in fiscal 2015; therefore, it was appropriate to state the projection period (Chart 2). At the same time, the Bank decided to double the monetary base as well as the amounts outstanding of its JGB and ETF holdings over two years, so it was appropriate to present the outlook up to fiscal 2015 by taking into account the lagging effects of monetary easing. Of course, further extension – for example up to fiscal 2016 – could also be considered. However, the degree of uncertainty tends to rise as the projection period lengthens. Chart 7 shows that the range of projected values is BIS central bankers’ speeches much greater for fiscal 2015 than for earlier periods; thus, further extension may not necessarily be useful. Other central banks treat the projection period differently, but it seems that three years is often selected.8 B. Clarification of the descriptions of risk factors Now, I would like to explain my views over the Bank’s risk assessments related to economic activity and prices, as described in Section II. My proposal on the impact of the consumption tax hikes as a risk factor to the economy The Bank’s overall risk assessment related to the economy was that it was “balanced.” Although my view is roughly in line with this assessment, I feel that the Bank should pay greater attention to an analysis of the risk factors associated with the impact of the consumption tax hikes. Let me make it clear that I strongly believe that the consumption tax hikes should be introduced as scheduled with a view to maintaining fiscal soundness and sustainability of the social security system. However, my concern lies in the possibility of the actual inflation projected for fiscal 2014 exceeding the level of inflation anticipated by households; this is because the timing of the tax hikes and the effects of large-scale monetary easing overlap. Therefore, unless households anticipate inflation as reflecting such impacts, households may face a greater-than-anticipated drop in real disposable income; consequently, the downside forces to the economy may become greater than the Bank estimates. Let me explain my concern in more detail. It is estimated that the first increase in the consumption tax rate in April 2014 from 5 percent to 8 percent will raise inflation for fiscal 2014 by about 2 percentage points. The next hike from 8 percent to 10 percent in October 2015 will lead to an increase by 0.6 percentage point for fiscal 2015. Through active media reporting, households and firms are already familiar with the 2 percent price stability target (with a time horizon of about two years) adopted by the Bank. Households, however, may not know whether the 2 percent inflation for fiscal 2014 is the outcome of the first tax hike or monetary easing. If both effects are taken into account, actual inflation in fiscal 2014 could approach 4 percent. According to the median of Policy Board members’ forecasts (the Bank’s view), inflation for fiscal 2014 including the tax hike will reach 3.4 percent (2 percent driven by the tax hike and 1.4 percent driven by such factors as monetary easing and import price increases), as shown in Chart 2. Are households really anticipating such a high level of inflation for fiscal 2014 – well above the 2 percent level? That would mean that households’ “short-term” inflation expectations covering the period of fiscal 2014 should be approaching at least around 3 percent (based on the Bank’s view); however, such expectations may remain at around 2 percent or less. Some indicators measuring short-term inflation expectations for fiscal 2014 indicate a rising trend, but they appear to be considerably less than around 3 percent (Chart 15). In addition, recognition of the price increases including the tax rate hikes may spread quickly among households from fiscal 2014, only after the actual implementation. Therefore, I The Federal Reserve released projections five times (January, April, June, September, and December) in 2012; of those, the first four issues provided projections for three years from 2012 and those in the longer run, while the last issue covered projections for four years and those in the longer run. The European Central Bank (ECB) releases four projections (March, June, September, and December) annually; of those, the first three issues cover projections of two years including the year concerned, whereas the final issue makes projections of up to three years. The BOE provides projections for three years using the "fan chart" without specifying figures. BIS central bankers’ speeches consider the possibility of a greater-than-expected decline in real income and, thus, aggregated demand. In light of these considerations, I believe that the following description on the possible outcome of the tax hikes in the Outlook Report is inappropriate: “Fourth, the extent of the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hikes may differ significantly depending on developments in real income and prices at each point in time.” I therefore presented a proposal at the MPM held on April 26 to revise the above description by incorporating more fully the risk related to a potentially large drop in households’ real income. At the same time, I took the strong view that the Bank should start to communicate more effectively and immediately to the public and market participants on the outlook for prices with and without the effects of the tax hikes so that the impacts of those hikes and other factors would be incorporated in short-term inflation expectations; this would be in contrast to the Bank’s previous tendency to stress the price outlook without the effects of the tax hikes. Based on the need for more insightful analysis, my proposal was meant to be an improvement over the description given in the Outlook Report together with the call for a better communication strategy with the public and market participants. This proposal was presented together with other suggestions related to the “two perspectives,” which I will explain later. However, my proposal was rejected by all the other Policy Board members. Thereafter, I decided to withdraw that proposal and support the chairman’s proposal on the Outlook Report. I did this because it was not my intention to oppose the chairman’s proposal since our basic views do not diverge significantly. I will of course continue to watch developments of prices and inflation expectations closely. My view on price responsiveness to the output gap as a risk factor to prices Although I support the overall assessment of risks to prices as being “largely balanced,” as discussed in Section II, I feel that the risks are tilted somewhat to the downside, particularly with regard to the responsiveness of prices to the output gap. The Phillips curve may remain flat owing to the high degree of uncertainty associated with the aforementioned issues related to the consumption tax hikes, especially for fiscal 2014 (Chart 10). If many firms perceive that the price increase triggered by the tax hikes could be sufficiently large to constrain household domestic demand, they may partially postpone raising their final sales prices (those related to the effect of the output gap and others) beyond the increase related to the consumption tax hike after fiscal 2015 – not fully within fiscal 2014. In such an event, the responsiveness of prices to the output gap would remain limited and the outcome for prices in fiscal 2014 could be lower than that projected by the Bank. Meanwhile, it is noted that the environment surrounding firms is gradually changing. The depreciating trend of the yen since late 2012 has contributed to turning the rate of change in yen-based export prices from negative to positive; it has also had moderating effects on inflows of some inexpensive import products. This may help mitigate the deflationary pressure prevailing among firms. Moreover, the moderate movements in foreign currencydenominated commodity prices have avoided a sharp increase in import prices; this is in contrast to the period of the mid-2000s that accompanied sharper yen’s depreciation and commodity price surge. Therefore, firms may find it easier to raise their sales prices and wages owing to the healthier prospects for profitability. I will closely watch firms’ pricing behavior. C. My proposal regarding the “two perspectives” Next, I would like to explain my views about the structure of the Outlook Report. This report consists of three sections: Section I focuses on the baseline scenario of the outlook for economic activity and prices; Section II examines upside and downside risks; and Section III covers the “two perspectives.” The first perspective examines whether the outlooks for BIS central bankers’ speeches economic activity and prices will follow a path of “sustainable growth under price stability” over the next two years or so. The second perspective relates to various risks relevant to the conduct of monetary policy, including (1) the overall assessment of risks to the economic activity and prices and (2) financial imbalances from a longer-term perspective. I have no objection to this framework. However, the description is not particularly clear and understandable for the public and market participants, and there is a need to improve the structure of the report. For example, it is not easy to understand the connections between sections I and II and the two perspectives in Section III. In addition, I am not sure that using the words “perspectives” without any explanation in the Outlook Report is appropriate. Consequently, readers would easily fail to understand the content relating to the two perspectives and thus not grasp the Bank’s intention. I have maintained such views about clarity of expression ever since I was appointed a member of the Policy Board and have called for improvements at every opportunity within the Bank. As a result, I submitted my official proposal at the MPM held on April 26, using the opportunity of the Outlook Report being released under the new leadership. My proposal called for completely removing the concept of the “two perspectives” from the report; instead, I suggested that what was written relating to the two perspectives in Section III be moved to appropriate sections throughout the entire report. My proposal consists of the following two points. First, the content described as the first perspective should be moved to the last part of Section I. “Baseline Scenario of the Outlook for Economic Activity and Prices in Japan” and placed there as a summary of the overall assessment. Second, the content related to overall risk assessment of economic activity in the second perspective should be moved to the last part of Section II.A. “Risks to Economic Activity.” Similarly, the content related to prices should be moved to the last part of Section II.B. “Risks to Prices.” The content related to the assessment of financial imbalances should remain in Section III, but it should be moved to a place after the description of the future conduct of monetary policy. I do not exclude the possibility of using alternative description styles. In any case, I believe that the Bank should make greater efforts to promote an understanding among the public and market participants of its monetary policy and pursue more effective communication strategies. Improving the writing style in official documents including the Outlook Report is one of the first steps toward achieving that goal. I will continue to work on this issue. That brings me to the end of my presentation. Thank you very much indeed for your kind attention. BIS central bankers’ speeches Chart 1 Outlook for economic activity (Real GDP) 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5 -4.0 y/y % chg. 2.9 Actual 1.4 1.2 1.6 0.2 Fiscal year Note: The circles in charts 1 and 2 indicate the median of the Policy Board members’ forecasts. Source: Bank of Japan. Chart 2 Outlook for prices (CPI) 4.0 y/y % chg. 3.4 3.5 With the consumption tax hikes 3.0 2.6 Without the consumption tax hikes 2.5 2.0 1.5 1.9 Actual 1.0 1.4 0.5 0.7 0.0 0.0 -0.5 -0.2 -1.0 -1.5 -2.0 Fiscal year Source: Bank of Japan. BIS central bankers’ speeches Chart 3 Output gap % -2 -4 -6 -8 -10 Year 12 13 Source: Bank of Japan. Chart 4 Real GDP and labor input y/y % chg. y/y % chg. Projection Labor input (left scale) Real GDP (right scale) -1 -2 -2 -4 -3 1995 96 -6 99 2000 01 04 05 06 Fiscal year Note: Labor input = number of employees × total hours worked. Sources: Cabinet Office; Ministry of Internal Affairs and Communications; Ministry of Health, Labor and Welfare. BIS central bankers’ speeches Chart 5 Prices and wages y/y % chg. y/y % chg. Projection Hourly cash earnings (left scale) CPI (all items less fresh food, right scale） -2 -1 -4 -2 -6 -3 99 2001 Fiscal year Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labor and Welfare. Chart 6 Medium- to long-term inflation expectations 3.0 y/y % chg. Households' inflation expectations (over the next 5 years) 2.5 Market participants' inflation expectations (2 to 10 years ahead) 2.0 Break even inflation (BEI, longest) 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 Year Sources: Bank of Japan; QUICK; Bloomberg. BIS central bankers’ speeches Chart 7 Forecast distribution charts of policy board members (1) Real GDP y/y % chg. 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5 -4.0 Fiscal year (2) CPI (All items less fresh food [excluding the effects of the consumption tax hikes]) y/y % chg. 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 Actual -1.5 -2.0 Fiscal year Notes: 1. Based on the aggregated probability distributions (i.e., the Risk Balance Charts) compiled from the distributions of individual Policy Board members, the Forecast Distribution Charts are compiled as follows. First, upper and lower 10 percentiles of the aggregated distributions are trimmed and second, colors indicated below are used to show the respective percentiles of those distributions. Upper 40% to lower 40% Upper 30 to 40% & lower 30 to 40% Upper 20 to 30% & lower 20 to 30% Upper 10 to 20% & lower 10 to 20% 2. The circles in the bar charts indicate the median of the Policy Board members’ forecasts (point estimates). The vertical lines in the bar charts indicate the range of the forecasts of the majority of Policy Board members. Source: Bank of Japan. BIS central bankers’ speeches Chart 8 Factors affecting long-term interest rates JGB purchases by the Bank of Japan Long-term = interest rates + Risk premia Expected path of short-term interest rates Liquidity of the JGB market, Improvement in the economic outlook, fiscal sustainability, medium- to long-term inflation expectations etc… (monetary base targeting), etc… Chart 9 Expansion in the monetary base and JGB purchases tril. yen End-2014 270 tril. yen Monetary base End-2013 200 tril. yen JGB holdings End-2014 190 tril. yen End-2012 138 tril. yen End-2013 140 tril. yen End-2012 89 tril. yen Year Projection Source: Bank of Japan. BIS central bankers’ speeches Chart 10 Phillips Curve CPI all items less fresh food, y/y % chg. 1983/Q1-2013/Q1 B A A: 1983/Q1-2013/Q1 y = 0.36x + 0.7 B: 1983/Q1-1995/Q4 y = 0.28x + 1.1 C: 1996/Q1-2013/Q1 y = 0.28x + 0.3 C -1 2013/Q1 -2 -3 -9 -8 -7 -6 -5 -4 -3 -2 -1 GDP gap (2-quarter lead, %) Note: The output gap is estimated by the Bank of Japan. Sources: Bank of Japan; Ministry of Internal Affairs and Communications; Cabinet Office. Chart 11 Medium- to long-term inflation expectations and the core CPI in Japan y/y % chg. CPI (all items less fresh food) Inflation expectations (6 to 10 years ahead) -1 -2 -3 Year Sources: Ministry of Internal Affairs and Communications; Consensus Economics Inc., “Consensus Forecasts.” BIS central bankers’ speeches Chart 12 Medium- to long-term inflation expectations and the CPI in the United Kingdom y/y % chg. Medium- to long-term inflation expectations (6 to 10 years ahead) Retail prices index excluding mortgage interest payments (RPIX) CPI Year Sources: Office for National Statistics; Consensus Economics Inc., “Consensus Forecasts.” Chart 13 Size of the asset purchase program tril. yen Maximum amount of the Program Schedule Jan. 2013 111 tril.yen Dec. 101 tril.yen Actual amount of increase Oct. 91 tril.yen Apr. 70 tril.yen Feb. 2012 65 tril.yen End-Dec. 111 tril. yen Sep. 80 tril.yen Oct. 55 tril.yen Aug. 50 tril.yen Started in Oct. 2010 35 tril.yen Mar. 2011 40 tril.yen Note: Dates indicate the intended timescale for completing the increase. BIS central bankers’ speeches Chart 14 Amount outstanding of banknotes issued and nominal GDP (1) Japan y/y % chg. Nominal GDP Banknotes -2 -4 -6 -8 -10 Year (2) United States y/y % chg. Nominal GDP Banknotes -2 -4 -6 Year (3) United Kingdom y/y % chg. Nominal GDP Banknotes -2 -4 -6 Year Sources: Bank of Japan; Federal Reserve; Office for National Statistics. BIS central bankers’ speeches Chart 15 Short-term inflation expectations y/y ％ chg. Households' inflation expectations (over the next year) Households' inflation expectations (1 year from now, weighted average) Market participants' inflation expectations (1 to 2 years ahead) -1 -2 Year Sources: Bank of Japan; Cabinet Office; QUICK. BIS central bankers’ speeches
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Statement by Mr Haruhiko Kuroda, Governor of the Bank of Japan, before the Committee on Financial Affairs, House of Representatives, Tokyo, 19 June 2013.
Haruhiko Kuroda: The Bank of Japan’s Semiannual Report on Currency and Monetary Control Statement by Mr Haruhiko Kuroda, Governor of the Bank of Japan, before the Committee on Financial Affairs, House of Representatives, Tokyo, 19 June 2013. * * * 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 2012 on June 14, 2013. 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 First, I will explain economic and financial developments in Japan. Japan’s economy has been picking up as exports and industrial production have continued to improve against the background that domestic demand remains resilient. As for overseas economies, while the manufacturing sector shows a lackluster performance, they are gradually heading toward a pick-up as a whole. In this situation, exports have started picking up. Business fixed investment has been resilient in nonmanufacturing and appears to have stopped weakening on the whole. Public investment has continued to increase, and housing investment has generally been picking up. Private consumption has been resilient, assisted by the improvement in consumer sentiment. Reflecting these developments in demand both at home and abroad, industrial production has been picking up. With regard to the outlook, Japan’s economy is expected to return to a moderate recovery path, mainly against the background that domestic demand increases its resilience due to the effects of monetary easing as well as various economic measures, and that growth rates of overseas economies gradually pick up, albeit moderately. Meanwhile, financial conditions are accommodative. The monetary base has increased significantly as asset purchases by the Bank of Japan have progressed, and firms’ funding costs have been hovering at low levels. The year-on-year rate of increase in the amount outstanding of bank lending has been at around 2 percent, mainly due to increased demand for working capital and funds related to mergers and acquisitions. Issuing conditions for CP and corporate bonds have remained favorable on the whole. Financial markets have shown somewhat volatile movements since late May, largely reflecting developments in overseas markets. Given that Japan’s economy is on a steady path toward recovery, however, they are expected to gradually regain stability, reflecting positive momentum in economic activity. On the price front, the year-on-year rate of change in consumer prices (all items less fresh food) has been negative, due to the reversal of the previous year’s movements in energyrelated and durable consumer goods. The rise in some market indicators of inflation expectations has come to a pause; however, indicators including the surveys conducted on households and economists suggest a rise on the whole. In May, the year-on-year rate of change in consumer prices in the Tokyo metropolitan area registered positive for the first time in four years and two months. Going forward, the year-on-year rate of change in consumer prices nationwide is likely to gradually turn positive. There remains a high degree of uncertainty concerning Japan’s economy, including the prospects for the European debt problem and the growth momentum of the U.S. economy as BIS central bankers’ speeches well as the emerging and commodity-exporting economies. The Bank will continue to pay close attention to further developments, including those in financial markets. II. Conduct of monetary policy Next, I will explain the Bank’s conduct of monetary policy. In April, the Bank introduced quantitative and qualitative monetary easing (QQE), aiming to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index at the earliest possible time, with a time horizon of about two years. QQE represents a new phase of monetary easing, both in terms of quantity and quality. More concretely, first, the Bank changed its main operating target for money market operations from the uncollateralized overnight call rate to the monetary base. On top of this, it will double the monetary base in two years. Second, the Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 50 trillion yen. As a result, the amount outstanding is also expected to double in two years. In addition, the average remaining maturity of the Bank’s JGB purchases has been extended from slightly less than three years to about seven years. Third, the Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. The Bank will continue with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. The transmission channels of QQE are as follows. First, the purchases of financial assets will exert influence on long-term interest rates and risk premia of asset prices. Second, a portfolio rebalancing effect, in which the investment behavior of financial institutions and institutional investors changes by increasing lending and/or shifting their portfolios to risk assets. Third, the clear commitment to achieving the price stability target at the earliest possible time and the continuation of massive purchases of assets are expected to drastically change the expectations of markets and economic entities. Through these channels, QQE will stimulate private demand and contribute to raising prices by improving the aggregate supply and demand balance and by raising inflation expectations. Such conduct of monetary policy by the Bank will support the positive movements in economic activity and financial markets, contribute to a rise in inflation expectations, and lead Japan’s economy to overcome the deflation that has lasted for nearly 15 years. The Bank will continue to conduct monetary policy as appropriate. 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 Penang Economic Conference in Malaysia, Penang, 29 June 2013.
Sayuri Shirai: Japan’s economy and monetary policy in an increasingly integrated Asia Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the Penang Economic Conference in Malaysia, Penang, 29 June 2013. * I. * * Introduction Good morning. It is a great honor to be here today at the Penang Economic Conference. Although I have often visited other places in Malaysia, this is my first time in Penang, so I am really looking forward to learning from you about this region. In my presentation today, I will focus on Japan’s recent monetary policy as well as the implications for the rest of Asia. Some of you may know that the Bank of Japan introduced a new monetary policy called Quantitative and qualitative monetary easing (QQE) at the Monetary Policy Meeting held on April 3 and 4, 2013. So I would like to take this opportunity to speak to you about our policy to promote understanding of the situation of the Japanese economy. II. The features of quantitative and qualitative monetary easing (QQE) and the transmission mechanism First of all, I would like to point out that Japan has suffered from a long-standing negative output gap and mild deflation over nearly the entire period since the second half of the 1990s. Some may find it difficult to understand why achieving even a degree of small inflation is such a challenging task. Japan is unique in the sense that such macroeconomic problems have not yet been overcome despite a series of accommodative monetary policy measures adopted previously. For this reason, in April the Bank introduced a new large-scale monetary policy framework, QQE, with the aim of achieving at the earliest possible time the 2 percent price stability target that had been adopted in January 2013 under the previous accommodative monetary policy regime, with a time horizon of about two years. Of course, a one-off achievement of the 2 percent target is not sufficient and the Bank intends to achieve the target stably in a favorable environment characterized by sustainable economic growth. Upon the introduction of QQE, the Bank made a commitment that it would continue with QQE as long as it is necessary to maintain the target in a stable manner. This is the so-called commitment to achieve the 2 percent target stably. I will now explain the essence of QQE by highlighting its three main characteristics and the transmission mechanism of monetary easing. A. The three characteristics of QQE The first characteristic of QQE is that the Bank designated the purchase of Japanese government bonds (JGBs) as the most important tool for achieving the 2 percent price stability target at the earliest possible time. Moreover, it was decided to extend the average remaining maturity of the Bank’s JGB purchases from the original level of slightly under three years to about seven years (that is, six to eight years) by purchasing JGBs with maturities of up to 40 years. The purpose is to exert further downward pressure on the entire yield curve. The yearly pace of increase in the amount outstanding of JGBs held by the Bank was set at about 50 trillion yen, and the increase will continue over two years, thereby doubling the amount outstanding from the end of 2012 to the end of 2014 (Chart 1). I believe that these changes constitute a considerable departure from previous practice both in terms of “quantity” (based on the size of the Bank’s Asset Purchase Program) and “quality” (based on the maturity length). The second characteristic of QQE is an increase in the purchase of two risk assets – exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) – since BIS central bankers’ speeches there is some room for further lowering of the levels of risk premia (that is, the expected excess returns demanded by investors relative to safe assets) and it is thought that the purchase of the two risk assets will have a large economic impact. Considering the market size and the risk volume borne by the Bank, the yearly purchase amount of ETFs and J-REITs was set at about 1 trillion yen and 30 billion yen, respectively. This would double the amount outstanding of ETFs held by the Bank from the end of 2012 to the end of 2014. The third characteristic of QQE is an emphasis on the expectations of markets, firms, and households – particularly medium- to long-term inflation expectations – as one of the most important channels for achieving the 2 percent target. If firms and households expect inflation to rise in the medium to long term, this may positively affect the current levels of sales prices and wages. Moreover, as long as the pace of increase in inflation expectations exceeds that in long-term nominal interest rates, long-term interest rates in real terms will decline and thus support an accommodative monetary environment. Aiming to raise medium- to long-term inflation expectations, the Bank decided to change the main operating target for money market operations from the uncollateralized overnight call rate (that is, interest rates) to the monetary base (that is, “quantity”), with the aim of communicating to the public in a clear and intelligible manner. On this basis, it was decided that the monetary base should rise at an annual pace of about 60-70 trillion yen over two years; this would double the amount outstanding from 138 trillion yen at end-2012 to about 200 trillion yen at end-2013 and to 270 trillion yen at end-2014 (Chart 1). The last figure would account for nearly 60 percent of nominal GDP – far above the levels of other advanced economies. B. Transmission mechanism for achieving the 2 percent target under QQE Regarding the transmission mechanism of monetary easing under QQE on economic activity, three channels have been considered. In terms of the first channel, the purchase of assets continues to exert downward pressure on long-term nominal interest rates and the risk premia of risk asset prices. This channel would contribute to increasing firms’ and households’ investment and consumption activities through (1) a decline in the funding costs of firms and households, (2) improvement in the balance sheets of firms and financial institutions, and (3) the wealth effect of households. In terms of the second channel, the continuation of JGB purchases by the Bank may encourage investors and financial institutions to shift some of their portfolios to risk assets as they adjust some of their asset management policies away from deflation-oriented strategies. This so-called portfolio rebalance effect may generate some risk money that could be allocated to viable, innovative emerging or growing firms, strengthening the growth potential of the Japanese economy. In terms of the third channel, increases in medium- to long-term inflation expectations are expected to lead to a decline in long-term interest rates in real terms. In addition, the anticipation of higher inflation may hasten firms’ business investment and households’ durable goods consumption as well as residential investment. Through these three channels, an expansion of aggregate demand, an improvement in the output gap, and a rise in medium- to long-term inflation expectations are likely to take place, thereby raising the rate of actual price changes. Personally, I see the second channel, which would induce some degree of risk-taking, as essential to invigorate the Japanese economy. In the face of the deflation mindset that currently prevails, the opportunity cost of holding cash is so low that risk money is hardly generated, thereby restraining the allocation of funds to new business investment, research and development, or the promotion of entrepreneurs. This is one of the main reasons why the Bank decided to introduce QQE, hoping to affect investment strategies and corporate price-setting behavior that have been accustomed to deflation. Moreover, lowering long-term interest rates in real terms by raising inflation expectations is a new element of the Bank’s monetary policy, and is important to raise aggregate demand. Indeed, while different indicators may show different results, interest rates in real terms appear likely to have declined in recent months (Chart 2). BIS central bankers’ speeches III. Impact of QQE on Japan’s financial and capital markets and on Asia Following the introduction of QQE in early April, volatility increased in Japan’s financial and capital markets, particularly in the JGB market, followed by increased volatility in the stock and foreign exchange markets. Here, I would like to talk about factors related to these movements, especially with regard to the JGB market (although some signs of stabilization have been observed more recently), in addition to the impact of QQE on Asia. A. Developments in Japan’s financial and capital markets, and the foreign exchange market It is widely known that long-term interest rates can conceptually be decomposed into two components: (1) the risk premia (such as the term premium and the liquidity premium); and (2) the expected path of short-term interest rates. Based on this understanding, the Bank’s JGB purchases are expected to generate downward pressure primarily on the risk premia and then on the expected path of short-term interest rates. Moreover, the Bank’s commitment to achieve the 2 percent target stably is likely to enhance the downward pressure. Meanwhile, an improvement in the economic outlook, a gradual rise in medium- to long-term inflation expectations, and a rise in overseas long-term interest rates may lead to an increase in the expected path of short-term interest rates. Developments in long-term interest rates since the introduction of QQE reflect such downward pressure as well as upward pressure (Chart 3). My view is that three main factors have been at play. First, the U.S. economy has maintained moderate economic and employment growth with a relatively solid recovery trend in the housing market, notwithstanding the tightening of fiscal policy since the start of 2013. This indicates that the macroeconomic fundamentals have been strengthening. In May and June 2013, Federal Reserve Board Chairman Ben Bernanke indicated the possibility of tapering the monthly 85 billion U.S. dollar bond purchase program by late this year as long as the Federal Reserve observes continued, sustainable improvement. Some presidents of regional Federal Reserve Banks have suggested the same possibility. While these remarks are thought to have raised the awareness of many market participants about the direction of the Federal Reserve’s monetary policy toward the exit, the fact that economic data are mixed has led to divergent views on the timing of the tapering process. This seems to have contributed to amplifying the volatility of U.S. long-term interest rates, stock prices, and the exchange rate of the dollar, thereby affecting the government bond, stock, and foreign exchange markets in Japan and other economies (charts 4 and 5). The second factor at play is that the market environment has been gradually changing in Japan. In the past, long-term interest rates and volatility remained at low levels. However, since the introduction of QQE, some market participants have promptly adopted new investment strategies by taking into account the possibility of future inflation, while others have taken a wait-and-see attitude, and these divergent strategies and attitudes appear to be reflected on the movements of long-term interest rates. Meanwhile, the transaction volume of JGBs has not declined significantly, except during early April. Nor have bid-ask spreads been particularly high in light of historical levels. At the same time, however, it has been pointed out that fewer market makers are standing behind their bid and ask quotes, and so the execution of large-scale transactions at the same (preferred) prices as before has become difficult. In other words, transaction costs have increased and the price-discovery function has weakened somewhat. Moreover, an indicator of market liquidity – defined as the ratio of the daily price range to the transaction volume – has reached relatively high levels (Chart 6). The third factor at play, which is related to the second factor, arises from the fact that market participants have significantly different views on the impact of QQE in terms of the degree to which it will affect long-term interest rates, and the speed. Some believe that yields will rise relatively quickly, while others expect a gradual increase. This divergence may have contributed to the volatility of the yields. On this issue, the Bank remains committed to achieving the 2 percent target at the earliest possible time, with a time horizon of about two BIS central bankers’ speeches years. And indeed, in the Bank’s Outlook for Economic Activity and Prices, released on April 26, 2013, the median of the forecasts by the Bank’s Policy Board members – which is regarded as the Bank’s view – indicates that an inflation rate of 1.9 percent is projected for fiscal 2015. To add to this, I place great importance on the Bank’s commitment to achieve the 2 percent target stably, and believe that it is crucial to make steady progress toward achieving this target. As for the outlook for long-term interest rates, even during a phase of intensified upward pressure, the continuation of the large-scale asset purchases is likely to maintain downward pressure, and this downward pressure may even strengthen with the cumulative growth of the amount purchased – in addition to the commitment to achieve the 2 percent target stably. These developments, together with a gradual rise in medium- to long-term inflation expectations, are likely to be reflected in long-term interest rates, which would eventually stabilize at levels consistent with the 2 percent price stability target. The Bank will continue to closely monitor developments in financial markets, including the bond market, under the flexible operational framework for JGB purchases and the fixed-rate funds-supplying operations, and through discussions with market participants. The Bank expects that both short- and long-term interest rates will move on a stable path on the whole. B. Impacts on other financial markets and bank lending While volatility in the JGB and stock markets increased temporarily, issuance conditions in the CP and corporate bond markets have not changed. Since April, issuance rates on CP have generally remained at low levels, and previously higher rates on the CP of some firms with less favorable business performance have recently declined. In addition, issuance of corporate bonds has steadily increased and their spreads have remained flat at low levels on the whole. Lending by financial institutions has increased moderately, and the amount outstanding of bank lending grew at a relatively high rate of 2.1 percent year on year both in April and in May. Some long-term fixed interest rates, such as fixed-rate mortgage and longterm prime lending rates, have risen somewhat lately. However, the amounts of mortgages and loans to the corporate sector have been growing and it appears that an adverse impact on economic activity has so far been avoided. C. Impact on financial and capital markets in Asia Concerns have been raised in emerging economies that the highly accommodative monetary policy stance by the Federal Reserve and the Bank may lead to volatile capital flows and unstable foreign exchange rate movements. In particular, some financial and capital markets in Asia are relatively small and in the process of development, so that a massive scale of capital inflows from abroad cannot be easily and effectively absorbed and increases the risk of credit booms and asset bubbles. This holds especially when the nature of capital inflows is short term and sensitive to various shocks, since such shocks could cause a sudden reversal of capital flows and subsequently a domestic financial crisis following the bursting of a bubble. It has also been pointed out that some Asian bond markets have seen a sharp increase in foreign currency-denominated bonds issued offshore since 2012 (largely in U.S. dollars, but also in euros and yen), with the pace accelerating further in the first half of 2013. The issues consist largely of investment-grade bonds, but also include high-yield, low-rated bonds whose issuance has been growing reflecting a decline in issuance rates and spreads. High-yield bonds largely originated from the United States and Europe, but have recently become more widespread in some Asian countries. In addition, some Asian countries face rapidly increasing real estate prices, a sign of overheating in asset markets. For these Asian economies, there may be a risk associated with a sudden reversal of capital flows and a resultant shortage of liquidity. With regard to the Bank’s QQE, however, the impact on Asian economies and financial and capital markets appears thus far to be limited. A look at the activity of large Japanese financial institutions shows that cross-border claims in Asia have grown since around 2010 BIS central bankers’ speeches and continue to rise steadily. This increase has not contributed to an overheating in regional economies, since exposures by financial institutions from other Asian economies (such as Hong Kong and Singapore) have expanded even further and the increase in cross-border claims by Japanese financial institutions has partially offset a curtailment of cross-border claims by the euro area banks (Chart 7). Most of the loans extended to Asia by Japanese financial institutions have been made in U.S. dollars, and these dollar funds often originate from headquarters in Japan. Some Japanese financial institutions plan to extend credit denominated in local currencies as they increase and diversify the sources of local currency funding for both Japanese and non-Japanese customers operating in Asia. As for the balance of portfolio investment, Japan currently records a net inflow. The movement of outward portfolio investment has continued to indicate a net inflow (or the amount of disposal exceeding that of acquisition) since the beginning of 2013, mostly because outward bond investment shifted from a net outflow (net acquisition) to a net inflow (net disposal), as seen in Chart 8. Japanese investors traditionally tend to concentrate their bond investment in the United States and Europe, with a limited amount allocated to Asia (Chart 9). Outward bond investment has recently turned from a net acquisition to a substantial net disposal, and a similar pattern has been observed in the case of outward stock investment, albeit to a lesser extent. Some point out that a shift to a net inflow in outward bond investment reflects (1) activity to maintain a stable degree of foreign exposure by some Japanese investors (so that an increase in foreign assets valued in yen as a result of the yen’s depreciation has induced a cut in their investment positions); (2) low returns on investment in European and U.S. bonds relative to domestic bond investment after taking into account the cost of foreign exchange hedging (Chart 10); and (3) low returns on the yen carry trade relative to historical trends. On the other hand, individual investors appear to be investing in securities originating in North America and some Asian countries, largely by utilizing investment trusts. Instead, there has been a large increase in “inward portfolio investment” to Japan from abroad, including Asia, indicating a net inflow (Chart 11). In particular, active investment in Japanese stocks is observed among foreign investors. Foreign investors shifted to net sellers (net disposal) in late May 2013 partly due to a plunge in stock prices. Since then, there have been somewhat volatile movements. Many of these investors base their investment on not only specific stocks but also economic growth strategies formulated by Prime Minister Shinzo Abe’s administration and the implementation of these strategies. Although the above observations do not necessarily suggest active cross-border outward portfolio investment, the Bank will continue to closely monitor the spillover effects of Japan’s monetary policy to cross-border movements of capital flows into the region. I personally believe that it would be beneficial for Asia if some of the abundant liquidity accumulated in Japan (partly as a result of growing deposits and savings and partly due to accommodative monetary policy) could be utilized to achieve a sustainable growth path in the region with high growth momentum – while enabling Japanese investors to diversify their asset allocation. It would be a positive development if such funds originating from Japan contributed to further deepening of financial and capital markets in the region. Some economies in the region also face challenges of an inadequate infrastructure and a shortage of long-term capital. An increase in the circulation of funds used for productive purposes within the region could generate a “win-win” situation in Asia as a whole, including Japan. D. Regional financial cooperation Initiatives in Asia Underlying the expansion in capital inflows to emerging countries including those in Asia are both pull factors (that is, higher growth and yields) and push factors (that is, low interest rates and low growth in advanced countries, as well as investors’ pursuit of higher profits). With the latter factors in mind, economies have introduced a range of country-specific measures including macro-prudential regulations to respond to sudden capital inflows and outflows in emerging economies. Thus far, there is no consensus on appropriate approaches to deal BIS central bankers’ speeches with such volatile capital flows. However, from a long-term perspective, it is important for Asia to develop stronger domestic financial and capital markets (denominated in local currencies), especially markets for long-term capital funding. In this sense, the long-standing initiatives by governments and central banks to foster local currency-denominated bond markets – such as the Asian Bond Markets Initiative (ABMI) and the Asian Bond Fund (ABF) – are highly significant. The amount outstanding of local currency bonds in Asia has exceeded 7 trillion U.S. dollars, more than six times the level of ten years ago. The bond markets are now a valuable source of funding, for not only the public sector but also the private sector, which I view as favorable developments. To reduce the vulnerability of local bond markets, however, it is crucial to improve transparency of the markets and foster domestic institutional investors. In addition, it makes sense for Asian economies to actively utilize their own savings for domestic productive purposes, provided that many of them enjoy surpluses in current account balances. From the viewpoint of monitoring capital flow movements and improving crisis prevention and management capacity in the region, I would like to stress the importance of the Chiang Mai Initiative (CMI), later renamed the Chiang Mai Initiative Multilateralization (CMIM). The CMI was established in 2000 as a framework for crisis prevention and management among the Association of Southeast Asian Nations Plus Three (ASEAN+3) countries. In early May 2013, the meeting of the Finance Ministers and Central Bank Governors of ASEAN+3 reached a consensus to transform the ASEAN+3 Macroeconomic Research Office (AMRO) – an independent regional surveillance unit supporting the CMIM – into an international organization. Considering that the AMRO conducts monitoring to see whether financial and economic conditions in Asia have accumulated imbalances, its promotion to an international organization can be regarded as an important decision ensuring its independence. Moreover, it was agreed in May 2013 to amend the CMIM Agreement to reflect the following measures agreed in May 2012: doubling the size of the CMIM from 120 billion to 240 billion U.S. dollars, introducing a crisis prevention facility of the Precautionary Line, and minimizing the IMF-linked portion from 80 percent to 70 percent (and further to 60 percent in 2014). I hope that these regional cooperation efforts will prevent the occurrence of financial crises or foster the capacity to manage crises effectively if they occur. E. Impact on trade relations with Asia Finally, I would like to offer some remarks on the impact of QQE on Japan’s trade relations with the rest of Asia. There are positive aspects of QQE on Asian economies, since economic recovery in Japan is likely to encourage imports from the region, contributing to an expansion of regional aggregate demand. On the other hand, some have expressed concern about possible side effects of QQE, in that a further depreciation of the yen may intensify competition between firms in Japan and those elsewhere in Asia. However, it is also important to bear in mind that a further depreciation of the yen may help to strengthen the competitiveness of Asian products by inducing a decline in the prices of intermediate goods imported from Japan to the region. Therefore, grasping the impact of QQE on trade relations with Asia is not all that simple. This reflects a formation of supply chain production networks across Asia involving Japan and many other economies. This means that the trade relations between Japan and the rest of Asia are highly integrated and complex. This is evident from the fact that Japanese firms have steadily increased their ratios of overseas production to total production as a result of large outward foreign direct investment. Consequently, the amount of sales by foreign subsidiaries of Japanese firms has already exceeded that of exports (charts 12 and 13). Based on these observations, we could say that Japan’s economic recovery and stable economic growth generally have a positive impact on the rest of Asia. BIS central bankers’ speeches IV. Concluding remarks The Bank has been conducting aggressive monetary easing since early April 2013, to overcome long-standing mild deflation and reinvigorate the economy. For its part, the government has implemented expansionary economic policy and unveiled economic growth strategies. I believe that Japan can contribute to development in Asia through its financial and trade activities as an Asian country. Moreover, Japan’s experience at the forefront of rapid population aging has the potential to contribute to the region as well, since some other economies will soon face similar aging issues. To this end, the Bank will do its utmost to revitalize Japan’s economy and achieve sustainable economic growth. The Bank will do its best to achieve the 2 percent price stability target. Your understanding of the Bank’s monetary policy is therefore greatly appreciated. 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
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Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Fukushima, 22 July 2013.
Takehiro Sato: Recent economic and financial developments, and monetary policy Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Fukushima, 22 July 2013. * I. * * Introduction It has been two years and four months since the Great East Japan Earthquake took place. First of all, I would like to offer my greatest appreciation and respect to everyone who has continued to work devotedly to achieve restoration and reconstruction since the earthquake disaster. I would also like to take this opportunity to express my sincere gratitude for your cooperation with the activities of the Bank of Japan’s Fukushima Branch. Today, I will begin by focusing on the Bank’s monetary policy and economic activity and prices in Japan and abroad. I will then touch briefly on the economy of Fukushima Prefecture in my closing remarks. Following my speech, I would like to hear your views on actual conditions in the local economy, including the progress in reconstruction, as well as on the Bank’s conduct of monetary policy. II. Recent conduct of monetary policy A. Quantitative and qualitative monetary easing and market reactions At the Monetary Policy Meeting (MPM) held on April 3 and 4, 2013, the Bank introduced quantitative and qualitative monetary easing (QQE). This policy aims to achieve the “price stability target” of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years. To achieve this, the Bank decided on new monetary easing measures. Specifically, the monetary base and the amounts outstanding of Japanese government bonds (JGBs) as well as exchangetraded funds (ETFs) will be doubled in two years, and the average remaining maturity of JGB purchases will be more than doubled (Chart 1). Since these policy measures exceeded market expectations, the initial reaction of the foreign exchange and stock markets was positive. Thereafter, in the JGB market, long-term interest rates rose with some volatility and these developments drew public attention (Charts 2 and 3). From late May, there was an increase in investors’ risk aversion worldwide reflecting speculation that the Federal Reserve would reduce the pace of its asset purchases earlier than expected, and the foreign exchange and stock markets were affected by these developments. Investors’ risk aversion was observed especially in emerging markets, but the Japanese stock and foreign exchange markets, which are considered to be sensitive to global economic fluctuations, were also affected to some degree. On the contrary, long-term interest rates in Japan were generally stable despite the rise in U.S. long-term interest rates. Summarizing these developments in financial markets, we can point to the following. In general, the central bank needs to communicate carefully to financial markets in the early stages of a policy change or in the course of discussion leading up to a change. This is because the message delivered by policymakers tends to be misinterpreted and financial markets tend to overreact in the early stages. Typical examples are (1) the case of the Bank’s policy change at the MPM on April 3 and 4; and (2) the case of Federal Reserve Chairman Ben Bernanke’s testimony to the U.S. Congress on May 22, 2013 and his press conference after the Federal Open Market Committee (FOMC) meeting on June 19. In the former case, some market participants misunderstood that the Bank of Japan had given up its commitment to the stability of short-term interest rates. In the latter case, market reaction BIS central bankers’ speeches was fairly large due to the reversal of movement until mid-May, when risk-taking activities in asset markets were active, mainly in emerging markets, due partly to speculation that the Federal Reserve would maintain the current pace of its asset purchases. This type of initial market reaction generally becomes contained as the policy intention of the central bank permeates financial markets through close communication between the central bank and financial markets based on economic indicators. As financial markets gain better understanding of the central bank’s policy intention and find a new equilibrium point, market volatility is usually contained even at the time of a policy change. Currently, the Japanese financial markets are becoming stable on the whole as they gain further understanding of the Bank’s policy intention regarding the April decision. The reaction by the U.S. financial markets is expected to moderate as they find a new equilibrium point as a result of the Federal Reserve’s intensive communication with them based on economic indicators. B. Stable bond market in Japan compared with that in the United States When Japanese long-term interest rates rose with volatility after the policy change in April, some regarded the new policy as a failure. But it is not appropriate to judge the validity of the policy merely from the initial reaction of the rise in interest rates immediately after the introduction of QQE. The market reaction after the policy change reflects the phenomenon of “buying on rumor and selling on fact,” which is observed frequently in financial markets. Market developments since end-2012 show that there has been a positive correlation between the JGB and stock markets – long-term interest rates rose when stock prices surged and long-term interest rates plunged when stock prices dropped. It can be added that Japanese long-term interest rates have been substantially contained despite the rising stock prices and fluctuations in foreign exchange rates since end-2012, given the effects of the increase in the Bank’s purchases of JGBs. Moreover, the recent stability in the JGB market compares favorably with the large fluctuations in the U.S. bond market since the end of May (Chart 2). C. Corporate and household sectors anticipate economic developments and prices As market participants anticipate a recovery in economic activity and prices, firms and households also anticipate a recovery and change their investment and consumption activities accordingly. In this sense, it would be unfair to disregard such changes in firms’ and households’ activities when assessing the effects on the economy of the rise in nominal interest rates. In fact, firms’ funding activities in the corporate bond market after the introduction of QQE were more active than usual on the whole, although some firms avoided issuing new bonds due to the high volatility in the JGB market. To put it another way, it was confirmed that investor demand was steady (Chart 4). In short, as market participants anticipate developments in economic activity and prices, firms also anticipate changes in funding conditions as well as demand in the bond market to seek investment opportunities, and investors anticipate the asset management environment in their investment decisions. Households also anticipate conditions following the economy’s overcoming of deflation; this is evidenced by the increase in the proportion of fixed-rate mortgages compared to the previously dominant floating-rate mortgages. These dynamics show that the economy and financial markets are currently seeking a new equilibrium point. Only three months have elapsed since the Bank introduced QQE. The Bank’s previous monetary policy was sometimes questioned by other countries, which later revised their judgments after experiencing a situation similar to that faced by Japan after the bubble economy burst in the 1990s. It might therefore be premature to assess the effectiveness of QQE solely from the money market reaction since early April. What is important is whether BIS central bankers’ speeches the underlying trend in Japan’s economic activity and prices is heading toward a recovery from a somewhat longer-term perspective after the introduction of QQE. As I will mention later, I am more optimistic about the outlook for Japan’s economy than in fiscal 2012, when the Bank revised downward its outlook for economic activity and prices several times because of the European debt problem and deceleration of the Chinese economy. D. Toward a stable JGB market It should be noted that QQE has contradictory, two-sided policy effects on the JGB market. Massive bond purchases by the Bank lower the risk premiums in the JGB market, and this contains nominal interest rates; at the same time, once the policy effect materializes, the market’s anticipation of a recovery in economic activity and prices exerts upward pressure on nominal interest rates. After the introduction of QQE, interest rates fluctuated due to these two contradictory factors, and the volatility in the JGB market rose as a result. Such high volatility, if it is prolonged, tends to prompt market participants to sell bonds for the purpose of risk management, and heavy bond sales could cause an unnecessary rise in interest rates. Given the heightened volatility in the JGB market, at the May MPM the Policy Board members discussed measures to stabilize long-term interest rates, and confirmed that for JGB purchases it was important for the Bank to conduct operations flexibly. At the end of May, the Bank clearly showed that it would conduct operations flexibly, for example by adjusting as necessary the parameters of its JGB purchases, such as frequency and allocation of purchase amounts by maturity (Chart 5). Subsequently, at the June MPM, the Policy Board members discussed the possibility of introducing funds-supplying operations against pooled collateral with a loan duration of more than one year. Based on the discussion at the MPM, the Policy Board members concluded that it was not necessary at that time for the Bank to extend the maximum duration of loans provided through its funds-supplying operations against pooled collateral, because (1) the effect of compressing risk premiums driven by the Bank’s massive JGB purchases was likely to strengthen steadily, and (2) flexible conduct of market operations was sufficiently ensured under the current guideline for the operations to contain the volatility. In other words, the current policy guideline allows a range of “about six to eight years” for the average remaining maturity of the Bank’s JGB purchases. By utilizing this guideline, it would be possible to stabilize the entire yield curve by purchasing JGBs with a maturity of one to five years more intensively. As the policy guideline allows a range of “about six to eight years,” I see no need for concern even if the actual remaining maturity of JGB purchases temporarily falls short of six years. Let me add that the Policy Board members judged that it was not necessary to introduce the funds-supplying operations against pooled collateral with a loan duration of more than one year, taking into account the following points. First, the introduction of such operations could cause misunderstanding that the Bank is encouraging financial institutions to hold JGBs even though the Bank has already introduced new measures to encourage portfolio rebalancing by financial institutions and investors. Second, since such operations contain a message regarding policy duration, the introduction of such operations could confuse market participants about the relationship between this message and the policy duration under the QQE framework – namely, to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. And third, the fund-provisioning measure to stimulate bank lending (the Stimulating Bank Lending Facility), whose first loan disbursement was made on June 20, 2013 and whose original aim was to encourage portfolio rebalancing by banks, works to reduce banks’ duration risk for a maximum of three years on their liability. The facility is in this sense substitutable to some extent with the fundssupplying operations against pooled collateral with a loan duration of more than one year, and thus it was necessary to reconsider the relationship between these two measures. The Bank, however, does not completely exclude the possibility of introducing these operations, since they could be an effective tool for stabilizing the market. BIS central bankers’ speeches E. Policy change from comprehensive monetary easing to QQE The Bank had pursued comprehensive monetary easing through March 2013, and in April it carried out a policy change and introduced QQE soon after the new Governor and Deputy Governors took office. Questions have been voiced regarding the Policy Board members who voted unanimously to approve the policy change in April, even though comprehensive monetary easing had been promoted through March. My understanding is that like the decision made at the MPM held on April 3 and 4, 2013, it was a major decision to introduce the 2 percent price stability target at the January MPM (Chart 6). While details of the discussions at the February and March MPMs held in the period after the price stability target was introduced but before the new Governor and Deputy Governors took office are referred to in the minutes, the topic of discussion shifted to specific measures to strengthen monetary easing with the aim of achieving the price stability target of 2 percent. In the discussions, issues were raised regarding purchases of JGBs with longer remaining maturities, and consolidation of purchases of JGBs under the Asset Purchase Program with those conducted in terms of money market operations (Chart 7). Although the set of decisions made at the MPM held on April 3 and 4 is called a new phase of monetary easing, some of the ideas largely reflect quantitative easing and comprehensive monetary easing, adopted from March 2001 to July 2006 and from October 2010 to March 2013, respectively. For example, the setting of the main operating target for money market operations to the monetary base instead of the uncollateralized overnight call rate is similar to the framework of quantitative easing – in which the main operating target was the Bank’s current account balances – on the premise that the outstanding balance of banknotes issued does not fluctuate significantly. Moreover, most of the financial assets currently being purchased are the same as those purchased during the period of comprehensive monetary easing – such as JGBs, ETFs, and Japan real estate investment trusts (J-REITs) (Chart 8). The extension of the average remaining maturity of the Bank’s JGB purchases to around seven years has consequently increased the scale of monetary easing. However, during the last phase of comprehensive monetary easing, the Bank had set the amount outstanding of the Asset Purchase Program at around 111 trillion yen by end-2014. In terms of the monetary base, this would be equivalent to around 200 trillion yen (although a range should be allowed for this number). The amount is less than the targeted amount outstanding under QQE, which is 270 trillion yen at end-2014, but one can argue that the Bank had already committed to considerably increasing the size of the monetary base. In this sense, the Bank’s policies over the years should be understood as being consistent. F. What it means to avoid an incremental approach Since late May 2013, expectations for further monetary easing had increased in the market, in a situation where instability had been observed in financial markets at home and abroad. However, QQE differs completely from the Bank’s other monetary easing policies adopted in the past in the sense that (1) the Bank had adopted the stance of pursuing bold monetary easing all at once to achieve the price stability target of 2 percent in about two years and to avoid an incremental approach; and (2) by doing so, the Bank aims to exert influence on the expectations of firms and households as well as financial markets. The former policy stance of avoiding an incremental approach is based on the lessons learned from the fact that Japan’s economy could not overcome deflation, even though the Bank had continued to fine-tune its policies under the framework of comprehensive monetary easing in accordance with the economic cycle. Therefore, this policy stance should be regarded as a serious one. The latter policy stance of aiming to exert influence on the expectations of firms and households as well as financial markets is associated with the former policy stance. The Bank aims to drastically change such expectations by implementing all possible measures called for at the time. To do so, it is important to first implement bold monetary easing measures that go beyond market expectations and then BIS central bankers’ speeches carefully monitor their effects, rather than adopting measures in a piecemeal manner, which would have adverse effects. At the same time, the Bank does not exclude the implementation of additional measures and will not hesitate to fine-tune its policies flexibly when unexpected tail risks materialize. The policy stance of the Bank that I have just described is not necessarily fully understood yet by market participants. Therefore, the Bank should provide a thorough explanation to the public of its policy stance through various communication channels, including dialogue with market participants. G. The meaning of the 2 percent price stability target I will now discuss my understanding of the price stability target of 2 percent. Generally, inflation-targeting policy is a flexible monetary policy framework and countries adopting it do not change their monetary policy stances mechanically in accordance with the achievement or undershooting of their targets. This understanding is widely shared by central banks that have adopted such a policy framework. I understand that the Bank’s monetary policy framework – in which the Bank sets the 2 percent price stability target – is a flexible one, in the sense that it focuses mainly on maintaining the 2 percent target in a stable manner rather than merely on achieving the target exactly (Chart 9). In terms of maintaining the target in a stable manner, it is almost impossible to stably maintain the inflation rate specifically at 2 percent, given the time lag required for the permeation of monetary policy effects and the uncertainty of such permeation. Rather, it is natural to think that there is an allowance of a certain range for upward and downward deviations of the actual inflation rate from the target. Of course, the degree of acceptable allowance varies depending on the view of each Policy Board member, but I think that if the inflation rate is projected to stabilize within a certain range with a median of 2 percent, then the main objective of QQE will have been fulfilled. Taking into account the trend of the inflation rate in Japan, unless inflation expectations rise soon, the possibility of achieving the price stability target of exactly 2 percent with a time horizon of about two years is not necessarily high. However, if we take the price stability target as a flexible framework with a certain range of allowance for inflation deviations, then the 2 percent target is reasonable and achievable. I would like to emphasize that the Bank’s aim under QQE is “achieving price stability, thereby contributing to the sound development of the national economy,” as stipulated in the Bank of Japan Act. Specifically, the economic situation the Bank aims to bring about is not one in which prices simply rise. Rather, it is one where a virtuous circle operates in which fixed investment and private consumption grow and corporate profits increase in line with the improvement in the economic situation as a whole, and prices rise in a balanced manner in line with the improvement in the employment and income situation. The sound development of the national economy must not be put at risk in achieving 2 percent inflation merely in a superficial sense. H. How to achieve the 2 percent inflation target To achieve the 2 percent price stability target, the Bank assumes three channels, as follows. First, the Bank’s purchases of financial assets will encourage a further downward pressure on interest rates across the yield curve and lower risk premiums of asset prices. Second, there will be a portfolio rebalancing effect. And third, the Bank’s commitment to achieving the price stability target and the continuation of massive asset purchases are expected to fundamentally change the inflation expectations of firms and households as well as financial markets. I will now discuss each of these three channels in turn. Regarding the first channel, as I mentioned earlier, risk premiums of asset prices have already been relatively contained due to the Bank’s purchases of JGBs, ETFs, and J-REITs. BIS central bankers’ speeches In this regard, some market participants have mistakenly assumed that the Bank’s commitment to stabilizing short-term interest rates weakened because the Bank changed its main operating target from the uncollateralized overnight call rate to the monetary base. However, the Bank’s commitment to maintaining short-term interest rates at a low level by generating a massive amount of financial institutions’ excess reserves has not changed at all. Purchases of medium- to long-term JGBs amounting to about 50 trillion yen at an annual pace alone are not sufficient to meet the policy guideline of increasing the monetary base at an annual pace of about 60-70 trillion yen. Therefore, it is implied that to fill the gap the Bank will purchase a certain amount of treasury discount bills (T-Bills) and/or conduct short-term funds-supplying operations. The scale of T-Bill purchases is not mentioned in the guideline for money market operations, because the Policy Board members consider that, given the experience of comprehensive monetary easing, the provision of short-term funds should be left to the discretion of the Bank’s staff, so that it can respond flexibly to potential fluctuations in short-term interest rates. When the Bank announced immediately after the MPM held on April 3 and 4 that it would introduce QQE and aim to achieve the price stability target of around 2 percent in about two years, market participants anticipated that short-term interest rates two years ahead might not be around 0 percent, and this affected medium- to long-term interest rates. Such a phenomenon may be observed again. On this issue, I expect that the effects of the automatic adjustment function of QQE will emerge and financial markets will be able to cope with price developments on their own. To elaborate on this, once the probability of achieving the 2 percent price stability target rises, this will inevitably be incorporated in medium- to longterm interest rates to some extent; on the other hand, if the probability of achieving the target remains low, such interest rates will continue to be contained. The important point is that the Bank should contain the level of medium- to long-term interest rates at a level below that consistent with market participants’ outlook for economic activity and prices by proceeding with JGB purchases and lowering risk premiums. So far, massive JGB purchases by the Bank have contained various factors that have exerted upward pressure on interest rates, and the effect of reducing risk premiums is expected to strengthen cumulatively as the amount of purchases increases (Chart 10). As for the second channel, the portfolio rebalancing effect is aimed at stimulating economic activity and asset markets. The Bank generates large amounts of financial institutions’ excess reserves through its massive purchases of JGBs from them and induces them to rebalance their portfolios from JGBs to risk assets with higher expected returns. The Bank decided to extend the average remaining maturity of JGB purchases at the MPM held on April 3 and 4 so that the portfolio rebalancing effect can strengthen. The portfolio rebalancing effect works as follows. The Bank’s asset purchases do not change the size of private financial institutions’ balance sheets, but the composition of their balance sheets changes on the asset side. In other words, private financial institutions’ holdings of JGBs and other assets decrease, and their current account balances at the Bank increase accordingly. From the viewpoint of private financial institutions’ asset management, the profitability of their portfolios as a whole decreases since their assets under management decline and their current account balances at the Bank increase. Private financial institutions are then expected to shift their portfolios to assets with higher expected returns such as risk assets and to increase lending to secure profits (Chart 11).1 It should be noted that when private financial institutions shift their assets to those with higher expected returns, their current account balances held at the Bank do not decrease accordingly, as some mistakenly assume. In fact, overall current account balances held at the Bank are not affected by transactions among individual private financial institutions. For example, when a private financial institution purchases stocks from a counterparty and reduces its own current account balance at the Bank, the current account balance of the counterparty that sells the stocks increases accordingly; thus, there is no change in the current account balances at the Bank as a whole. BIS central bankers’ speeches In this way, the Bank aims to generate massive excess reserves of financial institutions to encourage a change in the investment behavior of banks, life insurance companies, and pension funds. It is no simple matter to discuss whether portfolio rebalancing will spread among all investors, as there are also individual regulatory and accounting factors at work. In addition, such changes would not occur immediately. Nevertheless, I look forward to the progress in rebalancing despite the institutional constraints. Finally, for the third channel, inflation expectations are generally formed with an element of adaptive expectations (that is, expectations are formed by adjusting them based on previous data) and inflation expectations of firms and households as well as financial markets are likely to be low in a situation of persistent low inflation or deflation, as in Japan. However, the year-on-year rate of change in the CPI (all items less fresh food) in Japan is currently 0 percent due to (1) cost-push factors such as rises in fuel prices due to the recent weakening of the yen and in electricity charges, as well as (2) a halt in the decline in prices of TVs and IT-related goods such as personal computers. In this situation, the year-on-year rate of change in the CPI (all items less fresh food) is expected to turn positive this summer from the current level of around 0 percent. If actual inflation remains in positive territory, inflation expectations of firms and households as well as financial markets might shift upward accordingly. Some reports – such as the Consumer Confidence Survey released by the Cabinet Office, the Opinion Survey on the General Public’s Views and Behavior released by the Bank, and surveys conducted on economists and market participants – already suggest a rise in inflation expectations, although it is hard to gauge the extent to which this is caused by the scheduled consumption tax rate hikes. The Bank expects a mechanism of a feedback loop between inflation expectations and the actual inflation rate – in which a rise in inflation expectations causes a rise in actual inflation and vice versa – to operate and medium-term inflation expectations to rise accordingly. I. Wages and prices In considering channels more in line with economic activity, a wage increase – as well as the narrowing of the output gap – is indispensable for achieving the 2 percent price stability target (Chart 12). At a meeting with business leaders in Gunma Prefecture on February 6, 2013, I stated that a significant wage increase of approximately 4 percent was consistent with achieving 2 percent inflation. However, considering the slowdown in the pace of increase in labor productivity in recent years, I came to realize that the wage increase needed might be lower – approximately 2 percent. The reason is that a wage increase consistent with achieving a certain inflation rate is higher when the pace of increase in labor productivity is high, and lower when the pace is low (Chart 13). As for the supply and demand conditions in the labor market consistent with achieving a wage increase of 2 percent, judging from the wage Phillips curve – with the unemployment rate on the x-axis and the rate of wage inflation on the y-axis – which excludes a rise in inflation expectations, the unemployment rate would be roughly 3.0 percent to 3.5 percent. As the most recent unemployment rate is 4.1 percent, achieving the range of approximately 3.0 percent to 3.5 percent is not impossible. It is still uncertain whether such a situation close to full employment can be reached within about two years – the period in which the Bank aims to achieve the price stability target under QQE. Developments in employment and wages tend to lag behind economic growth, and therefore, once the economy returns to a moderate recovery path, a considerable time lag is expected for its effects to spread to wages. Nevertheless, as I mentioned, an inflationtargeting policy is generally a flexible monetary policy framework. As mentioned, what I think is important is not mechanically achieving the inflation rate specifically of 2 percent in two years, but creating a situation in which 2 percent inflation is in sight in about two years, as a result of the tightening of supply and demand conditions in the labor market. BIS central bankers’ speeches J. Creating a more favorable environment for firms to increase their base salary As the importance of a wage increase in overcoming deflation has become widely recognized, the government has taken the unprecedented action of appealing to the business community, urging its members to raise wages. In fact, increases in bonus payments have already been observed in particular industries and firms, and some nonmanufacturing firms are giving indications of raising their base salary, as their employment situation has tightened reflecting a drive to obtain new personnel. However, many firms remain hesitant to increase their base salary due to concerns about a rise in fixed costs. For the nonmanufacturing firms just mentioned, the increase in base salary has been limited to full-time employees and a majority of the workers who are part-timers have not yet received such benefits. The issue of widespread achievement of such an increase in base salary is deeply connected to the issue of ensuring flexibility in the employment systems and practices, and thus it might not be easy to form a consensus on these matters. Nevertheless, Japan’s economy has recently increased its robustness, and therefore economic developments are expected to support such structural reforms in the labor market. I will now discuss Japan’s economy. III. Economic activity and prices in Japan and abroad A. The current state of and outlook for Japan’s economy Even after the Lehman shock, Japan’s economy faced a series of headwinds such as the Great East Japan Earthquake and the flooding in Thailand in 2011, as well as the deceleration of the Chinese economy from 2012. However, it has overcome such shocks and a path toward a self-sustained recovery is finally in view. A high degree of uncertainty remains concerning the global economy, and I see risks to the economic outlook as somewhat tilted to the downside. However, the external environment as a whole is expected to exert positive effects on Japan’s economy unless a tail risk affecting the global economy emerges. Therefore, I believe that the present offers a window of opportunity for Japan’s economy to overcome deflation (Chart 14). Exports had lagged behind domestic demand, which has started to increase its resilience, but have been picking up led by exports of automobiles to the United States. Production of manufacturing firms followed a moderate increasing trend in the April-June quarter of 2013, and is expected to continue to do so in the July-September quarter judging from interviews with firms (Chart 15). Although the deceleration of the Chinese economy – which I will discuss later – is a major concern, it is not a serious obstacle to the recovery of Japan’s economy as long as the robustness of the U.S. economy is maintained. Private consumption for the January-March quarter of 2013 seemed to be supported by an improvement in sentiment and wealth effects. Private consumption is expected to continue increasing, as household sentiment has remained firm on the whole even amid the recent turmoil in financial markets, and as the employment and income situation improves moderately (Chart 16). According to anecdotal information, negative effects on consumption of high-end goods and services have not been observed to a large degree despite the recent turmoil in financial markets. The contribution of public investment to the economy is expected to increase again from the July-September quarter, supported by the effects of various economic measures (Chart 17). In these circumstances, coincident indicators of machinery investment – such as shipments of capital goods and the aggregate supply of capital goods – suggest that business fixed investment, which had been sluggish, is finally showing some signs of picking up from the April-June quarter. Investment for energy-saving and disaster prevention as well as pent-up demand for maintenance and replacement of business equipment seem to be emerging (Chart 18). Business fixed investment is expected to BIS central bankers’ speeches increase moderately as shown by firms’ business fixed investment plans in the June 2013 Tankan (Short-Term Economic Survey on Enterprises in Japan). Although there are disparities among demand components, they have shown some positive developments, and in this situation Japan’s economy has become increasingly robust – albeit gradually. In these circumstances, the employment and income situation, which had lagged behind other demand components, is expected to improve gradually. B. Outlook for and risks facing the global economy The prerequisite for Japan’s economy to return to a self-sustained growth path is that overseas economies move out of the deceleration phase that has continued since 2012 and return to a moderate recovery path. On this point, the resilience in the U.S. economy even under the fiscal drag is a positive factor, but it is a matter of concern that the Chinese and other emerging economies have not yet shown clear signs of acceleration in growth. The World Economic Outlook, updated in July by the International Monetary Fund (IMF), shows that the growth rates of these economies will increase gradually from 2013 to 2014, but these economic projections were revised downward from the April update (Chart 19). However, the U.S. economy – which is increasing its robustness – is expected to firmly propel the global economy even in a situation where emerging economies are losing their role as the driving force in the global economy. Therefore, on the whole, there is almost no considerable change in the outlook that the global economy will return to a moderate recovery path. The U.S. economy experienced a soft patch during the April-June quarter of 2013 due to the effects of fiscal austerity measures. From the July-September quarter, as the effects dissipate to some extent, the U.S. economy is likely to exhibit relatively high growth on the back of firm consumer sentiment and a pick-up in the housing market (Charts 20 and 21). The fact that the debt ceiling problem has been delayed until autumn 2013 at the earliest due to higher-than-expected federal government revenues is judged to be one of the factors reducing the immediate tail risk. The European economy still lags behind, but the situation does not call for a further downward revision to the economic outlook. This is because (1) European countries are shifting away from and softening fiscal austerity measures; (2) exports from Europe are improving to some extent; and (3) business and household sentiment is starting to show some signs of improvement (Charts 22 and 23). As for emerging economies, on the other hand, an issue of concern is that the pace of capital flows into these economies has been decelerating and an outflow of funds from these economies has been observed, amid a shift toward low-risk investments in global financial markets caused by emerging speculation about an earlier-than-expected reduction by the Federal Reserve in the pace of its asset purchases. Behind the speculation lies the fact that the U.S. economy has continued to recover steadily, and this itself is a positive factor for the global economy, including emerging economies. Nevertheless, I am paying careful attention to whether the speculation causes an abrupt change in capital flows, leading to a downturn in some emerging economies, or causes difficulty in funding conditions (Chart 24). Furthermore, in China, it has been clearly observed that the government is placing a high priority on coping with structural problems, such as population-related issues and the excess capacity problem, rather than on pursuing strong economic growth. Thus, we should not expect the growth rate to recover noticeably for the time being (Chart 25). The labor market is firm even though the annualized GDP growth rate is less than 8 percent, and this suggests that the potential growth rate in China is decreasing. Therefore, the Chinese authorities are concerned about inflation, even in a situation where the economic growth rate has not increased (Chart 26). In June 2013, short-term interest rates surged temporarily, but this reflects the fact that the Chinese authorities had clearly shown an intention of encouraging financial institutions to strengthen their liquidity risk management in view of rapid credit expansion, in addition to the tightening of the supply-demand conditions for funds toward the BIS central bankers’ speeches end of the first half of the fiscal year (Chart 27). This stance of the Chinese authorities will strengthen the quality of economic growth, contributing to stability in the global economy in the medium to long term. Taking into consideration the developments I have just mentioned, the global economy is expected to return to a moderate recovery path, supported by accommodative financial conditions, amid the weakening downward pressure from the fiscal side in countries such as the United States. We can point to the following factors as signaling a return of the global economy to such a recovery path: (1) steady household sentiment worldwide; (2) a globally favorable shipment-inventory balance in manufacturing; and (3) adjustment in the stance of fiscal austerity in Europe. By region, I am focusing especially on the U.S. economy, which is supported by the recovery in housing investment, as the driving force of the global economy. As for accommodative financial conditions, they are mainly attributable to an improvement in the funding conditions of financial institutions. The tail risk that the European debt problem will lead to global financial market turmoil and a significant global economic downturn has decreased on the whole, although considerable uncertainty remains. The recent stability in prices of primary commodities is another positive factor (Chart 28). The two main risk factors to the outlook for the global economy that warrant attention are as mentioned earlier, the effects of the reduction in the pace of asset purchases by the Federal Reserve on global financial markets, especially on emerging economies’ markets; and (2) the global disinflationary trend. The effects on global financial markets are expected to dissipate moderately with the expansion of global economic growth, and as the Federal Reserve's policy intention gradually permeates the markets. On the other hand, I am paying attention to the global disinflationary trend – particularly whether the recent decline in the inflation rate in the United States is temporary as assumed by the Federal Reserve. IV Concluding remarks Lastly, I would like to touch on economic activity in Fukushima Prefecture. Economic activity in the prefecture has been picking up reflecting factors such as an improvement in overseas demand and growth in demand related to post-disaster restoration and reconstruction. Public investment has continued to increase significantly at a pace far exceeding that of Japan as a whole, mainly due to decontamination work and construction orders related to restoration following the earthquake disaster. Housing investment has also been increasing significantly, supported in part by reconstruction of homes and demand from evacuees to transfer their residence (Chart 29). The situation for tourism remains severe, but there are signs of gradual improvement mainly in the area around Aizu, due to a historical TV drama series featuring the region. The Tohoku Rokkon Festival held in Fukushima Prefecture in early June was also very successful. As for the outlook, economic activity in the prefecture is expected to gradually show clear signs of picking up due partly to signs of an increase in production, in a situation where demand related to post-disaster restoration and reconstruction is expected to remain strong. It should be noted, however, that the effects of the earthquake disaster – and especially of the nuclear power plant accident – remain and a number of issues must be overcome to achieve economic reconstruction in the prefecture. According to statistics released by the prefectural government, about 150,000 residents are still displaced. Harmful rumors persist, and their effects continue to spread to industries such as food, agriculture, and tourism. Production activities are recovering, but the level of industrial production since the earthquake disaster has consistently been about 10 percentage points below the national average (Chart 30). There are challenges for the employment situation as well, such as the mismatch between supply and demand in the labor market and the employment situation for disaster victims. BIS central bankers’ speeches To overcome these challenges, it is important above all to proceed as promptly as possible with environmental restoration and rebuilding of the daily lives of evacuees in a broad sense, by achieving progress in decontamination work and restructuring in the evacuation zones, among others. From the viewpoint of ensuring economic reconstruction in the prefecture, it is particularly important to foster growing firms and vibrant industries that generate employment opportunities. Worthy of note in this regard are the efforts to foster new growth areas from a medium-term perspective contained in the Plan for Revitalization in Fukushima Prefecture, released by the Fukushima prefectural government. Directions for revitalization described in the plan include (1) the medical industry cluster project, such as investment in a new drug research center, as well as (2) the renewable energy promotion project, for example, expansion of renewable energy and clustering and fostering of renewable energy-related industries. Also called for are the rebuilding and revitalization of the agriculture, forestry, fisheries, and tourism industries. Fukushima Prefecture has long enjoyed a high degree of regional attractiveness and other advantages that support growth. These include (1) geographical proximity to the Tokyo metropolitan area, a very large market; (2) a strong manufacturing sector, as shown by the fact that the prefecture posts the largest value of shipments of manufactured goods in the Tohoku region; and (3) a range of tourist resources such as rich natural surroundings and hot spring resorts as well as local agricultural products. If the efforts described in the Plan for Revitalization in Fukushima Prefecture draw fully on the region’s attractions and advantages, the prefectural economy can be restored even more strongly and more rapidly. It is therefore deeply hoped that the range of cooperative efforts among industry, government, and academia progress steadily and support the economy’s reconstruction and further development. 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bank of japan
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 29 July 2013.
Haruhiko Kuroda: Japan’s economy and monetary policy – toward overcoming deflation Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 29 July 2013. * * * Introduction It is a great honor to have this opportunity to address you today at the Naigai Josei Chousa Kai. The Bank of Japan introduced a new regime of monetary easing called “quantitative and qualitative monetary easing” (QQE) this April with a view to achieving the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years. It has been three months since the introduction of the QQE, and there have been favorable developments spreading to financial markets and the real economy, and the public’s expectations for economic activity and prices are improving. At the same time, we have received various questions regarding the policy effect of the QQE. Today, I will first summarize developments in Japan’s economy and financial markets for the past three months, explain the outlook for economic activity and prices, and then provide my answers to questions regarding the QQE. I. Progress of the QQE and three positive developments A. Progress of the QQE Under the QQE, introduced in April, the Bank will increase the total amount of money it directly supplies to the economy – the monetary base – at an annual pace of about 60–70 trillion yen. As a result, the monetary base will be doubled in two years, increasing from 138 trillion yen at end-2012 to 200 trillion yen at end-2013 and to 270 trillion yen at end2014 (Chart 1). As a means to increase the monetary base, the Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at a pace of about 50 trillion yen annually. On a gross basis, this corresponds to purchasing a large amount of JGBs at a pace of over 7 trillion yen monthly. As a result of such purchases, the amount outstanding of JGBs held by the Bank will be more than doubled in two years, increasing from 89 trillion yen at end-2012 to 140 trillion yen at end-2013 and to 190 trillion yen at end2014. In addition, the Bank decided to more than double its average remaining maturity of JGB purchases from slightly less than three years to about seven years. This monetary easing measure has both a quantitative aspect – such as increasing the monetary base and the amount outstanding of the Bank’s JGB holdings – and a qualitative aspect – such as extending the average remaining maturity of the Bank’s JGB purchases. Hence the name “quantitative and qualitative monetary easing.” Over the past three months, the Bank has pursued the QQE as initially planned (Chart 2). The monetary base has expanded from 146 trillion yen at end-March to 173 trillion yen at end-June, at a somewhat front-loaded pace toward 200 trillion yen by end-2013. The amount outstanding of JGBs held by the Bank has also increased to more than 110 trillion yen recently from 91 trillion yen at end-March, at a steady pace toward 140 trillion yen by end2013. Also, the average remaining maturity of the JGBs purchased has extended to about seven years. Next, I would like to examine the changes that have been observed in financial markets and economic activity as the Bank has pursued the QQE. Starting with the conclusion, a favorable turn has been observed in financial conditions, in expectations, and in economic BIS central bankers’ speeches activity and prices (Chart 3). These changes include positive developments that had already begun to operate before the introduction of the QQE, on the back of expectations for monetary easing, and some also reflect expectations for the government’s so-called “three arrow” strategy as well as developments in the global economy. Therefore, not all of these favorable developments are attributable to the QQE; nevertheless, it most certainly is an important factor. B. Favorable turn in financial conditions Let me explain the three positive turnarounds, respectively. First, a favorable turn in financial conditions – in other words, financial markets and corporate finance are improving. First, stock prices are rising (Chart 4). To be specific, these rose from around 9,000 yen in autumn 2012 to the 15,000–16,000 yen level in mid-May on the back of heightened expectations for economic improvement and of the depreciation of the yen. While there have been declining phases in order to adjust to a rapid rise, stock prices have shown some resilience, recovering to around 14,000 yen once again. The rate of increase since the beginning of 2013 has marked around 35 percent, far higher than those registered in the United States (just under 20 percent) and Europe (over 6 percent). As I have consistently said, even during the period when stock prices fell temporarily, Japan’s economy is steadily improving, and financial markets – including stock prices – will reflect such fundamental movements in the real economy. Next is the developments in long-term interest rates (Chart 5). As the new policy framework has outdone prior market expectations both in terms of quantity and quality, it has taken time for market participants to digest the content and its effects, and this led to increased uncertainty in the JGB market. Such developments came to a pause toward end-April, but long-term interest rates in the United States rapidly rose from the beginning of May due to increased speculation that the Federal Reserve might taper the pace of its asset purchases, and the effects of this started to spread to Japan. Against this background, the Bank, while continuing with its massive JGB purchases, held an enhanced dialogue with market participants and conducted flexible market operations, such as making the maximum amount of those purchases per bidding smaller as well as increasing the frequency of purchases. Due mainly to such massive JGB purchases and flexible market operations, long-term interest rates in Japan have recently been almost flat, at around 0.8 percent, even in the midst of rising overseas rates. Meanwhile, in the foreign exchange market, the yen’s exchange rate against the U.S. dollar has been depreciating since autumn 2012, when it was around 80 yen to the dollar, and has recently been around 100 yen (Chart 6). Monetary easing aims at overcoming deflation and by no means intends to maneuver the exchange rate. Nonetheless, monetary easing will exert pressure toward depreciation ceteris paribus. Lastly, firms’ and households’ financial conditions have been accommodative. That is, with regard to funding conditions, the diffusion index (DI) for financial institutions’ lending attitudes as perceived by firms was on an improving trend in the Tankan survey (Short-Term Economic Survey of Enterprises in Japan), and issuing conditions for CP and corporate bonds have remained favorable on the whole. While the year-on-year rate of increase in bank lending had been at about 1 percent up to around last autumn, the pace of increase has gradually picked up since then and has been slightly above 2 percent most recently (Chart 7). The amount of corporate bonds issued in the April-June quarter registered the largest level since the Lehman shock. In terms of funding costs, bank lending rates, in terms of the average contracted interest rates to businesses and households, have continued to decline and remain at historically low levels. C. Favorable turn in expectations The second favorable turn is that in the public’s sentiment and expectations. BIS central bankers’ speeches First of all, consumer sentiment has been improving markedly (Chart 8). According to the Consumer Confidence Survey, which is a questionnaire survey on consumer perception conducted by the Cabinet Office, while there is discontinuity due to the change in the survey method, the DI has improved to a pre-Lehman shock level. By generation, sentiment improved not only among the elderly, who hold large amounts of stocks and are likely to benefit from stock price rises, but also for young people. It appears that expectations for improvement in economic activity and income have started to emerge across a wide range of generations. On top of this, business sentiment has also been improving (Chart 9). The DI for business conditions (all industries, all enterprises) in the June Tankan survey improved by 6 percentage points from the March survey to reach minus 2. It has now reached a level as high as that registered in the December 2007 survey. Moreover, the number of industries responding that business sentiment has improved has also increased, and now stands at 26 out of 31 industries. Lastly, the public’s inflation expectations are rising. Looking at various indicators related to businesses, the DI for output prices in the June survey improved irrespective of firm size and category (Chart 10). The forecast DI of large firms has now come close to zero. This has happened only twice in the last 30 years – once toward the end of the bubble period and the other just before the Lehman shock, when international commodity prices surged. As far as indicators related to households are concerned, according to the Opinion Survey on the General Public’s Views and Behavior, the share of respondents who expected that prices will go up one year from now exceeds 80 percent (Chart 11). A number of surveys collecting views among economists also indicate that the expected rate of inflation is rising. With regard to market indicators, break-even inflation – that is, the yield spread between fixed-rate coupon-bearing JGBs and inflation-indexed JGBs, and representative of the expected rate of inflation in the market – rose rapidly toward mid-May. While it has declined thereafter, breakeven inflation has clearly heightened compared with the beginning of the year (Chart 12). Based on these developments in the various indicators, it can well be judged that inflation expectations on the whole are picking up. D. Favorable turn in economic activity and prices The third favorable turn is in economic activity and prices reflecting the improvement in financial markets and the public’s sentiment. Private consumption remains resilient on the back of sharp improvement in household sentiment and the wealth effect from the stock market rally (Chart 13). As I mentioned earlier, in addition to spreading favorable expectations for the economic outlook, given that the cohort of the senior generation that holds a large amount of stocks tends to enjoy a higher propensity to consume – that is, they have an inclination to spend more money – than other generations, it is likely that a stronger wealth effect from the stock market rally is at work. Business fixed investment has stopped weakening as business sentiment and corporate profits have improved, and it is showing some signs of picking up (Chart 14). Indeed, in the June Tankan survey, the projections for fiscal 2013 show that firms intend to increase investment steadily on the back of improvement in sales and current profits. On the price front, while the year-on-year rate of change in the CPI (all items excluding fresh food) had been negative, it reached 0 percent in May and turned positive in June, at 0.4 percent, reflecting improvement in the economy and the yen’s depreciation (Chart 15). In sum, there have been favorable turns in financial conditions, in expectations, and in economic activity and prices. All these developments suggest that the aim of the QQE – to lead Japan’s economy toward overcoming the deflation that has lasted for nearly 15 years – is right on track so far. BIS central bankers’ speeches II. The outlook for economic activity and prices (an interim assessment of the outlook report) Next, I will move to the outlook for Japan’s economy. As for the baseline scenario, the economy is expected to recover moderately on the back of the resilience in domestic demand and the pick-up in overseas economies. While the economy is likely to be affected from next year onward by the front-loaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, it is likely to continue growing at a pace above its potential – which is considered to be around 0.5 percent – as a trend, as a virtuous cycle among production, income, and spending operates. In terms of the median of the Bank’s Policy Board members’ forecasts of the growth rates, this is 2.8 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.5 percent for fiscal 2015, averaging almost 2 percent (Chart 16). The year-on-year rate of change in the CPI, excluding the direct effects of the consumption tax hikes, is likely to follow a rising trend, mainly reflecting an improvement in the aggregate supply and demand balance as well a rise in the expected rate of inflation. In terms of the median of the Policy Board members’ forecasts of prices, the year-on-year rate of change in the CPI is expected to be 0.6 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.9 percent for fiscal 2015. It is highly likely to reach the price stability target of about 2 percent toward the latter half of the Bank’s projection period through fiscal 2015. Three key factors toward realizing the outlook For the above outlook to materialize, there are three key factors (Chart 17). First, the sustainability of firmness in domestic demand. It is important that the aforementioned current improvement in business and household sentiment lead to sustained spending in tandem with an increase in income. In the corporate sector, a virtuous cycle from income to spending appears to be gradually starting to operate. In terms of “income,” corporate profits have been improving, and in terms of “spending,” the June Tankan survey results revealed solid business fixed investment plans. Since the Lehman shock, firms have long restrained business fixed investment, and thus there seems to be large potential demand, mainly for maintenance and repair as well as replacement of existing equipment. As for the outlook, business fixed investment is likely to follow a moderate increasing trend, and we will confirm this with the actual data to be released. In the household sector, despite the absence of a marked increase in labor income, private consumption has been resilient, mainly due to an earlier improvement in consumer sentiment and wealth effects brought about by the rise in stock prices. Hereafter, it is important that the increase in private consumption and housing investment continue, backed by firmness on the “income” front, such as an improvement in employment and wages. In this regard, the supply and demand conditions in the labor market are improving moderately, with the ratio of job offers to applicants having risen to 0.90 – a level observed for the first time since June 2008 – and the unemployment rate heading toward a decline. In terms of wages, the year-on-year rate of decline in nominal wages per employee has slowed recently to minus 0.1 percent due to an improvement in the number of unscheduled hours worked and in bonus payments. It will be necessary to make sure that such improvements in employment and wages continue into the future, thereby supporting an increase in private consumption. Second, among factors that determine prices, I would like to point to developments in inflation expectations. The inflation rate is determined mainly by two factors. One is the aggregate supply and demand balance of the economy – the so-called output gap – and the other is medium- to long-term inflation expectations. In order to achieve the price stability target of 2 percent, both factors need to operate toward raising prices. As for the first factor – namely, the output gap – the intuitive view is that prices will rise if economic activity improves and the supply and demand balance tightens. In other words, as BIS central bankers’ speeches the level of economic activity increases, the capacity utilization rate would rise and the number of employees would increase, leading to a decline in the unemployment rate. The supply and demand balance would then tighten in the labor market and for products and services, thereby leading to a rise in wages and in prices of products and services. In the baseline scenario, which I mentioned earlier, the output gap will turn from negative to positive and gradually widen as the economy continues growing at a pace above its potential. In this way, upward pressure on prices will operate through developments in the output gap. What warrants more attention is the second factor that determines prices – that is, mediumto long-term inflation expectations. When firms and households make decisions on investment and consumption, they take actions based on their outlook for future inflation. For example, if a view spreads among the public that prices will rise in the future, firms would likely raise the prices of products and services accordingly, and wages would also be raised. Consequently, consumer prices would be pushed up. In this regard, inflation expectations have already begun to rise, and I expect the expected rate of inflation to gradually converge toward the global standard of 2 percent, due to the effects of the Bank’s strong commitment to meet the price stability target as well as the effects of its bold monetary easing. The third factor is developments in overseas economies. We consider a downturn in overseas economies to be the largest risk factor to the outlook for economic activity and prices I have outlined so far. The baseline scenario is that overseas economies are expected to pick up against the backdrop that the U.S. economy would stay firm and the European economy would start to bottom out. However, there are also risks that warrant attention in the European economy, emerging and commodity-exporting economies, and the U.S. economy, respectively. With regard to the European economy, although the tail risk of substantial financial market turmoil having a global impact has receded due to efforts made thus far by policymakers, the European debt problem is yet to be fundamentally resolved. The Bank is paying close attention to whether the prolonged fiscal austerity measures and a receding economy would lead to political turbulence or instability in financial markets. Next is developments in the Chinese economy. There is a view that is becoming widely held that the economy will not return to the level of high growth observed earlier, as policymakers are enforcing their stance of emphasizing “quality-based” rather than “speed-based” growth. It is also likely that the over-capacity issue mainly seen in manufacturing, such as materials, could restrain growth for the time being. As developments in the Chinese economy have substantial effects not only on Japan’s economy but also on commodity-exporting economies and other emerging economies, whether the Chinese economy will be able to make a soft landing to achieve economic growth at a cruising speed warrants vigilance. Lastly, we have the effects of the Federal Reserve’s tapering of its asset purchases. The discussion about such a move is based on the backdrop that the U.S. economy is recovering steadily, albeit moderately, which in itself has positive implications for the world economy as a whole, including emerging economies. Nevertheless, it is necessary to continue to pay close attention to developments in global financial markets, including capital flows to emerging economies. III. Q&A about the policy effects of the QQE I have so far described the Bank’s QQE, the state of Japan’s economy, and its outlook. Let me next respond to some of the questions regarding the policy effects of the QQE. A. Effects of putting downward pressure on long-term interest rates Effect of containing nominal interest rates First is the effects on long-term interest rates. Following the introduction of the QQE, as longterm interest rates rose compared with those immediately before the introduction, some questioned whether the policy transmission mechanism of putting powerful downward pressure on long-term interest rates was working effectively. BIS central bankers’ speeches Before examining this point, let me summarize factors that put upward and downward pressure on long-term interest rates. Long-term interest rates are formed based on expectations for future short-term interest rates and on risk premiums (Chart 18). For example, in the case of 10-year government bond yield, this will be the sum of the short-term interest rate path for the next ten years and various risk premiums associated with holding government bonds. Of those, given that expected short-term interest rates will be determined according to economic and inflation outlooks, if economic activity improves and expectations for future price increases spread, there will be upward pressure on long-term interest rates. Risk premiums will increase, reflecting such factors as a rise in interest rate volatility or in interest rates overseas, thereby putting upward pressure on long-term interest rates. In response, the Bank’s massive purchases of government bonds under the QQE will put a powerful squeeze on the risk premiums, thereby having the effect of putting downward pressure on long-term interest rates. Let us confirm whether this effect has actually materialized, based on two facts. First is the comparison with last autumn, when long-term interest rates were almost at the same level as today. Comparing the situation of financial markets and the outlook for economic activity and prices, stock prices have risen about 60 percent from about 9,000 yen last autumn and the yen rate against the U.S. dollar has depreciated about 25 percent from 75–79 yen. When looking at the outlook for economic activity and prices using the ESP Forecast Survey, which compiles economists’ forecasts, the outlook for the real GDP growth rate for fiscal 2013 has improved substantially from 1.54 percent as of October 2012 to 2.75 percent as of July 2013, and the outlook for the year-on-year rate of change in consumer prices has also increased from 0.11 percent to 0.36 percent during the same period. The economic and inflation outlooks for the longer term have also been revised upward. While such improvement in financial markets and the outlook for economic activity and prices naturally create upward pressure on long-term interest rates, actual long-term interest rates have nevertheless been contained at almost the same level as last autumn. Second is the comparison with developments in long-term interest rates overseas. As mentioned earlier, since May this year, interest rates overseas have been rising due in part to increased speculation that the Federal Reserve might taper the size of its asset purchases. Looking at changes since mid-May, the U.S. long-term interest rate has risen by 0.5 percentage point from 2.0 percent to 2.5 percent. In contrast, Japan’s long-term interest rate has been roughly flat. These facts suggest that the Bank’s massive purchases of government bonds have effectively compressed risk premiums and powerfully contained upward pressure on longterm interest rates. Hereafter, although there is likely to be upward pressure on long-term interest rates as the outlook for economic activity and prices improves, downward pressure to contain interest rates is expected to further increase as the Bank’s purchases of JGBs progress. Effect of lowering real interest rates So far I have provided an explanation from the viewpoint of downward pressure on nominal interest rates. In terms of stimulating an effect on economic activity, what is important is “real interest rates,” which affect decision-making on spending, including business fixed investment and housing investment. The real interest rate is the interest rate that has been adjusted for the effects of rises and falls in prices, and can be calculated by subtracting the expected inflation rate from the nominal interest rate. As real interest rates cannot be observed directly, you may wonder how firms will make decisions based on real interest rates. Suppose you are making a decision regarding business fixed investment. If you consider that prices will rise in the future and prices of your products will also rise, business fixed investment to that extent should pay off even if the nominal borrowing rate is high. This illustrates the importance of real interest rates. BIS central bankers’ speeches The QQE aims at lowering real interest rates both in terms of putting downward pressure on nominal interest rates and raising expected rates of inflation. As I have been explaining, judged from various indicators, expected rates of inflation have been rising on the whole. As nominal interest rates have been more or less flat, real interest rates seem to have been declining. Also in this regard, the QQE has been exerting its intended effects. B. Increase in bank lending Next, we have sometimes been presented with the view that, even though the Bank provides massive money to the financial markets, such money might not be channeled from financial institutions to firms and households. In relation to this, what I want to focus on is the development in bank lending. As mentioned earlier, the year-on-year growth rate of bank lending has been increasing moderately since last autumn, and has recently been slightly above 2 percent. The backdrop to this is that the behavior of firms, households, and financial institutions could have become positive, reflecting various policy measures by the Bank, including the QQE. In addition to putting powerful downward pressure on long-term interest rates, the QQE – as a result of the Bank’s massive purchases of government bonds – exerts effects on investors and financial institutions that used to invest their funds in government bonds in order to shift their investment in lending and other assets – the so-called portfolio rebalancing effect. In addition, the QQE has the effect of generating proactive demand for funds, including business fixed investment and housing investment, by converting households’ and firms’ “deflationary sentiment” – in other words, a natural way of thinking that prices will not rise. Furthermore, in order to support financial institutions’ efforts to increase lending, the Bank has established such facilities as the “Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth” and the “Fund-Provisioning Measure to Stimulate Bank Lending.” The amount provided through these facilities has reached about seven trillion yen, supporting financial institutions’ efforts to tap firms’ proactive demand for funds. Due to prolonged deflation, many firms now hold massive cash and deposits. As firms can make business fixed investment and other investment by first using such cash and deposits, there is some uncertainty as to what extent firms’ demand for investment might lead to an increase in demand for borrowing from financial institutions. In that sense, while it will not be desirable to solely focus on the growth rate of lending, be it based on own funds or external borrowing, it is important to prepare an environment that enables firms’ positive actions. C. Relationship between wages and prices Lastly, we often have been asked whether, in achieving the 2 percent “price stability target,” if only prices rise and wages do not, this might have a costly impact on people’s lives. In this regard, the Bank does not consider it sufficient if only prices go up. With Japan’s economy growing in a well-balanced manner amid a virtuous cycle among production, income, and spending, the Bank aims to create a situation in which a gradual rise in the inflation rate is accompanied by an increase in employment and wages. For wages to increase against the backdrop of such positive developments in the economy, it becomes necessary for firms to anticipate future increases in the growth rate and to become confident with regard to increasing new hiring. In addition, as mentioned earlier, if people’s “deflationary sentiment” is converted thanks to the Bank’s monetary policy, decisions on wages will be changed such that they are based on the assumption that prices will rise. Looking at the developments in the growth rate of hourly cash earnings and that of the CPI, one can confirm that, when prices actually rise, wages increase almost simultaneously (Chart 19). It is therefore important that the environment I have just described be put in place, whereby wages can be raised, and to realize an economy in which a rise in inflation rates is accompanied by an increase in wages, as in the past. BIS central bankers’ speeches Concluding remarks I have so far described the policy effects of the QQE, based on the situation in financial markets as well as in economic activity and prices over the past three months. The QQE itself is an extremely powerful policy, but it will exert maximum effects when combined with the various measures by the government. In relation to this, I would like to note two points in particular. First is the government’s growth strategy. I have explained the transmission channel of monetary easing in terms of the funding costs, particularly of firms, mainly based on expected inflation rates and real interest rates. In more accurate terms, the degree of monetary easing is determined by the spread between return on assets and funding costs. In other words, if firms’ outlook for profitability improves due to the growth strategy, the effects of monetary easing will further strengthen. Also, as touched upon earlier, a rise in firms’ expectations for growth forms the basis for wages to rise. The government has formulated concrete measures such as the “Japan Revitalization Plan,” and we expect their steady implementation. Second is securing confidence in public finance. The Bank’s measures, including JGB purchases, are conducted with the purpose of achieving the price stability target, but if this is perceived as financing the fiscal deficit, the effects of the QQE could be hampered as longterm interest rates rise due to an expansion in risk premiums. The joint statement released by the government and the Bank of Japan in January stated that the government will steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management. It is essential that this be put into action in order for Japan’s economy to overcome deflation and achieve sustainable growth. I would like to finish my speech today by stating that the Bank of Japan is committed to achieving the price stability target of 2 percent at the earliest possible time, by steadily continuing with the QQE, and to overcoming deflation, which is the greatest challenge facing Japan’s economy. Thank you. BIS central bankers’ speeches
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Federal Reserve Bank of Kansas City Economic Policy Symposium, Jackson Hole, Wyoming, 24 August 2013.
Haruhiko Kuroda: Japan’s unconventional monetary policy and initiatives toward ensuring stability of the global financial system Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Federal Reserve Bank of Kansas City Economic Policy Symposium, Jackson Hole, Wyoming, 24 August 2013. * * * Introduction I am honored by the invitation to be a panelist at this traditional policy symposium hosted by the Federal Reserve Bank of Kansas City. The global economy is yet to completely recover from the aftermath of the Lehman shock, and each country is grappling with its own thorny issues. Japan has not been able to escape from a vicious cycle of deflation and stagnant economic activity for the past 15 years and dynamism has gradually vanished from economic activity. For a sustained economic recovery, it is necessary to overcome deflation and turn firms’ and households’ actions into more proactive ones. The content of my presentation is described in Chart 1 of the handout. I will first outline the “Quantitative and Qualitative Monetary Easing” (hereafter QQE) that the Bank of Japan introduced in April, and then follow this with the characteristics of the QQE’s transmission channels, focusing on the effects on real interest rates and on the natural rate of interest. I will conclude by touching on several issues on the relationship between unconventional monetary policy and the global financial markets. I. Unconventional monetary policy in Japan Outline of the QQE As represented in the wording “quantitative and qualitative,” the Bank’s QQE aims to overcome deflation through both a “quantitative” increase and “qualitative” changes in the Bank’s balance sheet. As shown in Chart 2, there are three points. First, the Bank aims to achieve the price stability target of 2 percent in terms of the year-onyear rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years. Second, as shown in Chart 3, in terms of “quantity,” through purchases of various assets, mainly Japanese government bonds (JGBs), the Bank aims to double the monetary base in two years from 138 trillion yen at end-2012 to 270 trillion yen at end-2014. When looked at in terms of a ratio to nominal GDP, this has already exceeded 30 percent in the second quarter of 2013. Although it depends on future growth in nominal GDP, the ratio is likely to increase to a level of over 50 percent in the fourth quarter of 2014. Third, on the “quality” front, JGBs with all maturities, including 40-year bonds, were made eligible for purchase. As a result, the average remaining maturity of the Bank’s JGB purchases will more than double to about seven years. By working on interest rates across the yield curve, it is expected that the effects of the QQE on financial conditions and economic activity will be strengthened. In addition, in order to affect premiums of risk assets, purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) were increased. Assessment of the QQE to date The QQE has already started to exert effects. Let me point to three favorable turns, as shown in Chart 4. BIS central bankers’ speeches First, there has been a favorable turn in financial markets and corporate finance. As shown in Chart 5, stock prices are rising. Long-term interest rates, while once faced with increased volatility, have been almost flat recently despite a rise in interest rates overseas. Also, in terms of corporate finance, bank lending has gradually been increasing its growth rate, and lending rates have been at historical low levels. Second, there has been a favorable turn in the public’s expectations. Consumer sentiment and business sentiment have improved markedly. Many indicators suggest that inflation expectations have been picking up in the market, as well as among firms and households. A recent development in one such indicator is shown in Chart 6. This development, together with low and stable nominal interest rates, has been effective in lowering real interest rates. The third favorable turn is in economic activity and prices, as shown in Chart 7. Private consumption remains resilient on the back of improved household sentiment and the wealth effect from the stock market rally. Business fixed investment is showing signs of picking up, in line with improved business sentiment and corporate profits. The year-on-year rate of change in the CPI has turned positive, reflecting both improvement in the economy and the yen’s depreciation. II. Unconventional monetary policy, real interest rates, and natural rate of interest In this way, the Bank’s QQE has already started to gradually exert effects. Now, as in Chart 8, let me next look at the transmission mechanism of the policy effects from the two perspectives of real interest rates and the natural rate of interest. Needless to say, the effects of monetary policy will be determined by the difference between real interest rates and the natural rate of interest. Thus, there are two ways for monetary easing to be effective: First, lower real interest rates, given that the natural rate of interest is unchanged, or, second, increase the natural rate of interest, given that real interest rates are unchanged. The Bank of Japan’s QQE seems to have started to exert effects both in terms of lowering real interest rates and an increase in the natural rate of interest. Let me explain this in order. Lowering real interest rates First, let me consider the effect of lowering real interest rates. When lowering real interest rates as a policy, a central bank normally lowers nominal interest rates. Of course, for such policy to be taken, there should be sufficiently large room for reduction in nominal interest rates. For example, in the United States, based on the assumption that inflation expectations were anchored, it can be interpreted that real interest rates have been lowered as a result of reducing nominal interest rates. In Japan, as nominal interest rates were already at low levels, there was limited room to lower real interest rates by reducing nominal interest rates. Another way was needed to lower real interest rates. Namely, an increase in inflation expectations. While the purpose of lowering real interest rates itself was the same as in the United States, there was a stark contrast in terms of a strategy to achieve that purpose. The Bank aims to achieve the 2 percent price stability target with a time horizon of about two years and implement measures toward achieving the target, which would be effective in overcoming the policy constraints. With the implementation of the QQE, inflation expectations have actually been edging up, as I mentioned earlier, and thus the Bank’s policy has started to exert its intended effects. BIS central bankers’ speeches An increase in the natural rate of interest As the second issue for discussion, let me consider the relationship between unconventional monetary policy and the natural rate of interest. This issue has been little discussed, and thus might be controversial to some extent. To begin with, the natural rate of interest corresponds to expected returns from firms’ capital investment. The Bank’s QQE aims at conquering the “deflationary sentiment” that has been entrenched among the public and restoring what had been the intrinsic dynamism of Japan’s economy. As a consequence of the policy, if Japan’s growth potential recovers, investment opportunities will increase and the natural rate of interest will rise. As an unconventional monetary policy that contributes to strengthening growth potential, the Bank has established a facility called the “Loan Support Program.” The facility is composed of two measures. One is the fund provision for economic growth, which provides funds for financial institutions’ loans and investment that contribute to Japan’s economic growth. The second is the fund provision to stimulate lending, which provides long-term funds at low interest rates for financial institutions’ incremental lending, in order to support their efforts to increase lending. The facility aims to promote financial institutions’ initiatives toward finding demand for funds in high-growth firms and business fields. I would like to add one point here; namely, that maintaining the natural rate of interest at a high level is also important as a means of increasing the resilience of the economy against various shocks. In that regard, when the natural rate of interest increases sufficiently, the possibility that the policy rate will hit the zero lower bound again declines and the resilience of Japan's economy is likely to increase. III. Unconventional monetary policy and global financial markets Lastly, as already discussed in this symposium, let me touch on issues that relate to global liquidity and cross-border capital flows. Given the wide spectrum of important issues within this set of topics, let me focus on two such issues – taking into account my own experience – as shown in Chart 9. Unconventional monetary policy and cross-border capital flows First, the relationship between unconventional monetary policy and cross-border capital flows is quite complicated. While this is not new to central banks and related parties, almost all base money provided through monetary policy will be accumulated in the form of deposits with a central bank. Even if a country eases monetary conditions, this does not necessarily mean that money being provided directly “spills over overseas.” Starting from such accumulated base money and changes in demand-supply conditions in asset markets in which the Bank conducts purchase operation, the issue is with regard to how financial market participants’ expectations and transactions will change and how that will affect cross-border capital flows. This process is fairly complicated, and monetary easing does not necessarily lead to crossborder capital outflows. For example, if growth expectations heighten due to monetary easing, there might be capital inflows in search of a high natural rate of interest. Importance of international coordination among central banks Second, I would like to point out that – also in international coordination among central banks – “unconventional” initiatives have indeed been reinforced. In tandem with progress in financial globalization, the speed and magnitude of systemic risk contagion among countries have increased, and due vigilance is called for regarding the BIS central bankers’ speeches possibility that destabilization in the global financial markets will be a drag on the global economy. Following the Lehman shock, the Bank of Japan, in coordination with other central banks, has endeavored to maintain the stability of the global financial system through initiatives such as making currency swap arrangements, improving the framework of cross-border collateral, and enhancing regional financial infrastructures, including fostering Asian bond markets. As a person who has been involved in international finance in various positions, I would like to emphasize that it is increasingly important to have international coordination with regard to the prevention and management of a financial crisis. Concluding remarks The QQE aims to overcome deflation that has continued for 15 years and to rejuvenate Japan’s economy. While maintaining real interest rates at low levels through increasing inflation expectations, the policy will exert its maximum effects by working also on the natural rate of interest rate together with the government’s growth strategy. The Bank of Japan will pursue proper policy conduct to achieve the price stability target, while continuing to make efforts to maintain the stability of the global financial system. 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
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Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a meeting held by the Kyoto Chamber of Commerce and Industry (KCCI), Tokyo, 28 August 2013.
Kikuo Iwata: Quantitative and qualitative monetary easing and its transmission mechanism – logic behind the first arrow Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a meeting held by the Kyoto Chamber of Commerce and Industry (KCCI), Tokyo, 28 August 2013. * * * Introduction It is a great honor to appear in front of distinguished members and guests of the Kyoto Chamber of Commerce and Industry, and to have this opportunity to address you today. I have been told that this chamber was founded in 1882, and thus celebrated its 130th anniversary last year. Incidentally, the Bank of Japan was also founded in the same year. This means that our organizations have followed the same history over the years. In the old days, I understand that the business community in Kyoto made efforts to start new businesses, such as electricity generation, host an exposition, and establish this chamber, in an attempt to regenerate the vigor that had been lost in the aftermath of the capital’s relocation to Tokyo. At that time, Japan as a nation faced a need to found a central bank in order to collect the large amount of banknotes issued by the Meiji Government after the Seinan War in 1877. The fact that this chamber and the Bank were founded in the same year may not be a matter of coincidence, as these organizations respectively played crucial roles in helping with the initial footsteps for Kyoto toward becoming a modern city and Japan toward evolving into a modern nation. Kyoto is a city that enjoys more than 1,200 years of history. It is also called the city of innovation, where creative ideas have flourished for many years. Most recently, we have been reminded of this attractive quality of Kyoto in the person of Professor Yamanaka of Kyoto University, who received the Nobel Prize. In my view, the reason Kyoto excels in creating innovation owes much to the accumulation of knowledge over the years and the city’s culture of freedom and creativity being respected. Indeed, looking at the number of university students per population in each prefecture, Kyoto is ranked first, ahead of Tokyo, suggesting that it is the city of academics in Japan. For my part, as I had been in academia for a number of years before joining the Bank, I am particularly interested in how the interaction between the university – a place for education and research – and the industry – a place for businesses – can contribute to the development of Kyoto. I will keep my attention on this interaction with great interest. I. Three arrows Today, I would like to explain the monetary easing that the Bank has been conducting. As you know, the Japanese government has already fired “three arrows”; namely, bold monetary easing, flexible fiscal policy, and a growth strategy to encourage private investment. By combining these arrows, it aims to overcome deflation and address the challenges faced by Japan’s economy. Before discussing the main theme of my talk, let me elaborate on the respective roles that these play (Slide 1). The first arrow is bold monetary easing, with which the Bank is making progress. In a nutshell, the Bank conducts aggressive monetary easing with a view to achieving the price stability target of 2 percent. The intention is to close the negative output gap and put Japan’s economy back on track to a sustainable growth path, or potential growth path. I will explain my own thinking about the first arrow’s transmission mechanism and its effects on economy activity as plainly as possible. BIS central bankers’ speeches The second arrow is flexible fiscal policy. While the first arrow is an extremely powerful policy measure, it takes some time until favorable effects from this permeate the economy. It is for this reason that flexible fiscal stimulus by the government is necessary at an initial stage of the policy package in order to underpin economic activity from the demand side. At present, public investment has been increasing mainly on the back of the emergency economic measures that were based on the supplementary budget for fiscal 2012 enacted in February 2013. The third arrow is a growth strategy to encourage private investment. This is aimed at raising the sustainable growth path itself and enhancing the room for Japan’s economy to grow, whereas both the first arrow of monetary policy and the second arrow of fiscal policy are aimed at returning Japan’s economy to the sustainable growth path by expanding the size of the aggregate demand. While I will not go into the details of the third arrow today, we expect that the government will steadily implement various measures including those of the “Japan Revitalization Strategy,” released in June, under the leadership of Prime Minister Abe. The respective roles of the three arrows that I just explained can be summarized as in my presentation slide (Slide 2). The real GDP growth rate – which represents the vigor in economic activity – is plotted on the vertical axis, while the horizontal axis represents the time horizon and the bold line shows the growth trajectory of Japan’s economy. At present, the economy is below the dotted line that represents the potential growth path it is supposed to follow. This owes to the fact that it is in a vicious cycle under which a decline in aggregate demand on the back of a continued fall in prices – that is, a state of deflation – leads to a further fall in prices. In order to revitalize the economy, which has fallen into this vicious cycle of deflation and a decline in aggregate demand, bold monetary easing – the first arrow – is effective and imperative as a means of stopping the continued fall in prices and bringing economic activity to the level that should have been achieved. This represents the thinking behind the Bank’s current monetary easing policy. It is exactly what I have been emphasizing as a researcher for a number of years. As I said before, it will take some time until the effects of the first arrow (monetary policy) permeate the economy. It is for this reason that the effects of the second arrow (fiscal policy) will first materialize, and as the effects of monetary easing strengthen, the actual economic growth path will approach the potential growth path shown as the dotted line in Slide 2. In contrast, the third arrow (growth strategy) plays a role of raising the potential growth path depicted by the dotted line. In other words, while monetary policy and fiscal policy are the policies to restore economic strength from its temporary decline to being in a sound state, the growth strategy is meant to raise the capabilities of the economy itself. For Japan’s economy to achieve long-term growth, this growth strategy is a key to success. II. What is “quantitative and qualitative monetary easing”? Now, I would like to focus my speech on today’s main theme: the first arrow, which is the monetary easing policy the Bank has been conducting. On January 22, 2013, the Bank newly introduced the “price stability target” of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI). Furthermore, the Bank decided on April 4 to enter a new phase of monetary easing both in terms of quantity and quality in order to achieve that target at the earliest possible time, with a time horizon of about two years. This is the bold monetary easing policy called “quantitative and qualitative monetary easing” (hereafter QQE). I would now like to explain, as plainly as possible, the key features of the monetary easing that the Bank has been conducting. However, given that my speech is on monetary policy, it will indeed involve technical terms to some degree, and I would like to ask you to bear with me in that regard. BIS central bankers’ speeches First, the Bank has made a clear commitment to achieving the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. As concrete measures toward achieving that commitment, the Bank has implemented a new phase of monetary easing – the QQE (Slide 3). For the monetary easing measure to actually exert effects, it is vital that the central bank express its strong intention – in other words, a commitment – that it is responsible for achieving the price stability target of 2 percent, and that this is accompanied by concrete measures underpinning such a commitment. When the central bank commits itself to achieving the inflation target and implements bold monetary easing measures toward achieving the target, people’s expectations change from deflationary to inflationary, their behaviors change, and developments in the economy as a whole start to change. This is a major key to achieving policy effects. The second feature of the QQE is that the Bank’s main operating target for money market operations has been changed from the money market rates to an indicator called the monetary base. The monetary base is the total of banknotes and coins in circulation – in other words, the total amount of cash – and the amount outstanding of financial institutions’ current accounts held at the Bank; or, simply put, the amount equivalent to the money the Bank has supplied to the economy. We have decided to conduct money market operations so that the monetary base will increase at an annual pace of about 60–70 trillion yen. As a result, the amount outstanding of the monetary base is expected to almost double in two years, from 138 trillion yen at end2012 to 270 trillion yen at end-2014. This corresponds to the quantitative aspect of the QQE. The third feature of the QQE is that the Bank has expanded its purchases of Japanese government bonds (JGBs) as a measure to increase the monetary base (Slide 4). Specifically, the Bank purchases JGBs through financial markets so that their amount outstanding will increase at an annual pace of about 50 trillion yen. Consequently, the amount outstanding of the Bank’s JGB holdings is expected to more than double in two years, from 89 trillion yen at end-2012 to 190 trillion yen at end-2014. Furthermore, maturities of government bonds range from those with a short-term of few months to those with super-long maturities of 40 years. Upon making JGBs with all maturities eligible for purchases, the Bank has decided to extend the average remaining maturity of the Bank’s JGB purchases from slightly less than three years to about seven years, which is roughly equivalent to the average maturity of the amount outstanding of JGBs issued. In general, the longer the period until maturity, the higher the risk of volatility in prices of JGBs. Therefore, by extending the maturity of its JGB purchases, the Bank is thus taking higher risk. This increase in JGB purchases and their maturity extension represent monetary easing both in terms of quantity and quality. The fourth feature is that, aside from the aforementioned purchases of JGBs, the Bank has decided to expand purchases of other assets with higher risk; namely, exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). ETFs are investment trusts that are designed so that prices are linked to stock indices such as the Nikkei 225 Stock Average and TOPIX, and they are traded in stock exchanges. For example, purchasing stock index ETFs would be the same as indirectly buying stocks. By contrast, J-REITs are investment trusts that invest in multiple real estate such as office buildings and commercial facilities. In other words, purchasing J-REITs would mean indirectly investing in real estate. The Bank will increase the amount outstanding of its holdings of ETFs and J-REITs at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. We expect that the Bank’s purchases of such assets with relatively high risk – or put differently, the conduct of monetary easing from the qualitative aspect – will encourage risk taking activities in the real economy. BIS central bankers’ speeches The fifth feature of the QQE is that the Bank aims to achieve the 2 percent “price stability target” and will continue with the QQE as long as it is necessary for maintaining that target in a stable manner (Slide 5). The first feature I mentioned earlier is a commitment to definitely achieving the target, while the fifth is a commitment regarding the continuation of the QQE, such that the Bank will continue with the QQE for as long as it is necessary to achieve the target. These two types of commitments – accompanied with responsibility – will increase public confidence in the Bank’s policies and are an important key to ultimately achieving the policy effects. The last feature I would like to point out is that the Bank attaches great importance to its communication with market participants. As I have explained, the Bank’s monetary policy is conducted mainly through transactions with market participants in the money market; in other words, through its money market operations. As the Bank embarks on monetary easing of an unprecedented scale, its counterparty financial institutions will also face situations not experienced before. Therefore, we consider it crucial to hold an enhanced dialogue with market participants pertaining to money market operations and market transactions more generally, and to seek a reasonable way forward. III. Transmission mechanism of the QQE So far, I have explained the details of the Bank’s monetary easing policy, including those of a technical nature. The next question is: How does it affect people’s daily lives? I gather that participants today are most interested in this question. I will explain my own thinking on the QQE’s transmission mechanism and its effects permeating the economy. Slide 6, while somewhat technical, displays the major components of the transmission mechanism of the monetary easing policy. Please bear with me as I explain this slide by item. As I have already explained, there are two pillars, listed on the top of the slide, to the Bank’s monetary easing policy. The first is the commitment to achieving the price stability target of 2 percent. In other words, the Bank is committed to its responsibility to achieve “the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years.” The second pillar is the QQE that underpins this commitment, and here it is described as an increase in the monetary base. These two pillars – the introduction of the price stability target and the accompanying bold monetary easing – will lead to a rise in the expected rates of inflation – that is, the course of inflation that the public expects to take place in the future. As inflation expectations rise, the expected real interest rates — the real burden incorporating the price rises — will fall. Let me elaborate on what I mean by this, as it is somewhat difficult to understand. Suppose you borrow money at the rate of 3 percent. If inflation goes up by 2 percent per year, the value of the money you will pay back will decrease by 2 percent. Thus, even if the nominal interest rate is 3 percent, the real interest rate will become 1 percent, subtracting the rate of inflation (2 percent) from the nominal interest rate (3 percent). In mathematical terms, this can be written as follows: (expected real interest rates) = (nominal interest rates) – (inflation expectations). Therefore, if inflation expectations rise while nominal interest rates remain constant, real interest rates are expected to decline accordingly. Alternatively, even if nominal interest rates rise, real interest rates are still expected to decline as long as nominal rates do not go up by as much as the rise in inflation expectations. This may sound less than convincing, considering that you have gone through prolonged periods of mild deflation. Looking back at the end of the 1990s, the 10-year JGB yields were around 6.5 percent when inflation rates stayed at around 3 percent. While nominal rates were around 6.5 percent, the expected real rates were around 3.5 percent, if inflation rates were expected to stay at around 3 percent. If inflation rates were higher, the real rates could have been lower. BIS central bankers’ speeches A decline in the expected real interest rates through a rise in inflation expectations will feed into the economy by increasing demand through various channels. First, a decline in the expected real interest rates will lower the real cost of borrowing, thus stimulating business fixed investment and housing investment. In addition, it will become a factor in raising the prices of assets such as equities, homes, and land. Those who experienced a rise in the value of their own assets are likely to spend and consume more than before. This is called the wealth effect. Moreover, a rise in equity and land prices will improve the financial conditions of households and businesses; hence, it becomes easier for them to borrow money, and it is more likely that businesses will increase business fixed investment and households will increase housing investment. Furthermore, if the real interest rates of the yen become lower than those of other currencies, exchange rates are likely to move in the direction of the yen’s depreciation. Correction in the appreciation of the yen will become a factor in boosting exports and increasing business fixed investment through a rise in corporate profits. Tourist destinations like Kyoto can attract more foreign tourists who benefit from the yen’s depreciation. On top of that, the value of overseas assets, if revalued in yen, will rise, which could feed into an increase in consumption due to the wealth effect. As stated above, the decline in the expected real interest rates caused by the first arrow will lead to an increase in three demand components – consumption, investment, and exports. Coupled with an increase in government outlays by the second arrow, the aggregate demand of goods and services will gradually increase. In Slide 6, this is described as closing the negative output gap, as the aggregate demand catches up with the capacity to supply. The increase in the aggregate demand of goods and services will ignite production activity and increase the labor demand. This will lead to an increase in the workforce and eventually a rise in wages per person. As a result, the income of the workforce as a whole will increase and invigorate consumption. As consumption increases, business fixed investment and housing investment will rise accordingly. An increase in exports on the back of the yen’s depreciation will also lead to a pick-up in investment to increase production capacity. This vigor in consumption and investment will contribute to a further narrowing of the output gap, which will lead to an increase in production; hence, the virtuous cycle prevails. In the initial stage of this whole process, the important key is for the public to expect that prices will go up. Going through this process, demand will increase and prices will start to rise in reality toward the price stability target of 2 percent. This in turn will reinforce the public’s expectations that prices will rise stably in the future, thus contributing to low and stable expected real interest rates. As I have explained, Japan’s economy, which had fallen into the vicious cycle of deflation and shrinking demand, is indeed on the verge of entering the virtuous cycle of moderate and stable inflation as well as increasing demand. You may have an impression that my belief in the need to exert an effect on the public’s expectations sounds as though it is taken from a fairy tale. Intrinsically, monetary policy can elicit its effects through the public’s expectations. In my view, the most important point of our current conduct of monetary easing policy is to dispel the deflationary expectations that had been firmly embedded after nearly 15 years of deflation, and to generate mild and stable inflationary expectations. IV. Economic activity So far, with the help of the flow chart, I have explained how the Bank’s monetary easing policy works on economic activity. In the remainder of my speech, I would like to briefly review how economic activity has been developing, based on statistical evidence. BIS central bankers’ speeches First and foremost, there is a need to dispel the deflationary expectations firmly embedded in the public’s mind and to generate inflation expectations (Slide 7). In this regard, the most important initial step for the Bank is to set the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI and make a strong commitment to achieving that target at the earliest possible time, with a time horizon of about two years. Once the effects of the policy start to materialize and the actual rate of inflation stays stably around the price stability target, inflation expectations will be anchored. The question is: What do actual inflation expectations look like? While it is difficult to gauge how the public formulates inflation expectations, it appears that they are gradually picking up as the QQE progresses, as evidenced by inflation expectations derived from the yield spread between fixed-rate coupon-bearing JGBs and inflation-index JGBs, or from the surveys collected from the bond market participants in securities and institutional investment companies. In addition, according to the most recent result in the Opinion Survey on the General Public’s Views and Behavior conducted by the Bank, the share of respondents who expected that prices will go up one year from now – excluding the effects of the consumption tax hike – – reached 80 percent. This suggests that the inflation expectations of households are picking up. As I said at the outset, a rise in inflation expectations will lead to a decline in the expected real interest rates, which can be derived by subtracting inflation expectations from nominal interest rates. Looking at the actual interest rates observed in financial markets, the inflation expectations of market participants have been on a rising trend and the expected real interest rates have been on a declining trend since the beginning of 2013 (Slide 8). Next, let us review the effects of such a decline in the expected real interest rates on economic activity, based on historical data. Looking at the relationship between the expected real interest rates and business fixed investment, there is a tendency for the latter to expand when the expected rates are low (Slide 9). Moreover, a decline in the expected real interest rates will bring about a rise in asset prices. The movement between the Nikkei stock average and the expected real interest rates shows that they are inversely correlated to each other (Slide 10). A rise in asset prices will lead to an improvement in the financial positions of businesses and households, thereby generating an increase in investment. The movement between the Nikkei stock average and business fixed investment shows that investment is likely to increase as a trend when stock prices are high (Slide 11). How should we assess the effect of the correction in the yen’s appreciation that has resulted from monetary easing? The relationship between exchange rates and exports indicates that exports are likely to increase as a trend when the yen depreciates (Slide 12). Recent movements in exports ensure that exports are actually picking up during the process of adjusting the yen’s appreciation (Slide 13). In addition, consumption is on a rising trend, and an increase in aggregate demand – which is comprised of consumption, investment, exports, and government spending – feeds into an increase in production (Slides 14 and 15). The increase in production will generate a rise in employment. Recent indicators of employment, such as a decline in the unemployment rate and an improvement in the active job openings-to-applicants ratio, suggest that there is a clear sign that the labor market is improving (Slide 16). This will further contribute to an increase in total earnings by employees (Slide 17). This betterment of the labor market will stimulate consumption, and that will lead to an improvement in employment; hence, the virtuous cycle prevails (Slide 18). Lastly, as for prices, the year-on-year rate of change in the CPI (all items excluding fresh food) turned positive in June 2013, for the first time in 14 months. Looking in detail, though the CPI has been pushed up partly due to a rise in energy-related goods such as petroleum BIS central bankers’ speeches products and electricity costs, improvements across a wide range of goods on the back of resilient consumption have also contributed to a rise in the CPI. The widespread improvement can also be evidenced from the fact that the year-on-year rate of decline has slowed in the CPI for all items excluding food and energy. Such a moderate rise in prices will change the expectations of the people – who were somewhat sceptical about the feasibility of overcoming deflation – and raise inflation expectations further. This is expected to amplify the process of buoying the economy, which was triggered by a decline in the expected real interest rates, and lead the actual rates of inflation close to the price stability target of 2 percent (Slide 19). Concluding remarks In my remarks today, I have explained the transmission mechanism of the QQE and showed that economic activity has been moving in line with the developments envisaged under this mechanism. Before closing, I wish to point out several issues that require attention. First, the QQE is intended to generate a decline in the expected real interest rates by lifting the inflation expectations of the public – particularly those of investors in asset markets. This decline in the expected real interest rates is a trigger for changes in asset prices of government bonds, stocks, and foreign exchange. Such changes in asset prices will take place through investors’ portfolio rebalancing and are expected to start shortly after the QQE’s implementation. These changes in asset prices will increase aggregate demand including consumption, investment in fixed assets – that is, business fixed investment and housing investment – and exports, and this increase in aggregate demand will lead to a pickup in production and employment. All these changes in economic activity, however, require some time before they gather momentum. That is because it takes some time for households as well as domestic and overseas businesses to ascertain whether or not changes in asset markets are merely a temporary phenomenon. Once they feel confident that these changes are of a somewhat long-term nature, businesses will decide whether to expand their fixed investment and households will decide whether to increase spending and housing investment. Likewise, overseas businesses will determine whether to increase their imports from Japan. It has been less than 5 months since the Bank introduced the QQE. It will take some more time before we start seeing persistent and steady pickups in prices and wages as a result of an increase in demand for goods and services, and of a rise in employment. While it will take some time, Japan’s economy will improve, prices and wages will rise, and incomes for many households will increase for as long as the Bank strenuously continues with the QQE. I would remind everyone that the QQE is a new phase of monetary easing that we have just entered. Therefore I hope you will not jump to conclusions by saying that the recent pickup in prices attributes to a rise in energy prices on the back of the yen’s weakening – a typical story associated with “bad inflation” – or by grumbling about stagnant wages. Again, the QQE is still in its early stages, and I hope you will be patient enough to see its effects permeate the economy. Thank you. 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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Kisaragi-kai Meeting, Tokyo, 20 September 2013.
Haruhiko Kuroda: Overcoming deflation and quantitative and qualitative monetary easing Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Kisaragi-kai Meeting, Tokyo, 20 September 2013. * * * Introduction Thank you for giving me the opportunity to address you today. I assumed the position of Bank of Japan Governor just six months ago, on March 20. At the time, as the Governor of the Bank, which has a mission to ensure price stability, I resolved to pull Japan’s economy out of the deflation that has lasted for some 15 years. This is because, due to prolonged deflation, “deflationary expectations” (the recognition that prices will decline or not increase) were entrenched among people and firms, and this situation had been depriving Japan’s economy of vitality. Reflecting my determination, the new policy of quantitative and qualitative monetary easing (QQE) was introduced in April. The policy has already started to exert effects. Positive developments in the real economy and financial markets have been spreading, and people’s expectations in terms of economic activity and prices have been improving. Today, I will first briefly discuss developments in economic activity and prices at home and abroad. Then I will turn to a description of the deflation that has continued in Japan for some 15 years and delve somewhat into the background and what should be done to overcome it. I. Recent developments in economic activity and prices Let me start with recent developments in economic activity and prices. To summarize, with the QQE making steady progress, Japan’s economy has been proceeding smoothly along a path toward achieving the “price stability goal” of 2 percent, as the Bank has presented in its outlooks. Economic activity and prices Japan’s economy is recovering moderately, as a virtuous cycle from income to spending is gradually starting to operate in both the corporate and household sectors. In the corporate sector, corporate profits and business sentiment have improved significantly. A focus of attention had been whether this improvement would genuinely lead to an increase in spending, namely, business fixed investment, and recent data have confirmed that business fixed investment is starting to pick up mainly in the nonmanufacturing sector (Chart 1). For example, in the GDP statistics, business fixed investment in real terms for the April-June quarter increased on a quarter-on-quarter basis for the first time in six quarters. Machinery orders – a leading indicator for business fixed investment – also turned to an increase on a quarter-on-quarter basis in the April-June quarter, for the first time in five quarters, and have been expanding since then. As for the household sector, the pick-up in housing investment has become evident. Private consumption has also been resilient, registering three consecutive quarters of increase in real terms in the GDP statistics (Chart 2). Sales at department stores have remained firm, notably in imports and high-end products, and consumption of services such as outlays for travel and sales in the food service industry have held steady. Such resilience in private consumption had been supported by wealth effects from the rise in stock prices and an improvement in consumer confidence in the first half of 2013, and recently it has begun to be backed also by improvement in the income situation, such as employment and wages. Specifically, the ratio of job offers to applicants and the unemployment rate have both improved to a level observed for the first time in five years, with the former rising to 0.94 and the latter declining to 3.8 percent in July. As for BIS central bankers’ speeches wages, total cash earnings per employee was around the year-ago level in July, after having turned to an increase on a year-on-year basis in the April-June quarter mainly due to the fact that summer bonus payments rose (Chart 3). In addition to these positive developments in both the corporate and household sectors, as public investment has increased and exports have generally been picking up, production is increasing moderately. Looking ahead, Japan’s economy is expected to continue a moderate recovery as a virtuous cycle operates among production, income, and spending. In a situation where the economy is recovering, for prices the year-on-year rate of change in the consumer price index (CPI, excluding fresh food) accelerated to 0.7 percent in July, after having turned positive to 0.4 percent in June (Chart 4). Although the rise in energy-related goods such as petroleum goods has indeed pushed up prices, an improvement has been observed in a wide range of goods and services against the backdrop of resilient private consumption. In addition, looking at surveys conducted on households, economists, and market participants, inflation expectations are judged to be rising on the whole. The year-onyear rate of increase in the CPI is likely to rise gradually. Features of the current economic recovery Let me touch on the main features of the current economic recovery. This recovery has been following a pattern that differs from typical ones in the past. In many cases, the pattern of postwar economic recovery in Japan was that it started with improvement of corporate profits due to an increase in exports and production, which in turn led to an increase in business fixed investment. The longest postwar economic recovery – from 2002 to 2008 – also followed this pattern, on the back of an unprecedented expansion in the global economy, with the rise of emerging economies and housing bubbles in advanced economies. In this type of pattern, large enterprises in the manufacturing sector – which have an advantage in exports – are the first to recover and, as the employment and income situation improves on the whole, a recovery spreads gradually to the nonmanufacturing sector and small enterprises. However, this time the major feature of the recovery is that the nonmanufacturing sector has been leading it on the back of firm domestic demand, such as private consumption and public investment. Therefore, business fixed investment is weak in the manufacturing sector but strong in the nonmanufacturing sector. The Indices of Tertiary Industry Activity, which show developments in the nonmanufacturing sector, have recovered close to a level prior to the Lehman shock, while the Indices of Industrial Production have remained at about 80 percent of their peak prior to the Lehman shock (Chart 5). Taking into account the difference in recovery pattern, how should we view the sustainability of economic recovery in the future? What is important is, first, for the firmness in domestic demand to continue and, second, for exports, production, and business fixed investment in the manufacturing sector – which are lagging – to improve. In regard to the first point, as mentioned earlier, a virtuous cycle from income to spending has started to steadily operate, and thus firm domestic demand is likely to be sustained. Let me next touch on the second point. The key here is, above all, developments in overseas economies. Current state of and outlook for overseas economies Overseas economies as a whole are gradually heading toward a pick-up, although a somewhat weak performance is partly seen. The economies are expected to gradually pick up mainly as the U.S. economy moderately accelerates its pace of recovery and the European economy slowly bottoms out. By region, the U.S. economy has been on a moderate recovery trend against the background of steady private demand. Five years have passed since the Lehman shock, and U.S. households have finally begun to heal after the major damage caused by the subprime loan problem. Private consumption has been increasing moderately in the face of a termination of BIS central bankers’ speeches tax cuts at the beginning of the year. The housing market has entered a recovery process, albeit still at a low level, and housing investment has been improving despite the effect of an increase in mortgage rates. Such firmness in the household sector has gradually been spreading to the corporate sector, and business sentiment has started to improve. As accommodative financial conditions are likely to continue and downward pressure from the fiscal side is expected to diminish gradually, the pace of recovery in the United States is likely to accelerate modestly. In Europe, April-June real GDP registered the first positive quarter-on-quarter growth in seven quarters, and the economy seems to have bottomed out. Severe fiscal austerity measures were revised, and downward pressure from the fiscal side has weakened somewhat. Financial markets, which were under pressure on a number of occasions during the past several years, have generally been stable. Firms and consumers have gained some breathing space, and their sentiment has been improving. Production has stopped decreasing as exports have bottomed out. Of course, although the European debt problem has yet to be fully resolved and the consequences continue to warrant attention, the European economy is likely to pick up gradually as recent developments continue. The Chinese economy has continued to see stable growth, albeit at a lower level than before, as the government has engaged in a variety of structural reforms. Private consumption has been firm on the back of the favorable employment and income situation, although effects of the government’s frugality campaign are still observed. The pace of increase in fixed asset investment has been solid, mainly due to rises in investment in infrastructure and real estate. While the government has been placing weight on the quality of growth, at the same time it has given due consideration to economic activity. As for the outlook, there is a high degree of uncertainty associated with the effects of structural reforms, such as the response to the shadow banking problem, and the content and effects of policy measures to underpin the economy. However, supported by firm domestic demand, the Chinese economy is likely to register stable growth at the current pace. Some emerging economies have suffered instability in their financial markets, such as a plunge in stock prices and depreciation of currencies. A number of factors have been cited as the background. Examples include global investors’ renewed focus on the vulnerable economic structure of these countries as seen in current account deficits amid waning strong growth expectations, speculation on monetary policy conduct in advanced economies, and intensified risk aversion. Such movements in financial markets entail risks that the real economies of these countries will be affected by tightened financial conditions and worsened business and household sentiment. Although resilience has strengthened in terms of external debt and events are unlikely to lead to a severe situation, future developments warrant continued vigilance. As mentioned, each country and region has its own respective risk, but the baseline scenario is that the global economy will pick up gradually as the U.S. and the European economies improve. This will underpin an increase in exports and production, leading to a pick-up in the manufacturing sector’s business fixed investment in Japan. II. Deflation lasting for some 15 years, and the countermeasures Now let me move on to the main topic of my speech, the deflation that has continued for some 15 years in Japan. Here, I would like to make two points. The first is how the problem in Japan differs from that in other economies. Second, by looking at the past 15 years, I will show how Japan’s economic activity and prices have developed. By reviewing the problem of Japan’s deflation based on a comparison with overseas and historical perspectives, I hope to make the measures against deflation – namely, the Bank’s QQE – better understood. BIS central bankers’ speeches A. Challenges facing overseas economies and Japan’s economy Let me start by viewing the problem of Japan’s deflation through a comparison with overseas economies. As mentioned, overseas economies as a whole are gradually heading toward a pick-up, although the pace is quite modest. Therefore, in the United States and Europe a negative output gap remains – excess labor force and excess facilities – and unemployment rates remain elevated (Chart 6). Unemployment rates in the major advanced economies are at levels substantially higher than those prior to the Lehman shock. In the euro area, the rate surged after the Lehman shock and has increased further due mainly to the European debt problem. In the United Kingdom, the rate has remained at a high level. In the United States, while the rate has been declining moderately, its level remains somewhat high. In contrast, Japan’s unemployment rate has declined to 3.8 percent, almost the same level as the low of 3.6 percent prior to the Lehman shock. On the price front, even though many economies have registered somewhat lower growth compared with their potential, the year-on-year rate of change in consumer prices has been hovering around 2 percent, the rate targeted by central banks. The year-on-year rate of increase in the CPI in the United States, the euro area, and the United Kingdom has centered around 2 percent from a long-term perspective, albeit with some fluctuations (Chart 7). Firms’ and households’ medium- to long-term inflation expectations have also been stable generally around 2 percent. In this situation, we can say that inflation expectations are anchored. This means that even when the observed inflation rate is affected by economic conditions, inflation expectations do not deviate substantially from, and are thus anchored to, the central bank’s target inflation rate. Taking into account the economic and price developments across countries, at present – in the United States and Europe – the top priority is to continue to provide or to further strengthen the stimulus to the real economy. While this sounds like an orthodox challenge, from the standpoint of central banks, it presents difficulties in terms of steering their policy. As a result of fiscal actions taken in response to the economic plunge following the Lehman shock, the room is limited for providing further stimulus to the economy from the fiscal side, and there are strong expectations for policy responses from the monetary policy side. However, if the inflation rate continues to exceed the inflation target due to monetary easing, there is a risk that people’s confidence in the price stability target will be lost. It can be said that central banks in the United States and Europe have been addressing the challenge of how to stimulate the real economy from the monetary policy side while avoiding the risk of de-anchoring inflation expectations and inducing future inflation. In the United States and the United Kingdom, the central banks have declared that they will continue with monetary easing until unemployment rates decline to some extent, with the condition that inflation forecasts do not deviate significantly from the price stability target. These actions reflect an attempt to strike a balance in the trade-off between inflation and unemployment. In contrast, Japan faces a different type of challenge. In the United States and Europe, people’s inflation expectations have been anchored around the central banks’ targeted inflation rates. In Japan, amid some 15 years of deflation, deflationary expectations have become entrenched among people – in other words, people’s inflation expectations have been anchored at a substantially low level of around 0 percent. We need to de-anchor such expectations, increase them to the price stability target of 2 percent, and anchor the expectations again at this level. How can this be achieved? I will discuss this next while looking back at the changes in economic activity and prices since the second half of the 1990s. BIS central bankers’ speeches B. Changes since the second half of the 1990s Economic and price developments, and their effects since the second half of the 1990s In retrospect, since the second half of the 1990s a series of events – such as banks’ nonperforming-loan problems, the Asian currency crisis, the Lehman shock, and the Great East Japan Earthquake – weighed strongly on Japan’s economy. In addition, a variety of factors put direct downward pressure on prices. These included low-priced imports from emerging economies, firms’ low-price strategies to counter intensifying competition stemming from deregulation, and a reduction in the wage level due to firms’ increased reliance on nonregular employment. In response, the Bank implemented a series of monetary easing policies such as the zero interest rate policy, the quantitative easing policy, and the comprehensive easing policy. Thanks to these policies that stimulated the real economy, from time to time the economy began to head toward recovery. However, except for a period reflecting the effects of a surge in oil prices, these policies failed to put an end to the trend of a price decline. On the contrary, as deflation became protracted, deflationary expectations became entrenched, which made overcoming of deflation even more difficult, producing a vicious circle. Once the tendency to act based on such expectations becomes entrenched among households and firms, change is not an easy task. In this way, by becoming prolonged, deflation became a challenge that was even more difficult to overcome. Changes in the Phillips curve Let me explain the changes I have just mentioned by using the concept of the Phillips curve (Chart 8). The Phillips curve illustrates the relation between the output gap and the inflation rate. Put simply, it shows that when the economy is strengthening with the labor market as well as the goods and services markets being tightened, prices tend to increase. In the Phillips curve, the vertical axis depicts the inflation rate and the horizontal axis depicts the output gap. It is assumed that the relation of the two is an upward-sloping curve, that is, when the economy recovers and the output gap moves to the right, the inflation rate moves upward accordingly. Let us look at the change in the Phillips curve for Japan over the past 15 years. The blue line is the Phillips curve based on data through the first half of the 1990s. The red line is the Phillips curve based on data since the second half of the 1990s. As you can see, the entire curve has shifted downward. This means that, even with the same economic conditions, the inflation rate is now lower than in the past. When the output gap is zero – that is, when the economy is at an average level – the year-on-year rate of change in consumer prices is 1.1 percent on the blue Phillips curve, while it is 0.3 percent on the red Philips curve, showing a substantial decline. As a result of this downward shift, based on the current shape of the Phillips curve for Japan, a substantially positive output gap of 6 percent would be necessary to achieve the 2 percent price stability target. This gap matches the peak of the bubble period from the end of the 1980s to the early 1990s. Of course, the Bank does not aim to reproduce such a large output gap. Even if 2 percent inflation is achieved when the economy is booming, the inflation rate will decline again during the economic cycle. To achieve 2 percent inflation in a stable manner, therefore, it is necessary to create a relation between prices and economic activity such that inflation becomes 2 percent when the economy is in an ordinary state. If we think of it in this way, it becomes clear that the 2 percent price stability target cannot be achieved in a sustainable manner by simply following the past approach of increasing the inflation rate by stimulating the economy. A policy that aims at shifting the Phillips curve upward is required. To put it differently, a policy that is designed to change people’s deflationary expectations is necessary. To use the metaphor of the anchor, it is a policy to raise the anchor and set it at the new level of 2 percent. BIS central bankers’ speeches C. Overcoming challenges As I have explained, in Japan, due to prolonged deflation of some 15 years, the Phillips curve has shifted downward. In other words, there is an entrenched expectation that it is difficult for prices to increase. I will next explain how to escape from this situation. Of course, the traditional path of stimulating the economy through monetary easing and thereby narrowing the negative output gap continues to be important. At present, a negative output gap remains in Japan’s economy, and this needs to turn positive. In the process, the experience of an actual increase in the inflation rate will help increase people’s inflation expectations. However, given that deflation expectations are entrenched in Japan – that is, that the shape of the Phillips curve has changed – turning the output gap positive by itself will not suffice to overcome deflation. Therefore, the Bank considered it necessary to take a step significantly different from the previous policies by working directly on people’s expectations to dispel deflationary expectations – to shift the Phillips curve upward. Given that the continuation of deflation in itself makes overcoming of deflation even more difficult, the Bank judged it necessary to implement its new initiatives as soon as possible. This led to the introduction of the QQE (Chart 9). A strong and clear commitment as well as a new phase of monetary easing both in terms of quantity and quality The QQE comprises two features aimed at drastically changing people’s expectations at the earliest possible time. First, to eliminate deflationary expectations that were entrenched among firms and households, the Bank showed its determination that it would definitively overcome deflation through a strong and clear commitment. The Bank clearly stated that it would achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years, thus clearly specifying the period in which it would achieve the target. Second, considering that deflation had continued for some 15 years, even with a strong commitment, it was difficult for the Bank’s strong determination to be seen as convincing without underpinning measures in place. In particular, from the viewpoint of achieving the target “at the earliest possible time,” it was important for the Bank to take measures bold enough to be considered different from the measures in the past. The Bank therefore decided to change the main operating target for money market operations from the uncollateralized overnight call rate (i.e., interest rates) to the monetary base (i.e., quantity), to be doubled in two years. In addition, to achieve this target the Bank also decided to double its holdings of Japanese government bonds (JGBs) and exchange-traded funds (ETFs) in two years. Furthermore, the Bank decided to extend the average remaining maturity of its JGB purchases so that it would more than double. In this way, the Bank decided to introduce a new phase of monetary easing both in terms of quantity and quality. Continuation of monetary easing In addition, with regard to the future policy stance, the Bank clearly stated that it would continue with the QQE as long as it is necessary for maintaining the target of 2 percent in a stable manner. While the Bank’s commitment is to achieve a 2 percent inflation rate at the earliest possible time, this does not mean that a temporary achievement of this rate is sufficient. It is important to maintain the 2 percent target in a stable manner. To this end, it is necessary for not only the observed inflation rate but also medium- to long-term inflation expectations to be about 2 percent. If the observed inflation rate hovers around 2 percent on average and firms and households act on the assumption that prices will increase by about 2 percent, this will lead to price stability in the medium to long term. To use the metaphor of the anchor, the aim is to set the 2 percent anchor deeply in people’s understanding and BIS central bankers’ speeches make the observed inflation rate hover around the anchor. In terms of the Phillips curve, this means that when the economy is in an average state – when the output gap is zero – the 2 percent inflation rate will be achieved. This is what the Bank means when it says “maintain 2 percent in a stable manner.” The Bank will continue with the QQE as long as it is necessary to achieve such a state while assessing the trend developments in inflation. If I may hasten to add one point, to this end it becomes more necessary than ever to gauge inflation expectations as accurately as possible. However, inflation expectations are intrinsically difficult to measure. They are not directly observable, and there are a variety of inflation expectations depending on who is forecasting what type of prices. With this in mind, the Bank has been carefully analyzing a number of indicators of inflation expectations, such as the break-even inflation rate using inflation-linked bonds as well as various surveys conducted on households, economists, and market participants, and doing its utmost to gauge accurately the changes in people’s inflation expectations. The Bank will continue to improve the accuracy of its judgment by thoroughly examining a wide range of data, including firms’ inflation expectations, which are scheduled to be added to the Tankan (ShortTerm Economic Survey of Enterprises in Japan) survey in the first half of 2014. Concluding remarks A little less than six months have passed since the introduction of the QQE. The Bank has been steadily pursuing the policy as initially scheduled (Chart 10). The monetary base expanded to 177 trillion yen as of end-August from 146 trillion yen as of end-March, steadily accumulating toward the targeted 200 trillion yen as of the end of 2013. The Bank’s JGB holdings increased to 123 trillion yen as of end-August from 91 trillion yen as of endMarch, smoothly increasing toward the targeted 140 trillion yen as of the end of 2013. The average remaining maturity of the Bank’s JGB purchases has been extended to about seven years. The QQE is truly an unprecedented policy in the sense that it aims to increase inflation expectations in a situation where there is no room to further reduce the short-term interest rate, which is the main policy tool for a central bank. While the task is by no means easy, developments thus far have been encouraging. Improvements are observed in a number of areas such as economic activity, financial markets, and people’s sentiment, and Japan’s economy has been moving smoothly along the path to achieving the 2 percent “price stability target.” To overcome deflation, which has been weighing on Japan’s economy for a protracted period, as soon as possible, the Bank will continue to pursue the proper monetary policy. 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 Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the International Monetary Fund, Washington DC, 19 September 2013, and at the Board of Governors of the Federal Reserve System, Washington DC, 20 September 2013.
Sayuri Shirai: Monetary policy and forward guidance in Japan Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the International Monetary Fund, Washington DC, 19 September 2013, and at the Board of Governors of the Federal Reserve System, Washington DC, 20 September 2013. * I. * * Introduction It is a great honor to have this opportunity to address you today on Japan’s economy and its monetary policy. Since April 2013, when the Bank of Japan introduced quantitative and qualitative monetary easing (QQE) that further strengthened existing monetary easing, nearly six months have passed. In these six months, a number of positive outcomes have materialized: these also reflect stimulus measures taken by the Japanese government. Compared with last year, stock prices have been higher; more active transactions are taking place in the financial and real estate sectors; the yen’s exchange rate has been at more depreciated levels; and funding costs for firms and households in the loan and bond markets remain very accommodative. Most importantly, the growth momentum of Japan’s economy is gaining traction – this is evidenced by the positive economic growth rates seen in the last three consecutive quarters (with an annualized real GDP growth rate of 3.8 percent in the second quarter of 2013). The unemployment rate dropped to 3.8 percent in July 2013, approaching the lowest level in recent years of 3.6 percent recorded in July 2007, before the financial crisis. There are some signs of the economy moving out of deflation with the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food, or the core CPI, turning positive at 0.4 percent in June and 0.7 percent in July. Given the amount of global media attention being paid to QQE, it appears that its content is becoming increasingly familiar to many experts and market participants. For this reason, I would rather talk today about QQE from a somewhat different perspective, namely from the standpoint of “forward guidance” – a topic that has been hotly debated globally in recent years. In general, forward guidance refers to communication strategy undertaken by a central bank to provide information to the markets and the public (households and firms) on its future monetary policy stance. Forward guidance is currently used by some central banks in advanced economies facing the zero lower bound on short-term interest rates (hereafter called the zero lower bound) as an accommodative monetary policy. I will begin my speech by explaining why forward guidance is important for Japan in Section II. Section III will focus on general issues related to forward guidance. I will then give my viewpoint on the current practice of monetary policy as adopted by the Bank, compare it with previous monetary policy practices, and highlight some of the ways the practice differs in Japan compared with other economies. Section IV will review QQE progress to date through an overview of current price performance and its outlook, followed by an overview of economic activity. II. Why is forward guidance so important for Japan? I want to first address the question of why forward guidance is so important for Japan. As you know, the Bank is attempting to overcome the mild deflation that has lasted in Japan for nearly 15 years since 1998 and to achieve the 2 percent price stability target adopted in January 2013. The rate of price changes since 1998 is averaged at minus 0.3 percent. Before proceeding with my speech, let me pause here for a moment. I would like to bring up a question that I often encounter abroad. That is What is the problem with having mild deflation in Japan when the unemployment rate has remained so low even throughout the global financial crisis? BIS central bankers’ speeches Long-standing mild deflation It is a legitimate question. It is true that Japan’s unemployment rate has been much lower than that of other economies: the highest level it reached so far during the global financial crisis was only 5.5 percent in July 2009. Certainly, deflation is persistent, but it is mild and has avoided a deflationary spiral. On the surface, therefore, it may be difficult to comprehend Japan’s fundamental problems. My response is normally provided as follows. Mild deflation has been exerting adverse effects on Japan’s economy because it reflects a long-standing negative output gap (chronic demand shortage), low expectations of future economic and market growth by firms, as well as sluggish expectations of future income growth by households (Chart 1). Deflation is also closely associated with the long-term yen appreciation trend that adds to the pessimism of firms already struggling to maintain price competitiveness. These phenomena – together with a decline in total population, the rapid pace of aging of the population, and the slow pace of structural reforms – have discouraged firms from actively engaging in business fixed investment and innovative activities, have led to households saving more because of growing concerns about the future, and have prompted financial institutions to undertake risk-averse investment strategies. In this environment, households take the lower prices of goods and services for granted as they develop a deflation-oriented mindset and thus believe that prices will not increase. In addition, firms follow a deflation-oriented pricing behavior and hence use the sales prices of their rivals and the purchasing behavior of customers to set their prices, even when the supply-demand balance improves. Moreover, financial institutions become increasingly accustomed to deflation-oriented investment strategies, and shift their investments from risk assets (such as stocks, corporate bonds, mutual funds, loans, real estate, and foreign securities) to safer assets (such as Japanese government bonds [JGBs], deposits, and cash). Why was the 2 percent target adopted? As I mentioned earlier, in January of this year the Bank established a target of 2 percent to achieve price stability. I would like to explain here why this course was decided on. In essence, Japan’s economy had been quite depressed and gradually eroding for some time. Given this background the reason for setting the 2 percent target, in my view, is the belief that deflation is more harmful to an economy than inflation, and that it is important to achieve a comparable level of (mild) inflation to that of major advanced economies. 1 The Bank’s aim of achieving the 2 percent price stability target is particularly challenging. It implies that the medium- to long-term inflation expectations of both the markets and the public need to be increased and anchored at around the 2 percent level. No other major economies have ever had to face such an undertaking. In more formal economic terms, the important point is that by raising inflation expectations toward 2 percent, the Phillips curve shifts upward and its slope steepens, thereby enhancing the responsiveness of price changes to the supplydemand balance (Chart 2). Forward guidance used for anchoring inflation expectations I stress that “forward guidance” is essential to anchor inflation expectations, particularly in the case of Japan, with its requirement to firmly establish 2 percent medium- to long-term inflation expectations in the minds of the markets and the public. We should note here that the Bank needs to undertake an accommodative monetary policy with two main aims: (1) achieving economic recovery, and (2) anchoring inflation expectations at the target level. See Sayuri Shirai, “Japan’s Economic Activity, Prices, and Monetary Policy: Monetary Policy in the Past and Present,” Speech at a Meeting with Business Leaders in Asahikawa, Bank of Japan, 2013. BIS central bankers’ speeches Contrast this with the situation of other economies’ central banks. Their inflation expectations are already well-anchored at the target level of inflation, and thus, their primary aim is achieving economic recovery (see Section III). In Japan, the second aim of anchoring inflation expectations requires the Bank to first help transform the deflation-oriented behavior of all entities and then to steadily raise their inflation expectations. In this context, the Bank’s task can be considered more challenging than in other economies, and its forward guidance operates under different circumstances. It needs to particularly target price movements and have a stronger commitment regarding monetary easing policies. III. General issues on forward guidance and its implementation in Japan Forward guidance is now a popular topic among the central banks of advanced economies; however, it has been practiced in Japan for some time. Indeed, the Bank was the pioneer in using forward guidance as an accommodative monetary policy tool in the face of the zero lower bound, initiating the practice as early as 1999 when the zero interest rate policy was adopted (Chart 3). Since then, the Bank has come up with various forms of forward guidance at each monetary easing period, as I will later discuss. Moreover, since the onset of the global financial crisis, forward guidance has attracted global attention mainly as a result of its active use by the Federal Reserve under the zero lower bound. It has also recently been implemented as a tool by the European Central Bank (ECB) and the Bank of England (BOE), which is discussed in the Appendix to my speech. A. General issues relating to forward guidance The term “forward guidance” is now frequently used by a number of central banks and experts but it appears to have different meanings under different contexts. For clarity here, I assume that forward guidance simply refers to the provision of information by a central bank about future monetary policy to the markets and the public, regardless of whether or not the central bank calls it forward guidance. For example, the Bank does not officially use the term “forward guidance” to describe its communication strategy, but it could be regarded as such. Essentially, forward guidance is aimed at enhancing the effectiveness of monetary policy. It can be classified into two types depending on the objective. The first objective is to clarify a normal monetary policy reaction function (or the conduct of normal monetary policy) envisaged by a central bank. By contrast, the second objective commits to the continuation of a more accommodative policy under the zero lower bound than would otherwise have been anticipated with the normal policy reaction function. I will further explain these objectives shortly, but one difference between them is that the impacts on financial markets – such as generating downward pressure on long-term interest rates (and raising asset prices) – are not necessarily intentional and present in the case of the first objective, but are always deliberately pursued as a result of the unconventional monetary policy tool in the case of the second objective. While forward guidance has attracted recent attention for the role it takes in formulating exit strategies from monetary accommodation, as is the case in the United States, my speech today focuses instead on its role in introducing and maintaining a monetary stimulus. Forward guidance to clarify a normal monetary policy stance Forward guidance with the first objective may be regarded as communication strategy by a central bank to inform the markets and the public about the normal policy reaction function of the monetary policy (such as the Taylor rule). This can be classified as “Delphic forward guidance” according to Campbell et al. (2012). 2 Forward guidance in this instance can take the form of (1) indirect signals about a future monetary policy stance (for example, about a Jeffrey R. Campbell, Charles L. Evans, Jonas D. M. Fisher, and Alejandro Justiniano, “Macroeconomic Effects of Federal Reserve Forward Guidance,” Brookings Papers on Economic Activity, Spring 2012: 1–54. BIS central bankers’ speeches future policy interest rate path) through publishing comments and projections on the outlook for prices and economic activity with risk balance assessments, or it can take the form of (2) direct signals through releasing the future policy interest rate numerical projections. In any case, the future policy stance of a central bank is a forecast based on the currently available information and the normal reaction function. This forecast is updated as new information becomes available. The important point here is that the central bank makes no commitment on its future monetary policy. Generally, this type of guidance is used to enhance transparency and predictability for the markets and the public, so it does not necessarily affect financial markets. Nonetheless, there are some cases where this guidance may favorably influence financial markets. An example of this would be a case where forward guidance results in a clearer understanding by the markets and the public of a central bank’s policy reaction function. They thus adjust their expectations accordingly, even if the central bank’s monetary policy stance is constant. There may also be cases where their better understanding contributes to lowering the degree of uncertainty, and may result in, for example, reducing the volatility of the bond market and term premiums. Finally, there may be instances where the markets and the public believe that a central bank has superior information that can be used for assessing future prices and economic activity. Forward guidance used to signal a more accommodative policy stance The second objective of forward guidance is to signal a more accommodative policy stance. In this instance, it is used as communication strategy for a central bank at the zero lower bound and also as a deliberate additional monetary easing measure, by shifting from the normal policy reaction function. Campbell et al. refer to this type of guidance as “Odyssean forward guidance.” Here the central bank commits to a longer duration of accommodative monetary policy than is generally anticipated by the markets and the public. This commitment to a longer accommodative monetary policy is needed to compensate for the period constrained by the zero lower bound. There has been gradual accumulation of theoretical and empirical analyses on this perspective in the last decade. 3 Its most extreme form is an “unconditional commitment” to continue the current monetary easing policy in the future. In other words, a central bank will maintain its already-promised accommodative stance even after economic recovery strengthens and whatever shocks take place in the future. The lower the degree of conditionality, the more effective monetary policy is. However, there is a trade-off between greater effectiveness and higher flexibility regarding the conduct of future monetary policy. In practice, it is not realistic for a central bank to make an extreme unconditional commitment because of the time-inconsistency issues. It is difficult for a central bank to commit to a current accommodative monetary policy in the long term without taking any consideration of the fact that an excessive rise in inflation may dis-anchor medium- to long-term inflation expectations. A similar concern is often raised in relation to the impacts on excessive financial instability and asset price bubbles when a policy of low interest rates is sustained for too long. Therefore, “conditional commitment” or the use of expressions that reduces the degree of commitment is a form generally undertaken by central banks. See, for example, Paul R. Krugman, “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity, 1998 (2); 137–205; David Reifschneider and John C. Williams, ‘‘Three Lessons for Monetary Policy in a Low-Inflation Era,’’ Journal of Money, Credit and Banking, 32 Part 2, 2000: 936–66; Gauti B. Eggertsson and Michael Woodford, “The Zero Bound on Interest Rates and Optimal Monetary Policy,” Brookings Papers on Economic Activity, 2003 (1); 139–211; and Michael Woodford, “Methods of Policy Accommodation at the Interest-Rate Lower Bound,” Speech delivered at the 2012 Economic Policy Symposium, Federal Reserve Bank of Kansas City, 2012. BIS central bankers’ speeches Open-ended, calendar-based, and state-contingent forward guidance Forward guidance can take various forms. For example, it can be applied solely to the policy interest rate or to a broader set of monetary stimulus measures including the policy rate and asset purchases. It can be categorized as open-ended, calendar-based, or state-contingent (or threshold-based). 4 Open-ended guidance can refer to an abstract description of the monetary easing policy duration (such as “a considerable period” or “an extended period”) or of the economic conditions under which the accommodative policy will be maintained (such as “until deflationary concerns are dispelled”). Calendar-based guidance uses specific date expressions for monetary easing, such as “over the next six months.” Some people consider that calendar-based forward guidance is superior to open-ended forward guidance from a transparency and effectiveness perspective. State-contingent guidance provides a clear description of the economic conditions under which the accommodative policy will be maintained by using, for example, a threshold on the inflation outlook. When comparing calendar-based and state-contingent forward guidance, the state-contingent approach is regarded as being superior for two reasons. First, it provides assurance of a central bank’s intention to maintain its accommodative monetary policy even after economic recovery strengthens by introducing such specific expressions in the guidance. Second, a clear description of the relationship between the conduct of future monetary policy and the economic conditions contributes to enhancing transparency and predictability in the eyes of the markets and the public. The major drawback of the calendarbased approach is the difficulty in distinguishing whether an extension of the period for maintaining the current accommodative monetary policy is, for example, (1) the result of more pessimistic forecasts by a central bank on prices and economic activity or (2) the result of a more accommodative policy. The former may discourage aggregate demand while the latter may promote aggregate demand. The state-contingent approach may help to distinguish between these two cases. In relation to economic conditions (or thresholds), forward guidance can focus solely on prices or can include a wide set of economic variables (e.g., the unemployment rate). The different forms here reflect (1) the presence of other mandates given to the central bank, such as the dual mandate in the case of the Federal Reserve; (2) the specific environment surrounding monetary policy at the time (e.g., whether current inflation trends are above or below the inflation target); and (3) the detailed measures adopted (e.g., policy interest rate, asset purchases, or a combination of both). The most important point I wish to highlight here is that the degree of details contained in the description of forward guidance can vary over time. It can be refined over time as economic recovery becomes firm, by giving more specific information about the duration of monetary accommodation or the economic conditions. B. Forward guidance in Japan Let me now focus on forward guidance in Japan. The Bank has a long history of practicing communication strategy to generate monetary easing under the zero lower bound. There are a number of empirical analyses pointing to the effectiveness of this policy in Japan, particularly in regard to the impacts on financial markets. 5 Forward guidance also constitutes an important element of QQE. I will first explain the forward guidance used under the current See, for example, Bank of England, “Monetary Policy Trade-Offs and Forward Guidance,” 2013. See, for example, Nobuyuki Oda and Kazuo Ueda, “The Effects of the Bank of Japan’s Zero Interest Rate Commitment and Quantitative Monetary Easing on the Yield Curve: A Macro-Finance Approach,” Bank of Japan Working Paper Series, No. 05-E-6, 2005; Hiroshi Ugai, “Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses,” Bank of Japan Working Paper Series, No. 06-E-10, 2006; and Jouchi Nakajima, Shigenori Shiratsuka, and Yuki Teranishi, “The Effects of Monetary Policy Commitment: Evidence from Time-varying Parameter VAR Analysis,” IMES Discussion Paper Series, No. 2010-E-6, Bank of Japan, 2010. BIS central bankers’ speeches QQE, then provide my personal views on the rationale for its structure, followed by a comparison with past measures and other countries’ experiences. Forward Guidance under the Current QQE The Bank released a statement on April 4, 2013, with the introduction of QQE, containing the following two descriptions regarding the time span of monetary accommodation: (1) The Bank will achieve the price stability target of 2 percent . . . at the earliest possible time, with a time horizon of about two years (I will call this “the first set of forward guidance”). (2) The Bank will continue with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate (I will call this “the second set of forward guidance”). You might wonder what the relationship between these two descriptions is. In answer to this, Bank of Japan Governor Haruhiko Kuroda explained in his speech on April 12, 2013, that QQE included all the necessary measures to achieve the 2 percent target with a time horizon of approximately two years. He stressed, however, that because there is uncertainty in any economy and there is always a degree of latitude in people’s expectations, it was appropriate to state that the Bank would continue with monetary easing as long as it was necessary to achieve the 2 percent target in a stable manner so that everyone was convinced that sufficient monetary easing would be implemented. Thus, these two descriptions are closely connected to reinforce the credibility of the Bank’s commitment to achieving its stated target. I would like to further elaborate on this with my personal view, which does not necessarily reflect the consensus among the Bank’s Policy Board members, focusing on the respective roles of both parts of the released statement as forward guidance. In essence, this unique structure of providing two sets of forward guidance is attributable to the Bank’s challenging tasks of transforming the deflationary mindset and of increasing inflation expectations to anchor around the 2 percent level. The first set of forward guidance was included in the first part of the released statement and was positioned as the rationale for introducing “a new phase of monetary easing both in terms of quantity and quality” (Chart 4). To implement this bold new monetary policy, the Bank decided to shift the main operating target for money market operations from the uncollateralized overnight call rate to the monetary base. Decisions were also made to double the monetary base and the amounts outstanding of JGBs and exchange-traded funds (ETFs) in two years by end-2014, as well as to more than double the average remaining maturity of JGB purchases (from less than three years to about seven years). On an annual basis, the monetary base will be increased by about 60–70 trillion yen, JGBs (including those with maturities of up to 40 years) by about 50 trillion yen and ETFs by about 1 trillion yen (Chart 5). In addition, Japan real estate investment trusts (J-REITs) will be purchased at an annual pace of about 30 billion yen over the same period. 6 The purpose of this first set of forward guidance was to signal to the markets and the public the Bank’s strong determination to achieve its 2 percent target within a time horizon of about two years, normally pursued by other central banks under the inflation targeting framework. The guidance combines both calendar-based (i.e., about two years) and state-contingent (i.e., 2 percent) features. The calendar-based feature was considered to be essential to gain the confidence of the markets and the public in both the Bank’s intention and the possibility In addition, the Bank will continue the purchases of CP and corporate bonds until their amounts outstanding reach 2.2 trillion yen and 3.2 trillion yen, respectively, by end-2013. Thereafter it will maintain those amounts outstanding. The Bank also flexibly purchases treasury discount bills (T-Bills) and conduct money market operations up to the maximum duration of one year. BIS central bankers’ speeches of achieving 2 percent at the earliest possible time. An improvement in confidence may accelerate the pace of increasing the medium- to long-term inflation expectations and may enhance the responsiveness of price changes to the supply-demand balance. The second set of forward guidance was placed under the subheading “the continuation of QQE” in the mid part of the statement. It is a conditional commitment, because the continuation of monetary easing is subject to the examination of upside and downside risk factors (Chart 4). It is also a state-contingent one, linking to the continuation of QQE, and plays a greater role than the first set of forward guidance in stabilizing medium- to long-term inflation expectations at around 2 percent. As a related issue, the expression “in a stable manner” described in the Bank’s second set of forward guidance may give the impression of a broad description of the conditions. However, I view this expression to be appropriate at present, because the formation of medium- to long-term inflation expectations entails uncertainty. In my opinion, this is especially true when the Bank attempts to raise inflation expectations and subjective judgment by the Policy Board members is unavoidable on whether medium- to long-term inflation expectations will be stabilized at around 2 percent, and when. Additionally, there is no example in other countries where central banks raised inflation expectations, for the Bank to use as a reference. Some measurement constraints also exist, including the fact that (1) there are no precise indicators measuring the inflation expectations of households and firms; (2) statistical bias is included in some survey data – for example, households’ inflation expectations tend to be upwardbiased in Japan, while the diffusion index (DI) for expected sales prices in the Tankan (ShortTerm Economic Survey of Enterprises in Japan) tends to be downward-biased; (3) in terms of market-based indicators, the impact of the Bank’s JGB purchases needs to be taken into account; and (4) the breakeven inflation rate (BEI) indicator also reflects the differences in liquidity between fixed-rate and inflation-indexed bonds. Nevertheless, as prices and economic activity firmly improve and as the process of increasing inflation expectations becomes clearer, I personally feel that, in the longer-term view points, there may be an opportunity to refine the second set of guidance with more specific information. These two sets of forward guidance are not mutually exclusive, as the first set of guidance can be considered as the “necessary condition” for achieving the second, whereas the second set of forward guidance shows a strong commitment to continue QQE for as long as necessary to stably achieve the 2 percent target (Chart 4). Therefore, while the time horizon of these two sets of guidance overlaps, the second set of guidance may imply a somewhat longer time horizon. In addition, the second set of guidance plays an essential role in reducing volatility of long-term interest rates, and in preventing them from overshooting. In my view, this second set of guidance warrants any necessary actions by the Bank beyond the two-year horizon, if it judges it necessary to do so in light of stably achieving 2 percent. It also suggests that the Bank will not consider an exit from monetary easing before this statecontingent guidance is achieved. Is the bank’s forward guidance open-ended? The BOE referred to the Bank of Japan’s second set of forward guidance under QQE as “open-ended” in its report released August 2013. 7 Based on my earlier arguments, this classification is not consistent with my assessment, although I fully respect the BOE’s judgment and analysis. When the two sets of forward guidance are viewed together, my opinion is that the Bank’s forward guidance is multi-layered, largely state-contingent, and focuses on the 2 percent price stability target with a strong (conditional) commitment. The BOE’s conclusion may have been drawn from the fact that only the second set of forward Bank of England, “Monetary Policy Trade-Offs and Forward Guidance.” BIS central bankers’ speeches guidance was referred to in the Bank of Japan’s April 2013 statement under the subheading “The continuation of QQE” and that the expression “in a stable manner” may have appeared qualitative and vague. However, as described above, I feel that the expression “in a stable manner” is appropriate considering the circumstances. C. Clearer and stronger commitments compared with past practices The forward guidance used by the Bank for the current QQE reflects clearer and stronger commitments compared with previous guidance. In the past, the Bank adopted forward guidance at each period of monetary easing: (1) the zero interest rate policy (February 1999– August 2000); (2) the quantitative easing policy (March 2001–March 2006); and (3) comprehensive monetary easing (October 2010–March 2013), as summarized in Charts 6 and 7. First round of forward guidance: 1999–2000 The first round of forward guidance adopted in 1999 was transmitted to the markets and the public in the form of a declaration – rather than a statement – by the then Bank of Japan Governor Masaru Hayami, at a press conference in April 1999, two months after the adoption of the zero interest rate policy. He indicated that he thinks the Bank will maintain the zero interest rate policy until deflationary concerns are dispelled. This could be classified as openended forward guidance, linking to the continuation of the zero interest rate policy. However, it has been pointed out that the expression “deflationary concerns” was vague without providing any clear definition of deflation. As a result, this allowed for a wide range of interpretations of and judgments on the exit timing, thereby making it difficult for Policy Board members to make a collective judgment and for the markets and the public to be adequately convinced. For example, while industrial production and exports did improve, the rate of change in the (headline and core) CPI remained negative. Nonetheless, the Bank terminated this policy in August 2000 and raised the uncollateralized overnight call rate to an average of around 0.25 percent, claiming that downward pressure on prices stemming from weak demand had markedly receded. A number of external commentators have expressed the view that the exit timing was too early. Second round of forward guidance: 2001–2006 The second round of forward guidance was adopted when the quantitative easing policy was initiated in March 2001, after the policy rate was lowered to an average of around 0.15 percent in the previous month. Under the policy framework, the Bank shifted the main operating target for money market operations from the uncollateralized overnight call rate to the current account balances held by financial institutions at the Bank. The target amount of the balances was raised nine times from the initial 5 trillion yen (which was higher than the required reserve level of 4 trillion yen) to approximately 30–35 trillion yen in January 2004. The reserve targeting was achieved mainly through relatively short-term money market operations with some purchases of long-term JGBs. The Bank decided that the economic conditions warranted drastic monetary easing. It issued a statement in March 2001 stating that monetary easing would continue to be in place until the core CPI registers stably zero percent or an increase year on year. This was state-contingent guidance, linking to the continuation of the quantitative easing policy. It should be noted that the economic condition used in the guidance was based on the actual performance of the core CPI and was thus clearer than in the earlier zero interest rate policy case. In October 2003, the Bank provided further detailed information on the expression “stably zero percent or an increase” to clarify its commitment for continuing the quantitative easing policy. It refined the expression so that (1) not only that the most recently published core CPI should register zero percent or above, but also that such tendency should be confirmed over a few months, and (2) the prospective core CPI will not be expected to register below zero percent. These conditions were regarded as necessary to terminate the quantitative easing policy, and it was assumed that there might be cases where BIS central bankers’ speeches quantitative easing would be continued even if these conditions were fulfilled. This refined state-contingent guidance applied economic conditions based on both actual and projected price performance. In this circumstance, the core CPI growth rate turned positive in November 2005 (that of the headline CPI turned positive in January 2006). Judging that all the conditions were fulfilled, the Bank terminated the policy in March 2006 by reintroducing the uncollateralized overnight call rate as a money market operations operating target (initially at effectively zero percent). However, these CPI figures were retroactively revised downward and the previously positive figures fell into negative territory in August 2006, when the CPI base year was shifted from 2000 to 2005. The scale of the downward revision was greater than in previous cases and was thus larger than projected. Partly because of this downward revision, there were a number of external views that the exit timing was too early. Third round of forward guidance: 2010–March 2013 The third round of forward guidance was adopted in October 2010, when comprehensive monetary easing was introduced through a virtually zero interest rate policy and the Asset Purchase Program (hereafter the Program). The type of assets purchased under the Program covered JGBs (with remaining maturity from one to three years), treasury discount bills (T-Bills), CP, corporate bonds, ETFs, and J-REITs. The total amount outstanding of the Program was increased gradually from an initial 35 trillion yen to 65 trillion yen at the end of 2012. The amount was scheduled to further expand to 101 trillion yen by the end of 2013 and to 111 trillion yen by the end of 2014. Thereafter, the amount of 111 trillion yen was to be maintained for an undefined period of time. The forward guidance statement indicated that the Bank will maintain the virtually zero interest rate policy until price stability is in sight on the basis of the “understanding of medium- to long-term price stability,” on the condition that no serious risk factors were identified. In addition, “medium- to long-term price stability” was defined as a positive range of 2 percent or lower, with the midpoints of most members’ “understanding” being around 1 percent. This was state-contingent guidance, based on the outlook for prices and linking to the policy interest rate. It was also a conditional commitment, as a risk factor consideration was introduced for the first time as an additional constraint. Importantly, in February 2012, the guidance was further strengthened with the statement For the time being, the Bank will pursue powerful monetary easing by conducting its virtually zero interest rate policy and by implementing the Asset Purchase Program . . . with the aim of achieving the goal of 1 percent. The Bank will continue pursuing the powerful easing until it judges that the 1 percent goal is in sight, on the condition that no significant risk factors were identified. This refined guidance was state-contingent, linking to the maintenance of both the policy interest rate and asset purchases. It was clearer and more powerful than the original one for several reasons. First, it used the word “goal” (which is uniformly set through the consensus of all members of the Policy Board) rather than “understanding” (which was simply a collection of different member views). Second, it clarified that the Bank sets the goal at 1 percent for the time being, while maintaining the medium- to long-term goal within a positive range of 2 percent or lower. However, the drawbacks were that it was not clear whether the Bank was pursing the 2 percent goal or a lower one and how monetary easing was associated with the 2 percent goal. 8. Factors leading to the adoption of QQE Taking these drawbacks into account, the Bank finally adopted the 2 percent price stability target in January 2013. The statement it released indicated that the Bank will pursue Sayuri Shirai, “Japan’s Monetary Policy in a Challenging Environment,” Speeches at the Bank of Italy and at the Eurasia Business and Economics Society Conference Held in Rome, Bank of Japan, 2013. BIS central bankers’ speeches monetary easing and aim to achieve this target at the earliest possible time. Regarding the forward guidance, the statement indicated that the Bank will pursue aggressive monetary easing, aiming to achieve the 2 percent target, through a virtually zero interest rate policy and purchase of financial assets, as long as the Bank judges it appropriate to continue with each policy measure respectively. This was a remarkable leap in the history of the Bank’s monetary policy conduct. Nonetheless, there were some doubts expressed as to whether the 2 percent target would be achievable within the existing monetary policy framework (such as the existing asset purchase schedule and a method to purchase assets without defining the end date, which was scheduled to be introduced in January 2014). These doubts eventually led to the introduction of QQE in April of this year. 9 Differences between QQE and past practices In summary, QQE differs from the past practices in the following aspects: (1) a greater emphasis on the expectations of the markets and the public over the future monetary policy stance (this is why aggressive measures and an active use of forward guidance were adopted); (2) recognition of the importance of their medium- to long-term inflation expectations; and (3) larger-scale purchases of longer-term JGBs. Overviewing the Bank’s current and past forward guidance practices, it can be said that both the price stability objective and the related monetary policy conduct are clearer under QQE than in the past (Chart 7). Therefore, the effectiveness of QQE may be greater than that of past practices – mainly through exerting greater downward pressure on the entire yield curve, through stronger impact on the portfolio rebalance and wealth effects, and through indirect impact on the yen’s exchange rate. QQE is also likely to promote an increase in inflation expectations, thereby contributing to lowering long-term interest rates in real terms. D. Forward guidance: Differences between Japan and other advanced economies Next, I would like to make a brief comparison between forward guidance in Japan and that undertaken in the United States and Europe, details of which are included in the Appendix to my speech. I consider that there are two fundamental differences between the Bank’s current forward guidance and those adopted in other advanced economies. Need to anchor inflation expectations at the inflation target First and most importantly, major advanced economies including the United States and the United Kingdom successfully anchored the medium- to long-term inflation expectations at around 2 percent, as opposed to the case in Japan. Central banks in these economies currently hold the view that the expectations remain well-anchored, although there may be some limited concerns on dis-anchoring inflation expectations (downward in the case of the Federal Reserve because of a decline in actual inflation, and upward in the case of the BOE because of a persistent deviation of actual inflation above the 2 percent target). Therefore, the Federal Reserve and the BOE focus on maintaining the anchored inflation expectations, whereas the Bank of Japan focuses on increasing inflation expectations to around the 2 percent target and anchoring them there. This difference is reflected in the design of its forward guidance. Labor market issues The second difference in Japan’s forward guidance practice in contrast to other advanced economies is that both the Federal Reserve and the BOE have adopted employment-related conditions in their forward guidance, unlike Japan. The Federal Reserve has a dual mandate of promoting price stability and maximum employment, so the reason for this is clear. The Shirai, “Japan’s Economic Activity, Prices, and Monetary Policy.” BIS central bankers’ speeches BOE places price stability as its primary mandate; however, the inclusion of employmentrelated conditions may reflect the need to clarify the BOE’s views with regard to the existing trade-off between high inflation and low economic and employment growth. In contrast, in Japan the Bank’s primary mandate, clearly stipulated in the Bank of Japan Act, is to achieve price stability. In addition, the current unemployment rate is not a significant issue in Japan. The figure for July 2013 was as low as 3.8 percent (3.3 percent for female workers), with the lowest point in recent years being 3.6 percent in July 2007 (3.4 percent for female workers). Thus, it may not be relevant for Japan to consider introducing economic conditions relating to employment. In general, nominal wage rigidity is limited in Japan compared with the United States and Europe, which partly explains why the unemployment rate remains low. The reason for this is that firms tend to flexibly adjust wages along the business cycle through active use of bonuses for full-time workers, and an adjustment of working hours and days for part-time workers. There are issues such as differential treatments of regular and non-regular workers, and greater flexibility over labor market regulations demanded by firms. However, these are structural issues that are beyond the scope of monetary policy. IV. Price and economic performance under QQE Overviewing the framework of forward guidance in the context of QQE, you may be interested in its progress to date in Japan. I would like here to quickly review the current performance of prices and their outlook first, followed by the performance of economic activity. Some positive signs observed in prices There are some emerging signs that actual prices have begun to increase (Chart 8). The year-on-year rate of change in the core CPI finally turned positive in June 2013 at 0.4 percent and 0.7 percent in July, after a period of consecutive negative or 0 percent change starting in May 2012. The headline CPI also turned positive at 0.2 percent in June and 0.7 percent in July, following a declining trend since June 2012. This movement reflects higher import prices, improvements in economic activity, and a rise in inflation expectations. So far, the major contribution to this movement comes from an increase in electricity fees and gasoline prices mainly as a result of the increase in import prices driven by the yen’s depreciation, as well as the base effect. However, prices of a wide range of goods and services have also begun to show an increase. Moreover, the consistently-declining trends on durable goods (partly owing to the quality adjustment) appear to be mitigated. This reflects the fact that some large retail stores of home electronics are increasingly shifting from a discount price sales strategy to a higher value-added or higher unit sales price strategy. Some restaurants are also attempting to raise their unit sales prices by providing higher value-added menus and services. Hotel and lodging charges have also shown an increase. Regarding other price indices, the domestic corporate goods price index has already shown an upward trend with a positive year-on-year rate of change for five consecutive months. This is because the pace of transferring higher imported commodity prices onto corporate sales prices tends to be much faster than that of the CPI. It should be noted here that firms are likely to find it relatively easy to pass their increased input costs onto the sales prices in the near future, as compared with the past deflationary environment. The corporate services price index has also recorded a positive year-on-year rate of change for three consecutive months and there are other positive signs such as an increase in the prices of civil engineering and architectural services, hotels, and in leasing and rental. Additionally, land prices in the metropolitan areas recorded a turnaround recently, as evidenced by more active transactions and the resultant increase in residential and commercial land prices (Chart 9). Higher land prices help to improve the balance sheets of firms and financial institutions and the value of collateral, thereby contributing to more active business fixed investment and BIS central bankers’ speeches risk-taking behavior. The unit sales prices of housing have increased recently, possibly contributing to a shift in the deflation-oriented mindset and greater wealth effects. Price outlook and inflation expectations As for the outlook, the CPI performance is expected to improve further; and the price increase contributions arising on the back of improvements in the economy and higher inflation expectations are likely to be greater. Conceptually, the rate of price increase is mainly determined by the supply-demand balance (or the output gap) and inflation expectations. Currently, the output gap measured by the Bank and the Tankan composite indicator (the weighted average of the production capacity DI and the employment conditions DI) remains negative, which suggests that the economy is still operating with large slack. However, these indicators are likely to improve on the grounds of resilient domestic demand and an expected gradual pick-up in overseas demand (Chart 10). Looking at medium- to long-term inflation expectations of market participants, economists, and households, we can see that the indicators are generally rising, but are still well below the 2 percent target (Chart 11). It should be noted that shorter-term inflation expectations tend to be more volatile. They are expected to exceed 2 percent for fiscal 2014 and 2015, if the temporary impact of the scheduled consumption tax hikes is taken into account. It is estimated that an increase in the consumption tax from 5 to 8 percent in fiscal 2014 would boost inflation by about 2 percentage points for fiscal 2014, and an increase from 8 percent to 10 percent from October 2015 would boost it by about 0.7 percentage point for fiscal 2015. Given these estimates, it appears that the short-term inflation expectations have not yet fully incorporated the impacts of the scheduled tax hikes and other impacts (such as higher import prices, and accommodative monetary policy), as shown in Chart 12. There are only very short-term indicators available on the inflation expectations of firms; however, the DI for expected sales prices for the next quarter, as well as the computed sales price inflation expectations, is now showing a rising trend (Chart 13). Higher inflation expectations help to lower long-term interest rates in real terms. Depending on the measures undertaken, some indicators show that the real interest rates may have entered negative territory (Chart 14). This creates a more accommodative financial environment. An increase in inflation expectations may also contribute to promoting current consumption and housing investment. According to the Bank’s baseline scenario, the year-on-year rate of change in the core CPI is projected to reach around 2 percent – the price stability target – toward the latter half of the Bank’s projection period (fiscal 2013–2015). Taking the median price forecast of the Policy Board members, the CPI year-on-year rate of change (excluding the impact of the tax hikes) is expected to reach 0.6 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.9 percent for fiscal 2015 (Chart 15). The pace of achieving 2 percent depends on the future movement of the Phillips curve, which appears to remain largely flat at this stage (Chart 16). The closer the medium- to long-term inflation expectations are to the 2 percent target, the larger the shift in the curve (Chart 2). Additionally, the faster the pace of changing the deflation mindset of households and the deflation-oriented pricing behavior of firms, the steeper the curve will become (Chart 2). Because it may take some time before the full impact of QQE via these processes materializes, I consider there may be some degree of uncertainty regarding the duration of achieving the 2 percent target. Gradual rise in economic activity and outlook The favorable price developments discussed earlier are associated with positive economic activities. Both consumer and business confidence indicators have shown improvement (Chart 17). The high level of consumer confidence reflects the wealth effects driven by higher stock prices compared with last year and steady improvements in employment. This – together with a front-loaded increase caused by an expected rise in the consumption tax hike scheduled in April 2014 – has contributed to a resilient performance in private consumption and housing investment (Chart 18). Moreover, improved business confidence, BIS central bankers’ speeches together with an increase in sales and profits, is likely to expand the business fixed investment further as planned by firms (Chart 19). The outlook for the economy is consistent with the outlook for increased prices. According to the Bank’s baseline scenario, the economy is expected to continue a moderate recovery on the back of the resilience in domestic demand and the pick-up in overseas economies. While the economy is likely to be affected by the front-loaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, it is expected to continue growing at a pace above its potential growth rate (currently estimated to be about 0.5 percent), as a virtuous cycle of spending, production, and income operates. According to the median of the Policy Board members’ forecasts, the real GDP growth rate is expected to be 2.8 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.5 percent for fiscal 2015, averaging almost 2 percent (Chart 20). V. Concluding remarks I would like to conclude my speech today by emphasizing that the Bank’s task is not only to overcome deflation by promoting a change in the deflation-oriented mindsets of the markets and the public, but also to anchor inflation expectations at around 2 percent. This is the greatest challenge facing Japan’s economy. To this end, I believe that the Bank’s communication strategy – which in my view is constructed with two sets of forward guidance – is essential to accomplish this task. At the same time, the Bank will do its utmost to revitalize Japan’s economy and achieve sustainable economic growth. Let me also add that the success of the Bank’s monetary policy, QQE, is closely associated with the collective efforts of all entities involved. These include the government in implementing economic growth strategies and credible medium-term fiscal consolidation plans, firms in actively engaging in innovative activities and enhancing competitiveness, and financial institutions in generating risk money and innovative financial services needed to revitalize Japan’s economy. 10 I hope that my speech today was useful in fostering your understanding of the Bank’s monetary policy. Thank you very much for your attention. In this regard, the 2013 Article IV Consultation Report on Japan released by the IMF in August 2013 concludes that the full implementation of structural reforms and medium-term fiscal consolidation, with QQE, may lead to a realization of 2 percent inflation within two years and that this level of inflation can be sustained subsequently. BIS central bankers’ speeches Appendix Forward guidance practices in the United States and Europe A. Forward guidance in the United States The 2003–2004 experience In the United States, the Federal Reserve provided forward guidance in 2003–2004, when the economic recovery was weak and unemployment remained high. After lowering the target for the policy interest rate (i.e., the federal funds rate) to the historically low level of 1 percent in June 2003, the Federal Reserve provided forward guidance as a way to generate monetary accommodation. The statement issued in August 2003 indicated that the [Federal Open Market] Committee [FOMC] believes that policy accommodation can be maintained for a considerable period. This open-ended guidance was meant to signal the FOMC’s intention to keep the low policy rate for a longer period than might otherwise have been expected, to exert a greater effect on longer-term yields. 11 This expression was subsequently modified in the statement issued in January 2004, stating that the Committee believes that it can be patient in removing its policy accommodation. In May 2004, the FOMC reversed the course with an intention to gradually raise the policy interest rate. The interest rate was subsequently raised 16 times, by 25 basis points each, from June 2004 to June 2006. Forward guidance on the policy interest rate since the global financial crisis Since the global financial crisis onset, the Federal Reserve re-introduced forward guidance and applied it separately to the policy interest rate and to large-scale asset purchases adopted as unconventional measures, after lowering the policy interest rate target range to the lowest rate of 0 to 0.25 percent in December 2008. The descriptive style of forward guidance on the policy interest rate has become clearer and has evolved over time. The Federal Reserve initially started with the statement the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. The open-ended guidance was then replaced in March 2009 with the expression “an extended period,” bearing the nuance of a somewhat longer duration. It was further developed into a calendar-based style from August 2011 with the expression “at least through mid-2013.” It was subsequently adjusted to “at least through late 2014” in January 2012. In September 2012, the date description was modified to “at least through mid-2015.” In addition, the statement included the following description the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. The key here is that the expression “for a considerable time after the economy recovery strengthens” was added to the original description adopted in January 2012. The FOMC viewed that this modified description was consistent with the calendar-based description “at least through mid-2015.” Moreover, Janet Yellen, Vice Chair of the Board of Governors of the Federal Reserve System, pointed out in November 2012 that the date “mid-2015” is estimated to be later than the liftoff date implied by the normal policy rule (such as the modified Taylor rule). Moreover, this date is estimated to be shorter than, but closer to the liftoff date predicted by the optimal policy simulation (a rule to minimize the deviations of inflation from 2 percent and the deviations of Clemens J. M. Kool and Daniel L. Thornton, “How Effective Is Central Bank Forward Guidance?” Federal Reserve Bank of St. Louis Working Paper Series, 2012–063A, 2012. BIS central bankers’ speeches the unemployment rate from 6 percent with equal weight on both objectives). 12 This appears to prove that the monetary easing policy is consistent with the second objective of forward guidance (or Odyssean guidance). The most recent style, which was adopted in December 2012, has been transformed from a calendar-based to state-contingent one. The statement indicated that the Committee . . . currently anticipates that this exceptionally low range for the federal funds rate [0 to 0.25 percent] will be appropriate at least as long as the unemployment rate remains about 6.5 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. The FOMC viewed that these thresholds were consistent with the previous calendar date description of “at least through mid-2015.” These thresholds are regarded as a kind of zone of combinations of inflation and the unemployment rate, which is projected to allow the ongoing low levels of the policy interest rate. This guidance also implies that the 2 percent goal is an average concept – not a ceiling – so that the medium inflation outlook could temporarily exceed 2 percent, although the deviation will be contained to ensure that long-term inflation expectations remain well anchored. This is a clear signal that the Federal Reserve permits a more accommodative policy to fulfill both its mandates. This latest guidance was apparently influenced by the approach proposed by Charles Evans, President of the Federal Reserve Bank of Chicago, in 2011. 13 According to his proposal, the FOMC should state that the low levels of the policy rate would be maintained until the unemployment rate falls substantially to 7 percent as long as the medium-term inflation outlook stayed below 3 percent. Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, meanwhile suggested thresholds of 5.5 percent for unemployment and 2.25 percent for the medium-term inflation outlook. Forward guidance on the asset purchase program Regarding forward guidance on the asset purchase program, the FOMC statement issued in December 2008 pointed out its plan to purchase agency debt and mortgage-based securities (MBSs) using calendar-based guidance with an expression “over the next few quarters.” The subsequent statements continued to maintain calendar-based guidance (such as “this year” and “over the next six months”) every time the Federal Reserve increased its asset purchases including Treasury securities. When the Federal Reserve resumed the purchase of the agency MBSs (in September 2012) and Treasury securities (decided in December 2012 to be introduced from January 2013), forward guidance was shifted from a calendarbased to state-contingent one. In the statement issued in December 2012, the economic conditions for maintaining these asset purchases were described as until such [substantial] improvement [in the labor market] is achieved in a context of price stability. B. Forward guidance in the euro area The Governing Council of the ECB adopted forward guidance for the first time in July 2013. The introductory statement to the press conference indicated that the Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on the overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the real economy and Janet L. Yellen, “Revolution and Evolution in Central Bank Communications,” Remarks at the Haas School of Business, University of California, Berkeley, Board of Governors of the Federal Reserve System, 2012. Charles L. Evans, “The Fed’s Dual Mandate Responsibilities: Maintaining Credibility during a Time of Immense Economic Challenges,” Speech at the Michigan Council on Economic Education, Federal Reserve Bank of Chicago, 2011. BIS central bankers’ speeches subdued monetary dynamics. This is open-ended guidance, linking to the maintenance of the low policy interest rate (i.e., the main refinancing operations rate, currently set at 0.5 percent). Peter Praet, Member of the Executive Board of the ECB, explained that the objective of adopting the guidance was to reassert the ECB’s monetary easing policy. 14 He pointed out that the guidance envisages both the first (Delphic) and second (Odyssean) objectives of forward guidance mentioned earlier. It is Delphic because the guidance reveals the ECB’s future monetary policy stance based on currently-available information. It is also Odyssean as it clarifies the ECB’s commitment to the medium-term objective (i.e., below but close to 2 percent) and its determination to apply policy measures if necessary to meet the objective. The ECB’s action reflected concerns that the markets’ expected duration regarding the low interest rate policy had shortened in May 2013 as a result of a change in global financial conditions (largely caused by a rise in U.S. long-term interest rates due to speculation over the timing of “tapering” quantitative easing). This shortening occurred even though the ECB’s assessment of prices and economic activity and its monetary policy inclination remained constant. The earlier-than-projected hike in the interest rate implies a faster-than-projected monetary tightening, which may undermine the economic recovery process. In this sense, the ECB’s action can be interpreted as a provision of monetary accommodation, because it helped lengthen the expected duration of the current interest rate policy by financial markets in line with the ECB’s view. C. Forward guidance in the United Kingdom In the United Kingdom, the Monetary Policy Committee (MPC) of the BOE made a new move in July 2013, although it was not forward guidance describing the future monetary policy stance. After expressing concerns about the significant upward movement in market interest rates, the statement it issued indicated that in the Committee’s view, the implied rise in the expected future path of Bank Rate [the policy interest rate] was not warranted by the recent developments in the domestic economy. Because the statement helped to lower the market interest rates, the effects were similar to those of the ECB. Following a new remit letter from George Osborne, the Chancellor of the Exchequer, in March 2013, the MPC released a comprehensive set of forward guidance over the future conduct of monetary policy in August 2013. The statement indicated that the MPC intends not to raise Bank Rate from its current level of 0.5 percent at least until . . . the unemployment rate has fallen to a threshold of 7 percent, subject to the conditions below. The MPC stands ready to undertake further asset purchases while the unemployment rate remains above 7 percent, if it judges that additional monetary stimulus is warranted. It was also stated that the stock of asset purchases would be maintained until the 7 percent threshold is reached and subject to conditions. The conditions are then defined in the form of the following three “knockouts”: (1) the CPI inflation 18 and 24 months ahead will be above 2.5 percent; (2) medium-term inflation expectations do not remain well anchored; and (3) the Financial Policy Committee (FPC) judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the substantial range of mitigating policy actions available to the FPC. If any of these knockouts are breached, the MPC will cease the above-mentioned guidance. It is state-contingent guidance, linking to the policy interest rate, asset purchases and sales. The BOE explained that the objective of introducing explicit forward guidance is to provide greater clarity about the MPC’s views on the existing trade-off between inflation and unemployment and the associated monetary policy stance. Charlie Bean, Deputy Governor Peter Praet, “Forward Guidance and the ECB,” Column published on VoxEU.org, Centre for Economic Policy Research, 2013. BIS central bankers’ speeches of the BOE, explained in August 2013 that the release of the guidance was to clarify the MPC’s existing monetary policy stance rather than to provide additional monetary accommodation. 15.By reducing uncertainty, it aimed at lowering term premiums and preventing upward movements in market interest rates. While the MPC showed that the low policy interest rate is likely to remain throughout the three-year forecast period given the current unemployment rate outlook, there are some views that the possibility of breaching knockouts sooner than this forecast period might have added uncertainty regarding the future accommodative monetary stance. Charlie Bean, “Global Aspects of Unconventional Monetary Policies,” Speech delivered at the 2013 Economic Policy Symposium, Federal Reserve Bank of Kansas City, 2013. 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 Yoshihisa Morimoto, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Iwate, 29 August 2013.
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, Iwate, 29 August 2013. * * * I. Recent financial and economic developments and price developments A. Overseas developments 1. Overseas economies First, I will talk about key developments in overseas economies that are likely to affect the outlook for Japan’s economy. With the recovery in the U.S. economy starting to clearly gain hold, overseas economies as a whole are gradually heading toward a pick-up, although a lackluster performance is partly seen. As for the outlook, overseas economies are likely to start recovering, albeit at a moderate pace. However, amid sluggish growth in emerging economies, the pace of recovery is expected to remain moderate on the whole. I will now consider each region in more detail. 2. U.S. economy Despite downward pressure from the fiscal side, the U.S. economy has been on a moderate recovery trend against the backdrop of steady private demand. As for the employment situation, total nonfarm payroll employment has been increasing by almost 200,000 a month, and the unemployment rate has been on a downtrend. In the household sector, although the tax increase at the beginning of the year continues to have an effect, with the employment situation following an improving trend and asset prices rising, household spending, including private consumption and housing investment, has been firm. Taking a look at the corporate sector, business sentiment has been improving on the back of firm private demand, although the pick-up in production has been moderate partly reflecting a large cut in government expenditures. For the time being, close attention needs to be paid to fiscal issues – particularly the federal debt ceiling problem – and developments in financial markets as well as their effects on, for instance, housing investment. If household spending continues its uptrend, however, this could lead firms to gradually become more proactive, thus strengthening the recovery momentum of the economy as a whole. Furthermore, the benefits of the shale gas revolution could help boost economic activity, mainly by reducing the volume of crude oil imports, lowering energy prices, and increasing business fixed investment in related sectors. 3. Euro area economy In the euro area, with the European debt problem dragging on, an adverse feedback loop among the fiscal situation, the financial system, and economic activity has taken hold – particularly in peripheral countries – and economic activity has receded slowly. Looking at unemployment rates, these range from as low as 6–7 percent in Germany to as high as 26 percent in Spain, indicating widening regional disparities in business sentiment. Recently, however, there have been gradually growing signs of a bottoming out. Business and consumer sentiment in the area – including peripheral countries – is improving in a situation where financial markets have stabilized somewhat and the European authorities have modified their stringent fiscal consolidation plans, temporarily easing the measures. Exports are also bottoming out, and GDP growth for the April-June quarter turned positive for the first time in seven quarters. With these developments continuing, the euro area economy is likely to bottom out and head toward a pick-up. BIS central bankers’ speeches 4. China’s economy With regard to emerging economies, the Chinese economy continues to see stable growth against the background of firm domestic demand, as evidenced in particular by stable private consumption reflecting a favorable employment and income situation and by rising fixed asset investment, which is growing at a year-on-year rate of about 20 percent. Nevertheless, China’s economic growth rate has been at a relatively low level of around 7.5 percent. Underlying this are the structural reforms that the Chinese authorities are engaged in, which emphasize quality-based growth and lowering income disparities. Specifically, one area of focus is measures to curb the excess production capacity and the rapid expansion in credit accompanying the 4 trillion renminbi stimulus package implemented in the wake of the global financial crisis. The so-called shadow banking system is another focal point. The Chinese authorities are proceeding with policy responses to contain the risk of an overly rapid credit expansion through banks as well as non-banks. As a result, total social financing – a measure of aggregate credit supply to the economy mainly consisting of loans and corporate bonds – has been increasing at a slower pace. Although these structural reforms tend to restrain growth, the authorities have also made clear that they will remain vigilant regarding economic growth, stating that they will fine-tune policies in a timely manner to achieve a growth rate of about 7.5 percent for 2013. With the authorities aiming for well-balanced, sustainable growth, the Chinese economy is likely to continue growing steadily at the current pace. 5. Uncertainties regarding overseas economies Uncertainties in overseas economies that require careful monitoring include (1) the effects of speculation about the direction of U.S. monetary policy on financial markets and on emerging and commodity-exporting economies, (2) developments in the Chinese economy, and (3) the prospects for the European debt problem. In the United States, the Federal Reserve’s tapering of its asset purchases has become a matter of discussion. The background to this is the moderate but steady recovery in the U.S. economy, and this recovery itself is a positive development for the world economy. Furthermore, the Federal Open Market Committee (FOMC) has repeatedly conveyed the message that it will begin to adjust the pace of its asset purchases only when there continues to be substantial improvement in the outlook for the labor market. Although this stance of the Federal Reserve is gradually being understood in the market, market participants have in some cases withdrawn funds from markets in emerging and commodity-exporting economies in anticipation of an eventual tapering of the Federal Reserve’s asset purchases, and the risk of similar responses in the future remains. The world economy’s momentum for recovery is still weak, and there is high uncertainty regarding the possible effects on financial markets and economic activity in the event of a rapid outflow of funds. As for the Chinese economy, a key point of focus is whether it will be able to maintain stable growth. Specifically, it is necessary to pay close attention to whether, in grappling with various challenges such as overcapacity in the manufacturing sector and income disparities to achieve stable growth, the authorities can restrain credit expansion, such as in the shadow banking system at a pace exceeding economic growth, while steadily proceeding with structural reforms and rebalancing the economy from investment to consumption. Uncertainty regarding the European debt problem remains, even though the extreme tail risk of a potential disintegration of the euro, which some had feared at one time, has receded. However, market tensions could rise yet again if efforts to strengthen economic and financial union of the euro area and to push through fiscal reforms are seen to be in retreat. Political developments in euro member countries warrant vigilance, starting with the outcome of the German federal election scheduled in September. Geopolitical risks, particularly in the Middle East, also require close attention. BIS central bankers’ speeches B. Japan’s economy and prices 1. Current state of and outlook for Japan’s economy I will now explain the current state of, and outlook for, Japan’s economy given the overseas economic developments I have just outlined. Japan’s economy was relatively weak in the second half of 2012 as exports and production decreased mainly reflecting the deceleration in overseas economies, which in turn adversely affected domestic demand such as business fixed investment in the manufacturing sector. Economic conditions, however, have become favorable since the beginning of 2013. Recently, domestic demand, in particular public investment and private consumption, has been firm, exports have been picking up in a situation where overseas economies are gradually heading toward a pick-up, and industrial production is increasing moderately. Against this backdrop, the June 2013 Tankan (ShortTerm Economic Survey of Enterprises in Japan) showed a significant improvement in business sentiment not only in the manufacturing sector, which has greatly benefited from the correction of the yen’s appreciation, but also across a wide range of other sectors including nonmanufacturing, as well as upward revisions in firms’ business forecasts such as with regard to profits and fixed investment. Taking into account that the level of economic activity had been rising moderately and a virtuous cycle from income to spending had gradually started operating, the Bank of Japan, at the Monetary Policy Meeting held on July 10 and 11, 2013, raised its basic assessment of the domestic economy, from the assessment that the economy “has been picking up” to the assessment that it “is starting to recover moderately.” As for the outlook, exports are expected to increase moderately, mainly reflecting the pick-up in overseas economies and the correction of the yen’s appreciation. As for domestic demand, public investment and housing investment are expected to continue trending upward, business fixed investment is projected to increase moderately reflecting the improvement in corporate profits and the employment situation, and private consumption is expected to remain resilient. In this situation, industrial production is also expected to increase moderately, judging from interviews with firms and other relevant information. Against the backdrop of these developments in demand both at home and abroad as well as in production, Japan’s economy is expected to recover moderately. Let me elaborate on these developments for a moment. Due in part to the correction of the yen’s appreciation and the rise in stock prices since the end of 2012, business and consumer sentiment has improved, and this improvement is likely to help underpin private consumption for the time being and gradually entice firms to increase their spending. Increased private consumption is particularly evident among the middle-aged and the elderly, who hold more stocks than other age groups. Consumption activity of the baby-boom generation is expected to remain firm due to their higher propensity to consume than other generations and to firms’ efforts to capture new demand. Meanwhile, business fixed investment is projected to increase moderately, mainly due to the resumption of postponed investment for the maintenance and replacement of items such as machinery and to investment related to disaster prevention and energy. Upward pressure on the economy from the public demand side is expected to gather full momentum as seen in the fact that the value of public works contracted, a leading indicator of public investment, has already increased significantly. The key to ensuring that this trend toward economic recovery continues and to achieving the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) is that improvements in business performance lead to increases in employee income. Looking at the recent employment and income situation, supply and demand conditions in the labor market have improved, as evident in the unemployment rate and the active job openings-to-applicants ratio, and the year-on-year rate of change in the number of employees has been positive. In this situation, despite the downward pressure resulting from the uptrend in the ratio of part-time employees, the year-on-year rate of change in nominal wages per employee has turned slightly positive, with special cash BIS central bankers’ speeches earnings for June – which include summer bonus payments – showing an increase for the first time in three years. While uncertainty regarding the outlook remains, the Bank would like to confirm whether these developments also lead to a rise in scheduled cash earnings. Keeping these points in mind, I would like to summarize the outlook for Japan’s economy for the next three fiscal years. While the economy will be affected by the front-loaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, it is likely to continue growing at a pace above its potential, as a trend, as a virtuous cycle among production, income, and spending is maintained. In the Bank’s interim assessment in July of the April 2013 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the median of the Policy Board members’ forecasts for the economic growth rate is a somewhat high 2.8 percent for fiscal 2013 due to the effects of various economic measures and the front-loaded increase in demand, 1.3 percent for fiscal 2014 partly due to the subsequent decline in demand, and 1.5 percent for fiscal 2015. 2. Prices Next, I will talk about price developments. The year-on-year rate of change in the CPI (all items less fresh food) had been in negative territory through April 2013, but has recently turned positive for the first time in 14 months, partly reflecting the correction of the yen’s appreciation. Energy prices including those for petroleum products and electricity have been rising, and increases in the costs of raw materials have started to be passed on to sales prices of, for example, foodstuffs. Sales prices of some imported consumer goods such as personal computers and handbags have also been raised. Recently, there have been more signs of a change in firms’ price-setting behavior, including the introduction of higher-end products and services in some areas within the food service industry. Under these circumstances, firms’ forecasts for supply and demand conditions and prices in the June 2013 Tankan have clearly improved. As for the outlook, the year-on-year rate of increase in the CPI is likely to rise, reflecting factors such as the improvement in the aggregate supply and demand balance due to the recovery of Japan’s economy as well as the rise in mediumto long-term inflation expectations in response to fundamental changes in the public’s expectations. The rate of increase in the CPI is likely to reach around 2 percent – the price stability target – toward the latter half of the projection period, spanning from fiscal 2014 through fiscal 2015, as the overall economy improves in a balanced and sustainable manner. Specifically, in the Bank’s interim assessment in July of the April 2013 Outlook Report, the median of the Policy Board members’ forecasts for the year-on-year rate of increase in the CPI (all items less fresh food; for fiscal 2014 and fiscal 2015, excluding the direct effects of the consumption tax hikes) is 0.6 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.9 percent for fiscal 2015. II. Conduct of monetary policy A. Introduction of “Quantitative and Qualitative Monetary Easing” (QQE) 1. Framework of QQE Next, I would like to turn to the Bank’s conduct of monetary policy. In order for Japan’s economy to overcome deflation as early as possible and achieve sustainable growth with price stability, the Bank introduced in January 2013 the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI. It concurrently released a joint statement with the government, in which the government and the Bank clearly acknowledged the role each had to play and stated that they would work together to overcome deflation and achieve sustainable economic growth. Then, in April, the Bank introduced QQE to achieve the price stability target at the earliest possible time, with a time horizon of about two years. This policy measure represents a considerable departure from the Bank’s previous practice both in terms of quantity (the size of increase in the amount of BIS central bankers’ speeches currency provided by the Bank) and quality (the type of assets the Bank purchases to increase the amount of currency). Specifically, the Bank decided upon the following. First, with a view to pursuing quantitative monetary easing, the Bank changed the main operating target for money market operations from the uncollateralized overnight call rate to the monetary base, which is the sum of banknotes in circulation, coins in circulation, and current account deposits held by financial institutions at the Bank. On this basis, the Bank will increase the monetary base at an annual pace of about 60–70 trillion yen, thus doubling it in two years. Second, the Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 50 trillion yen. As a result, the amount outstanding of JGBs held by the Bank is likely to more than double in two years. Moreover, the Bank extended the average remaining maturity of its JGB purchases from slightly less than three years to about seven years. It should be noted that in practice the average remaining maturity is subject to fluctuations, depending on bids by financial institutions; thus, it is appropriate to allow for a range of about six to eight years. And third, the Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. The Bank will continue with QQE – consisting of these measures – aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. In order to achieve the price stability target, it is important to create a virtuous cycle in which prices rise moderately along with a balanced and sustainable improvement in economic activity that is accompanied by increases in corporate profits, employment, and wages. Furthermore, in order to fully ensure the effectiveness of monetary easing, it is important for the government to ensure market credibility of fiscal consolidation. Japan is facing serious fiscal imbalances, and if the credibility of its fiscal management were to decline, long-term interest rates would likely rise in a manner inconsistent with economic and price developments. The government indicated in the joint statement released in January that it would steadily promote measures aimed at establishing a sustainable fiscal structure. Moreover, in the Medium-Term Fiscal Plan, approved on August 8, 2013, it stated its targets of halving the primary deficit-to-GDP ratio by fiscal 2015 and of achieving a surplus in the primary balance by fiscal 2020. Based on these targets, it is expected that the government will continue making efforts toward fiscal consolidation. 2. Transmission channels of QQE The transmission channels of QQE are as follows. First, the purchases of financial assets will encourage declines in long-term interest rates and risk premiums on assets. This helps to increase firms’ and households’ investment and consumption by lowering their funding costs and through wealth effects. Second, both financial institutions and institutional investors are expected to change their investment behavior and rebalance their portfolios to loans and/or risk assets, such as stocks, in the pursuit of higher returns. This is referred to as the portfolio rebalancing effect. This effect may strengthen the growth potential of Japan’s economy if risk money is increasingly allocated to a wider range of emerging firms, for example. And third, the clear commitment to achieving the price stability target at the earliest possible time and the continuation of massive purchases of assets are expected to drastically change the expectations of markets and economic entities. With these channels acting together, QQE will contribute to pushing up prices by raising inflation expectations and, by stimulating private demand, improving the aggregate supply and demand balance. 3. Financial market developments since the introduction of QQE Looking at developments in economic activity and financial markets since the introduction of QQE, the monetary base has been increasing at an annual pace of about 60–70 trillion yen – in line with the Bank’s guideline for money market operations – owing to progress in the BIS central bankers’ speeches Bank’s large-scale JGB purchases as it proceeds with QQE. Despite some instability observed in the JGB market at the onset, the intended effects of QQE seem to have begun to materialize on the whole, with favorable developments spreading to economic activity and financial markets. Meanwhile, financial conditions remain accommodative. In terms of firms’ funding costs, the average contracted interest rates on new loans and discounts have been low, reaching a historical low, and the year-on-year rate of increase in the amount outstanding of bank lending has increased somewhat to a range of around 2 percent. Issuing conditions for CP and corporate bonds have continued to be favorable on the whole, and there have been several major corporate bond issues. The year-on-year rate of growth in the money stock (M2) has increased to its highest level since 1999, reaching almost 4 percent. Looking at financial markets, money market rates for all maturities have been stable, hovering at a level slightly below 0.1 percent. Long-term interest rates exhibited increased volatility and temporarily reached 1 percent, but have regained stability as the Bank conducted JGB purchases in a flexible manner while maintaining a close dialogue with market participants. Japan’s long-term interest rates have generally been flat in spite of a rise in overseas long-term interest rates reflecting speculation about the direction of U.S. monetary policy, and have recently been contained at a level of 0.7–0.8 percent, below the historical average. Meanwhile, it can be said that inflation expectations have been on a rising trend on the whole, as evidenced (1) by the rise in the diffusion index for output prices in the June 2013 Tankan as well as the rise in the inflation expectations of firms, households, and economists, and (2) by the upturn in market-related indicators following a halt in their decline. Under these circumstances, real interest rates – calculated as nominal interest rates minus the expected inflation rate – have been on a declining trend. If inflation expectations were to rise, this would exert upward pressure on long-term interest rates. The key to strengthening monetary easing effects therefore lies in maintaining real interest rates at a relatively low level, by exerting downward pressure on nominal interest rates through a compression of risk premiums (including term premiums). As for the outlook, downward pressure on interest rates is likely to become increasingly pronounced as the Bank proceeds with its large-scale JGB purchases. In this situation, portfolio rebalancing – in which investors and financial institutions that used to invest their funds in JGBs shift their investment to lending and other assets – is likely to spread steadily. Reflecting the wealth effects brought about by the rise in stock prices since the beginning of the year and the improvement in corporate profits due to the correction of the yen’s appreciation, business and household sentiment has recently improved and fundraising by the private sector has increased moderately. Looking ahead, with the effects of QQE on economic activity becoming increasingly pronounced, a virtuous cycle – in which positive developments in economic activity and changes in expectations bring about further improvement in economic activity and further increases in inflation expectations – would enable the Bank to achieve the 2 percent price stability target. B. Loan support program In order to maintain this virtuous cycle, it is important that firms and households actually make use of the accommodative financial conditions for funding and increase investment and spending, which in turn will lead to an improvement in the aggregate supply and demand balance. However, although some positive developments can now be observed in the demand for credit, many firms still do not borrow to finance their business fixed investment and instead invest only as much as their cash flow will allow. To promote full use of the accommodative financial conditions by firms and households, the Bank – in addition to implementing aggressive monetary easing measures – has established the Loan Support Program. The program consists of two measures: the fund-provisioning measure to stimulate bank lending (hereafter the Stimulating Bank Lending Facility) and the fund-provisioning BIS central bankers’ speeches measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility). 1. The stimulating bank lending facility The Stimulating Bank Lending Facility was introduced with the aim of prompting financial institutions to take a more active lending stance and stimulating greater proactive credit demand of firms and households. With this facility, the Bank provides long-term yendenominated funds at a low interest rate to financial institutions that have increased their lending, at their request, up to an amount equivalent to the net increase in their lending for a period of five quarters – the January-March 2013 quarter until the end of the January-March 2014 quarter – from the base period of the October-December 2012 quarter. There shall be no upper limit to the total amount of funds provided by the Bank under this facility. The lending, based on which the net increase is calculated, can be either yen-denominated or foreign currency-denominated. Japanese firms’ international operations as well as financial institutions’ activities to provide funds for such operations play an important role in capturing global demand, so that the Bank’s measure to support lending to firms located overseas or lending by domestic financial institutions’ overseas offices – including foreign currencydenominated lending – contributes to strengthening Japan’s growth potential. In the first loan disbursement under this facility in June 2013, loans amounted to as much as 3.1 trillion yen, underlining the strong demand for such funds. 2. The growth-supporting funding facility The Growth-Supporting Funding Facility was introduced with the aim of supporting the flow of funds to areas with growth potential. The Bank introduced this facility because, in order to overcome deflation and achieve sustainable economic growth with price stability, the Bank deemed it important to (1) reverse the downward trend in Japan’s growth rate in the face of the unparalleled decline in the birthrate and aging of the population, (2) increase medium- to long-term growth expectations for Japan’s economy, and (3) put Japan’s economy on a higher medium- to long-term growth path. With this facility, the Bank provides long-term funds – both yen-denominated and foreign currency-denominated – at a low interest rate to financial institutions for their lending and investment to areas that are expected to contribute to strengthening Japan’s growth potential, such as medical and nursing care; environment and energy; agriculture, forestry, and fisheries; and tourism. The total amount of lending under these arrangements was set to about 5.5 trillion yen, and the current amount outstanding is nearly 4 trillion yen. The amount of lending and investment actually provided by private financial institutions using this facility greatly exceeds the amount of loans disbursed by the Bank, demonstrating its usefulness as a catalyst. These measures are expected to continue promoting lending activity by financial institutions and to lead to an increase in firms’ proactive demand for credit, such as that for business fixed investment. In order to sustain this cycle for strengthening the economy’s growth potential, it is necessary to help private economic entities to realize their potential to the fullest. In addition to support from the financial side, it is therefore important to build an economic environment where innovations in a broad sense – including the development of new business models – can be achieved more easily. Recently, firms have been making active efforts in a wide range of areas to capitalize on social changes, including business focusing on the elderly, the environment and energy, and information and telecommunications. Such developments need to be supported on the policy side as well. Moreover, securing the labor force by increasing flexibility in the labor market is another significant issue. The labor force participation rate of women currently forms an M-shaped curve, declining to about 70 percent for women aged 25 to 45. If this rate were to rise gradually as a result of greater support for working mothers to both pursue a career and raise children, the decrease in the labor force overall would be moderated. Moreover, if an increasing number of those aged 60 and above were to participate in the labor force, it would be possible to maintain the labor force at the current BIS central bankers’ speeches level for the time being, even in the face of the decline in the birthrate and the aging of the population. In the joint statement with the Bank released in January 2013, the government made clear its intention to formulate measures for strengthening competitiveness and growth potential of Japan’s economy and promote them strongly, in order to revitalize the economy. In the government’s Japan Revitalization Strategy formulated in June, three action plans – (1) the Plan for the Revitalization of Japanese Industry, (2) the Strategic Market Creation Plan, and (3) the Strategy of Global Outreach – have been laid out as concrete measures to be given top priority among other steps forming the growth strategy. If these measures are steadfastly implemented and firms’ growth expectations rise further as a result, and given declining real interest rates, this would further enhance the stimulative effects of monetary easing. The Bank, on its part, will also continue to make its utmost contributions. C. Efforts on the financial side in response to the Great East Japan Earthquake I would now like to talk about the Bank’s efforts on the financial side following the Great East Japan Earthquake. Since immediately after the earthquake, financial institutions in the disaster areas have made strenuous efforts to maintain the functioning of financial and settlement systems by restoring their offices and establishing temporary ones. They have also responded to the needs of people and firms in the disaster areas in various respects, such as permitting the withdrawal of deposits in cases where depositors had lost their passbook, allowing for the exchange of damaged banknotes and coins, and providing support for the funding of disaster-stricken firms. More recently, these institutions have been providing strong support for the restoration of local economies, mainly in business matching and support for corporate turnarounds. From immediately after the earthquake, the Bank swiftly took 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. In this situation, in April 2011 the Bank decided to introduce a funds-supplying operation that provides financial institutions in the disaster areas with longer-term funds at low interest rates in order to lend support to their initial efforts to meet demand for funds for restoration and rebuilding. It also decided to broaden the range of eligible collateral for money market operations. As for the former operation, the deadline for new applications for loans was initially set at end-October 2011, six months after the introduction, but was successively extended thereafter up to the current deadline of end-April 2014. Looking at the usage of loans under this funds-supplying operation to support financial institutions in the disaster areas, the amount outstanding of loans a year after the earthquake reached about 500 billion yen vis-à-vis the 1 trillion yen ceiling, and most recently has been about 400 billion yen. The reason that financial institutions in the disaster areas have made little use of loans under this operation relative to the ceiling is that their funding conditions have generally been favorable as they have been receiving funds for reconstruction from various sources. Nevertheless, the operation can be regarded as effective in that it has provided a safety valve for any unanticipated demand for funds, providing leeway for these institutions in their efforts to meet demand for funds for restoration and rebuilding. As the disaster areas are expected to see an increase in the demand for funds as reconstruction progresses, the Bank will continue to provide firm support to financial institutions engaged in reconstruction efforts so as to allow for active lending. BIS central bankers’ speeches
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Summary of a speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Aomori, 11 September 2013.
Koji Ishida: Economic activity and prices in Japan and monetary policy Summary of a speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Aomori, 11 September 2013. * * * I. Monetary Policy A. Introduction of the “Price Stability Target” and the joint statement by the government and the Bank of Japan First, I would like to describe the status of the Bank of Japan’s monetary policy conduct at the beginning of this year. At the Monetary Policy Meeting (MPM) held on January 21 and 22, 2013, the Bank decided to introduce the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI). At the same time, it released a joint statement with the government, which clearly stated that the government and the Bank would strengthen their policy coordination and work together to overcome deflation early and achieve sustainable economic growth with price stability. In the statement, the Bank announced that, under the price stability target, it would pursue monetary easing and aim to achieve this target at the earliest possible time. Concurrently, the government announced that it would not only flexibly manage macroeconomic policy but also formulate measures for strengthening the competitiveness and growth potential of Japan’s economy, and promote them strongly. The government also announced that it would steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management. B. Quantitative and Qualitative Monetary Easing (QQE) Now I would like to talk about the Bank’s current monetary policy measures, which aim at overcoming deflation. At the MPM held on April 3 and 4, 2013, the Bank introduced QQE to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years. The features of this new monetary policy measure are as follows. First, with a view to pursuing quantitative monetary easing, the Bank changed the main operating target for money market operations from the uncollateralized overnight call rate to the monetary base, which is the total amount of money the Bank directly supplies to the economy. On this basis, the Bank increases the monetary base – defined as the sum of banknotes in circulation, coins in circulation, and current account deposits held by financial institutions at the Bank – at an annual pace of about 60–70 trillion yen. Second, the Bank purchases Japanese government bonds (JGBs) as the primary means of increasing the monetary base, so that their amount outstanding will increase at an annual pace of about 50 trillion yen. Moreover, the average remaining maturity of the Bank’s JGB purchases has been extended from slightly less than three years to about seven years – equivalent to the average maturity of the amount outstanding of JGBs issued. Third, in addition to JGBs, with a view to lowering risk premiums of asset prices, the Bank purchases exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at an annual pace of about 1 trillion yen and 30 billion yen, respectively. And fourth, the Bank will continue with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary to maintain that target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. So far, I have explained the basic framework of QQE. More than five months have passed since QQE was introduced at the beginning of April. The amount outstanding of the monetary base has increased from 146 trillion yen at the end of March to 177 trillion yen at the end of BIS central bankers’ speeches August, and has been accumulating smoothly toward 200 trillion yen, the amount projected at end-2013. The amount outstanding of JGBs has also been accumulating smoothly toward 140 trillion yen, the amount projected at end-2013, increasing from 91 trillion yen at the end of March to 123 trillion yen recently. C. Loan support program In addition to implementing QQE, the Bank has been employing the Loan Support Program in order to make the effect of aggressive monetary easing further permeate the economy. The Loan Support Program consists of two measures: the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility) and the fund-provisioning measure to stimulate bank lending (hereafter the Stimulating Bank Lending Facility). With the Growth-Supporting Funding Facility, the Bank 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. With the Stimulating Bank Lending Facility, on the other hand, the Bank provides long-term funds at a low interest rate to financial institutions that have increased their lending, at their request, up to an amount equivalent to the net increase in their lending, with a view to encouraging them to take more aggressive action and helping stimulate the proactive credit demand of firms and households. In addition, there is no upper limit to the total amount of funds provided by the Bank under this facility. The outstanding balance of the total loans provided through both facilities of the Loan Support Program has exceeded 7 trillion yen, supporting financial institutions’ efforts to tap firms’ proactive demand for funds. D. Developments in financial markets Reflecting such aggressive monetary easing measures, financial conditions in Japan have been substantially accommodative. As for firms’ funding costs, financial institutions’ lending rates have been significantly low. CP issuance rates have declined to around 0.1 percent – equivalent to the interest rate applied to excess reserve balances at the Bank – and yield spreads between corporate bonds and JGBs have remained narrow on the whole. With regard to credit supply, firms have continued to see financial institutions’ lending attitudes as being on an improving trend. From end-2012 until the beginning of April 2013, long-term interest rates in Japan declined significantly, reflecting heightened expectations for large-scale monetary easing by the Bank and some anticipation of abolishment of the payment of interest on excess reserve balances. However, since the introduction of QQE at the beginning of April, the entire yield curve has risen, reflecting (1) the correction of the level of interest rates on instruments with mediumterm maturities due to a drop in anticipation of abolishment of interest payments as well as (2) the phenomenon of “buying on rumors and selling on facts.” Moreover, since the middle of May, a rise in U.S. long-term interest rates stemming from speculation about possible changes in quantitative easing in the United States has been exerting strong upward pressure on Japan’s long-term interest rates. At present, yields on 10-year JGBs have been in the range of 0.7–0.8 percent, which in absolute terms are higher than those before QQE was introduced at the beginning of April. It should be noted, however, that while the rise in U.S. long-term interest rates has actually caused interest rates in Germany and the United Kingdom to follow suit, interest rates in Japan have recently been more or less flat at a low level. This is evidence that the Bank’s aggressive monetary easing has been working strongly to contain the upward pressure on Japan’s long-term interest rates. Reflecting such extremely accommodative financial conditions in Japan, the yen has been depreciating, albeit with some fluctuations, and stock prices have been trending upward. The year-on-year rate of increase in the amount outstanding of bank lending has been rising in recent months, as major banks’ lending stance has become active. According to the money stock statistics for August 2013, released on September 10, 2013, the year-on-year growth rate of broadly-defined liquidity was 3.5 percent, the highest since March 2007, and among BIS central bankers’ speeches its components, the growth rates of pecuniary trusts and investment trusts have been accelerating in particular since the turn of fiscal 2013. Although economic entities have just started to rebalance their portfolios, the monetary easing seems to have gradually taken effect. I would therefore like to continue close monitoring of future developments. II. Economic activity and prices A. The current situation of Japan’s economy 1. Economic activity Next I will talk about economic activity and prices. The Bank currently assesses Japan’s economy as recovering moderately. According to the second preliminary estimates of real GDP statistics released on September 9, 2013, Japan’s economy grew at an annualized rate of 3.8 percent in the April-June quarter, showing positive growth for the third consecutive quarter. The rate was largely revised upward from the first preliminary estimate of 2.6 percent as a result of increases in business fixed investment and inventory investment. As for domestic demand, private consumption showed relatively high growth while public investment continued to increase, and business fixed investment turned positive for the first time since the October-December quarter of 2011. External demand also made a positive contribution, with exports rising due to factors such as the depreciation of the yen. Other economic indicators have also been improving on the whole. Among various statistics on private consumption, the Synthetic Consumption Index, which combines demand-side and supply-side statistics, has been firm recently. Real exports, despite monthly fluctuations, have been gaining upward momentum from developments in foreign exchange rates and a moderate recovery in the U.S. economy. In particular, those of motor vehicles and related goods as well as of capital goods and parts have recently been moving toward a pick-up. Industrial production is also increasing moderately, reflecting these developments in demand both at home and abroad. Looking at corporate profits, listed firms expect to see large increases in their profits for fiscal 2013, which they forecast to recover close to the levels of the post-fiscal 2000 peak marked in fiscal 2007. Earnings of listed firms for the April-June quarter of 2013, announced in late July to early August, showed that corporate results of firms in domestic demand-oriented sectors were favorable on the whole, and that many firms reported increased sales and profits due to the effects of developments in foreign exchange rates and greater demand for motor vehicles, smartphones, and related goods. In this environment, firms are planning to increase business fixed investment for fiscal 2013, and supply and demand conditions in the labor market continue to improve moderately, as seen, for example, in a rise in the active job openings-to-applicants ratio. 2. Prices The year-on-year rate of change in the CPI (all items less fresh food) had turned positive in June 2013 for the first time in 14 months, and in July it rose to 0.7 percent. The CPI for the Tokyo metropolitan area rose to 0.4 percent in August year on year, showing a marginal increase from 0.3 percent in July. Looking at the components of Japan’s CPI reveals that rises in prices of energy-related goods, such as gasoline prices and electricity charges, are pushing up the CPI. In addition, some firms in the food products industry are passing their higher costs arising from the rise in import prices on to sales prices. The recent rise in the CPI is attributed to not only the increase in prices of energy-related goods but also rises in prices of a wide range of items as a result of resilient private consumption. This is evident from the fact that the decline in the CPI excluding food and energy is gradually coming to a halt. BIS central bankers’ speeches 3. Outlook for economic activity and prices, and challenges for Japan’s economy (a) Outlook I will now turn to the outlook for economic activity and prices in Japan. Japan’s economy is expected to continue a moderate recovery against the background of firm domestic demand and the pick-up in overseas economies. Specifically, exports are expected to increase moderately due to a gradual pick-up in overseas economies, mainly in the United States, and the definite, cumulative effects of developments in foreign exchange rates since last year. Looking at domestic demand, public investment is expected to continue trending upward supported by the supplementary budget for fiscal 2012 under the emergency economic measures, the budget for fiscal 2013 with higher weight on public investment, and the increased budget for reconstruction-related spending. Housing investment showed negative growth in the April-June quarter in the GDP statistics. However, the number of housing starts, a leading indicator of housing investment, increased clearly by 9.3 percent in the AprilJune quarter from the previous quarter. It is expected that actual implementation of housing investment will start rising firmly as (1) reconstruction of houses struck by the earthquake disaster in 2011 continues and (2) lower interest rates on loans and a surge in consumer spending prior to the consumption tax hikes are likely to encourage housing investment. Business fixed investment is projected to follow a moderate increasing trend as corporate profits continue to improve. Private consumption is expected to remain resilient, supported by improvement in the employment and income situation. Under these circumstances, industrial production is expected to continue increasing moderately. As for prices, the year-on-year rate of increase in the CPI is likely to continue rising. In a situation where the effects of the improvement in the supply and demand balance are expected to become clear with an economic recovery, a rise in petroleum product prices – reflecting the recent developments in foreign exchange rates and crude oil prices – and a further rise in electricity charges by electric power companies are likely to exert upward pressure on overall prices. Therefore, for the time being, the CPI is expected to continue to rise clearly on a year-on-year basis. I mentioned earlier that some firms in the food products industry are passing their higher costs on to sales prices, and wholesale and retail prices of imported goods, such as personal computers and handbags, are also being raised in some cases. In forecasting price developments, close watch should be kept on changes in firms’ price-setting behavior. Price increases could spread gradually if private consumption remains resilient and firms are encouraged to raise prices. (b) Challenges for Japan’s economy In order for the economy to move in line with the outlook I have described, it is necessary for production levels to rise firmly. The sluggish pace of increase in exports appears to have caused industrial production for the first half of 2013 to remain lower than a year earlier. As a result, business fixed investment remains lackluster, restraining growth in production. In the past, exports were usually the driving force of economic recovery in Japan. The present recovery, however, is being led by domestic demand, such as private consumption, housing investment, and public investment. It is time for exports to take the lead. The cause of the current slow recovery in exports can be partly attributed to structural factors, such as declining competitiveness of firms in some industries and a greater shift to overseas production and local procurement of goods since the earthquake disaster. In order for Japan’s economy to return to a stable growth path, exports must rise, and thus developments in overseas economies hold the key. B. Overseas economies 1. Europe Economic activity in the euro area deteriorated due to the European debt problem that engulfed Greece, Portugal, and Spain. More recently, however, the economy has finally BIS central bankers’ speeches bottomed out and is now showing signs of heading toward a pick-up with an improvement in consumer and business sentiment. Although some countries are still subject to factors that might lead to instability, investors have become less risk-averse and the financial conditions of financial institutions have been improving. While economic activity in the euro area cannot be expected to improve significantly for the time being, the situation there will no longer exert a large negative impact on the global economy. 2. The United States The U.S. economy has been on a moderate recovery trend against the backdrop of steady private demand, despite downward pressure from the fiscal side. Private consumption remains on a moderate increasing trend as the employment situation follows an improving trend and prices of houses and other assets rise. The U.S. economy is expected to remain on a recovery trend. In view of this, the Federal Reserve is planning to gradually reduce the size of its asset purchases, and long-term interest rates have started to rise. Given the possibility of a further increase in interest rates, it is necessary to monitor how this will affect housing investment, which has been the engine of U.S. economic growth, just as automobile sales have been. 3. Emerging and commodity-exporting economies Economic growth in China, which has been the driving force of global economic growth, has decelerated due to sluggish economic activity in Europe, an important trade partner, and slower growth in China’s manufacturing sector activity owing to excess capital stock. The Chinese economy is currently aiming for a soft landing followed by stable growth led by domestic demand. Other emerging and commodity-exporting economies have been benefiting thus far from China’s robust economy and monetary accommodation in advanced economies; however, deceleration in the Chinese economy and speculation about possible changes in quantitative easing in the United States are currently exerting strong downward pressure on their financial markets, trade, and commodity prices. 4. Challenges for overseas economies Action by the Federal Reserve to gradually reduce the size of its asset purchases is sensible for the U.S. economy since it is showing signs of recovery, and it would be a natural policy decision for the United States. An ensuing rise in U.S. long-term interest rates, however, could trigger a rise in long-term rates in other countries, which would restrain their economic growth. In emerging economies, growth has been propelled in part by a large inflow of funds caused by the quantitative easing policy in the United States. However, an outflow of these funds from emerging economies could lead to depreciation of their currencies, declines in stock and bond prices, and to higher inflation, thereby exerting negative effects on economic growth. It is necessary to continue close monitoring of whether these negative effects will be offset by the positive effects to be generated by growth in the U.S. economy. Close monitoring is also required of developments in capital flows, since they would influence whether emerging economies can eliminate their twin deficits, draw up effective measures to stem inflation, and implement structural reforms. III. Overcoming deflation A. Outlook for Japan’s economic activity and prices From fiscal 2014 toward fiscal 2015, Japan’s economy is expected to follow the baseline scenario presented in the April 2013 Outlook for Economic Activity and Prices, released by the Bank. That is, the economy is expected to continue growing at a pace above its potential, as a trend. As for prices – excluding the direct effects of the scheduled consumption tax hikes – the year-on-year rate of change in the CPI is expected to follow a rising trend, reflecting factors such as the improvement in the aggregate supply and demand balance as BIS central bankers’ speeches well as the rise in medium- to long-term inflation expectations. It is likely to reach around 2 percent – the price stability target – toward the latter half of the projection period, spanning from fiscal 2014 through fiscal 2015. B. Overcoming deflation As I have explained, the Bank is implementing the aggressive monetary easing policy to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI, and thereby achieve sustainable economic growth with price stability as stated in the joint statement with the government released in January 2013. Many people believe that economic activity will pick up and the quality of people’s lives will improve when the economy overcomes deflation. Economic growth, however, will be temporary and unsustainable if price increases following the efforts to overcome deflation are not accompanied by increases in income; a decline in households’ real purchasing power would dent private consumption and lead to economic deterioration. If this turns out to be the case, it is meaningless to aim at overcoming deflation. Japan’s economy has finally started to recover moderately, and it is at an extremely important stage where a virtuous cycle has just begun to operate. Given that the year-onyear rate of increase in the CPI is likely to rise from fiscal 2014, it is essential for nominal income to increase steadily so that the present recovery enters a stable growth path. For this to happen, it is necessary that the current positive momentum of the economy is maintained and that the overall level of corporate profits rises sufficiently. Furthermore, it is necessary to dispel concerns about the outlook for Japan’s economy and secure growth expectations. To this end, as specified in the joint statement, it is vital for the Bank to vigorously implement aggressive monetary easing measures to achieve the price stability target – and for the government, for its part, to be flexible in its public spending, steadily implement growth strategies, and ensure the credibility of its fiscal management. In order to realize effectively a steady expansion of consumption expenditures, increases in nominal income made in the form of increases in scheduled cash earnings – which comprise about three-fourths of nominal wages and are considered to be stable and less variable – would be superior to increases in special cash earnings, which are considered to be more variable. In this context, it is crucial that from fiscal 2014 onward base levels of salaries, which have hardly increased since the beginning of the 21st century, are once again raised on an annual basis in a wide range of industries. In Japan, the deflationary mind-set has taken hold as a result of years of sluggish income and prices. However, an actual steady increase in income as a result of economic growth accompanied by a rise in prices will change this mind-set, thereby helping Japan’s economy to overcome deflation. BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Council on Foreign Relations, New York, 10 October 2013.
Haruhiko Kuroda: Overcoming deflation – the Bank of Japan’s challenge Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Council on Foreign Relations, New York, 10 October 2013. * * * Introduction Good morning. I am honored to be given an opportunity to speak this morning at the longestablished Council on Foreign Relations. Today, I will talk about what Japan’s deflation is all about and what challenges Japan is faced with, followed by how the Bank of Japan is trying to overcome deflation. I. Deflation that Japan has been experiencing Japan has been mired in deflation for the past 15 years. Let me bring up some figures. In Tokyo, the minimum fare for the subways of 160 yen, or 1.6 dollars, has not changed since 1995. During the same period, the fare in New York increased from 1.5 dollars to 2.5 dollars. As fees for public services are not likely to be reduced as a rule, the minimum fare for the subways in Tokyo has not declined, but prices as a whole have declined moderately for a long period in Japan. The feature of Japan’s deflation is that it is moderate but persistent. This is a phenomenon quite different from the deflation seen in the days of the Great Depression. In the period of deflation that occurred in the United States during the Great Depression, prices plunged in a short period. Prices declined significantly in the two years of 1931 and 1932, by almost 10 percent annually, but deflation continued for only four years. In contrast, Japan’s consumer prices have fallen 4.1 percent in the past 15 years from fiscal 1998 to fiscal 2012. That is merely a 0.3 percent decline on an annual average basis. However, the deflation in Japan has been extremely persistent. Young Japanese people have been born into a life of carrying the recognition that prices either will be constant or decline. The continuation of price declines, albeit moderate ones, for a protracted period has deprived Japan’s economy of vitality. In a state of deflation, the holding of cash or deposits will become a relatively better investment. In fact, cash and deposits held by Japanese firms have reached 230 trillion yen, close to 50 percent of nominal GDP. Persistent deflation has created an environment in which the status quo is better than making investment in new initiatives, and has brought a sense of stagnation to Japan. In an economy with few new challenges and investment, growth potential will decline gradually. Therefore, it is necessary to overcome deflation this time around and enhance people’s willingness to take on new challenges. There were economic cycles during the past 15 years. However, even when the economy recovered, prices did not increase in a sustainable fashion. The major reason for this is that, due to prolonged deflation, persistent deflationary expectations – that is, the recognition that it is natural for prices not to increase – have become entrenched among people, and they took actions based on such expectations. In such a situation, firms, households, and even labor unions will act on the assumption that prices will not increase, and thus it has become intrinsically difficult to increase prices. In the past, the Bank of Japan (BoJ) took a variety of initiatives, including the adoption of unconventional measures ahead of other central banks, such as a zero interest rate policy, quantitative easing, and – in the latest wording – forward guidance. Nevertheless, while those policies were effective in terms of stimulating economic activity, they could not change people’s persistent deflationary expectations. The greatest challenge in overcoming deflation this time is to raise people’s inflation expectations. BIS central bankers’ speeches II. Introduction of quantitative and qualitative monetary easing The BoJ introduced the quantitative and qualitative monetary easing (QQE) in April. The new policy aimed at working directly on inflation expectations, with the goal of increasing inflation to the global standard of 2 percent. The question is: how? The conclusion we reached was, first, to show our clear commitment to achieving the 2 percent price stability target in a stable manner as soon as possible, and, second, to underpin this determination by launching massive monetary easing that clearly differed from the past policies. Specifically, we declared that there would be a doubling in two years of the monetary base the BoJ provides. With this QQE, Japan’s monetary base two years from now will become 270 trillion yen, or 2.78 trillion dollars, reaching 56 percent of nominal GDP. For reference, the current monetary base in the United States is 329 trillion yen, or 3.39 trillion dollars, which is 20 percent of nominal GDP. To build the monetary base, on the asset side of the BoJ’s balance sheet, the holdings of Japanese government bonds (JGBs) would be doubled. An associated massive purchase of JGBs would alter supply and demand conditions in the JGB market and put strong downward pressure on long-term interest rates. However, there was a problem. The 10-year government bond yield in Japan was less than 1 percent. How could we make additional room for monetary easing? The point was the real interest rate, which is the nominal interest rate minus the expected inflation rate. In this regard, the situation facing Japan, in which expected inflation rates were stagnant, fortunately provided a breakthrough to this question. By raising inflation expectations while containing a rise in nominal interest rates, we would be able to lower real interest rates, which affect decision-making with respect to business fixed investment and private consumption. Let me elaborate on this. In the United States and Europe, amid stagnant growth, observed inflation rates have been hovering around central banks’ targeted inflation rate of 2 percent, and firms’ and households’ medium- to long-term expected inflation rates have also been stable at around 2 percent. In other words, expected inflation rates are anchored at around targeted inflation rates. In such cases, central banks cannot afford to raise expected inflation rates further. Therefore, to lower real interest rates, nominal interest rates need to be lowered. When long-term interest rates fall to the historic low level of less than 2 percent, room to further lower real interest rates becomes limited, as there is not much room to further lower nominal interest rates. By contrast, in Japan, expected inflation rates have been anchored at too low of a level compared with the 2 percent price stability target, and thus there is sufficient room to raise them. If a rise in nominal interest rates can be contained to a lesser extent than an increase in inflation expectations, then real interest rates can be lowered by that extent. With such a decline in real interest rates, business fixed investment and private consumption are expected to be stimulated, thereby elevating economic activity. Observed prices are also expected to increase gradually. In addition, a rise in observed inflation will lead to an increase in inflation expectations. There is little time today to explain all the transmission channels of the QQE, but I have covered the core part. Through its effects, it is our aim to stimulate the economy, improve the output gap and, above all, shift inflation expectations upward, and achieve the 2 percent price stability target as soon as possible. III. Achievements under QQE and perspective on overcoming deflation Now that six months have passed since the QQE was introduced, is it working? As it turns out, there have been improvements in financial markets, economic activity and prices, and people’s expectations, and the QQE has been powerfully exerting its effects. Let me point out some examples. BIS central bankers’ speeches In the financial markets, stock prices have risen by more than 30 percent since the beginning of the year. This substantially exceeds the rate of increase not only in Europe, of around 13 percent, but also in the United States, of around 16 percent. On the real economy front, real GDP has marked high growth since the turn of the year of around an annualized 4 percent for two consecutive quarters. The unemployment rate has recently declined to the levels seen prior to the Lehman shock of around 4 percent. People’s expectations have also changed. Consumer confidence indicators clearly have tilted upward since around the end of last year. Looking at business confidence indicators, according to the BoJ’s business survey, called the Tankan survey, the diffusion index (DI) for business conditions bottomed at minus 9 percentage points in the last December survey and has improved to plus 2 percentage points in the latest September survey – the same level as that in December 2007, prior to the Lehman crisis. Turning to price developments, expected inflation rates have increased as a whole, according to market indicators and various surveys. The break-even inflation rate (BEI) has increased to close to 1.7 percent, from around 0.70 a year ago. In the Opinion Survey on the General Public’s Views and Behavior conducted by the BoJ, in which consumers are asked their views on the inflation rate one year from now, the proportion of consumers who answered that prices would increase was just over 50 percent in the last December survey, but increased to above 80 percent in the September survey. In addition, the DI for selling prices in the Tankan survey, which is calculated based on a question firms were asked of developments in selling prices of their own products and services, have improved for large firms from minus 15 percentage points in the last December survey to zero in the September survey. Looking at the observed inflation rates, the CPI inflation rate turned positive in June for the first time in 14 months, and accelerated to 0.8 percent in August. As explained, stock prices have been rising and the real economy has been improving steadily. The inflation rate has turned positive and inflation expectations have risen. Such improvements in economic activity, prices, and people’s expectations could be factors in increasing interest rates. Nevertheless, thanks to strong downward pressure stemming from the BoJ’s JGB purchases, Japan’s long-term interest rates have been slightly lower than those of a year ago, with 10-year JGB yields hovering at less than 0.7 percent. In addition, while long-term interest rates have been rising since May in the United States and other overseas economies, those in Japan have been more or less flat or slightly declining. Commercial banks’ lending rates on new loans – an average of loans to firms and individuals – have declined to a historic low of below 1 percent. Meanwhile, as people’s inflation expectations have been increasing gradually on the whole, real interest rates have been declining. Thus, the situation we have aimed for has been generated. This decline in real interest rates is likely to stimulate business fixed investment, housing investment, and private consumption, thereby bolstering the economy. In addition, the QQE and various measures by the government seem to have been gradually improving people’s sentiment, making them proactive and igniting their animal spirits. In fact, there are signs that firms’ funding is becoming active. The year-on-year rate of increase in bank lending, which once declined to below 0.5 percent in the first half of fiscal 2012, has since been moderately expanding to slightly over 2 percent. The amount of corporate bonds issued in the April-June quarter reached a high level for the first time since the July-September quarter of 1998, which was coincidentally the quarter when deflation began. Initial public offerings by firms have also become active recently. So far, the QQE has been exerting its intended effects, which is quite encouraging. By continuing to pursue the QQE with a strong determination to achieve the 2 percent price stability target, we are convinced that we will definitely overcome deflation. BIS central bankers’ speeches Concluding remarks Japan has a solid growth base. It has first-class technology and human resources. What has been lacking is positive sentiment – both the confidence in our ability to succeed and in our animal spirits – which were lost amid the sense of stagnation under persistent deflation. The overcoming of deflation will progress in line with a dispelling of this sense of stagnation. I am a firm believer that Japan will regain confidence and grow with vigor again. There is another tail wind for Japan. The recent decision to hold the 2020 Olympics in Tokyo is boosting the level of people’s sentiment. At the time of the Olympics, seven years from now, we will welcome you to a Japan that has regained its brightness. However, I am afraid that you may not be able to ride subways in Tokyo at a minimum fare of 160 yen at that time. Thank you for your attention. BIS central bankers’ speeches
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the International Council Meeting of the Bretton Woods Committee, Washington DC, 10 October 2013.
Haruhiko Kuroda: Quantitative and qualitative monetary easing Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the International Council Meeting of the Bretton Woods Committee, Washington DC, 10 October 2013. * * * Introduction It is my honor to take part in this wonderful meeting as a panelist today. When I first looked at the list of questions prepared by the Committee to shape my remarks, I was stunned by the sheer number and scope of the questions. This points to the fact that we are surrounded by daunting challenges in this interconnected world, and it is our responsibility to sincerely meet those challenges. Given the time constraints today, my focus will naturally be on monetary policy. The steering of policy has become increasingly difficult in recent times, and many of my fellow central bankers have found themselves in uncharted waters. Since the outbreak of the Lehman crisis, major central banks around the globe have introduced unconventional monetary policy measures, including asset purchases, amid the constraints of a zero lower bound for nominal interest rates. The Bank of Japan has also implemented unconventional monetary policy several times, since more than a decade ago, and has successfully accumulated ample experience. However, we have not been successful in overcoming deflation. To this end, in April, immediately after I became the Governor of the BoJ, we introduced quantitative and qualitative monetary easing, dubbed the QQE. The QQE is markedly different from the policies the BoJ implemented in the past and from unconventional monetary policies other central banks have been carrying out. Today, in the time allotted to me, I would like to explain the uniqueness of the QQE. Challenges and economic situation Japan’s economy has been mired in deflation for the past 15 years. In the meantime, people’s inflation expectations declined and the recognition that prices will not increase – namely, deflationary expectations – became entrenched. Amid the situation of prices not increasing, the holding of cash or deposits became a better investment, and thus firms and households hoarded cash and did not make other productive investments. Persistent deflation encouraged behavior to stay status quo, and this deprived Japan’s economy of vitality. There were phases of economic recovery in the meantime, but they did not lead to a sustainable increase in prices. The Phillips curve, which shows the relationship between the output gap and inflation, shifted downward in tandem with a decline in inflation expectations. The average inflation rate envisaged when the economy is at an average state has been 0 to 0.5 percent for the past 15 years or so. Those in the other six G7 countries have been anchored around the inflation target of 2 percent. The largest problem for Japan’s economy is that prices will not increase even if the level of economic activity rises. Therefore, the greatest challenge is to raise inflation expectations. Uniqueness of the QQE Based on this recognition, the BoJ introduced the QQE in April. This new policy aimed at increasing inflation to the global standard of 2 percent by working directly on inflation expectations. Specifically, the policy comprised two features. First, to show the BoJ’s determination that it would overcome deflation at the earliest possible time through a strong and clear statement. Therefore, the period in which the BoJ would achieve the target was BIS central bankers’ speeches clearly specified as “about two years.” The second feature, for the purpose of underpinning such determination, was to launch massive monetary easing that clearly differed from the past policies. Specifically, the BoJ declared that there would be a doubling in two years of the monetary base that it provides. As a result, Japan’s monetary base two years from now will become 270 trillion yen, or 2.8 trillion dollars, reaching more than 50 percent of nominal GDP. This ratio is 20 percent for the U.S. Federal Reserve and 23 percent for the Bank of England. As the BoJ will double the holdings of Japanese government bonds (JGBs) on its asset side when increasing the monetary base, the QQE also aims at putting strong downward pressure on long-term interest rates. A core mechanism of the policy is to raise inflation expectations and contain long-term interest rates. Under the BoJ’s clear commitment and a new phase of massive monetary easing, inflation expectations will be raised, while an increase in long-term interest rates will be contained through massive purchases of JGBs. As a result, real interest rates will decline and this will create stimulative effects for economic activity. If this leads to an actual rise in price indices, it will in turn lead to an increase in inflation expectations. State of progress under the QQE Six months have passed since the introduction of the QQE, and this mechanism has steadily been operating. In Japan’s economy, real GDP has marked annualized growth of around 4 percent for two consecutive quarters and the CPI inflation rate (excluding fresh food) turned positive in June for the first time in 14 months, accelerating to plus 0.8 percent. The outlook for economic activity and prices has improved and stock prices have risen by more than 30 percent since the beginning of the year. While these should be factors that lead to increases in long-term interest rates, Japan’s long-term interest rates have declined from about 0.8 percent as of the beginning of the year to less than 0.7 percent. These rates have declined since end-May, even in a situation of long-term interest rates in the United States and many other countries having substantially increased across the board. The break-even inflation rate and expected inflation rates judged from various surveys have been increasing. Thus, the QQE has been exerting its intended effects and Japan has been steadily moving toward overcoming deflation. Concluding remarks The QQE is an unprecedented policy, in that it aims to increase inflation expectations in a situation where there is no room to further reduce nominal interest rates. While this is a daunting challenge, developments thus far have been encouraging. With the aim of achieving the 2 percent price stability target, the BoJ will continue with the QQE as long as it is necessary for maintaining that target in a stable manner. Thank you for your attention. BIS central bankers’ speeches
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a Meeting with Business Leaders, Shimane, 9 October 2013.
Hiroshi Nakaso: Japan’s economy and monetary policy Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a Meeting with Business Leaders, Shimane, 9 October 2013. * * * Introduction It is my great pleasure to be given an opportunity today to exchange views with administrative, financial, and business leaders in Shimane Prefecture. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the activities of the Bank of Japan’s Matsue Branch. On a personal note, my relationship with the San-in region goes back long years. My father was born in Yonago, Tottori, and I have visited his birthplace several times. The reason why I feel nostalgic, despite this being my first time in Matsue, is that my roots are in this region. Japan’s economy has long been in a state of deflation, since the financial crisis of the 1990s. For Japan’s economy to escape this situation and restore its vitality, it is most important to first overcome deflation and change the mind-sets of economic entities such as firms and households so that they become more proactive. In this sense, the biggest immediate challenge facing Japan’s economy is the overcoming of deflation at the earliest possible time, and I realize that the role the Bank of Japan has to play is crucial. Based on this recognition, the Bank introduced a new policy in April, called “quantitative and qualitative monetary easing” (QQE). Today, before exchanging views with you, I would like to talk about economic developments at home and abroad. I will also elaborate on the thinking behind the QQE. Lastly, I will talk about economic development in this region. I. Recent developments and outlook for economic activity at home and abroad Recent developments and outlook for Japan’s economy First, I will focus on Japan’s economy. A virtuous circle from income to spending has gradually been taking hold both in the household and business sectors. In the household sector, private consumption has been resilient. Sales at department stores have remained firm and consumption of services such as outlays for travel and sales in the food service industry have held steady. With underlying active consumption by senior citizens, notably baby boomers, such resilience in private consumption seems to have been sustained mainly by wealth effects stemming from a rise in stock prices and an improvement in sentiment since the turn of the year. It has gradually been supported by the improvement in the employment and income situation. The employment condition continues to improve moderately, as the unemployment rate and active job openings-to-applicants ratio recovered almost to levels seen prior to the Lehman crisis. Against this background, special cash earnings – such as bonuses – registered a clear increase year on year, and total cash earnings per employee have begun to bottom out. Reflecting this improvement in the employment condition, as well as in wages, employees’ total cash earnings in Japan as a whole have been increasing year on year. In the business sector, corporate profits continue to improve and business fixed investment has been picking up, mainly in the non-manufacturing sector, as evidenced by real business fixed investment in the GDP statistics registering a quarter-on-quarter increase for the first time in six quarters. This is an encouraging development, as we thought that a key to the sustainability of economic recovery would be business fixed investment. While the relatively lagging business fixed investment in the manufacturing sector is a matter of concern, BIS central bankers’ speeches potential demand for such investment seems to be growing as existing capital stock has become obsolete due to the restraint on business investment up to now, and firms have subdued their R&D investment. Under such circumstances, if overseas economies start to pick up gradually and exports increase moderately, an improvement in business fixed investment in the manufacturing sector – mainly in investment for maintenance and replacement of existing capital stock, R&D investment, and IT-related investment – is likely to become evident. In fact, in the recently released September Tankan survey, the business fixed investment plan in the manufacturing sector for fiscal 2013 was for an increase of 7.0 percent year-on-year, marking a steady increase. Owing to those developments, the Bank said in its statement released after the Monetary Policy Meeting in September that “Japan’s economy is recovering moderately,” using the words “is recovering” for the first time since the Lehman crisis. Going forward, the Bank expects that Japan’s economy is likely to continue recovering moderately on the back of a virtuous circle among production, income, and spending. While the economy will experience a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike, it is likely to continue growing, as a trend, at a pace higher than its potential growth rate. Main features of present economic recovery Let me touch on the main features of the current economic recovery. A typical pattern of Japan’s economic recovery in the past was that it started with an increase in exports and production, thereby centering on the manufacturing sector. However, unlike the pattern of past recoveries, the major feature of the recovery this time is that it is led by the nonmanufacturing sector against the backdrop of firmness in domestic demand such as private consumption and public investment. That might be because, while consumption by senior citizens and reconstruction-related spending have been underpinning domestic demand, there also have been effects of various stimulus policy measures under “Abenomics” and improvement in household sentiment on the back of high expectations for the current economic policy management, as well as favorable developments in financial markets. Indeed, while exports and production remain short of the pre-Lehman crisis levels, tertiary industry activity index – an indicator of the state of economic activity in the nonmanufacturing sector – has come close to the pre-Lehman crisis level. A pick-up in business fixed investment also has taken place mainly in the non-manufacturing sector, as I mentioned earlier. The non-manufacturing sector requires more human resources than the manufacturing sector. At present, improvement in employment and income, mainly in the non-manufacturing sector, is supporting private consumption in a virtuous cycle. The virtuous circle from income to spending has been gradually taking hold, and this has supported resilience in domestic demand. Such development is expected to continue. Recent developments and outlook for overseas economies In this recovery, the resilience in domestic demand has been pronounced. Exports are picking up, although they remain lackluster so far. In considering the future of Japan’s economy, it is important that overseas economies pick up while domestic demand is resilient, and that the economy move to a phase led by domestic demand and external demand as a pair of wheels. Let me now turn to the recent developments in overseas economies. Overseas economies as a whole are gradually heading toward a pick-up. Looking at respective regions, the U.S. economy is on a moderate recovery trend owing to firm private demand in the face of the fiscal drag. As for the fiscal situation, government debt increased significantly, mainly due to large-scale fiscal spending after the Lehman crisis. In response, there have been moves toward fiscal consolidation, and austerity measures – including an expiration of various tax reductions and a start to budget sequestration – have been taken since the turn of the year. In the face of this fiscal drag, U.S. private demand is resilient due BIS central bankers’ speeches to continuing accommodative financial conditions under low interest rates. For example, housing investment is picking up as a trend due to low mortgage rates. As a prerequisite for scaling back the pace of asset purchases, the Fed pointed out that employment conditions should continue to improve, supported by a moderate recovery in economic growth. Therefore, on the assumption that the Fed will continue with its proper conduct of monetary policy, it is unlikely that private demand will decline substantially. In this situation, as the fiscal drag will gradually fade, the pace of recovery is expected to gradually accelerate. The greatest uncertainty for the U.S. economy is the consequence of fiscal consultation, an issue on which the Democrats and the Republicans continue to oppose each other sharply. As a preliminary budget has not been agreed on, some government institutions have already been forced to close. The debt ceiling will be reached in the middle of this month, and the redemption and interest payment of government securities will be stopped if it is not raised. If that happens, this might have significant adverse effects on the global economy through a downgrading of U.S. government bonds and an associated rise in premiums transmitting to markets in other countries, inducing a rise in long-term interest rates, a plunge in stock prices, and fluctuations in foreign exchange rates. By contrast, if this problem is resolved successfully, this would eliminate the current uncertainty surrounding the U.S. economy, and thus might provide a boost toward economic recovery. At any rate, a prompt resolution of the fiscal consultation issue is critical for the global economy, including Japan. Turning to the European economy, while it continued to remain sluggish, real GDP growth registered a quarter-on-quarter increase in the April-June quarter of this year for the first time in seven quarters, suggesting that the economy is finally leveling off. As for crisis resolution, policy measures pertaining to the European debt problem have surely seen a material progression since the summer of 2012, including the introduction of the government bonds purchase program by the European Central Bank (ECB) and the establishment of the European Stability Mechanism, through which financial assistance will be provided in the event that the euro member countries encounter a fiscal crisis. In this situation, there is now improvement in both business and household sentiment. Some adjustment in the fiscal austerity program has also mitigated the downward pressure on the economy from the fiscal side. Moreover, exports are bottoming out, particularly in Germany. It is likely that the European economy will start picking up gradually as these developments continue. However, I must say that a fundamental resolution of the European debt problem has only reached the halfway point. The current stability in European financial markets seems to have been brought about because the ECB has been buying time through its large-scale monetary easing. In the meantime, it is necessary to steadily take steps through various structural reforms and toward forming banking, fiscal, economic, and political unions as presented in a roadmap for unification of Europe. The time the ECB can buy is limited and might be gradually becoming costly. The Chinese economy continues to grow steadily, although the pace of growth has become somewhat lower than that in the past. From the time of inauguration, the new government clearly showed its stance of pursuing structural reforms, by announcing frugality laws and measures to contain real estate prices. Against such a backdrop, there has been concern since around the turn of the year that the economy might slow down. However, the government in July showed its stance of focusing on achieving this year’s target of economic growth of around 7.5 percent and it decided various measures that paid due consideration to economic growth; thus, looking to the future, it is expected that stable growth at around the current pace will continue, supported by resilient domestic demand. In terms of further policy responses, the fiscal situation in China remains relatively sound and there is additional room for fiscal stimulus. Owing to these developments, the chance of the Chinese economy decelerating significantly, at least in the short run, is viewed as not great. In the meantime, what is somewhat worrisome are emerging economies. Looking back, after escaping from acute symptoms of the Lehman crisis, the global economy recovered, led by BIS central bankers’ speeches high growth in emerging economies. Behind this, there were mainly two reasons. First, the trend of domestic demand in those economies was robust due to the consumption spree associated with a rise in the living standard and to the need to expand social infrastructure. Second, after the financial crisis, aggressive monetary easing in advanced economies led to capital inflow to emerging economies, providing additional impetus for emerging economies to grow. However, recently, the U.S. and European economies have been improving, while growth momentum in emerging economies is somewhat weak. The first thing that comes to mind as a reason for this is that, immediately after the financial crisis, emerging economies also adopted expansionary policy measures, and some “excesses” in business fixed investment and lending may have emerged during that process. Second, while economic activity in the United States and Europe has been recovering, concern has been raised that capital inflow into emerging economies may reverse its course. Under such circumstances, triggered by speculation that the Fed is likely to scale down the pace of its asset purchases, financial markets in the emerging economies have recently become instable, with some, mainly current-account deficit countries, experiencing depreciation in their currencies. Such instability in financial markets might have adverse effects on the real economy through tightening financial conditions and deteriorating business and household sentiment, and this requires attention. Having said that, in my view, the likelihood that the current situation will become one similar to the Asian currency crisis in 1997–98 seems marginal. The Asian crisis became widespread due mainly to vulnerability of the banking systems in Asian countries. By contrast, the current situation is limited to market risk, as exemplified by the heightening of market volatility. Moreover, from the perspective of safety nets, those economies have accumulated substantial foreign reserves and backstops were put in place, such as the Chiang Mai Initiative – a swap agreement network to make short-term foreign currencies available among participating countries. Owing to these developments, emerging economies have become more resilient against possible capital outflows. In addition, as seen at the G20 meeting and meetings at the Bank for International Settlement, frameworks are now in place that enable advanced economies and emerging economies to have direct discussions. To sum up, while each country or region has its own risk factors, it is expected that overseas economies – most notably the U.S. economy – will generally start picking up gradually. Under such circumstances, exports and production in Japan are expected to increase. II. Basic thinking behind QQE I would now like to explain the thinking behind the QQE that the Bank is currently pursuing. In April, the Bank, with a view to achieving the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index at the earliest possible time, with a time horizon of about two years, introduced a new policy of “quantitative and qualitative monetary policy” (QQE). In this policy, the main operating target for money market operations was changed from the short-term interest rate to the monetary base, which is the sum of banknotes and currency in circulation as well as commercial banks’ current account balance held with the Bank, and the Bank will double the monetary base in two years. In doing so, it will purchase massive amounts of Japanese government bonds (JGBs), with all maturities made eligible for purchases. In addition, in aiming to achieve the price stability target of 2 percent, the Bank made a commitment that it would continue with such drastic monetary easing as long as it is necessary for maintaining the target in a stable manner. The Bank conducts monetary policy based on the principle of “achieving price stability, thereby contributing to the sound development of the national economy.” Therefore, in achieving the price stability target, it is important to create a virtuous cycle of prices that gradually increase as the economy as a whole grows in a sustainable fashion and as people’s standards of living improve. BIS central bankers’ speeches Routes to raise inflation expectations The QQE is expected to raise prices via the following two different routes. The first is improving the supply and demand balance of the economy as a whole by stimulating economic activity. Namely, through elevating the level of economic activity in Japan as a whole, the supply and demand balances in goods, services, and labor will tighten, leading to a pickup in prices and wages. The supply and demand balance of the economy as a whole is gauged as the output gap – namely, the difference between potential GDP, which can be produced in an average situation for the labor force and for facilities, and actual GDP. There seems to be a negative output gap – where actual GDP is below potential GDP and there is an excess in the labor force and in facilities – remaining in Japan’s economy. We need to move this into positive territory. Japan’s GDP has been growing at an annualized rate of about 4 percent for two consecutive quarters. This growth rate substantially exceeds the potential growth rate, which is estimated to be around 0.5 percent. In this situation, the output gap has been steadily narrowing and is expected to turn positive. The second route is raising people’s inflation expectations. While some may be unfamiliar with this terminology, these are inflation rates that the public foresees. As deflation has continued for nearly 15 years in Japan, the view that prices are unlikely to rise has become embedded. In a state of deflation, holding cash and deposits, as well as related assets, becomes a relatively better investment. In this situation, businesses and households have been refraining from consumption and making investment, and the economy’s vitality has been lost. In order to escape from such a situation, it became necessary to dispel such deflationary expectations entrenched among the public; namely, to raise their inflation expectations. To this end, the Bank, upon making a strong and clear commitment that it would achieve the price stability target of 2 percent with a time horizon of about two years, decided on drastic monetary easing both in terms of quantity and quality to underpin the commitment. By doing so, the QQE aims to drastically change the deflationary expectations of economic entities such as businesses and households. Specifically, how do these two routes work on the real economy? I will explain this next. Impact on interest rates: logic behind real interest rates While the QQE has a number of transmission channels, what is important above all is to influence real interest rates. Real interest rates are calculated by subtracting expected rates of inflation from nominal interest rates. In other words, if businesses and households consider that prices will rise and sales as well as wages will likewise rise in the future, the interest burden in real terms will be smaller than what nominal rates may suggest. As the spending behavior of businesses and households will be greatly influenced by real interest rates, if real rates can be lowered, both private consumption and business investment will be stimulated and the level of economic activity will heighten. As a result, supply and demand balances will tighten in goods and services markets, as well as the labor market, and prices will rise accordingly. It is considered that nominal interest rates, notably long-term interest rates, will be determined according to the outlook for economic activity and prices. Therefore, intrinsically, if the real economy and prices improve and inflation expectations increase, nominal interest rates will rise. Were nominal interest rates to rise in parallel with a rise in inflation expectations, real interest rates would not change. That is, to lower real interest rates, it is necessary to raise inflation expectations while containing a rise in nominal rates. It is for this reason that the QQE, while lifting the public’s inflation expectations by changing their expectations, undertakes market operations to contain a rise in nominal rates as much as possible through the massive purchase of the JGBs. This is a highly difficult policy to conduct, and it requires subtle balancing. BIS central bankers’ speeches Interest rate developments after introduction of QQE So far, this policy conduct has been successful. Inflation expectations appear to be rising on the whole. While it is difficult to directly observe inflation expectations, taking break-even inflation rates measured by inflation-linked government bonds and various surveys on households, economists, and market participants as a whole, people’s inflation expectations seem to have been rising. By contrast, Japan’s long-term interest rates have been hovering in a stable fashion. Given that market operations to contain an increase in nominal interest rates as much as possible are what the Bank is trying to achieve by purchasing massive amounts of JGBs in the JGB market, it is essential to have market participants’ cooperation. Therefore, from the very day the Bank introduced the QQE in April, it started a dialogue with market participants. Subsequently, there were phases in which the volatility in the JGB market heightened as market participants digested the QQE’s contents, and long-term interest rates rose in reflection of the cautious attitude of market participants toward JGB investment. In response, based on its dialogue with market participants, the Bank has been improving its methods of purchasing JGBs. As a result of these efforts, the JGB market regained stability, and now long-term interest rates in Japan remain stable at low levels of less than 0.7 percent. Amid the upticks in longterm interest rates overseas in response to a rise in the U.S. long-term interest rates, on the back of speculation over the Fed’s scaling down of its pace of asset purchases, the stability in Japan’s long-term interest rates has been conspicuous. With JGB yields, which form the basis for bank lending rates, having been stable at low levels, contractual lending rates, which show developments in lending rates to firms and households as a whole, have remained at historic low levels. As people’s inflation expectations appear to be rising on the whole while long-term interest rates remain stable, real interest rates are expected to be on a declining trend. Under such circumstances, prices in Japan – when assessed by the year-on-year rate of change in the consumer price index excluding fresh food – turned positive in the middle of this year and accelerated to 0.8 percent in August. Looking ahead, as the aggregate supply and demand balance in the economy is expected to improve and inflation expectations to rise further, the year-on-year rate of change in the CPI is likely to reach close to the price stability target of 2 percent from the latter half of fiscal 2014 through fiscal 2015. While we recognize that lifting inflation expectations through monetary policy is an extremely ambitious approach in unchartered waters, we would like to meet the longstanding challenge of overcoming deflation on all counts by steadily gaining the fruits of pursuing the QQE. Concluding remarks In conclusion, I will touch on the economies of Shimane Prefecture and the San-in region. Shimane Prefecture seized the historical watersheds of “1300 years of the Kojiki – Japan’s oldest chronicle” in 2012 and “Izumo Taisha’s Sengu – a period of massive repair work – of the Heisei Period” in 2013 as golden opportunities, and has been making efforts all over the prefecture to establish a sightseeing brand. Its aggressive PR activities are also seen in the metropolitan area. Together with the recent boom in visitors to spiritual places and the opening of the Matsue Expressway, tourism demand has been increasing to a substantial degree. According to the Bank’s Matsue branch, the economic effect of an increase in tourism demand in 2013 stemming mainly from Izumo Taisha’s Sengu was estimated to be slightly less than 30 billion yen. Given that Shimane’s gross prefectural production is slightly more than two trillion yen, the increase in tourism demand will be a substantial boost for the regional economy, for which the average growth rate over the past 10 years has been about zero percent. In addition to firm tourism, business conditions in the non-manufacturing sector, including the construction industry, which has been underpinned by an increase in public and private BIS central bankers’ speeches construction, have been generally improving. Business conditions have also been improving in the manufacturing sector due mainly to strong production in electronic parts for smartphones and tablet computers as well as automobile-related goods, and increased production in food & beverages and construction-related materials, reflecting an increase in domestic demand such as tourism and public investment. As a result, the economy of Shimane Prefecture has been moderately recovering. According to the recently released September Tankan survey, business conditions in the San-in region reached the highest level since 1991, confirming that economic recovery has been spreading. The business conditions have been at almost the same level compared with those nationwide. During Japan’s longest post-war economic recovery, between 2002 and 2007, an improvement in business conditions in the San-in region was markedly sluggish compared with that of the national average. There were several reasons behind this. As the economic recovery at that time was led by external demand reflecting an expansion in the global economy, the region was not able to benefit much from the recovery. In addition, the effects of a cut in public investment during the period weighed heavily on the regional economy, in which the contribution of construction industry to the regional economy as a proportion was high. By contrast, the reason why business conditions in the San-in region have been improving in tandem with those nationwide during this recovery phase seems to be that the feature of this recovery – namely, that firm domestic demand has been inducing an improvement in economic activity in the non-manufacturing sector – has similarly occurred in the San-in region. In addition, the structure of the regional manufacturing sector – namely, a relatively high contribution to the regional economy as a proportion, compared with nationwide, of the food & beverages industry and lumber & wood products industry, which are highly domestic demand-dependent – has partly bolstered production in the manufacturing sector. Against such a backdrop, due mainly to a moderate increase in production, a virtuous circle from income to spending has also started to operate in this region, mainly in the business sector. The Bank will steadily pursue the QQE to ensure that this fledgling virtuous circle seen nationwide, inclusive of this region, will keep operating firmly in the future. In doing so, we believe it is critical to carefully examine economic activity and prices while firmly gauging developments in regional economies through the Bank’s nationwide branch network, including the Matsue branch. From this perspective, we would like to continue to seek your cooperation with respect to research and other activities of the Matsue branch. This region has plenty of “resources” – namely, the ample resources of tourism and of agriculture, forestry, and fisheries, as well as a concentration in the manufacturing sector with advanced technologies. For Shimane’s economy not to make the current recovery a transient one, it is critical to effectively utilize these resources to improve growth potential. In this regard, it is expected that, with the tourism industry and other regional industries working together, there will be further promotion of initiatives related to “local production for local consumption” in a broad sense – namely, to “effectively make use of regional resources to spur production and expand regional consumption.” With heartfelt hope for further development through these initiatives in the economy of the region of my roots, I would like to conclude my speech. Thank you. 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Special lecture by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, commemorating the 50th Anniversary of the Institute of Economic Research, Chuo University, Chuo, 18 October 2013.
Kikuo Iwata: Purpose and mechanism of quantitative and qualitative monetary easing Special lecture by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, commemorating the 50th Anniversary of the Institute of Economic Research, Chuo University, Chuo, 18 October 2013. * * * Introduction It is a great honor for me to give a special lecture to commemorate the 50th anniversary of the foundation of the Institute of Economic Research, Chuo University. I wish to extend my great respect to those who were involved in its foundation and activities, and thank you for inviting me to speak on such a distinguished occasion. On April 4, the Bank of Japan introduced a new policy framework, called quantitative and qualitative monetary easing (QQE). It decided that it would continue with the QQE, aiming to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI), as long as it is necessary for maintaining that target in a stable manner. In my lecture today, I would like to answer the following three questions. First, why does the Bank aim to achieve and maintain the price stability target of 2 percent? Second, what is the transmission mechanism through which the QQE achieves and maintains its purpose? Lastly, is Japan’s economy moving along the path that the Bank has anticipated? I. Reason behind the price stability target of 2 percent Let me start with the first question – namely, why does the Bank aim to achieve and maintain the price stability target of 2 percent? The first answer is that deflation must be avoided once and for all. It squeezes corporate profits through price declines of goods and services. For this reason, unless companies manage to sell more goods and services, they will be put in a situation where they cannot pay their debts. Put differently, the real value of debts will increase as deflation continues. In light of an increasing real value of debts, firms become cautious in terms of their attitude toward business investment that requires fund-raising. As a result, production and labor demands of the economy as a whole will decline, leading to a rise in the unemployment rate and a decline in wages; hence, people’s living standards will go down as well. On top of this, an inflation rate of about 1 percent is not necessarily enough as a buffer against the slightest risk of deflation. The second answer to the question is the upward bias in the CPI. The price stability target refers to the CPI (all items excluding fresh food), which is considered to contain an upward bias of nearly +1 percentage point. As for the reason behind such a bias, it is pointed out that, in general, while households are more likely to reduce their consumption of those goods and services for which prices have risen, revision of the CPI only takes place every five years; hence, the CPI does not accurately capture changes in the composition of consumption until it goes through that revision. Assuming that such an upward bias of nearly +1 percentage point exists, even if the CPI registers 1 percent on a year-on-year basis, the inflation rate in practice is likely to be close to zero percent. In other words, targeting an inflation rate of 1 percent could suggest that the aim is to achieve a deflationary environment or something close to it. This leads one to conclude that a target of a somewhat higher rate of change is necessary once the presence of such an upward bias is taken into account. BIS central bankers’ speeches The third answer to the question of why the Bank aims to achieve and maintain the price stability target of 2 percent owes much to the fact that, from the 1990s up to now, the advanced economies that have maintained inflation rates of about 2 percent have shown relatively better performance, by registering higher economic growth and lower unemployment rates. Taking all of these into consideration, it is also appropriate for Japan to aim for the price stability target of about 2 percent. II. How to achieve the price stability target Based on such understanding, the Bank has set the price stability target of 2 percent, and in order to achieve that target, it has embarked on a new phase of monetary policy – namely, the QQE. Put differently, the QQE is a bold means through which to achieve the price stability target of 2 percent. Based on the better understanding of the relationship between the price stability target and the QQE, I will next talk about how the Bank aims to achieve that target through implementation of the QQE. Two pillars of the QQE The QQE consists of the following two pillars. The first is a “commitment” to early achievement of the price stability target of 2 percent. Specifically, the Bank is clearly committed to “achieving the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years.” The second pillar is the demonstration of “concrete actions” that underpin the first pillar’s commitment. These are well captured in the words “quantity” and “quality,” and changes have already been seen in the expansion (i.e., quantity) and composition (i.e., quality) of the Bank’s balance sheet. In terms of the expansion of the balance sheet, the Bank will increase the monetary base massively through purchases of a variety of assets including Japanese government bonds (JGBs). It aims to almost double the amount outstanding of the monetary base in two years, from 138 trillion yen at end-2012 to 270 trillion yen at end-2014. In terms of the composition of the balance sheet, the Bank will increase assets with relatively high risks. It now purchases JGBs in all maturities including those with super-long maturities of 40 years. As a result of this, the average remaining maturity of the Bank’s JGB purchases has been more than doubled, extending from slightly less than three years to about seven years. It is expected that the effects of policy accommodation on financial conditions and the real economy will strengthen through working on interest rates across the whole yield curve. On top of this, the Bank has increased the purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) in order to suppress risk premiums associated with those types of assets. Impact on nominal interest rates and inflation expectations Consisting of the two pillars that I have just explained, the QQE permeates the economy through nominal interest rates and the inflation expectations of financial market participants. First of all, the Bank’s ample provision of liquidity to the private sector through the purchases of JGBs and other assets will lower nominal interest rates. Moreover, the QQE, with the commitment to the 2 percent price stability target, will lift market participants’ inflation expectations. Let me come back to this point later. Both the downward pressure on nominal rates and upward pressure on inflation expectations will contribute to declines in the expected real interest rates, because the expected real BIS central bankers’ speeches interest rates are derived by subtracting inflation expectations from nominal interest rates. This has an important implication for the economy. Nonetheless, the upward pressure on inflation expectations is a double-edged sword: on the one hand, it is a factor contributing to declines in the expected real interest rates; on the other, it can lift up nominal interest rates. As I will explain shortly, the overcoming of deflation and the achievement of the 2 percent price stability target require that the expected real interest rates be maintained at low levels. It is therefore important that the extent of a pickup in nominal interest rates due to a rise in inflation expectations be lower than that of a rise in inflation expectations itself. Why do inflation expectations rise? I said at the beginning that the QQE will lift market participants’ inflation expectations. The reason behind the lift in inflation expectations owes much to the market expectations that a sharp increase in the monetary base (i.e., the monetary base defined as the total of banknotes and coins in circulation and the amount outstanding of financial institutions’ current accounts held at the Bank) in order to achieve the 2 percent price stability target, with a strong commitment, will eventually lead to an increase in bank lending, and hence an increase in the amount of money (i.e., sum of cash and deposits) circulating in the economy. If the money in the economy increases, people will expect that it will be used partly for the purpose of purchasing goods and services, and eventually the rate of inflation will start to pick up as well. What is important in this context is that, even though an increase in money through an expansion of bank lending is not observed, inflation expectations could start rising on the back of an anticipated increase in money in the future. Let us now look at recent developments in inflation expectations. While it is difficult to measure those expectations, as they are formed by a wide range of economic entities, break-even inflation – that is, the yield spread between fixed-rate coupon-bearing JGBs and inflation-indexed JGBs, and representative of the expected rate of inflation in the market – and figures collected from the results of surveys summarizing the views of researchers and economists at home and abroad show that inflation expectations are gradually rising as the QQE proceeds. Moreover, according to the recent Opinion Survey on the General Public’s Views and Behavior conducted by the Bank, the share of respondents who expected that prices will go up one year from now reached as high as 83 percent. This suggests that inflation expectations in the household sector are also on the rise (Chart 1). Rise in inflation expectations generating rise in stock and foreign currency markets The expected real interest rates are derived by subtracting inflation expectations from nominal interest rates. In the following, I simply refer to “real interest rates” instead of the expected real interest rates. While nominal rates are those that can be seen, real rates represent the extent to which money – i.e., purchasing power – will increase in reality, taking account of price changes. If people expect that inflation is on the horizon, the expected purchasing power of those assets, such as cash – which does not yield any returns – as well as deposits and bonds – which have fixed returns – will go down. Suppose the nominal rate of JGBs is 0.5 percent and the inflation expectation for the next 12 months is 1.0 percent. The real rate will then become minus 0.5 percent by subtracting the inflation expectation of 1.0 percent from the nominal rate of 0.5 percent. This example suggests that, even if the nominal rate is 0.5 percent, as long as the inflation rate remains at 1.0 percent, the purchasing power of JGB holdings after a year will go down by minus 0.5 percent. Likewise for cash, given that its nominal rate is 0 percent, the purchasing power BIS central bankers’ speeches of cash holdings after a year will decline by 1.0 percent if the inflation rate is 1.0 percent. Indeed, the real rates derived from the JGB yields have been declining moderately as a trend since end-2012 (Chart 2). As I explained, if people expect prices to go up down the road, the real rates of return from cash as well as deposits and bonds – for which interest rates are fixed – will decline. Holding those assets will become less attractive than in the past. In light of such developments, market participants with rising inflation expectations will shift part of their portfolios from cash, deposits, and bonds including JGBs to equities (including equity trust funds), real estate and homes (including real estate investment trusts such as J-REITs) or, alternatively, foreign-denominated assets for which returns are higher than those derived from yen-denominated assets. As a result of this, expectations would be for stock prices to rise, the yen to depreciate, and foreign currencies to appreciate (Chart 3). Increase in consumption and exports Both rising stock prices and the yen’s depreciation will lead to an increase in the value of household assets that are held in the form of either equities or foreign-denominated assets. According to recent statistics, the financial assets of households at end-June 2013 increased by 5 percent on a year-on-year basis. Looking at this in detail, while bonds decreased by 9 percent, shares and equities increased by 31 percent and investment trusts rose by 29 percent. The portfolio rebalancing that I just explained is actually taking place (Chart 4). Households facing a rising value of assets are likely to increase their consumption, and this is called the “wealth effect.” In addition, a rise in asset values, such as those of stock prices, will make people’s sentiment more upbeat. This improvement in sentiment is also an important factor in households increasing their spending. Household expenditure has been increasing since the beginning of this year, and this is largely due to the wealth effect that I just explained to you and the improvement in sentiment (Chart 5). As for the appreciation of foreign currencies, while the first thing that comes to our minds is an increase in exports, one should be reminded of an increase in foreign tourists in Japan, which is also an important factor for expanding domestic services demand (Chart 6). We know that the number of foreign tourists has been rising more recently (Chart 7). Increase in business fixed investment Such favorable developments will also provide positive movements in firms’ business fixed investment through different channels. First, an increase in household spending will necessitate that firms produce more in line with increasing demand; thus, they will become more aggressive with their business investment. A rise in stock prices and the appreciation of foreign currencies will increase the net asset values of firms – mainly exporting firms – that hold other firms’ equities and foreign currencies. This improvement in balance sheets will contribute to an increase in business fixed investment (Charts 8 and 9). According to estimates by Nomura Securities, the unrealized gains stemming from equity holdings of 1,830 listed firms increased by 32 percent, adding 3.7 trillion yen, from end-March to end-September 2013. Moreover, the improvement in business sentiment on the back of an increase in corporate profits is another factor in increasing business fixed investment. The ratio of current profits to sales in the corporate sector has been rising since 2012 and business sentiment has continued to improve (Charts 10 and 11). According to the recent data on business fixed investment, GDP statistics show an increase in such investment of 1.3 percent for the April-June quarter this year, thus marking the first such increase in six quarters. Likewise, based on the Financial Statements Statistics of Corporations by Industry, Quarterly, business fixed investment for all industries has been increasing since the October-December quarter last year. More specifically, while the year- BIS central bankers’ speeches on-year rate of change in business fixed investment in manufacturing declined by 0.6 percent for the April-June quarter this year, the extent of the decline narrowed. By contrast, that in nonmanufacturing registered a large increase – 4.7 percent – for the same quarter, buoyed by an increase in household spending (Chart 12). The relationship between cash flow and business fixed investment also shows that the latter is likely to follow an uptrend going forward (Chart 13). Changes in industrial structure and entities undertaking business investment Having said all this, it is likely that business fixed investment for large manufacturing firms will not increase at a pace as fast as those registered during the previous economic recovery phase in the early 2000s. The recovery after the 1990s was driven by public investment and/or by the export-led manufacturing sector. On the contrary, economic recovery this time is mainly led by the domestic demand-driven nonmanufacturing sector. This suggests that Japan’s industrial structure, like those of other large economies, is gradually changing and tertiary industrialization is in progress (Chart 14). In consideration of this point, there is a possibility that the major bearer of business fixed investment will gradually shift from the manufacturing sector to the nonmanufacturing sector in the future. From the perspective of improving the extent of productivity enhancement through business investment, deregulation will become vital in the nonmanufacturing sector, in particular business sectors such as medical and nursing care, as well as agriculture, which is currently going through the sixth industrialization. In addition, it is important to facilitate infrastructure in the metropolitan areas for the tertiary industry to flourish. Urban revitalization provides important underpinnings to start up new leading businesses. It will become an important issue to liberalize the floor-space ratio regulation as well as land-use regulation as part of a growth strategy. Should this kind of growth strategy be adopted, it could further reinforce the effects of the QQE. This does not mean, however, that the price stability target of 2% cannot be achieved without the growth strategy, as the Bank is equipped with powerful means to achieve the target. What I wanted to say here is that, if the growth strategy becomes successful, we can achieve a higher real growth rate even with the same 2 percent inflation rate. Improvement in labor supply-demand balance and increase in wages All in all, against the background of increases in demand through consumption, business investment, exports, and public investment, the real GDP for the January-March and AprilJune quarters this year grew at a brisk pace – 4.1 and 3.8 percent, respectively, on an annual basis. In the April-June quarter, both consumption and exports each contributed to its quarterly growth rate by 0.4 percentage point, and business fixed investment and public investment each contributed by 0.2 percentage point. In this circumstance, the unemployment rate declined to just under 4 percent in July and the active job openings-to-applicants ratio reached nearly 1 (0.95 in August). These figures suggest that the supply and demand balance in the labor market is moving in a favorable direction for employees (Chart 15). To be sure, the unemployment rate in August was 4.1 percent, somewhat higher than that in July. However, this was due to the fact that entry into the labor market increased on the back of improvement in the labor condition and that some people left their jobs voluntarily in an effort to look for better job offers. In sum, the uptick in the unemployment rate in August was a temporary phenomenon. The September Tankan survey also shows that the employment conditions DI was in the domain of “insufficient employment” rather than “excessive employment,” and this suggests that the supply and demand balance in the labor market has been tightening. BIS central bankers’ speeches As for wages, while scheduled cash earnings are yet to increase, the number of employees has started to rise and both non-scheduled cash earnings and special cash earnings (bonuses) have increased. As a result, employee income has started to increase (Charts 16 and 17). Due to such tightness in the supply-demand balance in the labor market, wages are expected to rise even further. A rise in income will lead to an increase in consumption, improving the supply-demand balance in the labor market and increasing employee income. This will further boost consumption; hence, the virtuous cycle prevails (Chart 18). Developments in the CPI As for prices, along with a rise in import prices and energy prices due to the yen’s depreciation, the extent of price declines for durable goods, which have continued to decline, has started to narrow against the backdrop of resilient consumption. As a result, the year-onyear rate of change in the CPI (all items excluding fresh food) registered 0.7 percent and 0.8 percent, respectively, in July and August. Excluding both fresh food and energy, the CPI declined by 0.1 percent in July and August year on year, and the extent of the decline since February has continued to narrow (Chart 19). Recent developments in the CPI reflect the narrowing of the output gap (Chart 20). As such, once the actual CPI starts to rise, the inflation expectations of households and firms will be reinforced, and this will accelerate an increase in consumption and investment. Furthermore, a rise in actual inflation will shift the Phillips curve upward through a rise in inflation expectations (Chart 21). As I have explained based on a number of indicators, Japan’s economy is judged to be on the verge of escaping from the deflation that has lasted for a long time, and it is recovering moderately. Going forward, I expect that the continuation of the QQE, aiming to achieve the 2 percent price stability target on a stable manner, will help Japan’s economy recover steadily, lead to an inflation rate close to 2 percent accompanied by wage rises, and achieve the overcoming of the deflation that has lasted for nearly 15 years. III. Excess reserves and inflation From a somewhat different perspective, I will now respond to criticisms raised regarding the Bank’s policymaking. More specifically, I would like to examine the rationale behind the hypothesis that inflation cannot be attained no matter how much the Bank increases the monetary base because its liquidity injection will only increase the excess reserves of financial institutions and not increase the amount of money in the real sector. First, let us review what occurred in the past: inflation expectations observed in the JGB market declined sharply after the Bank lifted its quantitative easing on March 9, 2006 (Chart 22). More recently in the United States, nominal rates went up, inflation expectations came down, and the expected real rates picked up after market participants started forming a view that the Fed would start tapering the pace of its asset purchases in light of Chairman Bernanke’s testimony on May 22, while in reality this was meant to slow the pace of increase in excess reserves. By contrast, the FOMC’s decision to continue with its quantitative easing on September 18 led to a decline in nominal rates, a rise in inflation expectations, and a decline in the expected real rates (Chart 23). What should we make of these episodes? In my view, they owe much to the fact that market participants make judgments on the monetary policy regime after they see changes in the monetary base and the excess reserves, and then form projections for the money stock, the future course of interest rates, and projections for prices. BIS central bankers’ speeches What matters to interest rates and inflation expectations is the monetary policy regime of a central bank and market participants’ views on the prospects for the money stock based on such a regime. The current level of money stock is irrelevant. It is in this sense that the simple “quantity theory of money,” in which there is a one-to-one relationship between the current money stock and prices, does not hold in practice. Nonetheless, there is a close relationship between the projected future course of the money stock and inflation expectations, and the present rate of inflation is determined based on inflation expectations formed in that way. IV. Risks and monetary policy Lastly, I would like to touch on risk factors that could suppress the effects of the QQE. These are mainly overseas factors, and they are regarded as downside risk. In the euro area, the real GDP growth rate finally turned positive in the April-June quarter of this year. As there is not a sufficient mechanism to segregate the negative feedbacks among fiscal policy, monetary policy, and the real economy, one cannot exclude the possibility that the worsening situation in financial markets – triggered by an event in peripheral countries – would put downward pressure on the euro area, thereby leading to a decline in Japan’s exports to that area. As for the U.S. economy, while the downside risk is diminishing, the U.S. federal government’s fiscal policy continues to be a major downside risk and a constraint on U.S. economic growth. Discussion pertaining to the federal debt ceiling and the effect of fiscal policy are uncertainties, and these could become another risk factor in financial markets and the real economy. In emerging economies, the risk of recurrence of the Asian financial crisis in the late-1990s is slim, but we need to bear in mind that, among economies with vulnerable economic structures, the outflow of capital – triggered by such reasons as the Fed’s possible tapering – may induce their own currencies to depreciate and stock prices to decline further. The economic growth path of the Chinese economy also needs to be monitored closely. Concluding remarks Monetary policy exerts effects on asset markets such as the bond, stock, and foreign exchange markets. However, it takes a considerable amount of time for monetary policy to have an effect on economic activity in terms of production, employment, prices, and wages. Considering that it has been just over six months since the Bank introduced the QQE, its effects on economic activity have in fact appeared earlier than with other past monetary policies. This is probably because when the framework of Abenomics was announced in midNovember last year, expectations for a new phase of aggressive monetary easing grew and the public – including investors – had already factored in the shift to aggressive monetary policy, and with this in mind they started taking action from around that time. In other words, the effects of the QQE had already started exerting effects from mid-November last year. In fact, the rise in stock prices and the depreciation of the yen had been observed from around that period. On this basis, the effective duration of the new phase of monetary easing has now reached eleven months, and it is only natural that it has already exerted effects on economic activity to the extent observed today. Japan’s economy has been recovering steadily so far, in line with the path envisaged by the Bank; however, taking into account the time lag that accompanies the effect of monetary policy on economic activity, the effects of the QQE will actually start to gain momentum in the economy hereafter. BIS central bankers’ speeches There are remaining downside risks such as overseas factors, but by continuing with the QQE, we can overcome the deflation that has continued for some 15 years within a timeframe of about two years, and achieve the 2 percent price stability target, accompanied by a rise in wages. 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 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 Kikuo Iwata, Deputy Governor of the Bank of Japan, at a symposium in honor of Korekiyo Takahashi, Tokyo, 27 October 2013.
Kikuo Iwata: Remarks at a symposium in honor of Korekiyo Takahashi Remarks by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a symposium in honor of Korekiyo Takahashi, Tokyo, 27 October 2013. * * * Introduction It is my great pleasure to speak at such a distinguished symposium. I would like to take this opportunity to express my sincere gratitude to the people of Yamaguchi Prefecture for your cooperation with the activities of the Bank of Japan, especially of our Shimonoseki Branch. I was invited to appear today at this symposium in honor of the eminent statesman Korekiyo Takahashi (1854–1936). Today, Japan’s monetary and fiscal policies are at a critical juncture with regard to overcoming the deflation that has lasted for nearly 15 years. It is indeed timely for us to look back on the great achievements of our predecessor, who faced and addressed policy challenges similar to those of today, notwithstanding the differing historical circumstances of his time. Takahashi lived through a very turbulent period, and his life contained enough adventures for any number of episodes on the big screen or television. To give just a few examples, after leaving for the United States as a youth in the late 1860s, he endured a period of indentured servitude. Later he became involved in developing mines in Peru, but was forced to return to Japan after the mine scheme was discovered to be a fraud and his financial resources were exhausted. These episodes show us that the first half of his life contained many challenges, but he remained a man of determination and liberal spirit. Toward the end of his 30s, he was assigned to this very place, Shimonoseki, as the first general manager of the Bank’s West Branch. It was at that time that he began his career as a banker as well as a financial administrator. In the second half of his life, he went on to assume a number of important roles – such as Governor of the Bank of Japan, finance minister, and prime minister – and left a record of many historic accomplishments. Here in Shimonoseki, there are many reminders of Japan’s long history. It likewise enjoys an important place in Japanese economic history, having nurtured a great statesman like Takahashi. Takahashi economic policy As I mentioned at the start of my remarks, among Takahashi’s many achievements we are particularly interested in a series of macroeconomic measures – called the Takahashi Economic Policy – which were put in place to respond to the Showa Depression of 1930–31. Looking back at economic developments around that time, the 1920s were a period of persistent depression following the economic boom during World War I, the Great Kanto Earthquake of 1923, and the Showa Financial Crisis of 1927. Then, in 1930, Junnosuke Inoue – finance minister under Prime Minister Osachi Hamaguchi – returned Japan to the gold standard, lifting the gold embargo that had been in place since World War I. Japan’s return to the gold standard meant a shift to a deflationary regime, with current deficits and price declines as a result of tight fiscal and monetary policies. In addition, in returning to the gold standard Inoue set the exchange rate between gold and the yen at its former level, which was equivalent to excessive appreciation of the yen. All of this served to produce a deflationary recession in Japan. In addition to these developments, the spillover of the Great Depression in 1929 into the domestic economy was regarded as the central cause of the Showa Depression. BIS central bankers’ speeches Against this background, in 1931 Takahashi assumed the post of finance minister for the fifth time in his career. Under Prime Minister Tsuyoshi Inukai, he implemented a package of accommodative macroeconomic policies combining fiscal and monetary policies. This became known as the Takahashi Economic Policy. On the first day of his return to office, he took the dramatic step of ordering an exit from the gold standard and a restoration of the gold embargo. As a result, foreign exchange rates became able to move in tandem with actual developments in the economy. In terms of fiscal policy, he increased fiscal expenditures, supporting the economy from the demand side. On the monetary policy front, the Bank pursued accommodative measures by cutting its official discount rate and underwriting Japanese government securities directly from the government. The Takahashi Economic Policy – combining fiscal, monetary, and exchange policies effectively – led to the adjustment of the yen’s excessive appreciation and counteracted declining price levels. As a result, among the major world powers, Japan became the first to succeed in achieving an economic recovery and escape from deflation during that period. The key to the Takahashi Economic Policy’s success was a shift in economic policymaking from the deflationary regime of Inoue to the reflationary one of Takahashi. This overcame the public’s deflationary expectations, generating inflation expectations. The need for a reversal of expectations through a change in policy regime is likewise inherent in the thinking behind the Bank’s quantitative and qualitative monetary easing of today. Indeed, macroeconomic policies initiated by Takahashi have many similarities with the economic policies under Prime Minister Shinzo Abe; namely, the first and second “arrows” of “Abenomics.” It is for this reason that the Takahashi Economic Policy is viewed as playing a pioneering role in Abenomics. The basic thinking behind the Takahashi Economic Policy was to manage aggregate demand through both fiscal and monetary policies, and this coincided with Keynesian principles. What is noteworthy about Takahashi’s policy package is that it was put in place before Keynesian economics became established. For instance, in the United States it was only from 1933 that President Franklin D. Roosevelt called for an exit from the gold standard, adopted a monetary easing policy, and introduced the New Deal, which was considered to embody the essence of Keynesian theory. By 1935, Takahashi judged that Japan’s economy had returned to a stable course. While tightening fiscal expenditure, he tried to stop the Bank from underwriting government securities; otherwise, this would lead to hyperinflation. His actions were opposed by the military, which sought a further expansion in military spending. He was eventually assassinated by young military officers on February 26, 1936. After his death, the Bank’s underwriting of government securities was mismanaged, which led to hyperinflation after World War II. The important point to remember is that it was not the Takahashi Economic Policy itself but the mismanagement of the Bank’s underwriting of government securities after Takahashi’s death that led to hyperinflation. Based on the lessons learned from history, subsequently the Public Finance Act prohibited the Bank from extending credit to the government by underwriting government securities. Moreover, under quantitative and qualitative monetary easing, the Bank has set its price stability target at 2 percent, based on the recognition that neither deflation nor hyperinflation is desirable. To conclude, the Takahashi Economic Policy was consistent with economic theory and Takahashi implemented his policy package expeditiously. It was indeed a successful macroeconomic policy of which Japan should be proud, and his great achievement still stands as exceptional when compared with the contemporary episode of deflation that lasted for nearly 15 years. BIS central bankers’ speeches Concluding remarks At today’s symposium, I understand that there will be a series of presentations highlighting the relationship between Shimonoseki and Korekiyo Takahashi. Looking back at the mission accomplished by this great predecessor, I believe that we may be able to find a number of insights as we conduct new policies going forward. With this in mind, I very much look forward to participating in the symposium. Thank you. BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 5 November 2013.
Haruhiko Kuroda: Japan’s economy and monetary policy Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 5 November 2013. * * * Introduction It is a great honor to have this opportunity to address such a distinguished gathering of business leaders in Osaka today. I would like to start by expressing my deep gratitude to you for your cooperation with our branches in Osaka, Kobe, and Kyoto. What I recognized most strongly when I assumed the role of the Governor of the Bank of Japan in March this year was that we must bring Japan’s economy out of deflation that has lasted for almost 15 years. Amid protracted deflation, Japan’s economy has been deprived of vitality. The greatest challenge facing Japan’s economy in the immediate future is a prompt overcoming of deflation, and the role the Bank has to play to that end is critical. Based on such recognition, a new policy of quantitative and qualitative monetary easing (QQE) was introduced in April. While pursuing this policy, the real economy, financial markets, and people’s sentiment and expectations have been improving, and thus the QQE has been steadily exerting its intended effects. As for the outlook, as shown in the Outlook for Economic Activity and Prices (Outlook Report) released last week, Japan’s economy is expected to grow above its potential, as a trend, amid a continued virtuous cycle among production, income, and spending, and is likely to steadily follow a path toward achieving a 2 percent price stability target. Today, before exchanging views with you, I would like to explain the Bank’s view on economic activity and prices, followed by thoughts on the QQE. I. Developments in domestic and overseas economies Outlook for Japan’s economy Let me start with the outlook for Japan’s economy. The economy has been recovering moderately as domestic demand has been firm and overseas economies have gradually been picking up. Since the turn of the year, real GDP has registered high growth of about 4 percent on an annualized basis for two consecutive quarters. Comparing external demand with domestic demand, while exports have generally been picking up at a somewhat slower pace, domestic demand, notably private consumption and public investment, has been firm. Compared with what was anticipated at the time of the Outlook Report six months ago, external demand has been somewhat weaker and domestic demand has been somewhat stronger. Looking ahead, while domestic demand is likely to maintain firmness as external demand is expected to increase, albeit moderately, the virtuous cycle among production, income, and spending is likely to be maintained. In terms of the real GDP projections in the Outlook Report released last week, that for fiscal 2013 is somewhat high, at 2.7 percent, partly reflecting a front-loaded increase in demand prior to the consumption tax hike. Thereafter, real GDP is expected to decline in fiscal 2014 to 1.5 percent, partly reflecting a drop following the tax hike, and should be 1.5 percent in fiscal 2015 (Chart 1). Therefore, while the economy will be affected by a swing of the front-loaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, it is likely to continue growing at a pace above its potential, which is estimated to be around 0.5 percent, as a trend. BIS central bankers’ speeches Two points that deserve particular attention in looking to the future of Japan’s economy are the sustainability of firm domestic demand and the outlook for overseas economies. Sustainability of firmness in domestic demand First is the sustainability of domestic demand. The major feature of the recovery this time is that, starting with domestic demand such as private consumption and public investment, the nonmanufacturing sector has been leading the recovery. This differs from typical patterns of postwar recovery in Japan, in which the recovery started with an increase in exports and production and was led mainly by the manufacturing sector. In fact, while production in the manufacturing sector has remained at about 80 percent of its peak prior to the Lehman shock, the indices of Teritiary Industry Activity, which show developments in the nonmanufacturing sector, have recovered to a level close to that seen prior to the Lehman shock. Looking at the diffusion index (DI) for business conditions in the Tankan survey, the DI for the nonmanufacturing sector has been better than that for the manufacturing sector in this recovery phase (Chart 2). Of this firm domestic demand, private consumption had been supported by an improvement in consumer confidence and wealth effects from the rise in stock prices since the turn of the year, while buoyant consumption by the elderly, notably baby boomers, had been serving as an underlying factor (Chart 3). Recently, it also has begun to be backed by improvement in the employment and income situation. Namely, the employment situation continues to improve moderately but steadily, with both the unemployment rate and the ratio of job offers to applicants having almost recovered to the level observed prior to the Lehman shock. There has also been an increasing sense of a labor shortage on the firms’ side (Chart 4). This improvement in the employment situation has started to influence wages. The year-on-year rate of change in nominal wages per employee has gradually stopped declining on the whole, partly due to growth in summer bonuses for the first time in three years. Meanwhile, scheduled wages per employee as a whole have remained negative year-on-year, and this is partly attributable to a shortening in hours worked due to the increased labor participation of women and the elderly in the form of part-time workers. Nevertheless, as the number of employees has been increasing, employee income – the number of employees times wages per employee – has turned positive year-on-year (Chart 5). Thus, the income situation as a whole has been gradually improving. Going forward, an improving trend in the employment situation is likely to continue as the economy recovers moderately, and nominal wages per employee are expected to be put under upward pressure gradually. From a somewhat longer-term perspective, wages will likely show a clear uptrend as the effects of tightening supply and demand conditions in the labor market emerge and inflation expectations rise. While we are intrinsically aware of the severe competitive environment surrounding firms, we expect that wages will increase, supported by improving corporate profits, and also by initiatives pursued through cooperation among the government, workers, and employers. Another important point in considering the future of domestic demand is the developments in business fixed investment in the corporate sector. Reflecting the major feature of the economic recovery this time, business fixed investment has been resilient in the nonmanufacturing sector, and recently there also are signs of improvement in the manufacturing sector, which has been lagging, and thus business fixed investment has been picking up on the whole (Chart 6). Regarding the outlook for the situation surrounding business fixed environment, accommodative financial conditions under the QQE are expected to underpin business fixed investment. In the context of investment profitability, the extent of the monetary easing stimulus to encourage investment is likely to strengthen, reflecting a rise in the rate of return on capital due to economic recovery, together with declining real interest rates, partly in BIS central bankers’ speeches reflection of a rise in inflation expectations. In addition, the effects of various anticipated tax reduction measures for businesses are likely to support business fixed investment through a decline in capital costs and stronger-than-expected cash flows. Furthermore, reflecting past restraints on firms’ investment attitude, existing equipment has aged and thus potential demand for maintenance and replacement is likely to be strengthened. If the level of economic activity further elevates and the improvement in corporate profits continues, such potential demand becomes more likely to surface cyclically. Overseas economies Next, I will turn to the outlook for overseas economies. As mentioned earlier, with regard to the outlook for Japan’s economy, while domestic demand is likely to maintain firmness, external demand is expected to increase, albeit moderately. This is based on the assumption that overseas economies are expected to pick up gradually as financial markets remain generally stable. In its world economic outlook released last month, the International Monetary Fund (IMF) projects that the world economy will gradually see an acceleration in its pace of growth from 2.9 percent in 2013 to 3.6 percent in 2014, and to 4.0 percent in 2015 (Chart 7). Looking at respective regions, the U.S. economy has been recovering moderately on the back of firm private demand under accommodative financial conditions, despite the fiscal drag. The economy is expected to gradually see an acceleration in its pace of recovery, as accommodative financial conditions will be maintained and the fiscal drag will gradually fade. Nevertheless, as uncertainty regarding the fiscal problem remains, such as the federal debt ceiling issue, future developments warrant attention. The European economy, which had been receding slowly, has finally bottomed out, and there has recently been movement toward a pick-up. Households’ and firms’ sentiment are improving as financial markets have remained stable. In addition, changes in the stance of fiscal austerity have been made to some extent and the fiscal drag has weakened somewhat. Exports, especially in Germany, are bottoming out. Although it is necessary to pay attention to the consequence of the European debt problem, as it has not yet been fundamentally resolved, the European economy is expected to gradually pick up on the back of the aforementioned developments. The Chinese economy is likely to maintain stable growth at around the current pace, as the government, while progressing with reforms in structural problems such as excess production capacity and excess debt in the manufacturing sector, is expected to carry out various policy measures to underpin economic activity in the event it weakens during the process. Meanwhile, growth in other emerging and commodity-exporting economies has been lacking momentum compared with a while ago, partly due to such problems as excess debt. In addition, financial conditions have been on a tightening trend – particularly in economies with current account deficits – such that progress in currency depreciation and declines in stock prices were partly observed, reflecting speculation about the direction of U.S. monetary policy, and in some economies, policy interest rates were raised in response to the currency depreciation. Therefore, these economies will likely lack growth momentum for the time being. From a longer-term perspective, however, growth rates are expected to pick up again as the U.S. and other advanced economies improve. As mentioned, each country and region has its own respective risks, but the baseline scenario is that overseas economies, particularly the advanced economies, are expected to pick up gradually. In this situation, with regard to Japan’s economy, external demand is expected to increase moderately. Effects of the consumption tax hikes At the beginning of October 2013, the government decided to raise the consumption tax rate to 8 percent in April 2014 as initially scheduled. The rate hike is a part of the government’s BIS central bankers’ speeches efforts to secure stable financial resources for social security functions and to establish a sustainable fiscal structure in the medium to long term, and the Bank considers the government’s decision as extremely meaningful. In the October 2013 Outlook Report, on the assumption that the consumption tax rate will be raised twice, the Bank considered that, while there will be a swing due to the front-loaded increase and subsequent decline in demand, Japan’s economy is likely to continue growing at a pace above its potential, as a trend. It is true that the consumption tax hikes will have adverse effects on households’ real disposable incomes. However, the adverse effects are expected to be mitigated to some extent, partly because (1) various economic measures are scheduled to be taken by the government, (2) the tax hikes seem to have already been factored in substantially among households, and (3) the rate hikes are expected to have the effect of alleviating households’ future concerns over the fiscal condition and the social security system. II. Price developments in Japan Let me now turn to the price developments in Japan. The year-on-year rate of change in the consumer price index (CPI, all items excluding fresh food) turned positive in June 2013 for the first time in 14 months and has recently been accelerating to the range of 0.5–1.0 percent. While it is true that a rise in the prices of energy-related goods such as petroleum products and electricity has contributed to lifting the index, there has been an improvement in a wide range of items as the economy continues to recover moderately, as seen in resilient private consumption. In fact, the year-on-year rate of change in the CPI (all items excluding food and energy) saw a steady reduction in the extent of its decline and became 0 percent in September (Chart 8). In addition, taking into account market indicators and various surveys, inflation expectations appear to be rising on the whole. The expected rate of inflation measured by using an inflation-indexed government bond for which principal and interest changes according to future inflation rates – the so-called break-even inflation rate – has been maintaining an uptrend viewed from a somewhat longer-term perspective. Also, in surveys on economists, medium- to long-term inflation expectations have been rising (Chart 9). At present, in Japan’s economy, it seems that there is still a negative output gap – namely, a situation in which labor force and production capacity are in excess (Chart 10). However, as the economy continues to grow above its potential growth rate, labor and capacity utilization will further rise and thus the output gap is likely to turn positive in the future. In such a situation, a tightening of supply and demand conditions of goods and services as well as labor will become evident, and prices and wages are likely to rise. Furthermore, a rise in medium- to long-term inflation expectations will also contribute to a rise in prices and wages. Under the QQE, medium- to long-term inflation expectations will follow an uptrend, supported by an actual rise in observed inflation, and will gradually converge on the price stability target of about 2 percent. Taking these points into consideration, the year-on-year rate of change in the CPI, on the basis of excluding direct effects of the consumption tax hikes, is likely to follow an increasing trend and reach the price stability target of about 2 percent through the second half of the projection period up to fiscal 2015. To cite the figures in the October Outlook Report, it is projected to be 0.7 percent in fiscal 2013, 1.3 percent in fiscal 2014, and 1.9 percent in fiscal 2015 (Chart 11). III. Conduct of monetary policy Lastly, I would like to talk about the conduct of monetary policy. The biggest challenge facing Japan’s economy is to overcome deflation. Over the nearly 15 years of deflation, inflation expectations of firms and households have declined and the BIS central bankers’ speeches deflationary mindset has been firmly embedded in their minds. Under deflation, holding of cash and deposits has become a relatively better investment. In fact, the total amount of currency and deposits held by Japanese firms has reached 230 trillion yen, equivalent to nearly 50 percent of the nominal GDP. The protracted deflation has created an environment in which maintaining the status quo is better than embarking on new challenges through investment, and this has deprived Japan of economic vigor. In order to exit such an environment, it is vital to dispel the deflationary expectations embedded in the people. To address the challenge of overcoming deflation, the Bank introduced the QQE in April. The QQE has two pillars: first, it commits to achieving the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years; second, it represents pursuit of a new phase of bold monetary easing in order to underpin such commitment. Specifically, the Bank declared that it would double the monetary base, the amount of money it directly provides, in two years. In order to do so, it decided to make massive purchases of Japanese government bonds (JGBs) including those with long remaining maturities. For the last six months since it introduced the QQE, the Bank has been progressing with the provision of the monetary base and the purchase of JGBs as scheduled (Chart 12). The effects of the QQE are expected to carry through the economy via several different routes. The most important of these is to lower real interest rates. Here, I would like to spend some time to explain the mechanism behind this. First of all, by committing to achievement of the 2 percent price stability target at the earliest possible time and announcing the continuation of a new phase of monetary easing into the future to underpin that commitment, the Bank aims to drastically change people’s expectations and raise inflation expectations. Second, the Bank will put strong downward pressure on nominal long-term rates through the massive purchases of JGBs. Consequently, real interest rates could be lowered if the extent of a pickup in nominal rates could be contained within the extent of a rise in inflation expectations. As the spending behavior of firms and households is influenced by real interest rates, the decline in real interest rates will stimulate business fixed investment, housing investment, and household consumption, thereby providing a strong backing to the economy. If the supply and demand balances in goods and services as well as labor supply and demand conditions tighten as the economy recovers, there will be upward pressure on prices. If actual prices rise, this will further lead to raising the people’s inflation expectations. In sum, triggered by a rise in inflation expectations through a new phase of monetary easing, we will generate a virtuous cycle of a decline in real interest rates, an improvement in economic activity, a rise in actual prices, and a rise in inflation expectations. For the last six months, our endeavor on this front has been successful. As I said before, inflation expectations appear to be rising on the whole. By contrast, long-term rates remain stable at a low level of around 0.6 percent in Japan despite the rise in long-term interest rates in other economies (Chart 13). Bank lending rates have declined to a historic low level. In such situation, real interest rates should be declining. With such stimulative effects coming from monetary easing, Japan’s economy has entered a recovery phase and the CPI has turned positive. What contributes to a rise in people’s inflation expectations is not just the Bank saying that it will achieve the 2 percent inflation, but also the fact that actual prices have been rising. As I have explained to you today, the QQE has been exerting its intended effects. Under the QQE, Japan’s economy has been following the path toward achieving the 2 percent price stability target as expected. The Bank will continue with the QQE, aiming to achieve that target, as long as it is necessary for maintaining it in a stable manner. It will thoroughly examine both upside and downside risks to economic activity and prices, and make adjustments as necessary to achieve the price stability target. With such conduct of BIS central bankers’ speeches monetary policy, the Bank will surely manage to overcome deflation, which has been the challenge for nearly 15 years. 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
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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, Nagano, 13 November 2013.
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, Nagano, 13 November 2013. * * * Introduction Thank you for giving me this opportunity to exchange views with people representing Nagano Prefecture, who have taken time to be here despite their busy schedules. Please allow me to express my gratitude for your cooperation with the activities of the Bank of Japan’s Matsumoto Branch and the local office in the city of Nagano. Today, I will review economic activity and prices in Japan, whose economy has been recovering moderately, and then discuss the Bank’s monetary policy. My concluding remarks will touch briefly on the economy of Nagano Prefecture. Following my speech, I would like to listen to your views on the actual situation of the local economy and to your candid opinions. I. Recent developments in economic activity and prices A. Moderate recovery in Japan’s economy Economic activity in Japan stopped weakening after the turn of 2013. Domestic demand remained resilient, partly due to the effects of monetary easing and various economic measures. Overseas economies were gradually heading toward a pick-up. Against this background, the economy then returned to a moderate recovery path around the middle of the year (Charts 1 and 2). I will elaborate on the recent developments in Japan’s economy. As for external demand, although some emerging economies other than China and commodity-exporting economies have shown signs of weakness, overseas economies as a whole are gradually heading toward a pick-up. Specifically, (1) the U.S. economy continues to recover moderately against the backdrop of firm private demand, (2) the European economy has stopped weakening, and (3) the Chinese economy has been stabilizing. On the back of these factors and partly supported by developments in foreign exchange rates, exports have generally been picking up, albeit at a moderate pace. As for domestic demand, business fixed investment as a whole has been picking up, as corporate profits and business sentiment are improving; in addition to the resilience in business fixed investment in the nonmanufacturing sector, positive developments have started to be seen in that in the manufacturing sector. While public investment has continued to increase, as positive effects of various economic measures have come to take hold fully, housing investment has also been increasing. Private consumption has remained resilient, reflecting an improving trend in consumer sentiment from a somewhat long-term perspective as well as recent improvement in the employment and income situation. Reflecting such developments in domestic and external demand, industrial production has been increasing moderately. An improvement in activity in the nonmanufacturing sector, including services and construction, has been more evident than that in production in the manufacturing sector. As for the outlook, Japan’s economy is expected to continue its moderate recovery (Chart 3). To elaborate, overseas economies – mainly the advanced economies – are expected to gradually pick up. Emerging economies other than China and commodity-exporting economies, some of which are exhibiting weakness, will likely continue to lack growth momentum for the time being. However, from a somewhat long-term perspective, their growth rates are likely to start picking up again with an improvement in the advanced economies. Under these circumstances, exports and industrial production are expected to increase moderately, and domestic demand is expected to remain firm. The pick-up in BIS central bankers’ speeches business fixed investment will become pronounced as moves to undertake postponed investment for maintenance and replacement spread in tandem with continued improvement in corporate profits. Private consumption is expected to maintain its resilience, underpinned by an improvement in the employment and income situation. In this way, a virtuous cycle will operate more clearly both in the corporate and household sectors. Meanwhile, as for prices, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food turned positive in mid-2013 and has recently been in the range of 0.5–1.0 percent, as prices of energy-related items such as petroleum products and electricity have been rising and cost increases have been passed on to selling prices with resilient private consumption. As for the outlook, although the upward pressure from energy-related items will weaken gradually, the year-on-year rate of change in the CPI is expected to continue to follow a rising trend as medium- to long-term inflation expectations will rise with a moderate improvement in the aggregate supply and demand balance. What I have presented is generally consistent with the path toward achieving the 2 percent price stability target, which I described in a speech in April 2013 at a meeting with business leaders in Gifu.1 In that speech, I presented a path consisting of the following five stages: (1) recovery in the world economy; (2) accommodative financial conditions, reflected in asset prices and foreign exchange rates; (3) a gradual rise in the potential growth rate of Japan’s economy accompanied by an increase in business fixed investment and structural reforms; (4) an improvement in the output gap amid firm household spending; and (5) a gradual heightening in inflation expectations. I then emphasized that, with this path, it was important that the year-on-year rate of change in the CPI rise above 1 percent during fiscal 2014. I continued that, if the virtuous cycle of the five-stage path was maintained thereafter and the medium- to long-term trend inflation rate increased toward 2 percent, the actual inflation rate was expected to approach the 2 percent price stability target. After about half a year, although the recovery in the world economy – the first stage of the path – has lagged somewhat behind and household spending – the fourth stage – has turned out to be somewhat stronger than expected, it can be judged that the path is generally on track to achieve the 2 percent price stability target. In particular, the recovery in private consumption, as well as in the nonmanufacturing sector, affects a wide range of economic activity, and therefore may support upward pressure on a broad range of prices. B. Risks to the outlook for economic activity and prices As I have described, Japan’s economy is likely to continue its moderate recovery. However, both upside and downside uncertainties exist over the economic outlook, such as the following, and I am paying slightly more attention to the downside risks overall. First, there is uncertainty regarding developments in overseas economies. In particular, some emerging economies other than China and commodity-exporting economies are facing structural problems such as current account deficits, and thus pose downside risks. I also recognize that attention should be paid to the possibility that the recovery in the U.S. economy and the world economy may be delayed depending on the consequences of the fiscal problem in the United States. Second is developments in households’ employment and income situation. For domestic demand to continue to maintain its firmness in the future, the key issue is whether a virtuous cycle whereby improvement in the employment and income situation supports consumption will be maintained. In this regard, despite some downside risks, I see a possibility that the mechanism of upward momentum may operate, about which I will explain in the next section. For details, see Ryuzo Miyao, “Economic Activity, Prices, and Monetary Policy”, Speech at a Meeting with Business Leaders in Gifu, Bank of Japan, April 18, 2013. BIS central bankers’ speeches Third is the effects of the consumption tax hikes. The hikes will have adverse effects on households’ real disposable income, but the effects are likely to be mitigated to some extent by, for example, the government’s various economic measures. On this basis, whether these effects will slow the economy by more than expected depends on the employment and income situation and developments in prices at each point in time. Therefore, attention should be paid to the effects of the consumption tax hikes. Fourth, firms’ and households’ medium- to long-term growth expectations are subject to uncertainty. These expectations may be either raised or lowered depending on firms’ innovations, such as their creative efforts to boost demand, on progress in regulatory and institutional reforms, and on future developments in tax reforms. C. Issues to be considered regarding private consumption and inflation expectations 1. Sustainability of the resilience in private consumption The current economic recovery is characterized by domestic demand-led growth, led by private consumption in particular, as opposed to recovery in the past that typically was led by external demand such as exports and production (Chart 4). In what follows, I will take up the topic of sustainability of the resilience in private consumption and explain its background as well as the issues I consider to be important with regard to anticipating developments in economic recovery. a. Improvement in consumer sentiment: rise in stock prices and improvement in the employment and income situation Favorable consumer sentiment is one factor that underpins private consumption. The Consumer Confidence Index, which is a major indicator for consumer sentiment, has been improving significantly since end-2012. It is often noted that this is attributable to the rise in stock prices during the same period (Chart 5). Looking at developments in stock prices, their uptrend continues on the back of the improvement in corporate profits and more accommodative financial conditions. Some take the view that, through the improvement in household sentiment, the rise in stock prices only boosts consumption by the wealthy and the elderly who hold stocks. Even so, it is reasonable to say that higher stock prices have been stimulating spending by those people who are willing to spend. It should be noted that wealth effects for the elderly seem to spill over into the working segment of the population, as seen in, for example, greater consumption related to grandchildren and increased demand for three-generation family trips.2 One factor that could affect consumer sentiment more broadly is the employment and income situation. For example, if firms offer more jobs and the number of employees rises, the overall outlook for income improves, thereby making consumer sentiment more favorable. An improvement in the employment and income situation could make people more willing to borrow and spend more confidently. In fact, a strong correlation is observed between the active job openings-to-applicants ratio – which represents the number of job openings relative to the number of job seekers – and the Consumer Confidence Index (Chart 6). Employment conditions as suggested by the active job openings-to-applicants ratio and the unemployment rate deteriorated in the wake of the Lehman shock, but thereafter have been on a recovery trend. If this trend continues, consumer sentiment is likely to be underpinned at a high level. The October 2013 issue of the Regional Economic Report released by the Bank contains a review of regional features of recent developments in consumption (available in Japanese). BIS central bankers’ speeches b. Sustainable improvement in income: rise in labor productivity A rise in labor productivity is important in terms of providing support for improvement in economic activity and income in the longer run, as this means strengthening the foundations for Japan’s economic growth. If prospects for a sustainable improvement in income are widely acknowledged, private consumption will continue to be resilient. Labor productivity per worker has been growing steadily, albeit at a moderate pace, and this trend has been firmly taking hold despite such significant events as the Lehman shock and the Great East Japan Earthquake (Chart 7). Looking at a breakdown by industry, labor productivity in the nonmanufacturing sector has been exhibiting higher growth in the past couple of years (Chart 8). The level of labor productivity in the nonmanufacturing sector is still lower than that in the manufacturing sector. In addition, it remains difficult to increase value-added in some segments of the nonmanufacturing sector, due in part to various regulations. However, labor productivity in the nonmanufacturing sector as a whole continues to show higher growth than in the past, and has been exceeding the level seen before the Lehman shock. Developments in labor productivity include the effects of cyclical economic recovery, but the underlying trend reflects a pick-up in economic growth potential from a somewhat long-term perspective. For example, reports on interviews with firms and other relevant information across regions suggest steady progress in firms’ efforts to create demand, such as for high value-added services, and to make active fixed investment, with both being done across a wide range of areas such as wholesaling and retailing, construction and real estate, accommodations, and eating and drinking services.3 Recent developments in the underlying trend of labor productivity in the nonmanufacturing sector show a strong correlation with developments in private consumption (Chart 9). There is a possibility – although this interpretation should be taken with care – that the rise in productivity has been boosting prospects for a sustainable improvement in income, leading to higher growth in private consumption. The rise in labor productivity in the nonmanufacturing sector may also be exerting upward pressure on a broad range of prices through the growth in consumption (Chart 10). It can be considered that this rise has exerted a positive influence on the inflation rate through an improvement in the supply-demand balance, as its effects of increasing value-added and demand would more than offset its effects of generating price competition through cost cuts and subsequently exerting downward pressure on prices.4 In the manufacturing sector, the rise in labor productivity in terms of value-added in Japan has come to a pause. However, looking at the corporate sector, firms have been steadily enhancing their ability to make profits on a global basis. Overseas, for example, they are increasing their production, fixed investment, and parts procurement. In the manufacturing sector, corporate profits have recently been growing rapidly, helped in part by developments in foreign exchange rates, and stock prices are firm, as are those in the nonmanufacturing sector (Charts 11 and 12). It should also be noted that Japan’s net income from the rest of the world exceeds the historical peak (Chart 13). If the current account surplus is maintained See the October 2013 issue of the Regional Economic Report released by the Bank (only the summary of the report is available in English) and the report on the features of and background to business fixed investment in the nonmanufacturing sector of the Chubu region released by the Bank’s Nagoya Branch on October 18, 2013 (available in Japanese). Empirical studies also indicate that a rise in productivity will improve the supply-demand balance in a sustainable manner, thereby exerting positive effects on the inflation rate. For example, see Ryuzo Miyao, “Nihon no Keiki Hendou Youin: Jikeiretsu Bunseki karano Shiten (Sources for Japan’s Economic Fluctuations: A Perspective from Time-Series Analysis)”, Gendai Keizaigaku no Chouryuu (Contemporary Trends in Economics), Toyo Keizai Inc., 2011, pp. 35–65 (available in Japanese). BIS central bankers’ speeches through an improvement in the income balance, the country’s net assets will increase, thereby exerting positive effects on consumption. 2. People’s inflation expectations: forward-looking expectation formation People’s inflation expectations have been rising on the whole. For example, in terms of shortterm inflation expectations such as those for fiscal 2013 or for a year ahead, many indicators – including the results of surveys conducted on households, economists, and market participants – show a gradual rise. Medium- to long-term inflation expectations, such as for five and ten years ahead, are also rising, according to surveys conducted on economists (Chart 14). Let me elaborate on how people form expectations of future inflation rates. Generally speaking, there are two ways to predict economic variables. One is backward-looking expectation formation, where past results are directly used to form expectations. A typical example is that the inflation rate for the previous period is simply assumed as the expected future inflation rate. In this case, expectations for future inflation rates are fixed to actual past inflation rates. The other is forward-looking expectation formation, where future inflation rates are predicted in line with the underlying mechanism of future developments in economic activity. As an example, let us simply consider the Phillips curve and assume that prices rise when economic activity improves. Given this, when prospects for a sustainable improvement in economic activity are widely acknowledged in view of efforts to strengthen the foundations for economic growth and the spread of policy effects, people expect a rise in prices based on the relationship between economic activity and prices at a future point in time – in other words, inflation expectations will rise. Meanwhile, in the corporate sector, better prospects for economic activity and sales will enable firms to ease price competition and pass higher costs on to selling prices. As a result, prices for the present period will likely incur upward pressure, thereby shifting the entire observed Phillips curve upward, or making the curve steeper than before. In the actual formation of inflation expectations, aspects of both the backward-looking and forward-looking formations are considered to coexist. This is called hybrid-type expectation formation. Based on past experiences, the aspect of backward-looking expectation formation is prominent in Japan. On the other hand, the government and the central bank have been strongly pursuing initiatives to work on forward-looking expectations. The government has been working to raise expectations for economic growth by increasing public spending and promoting regulatory and institutional reforms. The Bank has set the 2 percent price stability target and has been conducting large-scale monetary easing with the aim of achieving this target at the earliest possible time, and thereby continues to provide strong support from the financial side to ensure sustainable economic recovery. In the corporate sector, if there is a continuation of nonmanufacturing firms’ innovations and fixed investment that I mentioned earlier, their labor productivity will rise further, which could lead to continuous improvement in the income outlook. Taken altogether, with the prospect of sustainable improvement in economic activity, it is possible that the proportion of people who are oriented to forward-looking expectation formation will increase. Of course, whether Japan’s economy will move in line with the scenario I mentioned earlier is uncertain, as the environment surrounding firms and households remains severe. At the same time, however, macro data and information from interviews with firms – both of which indicate sustainable improvement in consumption and income – as well as the recent gradual rise in medium- to long-term inflation expectations suggest that Japan’s economy as a whole seems to be gradually moving in line with this scenario. Taking account of this mechanism, I see some possibility that medium- to long-term inflation expectations will rise. BIS central bankers’ speeches II. Monetary policy A. Conduct of Monetary Policy Let me now explain the policy framework of quantitative and qualitative monetary easing (QQE) introduced at the Monetary Policy Meeting held on April 3 and 4, 2013, and the state of progress in its implementation (Charts 15 through 18). First, the Bank conducts money market operations so that the monetary base will increase at an annual pace of about 60–70 trillion yen. Second, it purchases Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 50 trillion yen, and the average remaining maturity of the Bank’s JGB purchases will be about seven years. Third, it purchases exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. And fourth, for CP and corporate bonds, the Bank continues with these asset purchases until their amounts outstanding reach 2.2 trillion yen and 3.2 trillion yen, respectively, by end-2013; thereafter, it will maintain these amounts outstanding. The Bank will continue with QQE, which consists of the measures I have just cited, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. As a result, calculated on a stock basis, the monetary base and the amounts outstanding of JGBs as well as ETFs will double in two years. The ratio of the monetary base to nominal GDP is expected to increase to about 56 percent by end-2014. This not only stands above the other advanced economies, but also is more than three times larger than the ratio before the Lehman shock. The amounts outstanding of the monetary base and JGBs at end-October 2013 stood at about 189 trillion yen and about 132 trillion yen, respectively, and accumulation of the amount outstanding of the monetary base and purchases of assets have been progressing smoothly. B. Issues to be considered regarding QQE 1. Policy effects of QQE More than six months have passed since the introduction of QQE, and its effects, together with those of the government’s various economic measures, have emerged in the form of improvement in economic activity as well as in financial market developments. In financial markets, long-term interest rates have been stable at a low level of around 0.6 percent. Stock prices have risen by more than 30 percent compared with at the beginning of 2013, and this growth exceeds that in European and U.S. stock prices. Financial institutions’ portfolio rebalancing has not made marked progress yet, but households are increasingly investing in financial assets such as investment trusts. In terms of economic activity, real GDP in Japan registered a relatively high growth rate for two consecutive quarters through the April–June quarter of 2013. The unemployment rate has declined to around 4 percent – a level seen before the Lehman shock. On the price front, the year-on-year rate of change in the CPI for all items less food and energy has improved to around 0.0 percent, and inflation expectations appear to be rising on the whole, considering market indicators and the results of various surveys. Given that the effects of monetary policy on economic activity and prices appear with a time lag, these improvements in economic activity and prices can be partly attributable to the effects produced by successive monetary easing measures implemented before the introduction of QQE. In any case, it seems that the implementation of a large-scale monetary easing and a commitment to continuing with it as long as it is necessary for maintaining the 2 percent price stability target in a stable manner are underpinning the improvement in economic activity and prices. BIS central bankers’ speeches A final assessment of the effects of QQE on economic activity and prices can be made only after it is lifted, but I would like to explain at this point my empirical analysis on the effects of the quantitative easing (QE) policy – adopted by the Bank during 2001–06 – on the macroeconomy.5 The result, although tentative, showed that the QE policy had a certain effect on economic activity (production), and that a transmission channel through asset prices – namely, stock prices and foreign exchange rates – had been working. The QE policy’s effect on prices, however, was not as clear as that on economic activity. One possible way of interpreting this result is that prices had been less responsive to an improvement in economic activity brought about by the policy – that is, a slope of the Phillips curve had been relatively flat during the period of quantitative easing. Therefore, I think that the key issue is whether QQE will make the Phillips curve steeper than before or shift the entire curve upward in line with the mechanism I explained earlier. As I mentioned, inflation expectations could be more forward looking in the current phase of economic recovery that is led mainly by private consumption. Initiatives taken by the government and the corporate sector to achieve economic growth are likely to strengthen such effects by enhancing confidence in sustainable improvement in economic activity. I will continue to carefully examine efforts made by each economic entity as well as future developments in the Phillips curve to see if there is any progress in terms of a change in the slope or an upward shift. 2. Communication regarding the conduct of monetary policy Central banks in advanced economies are making efforts to increase transparency, aiming at appropriate communication to the public regarding their policy conduct. Specifically, such efforts include the following. First, clarifying the policy target by, for example, using numerical expressions. Second, explaining the outlook for economic activity and associated risks, which form the basis for policy decisions. Third, making public the process of policy formulation through release of the minutes of policy meetings and through press conferences. And fourth, communicating to the public, as necessary, regarding the future conduct of monetary policy and factors relevant to policy decisions, such as guidance with regard to continuation of monetary easing. Through all these efforts, it becomes easier for market participants and the public to predict the future course of monetary policy and utilize such prediction in their decision-making. On the other hand, there are in fact challenges to central banks’ communication with financial markets and the public, as uncertainties surround the economy and policy effects, particularly in the current situation where unconventional policies are taken. In the United States, since May 2013, given the prospects for economic recovery, the Federal Reserve had been suggesting the possibility that it might start reducing the pace of its large-scale asset purchases – known as “tapering”, in view of the prospect that the size of asset purchases would gradually be reduced – by end-2013. It thus enhanced communication regarding economic conditions and economic indicators that were necessary to initiating the tapering. In response, financial markets rapidly factored in the future normalization of policy, thereby causing the surge in U.S. long-term interest rates. The Federal Reserve postponed the start of tapering in September, which was the timing initially considered most likely by the markets, due in part to the slow pace of recovery in employment and the deadlock caused by the fiscal debate. The Federal Reserve might have been aware of the risk that the greater-than-expected rise in interest rates would actually impair the economic recovery. Long-term interest rates edged down thereafter but have been at a level of around 1 percentage point higher than that seen before May. For details of the analysis and the result, see Ryuzo Miyao, “Central Banking Further into Uncharted Territory”, Speech at the Foreign Correspondents’ Club of Japan, Bank of Japan, May 28, 2013. BIS central bankers’ speeches A series of events the Federal Reserve has experienced seems to be instructive for the Bank of Japan for the future. The Bank will continue to aim at making better communication to the public. Concluding remarks: the economy of Nagano prefecture My concluding remarks will touch on the economy of Nagano Prefecture. The postwar development of the economy of Nagano Prefecture has been supported mainly by manufacturing, such as of electric machinery, general machinery, and transportation equipment. However, because this is a manufacturing-oriented economy, it had been experiencing a relatively large adverse impact from the Lehman shock and the yen’s appreciation in recent years. As for nonmanufacturing, firms had been facing a difficult situation on the whole, mainly because public works had been declining due to the fiscal consolidation of municipal governments and because the number of tourists had been decreasing, reflecting a declining population of skiers. However, both the manufacturing and nonmanufacturing sectors have recently headed toward a moderate pick-up on the back of a recovery in exports and an increase in public works. Indeed, Nagano Prefecture has many advantages, such as a high level of technological capability in monozukuri, or manufacturing, and abundant resources related to tourism and agriculture. It also is worth noting that the average life expectancies for both men and women in the prefecture are the longest in Japan, and the employment rate of elderly people also ranks top in the nation. This suggests that the prefecture possesses the latent strength to maintain its economy’s vitality even in the midst of such structural changes as the aging population and declining birth rate. With the aim of making greater use of these advantages, Nagano Prefecture has formulated a strategic plan to promote monozukuri industry in the prefecture, encouraging cooperative efforts among those in industry, government, and academia to improve competitiveness, mainly in manufacturing, and to cultivate the industry’s next generation of human resources. Moreover, I heard that some financial institutions in the region have together established an investment fund to enhance support for the business revitalization of small firms. I believe that both of these actions are of significant importance with regard to stimulating the regional economy. Turning to transportation infrastructure, Nagano Prefecture is going to have two big events: an extension of the Hokuriku Shinkansen line and the launch of the Linear Chuo Shinkansen line. As a result, Nagano Prefecture will be linked much more closely not only with the Hokuriku region but also with the two major metropolitan areas of Tokyo and Nagoya. This could have an unprecedented impact on the industrial structure and demographic trends of Nagano Prefecture. I expect that the prefecture’s economy will make full use of its potential by viewing such changes as strategic opportunities. 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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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Paris Europlace Financial Forum, Tokyo, 25 November 2013.
Haruhiko Kuroda: Recent developments in Japan’s economy, and observations on the European situation given Japan’s experience during the 1990s financial crisis Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Paris Europlace Financial Forum, Tokyo, 25 November 2013. * * * Introduction I am honored to have this opportunity to speak before the Paris Europlace Financial Forum today. In the following few minutes, after briefly touching on the recent developments in Japan’s economy, I would like to go over what we can say about the European authorities’ various initiatives from our experience of Japan’s financial crisis in the 1990s, bearing in mind the recent European situation. The developments in Japan’s economy and prices I would like to start off with the recent developments in Japan’s economic activity and prices. The Bank of Japan introduced quantitative and qualitative monetary easing (QQE) in April this year with a view to bringing Japan’s economy out of deflation, which has lasted for nearly 15 years. In the subsequent eight months, the Bank has been steadily pursuing this policy. Positive developments have been spreading in financial markets and the real economy, as well as in people’s mindset and expectations. The QQE has steadily been exerting its intended effects. Japan’s economy is recovering moderately, with a positive spillover from income to expenditure in the household and corporate sectors taking course. Looking ahead, a virtuous circle among production, income, and spending is expected to continue, and Japan’s economy is projected to grow, as a trend, at a pace above its potential. On the price front, the year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food has recently been accelerating to a range between 0.5 and 1.0 percent. With the prospect of an improvement in the aggregate supply and demand balance and a rise in medium- to long-term inflation expectations, the year-on-year rate of change in the CPI is likely to follow a rising trend. Therefore, Japan’s economy has been following a path toward achieving the 2 percent price stability target as expected. European situation Now, let me briefly refer to the European situation. While details will be provided by Governor Noyer, our recognition is that the European economy is bottoming out and there are signs of a pick-up. As a recovery in the European economy is an essential factor not only for a sustained recovery of Japan’s economy but also for the stability of the global economy as a whole, we are watching developments very carefully. After European Central Bank (ECB) President Draghi’s remarks in July 2012 and the introduction of the Outright Monetary Transactions (OMTs) by the ECB in September 2012, fluctuations in international financial markets triggered by developments in Europe seem to have declined substantially. Meanwhile, progress also has been made on the financial stability front, with preparations for the Asset Quality Review (AQR) and stress testing progressing ahead of the formation of the Single Supervisory Mechanism next year. Along these lines, we note that discussions on the need to arrange a public backstop in case of capital shortages resulting from the AQR and stress testing have been moving forward as well. While difficult issues may lie ahead, including establishment of a resolution framework, we are confident that the European authorities will produce appropriate policy responses. BIS central bankers’ speeches In light of Japan’s experience Let me now move on to what we might be able to say based on our experience during the financial crisis in the 1990s in relation to the European authorities’ initiatives. Of course, the situation the authorities face and the primary features of the problem are probably not completely the same as what Japan endured in the 1990s. Thus, I do not think that Japan’s experience is wholly applicable, although I hope it will provide some insight. The first point I would like to make is with regard to the difficulty of establishing an appropriate resolution framework. During Japan’s financial crisis in the 1990s, the Japanese authorities were repeatedly criticized for acting too late. Admittedly, looking back, we could have acted more swiftly in some areas. However, there seem to be two factors behind the fact that it took time to establish an institutional framework. A trial and error situation was inevitable due to lack of a framework previously, and the overall process involved the need to gain understanding from the public. Measures to set up institutional frameworks, especially when it involves public money, are bound to take time. Coordination among various relevant parties to compile legislative measures has to be made, and the public’s understanding of the necessity for such a framework has to be gained. Public understanding of a resolution framework involving public money becomes important, especially in a case where there is a need to actually use or modify such a framework. While the establishment of a framework is taking place, financial markets tend to want immediate tangible results, and a gap between the timeframe of action by the market participants and that of the public authorities tends to emerge. Policymakers need to conscientiously and patiently deliver explanations in order to narrow the gap by as much as possible. The second point I would like to make is with regard to the detection of financial imbalances. As the source of Japan’s financial crisis in the 1990s was the bursting of the bubble that was generated in the late 1980s, active debate took place on how we can promptly recognize financial imbalances like the bubble. After the global financial crisis, the importance of having a macroprudential perspective has been underlined following a similar thought process. Based on past insights, the Bank has been examining whether there are financial imbalances using such techniques as "macro risk indicators" and "macro stress testing." Some of the results of such exercises have been included in our publications of the Financial System Report. In a number of countries including those in Europe, efforts have been made from macroprudential perspectives. In my view, it would be useful if we could share our discoveries and experiences so that we can better detect any future financial imbalances. The third point is that, even if the banking sector’s nonperforming asset problem has been solved, it could take time until funds are smoothly channeled to the real economy. In Japan’s case, after the financial crisis in the 1990s, financial system stability issues were mostly addressed by the mid-2000s; however, firms’ funding remained sluggish even after that. Against such a backdrop, the Japanese government implemented various policy measures. The Bank also provided support for corporate financing. Measures include expanding the range of eligible collateral to include asset-backed securities, purchasing asset-backed securities, commercial paper, and corporate bonds, and creating funds supplying facilities to support corporate financing. These measures did support corporate financing, especially in the face of a series of stress events such as the collapse of Lehman Brothers and the Great East Japan Earthquake in 2011. However, I have to admit that there are still a number of issues to be examined, such as to what extent a central bank should be involved in resource allocation and the effectiveness of individual measures. I understand that measures to promote lending to small and medium-sized firms are being contemplated in Europe. It also would be useful for us to share our findings and experiences in this field so that we will have a better understanding of what types of measures are appropriate in the area of corporate lending. BIS central bankers’ speeches Concluding remarks Regarding what I have talked about today, we do not have clear answers yet on such issues as the detection of financial imbalances or measures to revitalize corporate financing. These deserve further examination. It would be beneficial if, by using occasions like this event, we could accumulate our knowledge on those issues by also learning from the experiences of our European colleagues. By making use of views exchanged with you, the Bank, through bringing Japan’s economy out of deflation that has lasted for nearly 15 years while maintaining the stability of the financial system, will contribute to sustainable growth of the global economy. I would like to thank you very much for your kind attention. BIS central bankers’ speeches
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Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at the Japan Securities and Economics Club, Tokyo, 26 November 2013.
Takahide Kiuchi: The economic outlook and monetary policy Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at the Japan Securities and Economics Club, Tokyo, 26 November 2013. * * * Thank you for giving me an opportunity to speak at the Japan Securities and Economics Club. Today, I would like to talk about the economic outlook at home and abroad and the conduct of monetary policy in Japan. I. Economic outlook The Bank of Japan released the latest Outlook for Economic Activity and Prices (hereafter the Outlook Report) at the end of October 2013, and presented the following outlook. Comparing the current projection with that in the July 2013 interim assessment, overseas economies have been somewhat weaker than anticipated, but domestic demand is expected to be somewhat stronger, partly due to the effects of various economic measures by the government. As a result, the projected growth rates as well as the outlook for prices in Japan are expected to be more or less unchanged from the July assessment. As for Japan’s economy, while exports have been picking up at a somewhat slower pace, domestic demand, notably private consumption, has been firm and overseas economies are picking up moderately. Looking ahead, while domestic demand is likely to maintain firmness as external demand is expected to increase, albeit moderately, a virtuous cycle among production, income, and spending is likely to be maintained. As for prices, the year-on-year rate of change in Japan’s consumer price index (CPI, for all items less fresh food, and the same hereafter) turned positive in June 2013 for the first time in 14 months and has recently been accelerating to the range of 0.5–1.0 percent. The yearon-year rate of increase in the CPI, excluding the direct effects of the consumption tax hikes, is likely to follow a rising trend, reflecting factors such as the improvement in the aggregate supply and demand balance, as well as the rise in medium- to long-term inflation expectations resulting from economic recovery. In the October 2013 Outlook Report, it is projected to reach 1.9 percent in fiscal 2015 in terms of the median of the Bank’s Policy Board members’ forecasts. As the background to this outlook for Japan’s economy and prices, overseas economies have been somewhat weak, but they are expected to pick up gradually, particularly the advanced economies. Looking at respective major countries and regions, the U.S. economy has been recovering moderately on the back of firm private demand and is expected to gradually accelerate its pace of recovery, as accommodative financial conditions will be maintained and the fiscal drag will gradually fade. The European economy, which had been receding slowly, has finally bottomed out and is expected to gradually pick up. The Chinese economy is likely to maintain stable growth at around the current pace. By contrast, growth in other emerging and commodity-exporting economies will likely continue to lack momentum for the time being. II. Risk factors to the outlook The Outlook Report points out upside and downside risks to the Bank’s aforementioned baseline scenario regarding the economy and prices. I personally pay closer attention to downside risks. Moreover, I formulated a proposal both in April and October 2013 to change the description of the Outlook Report, such as in terms of the outlook for prices. Let me share some of my considerations regarding the outlook with you. BIS central bankers’ speeches A. Overseas economies I am paying particular attention to the uncertainty regarding developments in overseas economies. Looking at the revisions made to the World Economic Outlook released recently by the International Monetary Fund (IMF), the forecast for global economic growth has continued to be revised downward. In the latest forecast in October 2013, which updated the July 2013 forecast, global economic growth was revised downward in just three months by 0.3 percentage point for 2013 and 0.2 percentage point for 2014, mainly due to the lower growth outlook for emerging and commodity-exporting economies including China. This seems to reflect an adjustment of imbalances that have built up in emerging economies since the Lehman shock. Such a buildup of imbalances is clearly apparent in the form of significant accumulation of private-sector debt against the background of excessive fiscal and monetary policy measures since the Lehman shock, and of the increase in capital inflows to these economies based on excessive expectations for economic growth. If the adjustment process is actually occurring, growth in these economies will likely continue to lack momentum for a protracted period. Meanwhile, uncertainty remains regarding the momentum toward recovery for the U.S. economy and other advanced economies. In this situation, I am paying particular attention to the slowdown in the labor productivity growth trend in these economies, especially in the United States. With this slowdown, expectations for income increases may not rise easily even in a situation where employment continues to increase stably, and private consumption – a key determinant of the outlook for the U.S. economy – may not regain momentum soon. Therefore, I am carefully monitoring these developments. B. Domestic demand Economic recovery this time has been led by the nonmanufacturing sector so far, mainly driven by private consumption. In order to have continued firm domestic demand, it is important to maintain a situation in which improvement in the employment and income situation supports consumption. Another important factor in considering the future of domestic demand is the increase in firms’ business fixed investment. Turning to indexes related to consumption, private consumption remains resilient, but there is a sign of slowing in its growth momentum. The household activity-related diffusion indexes (DIs) for current and future economic conditions in the Economy Watchers Survey, which seem to reflect consumer confidence, dropped for the fifth consecutive month since April 2013. This development is consistent with that of real consumption expenditure in the Family Income and Expenditure Survey. The sign of slowing in consumption is also reflected to the latest GDP statistics. The real GDP growth rate in the July–September quarter of 2013 registered 0.5 percent on a quarter-on-quarter basis. On an annualized quarter-on-quarter basis, it slowed to 1.9 percent from around 4.0 percent in the first half of the year. Private consumption also slowed compared to the first half of the year, to 0.1 percent on a quarteron-quarter basis. Business fixed investment on the whole grew for the third consecutive quarter, reflecting an improvement in corporate profits, to 0.2 percent on a quarter-on-quarter basis, but the recovery in the manufacturing sector still shows a lackluster performance. Meanwhile, exports – which largely affect investment by manufacturing firms – lack resilience and decreased for the first time in three quarters, to minus 0.6 percent on a quarter-onquarter basis. I think the key to the future of domestic demand lies particularly in the extent to which business fixed investment will grow under these circumstances, but that a full-fledged recovery of such investment will take time. C. Outlook for prices As for the outlook for prices, I formulated a proposal to make the following changes in the October 2013 Outlook Report, although it was defeated by a majority vote during the BIS central bankers’ speeches Monetary Policy Meeting (MPM). First, with regard to the outlook for prices toward the latter half of the projection period, I proposed to change the current expression that the year-onyear rate of change in the CPI “is likely to reach around 2 percent – the price stability target” to a new expression that “the rate of increase in the CPI is expected to rise moderately”. Second, with regard to inflation expectations, I proposed changing the current expression that inflation expectations “are likely to continue on a rising trend under quantitative and qualitative monetary easing (QQE), partly supported by a rise in the observed inflation rate, gradually converging to around 2 percent – the price stability target” to a new expression that they “are likely to continue on a moderate rising trend, partly supported by a rise in the observed inflation rate”. In achieving the price stability target, it is important to create a virtuous cycle in which the inflation rate gradually rises as the economy as a whole grows in a sustainable manner and as people’s standards of living improve. From such a viewpoint, I personally consider that it is neither easy nor appropriate to aim at achieving a price stability target of 2 percent in a short time frame of about two years. The recent rise in prices is partly attributed to some strength in demand, but so far it has largely been attributed to other factors such as increases in energy prices and the effects of changes in foreign exchange rates. In order to achieve sustainable price increases together with economic improvement, a rise in wages – especially employees’ scheduled cash earnings – is considered to be the key. It is most likely that some firms will raise wages including base salaries in the upcoming spring wage negotiations and that the average rate of wage increase will rise to some extent. However, in order for an increasing number of firms to significantly raise base salaries and for prices to be on an uptrend as a result, supply and demand conditions in the labor market must improve further through a heightening of growth expectations. Since developments in employment and wages tend to lag behind economic growth, my view is that a considerable time lag is to be expected until the inflation rate rises together with the wage increase. For example, under an assumption that the real wage growth rate equals the labor productivity growth rate, if the labor productivity growth rate is about 1 percent, the nominal wage growth rate – consistent with the price stability target of 2 percent – should reach about 3 percent, and by the same token, if the labor productivity growth rate is about 0.5 percent, the nominal wage growth rate should rise to about 2.5 percent. To attain such a level of growth in nominal wages will take considerable time. Having said that, what I think is important is to create and maintain a virtuous cycle in which the inflation rate rises, albeit gradually, along with an increase in nominal wages. In this connection, I think that, even in a situation where wages and prices increase in a balanced manner over time, given that other advanced economies are currently on a disinflationary trend, Japan’s inflation rate may still be susceptible to downward pressure.1 III. Monetary policy The Bank introduced QQE in April 2013, with a view to achieving the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years. In this policy, the main operating target for money market operations was changed from the uncollateralized overnight call rate to the monetary base, and it was decided that the Bank would aim to double the monetary base in two years. In doing so, it would purchase massive amounts of Japanese government bonds (JGBs), For historical developments in Japan’s inflation rate and a comparison with other major economies, see “Recent Developments in Economic Activity and Prices, and Future Monetary Policy”, a speech by Takahide Kiuchi at a meeting with business leaders in Kanagawa on February 28, 2013, available on the Bank’s web site (http://www.boj.or.jp/en/announcements/press/koen_2013/ko130319a.htm/). BIS central bankers’ speeches with all maturities made eligible for purchases. In addition, in aiming to achieve the price stability target of 2 percent, the Bank made a commitment that it would continue with QQE as long as it is necessary for maintaining the target in a stable manner. So far, QQE has exerted positive effects on Japan’s economy through a positive influence on the expectations of financial markets and of firms and households. Since the introduction of the policy in April, however, while supporting the concrete measures of QQE, I have continued to propose changing the expression in the Statement on Monetary Policy regarding the time frame for achieving the 2 percent price stability target and for continuing with QQE, although my proposal has been repeatedly defeated by a majority vote during the MPMs. Let me explain the intention of my proposal as well as my personal views on some points of discussion regarding the conduct of monetary policy. A. Flexibility of the commitment My proposal is to replace the expression in the Statement on Monetary Policy with a new one stating that “the Bank will aim to achieve the price stability target of 2 percent in the medium to long term. On this basis, it will designate QQE as an intensive measure with a time frame of about two years, and thereafter will review the monetary easing measures in a flexible manner”. This proposal aims to make the current policy commitment more flexible. First, it does not restrict the time frame for achieving the 2 percent price stability target to about two years. Second, it clearly states the idea that the time frame for continuing with QQE should be about two years, and that when this time frame comes to an end, the Bank will review the monetary easing measures in a flexible manner, as necessary. As shown in the minutes of the MPM held on April 3 and 4, 2013, the reasons behind this proposal were that (1) achieving the price stability target of 2 percent with a time horizon of about two years entails high uncertainty; and (2) in such a situation there is concern that, if a rise in expectations – namely, that QQE would continue for a protracted period – were to occur, this could lead to a buildup of financial imbalances, for example, given that the Bank’s purchases of financial assets would be unprecedented in scale. In the minutes, other potential risks were also pointed out: the possibility of a rise in speculation that the Bank is engaged in financing fiscal deficits, the possibility that the financial system would become more vulnerable to risks with financial institutions’ profits being squeezed, and the possibility that market functioning would be impaired considerably. While fully recognizing these potential risks, I have nonetheless supported the concrete measures of QQE because I have judged that its positive effects on the economy outweigh, albeit slightly, the associated potential risks or side effects. However, if the current large-scale monetary easing were to be protracted or strengthened, there would be a possibility that the side effects would instead outweigh the positive effects. In this regard, one cannot rule out the possibility that, under the current policy commitment, if financial markets increasingly view achieving the price stability target in about two years as difficult, the Bank will be obliged to extend or strengthen its monetary easing driven by such external factors, even in a situation where it is judged that side effects outweigh positive effects on the economy. Taking this possibility into account, I have proposed not to restrict the time frame for achieving the price stability target, and proposed to designate QQE as an intensive measure with a time frame of about two years based on the recognition that it is appropriate to secure an opportunity for the Bank to thoroughly examine, after a certain period of time, whether the side effects of the large-scale monetary easing are not outweighing the positive effects and review the easing measures in a flexible manner depending on economic and financial conditions at the time. BIS central bankers’ speeches B. Price stability target and medium- to long-term inflation expectations In my proposal, the price stability target of 2 percent is set as a medium- to long-term goal because I think the 2 percent target may become consistent with Japan’s economic fundamentals only in the medium to long term. The Bank’s commitment to achieving the price stability target of 2 percent does not mean that a temporary achievement of this rate is sufficient. It is important to maintain the 2 percent target in a stable manner. To this end, it is necessary for not only the observed inflation rate but also medium- to long-term inflation expectations to be about 2 percent. If the observed inflation rate hovers around 2 percent on average and firms and households act on the assumption that prices will increase by about 2 percent, this will lead to price stability in the medium to long term. So far, the observed inflation rate has been rising, but many indicators suggest that the rise in medium- to long-term inflation expectations, such as for five to ten years ahead, will remain moderate. This implies that the Bank’s decision of setting the 2 percent price stability target alone is not enough for achieving its aim to raise medium- to long-term inflation expectations to the targeted level. I think that medium- to long-term inflation expectations are mainly determined by supply side factors such as the potential growth rate and the labor productivity growth rate, rather than by the supply and demand balances in the goods and labor markets. If QQE induces positive movements by private economic entities and the government’s economic growth strategy makes progress in parallel, the growth potential of Japan’s economy would gradually strengthen and, accordingly, medium- to long-term inflation expectations would likely rise as well. However, as shown in my proposal with regard to the outlook for prices in the Outlook Report, I take the view that such a process will take considerable time, and therefore think it appropriate not to set a specific time frame for achieving the price stability target. Moreover, I think there will be room for a future reconsideration of the level of the price stability target that is currently set at 2 percent, considering future changes in the growth potential and medium- to long-term inflation expectations. C. QQE and fiscal consolidation QQE itself is a powerful policy, but it will exert maximum effects when combined with the government’s efforts to secure confidence in fiscal sustainability. The Bank’s measures, including JGB purchases, are solely conducted for the purpose of achieving the price stability target, but if this is perceived by the markets as financing fiscal deficits, the effects of QQE could be hampered as long-term interest rates rise due to an expansion in risk premiums. The joint statement by the government and the Bank released in January 2013 stated that the government will steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management. The government’s recent decision to raise the consumption tax rate is part of such efforts toward fiscal consolidation. Apart from the government’s efforts toward fiscal consolidation, domestic private entities’ perception also constitutes an important factor when examining the fiscal risk. One of the reasons why Japan’s financial markets have been stable despite the increase in the amount outstanding of government debt lies in the fact that JGBs are mostly held by the domestic private sector, and market participants seem to believe that domestic private entities will ultimately behave rationally – for example, by accepting tax hikes and expenditure cuts – to avoid decreases in the value of their assets caused by realization of the fiscal risk. Market participants, however, may change their views if the public starts thinking that fiscal consolidation can be achieved without revenue and expenditure reforms, mainly reflecting the public’s excessively optimistic expectations for future potential growth, thereby significantly impairing the effects of the Bank’s monetary policy. In this respect, as much as it BIS central bankers’ speeches is important to achieve fiscal consolidation, it is also important that the public and the markets widely recognize that strengthening growth potential requires considerable time. IV. Concluding remarks While the Bank has been implementing QQE, other major central banks have also introduced unconventional monetary policy measures to deal with the economic and financial crisis that materialized in the aftermath of the bursting of the global credit bubble following the Lehman shock in the autumn of 2008. Such developments in other economies and related discussions will serve as a useful reference in considering the future conduct of monetary policy in Japan. In closing, I will touch on two points in particular. First, as I mentioned earlier, a slowdown in the labor productivity growth trend is observed in advanced economies, and this suggests a decline in potential growth rates in these economies. While monetary policy may be able to buy time until necessary adjustments are made for such structural changes, it cannot substitute for structural reforms such as raising the labor productivity growth rate and solving labor market mismatch. Therefore, policymakers have to correctly recognize structural changes and respond to them appropriately, while taking into account what monetary policy can and cannot do. If they do not recognize structural changes and depend too much on monetary policy, excessive easing could result in the accumulation of economic and financial imbalances. Second, I would like to refer to the division of roles between two policy tools; namely, conventional and unconventional monetary policy. Taking the Federal Reserve’s practice of these two types of policy tools as an example, my understanding is that the Federal Reserve regards the asset purchase policy as a measure to generate upward momentum in economic activity and prices and affect the direction of such momentum under the non-negativity constraint on nominal interest rates, while regarding the interest rate policy as a measure to encourage economic activity and prices to reach desirable levels. Such division of roles between the two policy tools in the United States will likely serve as a reference in considering Japan’s future monetary policy. In this regard, in calculating Japan’s policy interest rate under the Taylor rule,2 my estimate – which had been in negative territory – shifted upward, and it is around 0 percent at present. Although this estimate is subject to a considerable margin of error, as it could change depending on the specific assumption employed, this suggests that financial conditions are becoming increasingly accommodative on the back of the rise in prices and of the improvement in the output gap following the introduction of QQE, and that, therefore, maintaining the zero interest rate may lead to the accumulation of economic stimulus effects. Going forward, when an expansionary momentum of economic activity and prices becomes sufficiently strong as a result of the positive outcome of QQE, it will be important to find the most appropriate balance between the two types of policy tools by carefully weighing the associated positive effects and side effects that differ between them, while paying due attention to the increased effects on the economy of the zero interest rate policy. Thank you for your attention. The Taylor rule is a monetary policy rule under which the level of a benchmark policy interest rate is calculated based on a particular formula using, for example, the deviation of the observed inflation rate from the targeted inflation rate, and the output gap. 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, Tokushima, 27 November 2013.
Sayuri Shirai: Japan’s economic activity, prices, and monetary policy – some perspectives on the slope of the Phillips curve Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Tokushima, 27 November 2013. * I. * * Introduction Good morning. It is a great honor to have this opportunity to visit Tokushima Prefecture and meet with local representatives. This is my first visit, so I am really looking forward to learning from you about this region through an exchange of views. In addition, I would like to express my sincere gratitude for your cooperation with the activities of the Bank of Japan’s local office in Tokushima and the Takamatsu Branch. As you may know, at the Monetary Policy Meeting (MPM) held on October 31, 2013, the Bank updated its outlook for Japan’s economic growth rate and rate of price changes over the three-year period through fiscal 2015. Also in October, the Bank released the Outlook for Economic Activity and Prices (hereafter the Outlook Report). The Outlook Report describes the Bank’s baseline scenario as well as upside and downside risks to the scenario from fiscal 2013 to fiscal 2015. I believe that promoting the public’s understanding of the Bank’s outlook is an essential step in the conduct of monetary policy, so my speech today will focus on the main features of the report. Let me briefly describe the sequence of my speech, which contains five sections. In Section II, I will explain the Bank’s outlook for Japan’s economic activity and prices (the baseline scenario), touching on my views. In Section III, I will review the upside and downside risks to the baseline scenario, referring to my views and my related proposal that was presented at the October 31 MPM. In Section IV, I will discuss my current thinking on a number of “conceptual channels” that might lead to achieving the 2 percent price stability target adopted in January 2013 with a sustainable economic growth path based on the concept of the Phillips curve, which shows the empirical relationship between the rate of price changes and the output gap (the difference between actual and potential GDP). Finally, in Section V, I will present my proposal to improve the structure of the Outlook Report, to make the Bank’s communication strategy more effective. Following my speech, I look forward to hearing your candid opinions on its contents as well as the situation of the local economy. II. Baseline scenario of the outlook for economic activity and prices I will begin by describing the current condition of and the Bank’s outlook for economic activity based on the contents of the October 2013 Outlook Report, covering the projection period through fiscal 2015. This will be followed by my views on this outlook. Then, I will present the current condition of and the Bank’s outlook for prices in the same manner. A. Current condition of and outlook for economic activity Japan’s economy has been recovering moderately. On the demand side, exports have been picking up at a somewhat slower pace, but domestic demand – notably private consumption, public investment, and housing investment – has been firm. Reflecting the differences in the extent of recovery strength between domestic and external demand, the pace of increase in industrial production has remained moderate while activity in the nonmanufacturing sector, including services and construction, has been somewhat strong. Looking ahead, while domestic demand is likely to maintain firmness, external demand is expected to increase moderately. Therefore, Japan’s economy is projected to continue growing throughout the projection period at a pace above its potential rate of growth BIS central bankers’ speeches (considered to be around 0.5 percent on average). The projection would remain unchanged even if the economy were affected by the front-loaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, in April 2014 and October 2015. The above projection just mentioned assumes four underlying developments. • Stimulative effects of the accommodative financial conditions on private demand are likely to strengthen as economic activity improves. • Overseas economies are expected to pick up gradually – particularly the advanced economies – on the assumption that global financial markets remain generally stable. • Public investment is expected to remain at a high level through the first half of fiscal 2014, mainly reflecting additional economic measures to be implemented by the government as well as the effects of various past economic measures. • Firms’ and households’ medium- to long-term growth expectations are expected to rise moderately, due mainly to the adoption of the regulatory and institutional reforms and various tax reduction measures by the government, as well as firms’ efforts to expand domestic and external demand with innovative goods and services. A comparison of the current projection with that in the July 2013 interim assessment leads to the judgment that the real GDP growth rates are expected to be more or less unchanged. Nonetheless, the “median” of the Policy Board members’ forecasts showed slight modifications; namely, the real GDP growth rate is currently projected to reach 2.7 percent (2.8 percent in the July assessment) in fiscal 2013, 1.5 percent (1.3 percent) in fiscal 2014, and 1.5 percent (1.5 percent) in fiscal 2015 (Chart 1). My view is more or less in line with this baseline scenario. To highlight some differences, however, my baseline projections of the real GDP growth rates for fiscal 2014 and fiscal 2015 are somewhat lower than the median of the forecasts. This relatively conservative outlook has remained unchanged since the time of assessment in April (when the April 2013 Outlook Report was released) and July this year. The main reason I have maintained this outlook is that while the additional economic measures to be introduced by the government will likely raise the economic growth rates for fiscal 2014 and fiscal 2015, I believe that at present this positive effect may be offset by other countervailing factors – namely, the moderate recovery pace of real exports and industrial production. Indeed, the actual export performance has been unimpressive so far (Chart 2); and, I judged that the outlook for real exports and industrial production should be adjusted downward to some extent as well. A look at developments in overseas economies shows that the economic growth landscape has changed drastically this year. In other words, the growth dynamic has been reversed, and emerging and commodity-exporting economies are losing momentum while advanced economies are improving. This dynamic is likely to continue since the pace of increase in the economic growth rate is likely to be faster in advanced economies than in emerging and commodity-exporting economies in the future. However, the recovery path in the advanced economies is neither robust nor strong, since their output gaps are likely to remain negative throughout the projection period.1 Although the The IMF’s World Economic Outlook (October 2013) reports that the real GDP growth rate for advanced economies is projected to reach 1.2 percent in 2013, 2.0 percent in 2014, and 2.5 percent in 2015. That for emerging economies and developing countries is projected to reach 4.5 percent, 5.1 percent, and 5.3 percent, respectively. The output gap, whose projection is available for advanced economies up to 2014, is reported to be minus 2.9 percent in 2013 and 2.5 percent in 2014. The OECD Economic Outlook (November 2013) reports that the output gap for the OECD economies is projected to be minus 2.6 percent in 2013, minus 2.3 percent in 2014, and minus 1.8 percent in 2015. BIS central bankers’ speeches improvement in external demand is likely to increase Japan’s exports of items such as automobiles and capital goods, this increase may not be as large as that in the past recovery phase owing to the effects of the ongoing shift of production sites overseas and a change in the dynamic of international competitiveness. B. Current condition of and outlook for prices The year-on-year rate of increase in the core consumer price index (headline CPI excluding fresh food) has been positive since June this year and has recently been in the range of 0.5–1.0 percent. In the October 2013 Outlook Report, it was judged that the outlook for the year-on-year rate of change in the core CPI (excluding the direct effects of the consumption tax hikes) was expected to follow a rising trend and was likely to reach around 2 percent – the price stability target – toward the latter half of the projection period. This baseline scenario reflects the following assumptions about the developments of three factors that will primarily determine the inflation rate going forward. • The aggregate supply and demand balance (output gap) is expected to follow a moderate improving trend and expand toward the latter half of the projection period. Nominal wages are likely to see gradual upward pressure as a tightening of labor supply and demand conditions becomes evident. • Medium- to long-term inflation expectations are likely to continue on a rising trend with continued monetary easing, partly supported by a rise in the observed inflation rate, gradually converging to around 2 percent. • Import prices are expected to exert upward pressure for the time being, reflecting developments in international commodity prices and foreign exchange rates. Comparing the current projection with that in the July 2013 interim assessment, the October 2013 Outlook Report concluded that the projected rates of change in the core CPI (excluding the direct effects of the consumption tax hikes) are more or less unchanged. However, the median of the Policy Board members’ forecasts changed slightly; namely, the rate of change in the core CPI is projected to reach 0.7 percent (0.6 percent at the July assessment) for fiscal 2013, while those for fiscal 2014 and fiscal 2015 remain the same at 1.3 percent and 1.9 percent excluding the effects of the tax hikes, and at 3.3 percent and 2.6 percent including the effects of the tax hikes, respectively (Chart 1). This baseline scenario is more or less consistent with my assessment. However, some differences are present; that is, under my baseline scenario, projections for fiscal 2014 and fiscal 2015 are somewhat lower than the median of the Policy Board members’ forecasts. As is the case with the April and July 2013 assessments, I judge that the core CPI is expected to rise toward 2 percent at a more moderate pace than that of the median. My relatively conservative views for fiscal 2014 and fiscal 2015 arise from the assumption that a rise in medium- to long-term inflation expectations toward 2 percent is likely to occur gradually from now on and that it may take some time for an improvement in the output gap to be reflected in the observed rate of inflation. III. Upside and downside risks to the baseline scenario Next, I would like to review the upside and downside risks to the Bank’s baseline scenario that were presented in the October 2013 Outlook Report. After that, I will present my own views. Before proceeding, I would like to note that the judgment on risk factors is subject to adjustment in the future assessments, depending on changes in economic conditions. BIS central bankers’ speeches A. Risk to economic activity The October 2013 Outlook Report puts particular stress on the following five factors as upside and downside risks to the Bank’s baseline scenario for the economy (or real GDP growth rates). • Performance of overseas economies: warranting close attention are the effects of new energy sources and consequences of fiscal problems in the United States, European debt problems, China’s excess production capacity and debt issues, and economic developments together with developments in the global financial markets in some emerging and commodity-exporting economies that are facing current account deficits. • Developments in households’ employment and income situation: close attention should be paid to whether firms, in the face of intense competition, will increase wages by taking into account an improvement in corporate profits. • Effects of the consumption tax hikes:2 while the tax hikes will have adverse effects on households’ real disposable income, the adverse effects on consumption may be mitigated to some extent by (1) scheduled economic measures to be taken by the government, (2) the high probability that the tax hikes are already factored in among households, and (3) the positive effect of alleviating households’ future concerns over the fiscal condition and the social security system. • Developments in firms’ and households’ medium- to long-term growth expectations: these expectations may be affected by future regulatory and institutional reforms as well as tax reforms, firms’ innovation, and households’ income situation. From a somewhat long-term perspective, some positive effects from the hosting of the Tokyo 2020 Summer Olympic Games might be expected. • Medium- to long-term fiscal sustainability: a decline in confidence in fiscal sustainability may lead the economy downward through, for example, excessive rises in long-term interest rates. The opposite would occur if confidence in the path toward fiscal consolidation strengthens. Following a review of these upside and downside risks, the October 2013 Outlook Report assessed that risks to the Bank’s baseline scenario are “balanced” as a whole. B. My views and proposal on risks to economic activity In principle, I view the aforementioned list of risk factors as important elements. However, I do not feel very comfortable with the Bank’s overall risk assessment related to Japan’s economy as being “balanced.” This is because, based on my observation of various data, the downside risks appear to be somewhat greater than the upside risks at this stage. In addition, I found it important to indicate in a frank manner my awareness of greater downside risks to the public and market participants, as this might contribute to enhancing their confidence in the Bank’s conduct of monetary policy and thereby provide them with a greater sense of security regarding the future economic situation. Therefore, at the MPM held on October 31, 2013, I voted against the risk assessment described in the Outlook Report and presented a new proposal (the first point of my proposal that I made at the MPM). My proposal was to insert the following description in the last part of subsection “A. Risks to Economic Activity” in Section II titled “Upside and Downside Risks,” in the Outlook Report: “on the whole, attention should be paid to the downside risks since there is a high degree of I submitted a proposal at the MPM held on April 26, 2013, due to a lack of sufficient description of the risk analysis in the Outlook Report. This point was improved in the October 2013 Outlook Report, where a risk factor description has become much clearer. BIS central bankers’ speeches uncertainty regarding developments in overseas economies and households’ employment and income situation.” Let me explain my views on the risks to economic activity in detail. Overseas economies remain unlikely to fall into severe recession or face tail risk. However, since April 2013 I have been claiming consistently that “on balance, the risks are tilted somewhat to the downside.” This is because of uncertainty associated with the pace of recovery in overseas economies. Moreover, considerable time has passed since the yen depreciated sharply from late 2012, but the rate of growth in real exports appears to have remained sluggish, even after taking into account the J-curve effect and the slow pace of recovery in overseas demand. This means that the mediocre performance of exports may be reflecting structural factors – in addition to cyclical factors – such as a continuing shift of Japanese firms’ production sites to overseas and a change in their international competitiveness. Moreover, compared with the projections in the April and July 2013 assessments, I judge that uncertainty over developments in global financial markets and overseas economies has increased moderately, which may lead to underperformance in my baseline scenario. My concerns are focused especially on the following aspects. • Developments in global financial markets: as recovery in advanced economies proceeds, differences in the monetary policy stance among major central banks may become more apparent. This may cause frequent changes in market participants’ views regarding the direction of accommodative monetary policy measures and the interpretations of forward guidance. The resulting impact of such behavior of investors on financial markets and the global economy warrants close attention. • The performance of the U.S. economy: owing in part to postponement of the resolution of fiscal and debt issues until early 2014 as well as to the associated political and economic uncertainties, it is not clear whether the U.S. economy will be able to post economic growth above its potential growth rate – which is an annual rate of about 2.2 percent for 2013 to 2018 as projected by the Congressional Budget Office (CBO). Recent economic growth rates have been higher than the potential rate. This is a welcome development, but the pace of growth in business fixed investment and private consumption (excluding automobiles) has been slow, and therefore these developments require caution. The recovery in the housing market should also be closely monitored, since there is some uncertainty whether the recovery in the number of mortgage applications will be solid amid higher levels of mortgage interest rates and stringent lending attitudes toward first-time buyers. • The performance of the European economy: the euro area economy has bottomed out and shows signs of a moderate pick-up in recent months. Japan’s exports to Europe have also begun to increase. However, the banking sector within the euro area remains fragmented, and thus countries in the area still have lending interest rate differentials. Attention needs to be paid to uncertainty regarding Asset Quality Reviews and stress tests to be conducted by the European Central Bank (ECB) over the twelve months from November 2013 and the associated recapitalization process that may occur. The recent disinflation trend in the euro area may aggravate the repayment burden of peripheral countries as they seek to reduce their public- and private-sector debt, hampering their economic recovery. The internal devaluation in the euro area may also become harder to achieve. • Developments in emerging and commodity-exporting economies: given that growth in these economies has been lacking momentum in recent months, it is possible that a weaker-than-projected growth performance will materialize. Countries facing structural problems (such as current account deficits) as well as strong cross-border links with global financial markets may be more prone to the reversal of capital flows and changes in liquidity conditions in the securities and foreign exchange markets. The resultant tightening of financial conditions, together with the necessity to tighten BIS central bankers’ speeches the fiscal and monetary policies to cope with capital outflows in these economies, may undermine their economic recovery path. • Performance of the Chinese economy: while the rate of economic growth accelerated from 7.5 percent in the second quarter of 2013 to 7.8 percent in the third quarter, the sustainability of the current economic growth rate is uncertain, given the rise in the ratio of private-sector debt to GDP, concerns over the shadow banking system, the rapid pace of real estate price hikes in the metropolitan areas, and unresolved excess production capacity in some industries. As for domestic demand, greater attention should be paid to the downside risks on the following fronts, relative to the assessments made in April and July 2013. • Developments in wage growth: there is a possibility that the rate of wage growth will not catch up with that of inflation. Alternatively, wealth effects may not sufficiently offset a potential decline in real disposable income. Wealth effects appear to have become less pronounced, since the rising trend in stock prices and exchange rates appears to have leveled off from the second half of 2013.3 On this front, future asset price movements – together with the recent rise in stock prices and the yen’s depreciation – should be monitored closely. While private consumption will remain a major driving force of Japan’s economic growth in the immediate future, it may not be as resilient as projected once the effects of the front-loaded increase in demand prior to the consumption tax hike in April 2014 dissipate. • Developments in business fixed investment: business fixed investment is expected to increase in the fields of maintenance and replacement, energy savings and rationalization, and investment in earthquake resistance as well as research and development (R&D). This is because many firms have postponed their investment for several years due to a series of negative shocks. Nonetheless, investment to expand production capacity may be limited if firms do not foresee a sustainable increase in domestic sales. On the whole, growth in business fixed investment may turn out to be more moderate than projected, particularly in the manufacturing sector, where increased investment has just begun to take place. • Sustainability of households’ and firms’ medium- to long-term growth expectations: a sustainable increase in consumption and business fixed investment as well as associated credit demand may not be feasible without a steady increase in growth expectations. For example, according to the Bank’s Opinion Survey on the General Public’s Views and Behavior conducted in September 2013, the “growth potential diffusion index (DI)” of Japan’s economy deteriorated from minus 26.7 percentage points in June to minus 36.8 percentage points in September. This may, however, be attributable to the fact that the September survey was conducted before the announcement of Tokyo’s successful bid to host the 2020 Summer Olympic Games. C. Risks to prices Turing to risk factors related to prices, the October 2013 Outlook Report points out the following upside and downside risks. The Annual Report on the Japanese Economy and Public Finance 2009 compiled by the Cabinet Office presents an empirical analysis of the consumption function. It showed that an increase in stock assets of 100 yen leads to a rise in consumption of 3.5 yen. This effect is larger in the United States, partly because of the differences in exposure to stocks between the two countries. In the United States, the share of stockholdings in financial assets exceeded 40 percent for all age groups (as of 2007). By contrast, the share of stockholdings in Japan increased with age and reached a maximum level of slightly less than 15 percent for the 70–75 age group (as of 2008). BIS central bankers’ speeches • Developments in firms’ and households’ medium- to long-term inflation expectations: while there is a possibility that inflation expectations may not readily rise in reflection of the moderate decline in prices and wages observed in the past, there is also a possibility that they will rise relatively quickly with a rise in observed inflation and wages. Effects on these expectations of a price increase associated with the consumption tax hikes in items across the board warrant attention. • Uncertainty regarding the responsiveness of prices to the output gap: attention needs to be paid to whether firms will raise prices and wages in accordance with the extent to which the supply and demand balances in goods and services as well as in the labor market tighten over time. • Developments in import prices: there is a high degree of uncertainty regarding developments in import prices reflecting fluctuations in international commodity prices and foreign exchange rates, and the extent to which such developments are passed on to domestic prices. In the Outlook Report, the Bank assessed upside and downside risks on the price front as being “largely balanced,” although considerable uncertainty surrounds developments in medium- to long-term inflation expectations. D. My views and proposal on risks to prices The aforementioned list of risk factors related to prices has been covered sufficiently. However, I do not agree with the overall assessment of risks on the price front as being “largely balanced,” since, based on my observation of various data, the downside risks appear to be greater than the upside risks at this stage. As in the assessments made in April and July 2013, I have held the view that “on balance the risks are tilted somewhat to the downside.” Currently, however, I hold the strong view that greater attention should be paid to the downside risks at this stage. This is why I voted against the assessment described in the Outlook Report at the MPM held on October 31, 2013, with a new proposal (the second point of my proposal). My proposal was to insert the following description in the last part of subsection “B. Risks to Prices” in Section II titled “Upside and Downside Risks,” in the Outlook Report: “on the whole, attention should be paid to the downside risks, because there is a high degree of uncertainty regarding developments in medium- to long-term inflation expectations and the responsiveness of prices to the aggregate supply and demand balance.” Let me explain my concern in more detail. Recent Developments in Medium- to long-term inflation expectations Developments in “medium- to long-term” inflation expectations that are affecting the intercept of the Phillips curve have been closely monitored by the Bank as one of the essential factors for achieving the 2 percent target. The related indicators exhibited a rapid increase in medium- to long-term inflation expectations from late 2012. In recent months, however, while some indicators showed an uptrend, several others have showed a slow pace of increase or been more or less flat (Chart 3).4 Also, these inflation expectations are “Short-term” inflation expectations are more prone to current actual price developments and thus tend to be more volatile than “medium- to long-term” inflation expectations (Chart 4). In addition, the scheduled consumption tax hikes (an increase from 5 to 8 percent in April 2014 and an increase from 8 to 10 percent in October 2015) are likely to further raise “households’ short-term” inflation expectations, if the effects of these consumption tax hikes are factored in sufficiently. “Households’ medium- to long-term” inflation expectations will increase further if the term for these expectations covers the period in which the two tax hikes occur, but if the term covers a longer period of time the effects of the tax hikes will be diluted. As April 2014 approaches, short-term inflation expectations may rise further, and in fiscal 2014 they may exceed 2 percent in view of the effects of the tax hike, monetary accommodation, and the lagged impact of the yen’s depreciation. Attention should therefore be paid to whether short-term inflation expectations will turn out as expected. BIS central bankers’ speeches still well below the 2 percent target and thus there is uncertainty as to whether these expectations will rise to the level of 2 percent during the projection period. For example, breakeven inflation (BEI) rates increased rapidly in line with the yen’s depreciation from late 2012, although such a strong correlation had not been present earlier (Chart 5). However, the BEI rates appear to have become more or less constant since mid-2013, and this trend appears to be in line with the relatively stabilized exchange rate of the yen against the U.S. dollar. Changes in price responsiveness to the output gap Another important factor that could contribute to the achievement of the 2 percent target – in addition to the increase in inflation expectations – is an increase in the “responsiveness of prices to the output gap” (or the slope of the Phillips curve). In general, the slope of the Phillips curve steepens when firms find it easier to raise their sales prices or pass their input costs on to their sales prices given the level of the output gap. Also, an increase in the frequency of price adjustments will promote a steepening in the Phillips curve. The current situation signals a possibility that the price-setting environment of firms may be improving. Meanwhile, severe competition among firms may discourage them from raising their sales prices, if their concerns increase over a possible loss of market share. Especially in fiscal 2014, the Phillips curve may remain largely unchanged owing to the high degree of uncertainty associated with the consumption tax hike. If many firms perceive that the price increase triggered by the tax hike could be sufficiently large to constrain household domestic demand, they may partially postpone raising their final sales prices (those related to the effect of the output gap and a rise in inflation expectations) beyond the increase related to the tax hike in and after fiscal 2015 – that is, not fully raised within fiscal 2014. In such an event, the responsiveness of prices to the output gap would remain limited and the outcome for prices in fiscal 2014 could be lower than projected by the Bank. Please note that this remark has nothing to do with the debate on the timing of the tax hikes. In this regard, let me remind you that I have been supporting the scheduled introduction of the consumption tax hikes, with a view to maintaining fiscal soundness and sustainability of the social security system. My proposal related to the assessment on the “path” toward achieving the 2 percent target Based on the observations just described, I judged that the current path toward achieving the 2 percent target entails uncertainty. Reasons for this judgment can be summarized as follows. • Although prices of a wide range of consumption items have begun to increase, the fact that the core CPI inflation rate has been increasing in positive territory is largely attributable to the lagged impact of the yen’s depreciation at this stage and the increase in energy prices. The effects to the price rise of the improvement in the output gap and an increase in inflation expectations need to be confirmed with more evidence. • The pace of the increase in medium- to long-term inflation expectations appears to have moderated or become more or less flat in recent months. • There is a considerable difference between medium- to long-term inflation expectations and the 2 percent target. Thus, my judgment is not consistent with the assessment of the October 2013 Outlook Report placed in the final paragraph in Section III titled “Conduct of Monetary Policy,” which said that “Japan’s economy has been following the path toward achieving the 2 percent price stability target as expected.” I voted against this assessment and proposed that the BIS central bankers’ speeches expression “as expected” be replaced with “at a moderate pace.” This constituted the third point of my proposal. IV. Conceptual channels for achieving the 2 percent target One thing that I wish to emphasize is that I continue to support the 2 percent target with sustainable economic growth path. My determination to make as much effort as possible to achieve this target has remained intact. In this light, in Section IV of my speech I will present my current thinking on the “conceptual channels” that could lead to achieving the 2 percent target. Here, I intentionally used the term “conceptual.” This is because increasing “mediumto long-term” inflation expectations and anchoring them at around the 2 percent level – which the Bank is currently pursuing through quantitative and qualitative monetary easing (QQE) – is a challenging task that no other major central bank has ever undertaken in the past. Therefore, there is uncertainty regarding the realization of these channels at this point, and I feel that I should wait for more evidence to confirm their achievability. If these channels materialize gradually, I judge that the downside risks to the baseline scenario would decline accordingly. A. The estimated Phillips curve in the case of Japan In formal economic terms, with a view to raising inflation toward 2 percent, it is important to consider the relationship between the rate of price change and the output gap – a relationship known as the Phillips curve. The October 2013 Outlook Report presented the estimated Phillips curve for the observation period of 1983–2013 (Chart 6). The year 1983 was chosen as a starting year for the observation period, because the impact of the oil shocks that occurred in the 1970s had likely dissipated by that year. The Phillips curve was estimated for the entire observation period and for two subset periods (from 1983 to 1995 and from 1996 to 2013), as shown respectively by lines A, B, and C in Chart 6. The charts suggest two features: (1) line C, using the data of a more recent observation period, appears to be shifting downward, almost parallel to line B; and (2) the slope of line C appears to be flatter than that of line A, for which the observation period is longer. While various factors influence both features simultaneously, let me list some that may be considered to have affected each of these features.5 It is possible that some of the factors affected both the shift in the Phillips curve and its slope. However, for the sake of simplicity, I will separate the factors into those that have mainly shifted the Phillips curve and those that have mainly steepened its slope. (Main factors contributing to a downward shift in the Phillips curve) • Decline in medium- to long-term inflation expectations: the sharp drop in inflation expectations in the 1990s may be associated with declines in the potential growth rate and growth expectations for the economy (Charts 7 and 8). Indeed, the average real GDP growth rate dropped from 4.3 percent in the 1980s to 1.5 percent in the 1990s, and further to 0.6 percent in the 2000s. • Negative wage gap: average wages have dropped and the resultant lower level of real wages has not been consistent with that of labor productivity, partly as a result of deregulation in the labor market since the late 1990s. Unit labor costs have also See, for example, Bank of Japan, “Background Note regarding the Bank’s Thinking on Price Stability,” 2013; Kenji Nishizaki, Toshitaka Sekine, and Yoichi Ueno, “Chronic Deflation in Japan,” Bank of Japan Working Paper Series, No. 12-E-6, 2012; Maiko Koga and Kenji Nishizaki, “Bukka Chingin Firippusu Kyokusen no Suikei (Estimated Phillips Curve of Prices and Wages),” Kin’yu Kenkyu (Monetary and Economic Studies), 2006, pp. 73–105 (available in Japanese); and Ryo Kato and Takuji Kawamoto, “Nyu Keinjian Firippusu Kyokusen (New Keynesian Phillips Curve),” Bank of Japan Review Series No. 2005-J-6, 2005 (available in Japanese). BIS central bankers’ speeches been on a declining trend. In this circumstance, firms may have incentives to lower their sales prices as a result of improved profit margins driven by lower labor costs (Chart 9). • Declining trend of durable consumer goods: mild deflation has been affected by a persistently declining trend in the prices of durable consumer goods (a decline of about 4.5 percent on average from 1997 to 2011), which account for about 10 percent of the total CPI weight. Such a tendency has also been seen overseas, including in the United States, but the decline in durable consumer goods prices – specifically, prices of televisions and personal computers – is more pronounced in Japan despite minor differences in quality. Underlying factors may be national differences in the competitive environments of the retail sectors and quality adjustment. (Main factors contributing to a flattening in the slope of the Phillips curve) • A structural shift to the services sector: in general, the frequency of price changes in the services sector is lower than that in the manufacturing sector. Given the relatively large shares of raw material and input costs in the total production costs in the manufacturing sector, changes in these prices and costs tend to be reflected in sales prices. By contrast, in the labor-intensive services sector, lower shares of raw material and input costs as well as sluggish growth in nominal wages lead to a low frequency of price changes. • An increase in the price elasticity of demand: intensified competition at home and abroad and a series of negative shocks (and associated plunge in domestic demand) have led to an increase in the price elasticity of demand. This has made it difficult for firms to pass their marginal cost of production on to sales prices, generating constant downward pressure on profit margins and wages. Consequently, firms, supermarkets, and large discount stores have begun to set their sales prices according to their competitors’ and clients’ demand, rather than in response to the output gap or cost developments. A discount-based marketing strategy has become prevalent. Based on the observation of the aforementioned factors, turning the viewpoint conversely may lead to the following inference. That is, the Phillips curve may change positively – shifting upward with a steepening slope, in the case of Japan – if the trend in some of these contributing factors can be reversed (Chart 10). B. Conceptual channels leading to an upward shift in the Phillips curve This subsection will focus on my current thinking on the conceptual channels that may lead to an upward shift in the Phillips curve. Under the inflation-targeting framework, in general, “medium- to long-term” inflation expectations have little correlation with relatively volatile “short-term” inflation expectations, especially when medium- to long-term inflation expectations are anchored at the inflation target level. In this circumstance, medium- to longterm inflation expectations also become less correlated with the “actual” inflation rate; however, in the long run the actual inflation rate tends to move at around the level of these inflation expectations. This situation is not yet applicable in Japan, since the economy is still in the process of establishing an anchor on the higher medium- to long-term inflation expectations at around 2 percent. Until these expectations are firmly anchored, it is possible that the actual inflation rate, short-term inflation expectations, and medium- to long-term inflation expectations will continue to affect each other. My thinking on this, which I will now present, is based on such a perspective. BIS central bankers’ speeches Will the actual inflation rate Promote an increase in medium- to long-term inflation expectations? In terms of the first conceptual channel, as the public grows convinced that the actual inflation rate has been rising moderately to date and is expected to approach 1 percent by the end of 2013, medium- to long-term inflation expectations may increase further. According to the Opinion Survey on the General Public’s Views and Behavior conducted by the Bank in September 2013, the respondents who chose “developments in gasoline prices” as the basis for their outlook for price levels over the next five years were nearly 50 percent of the total, and those who chose “developments in prices of frequently purchased items” (such as food and daily necessities) also were nearly 50 percent (with multiple answers allowed). Thus, it is conceivable that the continuation of price increases, especially in these items, will contribute to raising inflation expectations. Let me now refer to the experience of the United Kingdom, although in that nation it is a case of lowering medium- to long-term inflation expectations in the presence of a high level of actual inflation – the opposite of the case of Japan. The United Kingdom exited the European Exchange Rate Mechanism (ERM) in September 1992. To raise the credibility of monetary policy in line with this new move, the Bank of England (BOE) adopted inflation targeting in October 1992, with the initial target set in the range of 1–4 percent. The target was subsequently lowered to a level equivalent to or less than 2.5 percent in May 1995, and further changed to a point target level of 2.5 percent in May 1997. In 1998, the BOE achieved operational responsibility for setting interest rates and established the Monetary Policy Committee. The target level was further changed to 2 percent at end-2003, together with a change in the reference price indicator from retail prices to consumer prices (Chart 11). Currently, inflation below 2 percent is judged to be just as bad as inflation above 2 percent. If actual inflation surpasses 3 percent or falls below 1 percent, the Governor of the BOE must write an open letter to the Chancellor, explaining the reasons for such a deviation and prescriptions for correcting it. Looking at the case of the United Kingdom, we can point out four features. • Medium- to long-term inflation expectations (based on the average forecasts of private-sector economists) tend to change moderately, and such expectations dropped to around 2.5 percent by 1998. • Setting the inflation target, as well as clarifying it, appears to have been effective in terms of lowering medium- to long-term inflation expectations. • A steady decline in the actual inflation rate toward the inflation target range or level appears to have improved the public’s confidence in monetary policy, contributing to lowering medium- to long-term inflation expectations. • The pace of decline in the actual inflation rate initially tends to be faster than that of medium- to long-term inflation expectations. Moreover, it is possible that the decline in the actual inflation rate will exceed the decline in the rate of inflation expectations, until these expectations are firmly anchored. Since the global financial crisis occurred, the actual inflation rate has been on a rising trend in the United Kingdom, due to several factors: (1) a depreciation of the pound sterling; (2) changes in consumption tax rates (a decline in 2008, followed by increases in 2010 and 2011); (3) fluctuations in commodity prices; and (4) the effects of administered and regulated prices. Following these movements, medium- to long-term inflation expectations appear to have risen moderately. On this point, however, the BOE holds the view that the expectations remain well anchored, although there may be some limited concerns about dis-anchoring of inflation expectations because of a persistent deviation of actual inflation above the 2 percent BIS central bankers’ speeches target.6 Regarding the shift from the inflation target range to the inflation target level or point, it has been pointed out as appropriate because such a shift has the advantage of clarifying monetary policy, and a “range bias” appears to have existed during the period when the target range was adopted, with the inflation expectations fixed at around the upper bound of the range. Once a point inflation target was introduced, inflation expectations fell steadily, as the range bias was ironed out.7 Applying the case of the United Kingdom to Japan, several points can be inferred. • It is conceivable that the actual inflation rate will lead to an increase in medium- to long-term inflation expectations as the actual inflation rate approaches the 2 percent target. • The increase in the actual inflation rate (which is likely to be affected by changes in commodity prices and other factors) may exceed that of medium- to long-term inflation expectations until these expectations are firmly anchored. • Applying a target point, rather than a target range, may be appropriate at this stage since a premature introduction may result in the actual inflation rate being stuck at the lower bound of the range (in the case of Japan), making it harder to achieve the 2 percent target. On the third point, the idea of applying a range to the inflation target – while it should not be ruled out – should be examined after the actual inflation rate exceeds at least 1 percent in a stable manner and after it is judged that inflation expectations will likely remain near 2 percent. A more important concern is that the public and market participants may mistakenly assume that the Bank’s intention to achieve the 2 percent target has weakened, thus, undermining the credibility of monetary policy. Will an increase in the growth expectations raise inflation expectations? Earlier, I mentioned that medium- to long-term inflation expectations may be positively correlated with the potential growth rate and growth expectations of the economy (Charts 7 and 8). Therefore, as the second conceptual channel, it is conceivable that an increase in inflation expectations can be promoted by the government’s economic growth strategies, firms’ efforts to raise competitiveness, and financial institutions’ initiatives to take greater risk to provide financial services to innovative and growth-supporting firms, with the continued support of the QQE. Conceptually, all these collective actions, if continued to be taken, will promote a heightening of firms’ and households’ growth expectations. Moreover, the Annual Report on the Japanese Economy and Public Finance 2013 compiled by the Cabinet Office reported that firms tend to raise their outlook for sales prices of goods and services over the next year, when they project that market prices over the same period will increase. This response accounted for about 70 percent of respondents in the manufacturing sector and more than 50 percent of respondents in the nonmanufacturing sector. In other words, if an increase in demand for goods and services leads to a rise in market prices, this may induce firms to raise their sales prices. This situation is more likely to occur if a sustainable expansion of the domestic market is projected. Will the negative wage gap be mitigated? When examining wage developments, I pay great attention to data on cash earnings per worker after separating workers into those who are full time and those who are part time. See Bank of England, “Inflation Report,” August 2013. See, for example, Andrew Haldane, “Targeting Inflation: The United Kingdom in Retrospect,” in Mario I. Blejerer et al., eds. Inflation Targeting in Practice, which contains summaries of presentations made at the IMF Seminar held in Rio de Janeiro, Brazil on May 3–5, 1999. BIS central bankers’ speeches More specifically, I find it important to look at the year-on-year rate of change in monthly cash earnings for full-time workers, and that in hourly cash earnings for part-time workers.8 These indicators show that hourly cash earnings for part-time workers have been on a rising trend over the past three years, reflecting the high level of the active job openings-to-applicants ratio (Chart 12). There is a sign that supply and demand conditions in the labor market have been tightening, particularly for part-time workers. In addition, the growth rate of monthly cash earnings for full-time workers has been positive in recent months, thanks to increases in bonuses and overtime payments. The unemployment rate was 4 percent in September 2013 (4.3 percent for males and 3.5 percent for females), approaching the full-employment level especially with regard to female workers. The Bank’s September 2013 Tankan (Short-Term Economic Survey of Enterprises in Japan) indicates a shortage in employment in the nonmanufacturing sector, regardless of firm size. Given these conditions and demographic changes, an increase in hourly cash earnings for part-time workers is expected to continue. This may help narrow the wage differences between part-time and full-time workers – although progress is likely to occur only gradually. It is conceptually apparent that these conditions may contribute to mitigating the negative wage gap mentioned earlier. If the negative wage gap shrinks and the increasing trend in wages becomes firm, as the third conceptual channel, this may eventually exert greater pressure on firms to raise their sales prices. C. Conceptual channels leading to a steepening in the slope of the Phillips curve This subsection will focus on the conceptual channels that may help steepen the slope of the Phillips curve. Current economic conditions appear to exhibit signs of a gradual steepening in the slope of the Phillips curve, although their sustainability is not yet clear. Will firms’ profit margins improve? Recently, it has been noted that the environment surrounding firms with respect to deflationary pressures is gradually changing. The depreciation of the yen has helped mitigate the deflationary pressure prevailing among firms, since firms no longer need to lower yenbased export prices to maintain (foreign currency-based) international price competitiveness. Indeed, the rate of change in yen-based export prices since late 2012 has turned from negative to positive. The yen’s depreciation has also had moderating effects on inflows of some inexpensive import products. Moreover, the moderate movements in foreign currencydenominated commodity prices have helped avoid a sharp increase in import prices; this contrasts with the mid-2000s, which were characterized by sharper yen’s depreciation and a commodity price surge. Taking these factors into account, in terms of the fourth conceptual channel, firms may be finding it easier to raise their sales prices and wages owing to the healthier prospects for profitability. Moreover, the September 2013 Tankan reports that the “DI for output prices” – or sales prices – of large firms in the nonmanufacturing sector turned positive and that of large These decomposed data are more useful than cash earnings per worker, since they remove the effects of the decline in the average wages caused by the uptrend in the ratio of part-time workers. In Japan, this uptrend has been taking place rapidly owing to (1) an increase in the number of workers in the labor market who had been working as regular workers but have temporarily become non-regular workers after retirement (until they meet the threshold for receiving benefits from their corporate pensions); (2) a structural shift to the services sector in the economy; (3) the effects of the spouse tax deduction applicable to the taxable income; and (4) an increase in the labor force participation ratios of female non-regular workers between 15 and 64 years old as well as of non-regular workers over 65 years old. Provided that some of these changes are structural, it is appropriate to separate full-time from part-time workers and look at their wage developments individually. In the case of part-time workers, it is suitable to use an hourly based indicator since their working times are more unstable than full-time workers. In the case of full-time workers, monthly cash earnings including bonuses and overtime payments – rather than base salaries alone – could be useful as an indicator to examine favorable wage developments as a first step. BIS central bankers’ speeches firms in the manufacturing sector approached closer to zero, suggesting that these large firms have found it relatively easier to raise their sales prices (Chart 13-1). In addition, firms’ profit margins – which can be estimated from the difference between the DIs for sales prices and for input prices – have also improved, regardless of sector and firm size, compared with 2008, when a greater depreciation of the yen and a hike in commodity prices caused a sharper increase in input prices and a deterioration in firms’ profit margins (Charts 13-1 through 14-2). Based on these observations, there is a sign that the price-setting environment for firms may be improving. Nonetheless, the conditions for small and medium-sized enterprises (SMEs) may continue to suggest difficulty, since the DIs for sales prices of such firms in all sectors remain negative and their profit margins over the next three months are expected to continue to deteriorate significantly (Charts 13-2 and 14-2). Given that SMEs account for the majority of Japanese firms, whether SMEs are able to pass their input costs on to their sales prices is increasingly becoming a key to determining future price developments. Will changes in the marketing strategies of firms and retail stores continue? Recently, it was noted that the prices of a wide range of goods and services have begun to show a moderate increase. More importantly, a persistently declining trend in the prices of durable consumer goods appears to have been mitigated. In particular, the rate of change in prices for some items – such as televisions and personal computers – has begun to turn positive. This reflects the fact that some large retail stores for home electronics are increasingly shifting from a discount price sales strategy to a higher-value-added or higher unit sales price strategy (the fifth conceptual channel), in addition to the rise in import prices reflecting the yen’s depreciation. Some restaurants are also attempting to raise their unit sales prices by providing higher-value-added menus and services. It seems that it has become increasingly important to focus on prices in order to secure profits, amid sluggish growth in the overall sales volume in Japan partly reflecting demographic changes. Changes in marketing strategies also reflect an improvement in household sentiment, a continued improvement in employment, wealth effects, and a front-loaded increase in demand prior to the consumption tax hikes. Above all, mitigation of the persistently declining trend in the prices of durable consumer goods – observed since the early 1990s – suggests that firms’ price-setting behavior is changing. Such developments have also started to be observed in clothes and footwear. It is conceivable that this trend will last for a considerable time if such a marketing strategy spreads widely throughout society. To sum up, I have outlined five conceptual channels in all as factors that may lead to a shift in the Phillips curve and a steepening in its slope. It is conceivable that the materialization of these factors will contribute to mitigating the downside risks to the Bank’s baseline scenario of the outlook for prices and to achieving the 2 percent price stability target. V. My views and proposal on the structure of the outlook report Lastly, I would like to explain my views on the structure of the Outlook Report. I believe that the description in the report is insufficiently clear for the public and market participants. In particular, I think that use of the word “perspectives” with no explanation is inappropriate and unfriendly to readers.9 Readers could easily fail to understand the connection between the contents of the report and the two perspectives contained in it, and as a result the Bank This was Section III in the Outlook Report – titled “Conduct of Monetary Policy” – which focuses on the two perspectives. The first perspective examines whether the outlooks for economic activity and prices will follow a path of “sustainable growth under price stability” over the next three years or so. The second perspective relates to various risks relevant to the conduct of monetary policy, including (1) the overall assessment of risks to the economic activity and prices and (2) financial imbalances from a longer-term perspective. However, these explanations are not provided in the Report. BIS central bankers’ speeches could lose the opportunity to communicate its intentions to the public. Ever since I was appointed as a Member of the Policy Board in April 2011, I have maintained views on the need to significantly improve the strategy of the Bank’s communication including that expressed through various official documents including the Outlook Report, to promote the public’s understanding of monetary policy, and have called for improvements.10 I submitted a proposal for the first time at the MPM held on April 26, 2013, after the new leadership of the Bank was appointed.11 Although the proposal was not accepted at the time, in the most recent Outlook Report released in October 2013 a new footnote was inserted in the section related to the Bank’s two perspectives, telling readers to refer to the related Statement on Monetary Policy released in January 2013. This improvement was a welcome step, addressing some of my concerns. However, I believe that the insertion of the footnote without any explanation of the two perspectives did not contribute sufficiently to improving the clarity for readers. Accordingly, I presented a new proposal (the fourth point of my proposal) at the MPM held on October 31, 2013, to include an introductory paragraph at the beginning of the Outlook Report. Under my proposal, the paragraph would have explained the sequence of the report and provided a brief description of the concepts behind the two perspectives. The suggested paragraph read as follows: “The October 2013 Outlook Report will first present the baseline scenario of the outlook for economic activity and prices in Japan for the next one to three years. It will next highlight upside and downside risks to the baseline scenario. The Bank will then assess that scenario from two perspectives: the first perspective concerns an examination of the scenario from the viewpoint of whether the economy will follow the sustainable growth path with price stability; the second perspective involves an examination of various risks considered most relevant to the conduct of monetary policy – including those in the longer term – from the viewpoint of achieving the sustainable growth path with price stability. Lastly, taking into account its assessment based on those perspectives, the Bank will outline its thinking on the future conduct of monetary policy.” This type of introduction appeared in the October 2011, April 2012, and October 2012 issues of the Outlook Report, but my proposal this time represents an advance in that it focuses on adding an explanation of the two perspectives. The Bank finds itself in an important phase as it aims to achieve the 2 percent price stability target through the conduct of unprecedented monetary easing, which is a challenging task. In this regard, it appears that some in the public and some market participants feel uncertain about the importance of achieving the 2 percent target, as well as about the Bank’s policy intention. Gaining the sympathy of the public and market participants with the Bank’s policy intention and promoting their belief in it are fundamental to successfully achieving the 2 percent target. Improving the reader-friendliness of the Bank’s official documents – including the Outlook Report – is one of the first steps toward increasing the number of readers and gaining their support of the Bank’s conduct of monetary policy. In this regard, I will do my best to pursue more effective communication by the Bank, continually examining how it can gain the understanding of the public and market participants, and thereby achieve the 2 percent target with a sustainable economic growth path. This brings me to the end of my speech. Thank you very much indeed for your kind attention. According to the Bank’s Opinion Survey on the General Public’s Views and Behavior conducted in June 2013, about 18 percent of the respondents answered “unclear,” nearly 40 percent answered “somewhat unclear,” and about 36 percent answered “difficult to say” to a question asking how they would describe the Bank’s explanation to the public. My proposal at the April 26 MPM called for completely removing the concept of the “two perspectives” from the report; instead, I suggested that what was written relating to the two perspectives in Section III be moved to appropriate sections throughout the entire report. 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 Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 2 December 2013.
Haruhiko Kuroda: Japan’s economy and monetary policy Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 2 December 2013. * * * Accompanying charts can be found at the end of the speech. Introduction It is my great pleasure to have this opportunity to address such a distinguished gathering of business leaders in the Chubu region today. I would like to express my sincere gratitude to you for your cooperation with our Nagoya branch. The greatest challenge facing Japan’s economy is overcoming deflation that has lasted for nearly 15 years. Amid protracted deflation, corporate profits and wages have been compressed, the spending of firms and households has declined accordingly, and Japan’s economy has become oriented toward contraction. Under deflation, as the real value of cash rises with a decline in the prices of goods and services, saving cash at hand will be relatively advantageous, rather than making investment that pursues new opportunities. In such a situation, the incentive to take on challenging new business opportunities will decline and people’s mindset as a whole will become pessimistic, thereby depriving Japan’s economy of vitality. In response, at the Monetary Policy Meeting held on April 3 and 4, the Bank of Japan made a clear commitment to achieving a 2 percent price stability target at the earliest possible time, with a time horizon of about two years, and introduced a new phase of “quantitative and qualitative monetary easing” (QQE) to underpin that commitment. So far, the QQE has been steadily exerting its intended effects, with an improvement in the real economy, financial markets, and people’s expectations and mindsets, and Japan’s economy has been following the path toward achieving the 2 percent price stability target, as expected. Today, before exchanging views with you, I would like to explain the Bank’s view on the current situation and outlook for economic activity and prices as well as effects of the QQE, in part by referring to the Outlook for Economic Activity and Prices (Outlook Report) released at the end of October. I. Current situation and outlook for Japan’s economy Japan’s economy has been recovering moderately as domestic demand has been firm and overseas economies as a whole have been picking up moderately. Compared with what was anticipated at the time of the April Outlook Report, the economy as a whole has been developing almost as expected, with external demand slightly weaker, as exports have been picking up at a somewhat slower pace, and domestic demand slightly stronger. Looking ahead, as external demand is expected to increase, albeit moderately, while domestic demand is likely to maintain firmness, a virtuous cycle among production, income, and spending is likely to be maintained. While the economy will be affected by a swing in the front-loaded increase and subsequent decline in demand prior to and after the two scheduled consumption tax hikes, it is likely to continue growing at a pace above its potential, which is estimated to be around 0.5 percent, as a trend. In terms of the median of the real GDP projections by the nine Policy Board members in the Outlook Report released at the end of October, it is 2.7 percent for fiscal 2013, 1.5 percent for fiscal 2014, and 1.5 percent again for fiscal 2015 (Chart 1). As for price developments against such a backdrop, the year-on-year rate of change in the consumer price index (CPI, all items excluding fresh food) turned positive in June 2013 and BIS central bankers’ speeches recently accelerated to 0.9 percent in October (Chart 2). While it is true that a rise in the prices of energy-related goods such as petroleum products and electricity has contributed to lifting the index, improvement has been spreading in a wide range of items as domestic demand, including private consumption, has been firm. This can be confirmed by the fact that the year-on-year rate of change in the CPI (all items excluding food and energy) has turned positive and that the number of items for which prices are increasing has surpassed that of items for which prices are decreasing (Chart 3). Looking ahead, the year-on-year rate of change in the CPI is likely to follow an increasing trend, as an improvement in the aggregate supply and demand balance brought about by economic recovery will contribute to lifting prices, and as people’s medium- to long-term inflation expectations are likely to rise, due partly to an increase in the observed inflation rate. In terms of the median of the CPI growth projections by Policy Board members, on the basis of excluding direct effects of the consumption tax hikes, it is 0.7 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.9 percent for fiscal 2015 (Chart 1). Namely, it is likely to reach around the price stability target of 2 percent toward the latter half of the projection period up to fiscal 2015. II. Outlook for Japan’s economy and overcoming of deflation Let me next talk about points that warrant attention with regard to achieving the aforementioned outlook after confirming the features of economic recovery this time around. Unlike the typical pattern of exports and large manufacturing firms leading economic recovery, this economic recovery features the nonmanufacturing sector recovering ahead of the manufacturing sector, led by private consumption and public investment. In fact, while the Indices of Tertiary Industry Activity, which show the level of activity in the nonmanufacturing sector, have recovered to a level close to that seen prior to the Lehman shock, production in the manufacturing sector has remained at about 80 percent of its peak prior to the Lehman shock. Looking at the diffusion index (DI) for business conditions in the Tankan survey, the DI for the nonmanufacturing sector has been improving ahead of that for the manufacturing sector (Chart 4). Given the pattern of economic recovery this time, in looking to the sustainability of economic recovery, the sustainability of firm domestic demand that has led the economy so far will be a key. Another key will be whether overseas economies recover and exports see a smooth increase while domestic demand underpins the economy. Let me touch on developments in overseas economies, followed by those in households’ employment and income situation and in firms’ business fixed investment in relation to the sustainability of domestic demand. Overseas economies Overseas economies as a whole are picking up moderately, although there are partly lackluster movements. They are expected to continue to pick up, led mainly by advanced economies. In its World Economic Outlook, the International Monetary Fund (IMF) projects that the world economy will grow 2.9 percent in 2013 and moderately accelerate its pace of growth to 3.6 percent in 2014, and to 4.0 percent in 2015 (Chart 5). Looking at respective regions, the U.S. economy is expected to gradually see an acceleration in its pace of recovery, led mainly by domestic demand, as the fiscal drag will gradually fade. The European economy is expected to gradually pick up on the back of recovery in exports in tandem with a pick-up in domestic demand. In addition, the Chinese economy is likely to maintain stable growth, as the government, while progressing with reforms to address structural problems, is expected to pursue policy measures that take due account of economic activity. Meanwhile, there are partly weak movements in other emerging and commodity-exporting economies, and thus those economies will likely lack growth momentum for the time being, from a longer-term perspective; however, growth rates are expected to pick up again. BIS central bankers’ speeches Of course, uncertainties remain high regarding the outlook for overseas economies, such as consequences of the government debt problem in the United States, the debt problem and efforts to restore financial soundness in Europe, outcomes of structural reforms to address problems such as excess production capacity in the manufacturing sector in China, and efforts to address structural problems in other emerging and commodity-exporting economies, all of which warrant attention. However, even bearing in mind such uncertainties, the baseline scenario is that overseas economies will continue to pick up and Japan’s exports will accordingly increase moderately. Developments in employment and income From the perspective of a sustainable recovery in domestic demand, I would like to talk next about developments in employment and income. As mentioned earlier, Japan’s economy is expected to recover moderately in a virtuous cycle among production, income, and spending, and will achieve the 2 percent price stability target. To this end, it is critical to have an improvement in income in order to underpin private consumption. Looking at current employment and income developments, supply and demand conditions in the labor market continue to recover steadily, albeit moderately, due partly to resilient domestic demand, and the unemployment rate has declined to the level observed prior to the Lehman shock, of around 4 percent (Chart 6). This improvement in supply and demand conditions in the labor market has started to influence nominal wages. The year-on-year rate of change in nominal wages per regular employee has become slightly positive, partly reflecting growth in summer bonuses for the first time in three years and an increase in overtime pay. In addition, the year-on-year rate of growth in hourly nominal wages per parttime employee has been modestly accelerating (Chart 7). Going forward, as the improvement in supply and demand conditions in the labor market continues, nominal wages are expected to be put under upward pressure gradually. While scheduled wages per employee have remained negative year-on-year, due partly to an increase in the proportion of part-time workers, if these stable wages start to increase, this will contribute to a sustainable increase in household spending. Amid increasing corporate profits, partly due to ongoing initiatives through cooperation among the government, workers, and employers, we anticipate an increase in scheduled wages, including an increase in base wages. Developments in business fixed investment Turning to the corporate sector, to achieve an economic recovery accompanied by a virtuous cycle among production, income, and spending, it is critical that an increase in corporate profits lead to an increase in business fixed investment. Corporate profits have been recovering, due partly to a correction of the past yen appreciation (Chart 8). Business fixed investment has been resilient in the nonmanufacturing sector, and there also are signs of improvement in the manufacturing sector, which has been lagging (Chart 9). Going forward, business investment is likely to follow a moderate increasing trend, reflecting an improvement in corporate profits as well as effects of monetary easing. In the context of investment profitability, profitability from business fixed investment is likely to improve and monetary easing effects are likely to strengthen, reflecting a rise in the rate of return on capital due to economic recovery together with declining real interest rates under the QQE. In addition, reflecting past restraints on firms’ investment, pent-up demand in business fixed investment is likely to surface (Chart 10). Furthermore, firms’ medium- to long-term growth expectations are likely to rise moderately, due partly to the positive initiatives to strengthen competitiveness and growth potential, such as the government’s regulatory and institutional reforms and various tax reduction measures, as well as firms’ restructuring efforts. Given such an environment, business fixed investment is more likely to increase as the level of economic activity further elevates. BIS central bankers’ speeches Looking back, amid nearly 15 years of deflation, firms have been accumulating cash in order to prepare for the worst by, for example, containing business fixed investment relative to cash flow (Chart 11). As a result, firms’ cash at hand has reached 230 trillion yen, which is almost 50 percent of nominal GDP. Given the deflationary economy, it seems rational for a firm to increase its cash at hand as a relatively better investment; however, as a result of a firm not effectively using precious cash, Japan’s economy as a whole has been deprived of vitality. In an economy that has overcome deflation, it will be better, unlike in the past, to effectively use cash in the form of business fixed investment, research and development, and staffing, rather than to save it. I expect firms to gauge such a change in environment as a business opportunity that will lead them to take positive economic actions. III. Conduct of monetary policy Lastly, I would like to talk about the conduct of monetary policy. In April this year, the Bank committed to achieving the 2 percent price stability target at the earliest possible time, with a time horizon of about two years, and introduced the QQE to underpin the commitment. Specifically, it would increase the monetary base at an annual pace of about 60–70 trillion yen and double the monetary base in two years. In order to do so, it would purchase Japanese government bonds (JGBs) so that the amount outstanding of JGB holdings would increase at an annual pace of about 50 trillion yen (Chart 12). While the chart shows the outstanding amounts of the monetary base and JGB holdings as of end-2013 and end-2014, these are projected amounts under the current policy and do not suggest in any way a time limit of the policy conduct. As I will mention later, the Bank will continue with the QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining the target in a stable manner. The effects of the QQE are expected to carry through the economy via several different routes, and the most important of these is to lower real interest rates. To be specific, first of all, by committing to achievement of the 2 percent price stability target at the earliest possible time and announcing the continuation of a new phase of monetary easing into the future to underpin that commitment, the Bank aims to drastically change people’s expectations and raise inflation expectations. Second, it will put strong downward pressure on nominal long-term interest rates through massive purchases of JGBs. Consequently, real interest rates could be lowered if the extent of a pick-up in nominal rates can be contained within the extent of a rise in inflation expectations. And the decline in real interest rates is expected to have the effect of stimulating business fixed investment and household spending. For the last eight months, our endeavor on this front has been successful. According to surveys on households and economists, inflation expectations seem to have been rising on the whole (Chart 13). By contrast, long-term rates have remained stable at a low level of around 0.6 percent in Japan despite the rise in long-term interest rates in other advanced economies (Chart 14). Therefore, real interest rates have been declining. Under such stimulative effects, Japan’s economy has been recovering moderately and the year-on-year rate of change in the CPI has turned positive. What contributes to a rise in people’s inflation expectations is not just the Bank saying that it will achieve the 2 percent inflation, but also the fact that actual prices have been rising. In such a manner, the QQE has been exerting its intended effects. Concluding remarks As I have explained to you today, Japan’s economy has been following the path toward achieving the 2 percent price stability target as expected. The Bank will continue with the QQE, aiming to achieve that target, as long as it is necessary for maintaining it in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as necessary to achieve the price stability target. I would like to conclude BIS central bankers’ speeches my speech by promising that the Bank will surely manage to overcome deflation, which is the largest challenge facing Japan’s economy, through such conduct of monetary policy. 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 Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hakodate,4 December 2013.
Takehiro Sato: Recent economic and financial developments, and monetary policy Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hakodate,4 December 2013. * I. * * Introduction On April 1, 2013, the Bank of Japan’s Hakodate Branch celebrated its 120th anniversary. I would like to take this opportunity to express my sincere gratitude for your long-term cooperation with the activities of the Hakodate Branch. In today’s speech, I will begin by focusing on economic and financial developments in Japan and abroad, as well as the Bank’s recent monetary policy. I will then touch briefly on the economy of southern Hokkaido. Following my speech, I would like to hear your views on actual conditions in the local economy and on the Bank’s conduct of monetary policy. II. Current situation of and outlook for Japan’s economy and the global economy A. Outlook for the global economy The general outlook for the global economy had temporarily become somewhat cautious due to the instability in global financial markets toward this summer. The global economy, however, is expected to gradually improve as global financial markets as a whole have regained stability, despite still showing nervousness. Specifically, with regard to the direction of U.S. monetary policy, speculation among investors about an earlier-than-expected reduction by the Federal Reserve in the pace of its asset purchases became heightened from around late May 2013. This triggered instability in global financial markets, as evidenced by the simultaneous declines in stock prices, bond prices, and in the value of currencies in some emerging economies. The forecast for global economic growth presented in the World Economic Outlook released by the International Monetary Fund (IMF), which had continued to be revised downward in the recent past, was revised further downward in October, mainly for emerging economies (Chart 1). This revision to the global economic forecast was mainly due to the revisions made to the outlook for emerging economies while that for advanced economies as a whole was left unchanged, and this seems to have certain implications for the outlook for the global economy, mainly in terms of risk factors. More specifically, the U.S. economy is on a recovery path, albeit at a moderate pace, against the background of progress in households’ balance-sheet adjustments and an improvement in the housing market. The European economy is starting to pick up against the backdrop of the amendments in the fiscal austerity policy and the bottoming out of business and household sentiment (Chart 2). The Chinese economy has also been expanding at a stable pace from this summer since the authorities – while taking the stance of pursuing a better quality of economic growth – have been implementing a small-scale economic package to prevent the economy from slowing down further (Chart 3). Emerging economies’ financial markets continue to show nervousness on the whole, but recently have regained stability because the Federal Reserve’s reduction in the pace of its asset purchases was postponed (Chart 4). Improvement in the U.S. and European economies, as well as positive developments that are within the scope of stable growth in the Chinese economy, both of which have gradually been exerting positive effects on economies such as those of South Korea and Taiwan, have contributed to somewhat brightening the outlook for the global economy in the short term. BIS central bankers’ speeches Under such circumstances, regarding risk factors in the short term, I am focusing especially on (1) the outcome of the postponed fiscal problem in the United States and (2) the possible destabilization in global financial markets that may occur at around the time when the Federal Reserve reduces the pace of its asset purchases. Regarding the first factor, the political situation in the United States continues to require vigilance. As for the second factor, I am concerned that, although global market participants have factored in the postponement of the Federal Reserve’s reduction in the pace of its asset purchases, the timing of such reduction is uncertain and they continue to speculate on when the Federal Reserve will actually make this move. In the medium term, I am concerned about the recent disinflationary trends and possible declines in potential growth rates both in the United States and Europe. A disinflationary trend has recently become evident, especially in the euro area (Chart 5). As background to this, the fall-off of the effects of (1) the previous year’s energy price hike and (2) the increase in the value-added tax rate is often pointed out. Moreover, there are other factors, such as (1) a decline in wages seen in some peripheral countries; (2) financial institutions’ balancesheet adjustments; (3) the malfunctioning of financial intermediation due to the decline in asset prices; and (4) the sluggish economic activity, which in part reflects the effects of the aforementioned factors. All four of these factors are common to what Japan had experienced during the post-1990s period of deflation. Although these disinflationary trends have exerted some effects on short-term inflation expectations so far, medium- to long-term inflation expectations remain intact. Such expectations in the United States and the euro area seem to be stable at around 2 percent (Chart 6). In light of Japan’s experiences, however, a persistently low inflation rate entails a risk that people’s expectations might change, leading to a decline in medium- to long-term inflation expectations in line with the actual inflation rate. Concerns over deflation in the United States are not yet as high as those in the euro area, but I consider it necessary to keep in mind the risk that not only short-term inflation expectations but also medium- to longterm expectations for the United States might decline given that the actual inflation rate has recently been below the level in the Federal Reserve’s outlook, partly due to the declining trend in energy prices brought about by the so-called shale gas revolution. Regarding the potential growth rates that I have raised as another concern for the medium term, it has been pointed out from various quarters that there is a possibility of potential growth rates in advanced economies being somewhat lower than those before the 1990s, in reflection of the slowdown in the pace of increase in labor input and in technological innovation.1 The recent growth rates in emerging economies are lower than those prior to the Lehman shock, and there is much argument on whether the low growth rates are caused by cyclical or structural factors. If the decline in the potential growth rates has not been particularly significant, the current disinflationary trends seen in the United States and the euro area are due to the slack persisting in production capacity and in the labor market. And thus it can be said that the disinflationary pressure will start to weaken as this slack dissolves. But another interpretation is that the recent decline in the potential growth rates caused not only a decline in the natural rate of interest, but also a decline in the inflation rate that is consistent with developments in the natural rate of interest. As I have stated, depending on how the potential growth rates are understood, the inflation outlook – and consequently the implications for macroeconomic policy – can change. In this sense, the change in the Federal Reserve’s communication regarding the aforementioned reduction in the pace of its asset purchases is noteworthy. Let me explain this in detail. Although the Federal Reserve uses the unemployment rate and inflation rate as major For a recent example, see Dave Reifschneider, William Wascher, and David Wilcox, “Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy,” Finance and Economics Discussion Series 2013–77, Federal Reserve Board, November 2013. BIS central bankers’ speeches benchmarks to determine the reduction in the pace of its asset purchases, it had seemed to me that, considering the series of messages from the Federal Reserve, it did not initially place much emphasis on the fact that the actual inflation rate remained below the longer-run goal it had set. However, it caught my attention that the Federal Reserve pointed not only to the general economic situation and fiscal problem as the reasons for postponing the reduction in the pace of its asset purchases in September 2013, but also to the inflation rate undershooting its longer-run goal. Also, I find it interesting that the Governing Council of the European Central Bank (ECB) surprisingly decided to reduce its policy rates in November on the grounds that the inflation rate had declined by more than it expected, and that it revised the price outlook downward. Central banks in major economies are seeking the optimal policy mix in a low-inflation environment, but it looks as though they are on a path similar to the one that the Bank has followed for years to this point. B. Outlook for Japan’s economy Japan’s economy has been recovering moderately. While it will be affected by the two scheduled consumption tax hikes, the economy is likely to continue growing at a pace above its potential, as a trend, on the assumption that the global economy will follow a moderate growth path (Chart 7). I would like to explain this assessment of the current situation of and outlook for Japan’s economy in line with the baseline scenario presented in the Outlook for Economic Activity and Prices (hereafter the Outlook Report) released on October 31, 2013. Japan’s economy registered high growth of around 4 percent on an annualized basis in the first half of 2013. This growth was led by strong domestic demand; for example, (1) public investment continued to increase as positive effects of various economic measures came to take hold fully and (2) private consumption remained resilient, reflecting an improvement in consumer sentiment supported by the depreciation of the yen and a rise in stock prices. According to the first preliminary estimate for the July-September quarter of 2013, the real GDP growth rate decelerated after recording high annualized growth rates of around 4 percent for two consecutive quarters, mainly due to a decrease in exports, with private consumption being more or less flat on the whole. Since the turn of 2013, exports have been picking up at a somewhat slower pace, reflecting signs of weakness observed in some emerging economies, and there has been a contrast between the performance in domestic and external demand. In this regard, the current economic recovery is quite unique compared to the recovery phases after World War II, which typically were led by increases in exports and production. However, in the short term, exports are expected to increase moderately thanks to a pick-up in overseas economies, and domestic demand is likely to retain its resilience due to the front-loaded increase in demand prior to the consumption tax hike. In this situation, real GDP growth rates are expected to rise again from the October-December quarter of 2013 through the January-March quarter of 2014, and the real GDP growth rate for fiscal 2013 is expected to reach close to 3 percent. The growth rate for fiscal 2014 is likely to dip temporarily in the April-June quarter due to a decline in demand subsequent to the front-loaded increase in the previous quarters. However, I do not expect an economic downturn such as what we experienced at the time of the previous consumption tax hike in 1997. This is because the current economic situation differs in some aspects from that of the previous tax hike. Specifically, (1) the government is preparing an economic package with a total size of about 5 trillion yen; (2) emerging economies, some of which suffered from simultaneous declines in stock prices, bond prices, and in the value of their currencies this year, are becoming resilient to negative shocks compared to 1997, when the Asian currency crisis occurred, due to the establishment of backstops such as the accumulation of foreign reserves; and (3) Japan’s financial system has been stable as a whole. Given these factors, domestic demand is likely to maintain firmness as external demand is expected to increase. After the second half of fiscal 2014, Japan’s economy is likely to continue growing at a pace above its potential as a virtuous BIS central bankers’ speeches cycle among production, income, and spending will be maintained. The median of the Policy Board members’ forecasts for fiscal 2014 remains more or less unchanged from that in the July 2013 interim assessment. This is because foreign and domestic factors are expected to offset each other; while a decline in the forecast for global economic growth, mainly for emerging economies, as shown in the IMF’s World Economic Outlook released in October 2013, will exert negative effects on Japan’s external demand, the government’s economic package will produce positive effects on the economy. Another consumption tax hike is expected in October 2015, but the background to the economic outlook for fiscal 2015 remains basically the same as that for fiscal 2014, and the median of the Policy Board members’ forecasts for fiscal 2015 is unchanged from that in the July 2013 interim assessment. It should be noted, however, that this economic outlook is based on the assumption that global financial markets will remain stable on the whole. Specifically, (1) the reduction in the pace of asset purchases by the Federal Reserve, which was postponed once, will be smoothly executed and will not cause turmoil in global financial markets; (2) international commodity markets will remain stable despite retained geopolitical risks in the Middle East; (3) the European sovereign debt problem will not cause turbulence in the financial markets; and (4) the U.S. economy will not experience turmoil stemming, for example, from a longterm government shutdown or default on government debt. If any of these assumptions collapses, this would affect Japan’s economy to a considerable degree through turmoil in global financial markets. In addition, I personally would like to keep paying close attention to the possibility of declining potential growth rates in major economies, including the U.S. economy, and the associated disinflationary trends in the U.S. and European economies. C. Outlook for prices in Japan As revealed in the minutes of the Monetary Policy Meeting held on October 31, 2013, I cast a dissenting vote regarding the descriptions of the outlook for prices in the Outlook Report, so I may not be in the right position to explain the baseline scenario of the outlook for prices in Japan. Thus, in the following section, I would like to express my views on prices by pointing out the main differences between my views and the baseline scenario. Looking back at price developments up to the present, the year-on-year rate of change in the consumer price index (all items less fresh food; hereafter prices) has been moving in line with the baseline scenario against the backdrop of the depreciation of the yen, the hike in energy prices, and bottoming out in prices of digital appliances. Prices have already risen to close to 1 percent. However, the effects of these factors are likely to wane after having hit the peak in the July-September quarter of 2013, if we assume that foreign exchange rates and energy prices will be unchanged from the current level. Thus, even if the effects on prices of improvement in the output gap due to the high economic growth in the first half of 2013 appear in fiscal 2014, it seems unrealistic to expect prices to continue rising significantly above the 1 percent level achieved in fiscal 2013 given the recent flattened Phillips curve (Chart 8). This is why my outlook for prices for fiscal 2014 and 2015 is weaker than the median of the Policy Board members’ forecasts. Of course, my cautious outlook for prices also contains upside risks. After the bursting of the bubble economy, Japan rarely experienced an “inflationary period” in which prices exceeded the 1 percent level on a year-on-year basis, except for a period of time in 2008. The cases of prices exceeding 1 percent were only temporary because these were examples of cost-push inflation caused by the depreciation of the yen and high energy prices. Accordingly, inflation expectations did not shift upward at that time. If inflation of around 1 percent lasts for a certain period, the expectation formation of households, firms, and markets might change, leading to a significant upward shift in inflation expectations. This is because such expectations tend to be adjusted by the actual inflation rate. BIS central bankers’ speeches This holds true in the case of relatively short-term inflation expectations, however, and it is highly uncertain whether a short-term rise in the actual inflation rate could affect medium- to long-term inflation expectations (Chart 9). On top of that, given that short-term inflation expectations might have become stickier due to the deflation that has lasted for nearly 15 years, there is greater uncertainty over long-term inflation expectations. The results of various surveys conducted on households, firms, economists, and bond market participants reveal a rise in their inflation expectations as a whole. However, in most of these surveys, it is hard to discern accurately the degree to which this is caused by the increasing probability of the consumption tax hikes. As for breakeven inflation (BEI) rates – that is, the expected inflation rates calculated from the yield differentials between fixed-rate and inflation-indexed bonds – my personal view is that these rates are not necessarily appropriate for representing the inflation expectations of Japan’s economy or financial markets as a whole. This is because BEI rates are also susceptible to the aforementioned consumption tax hike problem. In addition, (1) they are possibly affected by changes in the liquidity risk premium on inflation-indexed bonds to a non-negligible degree due to the limited market liquidity of those bonds, and (2) BEI rates are also affected by the inflation expectations of some foreign investors who expect a rise in inflation (Chart 10). The BEI rates of 10-year inflation-indexed bonds with a guarantee at maturity (deflation floor) issued from October 2013 have been around 100 basis points. It is worth noting that the BEI rates calculated by these bonds will remain at such a low level for the next ten years even with the two consumption tax hikes in 2014 and 2015 totaling 5 percentage points. Regarding upside risks to the price outlook, I am paying close attention to wage developments as well. Labor unions tend to put emphasis on maintaining their employee headcount rather than increasing wages. Given this, it is a striking change to see both the progress of three-way discussions among the government, employers, and labor unions and the evidence that some business leaders who are influential in industry have recently taken a positive stance toward raising base salaries, reflecting the government’s persuasive efforts. It is an important first step for the discussions to work as a catalyst to change the negative expectations that “wages will not increase” into positive ones. However, in order to change people’s expectations, it is important that an increase in base salaries should not merely be a one-time event but continue for several years, and/or that people form expectations for such a continuation. Taking into consideration the structural downward pressure on scheduled cash earnings that stems from the recent increase in the number of part-time employees who work for short hours and the rising trend in the ratio of part-time employees to total employment, it is doubtful whether a rise in base salaries, mainly of full-time employees at some large firms, will constitute a significant wage rate hike from a macroeconomic viewpoint (Chart 11). Some statistics show that the share of large firms’ personnel expenses to total personnel expenses accounted for only about 25 percent in Japan as of fiscal 2012 (Chart 12). It is also worth mentioning the image of the labor market if wages were to increase considerably in Japan, even if such increases are made mostly by large firms. The wage Phillips curves for Japan and the United States – with the unemployment rate on the x-axis and the wage inflation rate on the y-axis – imply the possible changes that could occur in the labor market when wages increase considerably in Japan (Chart 13). Generally speaking, in the United States, if employment adjustments are needed, firms cut their employee headcount instead of wages in order to close unprofitable businesses in an expedient manner. As a result, nominal wages continue to grow at a rate of about 2–4 percent irrespective of the phase of the economic cycle, and the U.S. economy has a structure that makes it hard to fall into deflation, since excess labor supply is unlikely to be maintained. In Japan, on the contrary, employment adjustments through dismissals have been limited so far, and adjustments in personnel expenses have been executed mostly through wage reductions. This means that the Japanese labor market has a structure BIS central bankers’ speeches whereby the consolidation and reorganization of inefficient businesses tend to take longer and the share of labor in income distribution tends to remain at a high level; this slows the economy’s metabolism and allows excess labor supply to be retained. Thus, in Japan, sharing the cost of employment adjustments thinly and broadly in the labor market seems to be a factor of mild deflation. In order to realize sustainable increases in base salaries in Japan regardless of the economic situation, business leaders should be aware that they will have to face an increase in fixed costs, particularly during a recession. This might increase their incentives to cut employees, although not as drastically as in the United States, to realize increases in base salaries and avoid a rise in fixed costs at the same time. As a consequence, these moves might lead to an increase in volatility in the unemployment rate. In this case, the wage Phillips curve for Japan may flatten as in the United States; that is, increases in fixed costs might be adjusted using the employee headcount rather than wages. Taking into account these points, sustainable increases in nominal wages may raise the inflation expectations of households, firms, and market participants, turn people’s deflationary mindset toward positive inflation expectations, and lead to overcoming deflation becoming more likely. At the same time, however, it should be noted that the social cost of employment adjustments might increase due to heightened volatility in the unemployment rate. There is no free lunch, because an increase in wages boils down to the problem of how to distribute national income between compensation of employees and operating surplus. Economic growth is therefore indispensable to raising wages in a society as a whole (Chart 14). III. Recent conduct of monetary policy A. Pursuing quantitative and qualitative monetary easing It has been eight months since the Bank introduced quantitative and qualitative monetary easing (QQE) on April 4, 2013. Since then, Japan’s economic activity and prices have basically followed the expected path, in line with the baseline scenario in the Outlook Report. It should be noted that, although price developments have started to become upbeat, the inflation rate has only risen to close to 1 percent. Given the downside risks that I mentioned earlier, we are only halfway to realizing the price stability target. The Bank will continue with QQE steadily, with the aim of achieving the price stability target of 2 percent (Chart 15). With regard to the relationship between the economic outlook and monetary policy, the median of the Policy Board members’ forecasts for economic activity provided in the October 2013 Outlook Report factors in the effect of the two scheduled consumption tax hikes. Japan’s economy is likely to continue to see high growth at a pace above its potential through fiscal 2014 and 2015, even taking into account temporary declines due to the consumption tax hikes. As long as the effect of the consumption tax hikes on the real side of the economy is projected to be just a temporary swing in demand and within the scope of the Bank’s expectations, the Bank will not have to launch any additional preemptive measures. Let me turn to the relationship between the price outlook and monetary policy. There is a large gap between the baseline scenario in the Outlook Report and market consensus, and many market participants seem to be expecting that a future downward revision to the baseline scenario will trigger further strengthening of the monetary easing. It might not be appropriate for a policymaker to make comments on every single view held by market participants, but let me say just a few words to avoid any misunderstanding. The Bank does not assume a particular linear path toward reaching the 2 percent inflation rate. For example, the 1.3 percent inflation rate, which is the median of the Policy Board members’ forecasts for fiscal 2014 presented in the Outlook Report, is not an intermediate target toward achieving the 2 percent target. It should also be noted that, with implementation of QQE, the Bank intends to shift people's expectations via a marked change in its monetary policy through an BIS central bankers’ speeches initial bold move, after which it would adopt a wait-and-see stance to carefully monitor the permeation of policy effects. This means that the Bank is breaking away from the incremental approach adopted under the comprehensive monetary easing. That being said, I understand that this is the time to carefully monitor the emergence of policy effects, taking account of the future economic and price conditions. It should also be noted that, on April 4, the Bank took all possible policy measures that would be available for the time being. Therefore, additional easing measures, if any, could be counterproductive in terms of shifting people’s expectations. It is true that the Bank has reiterated in its statement released after Monetary Policy Meetings that it “will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate.” My understanding is that the downside risks described here refer to tail risks, including significant turbulence in global financial markets that would be comparable to the Lehman shock and the European sovereign debt crisis, and do not concern such trivial matters as a small divergence of the outlook for economic activity and prices from the baseline scenario. B. Price stability target and conduct of monetary policy Although I cast a dissenting vote on the introduction of the price stability target at the January 2013 Monetary Policy Meeting, I have approved of the policy commitment regarding the target since April, with the exception of the description of the price outlook in the Outlook Report. This is because I understand that the price stability target should be regarded as a flexible framework, and that it is not necessary to consider 2 percent as a rigid target. Let me elaborate on this point. As noted in the policy statement, “the Bank will continue with quantitative and qualitative monetary easing, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner.” In terms of “aiming to achieve the price stability target” and “maintaining that target in a stable manner,” it is almost impossible to stably maintain the inflation rate specifically at 2 percent, given the time lag required for the permeation of monetary policy effects and uncertainty regarding such permeation. Rather, the 2 percent price stability target should be regarded as a flexible concept in which there is an allowance for a certain range for upward and downward deviations of the actual inflation rate from the target, similar to other central banks' frameworks of inflation targeting. In this regard, the Bank does not intend just to achieve the 2 percent price stability target at all costs, but instead aims to bring about a situation where the national economy achieves sound development and prices rise moderately in a balanced manner as improvement in the employment situation brings wage hikes. I understand that the 2 percent price stability target should be regarded as representing such a desirable situation. C. Challenges related to forward guidance As any policy is accompanied by both pros and cons, a policy is carried out based on the judgment that the former will surpass the latter. Similarly, as shown in the minutes of the Monetary Policy Meeting on April 3 and 4, 2013, QQE was decided after carefully weighing the associated pros and cons. This weighing reflects the subjective value judgments, and therefore some who put emphasis on the adverse effects of QQE criticize it as reckless because it was decided without discussions on an exit strategy. Others point out that the Bank should explain more clearly the path to an exit – that is, provide clearer forward guidance. Although these criticisms and comments are somewhat understandable, one of the purposes of QQE is to shift people’s expectations, which had been diminished by the chronic deflation. Discussions on an exit strategy at this point could lead to a contradiction of this policy intention. In other words, discussing an exit strategy when launching a new policy could create the same situation as making fire with one hand while at the same time extinguishing it with the other. It should also be noted that, as evidenced by the Federal Reserve’s decision BIS central bankers’ speeches in September 2013 to postpone the reduction in the pace of its asset purchases, efforts to enhance policy transparency and secure policy flexibility may create a tradeoff. That is, improving transparency does not necessarily yield desirable results. Rather, too much information from a central bank might be difficult for market participants to digest, and could eliminate the central bank’s flexibility in responding to a change in economic and price conditions. Based on this idea, I am of the position that the Bank should show its guidance in a flexible and appropriate manner in response to changes in the outlook for economic and price conditions. I should note that the Bank’s current attempt – namely, aiming to achieve the 2 percent price stability target within about two years to overcome deflation – is unprecedented. This attempt to push up the inflation rate within a fixed timeframe is completely different from the conventional philosophy of forward guidance, which expects to influence longer-term interest rates by committing to continuing monetary easing as long as necessary and thereby bringing forward future demand. Thus, it is not appropriate to categorize the Bank’s current monetary policy as “traditional” forward guidance, as currently implemented by other central banks such as the Federal Reserve and the ECB (Chart 16). In addition, forward guidance entails the dynamic inconsistency problem (or time inconsistency problem) – that is, even if a central bank commits to continuing the policy as long as necessary, this commitment might be broken at some point. The notable example is that global financial markets became unstable after Chairman Bernanke of the Federal Reserve indicated a specific schedule for reducing the pace of its asset purchases in late May 2013. In this regard, other major central banks that adopt unconventional monetary policies are facing new challenges as to how to ensure the effectiveness of their forward guidance. That is to say, these central banks will keep trying to determine what kind of commitment is needed to make the public and market participants believe that such commitment will be fulfilled. D. Toward accumulating the monetary base The Bank has disclosed its monetary base target and balance sheet projections up until the end of 2014 as part of its efforts to achieve the price stability target with a time horizon of about two years. According to the projections, the expected amounts outstanding of the monetary base and Japanese government bonds (JGBs) at the end of 2014 are around 270 trillion yen and around 190 trillion yen, respectively. The amounts outstanding of both the monetary base and JGBs have been accumulated almost in line with the Bank’s projections, and they are within range of reaching the amounts projected for the end of 2013, to 200 trillion yen and 140 trillion yen, respectively (Chart 17). However, whether or not the Bank will be able to accumulate the target amount of the monetary base as expected depends on the stance of financial institutions with regard to making bids for the Bank’s market operations. This stance could change, reflecting not only economic factors, such as economic and financial developments as well as current and future levels of interest rates, but also non-economic factors; for example, the extent to which financial institutions are allowed to increase their current account deposits at the Bank from the viewpoint of their investor relations policies. Therefore, there is substantial uncertainty over the future accumulation of the monetary base in a situation where financial institutions already hold huge amounts of excess reserves at the Bank. Moreover, this uncertainty will heighten as the level of excess reserves increases. In other words, QQE is not a kind of monetary policy that can be continued forever. Despite these difficulties, the Bank will address any challenges and accumulate the amount outstanding of the monetary base to accomplish the commitment it announced on April 4, 2013. I appreciate your kind understanding regarding the Bank’s efforts. BIS central bankers’ speeches IV. Concluding remarks Lastly, I would like to touch on economic activities in southern Hokkaido. This region is rich in tourism resources including Hakodate, a popular tourist destination in Japan, as well as Lake Onuma at the base of Hokkaido-Komagatake, which is one of the so-called new three views of Japan. There is also a fishing ground – one of the major grounds in Japan – that is surrounded by four bodies of water: the Sea of Japan, Tsugaru Strait, the Pacific Ocean, and Funka Bay. Southern Hokkaido is also blessed with mild weather compared with other regions in Hokkaido, owing to the warm ocean currents. Taking advantage of these rich resources, this region has a competitive edge in tourism, fishery, and agricultural industries. The manufacturing sector, which includes (1) seafood processing that utilizes marine resources; (2) ceramics, stone, and clay products taken from limestone quarries; and (3) a shipbuilding industry with the largest dock in Hokkaido, also underpins the economy by making the most of the regional characteristics. At the same time, I hear that the economy of southern Hokkaido faces the challenges of an aging population and a population drain from the region, and thus developing a growth strategy that takes advantage of regional strengths and implementing such strategy promptly have been urgent matters. Efforts in this regard are already underway, such as attracting foreign visitors from other Asian countries, hosting various conventions and events that make the most of regional characteristics, activating the urban district of Hakodate, and developing a support system for exporting high-quality agricultural and marine products. In the meantime, the start of operations for the Hokkaido Shinkansen line in fiscal 2015 is expected to have a large impact on the region’s economy. To take advantage of this opportunity, the private and public sectors have already started making joint efforts to promote the tourism industry with a view to fostering future cooperation with Aomori Prefecture. In the medium- to long-term perspective, there have already been discussions about creating new industries and employment, such as (1) research regarding the marine energy business that utilizes the tidal currents of Tsugaru Strait and (2) the Hakodate Marine Bio Cluster program – a joint project by industries, government, and academia to enhance the value of marine resources in the region through technological innovations. To support these efforts, it is encouraging that financial institutions in this area are actively engaged not only in financing but also in providing solutions, such as business matching services. I hope each effort based on your ingenuity and hard work bears fruit, and that southern Hokkaido will achieve prolonged economic growth. 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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Graduate School of Public Policy, the University of Tokyo, Tokyo, 7 December 2013.
Haruhiko Kuroda: Public policy study and monetary policy management Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Graduate School of Public Policy, the University of Tokyo, Tokyo, 7 December 2013. * * * Introduction It is a great honor to have this opportunity to speak at the Public Policy Seminar of the Graduate School of Public Policy, the University of Tokyo, and at the Global Public Policy Network Conference 2013. I graduated from the University of Tokyo Faculty of Law in 1967 and joined the Ministry of Finance the same year. In the more than 40 years since then, I have been engaged as a practitioner in a wide range of works that relate to public policies, such as fiscal policy, tax policy, foreign exchange policy, development policy, and now monetary policy. During that time, I also had an opportunity to study economics at graduate school in England. What I learned through such experiences was that, to be involved in public policies, it is critical to link academic knowledge of jurisprudence and economics with practical knowledge obtained through the accumulation of experiences as a practitioner in a coordinated fashion. From such a perspective, progress in public policy study seems to be a historical inevitability, and I am quite encouraged by the fact that a global network such as the Global Public Policy Network has been established. Today, I would first like to provide my summary of the progress in public policy study and changes in monetary policy management. On that basis, I will then explain quantitative and qualitative monetary easing (QQE), which the Bank of Japan introduced this spring, as a specific example. I will conclude by expressing my views about the future of public policy study. I. Progress in public policy study Let me start with the progress in public policy study. First, I will cite two numbers: 30 in 2001 and 2,200 in 2012. These are the numbers of economic papers that get a hit when doing an internet search with the keywords “quantitative easing (QE).” In 2001, the Bank introduced the world’s first-ever QE. In academia, those within the field of economics did not have a particularly high interest in the QE at the time. It gradually attracted attention, however, and once the Federal Reserve (Fed) and the Bank of England (BOE) introduced their QE policies following the Lehman crisis, studies on QE increased dramatically. Progress in theories of economic policy, including monetary policy, has been made using policies that were actually implemented as important reference material. And actual policies were in turn designed while learning from those theories. In my view, such interaction between actual policies and theories is basic to economics, public policy studies, and social science in general. To begin with, the academic knowledge required when managing economic policy is knowledge of economics itself. Economics has been making remarkable progress year after year, both on the theoretical and empirical sides. In the management of economic policy including monetary policy, knowledge of economics has become essential. It is said that the Great Depression in the 1930s gave birth to a new macroeconomics, and economics has been evolving while overcoming failures in actual economic policies. More recently, from the mid-1980s through the mid-2000s, the global economy enjoyed high growth with low inflation, and that period was called the Great Moderation. With progress in economics, and macroeconomic policies based on such progress, fluctuations in the economy and prices were controlled, and even a view that recession had become a thing of the past was rumored. However, things drastically changed with the occurrence of the Lehman crisis in 2008. The Lehman crisis and the subprime loan problem, which was one BIS central bankers’ speeches cause of the crisis, taught us that greater consideration needs to be paid to the possibility that the financial sector could destabilize the real economy. In addition, the fact that economic growth in many countries has been extremely sluggish even 5 years after the crisis suggests that existing macroeconomic policies might not necessarily have been effective. More fundamentally, it suggests that our understanding of business cycles in economics has not been enough. Namely, we cannot sufficiently answer the following questions: what kind of impact does a plunge in economic activity or impairment in balance sheets have on the growth potential of the economy, and how should macroeconomic policies respond to such shocks? Meanwhile, the aggressive fiscal and monetary policies that were adopted by countries after the Lehman crisis, which were well outside the usual policy options in historical terms, seem to have revealed that there is considerable fruit to be harvested with regard to economic policy and economics. For example, during this financial crisis, unlike the Great Depression in the 1930s, a plunge in the real economy has been avoided. That was because once the crisis was recognized, large-scale fiscal stimulus measures were introduced and central banks lowered policy rates boldly and promptly, and after lowering the policy rates to almost 0 percent, they invoked unconventional monetary policies without hesitation. These can be viewed as significant fruits, in that central banks turned a knowledge of economics that also took account of the experience of Japan after the bursting of a bubble into actual policies to overcome their challenges. In such a manner, economic theory and actual economic policy are closely or even inseparably related, in that they are used to tackle challenges together, and are progressing given that new challenges will emerge one after another. Triggered by this global financial crisis, it is expected that economics will continue to evolve. At the same time, for a practitioner who is involved in public policy, there seems to be an implication that policy should be pursued by utilizing knowledge of economics while understanding its limits. In actual economic policy management, it is not rare to choose a policy that can be regarded as second best or third best. Even a policy that can be considered optimal or first best – namely, the most efficient one from the standpoint of economic theory – might not be suitable. That is, not suitable in terms of such social values as fairness and conventional wisdom, or it might be difficult to reach an agreement within the democratic political process. In addition, there were many cases in which a policy was considered desirable in theory but could not be adopted because of practical difficulty. Some policy needs to go through procedures such as budgeting and legislating when it is to put into practice. Let me take an injection of public funds to deal with a nonperforming asset problem as an example. At the time of the Lehman crisis in 2008, the importance of injecting public funds as soon as possible to dispose of nonperforming assets was widely understood. By contrast, in Japan in the 1990s, it was quite difficult to gain support for such an assertion within the democratic process. In Japan, it was in 1999 when a full-fledged injection of public funds was made to major banks: several years have already passed since the problem in the financial system surfaced. Thus, it is difficult to use taxpayers’ money before actual pains materialize, and this phenomenon can happen in any country, albeit with differing degrees. Taking these points into account, in order to actually pursue policy, it is necessary not only to study economics but also political economy and public policy theory. Specifically, it becomes necessary to have staffers who understand the aforementioned difficulties in actual pursuit of public policy, and who on that basis plan policies and put them into practice. I believe that a variety of staffers with different backgrounds, who not only studied economics or jurisprudence but also public policy theory, will be required as those in charge of economic policy, including monetary policy. I thus expect that public policy study itself will be further developed. BIS central bankers’ speeches II. Changes in monetary policy management Based on the summary I have just presented, let us look back at changes in monetary policy among public policies. In the United States, Europe, and also Japan, a central bank’s primary mission had long been to secure the smooth functioning of the financial system, rather than ensure price stability or economic stability. For example, the United Kingdom experienced repeated financial crises in the latter half of the 19th century. Its central bank – the BOE – was expected to play the role of preventing disturbance in the financial system as a whole by providing liquidity as a “lender of last resort” to financial institutions on the verge of a crisis. In the United States, the Federal Reserve System was established with the aim of resolving financial system instability, based on the lesson learned from successive financial crises from the end of the 19th century into the early 20th century. This well represents the thinking at the time of the role central banks should play on the financial system front. The Bank of Japan was established in 1882. In addition to the purpose of sorting out the massively issued government banknotes, there was an aim to establish a modern financial system centering around a central bank. In such a manner, the central banks’ objective at the time was to prevent the occurrence of a financial panic and to contribute to economic development by ensuring stability of the financial system. This situation gradually changed after the start of the 20th century. In particular, the international gold standard collapsed in the 1930s and each country shifted to a fiat money system. As a result, the supply of central bank money was released from the constraints of their gold holdings, and the extent of latitude in monetary policy increased substantially. Partly because of this, the idea of actively aiming to achieve economic stability – notably price stability – through monetary policy spread among major countries. While many central banks shouldered the role of supporting government bond prices amid expansion in fiscal spending during World War II, monetary policy after the war was separated from debt management policy, and thus recovered its autonomy. Since the mid-1980s – after weathering global surges in commodity prices and general prices due to two oil shocks – prices stabilized and business cycles became smooth in the United States and other major countries. For example, in the advanced countries, from the 1980s until just before the Lehman crisis, the fluctuations in economic growth rates were moderate, and the average inflation rate declined from 6.5 percent to 2.1 percent (Chart 1). Amid a situation of the global economy showing an unprecedented favorable performance, an idea gradually took hold that central banks should focus on playing the role of converging the inflation rate to a certain level. In addition, institutional frameworks concerning central banks on the back of such changes were gradually established. Namely, there were cases that occurred one after another in which, mainly through revisions of central bank laws, not only independence was given to a central bank but also it was clarified that a central bank should specialize in ensuring price stability. In monetary policy management, this trend led to major central banks’ adoption of price stability targets – namely, inflation targeting. Amid this global trend, the current Bank of Japan Act was enacted in 1997. At the same time, however, a somewhat different situation from other countries emerged in Japan. Since the 1990s, the financial system destabilized due to the nonperforming loan problem stemming from the bursting of the bubble, and Japan’s economy was to suffer from protracted low growth and deflation. The Bank implemented ahead of other countries unprecedented unconventional monetary policies, such as the zero interest rate policy and the QE policy. The government often carried out large-scale fiscal spending. As a result, an economic depression such as that of the 1930s was avoided, and there were periods of economic recovery. However, Japan was not able to overcome deflation for nearly 15 years. Various factors could be considered reasons for the protracted deflation – a continuation of low economic growth, destabilization of the financial system, a rise of emerging economies, and structural changes in the labor market. However, whatever the reason might be, it has been BIS central bankers’ speeches my view that the Bank, which is the central bank of Japan, is responsible for overcoming deflation and achieving price stability. In other words, I have thought that, because its commitment to ensuring price stability was weak, the Bank was unable to sufficiently influence economic entities’ expectations, which is an important transmission channel of monetary policy. Such thoughts led to the introduction of the QQE. III. Ideas of the QQE Let me next explain the QQE that the Bank has currently been pursuing. In April this year, the Bank introduced the QQE in order to achieve a 2 percent price stability target at the earliest possible time, with a time horizon of about two years (Chart 2). A problem that Japan’s economy currently faces is that, amid protracted deflation, people’s inflation expectations have declined and a sense that prices will not rise – namely, a deflationary mindset – has been embedded. Against such a backdrop, raising inflation expectations has become a policy agenda. Looking back at the history of central banking, raising excessively low inflation expectations through policy is a big challenge. Furthermore, in the case of Japan, short-term interest rates have already declined to close to 0 percent and long-term interest rates have also declined to a level below 1 percent. How should we raise inflation expectations through policy in a situation in which there is little room to further lower nominal interest rates? This is the challenge we are faced with, and the QQE is the prescription. Specifically, the QQE comprises two elements. First, demonstrate the Bank’s determination to definitively overcome deflation in the form of strong and clear commitment, in order to dispel deflationary expectations that have been embedded among firms and households. To this end, the Bank clearly expressed that it would achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years, and clearly specified a timeframe to achieve the target. Second, taking into account that deflation has been continuing for a protracted period, only exhibiting a strong commitment will not be enough to make people believe in the Bank’s strong will in the absence of a policy to underpin such commitment. In particular, from the standpoint of “at the earliest possible time,” it was necessary to embark on a new phase of bold monetary easing that people could clearly understand was not an extension of the past policies. Therefore, the Bank decided to double the monetary base – money the Bank directly provides – in two years. In order to achieve this, it also decided to conduct massive purchases of Japanese government bonds (JGBs) inclusive of those with longer-term remaining maturities. So far, the Bank has indeed been increasing the monetary base and purchasing JGBs as decided (Chart 3). The QQE aims to put downward pressure on the yield curve as a whole through massive purchases of JGBs, encourage investment in risk assets through portfolio rebalancing, and influence expectations of economic entities. In particular, as a major transmission channel, the Bank aims to lower real interest rates and stimulate economic activity through changing economic entities’ expectations and raising their inflation expectations on the one hand, and containing long-term interest rates through massive purchases of JGBs on the other. In addition, through a virtuous cycle, an increase in observed inflation rates resulting from such stimulation to economic activity is expected to lead to a further rise in inflation expectations. It has been eight months since the introduction of the QQE, and it has steadily produced the anticipated effects so far: favorable turns have been observed in the financial market, economic activity and prices, as well as in the public’s expectations. First, looking at financial markets, stock prices have risen by about 50 percent since the beginning of the year (Chart 4). While long-term interest rates in major advanced economies have risen across the board, those in Japan have been powerfully contained due to the massive JGB purchases by the Bank. Interest rates on 10-year JGBs have recently declined to around 0.6 percent from around 0.8 percent at the beginning of the year. In this situation, inflation expectations BIS central bankers’ speeches appear to be rising on the whole, as seen in various surveys showing that an increased proportion of people consider that prices will rise. As a result, real interest rates have declined, and this has steadily stimulated private demand. Against this background, Japan’s economy has been recovering moderately as a virtuous cycle among income and spending has been operating in both the household and corporate sectors. In terms of real GDP growth rates, the economy continued growing at an annual pace of about 4 percent in the first half of 2013, and has continued to grow at an annual pace of around 2 percent during July-September (Chart 5). As for prices, the year-on-year rate of change in the CPI excluding fresh food turned positive in June, and the pace of increase expanded to 0.9 percent in October (Chart 6). A look at the detailed developments in the CPI shows that not only energy-related goods such as petroleum products have pushed up the index, but also that there have been price increases across a wide range of items as private consumption remains firm and the economy continues to recover moderately. With regard to the outlook, as shown in its latest Outlook Report published a month ago, the Bank expects the economy to continue growing at a pace of around 2 percent, above its potential growth rate, as a trend (Chart 7). This projection was made on the assumption that the consumption tax will be raised 3 percent in April 2014 and 2 percent in October 2015, as scheduled. Against this background, inflation in terms of the CPI excluding fresh food is likely to gradually accelerate and reach around the price stability target of 2 percent toward the latter half of the projection period through fiscal 2015. As I have described, the QQE has been producing the anticipated results and Japan’s economy has been following the path toward achieving the 2 percent price stability target as expected. The Bank will continue with the QQE, aiming to achieve that target, as long as it is necessary for maintaining it in a stable manner. It will thoroughly examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. The prescription of the QQE that I have explained is in line with the basic ideas within economics and public policy theory. First, I firmly believe that, as a central bank is a public entity, the Bank must manage its policy in conformity with the legally given mandate of ensuring price stability. The Bank must clearly commit to this. Second, in the QQE, we took an approach of raising economic entities’ inflation expectations by combining the central bank’s clear commitment and underpinning large-scale monetary easing measures. This is putting economics, which recognizes the importance of expectations, into practice. Under such a basic framework, the QQE was designed by incorporating central banks’ experiences and practical elements of financial business practices. With this QQE, I believe that Japan can overcome deflation. IV. Future of public policy study I would like to conclude my speech by sharing with you my views on the future of public policy study. First is the importance of studies on political and administrative feasibilities. In pursuing economic policy, including monetary policy, political and administrative feasibilities should be properly recognized, as they limit the space of policies that can actually be pursued. In recognizing this space, it is necessary to have an accurate understanding of people’s behavior and the values of stakeholders who are politically crucial, as well as the background to how the current administrative system and practices have been formed. High-level judgment is required, as these factors are determined by each country’s history, culture, and social systems, as well as the social and political situations of the times. I expect public policy study to shed further light on political and administrative feasibilities of economic policy. Second is the importance of enhancing studies on how economic policy can influence expectations. As mentioned earlier, influencing economic entities’ expectations is critical to BIS central bankers’ speeches monetary policy. That has become increasingly emphasized in the recent monetary policy management of major central banks. For example, the Fed, the European Central Bank (ECB), and the BOE have adopted the so-called forward guidance one after another. This policy measure aims to reduce uncertainty and provide further monetary easing effects under the zero lower bound of nominal interest rates, by clearly indicating future management of monetary policy. However, to get market participants to form expectations just as a central bank intended – namely, expectation management – is not an easy task. This is because market participants’ expectation formation will be prescribed by various situations, such as their views on financial and economic conditions, past experiences, and portfolios they have created. An analysis of expectation formation in various social and economic situations continues to be an important issue of public policy study, and the fruits of this will substantially contribute to the management of monetary policy. Third is the importance of global policy interdependence. In a globalized world, not only do relations among countries become stronger but also the interrelationship of each country’s economic policy, whereby possibilities of policy coordination arise, becomes important. For example, after the Lehman crisis, each country’s government and central bank carried out an aggressive macroeconomic policy to prevent a plunge in economic activity. Many countries took measures to inject public funds to financial institutions and to guarantee financial institutions’ debt. In addition, in response to global liquidity tightening, international coordination among central banks, such as dollar funds supplying operations using the dollar swap arrangement with the Fed, has been swiftly implemented. Such policy coordination can be assessed as being successful in preventing a financial crisis from developing into a fullfledged economic crisis. However, in deploying public funds, the potential cost of taxpayers in each country should be taken into account, and we got a sense of the difficulty with international coordination in this regard. This is also the reality that policymakers are facing. To properly pursue policy coordination on the basis of such reality, it will be important not only to design a theoretically optimal policy but also to understand each country’s legal system and behavioral principles of stakeholders, which could be a hurdle in pursuing policy coordination. Concluding remarks Today, I have expressed my views under the theme of public policy study and monetary policy management by incorporating my own experiences and providing examples of what is actually happening recently on the economic policy front. As mentioned at the outset of my speech, in economic policy, academic knowledge and practical knowledge are close or even inseparable, and public policy study that bridges the two has become extremely important. This situation is common in any country, and as interrelationships among countries’ economic policies have been deepening, there is no doubt that the global network has increased its importance. Therefore, it is expected that each country’s graduate schools of public policy will promote public policy study through an expansion of joint studies and exchanges between professors and between students. From a central bank’s perspective, I have great expectations for properly managing monetary policy by thoroughly utilizing the fruits of such studies. At present, there are not many economic papers that get a hit when doing an internet search with the keywords “quantitative and qualitative monetary easing (QQE).” However, a few years from now, the experience of Japan and the Bank of Japan may have provided a new chapter for economics and public policy study. And I cannot help but expect that a theory worked out then will be one of the powerful weapons that central banks can use in the future to combat deflation. Thank you for your attention. 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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Meeting of Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 25 December 2013.
Haruhiko Kuroda: Overcoming deflation and after Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Meeting of Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 25 December 2013. * * * Accompanying charts can be found at the end of the speech. Original presentation is on the Bank of Japan’s website: www.boj.or.jp/en/announcements/press/koen_2013/ko131225a.htm/ Introduction It is a great honor to have this opportunity to address such a distinguished gathering of business leaders in Japan today. There is only one week left this year. As for Japan’s economy this year, it has been following a recovery path as expected, due partly to the effects of both monetary and fiscal policies (Chart 1). During the three quarters after the turn of the year, real GDP registered an average annualized growth rate of 3 percent on a quarter-on-quarter basis, which was substantially above the potential growth rate that is estimated to be around 0.5 percent. Business sentiment in the Tankan survey (Short-Term Economic Survey of Enterprises in Japan) released last week has continued to show a clear improvement and, on an all industry and all-sized enterprise basis, it has gotten back to the level of a peak prior to the Lehman crisis. There has also been an improvement on the price front this year (Chart 2). The year-on-year rate of change in the consumer price index (CPI, all items excluding fresh food) turned positive in June, increased to 0.9 percent in October, and is likely to slightly exceed 1 percent by the end of the year. Not only a rise in the prices of energy-related goods, including petroleum products, has contributed to raise the index, but also an improvement has been spreading in a wide range of items as the aggregate supply and demand balance of the economy has been improving. That can be confirmed by the fact that the year-on-year rate of change in the CPI (all items excluding food and energy) turned positive at 0.3 percent in October, the highest rate of increase in 15 years since August 1998. The Bank of Japan, with the aim of overcoming deflation at the earliest possible time, introduced quantitative and qualitative monetary easing (QQE) in April this year. Today, toward the year-end, I will express my views on what kind of economy and society we aim at by overcoming deflation while looking back at the developments in Japan’s economy from a medium- to long-term perspective. I. The problem of deflation The word “deflation” is generally understood as referring to a state in which prices decline persistently. Since the latter half of the 1990s, Japan’s economy has been in deflation for nearly 15 years (Chart 3). During that period, Japan’s economy was caught in various negative shocks: the nonperforming loan problem and the Asian currency crisis in the latter half of the 1990s, and a burst of an IT bubble in the United States, the Lehman crisis, and the Great East Japan Earthquake after the turn of the 2000s. In addition, there were many factors that put direct downward pressure on prices, such as an inflow of inexpensive import goods from emerging economies, firms’ low-price strategy amid intensified competition associated with deregulation, and reduction in the wage level due to an increasing use of non-regular employment. While it is not easy to specify the causes of deflation, what is important is that deflation was not only a result of economic stagnation but also a cause that protracted economic stagnation. Namely, amid nearly 15 years of deflation, behavior based on BIS central bankers’ speeches recognition that “prices would not rise” or “prices would moderately decline” has been embedded in the economy. Let me explain somewhat in detail about that point. Viewed from firms’ side, under deflation, as they cannot raise the prices of their products and services, their sales will not increase and profits will hardly increase. Therefore, firms will restrain labor costs and business fixed investment as much as possible. For households, as wages will not increase, consumption will be restrained. In addition, if future prices are to decline, they will become more inclined to defer consumption as much as possible. They will be better off if they buy after prices decline. If consumption is restrained in such a manner, firms will be forced to reduce the prices of their products and services. As a result, a vicious cycle of a decline in prices, a decrease in sales and profits, a restraint in wages, a slump in consumption, and a decline in prices will continue. What is important here is that both firms and households are acting rationally as respective economic entities. Notwithstanding each entity taking action considered rational, it leads to a bad result as a whole: that state is called a “fallacy of composition” or a “coordination failure” in terms in economics. Japan’s deflation since the latter half of the 1990s is a typical example of that. Let us confirm that point in terms of macroeconomic indicators since the 1990s. Nominal GDP and nominal employee income have not been able to get out of the long-term downtrend since their peaks in 1997 (Chart 4). Namely, amid deflation, Japan’s economic activity on a nominal basis has been consistently contracting. Such situation is quite rare among advanced economies. In the United States, nominal GDP and nominal employee income have maintained long-term growth trends, albeit a temporary decline due to the Lehman crisis. Japanese firms have been in a situation in which they have not been able to pass the costs related to production on to sale prices because of intensified competition (Chart 5). As for price conditions in the Tankan survey, since the latter half of the 1990s, the diffusion index of output prices has been consistently lower than that of input prices. As a reason for the difficulty in price pass-through, many firms have pointed out severity in price competition with rival firms, thus suggesting that the “fallacy of composition” or the “coordination failure” might have been taking place. At the same time, firms’ medium- to longterm growth expectations have been on a declining trend for a protracted period since the 1990s (Chart 6). Furthermore, the fact that the expected growth rate on a nominal basis was lower than that on a real basis even when corporate profits increased substantially in the mid-2000s tells us how persistent deflationary expectations were. Also viewed from the financial side, protracted deflation has deprived Japan’s economy of vitality. First, when deflationary expectations were embedded, real interest rates obtained by subtracting the expected rates of inflation from nominal interest rates remained high (Chart 7). What matters for firms’ decision-making in business fixed investment is developments in not nominal but real interest rates. Even though nominal interest rates decline, if prices are expected to decline as a trend, investment cost on a real basis will remain high and incentive for business fixed investment will wane. In order for firms to transform innovative ideas into actual technologies and products, it is necessary to introduce new machines and build new factories. The fact that real interest rates remained high amid deflation has deprived firms of incentive to make growth-enhancing investment. Second, when deflationary expectations were embedded, holding cash and deposits became a relatively better investment even if nominal interest rates were zero or at extremely low levels (Chart 8). Deflation reduced the rate of return on risk assets such as stocks and investment trusts on the one hand, but on the other increased the real rate of return on cash and deposits, whose principals are guaranteed. Against such a backdrop and due partly to investors’ long-standing preference toward safe assets, risk money backed by investors’ search for high returns was lacking in Japan’s financial market, and that weakened the power to support firms’ growth from the financial side. BIS central bankers’ speeches An aggregate flow of funds has substantially changed from the past amid a vicious cycle of deflation. The corporate sector had long been a “fund shortage” sector, in which investment exceeds savings, up to the first half of the 1990s. Firms’ innovations are a source of economic growth, and it is a normal state of the economy in which the corporate sector raises funds, conducts business fixed investment, and makes research and development investment. However, since the latter half of the 1990s, the corporate sector drastically changed to a “fund surplus” sector, in which savings chronically exceed investment. And firms have channeled most of their savings accumulated every year to relatively safe and better investment tools of cash and deposits (Chart 9). Viewed from the banking sector, that means an increase in the liability of deposits on the balance sheet, and, as firms’ appetite for business fixed investment remained stagnant, the banking sector could not easily increase its asset side of lending. Therefore, the banking sector has increased investment in Japanese government bonds (JGBs), which generates safe and certain returns even with low nominal interest rates (Chart 10). In the meantime, the government sector has been running substantial fiscal deficits due to a decline in tax revenue and repeated implementation of an economic stimulus and to an increase in the social security burden stemming from a declining and aging population. Consequently, government debt outstanding has continued to rise, but JGBs were issued smoothly, supported by buoyant demand from the banking sector. As deflation became protracted, a mechanism based on the assumption that prices will not increase has been embedded in Japan’s economic and social system. As I have mentioned earlier, each economic entity has been acting rationally and has been lacking incentive to change its behavioral pattern. In that sense, deflation has been in a state of equilibrium. That is why it has been also called “deflationary equilibrium.” It can be said that deflationary equilibrium has become protracted and become increasingly difficult to overcome precisely because it has been stable. However, such state of equilibrium will not continue forever. Above all, one cannot expect the long-term development of Japan’s economy in the absence of firms’ active efforts to create new businesses. For the sake of the future of Japan’s economy, it is critical to overcome deflation at the earliest possible time and convert “bad and shrinking equilibrium” to “good and expanding equilibrium.” II. Ideas behind QQE – drastic change in expectations Then, how can the economy overcome deflation? The Bank’s answer to this question was nothing but the QQE introduced in April. As mentioned earlier, the essence of deflation is in that taking action on the assumption that prices will not increase has been rational for both firms and households. To get out of such “deflationary equilibrium,” the economic environment needs to be changed so that taking action on the assumption that prices will moderately increase becomes a better option. Under deflation due to a “fallacy of composition,” raising prices and wages by only one firm will be a disadvantage. As many firms raising prices and wages simultaneously will have a positive effect on the economy as a whole, the policy authorities have to come up with bold policy measures that enable firms to change their mindset in such a manner. In sum, there is a need to change the rules of the game that prevailed in the “deflationary equilibrium.” To that end, the Bank is strongly and clearly committed to achieving the price stability target of 2 percent CPI inflation rate at the earliest possible time, with a time horizon of about two years. Besides, to underpin the strong and clear commitment, the Bank has decided to enter a new phase of bold monetary easing both in terms of quantity and quality (Chart 11). Furthermore, the Bank is also committed to continuing with the QQE as long as it is necessary to maintain the 2 percent target in a stable manner. In the process, the Bank will examine both upside and downside risks to economic activity and prices, and make appropriate adjustments. The Bank is totally committed to achieving the 2 percent price stability target. BIS central bankers’ speeches As specific measures for monetary easing, the Bank will purchase JGBs so that their holdings will increase at an annual pace of about 50 trillion yen, and double the monetary base in two years (Chart 12). The monetary base two years later will reach about 60 percent of nominal GDP. That size far exceeds that of the current 22 percent at the Federal Reserve (Fed) in the United States and 22 percent at the Bank of England in the United Kingdom, and thus the QQE is truly unprecedented monetary easing in modern history. The QQE anticipates various transmission channels, and what differs greatly from the Bank’s past monetary easing policies and the current monetary easing policies pursued by major central banks overseas is a particular focus on “a drastic change in expectations.” The QQE aims at, through strong and clear commitment and monetary easing that underpins the commitment, drastically changing the market’s and economic entities’ expectations, thereby working directly on raising inflation expectations. If inflation expectations rise and a recognition that prices will rise in the future becomes embedded, stimulative effects through channels such as a decline in real interest rates and portfolio rebalancing will be strengthened. Namely, first, the Bank’s purchases of JGBs put downward pressure on nominal long-term interest rates through directly influencing the supply and demand conditions of JGBs, and if a rise in inflation expectations is added to that, real long-term interest rates will further decline, thereby strengthening the effect of stimulating investment. Second, if inflation expectations rise, the relative attractiveness of holding cash and deposits will decline and thus it is expected that investors and financial institutions will shift their investment to risk assets such as stocks and foreign bonds or increase lending. Transmission channels of the effect of the QQE that focuses on influencing expectations are nothing but a process of reversing the vicious cycle embedded under deflation. Starting from dispelling deflationary expectations, the Bank aims at creating and embedding an economic virtuous cycle of a moderate rise in prices, an increase in sales and profits, an increase in wages, a boost in consumption, and a moderate rise in prices. III. Raising inflation expectations While the QQE focuses on raising inflation expectations, it seems that there have still been skeptical views among market participants and economists about the feasibility of raising inflation expectations through policy measures. To begin with, we are thoroughly aware that a central bank cannot change at will people’s and the market’s expectations. Having said that, here, I would like to make two points. First, looking at history, while there were not many cases in which people’s inflation expectations shifted dramatically in a short period, those cases were underpinned by a bold policy regime change being implemented based on the policy authorities’ strong resolution. For example, in the United States during the Great Depression in the 1930s, President Roosevelt clearly showed his strong resolution toward overcoming deflation and implemented the New Deal Policy (Chart 13). By that, inflation expectations shifted upward in a relatively short period, and severe deflation associated with the Great Depression was contained. Also in Japan during the same period, a combination of expansionary foreign exchange, fiscal, and monetary policies, the so-called Takahashi Economic Policy, achieved a significant result in overcoming the Showa Depression. While it is an example of containing inflation, it is well known that Fed Chairman Paul Volcker succeeded in lowering inflation expectations through aggressive monetary tightening from the end of the 1970s to the beginning of the 1980s, and laid a sound foundation for prosperity of the U.S. economy under low inflation (Chart 13). Second, in formulating inflation expectations, what is important is not only a forward-looking element, which is the Bank’s commitment and actions, but also an adaptive or backwardlooking element, which is an accumulation of achievements that the actual inflation rate increases as monetary easing progresses. The year-on-year rate of change in the CPI increased to 0.9 percent in October and is expected to hover at slightly above 1 percent BIS central bankers’ speeches through the first half of 2014. Given that deflation has continued for nearly 15 years, those are important changes. If people actually experience a rise in prices, inflation expectations are supposed to change substantially. The Bank holds the view that, due to a backwardlooking element together with a forward-looking element, inflation expectations will continue on a rising trend, gradually converging to around 2 percent – the price stability target. While I have said that prices are expected to rise gradually, the Bank has been aiming at ensuring price stability and not by any means artificially creating inflation. A numerical definition of what the Bank considers price stability based on a specific price index is 2 percent in terms of the year-on-year rate of change in the CPI. There are several reasons why 2 percent might be desirable. First, the existence of upward bias that an inflation rate calculated from the CPI will become higher than the true inflation rate. In other words, when the year-on-year rate of change in the CPI is 0 percent, that situation is in deflation to the extent of the bias. Therefore, to overcome deflation, it is necessary to aim at a somewhat positive inflation rate. Second, the idea of securing a “buffer” to reinforce monetary policy in responding to a price decline and economic deterioration. Nominal interest rates cannot be lowered to below zero percent. Since lowered to 0.5 percent in 1995, the short-term rate in Japan has been between 0 percent and 0.5 percent for about 20 years (Chart 14). Japan has been in a situation in which it has been difficult to stimulate economic activity by lowering nominal short-term interest rates even if prices decline or economic activity deteriorates. In fact, even in response to an extremely large adverse shock of the Lehman crisis, the Bank was only able to reduce about 0.4 percent of the nominal short-term interest rate. In the future, when about 2 percent inflation will be achieved in a stable manner and nominal interest rates will be formed at a somewhat high level reflecting the inflation rate, room will increase for flexibly responding to a price decline and economic deterioration by reducing the short-term interest rate. For similar reasons, many countries have set an inflation target at about 2 percent, and 2 percent has become a global standard. Concluding remarks As I have explained, the Bank has been aiming at creating a state in which 2 percent inflation rate will be maintained in a stable manner. It might be difficult to imagine such a situation because deflation has continued for a protracted period. I would like to conclude my speech today by briefly touching on an image of the economy and society after overcoming deflation. A state in which 2 percent inflation will be maintained in a stable manner is, to put it briefly, a state that each economic entity will act based on a recognition that prices will rise by about 2 percent even when the economy is in a normal state. In other words, a state in which about 2 percent inflation has been factored in price-setting and wage-setting. Such state has already been achieved in advanced economies such as in the United Stated and Europe, in which people’s medium- to long-term inflation expectations have been stable at about 2 percent. As about 2 percent inflation has been firmly embedded in the social system and practices, those economies have been able to avoid deflation of a continued decline in prices and wages even when there was temporary downward pressure on prices and wages due to economic deterioration. Let me cite one unique example. In wage negotiations between employees and employers in Sweden, a mechanism that the 2 percent inflation target set by the central bank serves as an important starting point for discussion to determine the wage increase rate was established as a common practice (Chart 15). In fact, in Sweden, as wages rise stably, the year-on-year rate of change in the CPI has been around 2 percent over the business cycle. Japan’s economy is now seeing a wide range of positive developments in the real economy and the financial market, as well as an improvement in people’s mindset and expectations. It is a golden opportunity for overcoming deflation. Let me reiterate that the Bank is committed to pursuing the QQE and achieving the 2 percent price stability target at the earliest possible BIS central bankers’ speeches time. I strongly expect that the favorable moves to achieve an economic virtuous cycle will spread in business and industrial circles. 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 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 Monetary Authority of Singapore, Singapore, 7 January 2014 and keynote speech at the Eurasia Business and Economics Society Conference, Singapore, 9 January 2014.
Sayuri Shirai: Central banks’ challenges in a rapidly changing global economic environment Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the Monetary Authority of Singapore, Singapore, 7 January 2014 and keynote speech at the Eurasia Business and Economics Society Conference, Singapore, 9 January 2014. * * * Accompanying charts can be found at the end of the speech. I. Introduction It is a great honor to visit Singapore and have this opportunity to address you today. I am a Policy Board member of the Bank of Japan (BOJ), responsible for making decisions on the conduct of monetary policy with Governor Haruhiko Kuroda and seven other members. Based on the experience I have gained from being in my current position, I would like to express my views on recent issues related to monetary policy and central banks’ challenges in the face of a rapidly changing global economic environment. I will begin my speech by talking about the adjustment process of the global economy. I will then focus on common features observed under the monetary policy framework in advanced economies (namely, the United States, the euro area, Japan, and the United Kingdom), as well as major challenges faced by the central banks in these economies. Next, I will concentrate on emerging (and developing) economies, especially in the Asian region (including India, Indonesia, Thailand, South Korea, and China), and introduce the challenges faced by their central banks in the context of greater linkages with global financial markets. Lastly, I will provide a review of issues related to the effects of monetary policies adopted by these central banks on one another and the ongoing debate on measures to cope with them. II. Three stages of the adjustment process of the global economy More than five years have passed since Lehman Brothers’ collapse in 2008 and the subsequent global financial crisis, and yet the global economy still faces a negative output gap (or demand shortage). In general, the global financial crisis has exerted relatively large negative effects on advanced economies, while emerging economies have weathered the crisis relatively well. Meanwhile, the global economy has been following the path toward recovery, which can be divided into three stages. First stage of the economic adjustment process: 2007–09 First of all, the global economy had been highly synchronized, focusing on the start of an apparent slowdown in the U.S. economy from 2007 and on the immediate aftermath of the global financial crisis up until 2009. This is demonstrated by the high level of correlation among countries, and between advanced and emerging economies, in terms of real GDP growth rates (Chart 1). This high correlation reflected the result of the global financial crisis triggered by the largest economy in the world, the United States, from which the contagion spread to the largest economic region, the euro area, mainly through financial linkages. At the same time, the synchronization – together with the collective worldwide efforts to inject monetary and fiscal stimulus – reflects how the global economy overcame a severe recession by the end of 2009. Second stage of the economic adjustment process: 2010–12 Subsequently, the global economy entered a second stage in which a divergence emerged between the growth paths of advanced economies and emerging economies. This is shown by a sharp drop in the correlation of real GDP growth rates between those economies (Chart 1). Advanced economies remained relatively weak during this recovery, and the BIS central bankers’ speeches peripheral economies in the euro area began to face severe fiscal austerity and recession with the occurrence of the debt crisis from 2010 (Chart 2). Nonetheless, advanced economies coped with large negative output gaps through unprecedented aggressive monetary easing, thereby preventing these economies as a whole from falling into a double dip recession. In contrast, emerging economies posted relatively high growth, and those in the Asian region in particular gained growth momentum and became the main driving force for global economic growth. The favorable growth performance in emerging economies helped advanced economies by encouraging an increase in external demand, mainly through trade and foreign direct investment (FDI) channels, and this supported activities of multinational firms in advanced economies. The strong growth dynamics of emerging economies are partly attributable to steady improvement in economic fundamentals achieved after the Asian currency crisis of 1997–98. This is evidenced by, for example, relatively strong fiscal and government debt positions, reduced external debt positions, an accumulation of foreign reserves as buffers, and a relatively resilient financial sector with better prudential regulation and surveillance. Moreover, the emergence of the middle class strengthened these economies’ domestic demand for goods and services, offsetting weak external demand deriving from sluggish advanced economies. In addition, China’s strong growth – mainly driven by the large-scale fiscal stimulus package implemented in 2009–10 and the accommodative monetary policy – supported other emerging economies through greater intra-regional trade and production linkages, as well as FDI activities in the Asian region. The resilient domestic demand and growing regional economic activities not only allowed many of the Asian emerging economies to achieve above-trend economic growth, but also caused an overheating in some of the economies, a heightening of inflationary pressures, and a rise in international commodity prices. Third stage of the economic adjustment process: 2013-Present The third stage of the global economic adjustment process appears to have begun in 2013, as the economic growth landscape had changed. In other words, emerging economies are losing momentum to some extent, while advanced economies are improving (Chart 2). According to the outlook of international organizations, such dynamics will continue and the pace of economic growth is likely to be faster in advanced economies than that in emerging economies for the next few years. The recovery in advanced economies is not particularly robust, however, since their output gaps are likely to remain negative over the next few years.1 Furthermore, the variance in the pace of growth is likely to become evident among advanced economies, and differences in the monetary policy stances of central banks are projected to gradually become evident. This might cause frequent changes in market participants’ views regarding the direction of accommodative monetary policy measures and the interpretations of forward guidance adopted by the central banks in advanced economies. The resulting impact of such behavior of investors on global financial markets and the global economy warrants close attention. Meanwhile, economic growth in many emerging economies has recently slowed somewhat. This appears to reflect the moderation of the fiscal and monetary stimulus measures and surfacing of structural problems in some economies (such as a deterioration in the fiscal and current account deficits, private-sector debt accumulation, and signs of real estate bubbles) (Chart 2). Over the past decade, the Asian region has strengthened financial linkages with The International Monetary Fund’s (IMF’s) World Economic Outlook (October 2013) reports that the real GDP growth rate for advanced economies is projected to reach 1.2 percent in 2013, 2.0 percent in 2014, and 2.5 percent in 2015. That for emerging economies and developing countries is projected to reach 4.5 percent, 5.1 percent, and 5.3 percent, respectively. The output gap for advanced economies is projected to be minus 2.9 percent in 2013 and minus 2.5 percent in 2014. The OECD Economic Outlook (November 2013) reports that the output gap for the OECD economies is projected to be minus 2.6 percent in 2013, minus 2.3 percent in 2014, and minus 1.8 percent in 2015. BIS central bankers’ speeches global financial markets through the portfolio investment channel, in addition to the existing FDI channel. This portfolio investment channel has brought new challenges to emerging economies, distinct from those encountered in the 1990s, when loans extended by foreign financial institutions had been a major source of external financing, as will be described later. III. Central banks’ challenges in advanced economies Next, I would like to talk about the common features observed regarding the monetary policy framework adopted by major central banks in advanced economies, as well as their challenges. A. Common features related to monetary policy and the role of central banks Since the global financial crisis, major central banks in advanced economies have actively conducted accommodative monetary policy measures. Over the course of time, some convergences and/or common features have become apparent regarding the conduct of monetary policy and the role expected of a central bank. These are (1) the adoption of 2 percent, or close to 2 percent, as a target or a numerical definition of price stability; (2) the growing importance of anchoring medium- to long-term inflation expectations to achieve price stability; (3) large-scale purchases of financial assets as a nontraditional monetary policy tool; (4) the adoption of forward guidance over the future monetary policy stance as another nontraditional monetary policy tool; and (5) the strengthened role of central banks in light of macroprudential policy. Let me now explain each of these features. Feature (1): adopting 2 percent as the price stability target First, the medium- to long-term price stability target for major central banks in advanced economies has converged to 2 percent, or close to 2 percent, as a part of comprehensive efforts to improve transparency over the conduct of monetary policy. The European Central Bank (ECB) and the Bank of England (BOE) were forerunners in this regard, having already adopted this price stability target prior to the global financial crisis, while the Federal Reserve and the BOJ did so after the crisis. • The Federal Reserve specified the longer-run goal for inflation as 2 percent in January 2012, as measured by the personal consumption expenditure (PCE) deflator. • The ECB defined price stability as “below, but close to, 2 percent over the medium term” in May 2003, as measured by the Harmonized Index of Consumer Prices (HICP) for the euro area. • The BOJ adopted the 2 percent price stability target in terms of the consumer price index (CPI) in January 2013. It also stated that monetary easing will be pursued with the aim of achieving this target at the earliest possible time. • In the United Kingdom, the Chancellor adopted the 2 percent target in December 2003 when the reference indicator was changed from the Retail Prices Index excluding mortgage interest payments to the CPI. The BOE conducts monetary policy to achieve this target. As one of the monetary policy decision makers at the BOJ, I would like to emphasize that the adoption of the 2 percent target signifies a major transition in terms of Japan’s historical conduct of monetary policy. It symbolizes the BOJ’s strong determination to overcome mild deflation that has lasted for the past 15 years. During this time, the economy had been quite depressed, with low levels of growth expectations, and a deflation-oriented mindset among households, firms, and financial institutions had been prevalent. In order to avoid a return to such a situation, the BOJ is currently exerting its full efforts to achieve the target, as I will describe later. BIS central bankers’ speeches The convergence of major central banks’ price stability targets to the level of around 2 percent indicates a rather remarkable achievement in the context of the international financial architecture. This is because, according to a remark by Mr. Jean-Claude Trichet, the former President of the ECB, the four key currencies – the U.S. dollar, the euro, the Japanese yen, and the pound sterling – “have now an affirmed global nominal anchor for the first time since the dismantling of the Bretton Woods System.”2 Currently, the actual level of inflation in the four economies deviates from 2 percent, partly as the economies are still recovering from the global financial crisis. Nonetheless, once economic conditions are normalized, the central banks are expected to ultimately achieve price stability of around 2 percent. In this circumstance, more stable developments in foreign exchange rates may be promoted among major currencies in the long term. This may indirectly support the establishment of a more stable international financial architecture. I believe that establishing a global nominal anchor has an important implication for Japan as well, because the yen’s long-standing appreciating trend since the 1970s is likely to be closely associated with the consistently low level of inflation relative to other advanced economies. You may wonder why major central banks have chosen the numerical value of 2 percent. This reflects the fact that central banks commonly believe it is important to have a sufficient buffer with regard to inflation in order to avoid deflation, since deflation is more harmful to the economy than mild inflation. In addition, central banks find it necessary to achieve inflation to some extent in order to avoid the zero lower bound on short-term interest rates, in which there is no room for a further decline in the policy interest rate. In other words, central banks find it necessary to leave sufficient room for the conduct of flexible monetary policy by achieving a certain level of inflation in normal periods, especially to cope with recessionary phases. Feature (2): anchoring medium- to long-term inflation expectations at around 2 percent Second, the central banks in advanced economies pay close attention to developments in medium- to long-term inflation expectations, because stability in such expectations is essential to achieving long-term price stability. The Federal Reserve, the ECB, and the BOE have judged that they have successfully anchored medium- to long-term inflation expectations at around 2 percent. They currently hold the view that these expectations remain well anchored although there may be some concerns that the inflation expectations may become unstable. Therefore, one of the main tasks for these central banks is to continue with monetary easing measures to seek economic improvement, while ensuring that the anchored inflation expectations are maintained. Anchoring inflation expectations at around 2 percent implies that actual inflation has a tendency to converge toward 2 percent in the long term – although actual inflation may move above or below 2 percent on a daily basis as a result of various effects, including those of business cycles, and of fluctuations in commodity and food prices. By contrast, the BOJ has not yet successfully anchored medium- to long-term inflation expectations at around 2 percent. Thus, achieving the 2 percent price stability target is particularly challenging relative to other central banks as this implies that the BOJ must aim at achieving economic recovery and anchoring inflation expectations at a higher level than at present. Achieving this aim of anchoring inflation expectations requires the BOJ to first help transform the deflation-oriented mindset and behavior of all economic entities, and then steadily raise their inflation expectations. See Jean-Claude Trichet, “2013 Per Jacobsson Lecture: Central Banking in the Crisis – Conceptual Convergence and Open Questions on Unconventional Monetary Policy,” Lecture at an event for the IMF/World Bank Annual Meetings in Washington, D.C., The Per Jacobsson Foundation, 2013. BIS central bankers’ speeches Feature (3): large-scale asset purchases as a nontraditional monetary policy tool Third, the Federal Reserve, the BOJ, and the BOE have adopted nontraditional monetary easing policy through asset purchase operations. This practice substantially differs from the past, when monetary easing was conducted mainly through a reduction in a very short-term nominal interest rate – namely, the policy interest rate. All three central banks and the ECB have faced a situation in which very short-term interest rates declined to nearly zero after Lehman Brothers’ collapse in 2008.3 In such a situation, the Federal Reserve, the BOJ, and the BOE have attempted to create an accommodative monetary environment by exerting downward pressure on longer-term interest rates, which remain in positive territory despite the policy rate reaching nearly zero (as pointed out later). For example, yields on government bonds often function as a benchmark for measuring the long-term interest rates related to corporate loans, corporate bonds, mortgages, etc. Therefore, downward pressure on government bond yields is likely to contain funding costs, which may promote firms and households to increase their economic activities. • The Federal Reserve purchased longer-term Treasury securities at a pace of 45 billion U.S. dollars per month and agency mortgage-backed securities (MBSs) at a pace of 40 billion U.S. dollars per month until December 2013. From January 2014, the pace of its asset purchases will be reduced to 40 billion U.S. dollars and 35 billion U.S. dollars, respectively. Meanwhile, the Federal Reserve is maintaining the existing policy of rolling over maturing Treasury securities at auction and of reinvesting principal payments from its holdings of agency debt and agency MBSs in agency MBSs. • The BOJ currently purchases Japanese government bonds (JGBs) at an annual pace of about 50 trillion yen (on an outstanding basis) each year to double the amount outstanding in two years (2013–14). It also purchases treasury discount bills (T-Bills), exchange-traded funds (ETFs), Japan real estate investment trusts (J-REITs), and other assets. While the amounts purchased are specified only for two years at this stage, this does not mean that the purchases will end after two years, as specified in forward guidance, which I will describe later in my speech. • The BOE is maintaining the stock of past asset purchases, mostly consisting of gilts, at 375 billion pounds. In a statement issued by the Federal Reserve in December 2012, the economic conditions for maintaining these asset purchases were described as “until such [substantial] improvement [in the labor market] is achieved in a context of price stability.”In June 2013, Chairman Ben Bernanke provided more comprehensive guidance about the criteria related to the decision to reduce the pace of asset purchases at the press conference. These included (1) continued improvements in the labor market, (2) a moderate pick-up in economic growth, and (3) the outlook that inflation would move back toward 2 percent over time. He also stressed that, if incoming data were consistent with these outlooks, the reduction might begin later in 2013 and the asset purchases might end by mid-2014. In December 2013, the Federal Reserve decided to modestly reduce the pace of its asset purchases beginning in January 2014, in light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions. Also, it was indicated that the pace of asset purchases will likely be reduced in further measured steps at future meetings (the general consensus is that this will be a reduction of 10 billion U.S. dollars per meeting) if The Federal Reserve has maintained the intended federal funds rate at 0–0.25 percent since December 2008. The ECB resumed a cut in the interest rate on the main refinancing operations in November 2011 from 1.5 percent to 1.25 percent, and has steadily lowered the interest rate since then. Most recently, the interest rate was lowered further from 0.5 percent to 0.25 percent in November 2013. The BOE has maintained Bank Rate at 0.5 percent since March 2009. Meanwhile, the BOJ lowered the uncollateralized overnight call rate from around 0.1 percent to around 0–0.1 percent in October 2010. It then shifted to monetary base targeting in April 2013. BIS central bankers’ speeches incoming information broadly supports the expectation for ongoing improvement in labor market conditions and for inflation moving back toward its longer-run objective of 2 percent. The ECB’s practices differ from those of the three central banks, since its major nontraditional monetary policy tool is the “fixed-rate full allotment liquidity provision,” for which the duration is longer than normal open market operations with a wider range of collateral accepted. The three-year longer-term refinancing operations (LTROs) were conducted in 2011 and 2012, in addition to the three-month LTROs. Moreover, the Outright Monetary Transactions (OMTs) were introduced in September 2012 in order to potentially purchase an unlimited amount of sovereign bonds with a remaining maturity of one to three years with a conditionality attached on the basis of a full or precautionary macroeconomic adjustment program.4 Since the liquidity injected into the markets will be fully sterilized, this measure is not regarded as a quantitative easing policy. Since 2013, some European banks have started to make early repayments of the three-year LTROs. Feature (4): forward guidance as a nontraditional monetary policy tool Fourth, all four central banks have adopted forward guidance, which refers to a communication strategy undertaken by central banks to provide information to the markets and the public (households and firms) on its future monetary policy stance. In general, a central bank uses forward guidance for two main purposes. One is as a communication strategy to inform the markets and the public about the “normal” policy reaction function of monetary policy (such as the Taylor rule). The other is to inform the markets and the public that a central bank at the zero lower bound will pursue further monetary easing than would have been expected under the normal policy reaction function by the markets and the public. • The Federal Reserve indicated in December 2012 that it anticipated that a target range of the federal funds rate of 0 to 0.25 percent would be appropriate at least as long as “(1) the unemployment rate remains above 6.5 percent, (2) inflation between one and two years ahead is projected to be no more than a half percentage point above the [Federal Open Market] Committee’s 2 percent longer-run goal, and (3) longer-term inflation expectations continue to be well anchored.” This guidance was further strengthened in December 2013 with the addition of “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.” • The ECB stated in its introductory statement at a press conference in July 2013 “[it] expects the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on the overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the real economy and subdued monetary dynamics.” • The BOJ used two descriptions regarding the time span of monetary accommodation when quantitative and qualitative monetary easing (QQE) was introduced in April 2013. The first was a statement of its intention to achieve the 2 percent price stability target at the earliest possible time, with a time horizon of about two years. To fulfill this objective, the main operating target for money market operations was switched from the uncollateralized overnight call rate to the monetary base; it was then decided that the size of the monetary base would rise at In 2010–11, the ECB purchased a limited amount of long-term sovereign bonds under the Securities Markets Programme (SMP), but the equivalent amount of liquidity injected was sterilized. This measure is aimed at improving the transmission mechanism of the monetary policy as a credit easing policy. The OMTs replaced the SMP. Furthermore, a limited amount of covered bonds were purchased in 2009–10 and 2011–12 in order to ease funding conditions for financial institutions. These bond purchases were also regarded as part of an enhanced credit easing policy, not as a quantitative monetary easing policy. BIS central bankers’ speeches an annual pace of about 60–70 trillion yen, to be doubled in two years (2013–14). The second description was a commitment to continuing with QQE as long as it was necessary for maintaining the 2 percent target in a stable manner. This description also added a condition that both upside and downside risks to economic activity and prices would be examined, and that adjustments would be made as appropriate.5 • The BOE expressed in August 2013 “[it] intends not to raise Bank Rate from its current level of 0.5 percent at least until . . . the unemployment rate has fallen to a threshold of 7 percent, subject to the [given] conditions.6 [It also] stands ready to undertake further asset purchases while the unemployment rate remains above 7 percent if it judges that additional monetary stimulus is warranted. But until the unemployment threshold is reached, and subject to the [given] conditions, [it] intends not to reduce the stock of asset purchases.” Here, I would like to highlight three differences regarding the structure of forward guidance. On the first difference, the forward guidance adopted by the Federal Reserve, the ECB, and the BOJ is used deliberately as an accommodative monetary policy tool aimed at generating downward pressure on long-term interest rates, whereas this is not necessarily the case with regard to the BOE. The BOE’s intention is to clarify its policy reaction function or to provide greater clarity about the Monetary Policy Committee’s (MPC’s) views on the existing trade-off between inflation and unemployment and the associated monetary policy stance. Charlie Bean, Deputy Governor of the BOE, explained in August 2013 that the release of the guidance was to clarify the MPC’s existing monetary policy stance rather than to provide additional monetary accommodation.7 By reducing uncertainty, it aimed at lowering term premiums and preventing upward movements in market interest rates. Regarding the second difference, forward guidance is applied to the policy interest rate in the case of the Federal Reserve and the ECB. The BOE appears to apply forward guidance mainly to the policy interest rate. However, it is also linked to the possibility of further asset purchases as well as maintaining the stock of past asset purchases. Recently, these three central banks have been increasingly emphasizing forward guidance as the key monetary policy tool. The BOJ, meanwhile, applies forward guidance to QQE as a package, not specifically to the policy interest rate. Under QQE, the main operating target for money market operations is the monetary base, and various assets (with JGB purchases being the main operational tool) are purchased under the target. As the third difference, while forward guidance in the Federal Reserve, the BOJ, and the BOE is commonly regarded as “state-contingent” or “threshold-based,” both the Federal Reserve and the BOE include employment-related thresholds, unlike Japan. The Federal Reserve has a dual mandate of promoting price stability and maximum employment, so the reason for this is clear. The BOE places price stability as its primary mandate; however, the inclusion of employment-related conditions may reflect the need to clarify the MPC’s views These two descriptions are mutually non-exclusive. The first description (which is a combination of “statecontingent” and “calendar-based” forward guidance) could be regarded as a necessary condition to the second description (which is a combination of “state-contingent” forward guidance and “conditional commitment”). For more details, see Sayuri Shirai, “Monetary Policy and Forward Guidance in Japan,” Speeches at the International Monetary Fund (September 19) and the Board of Governors of the Federal Reserve System (September 20) Held in Washington, D.C., Bank of Japan, 2013. The conditions are then defined in the form of the following three “knockouts”: (1) the CPI inflation 18 to 24 months ahead will be 2.5 percent or above; (2) medium-term inflation expectations do not remain well anchored; and (3) the Financial Policy Committee (FPC) judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the substantial range of mitigating policy actions available to the FPC. If any of these knockouts are breached, the above-mentioned guidance will be ceased. Charlie Bean, “Global Aspects of Unconventional Monetary Policies,” Speech at the 2013 Economic Policy Symposium, Federal Reserve Bank of Kansas City, 2013. BIS central bankers’ speeches with regard to the trade-off between inflation and unemployment, in the face of high inflation that is concurrent with a high unemployment rate. By contrast, the need for the unemployment threshold to be used in the BOJ’s guidance is relatively small, owing to the fact that (1) the BOJ’s primary mandate is to achieve price stability and that (2) the current unemployment issue is more likely to be structural, rather than cyclical. The unemployment figure for November 2013 was as low as 4 percent, close to the lowest point in recent years of 3.6 percent in July 2007. The reason for the relatively low unemployment rate level is that firms tend to flexibly adjust wages along the business cycle, through bonuses and overtime hours for full-time regular workers and an adjustment of working hours and days for part-time, non-regular workers. There are issues such as differential treatment of regular and non-regular workers, and greater flexibility over labor market regulations demanded by firms. However, these are structural issues that are beyond the scope of monetary policy in Japan. Regarding the ECB, no specific threshold is provided, unlike the three central banks. The guidance seems to be based on the medium-term inflation outlook (while also paying close attention to the economy as well as monetary aggregates and credit flows). At a press conference held in August 2013, Mario Draghi, President of the ECB, explained that the ECB’s policy reaction function is linked to the outlook for price stability in the medium term in a timely manner. Feature (5): the strengthened role of central banks in light of macroprudential policy Fifth, the global financial crisis has placed macroprudential policy as an increasingly important policy. This reflects the view that stability in the financial system as a whole may not be achieved solely with the existing “microprudential policy” (which monitors the soundness of individual financial institutions). This arises from the shared view that the “Great Moderation” period – which continued until the mid-2000s – successfully achieved general price stability but failed to prevent a global financial crisis. Macroprudential policy pays greater attention to major financial institutions and markets (and their relationship) as major constituents of the financial system, as well as the relationship between economic activity and the financial system. In this light, central banks closely monitor macroeconomic and financial market developments, collect information regarding financial transactions, and function as the lenders of last resort to individual financial institutions with the aim of achieving financial stability. Thus, the use of these specific skills, knowledge, and functions is considered effective as a means of optimizing the effects of macroprudential policy. In this manner, central banks in some advanced economies have strengthened their role with regard to enhancing macroprudential policy. For example, in the case of the United Kingdom, the function of supervising financial institutions was transferred from the Financial Services Authority (FSA) to the BOE with the establishment of the Prudential Regulation Authority (PRA) in 2013. Also, the Financial Policy Committee (FPC) was officially established at the BOE in 2013 as an entity to engage in macroprudential policy. The FPC will introduce “countercyclical capital buffers” reflecting the Basel III agreement, and is also expected to utilize “sector-based capital buffers” as major policy tools. Furthermore, the FPC is currently seeking specific means by which to encourage coordination with the Monetary Policy Committee (MPC) – which is in charge of monetary policy conduct. With regard to the European Union (EU), moreover, the European Systemic Risk Board (ESRB) – including the ECB president and vice presidents, as well as the presidents of national central banks – was established in 2010 as a regional entity responsible for macroprudential policy. The ESRB is responsible for identifying various risks associated with the regional financial system, sending warning signals over the fragility inherent in the financial system, and providing recommendations for corrective measures. In the United States, the Financial Stability Oversight Council (FSOC) – where the Secretary of the Treasury chairs the council and members include Chairman of the Federal Reserve and other regulatory agencies – was established in 2010. The FSOC is responsible for monitoring potential risks related to financial stability and to make recommendations to the BIS central bankers’ speeches Federal Reserve on prudential regulations and supervision. Meanwhile, in Japan, the BOJ, as the central bank, and the Financial Services Agency, as the primary financial regulatory authority, are making coordinated efforts to promote financial system stability by making contributions in their respective fields of responsibility. In this regard, the BOJ conducts onsite examinations and off-site monitoring of individual financial institutions, and thereby carries out various analyses on financial system stability and related risks from macroprudential perspectives. B. The major challenges faced by central banks in advanced economies The nontraditional monetary policy measures are expected to generate positive effects on the economies through various channels. Although they are interconnected, the main channels can be summarized as (1) downward pressure on long-term interest rates; (2) the portfolio-rebalancing effect; (3) wealth effects; (4) foreign exchange rates; and (5) credit easing effects. Downward pressure on long-term real interest rates could be exerted either through downward pressure on nominal interest rates by lowering term premiums or through downward pressure on real interest rates by increasing medium- to long-term inflation expectations. While downward pressure on the term premiums has been somewhat expected by the four central banks, an increase in inflation expectations is expected mainly by the BOJ. Challenge (1): moderate or sluggish credit growth In practice, some of these channels have materialized and thus have affected these advanced economies favorably. Nonetheless, one challenge is that private-sector credit growth remains relatively moderate in the United States and Japan, notwithstanding the massive injection of liquidity into the market (Charts 3 and 4). In the euro area and the United Kingdom, credit growth remains in negative territory, although the negative trend appears to have bottomed out recently. The size of the monetary base in the euro area has declined, mainly due to the early repayments of the three-year LTROs by some European banks. In general, mortgages have been increasing in the euro area, Japan, and the United Kingdom, whereas such a trend is not yet visible in the United States owing to the deleveraging process in the household sector and tight lending conditions for non-prime individual borrowers (Chart 4). In the core euro area and the United Kingdom, the increase in mortgages reflects a hike in housing prices in some cities in addition to the low level of interest rates. In Japan, this is attributable to the front-loaded increase in housing investment caused by a scheduled consumption tax hike in April 2014, employment and income growth, wealth effects, and an expected rise in real estate prices in the Tokyo metropolitan area. On the other hand, while corporate loans are rising – albeit moderately – in the United States and Japan, those in the euro area and the United Kingdom have continued to decline. Features common to the four economies are ample retained earnings, easy access to bond financing for large firms, and concerns about future economic uncertainty (Chart 5). Credit demand for business fixed investment in the United States and the euro area appears to be sluggish. Challenge (2): monetary accommodation and growing financial linkages The second challenge is related to the growing linkages across financial markets. A rise in long-term government bond yields in a major overseas economy may exert upward pressure on the government bond yields of another economy. The upward pressure could reflect the change in economic conditions in the affected economy, but could also be driven by market investors’ reactions to various data and news related to the domestic and foreign economies, as well as speculative activities. The upward force may work against the downward pressure maintained by the accommodative monetary policy adopted by an affected economy, thereby possibly weakening the effectiveness of monetary policy. BIS central bankers’ speeches Given this background, for example, one of the reasons for adopting forward guidance by the ECB was to cope with this unintended upward pressure. At the July 2013 press conference, President Mario Draghi expressed his concerns over increases in various segments of the interest rate curve, in the presence of a by and large continuing weakness in the economy. He then explained that forward guidance was introduced to clarify the ECB’s assessment of the medium-term outlook for inflation and what its policy reaction function was. This indicates that the guidance was used to clearly communicate the ECB’s accommodative monetary policy stance to market participants that low levels of market interest rates should be appropriate for the time being. In the case of Japan, the upward pressure on long-term interest rates remains limited so far, since the BOJ’s massive purchases of JGBs have helped to generate stronger downward pressure on the interest rates with reduced risk premiums. Chart 6 shows the decomposition of key factors contributing to long-term JGB yields. It indicates that in recent months downward forces caused by “other factors” (which largely reflects domestic factors) have been greater than upward pressure caused by “common factors” (which largely reflects global factors). Challenge (3): avoiding disinflation or deflation Regarding the third challenge, some advanced economies have recently suffered declines in both headline and core inflation. For example, the year-on-year rates of change in the PCE deflator in the United States have been at substantially low levels for the past few years, at 0.9 percent in the case of the headline index and 1.1 percent in the case of the core index for November 2013 (the CPI headline index reported at 1.2 percent and the core index at 1.7 percent). In the euro area, a similar trend is observed both in the headline and core HICP. The headline HICP and the core HICP remained low at 0.9 percent and 1.1 percent, respectively, in November (0.7 percent and 1.0 percent, respectively, in October). This decline in inflation, or the so-called disinflationary trend, reflects a decline in energy and food prices, the negative output gap, and a deceleration in wage growth. The disinflationary trend is somewhat of a concern in the euro area, since the negative output gap had deteriorated until recently and the unemployment rate remains at a high level. On the other hand, the disinflationary concern is rather limited in the United States owing to continued economic recovery in recent quarters. Nonetheless, if the actual inflation rate continues to be below 2 percent for a prolonged period, this may cause a downward shift in medium- to long-term inflation expectations in both the euro area and the United States. In addition, as a medium- to long-term issue, we may need to consider whether the decline in prices, particularly in natural gas prices owing to the increased shale gas development in the United States, would bring down the country’s trend inflation rate in the long run. Among advanced economies, a number have been paying close attention to the deflation experience of Japan since the late 1990s, following the bursting of the real estate and stock price bubbles in the early 1990s and the associated banking crisis. So far, central banks in these economies have promptly taken necessary measures and successfully avoided deflation. While there is no apparent sign of deflation at this stage, these central banks have expressed their intention to take necessary measures whenever judged necessary. Challenge (4): the BOJ’s challenge to achieve the 2 percent price stability target In Japan, the year-on-year rates of change in the headline and core CPI (excluding fresh food) have turned positive from June 2013, with the pace of increase accelerating since then. The headline CPI inflation for November reached 1.5 percent (core CPI 1.2 percent), exceeding inflation in the United States and the euro area (Chart 7). Regarding the CPI excluding food and energy (the so-called core index according to the definition adopted in the United States and Europe), the rate of change in Japan improved to 0 percent in September 2013 and turned positive in October 2013 reaching 0.3 percent, and 0.6 percent in November. However, this rate of inflation remains lower than those of the BIS central bankers’ speeches United States and the euro area. While a wide range of consumption items have shown a mild increase, the major factors contributing to the increase arise from energy prices, administrative prices, and the lagged impact of the yen’s depreciation at this stage. The BOJ expects that the price rise will increasingly reflect an improvement in the output gap and a rise in inflation expectations. The BOJ judged in January 2013 that setting the 2 percent price stability target in terms of the CPI was important for the economy. This judgment was made taking into account, for example, (1) the sufficient room needed to avoid another deflation; (2) the sufficient room needed for the conduct of flexible monetary policy in normal periods to avoid the zero lower bound in the recessionary phase of the economy; (3) the upward bias in the CPI statistics; and (4) the need to align with the global standard of a price stability target, as touched upon earlier. Moreover, achieving sufficiently high nominal GDP growth rates – not only through positive real economic growth but also through moderate increase in the GDP deflator – is essential for the economy to boost expectations for economic growth formed by firms and households. In general, the duration for achieving the target is about two years within inflation-targeting countries. Thus, the BOJ expressed in April 2013 its intention to achieve the target at the earliest possible time with a time horizon of about two years. I also believe that the BOJ should do its best to achieve 2 percent at the earliest possible time. It is good if 2 percent is achieved within about two years, while ensuring the sustainable growth path and with no serious burden imposed on firms and households by a rapid rise in the inflation rate. Nonetheless, I personally consider that it may take some time before the full impact of QQE materializes, taking into account consumers’ concern about a rapid decline in real disposable income as well as firms’ cautiousness in raising sales prices (in fear of losing their market shares). Thus, there may be high uncertainty regarding the duration in which to achieve the target.8 In the end, what is important is that the BOJ is conducting monetary easing with the aim of achieving 2 percent inflation in a stable manner with sustainable economic growth, rather than merely achieving 2 percent in a specific year and failing to meet the target in subsequent years. As a related issue, I believe additional monetary easing measures should be taken without hesitation so as not to jeopardize the BOJ’s credibility, whenever downside risks to the BOJ’s baseline scenario (of the outlook for economic activity and prices) are judged to have materialized. That said, there could be instances where it may be appropriate to conduct monetary easing aimed at achieving 2 percent at a pace slower than about two years – provided that the pace of inflation is judged to be creating an excessive burden on households and firms. In addition, I would like to point out that an adequate understanding by the public of the importance of the 2 percent target is a prerequisite to the success of QQE. While most of the public acknowledges the past 15 years of mild deflation as an unfavorable experience, they also consider a rise in inflation as unfavorable because of an associated rise in living expenses. In particular, an increase in the consumption tax rate is scheduled in April this year, and thus, together with the effect of monetary easing, the inflation rate may temporarily exceed 2 percent. It also appears that some in the public feel uncertain about the importance of achieving the target. Thus, it is important for the BOJ to clearly explain and respond to their questions, such as how achieving the 2 percent price stability target will improve their daily lives. On this front, the BOJ has recently upgraded its web site and created a new section on its top page titled “Price Stability Target of 2 percent and Quantitative and Qualitative Monetary Easing” in order to enhance accessibility to relevant documents. While this move is a welcome step, further improvement is necessary with regard to its For details, see Sayuri Shirai, “Japan’s Economic Activity, Prices, and Monetary Policy: Some Perspectives on the Slope of the Phillips Curve,” Speech at a Meeting with Business Leaders in Tokushima, Bank of Japan, 2013. BIS central bankers’ speeches communication strategy, especially that to the general public. In this regard, I will do my best to continually examine how the BOJ can gain the understanding of the public and thereby achieve the 2 percent target stably. IV. Central banks’ challenges in emerging economies Now, let’s shift to the topic of emerging economies. The Asia region performed well and large capital inflows took place in the second stage of the economic adjustment process in 2010–12, as indicated earlier. Thus, I will focus on the issues faced by emerging economies with regard to capital flows as well as the related challenges faced by their central banks. A. The three challenges related to the capital inflows Expansion of cross-border capital flows to emerging economies is attributable to (a) high economic growth expectations, higher yields, and favorable economic fundamentals (the socalled “pull factors”); and (b) low yields in advanced economies with accommodative monetary policies and investors’ pursuit of higher yields (the so-called “push factor”). Chart 8 indicates that Indonesia and Thailand, followed by India, experienced relatively large-scale capital inflows in recent years – exceeding the level before the global financial crisis. Generally, those capital inflows gave rise to the following three features in the Asian region: (1) “follow-the-leader behavior” in setting short-term policy interest rates; (2) growing importance of macroprudential policy to deal with capital inflows; and (3) growing issuance of local currency-denominated bonds and enhanced linkages with global bond markets. “Follow-the-leader behavior” in setting short-term policy interest rates First, large-scale capital inflows, while bringing various favorable effects to emerging economies, put the economies’ central banks in a trade-off regarding the decision to set short-term policy interest rates. That is, on the one hand, an increase in the short-term policy interest rates (either as a result of tight monetary policy or of foreign exchange market intervention followed by sterilization) helps to lower inflationary pressures, but may invite a new round of capital inflows by investors in search of higher yields. It may also damage exporting sectors through an appreciation of their domestic currencies. On the other hand, a decline in the short-term policy interest rates (either as a result of accommodative monetary policy or of unsterilized foreign exchange market intervention) helps exporting sectors through a limited degree of appreciation of their domestic currencies and volatility of foreign exchange markets. However, such a decline may increase inflationary pressures and cause deterioration of financial imbalances (such as real estate bubbles and financial instability). Taking into account this trade-off, some emerging economies tend to choose the latter option – namely, a decline in the interest rates – reflecting concerns over a sharp appreciation and volatile exchange rates. This is because high volatility in exchange rates often leads to heightened volatility in output, which in turn may well amplify the vulnerability of the economies. Consequently, a number of central banks in emerging economies with large capital inflows tend to maintain lower short-term policy interest rates than usual – or lower than the interest rates that would have been adopted on the basis of certain monetary policy rules (such as the Taylor rule).9 This phenomenon is also referred to as “follow-the-leader behavior” in setting short-term policy interest rates, since emerging economies tend to set short-term policy interest rates in line with the low interest rates set by major central banks in See Dong He and Robert N. McCauley, “Transmitting Global Liquidity to East Asia: Policy Rates, Bond Yields, Currencies and Dollar Credit,” BIS Working Papers, No. 431, Bank for International Settlements, 2013; and Michael Spencer, “Updating Asian ‘Taylor Rules’,” Global Economic Perspectives, Deutsche Bank, 2013. BIS central bankers’ speeches advanced economies.10 This may suggest that the price stability target could be challenged over the exchange rate stabilization objective. Growing importance of macroprudential policy to deal with capital inflows Compared to advanced economies, a number of emerging economies had already installed some policy measures that are known today as macroprudential policy measures prior to the global financial crisis. This is because it was considered in these economies that preventive measures to contain volatile capital inflows and mitigate resultant adverse impacts were an effective tool for mitigating financial and economic imbalances. This partly reflects the lessons learnt from the Asian currency crisis of 1997–98, when a sufficient structure for regulations and supervision of the banking sector had not yet been established. Generally, macroprudential measures could be (1) capital-based measures (covering various capital buffers), (2) liquidity-based measures (such as a liquidity requirement, reserve requirement, and limit on net open positions), and (3) asset-side measures. The asset-side measures include a limit on aggregate credit supply, the application of loan-to-value (LTV) ratios and the debt-to-income (DTI) ratios, which are generally applied to the mortgage application, and various types of taxes imposed on real estate purchases. The liquidity-based and asset-side measures are frequently used by many emerging economies. Nevertheless, a consensus regarding the effectiveness of these measures has not yet been established. Local currency-denominated bonds and enhanced linkages with global bond markets Third, emerging economies in the Asian region have been shifting from a bank-based system to a more diversified financial system combining bank loans and securities market financing since the Asian currency crisis. A wide range of entities have increased their bond issuance. More importantly, the share of local-currency denominated bonds saw a remarkable increase – for example, from 88 percent in 2000 to 94 percent in 2011, and from about 1 trillion U.S. dollars to 7 trillion U.S. dollars over the same period.11 The amount of issuance continued to grow even after the global financial crisis (with the exception of the turbulence experienced in 2008–09), helping to offset a slowdown in the growth of bank loans. The increase also reflected the active issuance of government bonds to finance expansionary fiscal policy. The maturity of both government and corporate bonds has also lengthened, even after the global financial crisis. These developments enabled emerging economies to reduce double mismatches (maturity and currency mismatches between assets and liabilities), thereby improving the balance sheets of governments, firms, and financial institutions. These bond market developments are partly attributable to the long-standing initiatives by the governments and central banks in the Asian region to foster local currency-denominated bond markets – such as the Asian Bond Markets Initiative (ABMI) and the Asian Bond Fund (ABF). Capital inflows have been reversed for some emerging economies since May 2013. This is evident especially for those with relatively weak economic fundamentals (such as the current account deficit, fiscal deficit, and high private-sector debt) or those linked closely with global financial markets (Charts 9 through 11). The reversal was triggered by the change in foreign investors’ views over the expected timing for the Federal Reserve to reduce the pace of its asset purchases, and the subsequent interest rate hike in the United States – in addition to the change in their views over the growth expectations for emerging economies. The See Jaime Caruana, “Ebbing Global Liquidity and Monetary Policy Interactions,” Speech at the Central Bank of Chile Fifth Summit Meeting of Central Banks on Inflation Targeting: “Global Liquidity, Capital Flows and Policy Coordination,” Bank for International Settlements, 2013. See Iwan J. Azis, Sabyasachi Mitra, Anthony Baluga, and Roselle Dime, “The Threat of Financial Contagion to Emerging Asia’s Local Bond Markets: Spillovers from Global Crises,” ADB Working Paper Series on Regional Economic Integration, No. 106, Asian Development Bank, 2013. BIS central bankers’ speeches accumulated large amount of capital inflows to these economies as well as a shift in global financial conditions also contributed to a shift in capital flow movements. In spite of reduced exposure to the double mismatches, emerging economies suffered from a reversal of capital inflows – mainly through a sudden decline in liquidity in the bond and foreign exchange markets. In May–August 2013 in particular, bond prices dropped and exchange rates depreciated sharply in some of these economies, while some also faced large declines in stock prices (Charts 12 through 14). In other words, the greater linkages with global financial markets through securities market financing might have made emerging economies more sensitive to movements in interest rates in advanced economies. Some foreign investors tend to adjust their long positions relatively quickly by selling their holdings of securities when the volatility of interest rates rises suddenly. Moreover, foreign investors, during periods of reduced liquidity, increasingly take short positions over exchange rates in order to hedge their positions over securities; this may lead to a sudden depreciation of exchange rates without accompanying large-scale actual capital outflows. B. Diverging economic performance in Asian emerging economies Capital inflows, together with expansionary fiscal policy and inadequate structural reforms, have in the end contributed to the deterioration in the current and fiscal account balances of some economies in the ASEAN countries and South Asia (Charts 9 and 10). Since the reversal of capital flows in May 2013, these economies have responded with a tightening of monetary and fiscal policies to mitigate capital outflows. Some of them may face a slowdown in their economic growth rates for the time being, considering that such a policy action may be needed for a while. By contrast, other emerging economies, largely in East Asia, have been affected hardly at all by the financial turbulence from May 2013. These economies have generally maintained strong fundamentals, with adequate foreign reserves (relative to shortterm foreign loans) as well as surpluses in their current account and fiscal account balances. This means that foreign investors have begun to differentiate emerging economies, when investing in them, based on the soundness of their economic fundamentals. Thanks to this differentiation, the Asian region as a whole has managed to escape massive capital outflows and contagions, thereby avoiding a sharp slowdown in its overall economic growth performance. This is in contrast with the crisis in the mid-1990s triggered by Thailand, when capital outflows there spread from one economy to another (including Indonesia and South Korea). The greater availability of information about the region and greater soundness with regard to the financial system have contributed to mitigating the herding behavior of investors. Nonetheless, less affected economies also need to be well prepared for a potential rise in volatility in the securities and foreign exchange markets, which may be caused by a sudden change in investors’ sentiment and speculative activities. V. Final remarks More than five years have passed since the global financial crisis, and yet the central banks in large advanced economies continue to conduct unprecedented highly accommodative monetary policy to boost the economy and prevent disinflation. While these policies are necessary and consistent with the mandate of the relevant central bank laws, it is also true that such policies could exert spillover effects on other economies. As a result, each central bank more closely monitors developments of monetary policy adopted by those in major economies. It is also becoming crucial for central banks to monitor global investors’ risk appetite as well as capital flows and derivatives activities in considering the transmission mechanism of monetary policy. The exceptionally low interest rates set by central banks in advanced economies and their supply of ample funds through nontraditional measures they have taken, as well as speculation about their outlook, may have accelerated the pace of capital movements across the globe and enhanced linkages across securities and foreign exchange markets. At the same time, some central banks in emerging economies may be conducting “asymmetric” BIS central bankers’ speeches monetary policy to mitigate the volatility of exchange rates – that is, the conduct of accommodative monetary policy during a period of capital inflows and high economic growth on the one hand, and that of tight monetary policy during a period of capital outflows and sluggish economic growth on the other. Such asymmetric monetary policy is likely to amplify the boom-bust cycle in emerging economies and contribute to a rapid increase in global commodity prices. There is no consensus among central banks as to whether the major factor contributing to capital flows and related problems arises mainly from the side of advanced economies or the side of emerging economies. Nor is there a consensus with respect to appropriate prescriptions in such circumstances. In this situation, efforts have been made to cope with the rapidly changing global economic environment. Among advanced economies, for example, the six central banks – the Bank of Canada, the BOE, the BOJ, the ECB, the Federal Reserve, and the Swiss National Bank announced in October 2013 that the existing temporary bilateral liquidity swap arrangements (established in 2007 and due to expire in February 2014) will be converted to standing arrangements and remain in place until further notice. The arrangements allow for the provision of liquidity in each jurisdiction in any of the five currencies foreign to that jurisdiction, should the two central banks in a particular bilateral swap arrangement judge that market conditions warrant such action in one of their currencies. The arrangements have helped to ease strains in financial markets, especially in the euro area. In the Asian region, meanwhile, the Chiang Mai Initiative Multilateralization (CMIM) has been established from the viewpoint of monitoring capital flow movements and improving crisis prevention and management capacity. In May 2012, the decision was reached to amend the CMIM agreement in order to (1) double the size of the CMIM from 120 billion to 240 billion U.S. dollars, (2) introduce a crisis prevention facility of the Precautionary Line, and (3) minimize the IMF-linked portion from 80 percent to 70 percent (and further to 60 percent in 2014 upon the review of certain conditions). The ASEAN+3 Macroeconomic Research Office (AMRO) was established in Singapore in April 2011 as an independent regional surveillance unit to monitor and analyze regional economies and support CMIM decisionmaking. Lastly, I would like to stress that the global financial crisis and the rapidly changing global economic environment have presented new challenges for central banks on a global scale. In this light, it is becoming important to promote communication among central banks, as well as with the markets and the public. Such initiatives will allow for discussion on the development of new systems and mechanisms as well as on appropriate policy methods, and may become an essential step to the search for a better international financial architecture, and ultimately the stability and prosperity of the global economy. I would like to end my speech 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 BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a meeting with business leaders in Miyazaki, 6 February 2014.
Kikuo Iwata: Japan’s economy and monetary policy Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a meeting with business leaders in Miyazaki, 6 February 2014. * * * Introduction It is my great pleasure to speak before the people of Miyazaki Prefecture. I would like to express my sincere gratitude to you for your cooperation with the activities of the Bank of Japan, especially of our Kagoshima Branch and Miyazaki Office. Let me start with a personal note. When I was a high school student, a long time ago, I came to Miyazaki in early spring during a trip around Kyushu. Today, it is my great pleasure to be back here after a long while. I recall fond memories of my youth, such as the brightness of the Nichinan coast and the beautiful fields of mustard flowers. Over the years, I have consistently emphasized from an academic viewpoint that the biggest challenge for Japan’s economy is to overcome deflation at the earliest possible time and that the role of monetary policy is crucial. It is for this reason that I accepted the post of deputy governor last March. I have a strong desire and willingness to meet this challenge of overcoming deflation that has entrenched Japan’s economy for decades, and want to make my best effort to eliminate it once and for all. This desire is embodied in a new policy framework called quantitative and qualitative monetary easing (QQE), which was introduced on April 4 last year. Under the QQE, the Bank aims to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) and continue with the QQE as long as it is necessary for maintaining that target in a stable manner. Based on this, it has been steadily increasing the monetary base, mainly through the purchase of long-term Japanese government securities. Looking at recent economic and financial developments, Japan’s economy has steadily been pursuing its course toward overcoming deflation. In my view, however, the impact of monetary easing will be full scale from now on, and it is particularly important for the Bank to facilitate a deeper understanding of monetary policy within the public by explaining our aim and commitment under the QQE in order to ensure that its expected effects will be realized. Today, before exchanging views with you, I will first explain the Bank’s assessment of the current and future developments in economic activity in Japan and overseas. Next, I will explain the background and underlying thinking behind the QQE. I. Current and future developments in economic activity in Japan and abroad A. Current and future developments in Japan’s economy First are the current and future developments in economic activity in Japan. Japan’s economy has continued to recover moderately, underpinned by a virtuous cycle among production, income, and spending. This cycle is currently at work both in the corporate sector and the household sector. On the price front, the year-on-year rate of increase in the CPI excluding fresh food has been widening across an increasing number of items, having registered 1.3 percent in December 2013. The CPI excluding food and energy has also been improving, with its rate of increase having registered 0.7 percent in December 2013. BIS central bankers’ speeches Looking ahead, while domestic demand is likely to maintain firmness, external demand is expected to increase, albeit moderately, and the virtuous cycle among production, income, and spending is likely to be maintained. Against this backdrop, while the economy will be affected by the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike, it is expected to continue growing at a pace above its potential, as a trend. At the monetary policy meeting held last month, the Bank reviewed its outlook for economic activity and prices through fiscal 2015. The medians of the Policy Board members’ forecasts for the real GDP growth rates are 2.7 percent in fiscal 2013, 1.4 percent in fiscal 2014, and 1.5 percent in fiscal 2015, respectively. As for prices, the Bank expects moderate inflation – accompanying a rise in wages – to continue in light of improvement in the aggregate supply and demand balance on the back of this economic development, and of rising inflation expectations. Looking at the outlook for prices in more detail, the inflation rate – on the basis of figures excluding the direct effects of the consumption tax hikes – is likely to be around 1¼ percent until this summer as the positive contribution stemming from the rise in energy prices such as petroleum prices will gradually decline while the underlying upward pressure on prices is likely to strengthen. Subsequently, however, against the background of further improvement in the aggregate supply and demand balance and the rise in the medium- to long-term inflation expectations, the inflation rate is expected to pick up and is likely to reach the price stability target of 2 percent toward the latter half of the projection period. Again, citing the medians of the Policy Board members’ forecasts, the inflation rate is expected to register 0.7 percent in fiscal 2013, 1.3 percent in fiscal 2014, and 1.9 percent in fiscal 2015. B. Looking to the future Let me now elaborate on several points that deserve particular attention in terms of realizing the outlook for economic activity and prices that I just mentioned. I will first touch on issues related to domestic demand, followed by those concerning external demand. Effects of consumption tax hike As far as domestic demand is concerned, the first is the effects of the consumption tax hike. From this April, the consumption tax will be raised from the current 5 percent to 8 percent. The tax hike will affect the economy through two channels. First, it will generate the frontloaded increase and subsequent decline in demand prior to and after the hike. Second, it will lead to a decline in disposable income. As for the first channel, while the front-loaded increase in spending has already been observed in the areas of housing investment and spending on durable goods such as automobiles, the growth rates of the October–December quarter in 2013 and the January– March quarter in 2014 are expected to be quite high on the back of the front-loaded increase in consumer spending. By contrast, the growth rate for the April–June quarter in 2014 is likely to decline due to the subsequent drop in spending. That said, after entering the July– September quarter in 2014, the economy will likely return to a growth path above its potential without losing momentum toward economic recovery as the effects of the subsequent decline in spending will gradually ebb away, public investment will remain at a high level, and exports and business fixed investment are expected to increase moderately. Having said all this, some people may be more cautious about the outlook for the economy because the tax hike will impose a negative impact on households’ disposable incomes. In my view, such a negative effect will be mitigated due to the following reasons. First, various economic measures are being taken by the government. Second, the tax hikes seem to have already been factored in substantially among households. And third, the rate hikes are expected to have the effect of alleviating households’ future concerns over the fiscal condition and the social security system. In sum, the consumption tax hike will temporarily generate a swing in the economy’s growth rates and negatively affect disposable income. Despite such developments, the virtuous BIS central bankers’ speeches cycle that has already been working in Japan’s economy will continue and the economy is likely to continue growing at a pace above its potential, as a trend. Employment and income situation The second issue related to domestic demand concerns the employment and income situation. The current economic recovery is characterized as being driven by domestic demand such as private consumption and public investment. Going forward, in order to maintain the firmness in domestic demand, it is important that the improvement in the employment and income situation continue to sustain private consumption. In particular, in the context of rising prices, wages have to rise in a balanced manner to ensure sustainable growth in the economy. Looking at the current developments in employment and income, the supply and demand balance in the labor market continues to improve moderately. The unemployment rate is in the range of 3.5–4.0 percent and the active job openings-to-applicants ratio stands at just over 1.0. That is, they have reached the levels seen prior to the Lehman crisis. Likewise, according to the December 2013 Tankan survey (Short-Term Economic Survey of Enterprises in Japan), the employment conditions DI shows that insufficiency in employment was aggravated, particularly within the nonmanufacturing sector. In these situations, the year-on-year rate of change in total cash earnings of full-time employees per employee has registered an increase, albeit marginally, against the backdrop of increases in non-scheduled cash earnings (i.e., overtime payment) and special cash earnings (i.e., bonuses). Moreover, hourly cash earnings of part-time employees have continued to increase moderately year-onyear. Looking ahead, from somewhat of a longer-term perspective, an uptrend in total cash earnings is expected to gradually become evident, accompanied by a pick-up in scheduled cash earnings, including base pay, on the back of the improvement in corporate profits and the rise in inflation expectations, in addition to tighter labor supply and demand conditions brought about by economic recovery. Cooperation among the government, workers, and employers in order to realize the virtuous cycle is also expected to contribute to a pick-up in wages. Against the background of continued improvement in the employment and income situation, private consumption will likely remain resilient as a trend despite downward pressure on disposable income stemming from the tax hike. Business fixed investment The last issue related to domestic demand concerns the outlook for business fixed investment. Corporate profits have improved, and business fixed investment has been picking up against this backdrop. As machinery orders – a leading indicator of machinery investment – clearly show signs of picking up, the improving trend in investment in the manufacturing sector, which was somewhat lagging, has become more evident. Going forward, on the back of continued improvement in corporate profits, as the effects of monetary easing – particularly through the decline in expected real rates – will materialize at full scale, business fixed investment is likely to follow an increasing trend. Investment in the manufacturing sector is also likely to gain momentum as exports are expected to increase moderately during the course of the recovery in overseas economies. This is an issue that I will now talk about. Overseas economies and exports Next, I would like to explain external demand. While Japan’s exports have been picking up as a trend, they still lack momentum. Looking ahead, whether an increase in exports will become evident is critical for Japan’s economy. While some emerging economies still face lackluster performance, overseas economies – particularly advanced economies such as the U.S. and European economies – are starting to recover. As for the outlook, overseas economies are expected to continue recovering moderately, mainly driven by advanced economies. According to the global outlook report BIS central bankers’ speeches released by the International Monetary Fund last month, the growth rate of the global economy is expected to rise gradually at a projected pace of 3.0 percent in 2013, 3.7 percent in 2014, and 3.9 percent in 2015. On a regional basis, the downside risk of the U.S. economy has declined, reflecting progress in the fiscal situation. The economy is likely to grow at a faster pace as downside pressure from the fiscal side will ebb away. As for the European economy, while further developments regarding the European debt problem still require attention, financial markets have shown stable performance, as exemplified by the decline in interest rates of sovereign bonds issued by peripheral countries. The economy as a whole has become increasingly resilient. In China, the authorities have positioned themselves to address structural problems while paying due regard to economic growth, and the Chinese economy is expected to grow at a pace similar to where it is now. By contrast, some emerging economies – including the ASEAN economies – continue to show lackluster performance. They are expected to lack momentum in terms of growth for some time while they are faced with structural problems such as fiscal deficits and current account deficits. In the medium- to long-term, however, as the economic recovery in the United States, Europe, and China starts to spread, they will gradually gain growth momentum. In light of these developments, exports from Japan are picking up but are lacking momentum somewhat. There are several reasons behind this. While a structural factor such as a shifting of production sites to overseas by the manufacturing companies may have a role to play, there is a more fundamental issue of the effects stemming from moderate growth in the ASEAN economies that are closely tied with Japan, possibly having a large impact on the exports’ performance. Indeed, analyzing exports to different regions, while exports – mainly of automobiles – to the United States have been on an increasing trend and those to Europe and China are picking up as a trend, those to the ASEAN economies continue to show somewhat weak performance. Down the road, exports to the United States, Europe, and China will continue to pick up and those to the emerging economies including the ASEAN economies, where somewhat weak performance has been observed, are expected to start picking up as growth in these economies gathers momentum. Thus, exports on the whole will likely increase moderately as overseas economies recover. II. Conduct of monetary policy A. Details of the QQE and its transmission mechanism Next, I would like to explain the thinking behind the QQE. The QQE consists of two pillars. The first pillar is the commitment under which the Bank will achieve the price stability target of 2 percent as soon as possible. In its statement, the Bank said that it “will achieve the price stability target of 2 percent” at the earliest possible time, “with a time horizon of about two years.” This is a strong and clear commitment by the Bank. The second pillar is to engage in actions that embody the commitment specified in the first pillar. As exemplified by the words comprising the name “quantitative and qualitative monetary easing,” these actions are to increase the “quantity” of the Bank’s balance sheet and change the “quality” of its asset purchases. An increase in quantity requires massively increasing the monetary base – that is, the amount of money the Bank supplies to the financial system – by purchasing different assets, mainly Japanese government bonds (JGBs). A change in quality requires purchasing assets with a higher risk profile. Among JGBs, the Bank started purchasing those with longer remaining maturities. In addition, it increased the BIS central bankers’ speeches amounts of purchases in exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) in order to reduce risk premiums. While the QQE consists of these two pillars, as far as its transmission channels are concerned, the most important factor of all in terms of affecting the economy is lowering expected real interest rates. The effect the QQE has of reducing nominal interest rates, coupled with the effect of lifting inflation expectations, will exert powerful downward pressure on expected real interest rates, which are derived from subtracting expected rates of inflation from nominal rates in financial markets. While nominal rates are visible, expected real rates are based on the public’s expectations, taking account of changes in prices. These expectations are akin to asking “how much would my effective purchasing power go up if I buy JGBs?” They also can be viewed as equivalent to borrowers’ expectations regarding their real costs of borrowing, taking into account price changes, when they borrow money at a certain nominal interest rate. Consequently, the lower the expected real rates, the more subdued their real cost of borrowing. The decline in expected real rates will stimulate demand in economic activity in a number of ways. For example, by encouraging the decline in those rates, investment in cash, deposits, and fixed-income securities becomes less attractive; thus, people will shift their portfolios from those financial assets to equities and tangible assets such as land and houses, or to foreign-denominated assets with higher returns. The rise in equity prices and the appreciation of foreign currencies will stimulate private consumption through the wealth effect. In addition to the decline in expected real rates, other factors – including an increase in consumption and the depreciation of the yen – will encourage firms to be more aggressive in their business fixed investment. Furthermore, exports will be expected to increase on the back of the yen’s depreciation. Through an increase in a range of demand components such as private consumption, business fixed investment, exports, and public investment, the output gap of the economy will improve by closing its negative gap, and Japan will then find its way out of deflation. The economy is also expected to maintain the virtuous cycle in which the household sector will further increase its spending on the back of a better labor supply and demand condition and higher employee income, and the corporate sector will increase its business fixed investment, supported by higher corporate profits, as an increase in demand will trigger more production. B. Working on expectations: What does it mean? As I explained earlier, one of the Bank’s challenges under the QQE is to change the way the public forms its view on inflation for the future. To work on the public’s expectations sounds somewhat ambiguous and may leave an impression with you that monetary policy is not entirely reliable. In fact, it is not only monetary policy but also other economic policies that influence the way people form their expectations. This is because human beings decide their current behavior by forming expectations for the future. As a result, it is very important to conduct policy by taking account of their expectations. Likewise, concerning expectations about economic phenomena, it is important to understand that expectations can be self-fulfilling. A simple example is as follows. If many investors buy stocks of a company based on a belief that these stocks will go up, the actual price will rise. Self-fulfilling expectations have a big impact on the actual economy. BIS central bankers’ speeches Up until recently, many people shared the view that deflation or declining prices would continue, and based on such expectations they refrained from spending and investment. This may have aggravated the deflationary environment. Put differently, deflationary expectations have generated actual deflation; hence, the situation of persistent self-fulfilling deflation. In order to overcome deflation and achieve price stability in a stable manner, it is vital to change the public’s mindset from having “deflationary expectations” to adopting “inflationary expectations.” This is why the Bank has been aggressively pursuing the QQE in order to shift their expectations. Changing the public’s expectations as a main challenge on monetary policy is surely unprecedented in the history of central banking. It is for this reason that the Bank is pursuing this policy with a strong determination to cultivate the frontier of monetary policy making. C. The QQE and increase in lending So far, I have explained that the main challenge of the QQE is to generate aggregate demand by reducing the expected real interest rates, which will lead to the overcoming of deflation. Related to this, we sometimes hear people say that lending by financial institutions has not increased no matter how much money the Bank provides by expanding the monetary base. They further point out that this may be a sign that monetary easing is not working. Let me offer my thoughts on these views. Faced with prolonged deflation, many firms including SMEs have hoarded cash and deposits; as a result, the corporate sector has registered a financial surplus. Indeed, during the deflation that lasted for some 15 years, firms restrained their business fixed investment and accumulated cash and deposits. Consequently, the total amount outstanding of cash and deposits held by the corporate sector reached as high as about 230 trillion yen. This is nearly half of Japan’s GDP. At the initial phase of getting out of deflation, firms finance their credit demand for working capital and business fixed investment with their cash at hand. Moreover, increasing cash flow will be used to repay debts; thus, none of these lead to a situation where lending by financial institutions simply increases. A pick-up in lending will only start once firms are no longer able to finance their credit demand for inventory investment or business fixed investment with their cash at hand. Moreover, during the process of overcoming deflation, stock prices will rise significantly and the markets’ expectations regarding future interest rates will also go up. Under such circumstances, more firms will decide to raise long-term funds from the capital market by issuing new stocks and bonds rather than borrowing short-term funds from banks. This is another reason for the lackluster performance in lending that exists for some time during the initial stages of overcoming deflation. More recently, a typical situation was seen during the recovery phase at the beginning of the 2000s. At that time, bank lending decreased rather than increased for some time after the economic recovery gradually gathered steam, although one needs to take note that the disposal of non-performing loans was well under way and this led to a decline in bank lending. Recent developments since end-2013 show that lending by commercial banks has increased year-on-year and the pace of increase has picked up. Compared with the economic recovery phase of the early 2000s, the pick-up in lending during the current economic recovery phase is actually stronger than originally anticipated. D. Time horizon of the QQE and further easing Next, I will explain the time horizon of the QQE and then touch on the issue of the possibility of further easing. This is a question that has received considerable attention quite recently. BIS central bankers’ speeches After exchanging views with a range of people, I was left with an impression that there is a misunderstanding that the Bank will start tightening monetary policy soon after it achieves the price stability target of 2 percent. This might be due to the fact that the message to “achieve 2 percent in two years” was forceful. On this point, the Bank has made it clear since last April, when it introduced the QQE, that it aims to achieve the price stability target of 2 percent and continue with the QQE as long as it is necessary for maintaining that target in a stable manner. Based on this commitment, the Bank promised to achieve the price stability target at the earliest possible time, with a time horizon of about two years. This commitment might not have been so clear to the public. The point I would like to emphasize is the part of commitment that reads “as long as it is necessary for maintaining that target in a stable manner.” In other words, even if the CPI reached 2 percent year-onyear, unless the Bank projects that inflation is likely to remain at around 2 percent in a stable manner, it will not simply end monetary easing. This is the commitment the Bank has made under the QQE. If the Bank judges that achieving the 2 percent target will become difficult due to some unforeseeable risk factors, then it will make adjustments in the conduct of monetary policy as appropriate. Referring to the policy statement, this has been written as follows: the Bank “will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate.” According to the Bank’s outlook, Japan’s economy is on track to achieve the price stability target of 2 percent and the year-on-year rate of increase in the CPI is likely to reach around 2 percent toward the latter half of the projection period through fiscal 2015. Taking the above outlook into account, what is most important at this juncture is that the Bank steadily make progress under the current policy framework of the QQE. E. Pace of JGB purchases In the last part of my explanation about monetary policy, let me elaborate on somewhat of a technical issue. Under the QQE, the Bank has been purchasing JGBs so that their amount outstanding will increase at an annual pace of about 50 trillion yen. This 50 trillion yen is equivalent to a net purchase – i.e., subtracting the amount of redemption from that of new purchases. As JGBs that had already been purchased by the Bank in the past come to maturity, it is necessary to offset such reduction in the amount outstanding held by the Bank, through additional purchases of (i.e., reinvestment in) JGBs. Therefore, on a gross basis, the amount of purchases should far exceeded 50 trillion yen, and naturally the amount of purchases on a gross basis will change depending on the amount of redemption (i.e., the amount of reinvestment). Nevertheless, there is a view in the market that an increase or decrease in the amount of purchases on a gross basis reflects changes in the Bank’s monetary easing stance. Let me emphasize that the amount of purchases on a gross basis may increase or decrease depending on the amount of redemption; thus, it is by no means a tapering of the pace of JGB purchases nor a reduction of quantitative easing as long as the annual pace of purchases on a net basis remains about 50 trillion yen. Furthermore, the JGB purchases are carried out in a flexible manner from the perspective of putting downward pressure on interest rates across the yield curve while taking account of financial market conditions. Owing to these reasons, monthly purchases can change depending on developments in the financial markets. Indeed, when we look back at the track record since last April, monthly purchases have fluctuated in the range of about 6–8 trillion yen from one month to the next. BIS central bankers’ speeches Concluding remarks Let me finish my remarks by touching on the economy of Miyazaki Prefecture. Miyazaki’s economy was hit harshly by a number of natural disasters from 2010 to 2011 – namely, foot-and-mouth disease, avian flu, and the eruption of the Shinmoedake volcano. After that, the economy started to pick up gradually, as seen in the improvement in the tourism sector. I would like to extend my great respect for the efforts made by those who have confronted and overcome such difficulties during those years. From somewhat of a medium- to long-term perspective, Miyazaki produces a variety of foods and there are many items – such as livestock and vegetables – for which production is at the top in Japan. Some of them are so renowned that they are named after Miyazaki, such as “Miyazaki mango” and “Miyazaki beef.” There are many picturesque places that are deeply rooted in Japan’s historical record of ancient matters, such as Kojiki and Chronicles of Japan, as well as attractive touristic places set in the exotic locale of a southern land. Furthermore, Miyazaki is famous as a spring training base for professional baseball teams and has hosted major golf tournaments. By taking full advantage of its abundant resources and environment and capturing the potential demand of consumers, Miyazaki can further reinvigorate its economy. There are a number of achievements that have highlighted your dedicated efforts over the years. One is that Miyazaki beef was awarded the gold medal in 2012 at a contest, held once every five years, to select the best Wagyu beef in Japan. This was the first time the same brand of beef had received this award on a consecutive basis. Another is that production of Miyazaki caviar started at end-2013 after almost 30 years of R&D activity. Going forward, construction of the East Kyushu Highway will be accelerated, extending from Miyazaki City to Kita-Kyushu City in fiscal 2014. In addition, the number of scheduled flights connecting Miyazaki and Taipei will go up next month. All these factors show that the social infrastructure in transportation will be built at an accelerated pace and this will further extend the chance for Miyazaki’s economy to take a major step forward. I sincerely hope that all the endeavors people in Miyazaki are making will bear fruit and contribute to the further growth and prosperity of your esteemed prefecture. Thank you. BIS central bankers’ speeches
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Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the International Bankers Association of Japan, Tokyo, 27 February 2014.
Takehiro Sato: Maximizing the potential of Japanese government bonds (JGBs) as global financial assets – recent initiatives to improve the market infrastructure for JGB settlement Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the International Bankers Association of Japan, Tokyo, 27 February 2014. * * * Introduction It is a great honor to have this opportunity to speak at the International Bankers Association (IBA) of Japan. As an association of international financial institutions serving Japan’s financial markets, IBA has an impressive track record in facilitating exchange of views among member financial institutions and fostering dialogue with the relevant authorities. Through those activities, IBA greatly contributes to Japan’s economy as well as the development of financial markets in Japan. I pay my respect and extend my gratitude for constant efforts by the IBA members. Today, I will talk about the payment and settlement services provided by the Bank of Japan. In particular, I will focus on the future services for the settlement of Japanese government bonds (JGBs). The Bank has long put a great deal of effort into the development of payment and settlement systems. Currently, we are carrying out a major project to renew the Bank of Japan Financial Network System or the BOJ-NET, which forms an essential part of Japan’s payment and settlement systems. I will talk about this project in more detail later on. To leverage a new capability in the new BOJ-NET, we are discussing with the market participants, including several IBA members of course, the possible extension of the BOJNET operating hours. After those payment and settlement issues, I will close my speech with some remarks about the Bank’s recent conduct of monetary policy. I. Role of the Bank of Japan in payment and settlement systems The Bank of Japan plays a multi-faceted role in Japan’s economy. It is responsible for monetary policy and, at the same time, as a bank for banks, it provides banking services and maintains the stability in the settlement of funds and securities in Japan. The Bank plays a multi-faceted role in the field of payments and settlements, too. First, the Bank provides account and settlement services for the Japanese yen and JGBs. Second, the Bank encourages the operators of private-sector payment and settlement systems to maintain and enhance the safety of their services, an important activity which is commonly called “central bank oversight.”1 Third, the Bank cooperates with market participants and supports your initiatives to review and improve market practices related to trading, payment, clearing and settlement. Here I will focus on our role as an operator of the JGB settlement system and talk about what has been done to date and what will be done in the future. Central bank oversight of Financial Market Infrastructures (FMIs) is defined as the central bank’s activities to monitor the design, risk management, and operations of FMIs; to assess them against established safety and efficiency objectives; and to induce changes where necessary. In its oversight of FMIs, a central bank seeks to establish a common understanding with FMI operators and other stakeholders on ways to maintain and improve the safety and efficiency of FMIs, and support their efforts for improvements. Through those activities, the central bank aims to ensure the safety and efficiency not only in individual FMIs but also in the overall FMI in an economy. BIS central bankers’ speeches II. Initiatives to improve the safety of JGB settlement The Bank of Japan implemented online processing of JGB settlement back in 1990 (Chart 1). For the past quarter century, the Bank has been working with the JGB market players on various initiatives aimed at improving the safety of JGB settlement. Those include the introduction of a delivery-versus-payment (DVP) mechanism2 for JGB transactions and the changeover from deferred net settlements (DNS) to real-time gross settlements (RTGS).3 Meanwhile, market participants and the Bank worked together to achieve a new market practice of the rolling settlement of JGBs, in which settlements take place every business day. Before the introduction of the rolling settlements, settlements took place only several times a month. In addition, the Bank encouraged market participants to introduce a central counterparty, or CCP in short, for JGB transactions and subsequently supported the CCP’s efforts to strengthen its risk management. Those efforts by market participants over the years helped prevent the failure of Lehman Brothers from causing devastating ripple effects across the whole financial market in Japan.4 It is also true, however, that the experience of the recent financial crisis revealed a few challenges of making the clearing and settlement of JGBs more robust. That has led market participants to make constant efforts to improve the safety of JGB settlement. I will illustrate two major examples of such market initiatives. One is to shorten the JGB settlement cycle, which is aimed at shortening the time-lag between the execution of JGB trading and their settlement. The other is to widen the use of a CCP and the reinforcement of its risk management that is commensurate with the wider use. A. Shortening of JGB settlement cycle First, let me talk about the issue of a settlement cycle of JGBs (Chart 2). Since the late 1990s, a shorter settlement cycle for JGB transactions has been a major goal in the reform of Japan’s securities settlement systems. The longer the time-lag between trading and settlement, the more unsettled positions, leading to a build-up of settlement risk. Actually, the risk became imminent in the financial crisis of autumn 2008, when the failure of Lehman Brothers resulted in a significant amount of settlement failures in the delivery of JGBs. Market participants who had entered JGB trading with the failed financial institution had to go through time-consuming procedures for terminating unsettled transactions and replacing them with new ones in the markets. Those events highlighted the importance of reducing the time-lag between trading and settlement and led market participants to establish a working group under the Japan Securities Dealers Association in order to identify and examine the issues related to a shorter settlement cycle for JGB transactions. Based on the study by the working group, the JGB market moved to the shorter settlement cycle, from T+3 to T+2, in April 2012. There are on-going efforts by market participants toward a shorter settlement cycle with an aim of achieving T+1 for JGB transactions by the earliest possible time after 2017. The issues currently being reviewed include possible changes to trading practices and the creation of a market-wide infrastructure for collateral management. In addition to the DVP is a mechanism which ensures that “a delivery of securities occurs if, and only if, payment occurs.” DVP mechanism eliminates the principal risk associated with settlement of a securities transaction, which sometimes results in a large-scale loss. Compared with DNS, RTGS substantially reduces systemic risk. Systemic risk materializes when one participant fails to settle its transactions, especially in a DNS system. DNS is a settlement mode which effects settlement of transactions among counterparties on a net basis at designated times. In conjunction with those improvements in the safety of JGB settlement, a number of improvements have been made in terms of the efficiency of JGB trading and settlement, including (1) the introduction of market practices on the bilateral netting and fails-to-deliver when the changeover to RTGS was done and (2) the creation of the JGB repo market when the rolling settlement was introduced. BIS central bankers’ speeches expected benefit of reducing settlement risk, the shorter settlement cycle is expected to help increase the market liquidity in that it makes it easier to quickly convert financial assets into cash. The Bank is providing active support for the project. B. The wider use of a CCP for JGBs and the reinforcement of its functions Let me now turn to the second example of a market initiative, which is the wider use of a CCP and reinforcement of its functions (Chart 3). During the financial crisis, the JGB market, and Japan’s financial market more broadly, were able to avoid the contagion of disruptions thanks to the clearing function of Japan Government Bond Clearing Corporation (JGBCC), which is today’s Japan Securities Clearing Corporation or JSCC in short. As you know, JSCC is a CCP for over-the-counter (OTC) JGB transactions and plays the role of a buyer to every seller and the role of a seller to every buyer, and provides guarantee for settlements even in the case of the default of a buyer or seller. That experience highlighted the importance of central clearing and led market participants to promote the wider use of JSCC in JGB transactions. Against that background, trust banks, which are major providers of funds in the JGB repo market, are expected to use JSCC in the form of so-called “repo trust” in the first half of 2014. Benefiting from the lessons during the financial crisis, JSCC is reviewing and strengthening its risk management including loss-sharing arrangements, contingent liquidity lines and participant default procedures so that its risk management remains robust enough in light of the growing clearing volume with new users. I am sure those measures will greatly enhance the JGB settlement infrastructure and the Bank will continue encouraging JSCC’s efforts through daily activities of the central bank oversight. III. Initiatives to increase the efficiency of JGB settlement For payment and settlement systems, striking a balance between safety on one hand and efficiency and convenience on the other hand is the key. A settlement service that is convenient but less safe may attract users for a short period of time, but it is likely to lose them in the long run. On the contrary, a safe but inconvenient service cannot fully fulfill the potential of its safety, because settlement demand moves away from such an inconvenient service. Since the latest financial crisis, a series of new regulations have been introduced and that certainly has contributed to greater safety of payment, clearing and settlement, and the global financial system. A flip side to this, in my view, is that the enhancement of efficiency and convenience is somewhat left behind. So, while there is no doubt we need to implement the on-going measures for greater safety as planned, it is essential that we now make more efforts to improve the efficiency of JGB settlement so that we can better meet the existing and emerging needs of the industry and financial markets. I am sure such improvement in efficiency will support Japanese companies and financial institutions in expanding their businesses, make JGBs as well as Japan’s financial markets more attractive and competitive, and ultimately stimulate the Japanese economic growth. A. Enhancement of cross-border settlement In that regard, I emphasize that cross-border activities should be one of our primary targets in enhancing the efficiency and convenience of payment and settlement systems. For example, Japanese companies are expanding their businesses in the overseas markets, especially in Asia, and consequently their traffic of cross-border funds transfer in the Japanese yen is growing (Charts 4 and 5). Naturally, Japanese financial institutions are increasing their overseas lending in line with the growing foreign business of their customers, and therefore it is becoming very important for them to have stable sources of funding in foreign currencies, for example, by making use of financial assets denominated in the Japanese yen that they have abundantly on their balance sheets. In addition, as more and more non-residents are investing in JGBs, there are growing business opportunities to offer JGB custody services to foreign customers. Furthermore, there is an increasing awareness BIS central bankers’ speeches among market participants that the new regulations related to OTC derivatives, for instance, are likely to increase the importance of market infrastructures that support flexible mobilization of JGBs and other high-quality collateral assets. How could Japan’s future settlement infrastructure address those environmental changes that I just mentioned? In my eyes, the future settlement infrastructure should offer an environment that facilitates the smooth delivery of the Japanese yen and JGBs anywhere, anytime, which I would call the ubiquity of the Japanese yen and JGBs. To increase the usability of JGBs as high-quality financial assets will benefit not only financial institutions in Japan but also broader financial markets around the world. The outstanding balance of JGBs is fairly close to that of the U.S. Treasuries, but the U.S. Treasuries are currently used as collateral much more widely in global financial markets. If we look at the bright side of this, JGBs have much room for expanded use as collateral in global financial markets. More broadly, various initiatives are already underway to achieve more efficient and convenient settlement systems, in particular with respect to cross-border settlements. In the ASEAN+3 region, market participants and the authorities, including central banks, are working to improve cross-border securities settlement infrastructure in their efforts to stimulate cross-border securities transactions in the region. In Europe, international central securities depositories are upgrading their global collateral management services that help mobilize collateral assets across borders. In Japan, as I mentioned earlier, market participants are reviewing the case of developing a collateral management infrastructure that will support the achievement of the shorter settlement cycle for JGBs. Such a collateral management infrastructure, if established, will also provide leverage in the improvement of cross-border settlements of JGBs in the future. Combining those initiatives in Japan and abroad, the Bank of Japan’s efforts to improve its payment and settlement systems will be one piece of the puzzle to make global settlement infrastructure safer and more efficient, and hopefully contribute to the growth of the Japanese and global economies. B. Central bank cross-border collateral arrangements Now, let me talk about another example of the enhancement of cross-border settlement infrastructure, which is a cross-border collateral arrangement for JGBs among central banks. The Bank of Japan has been collaborating with other central banks to establish such arrangements, where a foreign central bank provides liquidity in its local currency against JGBs to its counterparty financial institutions, using the Bank of Japan as a custodian for receiving JGB collateral from those financial institutions. The Bank has been working with Asian central banks to establish such cross-border collateral arrangements. For example, we worked with the Bank of Thailand to establish an arrangement for providing the Thai Baht liquidity against JGBs, which has been put into effect since November 2011 (Chart 6). In addition, we have made an agreement with the Monetary Authority of Singapore and separately with the Bank Indonesia to establish similar arrangements.5 With those arrangements, Japanese banks and other financial institutions will have additional sources of local currencies from local central banks in stressed funding conditions in local financial markets. That backstop will enable global financial institutions to manage their liquidity in each local currency more stably, which will in turn facilitate their stable lending to corporate customers in local currencies. In addition, six central banks, namely the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, the National Bank of Switzerland, and the Bank of Japan, have set up foreign exchange swap arrangements as a liquidity backstop. BIS central bankers’ speeches C. Toward the regional securities settlement infrastructure in Asia The cross-border collateral arrangements that I just mentioned provide a liquidity backstop in times of stress. In that respect, market-based solutions for stable daily funding in foreign currencies are just as important as, or possibly more important than, those central bank arrangements. As part of the response to such market needs, the ASEAN+3 countries established a forum to explore the possibility of establishing cross-border settlement infrastructure in the region (Chart 7). This forum discusses several possible models for such infrastructure. One idea is to link a securities settlement system in one country with a central-bank-operated payment system in another country. Another idea is to set up a cross-border link between securities settlement systems. With such cross-border links, market participants will be able to settle foreign-currency funding transactions against domestic collateral assets, known as crosscurrency repos, in safe central bank money on a DVP basis. Further, with such links, local investors will have easier access through their local securities settlement system to foreign securities, which will help increase intra-regional securities investment in the long run. Given that market participants and central banks are undertaking similar initiatives in Europe with an aim of improving securities settlement across borders in the region, it would be conceivable that market participants in Asia will start dialogue with their counterparties in regions outside Asia to review the possibility of a cross-border link between settlement infrastructures. IV. Development of the new BOJ-NET and extension of its operating hours Now, let me move on to the new BOJ-NET. Here I will talk about the possible extension of the BOJ-NET operating hours, which the Bank of Japan and market participants are intensively discussing, and the new features that will become available with the completion of the new BOJ-NET. I will try to put those points in the context of the enhancement of crossborder settlements. A. The development of the New BOJ-NET We have been developing the new BOJ-NET to replace the whole IT platform of the current BOJ-NET. The main purpose is to develop a flexible system that can respond to on-going and future market developments such as the globalization of financial markets and increasing interconnectedness among market infrastructures. The new BOJ-NET is built upon an IT platform equipped with a technical capacity of operating substantially longer hours so that it can respond to user demand for settlements early in the morning and late at night. The possible extension of BOJ-NET operating hours will create a larger overlap between the operating hours of the BOJ-NET and those of the overseas payment and settlement systems, which will provide a solid foundation for the possible future enhancement of cross-border settlements that I talked about earlier. The new BOJ-NET employs the latest information technology for improved convenience for users. For example, the new BOJ-NET adopts a new technology which facilitates the acceptance of different data formats and communication protocols. It also adopts ISO20022, internationally accepted message formats. Those new features will be introduced in order to enhance the accessibility to the BOJ-NET by other domestic or foreign infrastructures and financial institutions. As those new capabilities will be widely utilized, the new BOJ-NET will demonstrate a greater ability to support financial institutions that seek to achieve a higher level of straight-through processing and to address the future increase in cross-border settlements. The new BOJ-NET is being developed in two phases in order to make a smooth transition to the new system (Chart 8). In January this year, the first phase of the new BOJ-NET was launched, as originally planned, with the services related to the auction for JGB issuance and BIS central bankers’ speeches those related to the monetary policy operations. The new BOJ-NET has been operating smoothly since its introduction, and I am grateful to all IBA members and other market participants for making this happen. In the second phase, all the remaining services, including core services related to the settlement of funds and JGBs, will migrate to the new BOJ-NET. The second phase is currently planned to be launched sometime between the autumn of 2015 and the beginning of 2016. B. The operating hours of the BOJ-NET The Bank of Japan made an announcement that, with the launch of the second phase, the BOJ-NET Funds Transfer System and JGB Services would start their daily operation at 8:30 a.m., which is 30 minutes earlier than the present, and close the operation at 7:00 p.m., which is two and a half hours later than the present with respect to JGB services. In addition, the Bank formed an industry forum in August last year to discuss the possibility of extending the operating hours of the BOJ-NET further beyond 7:00 p.m. The forum consists of major market players and industry representatives including of course the IBA secretariat and several member institutions of the association. I am very much grateful for your active involvement in this important work. I hear that this industry forum will be soon delivering a report with the results of their reviews and that the discussion has demonstrated that a great majority of participants see a huge advantage in extending the operating hours up to 9:00 p.m. as an initial step in maximizing the use of JGBs as collateral in global financial markets and providing their customers outside Japan with improved Japanese yen remittance services (Chart 9). In response to the forthcoming report by the forum, the Bank will make its decision on the operating hours and related issues in due course. The extension of the operating hours will conceivably open up a new opportunity for the greater use of JGBs in global financial markets (Chart 10). For example, as the discussion of the forum has made clear, market participants in Japan would be able to deliver JGBs to CCPs and trading counterparties overseas in response to a margin call for derivatives transactions and get back excess collateral immediately when it becomes available for return. In addition, market participants would be able to obtain liquidity in overseas markets more conveniently with the same-day cross-currency repo against JGBs. Further, financial institutions with a large amount of JGBs in their portfolios would see a greater opportunity for transactions in global securities lending markets for high-quality collateral assets. C. The future of JGB settlement As I said earlier, in the future of JGB settlement, the smooth delivery of JGBs and associated payments in the Japanese yen across borders and across time zones will no longer be a luxury that may be unaffordable today. The Bank will strive toward such future vision in close cooperation with market participants. In doing so, we will be making Japanese financial markets more attractive to diverse sources of investment. As part of those efforts, the Bank will continue to review a range of possibilities for improving the accessibility of the BOJ-NET such as the possible extension of the BOJ-NET operating hours as I mentioned earlier. It is not an easy task to develop market infrastructure that will form the backbone of market’s trading and settlement activities, not least because it will involve many actors and a considerable amount of time and cost. It is therefore crucial that market players including the IBA members, as well as the operators of settlement infrastructures including the Bank of Japan, keep a long-term perspective and cooperate steadily to achieve better market infrastructure. For that reason, I would like to ask for your continued support and cooperation in the area of payment, clearing and settlement. V. Conduct of monetary policy Lastly, let me touch on the recent conduct of monetary policy. BIS central bankers’ speeches It has been almost a year since the Bank introduced quantitative and qualitative monetary easing (QQE) last April. Economic activity and prices have been broadly in line with the baseline scenario presented in the Outlook Reports and interim assessments. Accordingly, the Bank’s policy board has judged it appropriate to steadily pursue the QQE under its current guidelines of asset purchases. Meanwhile, I acknowledge that there is a wide range of views in financial markets concerning how long the QQE will last and whether or not the Bank needs to take further easing measures. Those views are based on a belief that it is not easy, or at least takes more time, to achieve the outlook – particularly that for prices – presented in the Bank’s baseline scenario. As a policymaker, I am somewhat hesitant to comment on those views, but let me provide my thoughts specifically on the policy duration of the QQE, as communication with the market is a matter of significant importance to us. First of all, let me stress that the Bank, in its conduct of the QQE, has made a firm commitment. That is, to achieve the price stability target of 2 percent in terms of the year-onyear rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years. At the same time, the Bank has made it clear that it will continue with the QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. In my understanding, there are three things about the policy duration of the QQE. First, the QQE does not automatically end in two years. It does not imply that the Bank can step back, no matter how small, from the commitment to achieve the 2 percent price stability target at the earliest possible time, with the time horizon of about two years. Second, the commitment to achieve the 2 percent target in about two years does not contradict the policy to continue with the QQE as long as it is necessary for maintaining that target in a stable manner. In my view, the phrase “as long as it is necessary for maintaining that target in a stable manner” embodies the Bank’s forecast targeting. If, for example, the Bank judges that the inflation rate of 2 percent can be achieved on a sustainable basis after taking account of various conditions, it will exit from the current policy before the actual rate of inflation reaches 2 percent, taking the lagged effects of monetary policy actions into consideration. Conversely, the Bank will continue with the QQE even after the actual rate of inflation reaches 2 percent, if it judges that the inflation rate of 2 percent is not sustainable. “As long as it is necessary” is a notion that enables the Bank to act flexibly in response to uncertainties that may arise in the future, and complementary to the strong and bold commitment that I described earlier. Third, the price stability target of 2 percent constitutes part of a flexible policy framework akin to those frameworks adopted by major central banks overseas. Put differently, monetary policy requires long and variable time lags before its effects permeate the economy, and thereafter prices. From the perspective of achieving a sustainable growth path in the context of price stability, monetary policy needs to be flexible by examining the current conditions and the outlook for economic activity and prices, as well as various risk factors including the accumulation of financial imbalances. Such an idea of flexible monetary policy has been widely shared with other countries. Particularly in the aftermath of the global financial crisis, major overseas economies have become increasingly attentive to the flexibility of monetary policymaking by laying out the importance of paying due attention to the stability of the financial system. From that viewpoint, the price stability target is by no means a rigid and superficial framework which calls for the inflation rate to touch 2 percent temporarily. It is a flexible and practical framework which accommodates the needs arising from economic developments. As described in the minutes of the Monetary Policy Meeting held on October 31, 2013, my own view on the outlook for prices is somewhat more cautious than the majority view of the Bank’s Policy Board members. That does not mean that I am skeptical of the QQE’s effects, nor does it mean that I deny the ability of the QQE’s transmission mechanism – envisaged by the Policy Board – to shift people’s expectations. BIS central bankers’ speeches My understanding is that the price stability target is not to be aimed at with surgical precision, but rather that it represents a flexible policy framework in which some margins – both upside and downside – should be accommodated. Based on this understanding, I see some latitude with regard to the achievement of the 2 percent price stability target. On that point, what the price stability target aims to achieve after all is not simply a rise in prices. Rather, it aims to achieve a situation in which a rise in prices is accompanied by a rise in wages, coupled with an improvement in the overall economy. Down the road, people will become increasingly more sensitive to a rise in prices as Japan sees the consumption tax hike occur this coming April. Under such circumstances, we have to avoid leaving an impression that the Bank has been solely pursuing a pick-up in prices without due attention to the economy. It is for that reason that I emphasize once again the flexible nature of the policy framework to achieve the 2 percent price stability target. 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 Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a seminar held at Columbia University, New York City, 27 February 2014.
Sayuri Shirai: Monetary easing and communication policy – a review based on several surveys Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a seminar held at Columbia University, New York City, 27 February 2014. * I. * * Introduction It is a great honor to be here today and have the opportunity to speak at Columbia University. I would like to add how very nice it is to return to this university, where I received my Ph.D. in economics, and I am looking forward to exchanging views with professors and students after my presentation. Today, I would like to talk about communication on monetary policy – a topic of growing interest among central banks – in the context of the Bank of Japan. To begin with, let me pose a question: why do central banks pay special attention to their communications on monetary policy with the public (meaning market participants and the general public)? I think there are at least three reasons: (1) to ensure central bank accountability; (2) to enhance the effectiveness of monetary policy; and (3) (in a narrower sense) to make active use of communication as a nontraditional monetary easing measure among central banks in the face of the zero lower bound on short-term interest rates. Communication plays a crucial role in successful conduct of monetary policy by the Bank. I would like to highlight three reasons why this is so. First, the Bank adopted its 2 percent price stability target in terms of the year-on-year rate of change in the consumer price index (CPI) in January 2013. There is an inherent challenge in convincing households of the benefits of this target, since they tend to see a rise in inflation as unfavorable. This is especially true when a rise in wages does not take place immediately, or expectations of future wage growth are not fulfilled. Thus, communication is important in this regard. Second, as stipulated in the Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth, released in January 2013, the Bank recognized that the inflation rate consistent with price stability on a sustainable basis would rise as efforts by a wide range of entities to strengthen the competitiveness and growth potential of Japan’s economy progressed (Chart 1). Based on this recognition, the Bank set the price stability target at 2 percent. In this spirit, quantitative and qualitative monetary easing (QQE) was introduced in April 2013. Thus, promoting continuous dialogue with the government, firms, and financial institutions is essential to achieving the target. Third and finally, the Bank is actively using its communication strategy to generate monetary accommodation under QQE. Let me outline the sequence of my speech. I will first explain the Bank’s current communication practices. Next, to examine the effectiveness of QQE from a communication perspective, I will review a range of data, such as those regarding inflation expectations, and the results of several surveys targeting households, firms, market participants, and economists. II. The Bank’s monetary policy communication practices I will begin by describing in three steps the Bank’s communication practices on monetary policy. First, I will explain the legal requirement with regard to communication. Second, I will focus on the current communication practices on monetary policy. Third and finally, I will discuss the active use of communication as a nontraditional monetary easing measure under QQE, that is, forward guidance with regard to the continuation of monetary accommodation. BIS central bankers’ speeches A. Legal requirement to ensure communication accountability The Bank enjoys independence regarding monetary policy under the Bank of Japan Act (hereafter referred to as the Act). The Act stipulates that the mandate of monetary policy is to achieve price stability.1 Monetary policy is determined by a majority of votes of the Bank’s Policy Board at regular Monetary Policy Meetings (MPMs). The Policy Board comprises nine members (the Governor, two Deputy Governors, and six other members). All the members are appointed by the Cabinet, subject to the consent of Japan’s House of Representatives and the House of Councillors, with a five-year term. The schedule of MPMs for the coming twelve months is made public in June and December each year. Given that monetary policy affects the daily lives of the public, in a democratic society it is essential to conduct such policy with accountability. Therefore, the Act stipulates that the Bank endeavor to clarify to the public the content of its decisions, as well as its decisionmaking process, regarding currency and monetary control (that is, monetary policy). To meet this accountability requirement, the Act requires the Bank to promptly publish the minutes of the MPM, which provide a summary of discussions held at each MPM, and to publish a transcript (available only in Japanese) of each MPM. The minutes of each MPM are approved at the following MPM and released three business days later. The transcript of discussions held at each MPM, which shows the details of each participant’s remarks along with the names of speakers, is made public ten years after the MPM concerned. Furthermore, pursuant to the Act, the Bank periodically submits a Semiannual Report on Currency and Monetary Control to the Diet (Japan’s national government body) on its policies. In addition, the Governor and the Bank’s other officers appear frequently before the Diet to explain current monetary policy. B. Communication policy to enhance the effectiveness of monetary policy There is growing consensus among central banks that communication should be enhanced to improve transparency for the public. This reflects the view that it is best to minimize “surprises” in financial markets that are triggered by unexpected monetary policy decisions, to boost the effectiveness of monetary policy. Increasing transparency on future monetary policy stances should improve public comprehension of financial forecasting, helping the public to form views on future monetary policy stances similar to those of central banks. In other words, such a communication policy aims to inform the public about the “normal” policy reaction function of monetary policy or the conduct of traditional monetary policy in a normal economic environment where the zero lower bound is absent. This practice may favorably influence financial markets in several ways. First, clear understanding by the public of a central bank’s policy reaction function may help the public to adjust their future short-term interest rate expectations accordingly. This would affect longterm interest rates, since the yields reflect the average of expected future short-term interest rates. Second, in some cases clear public understanding may decrease the level of uncertainty and thus reduce volatilities in interest rates, foreign exchange rates, and financial asset prices. Finally, there may be instances where the public believes that a central bank has specialized information that can be used to assess future prices and economic activity. In such cases, a central bank could favorably affect financial markets by making public such detailed information. The Bank’s current monetary policy communication practices Let me now explain the Bank’s current communication practices with regard to monetary policy. As stated earlier, monetary policy decisions are made at the MPMs, which are held The Act states that monetary policy should be “aimed at achieving price stability, thereby contributing to the sound development of the national economy.” BIS central bankers’ speeches 14 times each year; these are held on a regular basis, and additional unscheduled emergency meetings may also be held. Of the 14 MPMs, there are twelve two-day meetings held on a monthly basis with two one-day meetings at the end of April and October each year. The Bank releases a public statement immediately after each MPM. For the two-day monthly MPM, the statement contains (1) the policy decisions made at the MPM including the guideline for money market operations; (2) a summary of the assessment of current economic activity and prices, as well as the outlook (up to about six months ahead); (3) an assessment of upside and downside risks; and (4) the future monetary policy stance. For example, current QQE policy decisions are made at each MPM on whether the annual monetary base increase (namely, about 60–70 trillion yen) will be maintained until the next MPM. During the one-day MPMs at the end of April and October, the Policy Board members prepare forecasts for real GDP growth and core CPI inflation (CPI for all items less fresh food) over the coming three fiscal years. For example, in the case of fiscal 2013 (beginning in April 2013), projections were prepared for fiscal 2013–15, and were released immediately after the MPM at the end of April 2013 (forecasts for real GDP growth rate for the previous fiscal year – that is, fiscal 2012 – were also released in April). The median and the range of the forecasts are disclosed together with the forecast distribution charts that are based on the aggregated probability distributions compiled from the individual members’ distributions. The semiannual Outlook for Economic Activity and Prices (hereafter referred to as the Outlook Report) contains the Bank’s View on the outlook and risk factors for economic activity and prices over the coming three fiscal years, as well as its views on the future course of monetary policy. The Bank’s View is approved at the MPM and published at 3:00 p.m. after the MPM, while the public statement is released immediately after the MPM. Interim assessments of the outlook as laid out in the previous Outlook Report are undertaken during the respective January and July MPMs, and these interim assessments are included in the public statements. The Governor of the Bank, as Chairman of the Policy Board, holds a press conference usually from 3:30 p.m. on the last day of each MPM and explains the thinking behind the decisions made. A press conference summary (available only in Japanese) is then released on the following business day. Furthermore, a Monthly Report of Recent Economic and Financial Developments is released on the next business day after the first MPM of each month, and contains a detailed background of the Bank’s assessment of economic activity and prices, as well as financial developments on which policy decisions are based. Strengthened communication with the adoption of the 2 percent price stability target I mentioned that the Bank improved its transparency in January 2013 by adopting the 2 percent target. This target replaced an earlier, broader target – “price stability goal in the medium to long term” – which was defined as a positive range of 2 percent or lower with a goal of 1 percent having been set for the time being. This broader expression was chosen to cover the diverging views of the Policy Board members with respect to the appropriate level of long-term inflation. I take the view that the word “goal” (especially the connotation of the related term medo that was adopted in the Japanese version) and the ambiguous references to the range suggested a degree of passivity. As a result, the public was unsure whether the Bank was genuinely pursuing the 2 percent level or targeting a lower figure. Against this background, the adoption of the 2 percent target in January 2013 eliminated such ambiguities. C. Communication strategy as a nontraditional accommodative monetary policy It is widely known that theoretically one alternative accommodative monetary policy under the zero lower bound is to introduce forward guidance by committing to the continuation of a more accommodative policy than would otherwise have been anticipated with the normal BIS central bankers’ speeches policy reaction function. That is, forward guidance is used as a communication strategy to generate additional monetary accommodation. This commitment to a longer accommodative monetary policy is needed to compensate for the period constrained by the zero lower bound. In general, central banks in advanced economies have adopted forward guidance with a somewhat more flexible interpretation than suggested by theory. Forward guidance adopted under QQE Forward guidance constitutes an important element of QQE. The Bank released a public statement in April 2013 that introduced QQE and contained two descriptions of the time span of monetary accommodation. The first description was a statement of the Bank’s intention to achieve the 2 percent price stability target at the earliest possible time, with a time horizon of about two years. The second description was a statement of its intention to continue with QQE as long as it was necessary for maintaining the 2 percent target in a stable manner. This description also added a condition that both upside and downside risks to economic activity and prices would be examined, and that adjustments would be made as appropriate (Chart 2). The purpose of the first description was to signal to the public the Bank’s determination to achieve its 2 percent target within a time horizon of about two years, normally pursued by other central banks under an inflation targeting framework. Mentioning the specific time span was considered essential to gain the confidence of the public as part of the Bank’s intention to overcome mild deflation. To fulfill this objective, the main operating target for money market operations was switched from the uncollateralized overnight call rate to the monetary base; it was then decided that the size of the monetary base would rise at an annual pace of about 60–70 trillion yen, to be doubled in two calendar years (2013–14). Under this monetary base target, the Bank currently purchases Japanese government bonds (JGBs) of approximately 50 trillion yen (on an outstanding basis) each year to double the amount outstanding in two years.2 Some market participants considered the first description to be a strong calendar-based commitment with a time limit, from the way the Bank presented its QQE in April 2013. My personal view is that the first description could be interpreted as both calendar-based (about two years) as well as state-contingent (2 percent) guidances. However, in this case, the time horizon of “about two years” should be interpreted with some flexibility rather than as a rigid “two years.” The second description is related to a conditional commitment, because the continuation of QQE is subject to the examination of upside and downside risk factors. It is also statecontingent guidance (to maintain the 2 percent target in a stable manner), linked to the continuation of QQE, and plays a greater role than the first description in stabilizing long-term inflation expectations at around 2 percent, thus helping to reduce long-term interest rate volatility and preventing its overshooting. The first description can be considered as a “necessary condition” for achieving the second description, if the first description is regarded as referring to the achievability of the 2 percent target and the second as referring to the maintenance of the 2 percent target in a stable manner. While the time horizon of these two descriptions could overlap, the second description implies that time horizon is somewhat longer and that the asset purchases may not come to an end after two years. Thus, these two descriptions are mutually non-exclusive. Based on the framework I have described, the Bank holds the baseline scenario that core CPI inflation (excluding the direct effects of the consumption tax hikes) is expected to reach around 2 percent toward the latter half of the projection period of fiscal 2013–15.3 The The Bank also purchases treasury discount bills (T-Bills), exchange-traded funds (ETFs), Japan real estate investment trusts (J-REITs), and other assets. The consumption tax rate in Japan is scheduled to increase from 5 percent to 8 percent in April 2014 and further to 10 percent in October 2015. The hikes are expected to raise CPI-based inflation by about BIS central bankers’ speeches median of the Policy Board members’ forecasts is 0.7 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.9 percent for fiscal 2015 (Chart 3). Personally, I am aware of the possibility that it may take some time to achieve the 2 percent target, since the duration depends crucially on “the pace of improvement in the employment and income situation in Japan.” Moreover, it is possible that it may take even longer to achieve a situation where the 2 percent target is maintained in a stable manner, considering the duration required to judge whether the condition described as “in a stable manner” is met. During this period, support from monetary policy is likely to be necessary. As I pointed out earlier in the joint statement of the government and the Bank, bear in mind here that the Bank adopted the 2 percent target in January 2013, assuming that such an inflation rate should be sustainable. Hence, the Bank’s decisions on the necessity and measures of future monetary easing should be judged in line with the objective to pursue a society with 2 percent price increase in a stable manner. Contrast with forward guidance adopted by other major central banks You may notice that the form of forward guidance adopted by the Bank differs greatly from the forms adopted by other major central banks (Chart 4). First, the Federal Reserve applies forward guidance to maintain a very low federal funds rate. Asset purchases are regarded as a separate monetary easing policy tool and are supplementing the interest rate policy and forward guidance. In contrast, the Bank applies forward guidance to QQE as a package. Under QQE, the monetary base is the main operating target for money market operations, and various assets (mainly JGBs) are purchased to fulfill the monetary base target.4 Second, the views of the Bank and other central banks differ in regard to long-term inflation expectations. Forward guidance issued by the Federal Reserve assumes that longer-term inflation expectations have been anchored at around 2 percent. The Bank of England (BOE) includes a similar view in one of its conditional forward guidance “knockouts.” Therefore, one of the main tasks for these central banks is to continue with monetary easing measures to seek economic recovery, while ensuring that the anchored inflation expectations are maintained. In contrast, the Bank has not yet successfully anchored long-term inflation expectations at around 2 percent. Thus, the Bank must focus on first transforming the deflation-oriented mindset and then increasing inflation expectations to a higher level than the current one. Third, Federal Reserve and BOE forward guidance includes employment-related thresholds. The Federal Reserve has a dual mandate of promoting price stability and maximum employment, so the reason for this is clear. The BOE sees price stability as its primary mandate; however, the inclusion of employment-related conditions may have reflected the need to clarify its views on the trade-off between inflation and unemployment. In contrast, there is a relatively small need for the unemployment threshold to be used in the Bank’s guidance. The unemployment rate for December 2013 was 3.7 percent, close to the lowest point in recent years of 3.6 percent, which was attained in July 2007. Some labor issues exist, such as the differential treatment of regular and non-regular workers and firms’ demand for increased flexibility over labor market regulations. However, these are structural issues that are beyond the scope of monetary policy. 2 percentage points for fiscal 2014 and by 0.7 percentage point for fiscal 2015, respectively. When assessing the inflation rate, the Bank disregards the effects of these increases as they are temporary. The Bank has charged 0.1 percent on excess reserves since October 2008. Thus, this interest rate functions largely as a floor for the interbank market interest rates. BIS central bankers’ speeches III. Performance of QQE in light of communication on monetary policy Next, I would like to focus on the current performance of QQE in light of the public’s perceptions of monetary policy and price developments. A. Households’ understanding of the QQE framework and inflation expectations Households are important economic entities that undertake consumption and residential investment. Thus, understanding their current and future behavior is essential to examining the transmission mechanism of monetary easing. Moreover, changes in households’ inflation expectations are likely to influence actual inflation by affecting their consumption and residential investment demand (and thus the output gap) as well as wage negotiations. Awareness of the 2 Percent Target and QQE In relation to the public’s knowledge of QQE, the quarterly Opinion Survey on the General Public’s Views and Behavior conducted by the Bank posed a new set of questions in its September and December 2013 surveys. These included (1) whether respondents knew of the 2 percent price stability target, and (2) whether respondents knew that the Bank had embarked on QQE.5 The first question results indicated that 78 percent of the respondents were aware of the 2 percent target in the September survey (Chart 5); however, the detailed analysis revealed that only 37 percent said that they “know about it” while 41 percent said that they “have read or heard of it, but do not know much about it.” In the December survey, the overall awareness of the 2 percent target dropped significantly to 60 percent and only 29 percent of the respondents said that they “know about it” and 31 percent said they “have read or heard of it, but do not know much about it.” Regarding the second question results, the September survey indicated that 72 percent of the respondents were aware of QQE; however, the detailed analysis showed that only 29 percent said that they “know about it” while 43 percent said that they “have read or heard of it, but do not know much about it.” In the December survey, those claiming awareness of QQE dropped slightly to 69 percent, with 39 percent saying they “have read or heard of it, but do not know much about it.” However, the proportion of respondents who answered that they “know about it” increased slightly from the September survey, accounting for 30 percent. Moreover, one of the regular questions in the same survey was whether the respondents perceived the present price levels to have risen compared with one year earlier. In the September and December surveys, about 67 percent of the respondents said that prices “have gone up” (either “significantly” or “slightly”). Furthermore, more than 80 percent of the respondents that stated prices “have gone up” described the price rise as “rather unfavorable” in both surveys, while that proportion has followed a long-term declining trend (Chart 6). These various survey results suggest that QQE is fairly widely known to the public. At the same time, it is striking to note that the majority view price rises as unfavorable. This implies that the importance of achieving the 2 percent target may not be widely understood and shared by households. Thus, it is vitally important for the Bank to clearly explain to the public and respond to questions as to why the Bank aims to achieve the 2 percent price stability target and how this will improve daily lives in the medium to long term. This is particularly important given that a consumption tax hike is scheduled in April this year, and the inflation rate may temporarily exceed 2 percent, together with the effects of monetary easing. The survey sample size is 4,000 people living in Japan who are at least 20 years of age, with about 56 percent providing valid responses. BIS central bankers’ speeches Long-term inflation expectations and sources of inflation used to form expectations Now let us look at households’ long-term inflation expectations to see whether they tend to rise reflecting the impact of QQE. The Bank usually forms its understanding of inflation expectations based on various indicators, but for the sake of simplicity I will use the Bank’s aforementioned opinion survey as a crude indicator to measure long-term inflation expectations. In doing so, I will focus on the median of the respondents with regard to their inflation expectations over the next five years (changes in price levels per year on average). The data should be interpreted with caution, since an empirical analysis based on the Bank’s opinion survey has pointed out that households’ inflation expectations are upward-biased.6 It should be noted that the responses exclude the potential impacts of the consumption tax hikes from the June 2013 survey. Chart 7 shows that households’ long-term inflation expectations have remained steady at around 2.0–2.5 percent since the middle of 2011, and thus there is no rising trend to date. The same survey also asks about present price level perceptions (change in price levels compared with one year ago) and the results show a clear rising trend since early 2013.7 Some might wonder about the source of information used by households when forming longterm inflation expectations. The September 2013 survey included a special set of questions about the “basis for the perception” of the present price levels as well as the outlook for price levels over the next five years. Respondents could choose up to three answers from predefined choices. An interesting result was that the respondents relied more on general pricerelated information and various other sources when forming longer-term inflation expectations than when forming perceptions on present price levels. For example, they relied heavily on “media reports on individual prices of goods and services and prices in general,” “developments in foreign exchange rates such as depreciation/appreciation of the yen,” “developments in stock prices and land prices,” and “the Bank of Japan’s monetary policy” (Chart 8). In contrast, it showed that they relied heavily on “developments in prices of frequently purchased items such as foodstuffs” and “developments in gasoline prices” when forming perceptions of the present price levels. These observations may suggest that households tend to use rational expectations – in addition to adaptive expectations – when forming longer-term inflation expectations. For example, past research shows that about 40 percent of households’ inflation expectations is allocated to adaptive expectations and nearly 60 percent to rational expectations.8 Hence, a deeper understanding of the QQE framework as well as the actual and past price increases may help raise households’ inflation expectations and increase the achievability of the 2 percent target. B. Firms’ views on the 2 percent target and inflation expectations Firms are very important economic entities, since they are not only producers and investors but also major borrowers from financial markets. Moreover, they are price setters that Note here that households who hold negative inflation expectations tend to choose zero rather than the true value. See Koichiro Kamada, “Downward Rigidity in Households’ Price Expectations: An Analysis Based on the Bank of Japan’s ‘Opinion Survey on the General Public’s Views and Behavior,’” Bank of Japan Working Paper Series, No. 13-E-15, 2013. The same survey also provides information on short-term inflation expectations over the next twelve months; these showed an increase in the March 2013 survey (but not to as high a level as after 2010) and have since remained at the same level as the June 2013 survey. On the other hand, the Consumer Confidence Survey compiled by the Cabinet Office showed a clear rise in the pace of increase in short-term inflation expectations (in the next twelve months) from the beginning of 2013. However, it is not clear whether such expectations included the tax effects. See Ko Nakayama and Kazuo Oshima, “Infure Kitai no Keisei ni Tsuite (On Inflation Expectations),” Bank of Japan Working Paper Series, 99–7, 1999 (available only in Japanese). The paper uses short-term inflation expectations (one year ahead). BIS central bankers’ speeches significantly influence actual inflation. During the period of prolonged mild deflation, firms tended to set their sales prices according to their competitors’ and clients’ demand, rather than in response to the output gap or cost developments. This was partly attributable to an increase in the price elasticity of demand caused by intensified competition at home and abroad, and a series of negative demand shocks. Thus, in aiming to achieve the 2 percent target, it is important to examine firms’ recognition of QQE and inflation expectations to analyze whether their price-setting behavior is changing. Views on the achievability of the 2 percent target Regarding the recognition of QQE by firms, we could look at QUICK Tankan, a monthly statistical survey compiled by QUICK Corp., which is often used as an early indicator of the Bank’s Tankan (Short-Term Economic Survey of Enterprises in Japan). QUICK Tankan included a special question in its January 2014 survey on “the achievability of the 2 percent target” (Chart 9).9 The result indicated that 62 percent of the respondents stated “an even chance,” followed by “the probability is low” (23 percent) and “the probability is high” (15 percent). This may suggest that, compared with households, firms generally have higher recognition of QQE and hold a better outlook for its achievability. Looking at sector breakdowns, approximately 60 percent of both manufacturing and nonmanufacturing firms stated “an even chance” and approximately 20 percent of both stated that “the probability is low.” In contrast, 50 percent of financial institution respondents stated “an even chance” and 40 percent stated “the probability is low.” The fact that the majority of firms responded “an even chance” suggests that their perception could swing either way. Nonetheless, those with indecisive views could be adjusted toward “the probability is high,” as the collective efforts of all economic entities to overcome mild deflation make further progress and as firms gain greater confidence in QQE through the Bank’s further communication efforts. Inflation expectations and sources of inflation used to form expectations The most frequently used indicator of firms’ inflation expectations is obtained from the Bank’s quarterly Tankan.10 Generally, it uses the diffusion index (DI) of “rise” minus “fall” with respect to output prices for the next quarter. In addition, the difference between this DI and the correspondent DI for input prices is often used as a proxy for profit margins (Chart 10). It is known that the DI for output prices tends to be downward-biased and the DI for input prices tends to be upward-biased, so the interpretation of these indicators needs to take these tendencies into account.11 The drawback of this approach is that the data are only available for the next quarter, so only very short-term inflation expectations can be measured. The chart shows that there are some signs of an increase in firms’ inflation expectations based on the DI for output prices, but the indicator has leveled off very recently. Fortunately, the Bank will begin publishing a survey of firms’ longer-term inflation expectations (looking one, three, and five years ahead) beginning with the March 2014 Tankan survey. It is expected that this will promote a better understanding of firms’ inflation expectations and their price-setting behavior. Regarding factors contributing to firms’ inflation expectations, the Annual Report on the Japanese Economy and Public Finance 2013, compiled by the Cabinet Office, conducted an interesting survey in February 2013. It showed that firms tend to raise their outlook for sales The respondents covered 367 listed firms. Approximately 56 percent were nonmanufacturing firms, 41 percent were manufacturing firms, and the remainder were financial institutions. The survey population encompasses about 210,000 firms (excluding financial institutions) that have at least 20 million yen in capital. More than 11,000 firms are sampled in each survey. See, for example, Koichiro Kamada and Kentaro Yoshimura, “Kigyo no Kakaku Mitoshi no Kochokusei: Tankan DI wo Mochiita Bunseki (Rigidity in Firms’ Price Expectations: An Analysis Based on the Bank of Japan’s Tankan [Short-Term Economic Survey of Enterprises in Japan] DI),” Bank of Japan Working Paper Series, No. 10-J-3, 2010 (available only in Japanese). BIS central bankers’ speeches prices of goods and services over the next year when they project that market prices over the same period will increase.12 This response was provided by approximately 70 percent of manufacturing respondents and more than 50 percent of nonmanufacturing respondents. In other words, if an increase in demand for goods and services leads to a rise in market prices, this may induce firms to raise their sales prices. This situation is more likely to occur if a sustainable expansion of the domestic market is projected. In addition, firms may reflect more adaptive expectations than households when forming inflation expectations. For example, it should be noted here that about 50–70 percent of firms’ inflation expectations is allocated to adaptive expectations and about 50–30 percent to rational expectations.13 Hence, the actual and past price performances may be the most important element in raising firms’ inflation expectations to achieve the 2 percent target, while at the same time, a deeper understanding of the QQE framework could also be of help. C. Market participants’ and economists’ views on the 2 percent target and inflation expectations In addition to the views of households and firms, it is important to pay attention to the views of market participants and economists. After all, financial markets do influence the behavior of households and firms through changes in interest rates, foreign exchange rates, and financial asset prices. Moreover, the financial market indicators reflect financial asset valuations by market participants and economists as well as their expectations of future inflation and economic developments. These indicators respond directly to monetary policy measures, the release of the latest macroeconomic data, news items, and exogenous shocks. Views on achievability of the 2 percent target Generally, market participants and economists are familiar with the QQE framework. Thus, the focus is on their views regarding whether the Bank will be able to achieve the target and, if so, when the target will be achieved. As mentioned earlier, the Bank’s latest baseline scenario says that core CPI inflation is expected to reach around 2 percent toward the latter half of the projection period of fiscal 2013–15. Two surveys were conducted recently regarding the achievability of the 2 percent target. One was the ESP Forecast Survey undertaken by the Japan Center for Economic Research on about 40 economists. In the January and February 2014 surveys, a question on the achievability of 2 percent within two years (around March or April 2015) was posed. In the January survey, 2 percent of the respondents (one economist) stated “yes/can be achieved,” 85 percent (34 economists) stated “no/cannot be achieved,” and the remaining 13 percent (five economists) stated “difficult to say.” The results improved slightly in the February survey, with 5 percent of the respondents (two economists) stating “yes/can be achieved,” 80 percent (33 economists) stating “no/cannot be achieved,” and the remaining 15 percent (six economists) stating “difficult to say” (Chart 11). Chart 12 shows the evolution of the economists’ forecasts for inflation (including the tax effects) over the period of fiscal 2013–15 by plotting the distribution of their forecasts for each fiscal year. It reveals that the economists’ forecasts for inflation were adjusted toward the higher levels with greater probability for fiscal 2013 as the observation point approached the end of the observation year concerned. A similar but more moderate pattern was present for fiscal 2014. The average of the economists’ forecasts and the median of the Bank’s Policy Board members’ forecasts were then compared in Chart 13. This suggested the presence of a clear convergence for fiscal 2013, as a result of adjustments made mainly by the economists. A The sample size was 6,000 listed and unlisted firms, with a 20 percent response ratio. See Ko Nakayama and Kazuo Oshima, “Infure Kitai no Keisei ni Tsuite (On Inflation Expectations),” Bank of Japan Working Paper Series, 99–7, 1999 (available only in Japanese). BIS central bankers’ speeches moderate degree of convergence was also observed for fiscal 2014, while a relatively large difference remained for fiscal 2015. The second survey was conducted by Bloomberg News on about 35 economists. This survey posed a question regarding when the Bank should start the “tapering” process subsequent to judging that the 2 percent target would be maintained in a stable manner. The survey results for February 2014 reported that 6 percent of the respondents (two economists) stated “in 2015,” 21 percent (seven economists) “in 2016,” 9 percent (three economists) “in 2017,” and 21 percent (seven economists) “in 2018 and beyond,” while 41 percent (14 economists) responded “cannot be foreseen” (Chart 14). Hence, there is a large gap between the Bank’s view and those of economists. Nonetheless, the ratio of respondents who have recognized the possibility of achieving the target in the medium to long term increased, compared with the November 2013 survey results. These survey results indicate that most market participants and economists feel that it will take some time for the Bank to achieve the 2 percent target, and to achieve it in a stable manner, while their confidence in its achievability is gradually spreading. To reduce the perception gap between the Bank and these groups, it is important for the Bank to further enhance its dialogue with them by (1) exchanging views on forecasting methods as well as (2) providing clearer explanations about the transmission mechanism of monetary easing (including background analysis) and the direction of QQE for achieving the target. Survey-based and market data-based long-term inflation expectations Now I would like to present some indicators related to long-term inflation expectations. Chart 15 shows three survey-based indicators with projections made by (1) economists based on the ESP Forecast Survey for two to six years ahead, (2) economists based on Consensus Forecasts released by Consensus Economics Inc. for six to ten years ahead, and (3) bond market participants based on the QUICK Bond Monthly Survey for two to ten years ahead. Chart 16 shows two types of market data-based indicators: (4) the breakeven inflation (BEI) rates for inflation-indexed JGBs (about five years and ten years); and (5) inflation swap rates (five-year rate and implied five-year forward rate five years ahead). These indicators recently show a general increase in inflation expectations. However, they require caution in interpretation, as an increase in the inflation expectations may reflect the potential impacts of the consumption tax hikes. The ESP Forecast Survey excludes the tax effects from the October 2013 survey, while the QUICK Bond Monthly Survey includes the tax effects from the September 2013 survey.14 The BEI and inflation swap rates reflect the tax hikes. The BEI indicator also reflects the differences in liquidity between fixed-rate and inflation-indexed bonds. A rising trend in long-term inflation expectations based on the ESP Forecast Survey even after excluding the tax effects is encouraging, but is still well below the 2 percent target (Charts 15 and 16). Other indicators also show an increase, but the levels (after excluding the tax effects) are similar to pre-global financial crisis figures. IV. Concluding remarks I have talked today about communication on the Bank’s monetary policy. Several survey results have indicated that some among the public remain unaware of the QQE framework and uncertain about the achievability of the target. Such public views may be reflected in inflation expectations, which are generally rising but still well below 2 percent. Nevertheless, survey results have also indicated some encouraging signs of improvement, and the current progress in actual price and economic performance may further improve the public’s recognition of and confidence in the target achievability. At the same time, gaining the public’s understanding of the Bank’s policy intention may strengthen the process. The tax effects are irrelevant for the Consensus Forecasts data for six to ten years ahead. BIS central bankers’ speeches While the Bank has been increasing its efforts to promote communication, I believe there is still room for further enhancement of communication practices. The results of various surveys showed that there are differences among households, firms, as well as market participants and economists in their understanding of the QQE framework and their views on achievability of the 2 percent target. In this regard, the Bank could consider communicating more effectively with targeted approaches that take these differences into account. For example, the Bank needs to review published documents to include clearer language and explanations. Increased contact with a range of social groups and local communities in collaboration with the Bank’s 32 branches and 14 local offices, as well as more effective use of the media and its web site, would likely be effective in reaching out to firms and the general public. On the other hand, for market participants and economists, increased dialogues to explain forecasting methods and the Bank’s view backed by analytical output would be a powerful tool to enhance understanding of the Bank’s conduct of monetary policy. A successful example of such communication practices was seen during April-July 2013, when the JGB market became unstable. The Bank responded by holding several dialogues with market participants, which led to the adoption of a flexible operational framework and helped to stabilize the market. All such enhanced communication efforts are considered to be essential steps to achieving the 2 percent target in a stable manner. This brings me to the end of my speech. Thank you very much 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 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 Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the 2014 Monetary Policy Forum, New York City, 28 February 2014.
Sayuri Shirai: Communication and forward guidance in a world of unconventional monetary policy – the case of the Bank of Japan Remarks by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the 2014 Monetary Policy Forum, New York City, 28 February 2014. * I. * * Introduction Thank you very much for inviting me to the 2014 U.S. Monetary Policy Forum. I feel greatly honored to have the opportunity to talk about communication on monetary policy in the context of the Bank of Japan. As you may know, the Bank adopted quantitative and qualitative monetary easing (QQE) in April 2013. Prior to this, the Bank had adopted the 2 percent price stability target in terms of the year-on-year rate of change in the consumer price index (CPI) in January 2013. The Bank committed to pursuing monetary easing to achieve the 2 percent target as early as possible. Despite this increased transparency on its inflation target, some in both the markets and the public soon questioned the achievability of the 2 percent target under the then existing monetary easing framework called comprehensive monetary easing (CME) adopted in October 2010. This appears to have reflected (1) a perception of lack of boldness under CME,1 (2) doubt about the Bank’s determination to overcome deflation due to ineffective communication between the Bank and the markets as well as the public, and (3) disbelief arising from the Bank’s past monetary policy because of a poor track record in achieving its stated objectives.2 Under these conditions, QQE was introduced in April 2013. Given this background, my presentation will begin by touching on the main features of QQE. I will then explain the Bank’s forward guidance, or its communication strategy, on its future monetary policy stance. Finally, I will discuss issues related to the Bank’s communication on monetary policy. II. Main features of QQE and the Bank’s forward guidance Let me first highlight some distinctive differences between the current QQE and the previous CME (Chart 1). Shifting from interest rate targeting to monetary base targeting First, the main feature of QQE was a shift in the main operating target for money market operations from the uncollateralized overnight call rate to the monetary base. There were several reasons for this shift. It was thought it would be intuitively easier for the public to grasp the essence of monetary easing: an increase in the “quantity” could easily be connected to a large-scale supply of cash, creating an image of inflation. Moreover, market participants use the monetary base as a reference for measuring the scale of monetary easing across central banks when engaging in financial transactions. Certain academic research studies were also taken into account in regard to the Bank’s adoption of monetary base targeting.3 Moreover, there was general agreement among the Policy Board members The size of the Asset Purchase Program was increased nine times, each time in the range of 5–10 trillion yen. The purchase of JGBs was mainly up to a remaining maturity of three years. This often refers to the exit timings of the zero interest rate policy in August 2000 and quantitative monetary easing in March 2006. These research studies, including those related to the Bank’s monetary policy, include Paul R. Krugman, “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity, 1998, 2, pp. 137–205; Allan H. Meltzer, “The Transmission Process,” paper presented to the Deutsche Bundesbank BIS central bankers’ speeches that changing the main operating target would effectively signal a much-needed change in the monetary policy framework and enable the Bank to wipe away its image as a reluctant monetary accommodator. Hence, the shift was decided as part of the Bank’s communication policy tool. The purchase of Japanese government bonds (JGBs) was viewed as the main tool to fulfill the monetary base target. The Bank now purchases JGBs with a remaining maturity from a minimum of less than one year up to the maximum 40 years. Importance of raising long-term inflation expectations Here, I should also mention that QQE relies more heavily on long-term inflation expectations to achieve negative long-term real interest rates than the monetary policies adopted by other central banks. A decline in long-term interest rates in real terms may increase investment and consumption. The anticipation of higher inflation may hasten such increases. These expectations may also affect current sales prices and wages. Thus, the Bank decided to use all available tools to convince the markets and the public of its strong determination to overcome mild deflation and to help transform the deflation-oriented mindset. In this spirit, the “quantity”-based targeting approach was considered reasonable. This feature draws a clear line between QQE and the previous CME, which placed little emphasis on influencing such expectations and perceptions relating to the Bank’s monetary policy stance. The Bank’s communication strategy and two descriptions in its forward guidance QQE entails forward guidance as one of its most important elements (Chart 2). The Bank released a public statement in April 2013 that introduced QQE, and contained two descriptions of the time span of monetary accommodation. The first description was a statement of the Bank’s intention to achieve the 2 percent price stability target at the earliest possible time, with a time horizon of about two years. The second description was a statement of its intention to continue with QQE as long as it was necessary for maintaining the 2 percent target in a stable manner. This description also added a condition that both upside and downside risks to economic activity and prices would be examined, and that adjustments would be made as appropriate. The purpose of the first description was to signal to both the markets and the public the Bank’s intention to achieve its 2 percent target within a time horizon of about two years, normally pursued by other central banks under an inflation targeting framework. The reason the Bank set a time span was to show its determination to achieve the target and increase the confidence of the markets and the public. To fulfill this objective, the main operating target for money market operations was switched from the uncollateralized overnight call rate to the monetary base; it was then decided that the size of the monetary base would rise at an annual pace of about 60–70 trillion yen, to be doubled in two calendar years (2013–14). Under this monetary base target, the Bank currently purchases JGBs of approximately 50 trillion yen (on an outstanding basis) each year to double the amount outstanding in two years (Chart 3). Some market participants considered that the first description is a strong calendar-based commitment. This may have partly reflected an impression gained from the Bank’s communication about QQE in April 2013. Namely, the Bank stressed the number “two” on many occasions – the 2 percent price stability target, a time horizon of about two years, doubling the monetary base and the amount outstanding of JGBs, and more than doubling Conference on the Monetary Transmission Process: Recent Developments and Lessons for Europe, 1999; Ben S. Bernanke, “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” in Adam Posen and Ryoichi Mikitani, eds. Japan’s Financial Crisis and Its Parallels to U.S. Experience, Special Report 13, Institute for International Economics, Washington, D.C., 2000, pp. 149–166; and Bennett T. McCallum, “Alternative Monetary Policy Rules: A Comparison with Historical Settings for the United States, the United Kingdom, and Japan,” Economic Quarterly, Federal Reserve Bank of Richmond, 2000, pp. 49–79. BIS central bankers’ speeches the average remaining maturity of JGB purchases. This presentation was successful in sending a clear message about the new framework. However, the message may also have been interpreted by some market participants as a strong calendar-based commitment with a time limit, with a lesser focus on the second description (which I will describe in a moment). Personally, I believe that the first description could be interpreted as both calendar-based (about two years) as well as state-contingent (2 percent) guidances. However, in this case, the time horizon of “about two years” should be interpreted with some flexibility rather than as a rigid “two years.” The second description is related to a conditional commitment, because the continuation of QQE is subject to the examination of upside and downside risk factors. It is also statecontingent guidance (to maintain the 2 percent target in a stable manner), linked to the continuation of QQE, and it plays a greater role than the first description in stabilizing longterm inflation expectations at around 2 percent. This helps to reduce long-term interest rate volatility and prevent its overshooting. The first description can be considered as a “necessary condition” for achieving the second description, if the first description is regarded as referring to the achievability of the 2 percent target and the second as referring to the maintenance of the 2 percent target in a stable manner. While the time horizon of these two descriptions could overlap, the second description implies that the time horizon is somewhat longer and that the asset purchases may not come to an end after two years. In this sense, the QQE time framework may be described as “open-ended,” although the April 2013 public statement stipulated the annual pace of increase in the monetary base for the coming two calendar years. Thus, these two descriptions are mutually non-exclusive. Based on the framework I have described, the Bank holds the baseline scenario that core CPI inflation (CPI for all items less fresh food; excluding the direct effects of the consumption tax hikes) is expected to reach around 2 percent toward the latter half of the projection period of fiscal 2013–15.4 Personally, I am aware of the possibility that it may take some time to achieve the 2 percent target, since the duration depends crucially on “the pace of improvement in the employment and income situation in Japan.” Moreover, it is possible that it may take even longer to achieve a situation where the 2 percent target is maintained in a stable manner, considering the duration required to judge whether the condition described as “in a stable manner” is met. During this period, support from monetary policy is likely to be necessary. Bear in mind here that the Bank adopted the 2 percent target in January 2013, assuming that such an inflation rate should be sustainable.5 Hence, the Bank’s decisions on the necessity and measures of future monetary easing should be judged in line with the objective to pursue a society with 2 percent price increase in a stable manner. Why is the Bank’s forward guidance so different from that of the Federal Reserve? The form of forward guidance adopted by the Bank differs from that of the Federal Reserve on several fronts (Chart 4). First, the Federal Reserve applies forward guidance to its primary short-term policy interest rate (the overnight federal funds rate) and provides guidance to the The consumption tax rate in Japan is scheduled to increase from 5 percent to 8 percent in April 2014 and further to 10 percent in October 2015. The hikes are expected to raise CPI-based inflation by about 2 percentage points for fiscal 2014 and by 0.7 percentage point for fiscal 2015, respectively. When assessing the inflation rate, the Bank disregards the effects of these increases as they are temporary. The Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth, released in January 2013, stated, “The Bank recognizes that the inflation rate consistent with price stability on a sustainable basis will rise as efforts by a wide range of entities toward strengthening competitiveness and growth potential of Japan’s economy make progress.” Based on this recognition, the Bank set the 2 percent target. BIS central bankers’ speeches markets and the public about how long it expects to keep the current exceptionally low level. In other words, the Federal Reserve attempts to exert downward pressure on longer-term interest rates by influencing expectations of the markets and the public regarding the continuation of the current low level of short-term interest rates over an extended period of time. Asset purchases are regarded as a separate monetary easing policy tool and are supplementing the interest rate policy and forward guidance. In contrast, the Bank applies forward guidance to QQE as a package. Once the pace of the annual increase in the monetary base is set, the approximate pace of increase in JGB purchases is determined accordingly. In this sense, the pace of increase in the monetary base and that in asset purchases are treated as “non-separable,” as shown in Chart 3. Then the Bank uses forward guidance to inform the public of its intention to maintain an increase in the monetary base and thus in asset purchases in the future. In other words, the Bank attempts to exert downward pressure on the entire yield curve by influencing the expectations of the markets and the public about the low level of the yield curve in the future. Second, the Bank purchases treasury discount bills (T-Bills) and other assets, in addition to JGBs, to meet the monetary base target.6 Moreover, it regularly conducts fixed-rate fundssupplying operations (with a duration of mainly three months, but available up to one year). Therefore, these short-term operations exert downward pressure directly on short-term interest rates. In contrast, the Federal Reserve purchases longer-term Treasury securities (with a remaining maturity from four to 30 years) and agency mortgage-backed securities (MBSs). The downward pressure on short-term interest rates is exerted through the forward guidance. Third, the Bank and the Federal Reserve have different views on long-term inflation expectations. Forward guidance issued by the Federal Reserve assumes that longer-term inflation expectations have been anchored at around 2 percent. However, there may be some limited concerns on the dis-anchoring of inflation expectations. Therefore, one of the main tasks for the Federal Reserve is to continue with monetary easing measures to seek economic improvement, while ensuring that the anchored inflation expectations are maintained. In contrast, the Bank has not yet successfully anchored long-term inflation expectations at around 2 percent. Thus, the Bank must help transform the deflation-oriented mindset of all economic entities and then increase inflation expectations to a higher level of 2 percent. Therefore, the threshold used for forward guidance concentrates solely on “2 percent” or “maintaining 2 percent in a stable manner.” Fourth, Federal Reserve forward guidance includes employment-related thresholds. It has a dual mandate of promoting price stability and maximum employment, so the reason for this is clear. In contrast, the Bank’s primary mandate is to achieve price stability and there is relatively small concern about the unemployment rate. In fact, the unemployment rate for December 2013 reached 3.7 percent, close to the lowest point in recent years of 3.6 percent, which was attained in July 2007. Some labor issues exist, such as the differential treatment of regular and non-regular workers and firms’ demand for increased flexibility over labor market regulations. However, these are structural issues that are beyond the scope of monetary policy. III. Communication and challenges faced by the Bank As you may know, Japan’s economy is performing relatively well and the core CPI turned positive in June 2013 and reached 1.3 percent in December 2013. Together with expansionary fiscal measures and a front-loaded increase in consumption, QQE has Other assets include exchange-traded funds (ETFs), Japan real estate investment trusts (J-REITs), CP, and corporate bonds. The Bank has also charged 0.1 percent on excess reserves since October 2008. Thus, this interest rate functions largely as a floor for the interbank market interest rates. BIS central bankers’ speeches contributed to the favorable performance. That said, I will present my own views on some possible communication-related challenges that the Bank may face in the future. Maintaining low levels of real interest rates and communicating with the markets One clear achievement of QQE (and of the anticipated greater monetary easing from the end of 2012) is that long-term real interest rates turned negative and have remained in negative territory (Chart 5). This reflects two factors. One factor is the continuous downward pressure being exerted on long-term nominal interest rates. Chart 6 shows that upward pressure on long-term interest rates remains limited to date, since the massive purchases of JGBs have helped to generate strong downward pressure on interest rates. The chart shows the decomposition of key factors contributing to long-term JGB yields. It indicates that in recent months downward forces caused by “other factors” (which seems to largely reflect domestic factors) have been greater than upward pressure caused by “common factors” (which largely reflects global factors). Another factor is an increase in long-term inflation expectations since late 2012. Chart 7 shows survey-based indicators (such expectations of households, economists, and market participants), while Chart 8 shows market data-based indicators. These indicators show a general increase in inflation expectations. However, they require caution in interpretation, as an increase in the inflation expectations may reflect the potential impacts of the consumption tax hikes. After excluding the tax effects, they are still well below the 2 percent target and the recent movement of some indicators appears to have leveled off to some extent. A current and future challenge relates to the growing linkages across financial markets. A rise in long-term nominal government bond yields in a major overseas economy may exert upward pressure on the government bond yields in Japan. The upward force may work against the downward pressure maintained by QQE, potentially weakening the effectiveness of monetary policy and leading to greater volatility in long-term nominal and real interest rates. Yet, even in the phase of intensified upward pressure, the continuation of the Bank’s large-scale asset purchases is likely to maintain the downward pressure – in addition to the forward guidance applied to QQE. As long as the rising pace of long-term interest rates is more moderate than that of inflation expectations, real interest rates are likely to remain at low levels. Maintaining relatively low levels of nominal and real interest rates as well as contained volatilities are important in terms of supporting the economic recovery path. While the Bank expects that both short- and long-term interest rates will move largely on a stable path, it is important to continue dialogues with the market participants regarding the framework of QQE. Indeed, during April-July 2013, when the JGB market became unstable, the Bank held several dialogues with market participants and adopted a flexible operational framework, which helped to stabilize the market. Inflation outlook gap between the bank and economists, and promotion of communication with the latter As mentioned earlier, according to the Bank’s baseline scenario, the core CPI inflation (excluding the direct effects of the consumption tax hikes) is projected to reach around 2 percent toward the latter half of the projection period of fiscal 2013–15. As shown in Chart 9, the median of the Policy Board members’ forecasts is 0.7 percent for fiscal 2013, 1.3 percent for fiscal 2014 (3.3 percent including the effects of the tax hike), and 1.9 percent for fiscal 2015 (2.6 percent including the effects of the tax hike).7 Now let me show you the projections on core CPI-based inflation envisaged by about 40 economists. Chart 10 shows the evolution of the economists’ forecasts for inflation There is a large gap between the maximum and minimum Policy Board member inflation forecasts, suggesting the presence of divergent views. This divergence widens somewhat for fiscal 2015. BIS central bankers’ speeches (including the tax effects) over the period of fiscal 2013–15 by plotting the distribution of their forecasts for each fiscal year. It reveals that the economists’ forecasts for inflation were adjusted toward the higher levels with greater probability for fiscal 2013 as the observation point approached the end of the observation year concerned. A similar but more moderate pattern was present for fiscal 2014. The chart indicates that a divergence of views was also present among economists for fiscal 2014 and 2015. Next, a comparison was made between the average of the economists’ forecasts and the median of the Bank’s Policy Board members’ forecasts. Chart 11 indicates that a clear convergence was present for fiscal 2013, as a result of adjustments made mainly by the economists. A moderate degree of convergence was also observed for fiscal 2014, while a relatively large difference still remained between the projections for fiscal 2015. The observations I have described suggest that a degree of uncertainty exists regarding the path toward 2 percent and the time it will take to achieve the 2 percent target. These differences appear to reflect differing views between the Bank and economists, with respect to (1) the pace of improvement in the employment and income situation in Japan, (2) the pace of the rise in long-term inflation expectations, and (3) the ability of firms to raise their sales prices owing to the healthier prospects for profitability. The views of economists and market participants are particularly important for the Bank. This is because financial markets influence the behavior of households and firms through changes in interest rates, foreign exchange rates, and financial asset prices, but these financial market indicators reflect the valuations of economists and market participants for various financial assets as well as their expectations of future inflation and economic developments. These financial indicators respond directly to changes in market conditions caused by (present and anticipated) monetary policy measures, in addition to the release of the latest macroeconomic data, news, and exogeneous shocks. Thus, to help narrow the perception gap between the Bank and these groups, it is important for the Bank to enhance its dialogue with them by (1) exchanging views on forecasting methods as well as (2) providing clearer explanations about the transmission mechanism of monetary easing (including background analysis) and the direction of QQE for achieving the target. Communication to enhance public understanding on the importance of the 2 percent target The Bank needs to increase its dialogue with the public to promote understanding of the importance of the 2 percent target. In January 2013, the Bank judged that setting the 2 percent price stability target was important for the economy. This judgment took into account, for example, (1) the scope needed to avoid another deflationary period, (2) the scope needed for the conduct of flexible monetary policy in normal periods to avoid the zero lower bound in the recessionary phase of the economy, (3) the upward bias in the CPI statistics, and (4) the need to align with the global standard of a price stability target. Moreover, achieving sufficiently high nominal GDP growth rates is essential for the economy to boost firms’ and households’ economic growth expectations. In Japan, the majority of households continue to view price rises as unfavorable. This implies that the importance of achieving the 2 percent target may not be widely understood and shared by households. Thus, it is vitally important for the Bank to clearly explain to the public and respond to questions as to why the Bank aims to achieve the 2 percent price stability target and how this will improve daily lives in the medium to long term. This is particularly important given that a consumption tax hike is scheduled in April this year, and the inflation rate may temporarily exceed 2 percent, together with the effects of monetary easing. Communication about the 2 percent pinpoint target Some argue that the Bank should adopt an inflation target range, rather than an inflation target point. I believe that the Bank should maintain the current inflation target point (that is, 2 percent). The idea of applying a range to the inflation target should not be ruled out and BIS central bankers’ speeches might be examined after the actual inflation rate exceeds at least 1 percent in a stable manner and after it is judged that inflation expectations are likely to rise toward 2 percent. However, the premature introduction of a range may result in the actual inflation rate getting stuck at the lower bound of the range, making it harder to achieve the 2 percent target. A more important concern in this case is that the markets and the public may mistakenly assume that the Bank’s intention to achieve the target has weakened, undermining the credibility of monetary policy. Communication on achieving the 2 percent target in a stable manner Lastly, the expression “in a stable manner” contained in the second description of the Bank’s forward guidance may give the impression of ambiguity in terms of its description of the conditions. This expression, however, appears to be appropriate at present, because the formation of long-term inflation expectations entails uncertainty. In addition, judgment on how and when long-term inflation expectations will be stabilized at around 2 percent is likely to require a clear understanding of the features and movements of a range of indicators measuring inflation expectations. Nevertheless, as economic activity and prices firmly improve and as the process of increasing inflation expectations becomes clearer with an enhanced understanding of their developments, I think that the second description of forward guidance could be refined with more specific information about what constitutes “in a stable manner” from a longer-term perspective. I would like to end my presentation 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
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Japan Chamber of Commerce and Industry, Tokyo, 20 March 2014.
Haruhiko Kuroda: Aiming at 2 percent inflation. Why? Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Japan Chamber of Commerce and Industry, Tokyo, 20 March 2014. * * * Introduction It is my honor to be given the opportunity to speak in front of you, who are successful at the forefront of Japan’s economic world. The Bank of Japan, aiming at overcoming deflation at the earliest possible time, introduced quantitative and qualitative monetary easing (QQE) last April. Almost one year has passed since then, and the QQE has been steadily exerting its effects and Japan’s economy has been following a path toward achieving a price stability target of 2 percent as expected. Japan’s economy has continued to recover moderately in association with a virtuous cycle among production, income, and spending. The real GDP growth rate has marked five consecutive quarters of positive growth, and domestic demand has been registering high growth at an annual rate of about 3 percent since last year (Chart 1). As for the outlook, while the economy will be affected by a swing of the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike, it is expected to continue to recover moderately as a trend. As the economic recovery continues, prices have also been improving. The year-on-year rate of change in the consumer price index (CPI) excluding fresh food turned positive in June last year and accelerated since then, and was plus 1.3 percent for December last year and January this year. Not only have energy-related goods pushed up prices, but an improvement has also been seen in a wide range of items given that underlying upward pressure on prices has increased as the aggregate supply and demand balance has improved and inflation expectations have risen. Such spreading improvement is suggested by the fact that the year-on-year rate of change in the CPI excluding food and energy has increased to plus 0.7 percent (Chart 2). As for the outlook, the CPI inflation rate – on the basis of figures excluding the direct effects of the consumption tax hike – is likely to be around 1¼ percent until around this summer, as the underlying upward pressure on prices is likely to strengthen while the positive contribution stemming from the rise in energy prices will decline. Subsequently, against the background of further improvement in the aggregate supply and demand balance and the rise in inflation expectations, the inflation rate is expected to gradually return to an increasing trend, and is likely to reach around the price stability target of 2 percent toward the end of fiscal 2014 through fiscal 2015. The Bank considers that 2 percent in terms of the year-on-year rate of change in the CPI is the price stability target the Bank should aim at. On this point, various concerns have been raised. Among these, two are that “daily life will become difficult if prices go up” and “only prices might increase without an increase in wages.” For firms, there might be a concern that they cannot mark up output prices to the extent input prices have risen. In particular, as the consumption tax will be raised from next month, many might be worried about an increase in general prices. Therefore, today, I would like to explain my views, focusing on why the Bank aims at 2 percent inflation. I. Problems of deflation Let me start with confirming why deflation is problematic, by looking back at the past 15 years. In Japan’s economy, deflation has continued for 15 years since the second half of the 1990s. Deflation was not only a result of economic stagnation but also a cause that protracted BIS central bankers’ speeches economic stagnation. Amid 15 years of deflation, behavior based on the recognition that prices would not rise or prices would moderately decline has been embedded in the economy, and that led to protracted economic stagnation. Viewed from firms’ side, under deflation, as they cannot raise the prices of their products and services, their sales and profits will not increase. Therefore, firms will restrain labor costs and business fixed investment as much as possible. For households, as wages will not increase, consumption will be restrained. If households hold back consumption, firms will be forced to reduce the prices of their products and services in order to tap consumption. Deflation also affects the investment decisions of firms. For firms to decide on business fixed investment, what matters is developments not in nominal but in real interest rates. If deflationary expectations are embedded, real interest rates, which are obtained by subtracting expected rates of inflation from nominal interest rates, remain high. Namely, even with no change in nominal borrowing interest rates, expected profits will become less if a price decline is expected to continue, and the effective burden of repayment of borrowings will increase. In this situation, it is natural that firms’ incentives for business fixed investment will wane. Also, for households, if they expect that general prices will decline in the future, they will become more inclined to defer consumption as much as possible. They will be better off if they buy goods and services after those prices decline. Meanwhile, under deflation, holding cash and deposits will become a relatively better investment. Deflation will reduce the rate of return on investment in businesses and in risk assets such as stocks on the one hand, but on the other hand increase the real rate of return on cash and deposits, for which nominal values do not decrease. Therefore, for firms and households, it becomes a rational behavior to restrain business fixed investment and consumption and to hold surplus funds in the form of cash and deposits. Thus, under deflation, as firms and households turn away from risk-taking activities, a vicious cycle of a decline in prices, a fall in sales and profits, restraint in wages, stagnation in consumption, and further decline in prices has continued. Looking back at Japan’s economy for the past 15 years through macroeconomic indicators, GDP and employee income on nominal bases peaked in 1997 and have since been on a long-term downtrend (Chart 3). Amid deflation, Japan’s economic activity on a nominal basis has been consistently scaling down. Under deflation, Japan’s economy has been faced with the fallacy of composition that, despite each economic entity acting rationally, the economy as a whole has been contracting. As a result, it can be said that Japan’s economy has been trapped in deflationary equilibrium. Now, while deflation has been continuing in Japan’s economy, are you aware to what extent the CPI has declined? In the 15 years from fiscal 1998 to fiscal 2012, the annual decline in the CPI was actually only 0.3 percent on average (Chart 4). It may safely be said that the rate of change in the CPI during this period was negative, but almost 0 percent. This fact suggests that even an almost 0 percent rate of change in terms of the CPI is actually a state of deflation. In terms of what firms recognize, in the Tankan survey (Short-Term Economic Survey of Enterprises in Japan) for the past 15 years, the proportion of firms responding that output prices of their products and services declined has almost consistently exceeded that of firms responding that those prices increased (Chart 5). Taking account of these points, in order to overcome deflation, we have to aim at an inflation rate in terms of the year-on-year rate of change in the CPI that is higher than 0 percent. The question is, to what extent of a positive rate should we aim? The Bank considers this to be 2 percent. Let me explain the reasons for this in what follows. BIS central bankers’ speeches II. Aiming at 2 Percent Inflation. Why? A. Price stability As stipulated in the Bank of Japan Act, an aim of the monetary policy the Bank conducts is “achieving price stability, thereby contributing to the sound development of the national economy.” To achieve price stability is an aim of monetary policy as well as the Bank’s responsibility. After all, what the Bank aims at is price stability in this sense, and it has no intention to artificially create inflation. On that basis, the Bank considers that, if price stability is to be defined numerically in terms of the year-on-year rate of change in the CPI, this is 2 percent. There are three reasons for this (Chart 6). First, there is a feature to note in the CPI. The CPI has an upward bias – namely, there is a tendency toward seeing higher figures in the growth rate of the CPI. Second, there is a view that it is necessary to have a so-called buffer. In order to maintain the ability of monetary policy to respond to a substantial deterioration in economic activity, it would be better to secure some degree of an inflation rate. Third, these views have been widely shared among major central banks, and many are conducting monetary policy that aims at achieving an inflation rate of 2 percent. In other words, 2 percent has become a global standard. Let me elaborate on these three reasons. B. Features of price indices: upward bias in the CPI The prices that monetary policy should target are not prices of individual goods and services, of course, but prices as a whole. That said, to measure the level of prices in general, it is necessary to weight prices of individual goods and services and compile them; according to compiling methods, various indexes are then created. In judging price conditions, these indexes need to be used by taking account of the features they entail. While I will not go into detail, as this becomes too technical, it is generally known that the CPI has a tendency toward its growth rate showing higher figures – that is, to exhibit an upward bias. As for the GDP deflator, which is a price index used to calculate real GDP, its growth rate has become somewhat low. This is mainly because the deflator includes capital goods, for which price declines have been substantial. It is also because a rise in import prices has not been completely passed on to output prices, and this has worked to lower the deflator. In fact, since fiscal 1998, the year-on-year rate of change in the CPI has been about 1 percent higher on average than that in the GDP deflator (Chart 7). Many central banks, including the Bank of Japan, mainly use the CPI to judge price trends. This is because the CPI is an index in line with the public’s actual sentiment that covers goods and services that households consume, and is a quickly available statistic that is published monthly. Taking account of these points, the Bank’s price stability target is also defined as the year-on-year rate of change in the CPI. However, as I have just mentioned, the CPI has an upward bias, and thus, when defining the price stability target in the form of the year-on-year rate of change in the CPI, it needs to be presented as a somewhat positive figure. C. Ensuring room to reduce interest rates: the so-called buffer Let me turn to the view that there is a need to secure room for an interest rate reduction by maintaining a positive inflation rate, thereby enhancing the ability of monetary policy to respond to economic deterioration; that is, that there is a need to have the so-called buffer. Put in extremely simple terms, an interest rate level that is neutral to economic activity is determined by the sum of the economy’s growth potential and an average inflation rate. For example, if the potential growth rate is 1 percent and the inflation rate is 2 percent, the interest rate neutral to economic activity will be 3 percent．In this case, against economic deterioration, there is room amounting to 3 percent for a central bank to stimulate the economy by reducing the interest rate. However, even if the potential growth rate is BIS central bankers’ speeches 1 percent, if the inflation rate is 0 percent, the room to reduce the interest rate amounts to only 1 percent as the level of the neutral interest rate is 1 percent. Therefore, when the level of the neutral interest rate is low, the interest rate will easily reach the 0 percent bound. A situation in which the interest rate reaches close to 0 percent and there is no room for further monetary easing through interest rate control is called the “zero interest rate lower bound.” Japan was the first among advanced economies to face the zero lower bound. Since the Bank reduced its official discount rate to 0.5 percent in September 1995, for almost 20 years now, Japan’s short-term interest rate has not exceeded 0.5 percent and has been hovering in the range of 0–0.5 percent (Chart 8). Of the two pillars of macroeconomic policy – fiscal policy and monetary policy – there has been a continuing situation whereby the effectiveness of monetary policy has been significantly impaired. In the meantime, the Bank took various initiatives ahead of other central banks in the world, including the adoption of various unconventional monetary policy measures ranging from the zero interest rate policy and quantitative easing to forward guidance in recent terminology. To be sure, even under the zero lower bound, there is still some room to pursue monetary easing through such unconventional monetary policy measures. However, it is also certain that, during this period, the most effective and traditional monetary policy channel of interest rate control has been lost. In my view, the Bank’s monetary policy has yielded results to some extent over the past 15 years in smoothing economic fluctuations. However, it was not sufficient to stave off a worsening of disinflation and preempt deflation from becoming entrenched. If the Bank had aimed at a price stability target of 2 percent at an earlier stage, it could have pursued more timely and bolder monetary easing in response to a decline in the inflation rate, thereby enabling the economy to overcome deflation at an early stage. With its protraction, deflation has become a problem that is increasingly stubborn and difficult to overcome. Based on the difficulties of the past 15 years, we need to let Japan’s economy overcome deflation at the earliest possible time and prevent, by any means, the economy from falling back into deflation again. To that end, it is critical to preempt deflation with a conduct of monetary policy that aims at a 2 percent price stability target. And, so as not to lose the effective measure of interest rate control, I believe that it is critical to secure room for an interest rate reduction through achieving around 2 percent inflation in a stable manner and allowing an economic activity-neutral interest rate to be formed at a somewhat high level. D. Global standard So far, I have explained the reasons to aim at 2 percent inflation from two viewpoints: due to a feature of the CPI, and to secure room for an interest rate reduction. These views are not special ones that only the Bank is adopting. Based on similar lines of thinking, many central banks overseas have already been implementing policies aiming at 2 percent inflation. For example, central banks in the United Kingdom, Canada, and New Zealand have set an inflation target of 2 percent, and in the United States, the Federal Reserve has set its longerrun goal for inflation at 2 percent. In the euro area, the European Central Bank (ECB) has presented a numerical definition of price stability, which is below, but close to, 2 percent (Chart 9). While there are various ways of expression, conducting monetary policy aiming at around 2 percent of inflation has become a global standard. If talking only about the buffer – namely, securing room for an interest rate reduction – the higher the inflation rate, the better. However, what monetary policy is aiming at is to achieve price stability. An issue will be the balance between the two. Based on past experience in a variety of economies, it has become a general view globally that around 2 percent would be BIS central bankers’ speeches desirable. In other words, the global standard of 2 percent inflation has become established through past experiences rather than based on theoretical analyses. Amid long-term stagnation since the Lehman crisis, the inflation rate has recently been declining globally, mainly in the euro area. As the International Monetary Fund Managing Director Christine Lagarde said in a speech, “with inflation running below many central banks’ targets, we see rising risks of deflation,” and thus a risk of deflation has become an important topic globally. The world thoroughly understands how Japan has been suffering long-term stagnation amid deflation, and there is a strong recognition of the need to avoid being like Japan in this particular regard. In fact, the CPIs in the United States, the euro area, and the United Kingdom have recently been on a downtrend (Chart 10). That said, the year-on-year rate of change in the CPI even in the euro area, where a risk of deflation has been most discussed, is plus 0.7 percent. That is still at a sufficiently high level compared with Japan’s CPI inflation rate of the past ten years or so. Nevertheless, at the press conference following each meeting of the Governing Council of the ECB, President Mario Draghi has been repeatedly questioned of late about the risk of deflation. While noting that having low inflation for a protracted period of time is a risk in itself and that he would not ignore such a risk, he also emphasized that medium- to longterm inflation expectations are well-anchored at a level of “below, but close to, 2 percent,” a level that the ECB defines as price stability. Coupled with the prospects that economic activity in the euro area will continue to pick up moderately, it is unlikely that the euro area will fall into deflation. Nevertheless, these developments in the euro area indicate that the importance of aiming at 2 percent and, on the other side of the coin, the danger of falling into deflation, have been strongly recognized in the area. III. Wages and prices: prices viewed from the perspective of households As I have explained, aiming at a 2 percent price stability target in terms of the year-on-year rate of change in the CPI is appropriate in terms of macroeconomic policy management, conceptually and as a global standard. Nevertheless, an opinion that there will be a negative impact if taken from the viewpoint of households is naturally heard. Therefore, let me next talk about prices viewed from the side of households, focusing on the relationship between wages and prices. From households’ perspective, it is quite natural to think that price increases are not desirable. According to the latest Opinion Survey on the General Public’s Views and Behavior the Bank conducts on households, about 80 percent of respondents who have felt that prices “have gone up” have described the price rise as “rather unfavorable.” This is not surprising. If asked only about prices, respondents will respond on the assumption that other conditions, including wages, are unchanged. If wages were not to change, price declines ought to be desirable. However, it does not normally happen that prices rise without being accompanied by wage increases. If corporate sales grow and corporate profits increase due to a rise in prices of goods and services, wages paid to employees tend to increase accordingly. As employees will demand that the portion of an increase in a firm’s profits to which they contributed be paid as wages, on a macro basis, the rate of increase in nominal wages will be the sum of the inflation rate and the rate of increase in labor productivity. Otherwise, the ratio of labor income to total income, which is the employees’ share, will continue to decline with a price rise. Such a thing might happen temporarily, but would not continue in a sustainable manner. In fact, this is underpinned by past data. Comparing developments in the rate of increase in wages per hour and that in the CPI in phases in which prices were rising, the rate of increase in wages has been exceeding that in the CPI on most occasions. There have been only two periods since 1971 when things did not go that way and the rate of increase in the CPI was higher than that of wages – the second oil shock in 1980 and a surge in international commodity prices during 2007 and 2008 (Chart 11). Both episodes occurred when the BIS central bankers’ speeches inflation rate surged temporarily due to a supply shock; namely, to external factors other than domestic demand. Therefore, the real options we are faced with are whether to aim at a world in which both wages and prices rise moderately, or to aim at a world in which wages and prices decline, as has been the case over the past 15 years. The choice is obvious. In the situation the Bank aims at, in which a 2 percent inflation rate continues stably, wages and prices would rise moderately in the normal course of things. This is the kind of economy in which each economic entity acts on the assumption that prices will rise by about 2 percent annually, even when the economy is in a normal state. In such a society, a 2 percent price increase will be factored into wage setting. In this regard, in Japan, an increase in base pay – a scheme that was lost amid protracted deflation – has gradually been restored recently. This can be regarded as a step toward transferring to a new social economic system in which a 2 percent price increase is built in as a social norm, and this deserves focused attention. The extent to which nominal wages will increase in excess of inflation, or in other words, the extent to which real wages will increase, will hinge over time on the extent to which labor productivity – the amount of goods and services produced by an input of one unit of labor – will increase. An increase in real wages, which is a critical challenge, will ultimately be attained through an improvement in productivity. In this regard, in addition to efforts by individual firms, it is important to prepare an environment in which to improve productivity through various growth strategies and deregulation. The government has demonstrated that measures to raise the growth potential of the economy will be accelerated and reinforced through implementation of its Japan Revitalization Strategy. It is expected that further improvement in productivity will be achieved through such initiatives. For firms, especially small and medium-sized firms, there might be a concern that they cannot mark up output prices to the extent input prices have risen. In a situation in which prices rise upon escaping from deflation, as I’ve just explained, it will become easier for firms to pass an increase in input prices on to output prices. I said earlier that, under deflation, a vicious cycle of a decline in prices, a fall in sales and profits, restraint in wages, stagnation in consumption, and further decline in prices has continued. In such a situation, it was not easy to pass an increase in input prices on to output prices. In fact, according to the Tankan survey, over the past 15 years compared with previous years, the diffusion index for input prices – obtained by subtracting the proportion of firms responding that their input prices were falling from that of firms responding that input prices were rising – has been substantially exceeding the diffusion index for output prices (Chart 12). By contrast, in an economy and society in which 2 percent inflation continues stably, a cycle just the opposite of the vicious cycle under deflation will be achieved. Starting from a moderate increase in prices, a virtuous cycle of the economy of an increase in sales and profits, an increase in wages, rejuvenated consumption, and a moderate increase in prices will be achieved and become entrenched. In a situation in which an economic virtuous cycle continues and firm demand is maintained, it will become easier for firms to pass on an increase in input prices on to output prices. IV. Consumption tax hike and inflation Let me next talk about the consumption tax hike and its implications for inflation. From next month, the consumption tax rate will be raised to 8 percent from the current 5 percent. As items in the CPI include those that are tax-free or exempted from taxation, the year-on-year rate of change in the CPI will be pushed upward by about 2 percent in association with the 3 percent consumption tax hike. In relation to this, let me point out two things. BIS central bankers’ speeches First, any increase in the year-on-year rate of change in the CPI by the consumption tax hike will be a temporary one. With the consumption tax hike next month, it is estimated that the year-on-year rate of change in the CPI excluding fresh food will be pushed upward on the surface by about 2 percent during fiscal 2014, but that this will disappear in fiscal 2015. As a specific example, let us look at developments that occurred in the year-on-year rate of change in the CPI when the consumption tax was raised in April 1997 to 5 percent from 3 percent. It was plus 0.5 percent in March 1997 prior to the tax hike, and after the hike went to around plus 2 percent for one year, from April 1997 to March 1998. The rate of increase was pushed up by about 1.4 percent. However, in April 1998, one year after the tax hike, the rate of increase dropped to plus 0.2 percent and the effect of the tax hike disappeared (Chart 13). Needless to say, the Bank aims at maintaining the 2 percent price stability target in a sustainable manner. Therefore, in assessing the price situation in pursuing monetary policy, we believe that it would be appropriate to make assessments by excluding the shortterm variation factor on prices brought about by the consumption tax hike. The second thing is a negative impact on real income due to the consumption tax hike. Given that consumption tax is tax revenue for the government, it is unavoidable that the consumption tax hike will have such a negative effect. The increase in the year-on-year rate of change in the CPI does not represent a rise in the value of goods and services themselves, but rather is the result of adding a tax that would be paid at the time of consumption to the prices of goods and services. The impact of the consumption tax hike should be discussed in a context that includes taxation, public finance, and the social security system, and it is necessary to clearly distinguish this from ordinary discussions on inflation. In sum, we believe that an increase in the CPI due to a consumption tax hike needs to be considered separately from the price increase as a trend. The Bank aims at achieving the 2 percent price stability target on a trend basis that excludes the direct impact of the consumption tax hike. I should note that, for some fees for public services, the old tax rate of 5 percent will be applied as a transitional measure for a certain period after entering April. Such a measure will be reflected in compiling the CPI. Therefore, the year-on-year rate of change in the CPI excluding fresh food that will be pushed upward due to the consumption tax hike will remain at about 1.7 percent in April and will become about 2 percent from May onward. The Bank will also take this point into account in assessing the price situation from next month onward. V. Future monetary policy Let me conclude my speech by briefly mentioning monetary policy for the near future. As I have indicated today, we believe it is necessary to achieve the 2 percent price stability target as swiftly as possible in order to overcome 15 years of deflation and prevent a recurrence of deflation. As the state of deflation has continued for many years, in the process of transitioning to the 2 percent target, various changes might occur in the economic and social system. However, if comparing the economy in which good and expanding equilibrium has been achieved under the 2 percent price stability target with that of deflationary equilibrium during these 15 years, there will be no room for denying that the former is desirable. What is important is not to fear changes but to look for a style of business and living that suits the economy after overcoming deflation. The QQE has been steadily exerting its intended effects and Japan’s economy has been following a path toward achieving the 2 percent price stability target as expected. The Bank will continue with the QQE, aiming to achieve the 2 percent price stability target, as long as it is necessary for maintaining that target in a stable manner. It will thoroughly examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. If, in the future, the outlook will change due to the manifestation of some risk BIS central bankers’ speeches factors and adjustments become necessary in order to achieve the 2 percent price stability target, the Bank will make them without hesitation. With such monetary policy, we look to overcome deflation at the earliest possible time. 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
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the International Financial Symposium, hosted by the Institute for International Monetary Affairs, Tokyo, 19 March 2014.
Haruhiko Kuroda: Overcoming deflation with quantitative and qualitative monetary easing Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the International Financial Symposium, hosted by the Institute for International Monetary Affairs, Tokyo, 19 March 2014. * * * Introduction It is my honor to be an invited panelist at the International Financial Symposium hosted by the Institute for International Monetary Affairs. The theme of the symposium is the important issue of challenges and policies for world economic growth. Looking at the current situation of the global economy, it has finally overcome the financial crisis following the Lehman shock and has recently been heading toward recovery on the whole. However, the pace of recovery remains moderate and a risk of the euro area and other advanced economies tumbling into deflation has been noted. I do not think that such risk is significant because medium- to long-term inflation expectations are anchored at the levels central banks are aiming at. Inflation expectations is the key term in Japan’s experience of deflation and challenge toward overcoming deflation, which I am going to talk about now. Long fight against deflation In retrospect, a series of events since the second half of the 1990s – such as banks’ nonperforming loan problems, the Asian currency crisis, the Lehman shock, and the Great East Japan Earthquake – weighed strongly on Japan’s economy. In addition, a variety of factors put direct downward pressure on prices, such as low-priced imports from emerging economies and firms’ low-price strategies to counter intensifying competition stemming from deregulation. In response, the Bank of Japan implemented a series of unconventional monetary policies ahead of other central banks around the globe, such as the zero interest rate policy, the quantitative easing policy, and forward guidance. With these policies serving to stimulate economic activity, the economy headed toward recovery from time to time. However, these policies failed to put an end to the trend of a price decline. Rather, people’s inflation expectations declined as deflation became protracted, and deflationary expectations – a sense that prices would not increase – became entrenched. In a world in which deflationary expectations are entrenched, the holding of cash or deposits becomes a relatively better investment strategy, and firms’ incentives to launch new initiatives through investing in business facilities and in research and development become reduced. Thus, Japan’s economy was deprived of vitality and this generated a vicious cycle in which the low vitality made it more difficult to overcome deflation. Due to its long persistence, deflation has become a challenge that is more and more difficult to overcome. In order to escape from such a situation, it has become necessary to pursue a policy that quickly and drastically changes people’s sense that prices will not increase. To that end, what was introduced as a prescription last April was quantitative and qualitative monetary easing (QQE). This policy differs from the Bank’s past monetary easing policies, as well as monetary easing policies implemented by major central banks overseas, in that its policy effects focus on dispelling deflationary expectations by directly working on people’s expectations; in other words, on raising people’s inflation expectations. BIS central bankers’ speeches The QQE The QQE comprises two elements. First, to eliminate deflationary expectations that were entrenched among firms and households, the Bank showed its determination that it would definitively overcome deflation through a strong and clear commitment. The Bank clearly stated that it would “achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years,” and thus clearly specified the period in which it would achieve the target. Second, given that deflation had continued for a long period, even with a strong commitment, it was difficult for the Bank’s strong determination to be viewed as convincing without any underpinning measures in place. The Bank therefore decided to double the monetary base in two years, and to achieve this it decided to massively purchase Japanese government bonds (JGBs), including those with longer remaining maturities. So far, the Bank has been pursuing the decided provision of the monetary base, and the year-on-year rate of increase in the monetary base was about 55 percent in February. The monetary base is expected to reach about 56 percent of nominal GDP at the end of this year. This far exceeds the current ratio of 22 percent of the Federal Reserve in the United States and 22 percent of the Bank of England in the United Kingdom, and is an unprecedented monetary easing. The key to the QQE’s transmission mechanism is the lowering of real interest rates. By raising inflation expectations through a clear commitment and underpinning large-scale monetary easing on the one hand and containing nominal interest rates through massive purchases of JGBs on the other, real interest rates will be lowered, thereby generating the effect of powerfully stimulating economic activity. As the real economy improves due to such stimulus, the actual inflation rate will rise, which will lead to a further rise in inflation expectations: such a virtuous cycle can be expected to operate. Is such a mechanism actually at work? So far, the QQE has been steadily exerting its intended effects. Surveys on various economic entities and break-even inflation rates have suggested a rise in inflation expectations on the whole. As for nominal interest rates, in contrast with other advanced economies in which long-term interest rates have been rising in tandem with economic recovery, Japan’s long-term interest rates have been hovering in a stable manner at an extremely low level of around 0.6 percent. Under such financial conditions, Japan’s economy has continued to recover moderately in association with a virtuous cycle among production, income, and spending. On the price front, the year-on-year rate of change in the CPI excluding fresh food was negative when the QQE was introduced but has since improved, registering a positive figure of around 1¼ percent in the latest data. One year has passed since the introduction of the QQE, and we have reached the midpoint of “about two years” that we specified. So far, Japan’s economy has been following the path toward achieving the 2 percent price stability target as expected, and we have become increasingly confident that the anticipated transmission mechanism of the QQE is actually working. In Japan, two rounds of consumption tax hikes are scheduled. Based on the experience of the economy going into recession when consumption tax was raised last time, in 1997, there are some concerns that the same might happen again. However, looking at the economic conditions of that time, the economic growth rate plunged immediately after the tax hike but subsequently showed signs of recovery. The economy seemed to have instead been affected substantially by a series of failures of Japanese major financial institutions and by the Asian currency crisis that took place just when the economy showed nascent recovery. By contrast, at present, Japan’s financial system has been maintaining stability and emerging economies have become more resilient against negative shocks. The current conditions are quite different from those in 1997. Taking these differences into account, the Bank believes that, even assuming two consumption tax hikes, the virtuous cycle in the economy will not be interrupted and Japan’s economy will continue to grow above its potential growth rate as a trend. BIS central bankers’ speeches Challenges ahead to achieve the 2 percent To conclude, let me briefly touch on one of the challenges that lies ahead; namely, how prices and wages will be set when we achieve 2 percent inflation in a stable manner. The Bank is committed to continue with the QQE as long as it is necessary for maintaining the 2 percent price stability target in a stable manner. We are aiming at an economy and society in which actual inflation rates will be around 2 percent on average, and in which firms and households will behave on the assumption that prices will increase by about 2 percent. In the United States and Europe, people’s medium- to long-term inflation expectations have been anchored at about 2 percent, and the setting of prices and wages based on these expectations has been firmly established. We would like to achieve this in Japan as well. On this point, there have been encouraging developments in annual wage revisions for next fiscal year. We are paying close attention to how the wage decision framework based on the assumption of price rises will be created. Concluding remarks The QQE, which I have talked about today, holds the huge challenge of raising inflation expectations through monetary policy. So far, with the policy exerting its intended effects, Japan’s economy has been stepping toward achieving the 2 percent price stability target as expected. Of course, we are only halfway there. The Bank will steadily pursue the QQE to overcome as soon as possible the deflation that has continued for nearly 15 years. It will examine both upside and downside risks to economic activity and prices, and make adjustments if necessary to achieve the price stability target. Thank you. 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, Wakayama, 20 February 2014.
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, Wakayama, 20 February 2014. * * * I. Recent economic and price developments A. Japan’s economy and prices 1. Current state of and outlook for Japan’s economy I will begin by explaining the current state of, and outlook for, Japan’s economy. Economic activity had stopped weakening after the turn of 2013. The economy then returned to a moderate recovery path around mid-year as domestic demand remained resilient, mainly due to the effects of monetary easing and various economic measures. Japan’s economy has since continued to recover moderately as domestic demand has remained firm, although exports have somewhat lacked momentum. Business sentiment has been improving in a wide range of industries, including those of small firms, and in regional terms economic recovery has been spreading on a national basis. Taking a closer look at developments in demand, exports showed relatively high growth in the first half of 2013 but have somewhat lacked momentum since the second half amid somewhat sluggish movements in some emerging and commodity-exporting economies. As for domestic demand, private consumption has remained resilient as a trend, with improvement in the employment and income situation, and a front-loaded increase in demand prior to the consumption tax hike has been observed mainly in durable consumer goods, as suggested particularly by the recent noticeable rise in new car sales. Housing investment has been increasing. Public investment has been trending upward, mainly reflecting the effects of various economic measures implemented thus far. Business fixed investment has been picking up, as the aggregate supply of capital goods – a coincident indicator of machinery investment – has recently shown relatively high growth with improvement in corporate profits, and as machinery orders – a leading indicator of machinery investment – have been improving as a trend even in the manufacturing sector, albeit with fluctuations. Taking these developments as a whole, the employment and income situation has been improving, supported by resilient domestic demand, indicating that a virtuous cycle among production, income, and spending is being maintained. As for the outlook, while Japan’s economy will be affected by the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike, it is likely to continue growing at a pace above its potential, which is estimated to be around 0.5 percent, as a trend, as the virtuous cycle will continue to operate. Japan’s exports are expected to increase moderately as overseas economies – mainly advanced economies – recover moderately. Meanwhile, business fixed investment is likely to follow a moderate increasing trend, with improvement in corporate profits. Private consumption and housing investment, albeit with some fluctuations, are expected to remain resilient as a trend, as improvement in employee income is expected to gradually become evident. Public investment is expected to trend upward for the time being, supported partly by the effects of the implementation of the supplementary budget for fiscal 2013, and then remain at a high level. In the Bank of Japan’s January 2014 interim assessment of the October 2013 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the median of the Policy Board members’ forecasts for the economic growth rate was 2.7 percent for fiscal 2013, 1.4 percent for fiscal 2014, and 1.5 percent for fiscal 2015. BIS central bankers’ speeches 2. Prices Next, I will talk about price developments. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food turned positive in June 2013 and rose to 1.3 percent in December. The year-on-year rate of change in the CPI, excluding prices of food and energy-related goods such as petroleum products, was 0.7 percent in December, and improvement in prices is spreading across a wide range of items amid the improvement in the aggregate supply and demand balance, with the number of items for which prices have risen exceeding that for which prices have declined. As for the outlook, the year-on-year rate of increase in the CPI (all items less fresh food), excluding the direct effects of the consumption tax hike, is likely to be around 1–1/4 percent for some time as the effects of the upward pressure from prices of petroleum products subside. Thereafter, it is likely to rise, reflecting factors such as the improvement in the aggregate supply and demand balance due to the recovery of Japan’s economy as well as the rise in medium- to long-term inflation expectations in response to fundamental changes in the public’s expectations. The rate of increase in the CPI is likely to reach around 2 percent – the price stability target – toward the latter half of the projection period, through fiscal 2015. Specifically, in the Bank’s interim assessment in January of the October 2013 Outlook Report, the median of the Policy Board members’ forecasts for the year-on-year rate of increase in the CPI (all items less fresh food; for fiscal 2014 and fiscal 2015, excluding the direct effects of the consumption tax hikes) was 0.7 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.9 percent for fiscal 2015. B. Major issues surrounding economic activity and prices I would now like to talk about the key issues concerning assumptions related to the outlook for Japan’s economic activity and prices. Japan’s economy is expected to achieve sustainable growth as the virtuous cycle among production, income, and spending – including wage increases and a recovery in business fixed investment – continues to operate. However, Japan’s working-age population has been on a downtrend due to the aging population and declining birth rate. For the economy to achieve a higher growth rate, it is important to step up efforts to secure a sufficient labor force and raise productivity, allowing firms and households to raise their optimism about future income and demand. Positive developments have recently been observed, such as progress in the labor force participation of women and the elderly, as well as firms’ efforts in growth sectors. In the future, if growth expectations gradually rise as active efforts by the government and firms to strengthen Japan’s growth potential bear fruit, this in turn will eventually lead to a rise in Japan’s potential growth rate. At this point, I will discuss recent developments in overseas economies and Japan’s exports, business fixed investment, the employment and income situation, and inflation expectations, all of which are likely to have a significant effect on the outlook for economic activity and prices. 1. Developments in overseas economies and Japan’s exports I will first examine current developments in overseas economies to assess those in Japan’s exports. Overseas economies – mainly advanced economies – are starting to recover, although the performance remains lackluster in some parts of emerging and commodityexporting economies. As for the outlook, overseas economies – mainly advanced economies – are likely to continue recovering. In January 2014, the International Monetary Fund (IMF) revised upward its projections for global economic growth in its World Economic Outlook, forecasting that the global economy would moderately accelerate its pace of growth from 3.0 percent in 2013 to 3.7 percent in 2014 and 3.9 percent in 2015. Looking at respective regions, the recovery of the U.S. economy has gradually become widespread as the employment and income situation continues on an improving trend, with firmness in household spending spreading to the corporate sector and boosting production, although some effects of a winter snowstorm are still being observed. The benefits of the shale revolution are also being felt by the economy. Looking ahead, the U.S. economy is expected to gradually see an acceleration in BIS central bankers’ speeches its pace of recovery, led mainly by private demand, partly because the fiscal drag will gradually fade as uncertainties surrounding the economy abate somewhat, mainly due to progress in the fiscal debate. In the European economy, business and household sentiment has been on an improving trend as financial markets have regained stability. In such circumstances, private consumption has been picking up, albeit moderately, and production is starting to pick up. Further developments regarding the European debt problem, efforts to restore financial soundness, and the disinflationary trend warrant attention. Nevertheless, the economy is likely to continue picking up, as domestic demand is expected to do so as well and as exports are likely to recover moderately. The Chinese economy continues to see stable growth on the back of firm domestic demand including private consumption and fixed asset investment, although the pace of growth has decelerated somewhat. It is likely to maintain stable growth, as the government – while progressing with reforms to address structural problems – is expected to pursue policy measures that take due account of economic activity, although some uncertainties remain including the effects of excess production capacity and debt. Regarding some of the other emerging and commodityexporting economies, in a situation where they are facing structural problems such as fiscal deficits and current account deficits, there have been outflows of funds against the background of the U.S. Federal Reserve’s reduction of the pace of its asset purchases. Thus, continued attention is warranted on developments in these economies, including the effects on economic activity. Emerging economies other than China and commodityexporting economies as a whole will likely lack growth momentum for the time being, but from a longer-term perspective, positive effects of the recovery in advanced economies will spill over to them. Amid these developments in overseas economies, Japan’s exports have generally been picking up but continue to lack some momentum. This may be partly attributable to structural factors including the shift of Japanese firms’ production sites to overseas accompanying increased local procurement of parts by Japanese manufacturers. Fundamentally, however, the lack of momentum is considered to be largely due to the sluggishness in the emerging economies, particularly the ASEAN economies, which are closely linked to Japan’s economy. As for the outlook, exports as a whole – including indirect exports via Asian economies such as China and the NIEs – are likely to increase moderately, as the growth rates of advanced economies such as those of the United States and Europe increase. 2. Developments in business fixed investment Turning to the corporate sector, it is important that increases in corporate profits and demand lead to growth in business fixed investment. Corporate profits have been recovering on the back of firm domestic demand and developments in the foreign exchange market. Business fixed investment has been picking up on the whole, including the manufacturing sector, which had been lagging behind. Going forward, business fixed investment is likely to follow a moderate increasing trend against the backdrop of an improvement in corporate profits and the effects of monetary easing. In the context of investment profitability, profitability from business fixed investment is likely to improve and the extent of the monetary easing stimulus to encourage investment is likely to strengthen, owing to a rise in the rate of return on capital due to economic recovery combined with the decline in real interest rates mainly reflecting a rise in inflation expectations. As to the objects of investment, latent demand for the maintenance and replacement of equipment has built up, reflecting past restraints on firms’ investment, and has become more likely to materialize. Investment related to disaster prevention and energy is also expected to increase. Furthermore, firms’ medium- to long-term growth expectations are likely to rise moderately, due partly to the positive initiatives to strengthen the competitiveness and growth potential of Japan’s economy, such as the government’s regulatory and institutional reforms and various tax reduction measures, as well as firms’ restructuring efforts. In such an environment, if business fixed investment continues on an uptrend and firms’ efforts to accumulate capital in growth sectors and increase labor BIS central bankers’ speeches productivity make headway, the potential economic growth rate – the real strength of the economy – should also rise moderately. 3. Employment and income situation I would now like to talk about the employment and income situation, which is one of the key factors in achieving a sustainable recovery in domestic demand. Private consumption has recently been resilient thanks to continued active spending by the elderly – the baby-boom generation in particular – and is underpinned by the wealth effects of the rise in stock prices. While active spending by the elderly is expected to continue as firms work to capture demand, the key to economic improvement in a well-balanced manner lies in improvement in income supporting private consumption. Looking at the current employment and income situation, supply and demand conditions in the labor market continue to improve steadily, with the active job openings-to-applicants ratio having risen to the level observed prior to the Lehman shock of just over 1.0 and with the unemployment rate similarly having fallen to the pre-Lehman shock level of 3.7 percent, mainly due to resilient domestic demand. Firms are increasingly experiencing a shortage of labor, as suggested by the fact that the employment conditions diffusion index (DI) (the proportion of firms responding that employment is “excessive” minus the proportion of those responding that it is “insufficient”) in the latest Tankan (Short-Term Economic Survey of Enterprises in Japan) is deeper in negative territory, particularly in the nonmanufacturing sector. Reflecting these supply and demand conditions in the labor market, a growing number of firms, especially among industries increasingly experiencing a shortage of labor, have eased or made more flexible their hiring criteria, or have adopted the “hire-and-nurture” recruiting method, which involves supporting their workers’ efforts to obtain the qualifications necessary for their jobs. At the same time, firms are making progress in terms of actively employing women, the elderly, and foreign nationals, and in increasing the diversity of their employment methods. This has resulted in more active job searches by women and those who had been out of the workforce, resulting in the recent growth of the labor force population. If these diverse employment styles gradually become established with a sustained economic recovery, this will help secure a sufficient labor force despite the declining trend of the working-age population, underpinning the medium- to long-term growth potential of Japan’s economy. The improvement in supply and demand conditions in the labor market is influencing nominal wages. Specifically, the year-on-year rate of change in nominal wages per full-time employee has become slightly positive, reflecting increases in overtime pay and winter bonuses. In addition, hourly nominal wages per part-time employee remain on a modest increasing trend year on year. Looking at workers as a whole, scheduled wages per employee have remained slightly negative year on year, due partly to the increase in the proportion of part-time workers, whose wage levels are relatively low. Still, the employment and income situation has been improving on the whole, with employee income – wages per employee multiplied by the number of employees – continuing to register year-on-year increases. Going forward, as the improvement in supply and demand conditions in the labor market continues, nominal wages are expected to be put under upward pressure gradually. Regarding the wage negotiations to be held this spring, labor unions are demanding wage hikes, including an increase in workers’ base wages. At the same time, a growing number of firms appear to be indicating their willingness to allow for a certain rise in wages in terms of total remuneration, including base wages. Amid increasing corporate profits, close attention will be paid to whether firms carry out wage hikes to some extent, including an increase in scheduled wages. 4. Developments in prices and inflation expectations I will now turn to price-related issues. Japan’s economy has been following the path toward achieving the 2 percent price stability target, as expected, and we can say that the year-onyear rate of change in the CPI (all items less fresh food) has been somewhat higher than BIS central bankers’ speeches market expectations thus far. Inflation expectations of firms and households have also risen on the whole, and are likely to remain on an increasing trend under the Bank’s quantitative and qualitative monetary easing (QQE), due in part to a rise in the actual inflation rate. However, since the year-on-year rate of increase in the CPI is expected to be around 1–1/4 percent for some time, close attention still needs to be paid to whether medium- to long-term inflation expectations will rise as expected. In addition, it is important that a virtuous cycle between price rises and wage increases operates effectively in order for prices to rise in a sustainable fashion. Discussions on efforts to raise productivity and on price developments in the upcoming wage negotiations will therefore be monitored closely. II. Conduct of monetary policy A. Quantitative and qualitative monetary easing (QQE) 1. Framework of QQE Next, I would like to turn to the Bank’s conduct of monetary policy. In order for Japan’s economy to overcome deflation as early as possible and achieve sustainable growth with price stability, the Bank introduced in January 2013 the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI. Then, in April the Bank introduced QQE to achieve the price stability target at the earliest possible time, with a time horizon of about two years. Specifically, the Bank decided upon the following. First, with a view to pursuing quantitative monetary easing, the Bank decided to increase the monetary base – which is the total amount of currency it directly supplies to the economy (the sum of banknotes in circulation, coins in circulation, and current account deposits held by financial institutions at the Bank) – at an annual pace of about 60–70 trillion yen, thus doubling it in two years. Second, to achieve this, the Bank has been purchasing Japanese government bonds (JGBs) so that their amount outstanding increases at an annual pace of about 50 trillion yen. In doing so, the Bank has aimed at working on interest rates across the yield curve – including longerterm ones – extending the average remaining maturity of its JGB purchases to about seven years. And third, the Bank has been purchasing exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. The Bank will continue with QQE – consisting of these measures – aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. In order to achieve the price stability target, it is important to create a virtuous cycle in which prices rise moderately along with a balanced and sustainable improvement in economic activity that is accompanied by increases in corporate profits, employment, and wages. 2. Effects of QQE Now I will talk about developments since the introduction of QQE. The monetary base has been increasing at an annual pace of about 60–70 trillion yen – in line with the Bank’s guideline for money market operations – owing to progress in the Bank’s large-scale JGB purchases, and reached its initial projection of 200 trillion yen at end-2013. The Bank intends to increase its monetary base to 270 trillion yen – corresponding to as much as approximately 60 percent of Japan’s nominal GDP – toward end-2014. Despite some instability observed in the JGB market soon after the introduction of QQE last April, the market gradually regained stability as the Bank implemented detailed money market operation measures while maintaining a close dialogue with market participants. QQE has thus been exerting its intended effects, with favorable developments spreading to economic activity and financial markets. BIS central bankers’ speeches The Bank conducts QQE keeping in mind two key transmission channels, that is, routes by which the effects of QQE are expected to carry through the economy: (1) lowering real interest rates by exerting downward pressure on nominal long-term interest rates and raising inflation expectations; and (2) the portfolio rebalancing effect. In lowering real interest rates, the Bank first applies strong downward pressure on nominal long-term rates by tightening JGB market conditions through the massive purchases of JGBs. Then, through a clear explanation of its determination to achieve the price stability target at the earliest possible time and the continuation of massive purchases of assets underpinning this determination, it aims to raise inflation expectations by boosting people’s expectations that the economy will become revitalized. Consequently, real interest rates could be lowered if the extent of a pickup in nominal rates is contained within the extent of a rise in inflation expectations. As the spending behavior of firms and households is influenced by real interest rates, a decline in such rates would help to increase firms’ and households’ investment and consumption. As for recent developments, in a situation where nominal long-term interest rates have been stable at low levels, real interest rates appear to be on a declining trend on the back of a rise in inflation expectations as a whole. Real interest rates are expected to continue on a declining trend given that the Bank’s large-scale JGB purchases will put strong downward pressure on nominal long-term rates and as inflation expectations rise in line with an increase in the actual inflation rate. Next, the portfolio rebalancing effect can be described as the effect produced by the Bank’s asset purchases, in which they encourage financial institutions and institutional investors to shift their asset portfolio toward lending and investment in risk assets such as stocks. The aggregate flow of investment – including by households – confirms that investments in stocks and investment trusts as well as in corporate bonds, in addition to lending, have been increasing, while the amount of JGB holdings has been decreasing. The increases are partly attributable to the rise in stock prices, and the increase in the amount of lending is still small compared with that of the monetary base. Nevertheless, portfolio rebalancing – mainly characterized by the shift in investment to risk assets – is likely to gradually gather momentum as firms’ demand for funds continues to strengthen and given that business fixed investment is expected to continue on a moderate increasing trend. With these channels acting together, it is likely that the aggregate supply and demand balance will improve and that the actual inflation rate will rise further. 3. Developments in financial markets Meanwhile, financial conditions remain accommodative. Firms’ funding costs have been hovering at low levels, with long-term average contract interest rates on new loans and discounts having declined to the 0.8–0.9 percent level, reaching a historical low. Firms see financial institutions’ lending attitudes as being on an improving trend. The DI of financial positions of small firms has been recovering, reaching the most recent peak level seen around 2006. In addition, the number of corporate bankruptcies has been at a low level, with figures for January 2014 at the lowest for a January since 1991. The amount outstanding of bank lending has been at around 2.5 percent, with lending to small firms extended to those across a wider range of industries and a climb observed in the year-on-year rate of increase in the amount outstanding of such lending. Issuing conditions for CP and corporate bonds have continued to be favorable. In these circumstances, the year-on-year rate of growth in the money stock (M2) has been high at around 4.5 percent. Looking at financial markets, money market rates have been below the 0.1 percent level for all maturities. Long-term interest rates have been stable at a historically very low range of 0.6–0.8 percent, even at a time when overseas interest rates rose on the whole, with U.S. long-term interest rates reaching around 3.0 percent, mainly against the backdrop of an economic recovery. In addition, stock prices have risen substantially and a correction in the yen’s appreciation has been taking place in the foreign exchange market. Regarding economic activity, a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike are expected. In making future monetary policy BIS central bankers’ speeches decisions, it is important to assess whether Japan’s economy is following the path toward achieving the 2 percent price stability target as expected, after smoothing out related fluctuations in demand. At present, the virtuous cycle continues to operate as the effects of QQE on economic activity are becoming pronounced. Nevertheless, it is important to continue to carefully examine economic developments and the effects of monetary policy. Furthermore, in order to fully ensure the effectiveness of monetary easing, it is essential for the government to ensure the market credibility of fiscal consolidation. Japan faces serious fiscal imbalances, even by international standards. If the credibility of its fiscal management were to decline, long-term interest rates would likely rise in a manner inconsistent with economic and price developments. The government has indicated that it aims to halve the primary deficit-to-GDP ratio by fiscal 2015 and achieve a surplus in the primary balance by fiscal 2020. Based on these targets, it is expected that the government will continue making efforts toward fiscal consolidation. B. Loan support program Next, I will discuss the Bank’s Loan Support Program. To support full use of the accommodative financial conditions by firms and households, the Bank – in addition to implementing aggressive monetary easing measures – has established the Loan Support Program. The program consists of two measures: the fund-provisioning measure to stimulate bank lending (hereafter the Stimulating Bank Lending Facility) and the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility). At the Monetary Policy Meeting held on February 17 and 18, 2014, the Policy Board decided to double the scale of the two facilities and to extend the application period for them, both of which were due to expire shortly, by one year. It also decided to extend the duration of loans, enabling financial institutions to borrow funds at a fixed rate of 0.1 percent per annum for four years instead of the current one to three years. Let me elaborate on the framework of and the recent enhancements made to these facilities. First, the Stimulating Bank Lending Facility aims to prompt financial institutions to take a more active lending stance and stimulate firms’ and households’ demand for credit. With this facility, the Bank provides long-term yen-denominated funds at a low interest rate to financial institutions, at their request, up to an amount equivalent to the net increase in their lending. There is no upper limit to the total amount of funds provided by the Bank under this facility. Under the enhanced framework, the Policy Board decided to double the maximum amount of its fund-provisioning to each financial institution – formerly set to the net increase in its lending – allowing it to borrow funds from the Bank up to an amount that was twice as much as the net increase in its lending. Moreover, the duration of loans was extended from the former period of one to three years with a fixed interest rate of 0.1 percent per annum to four years with a fixed rate of 0.1 percent per annum. The amount outstanding of fundprovisioning under the Stimulating Bank Lending Facility is about 5 trillion yen as of end2013. Based on the assumption that the growth rate of bank lending and the utilization rate of the facility will remain more or less at current levels, the amount outstanding of fundprovisioning under the enhanced framework is estimated to be around 30 trillion yen. I will now move on to the Growth-Supporting Funding Facility, which aims to support the flow of funds to growth sectors. With this facility, the Bank provides long-term funds – both yendominated and foreign currency-denominated – at a low interest rate to financial institutions for their lending and investment to areas that are expected to contribute to strengthening Japan’s growth potential, such as medical and nursing care; environment and energy; agriculture, forestry, and fisheries; and tourism. Before the enhancements, the Bank set the maximum amount of its fund-provisioning to financial institutions under the main rules and special rules as follows: 3.5 trillion yen under the main rules for financial institutions’ investments and loans amounting to 10 million yen or more; 500 billion yen under the special rules for financial institutions’ equity investments and asset-based lending (ABL) – the latter BIS central bankers’ speeches of which uses assets such as accounts receivable and inventories as eligible collateral; 500 billion yen under the special rules for financial institutions’ small-lot investments and loans; and 12 billion U.S. dollars – equivalent to 1.2 trillion yen – under the special rules for a U.S. dollar lending arrangement using the U.S. dollar reserves already held by the Bank. In the recent enhancement of the facility, the Policy Board decided to double the maximum amount of the Bank’s fund-provisioning under the main rules, which had almost reached its limit, to 7 trillion yen, and increased the maximum amount of its fund-provisioning to each financial institution from 150 billion yen to 1 trillion yen. It was decided that the duration of all loans – excluding those made under the U.S. dollar lending arrangement – would be extended from the former period of one to two years with a fixed interest rate of 0.1 percent per annum to four years with a fixed rate of 0.1 percent per annum. In order to maintain the virtuous cycle, it is important that firms and households actually make use of the accommodative financial conditions for funding and increase investment and spending, which in turn will lead to an improvement in the aggregate supply and demand balance and further to the strengthening of the economy’s growth potential. The recent enhancement of the two facilities, and the extension of their application period, will likely promote such movements. The corporate sector has accumulated 230 trillion yen worth of cash and deposits amid firms’ persistent tendency to invest only as much as their cash flow allows. Recently, however, firms have increasingly shown a willingness to take the opportunity to start new investment using external funds. Through the measures I have just explained, the Bank will continue to provide firm support enabling them to meet their challenges. I hope that these measures, together with steady progress in the implementation of the Japan Revitalization Strategy – aimed at strengthening the government’s competitiveness – will prompt financial institutions to take a more active lending stance and stimulate firms’ and households’ demand for credit, with a view to encouraging banks’ lending and strengthening the foundations for economic growth. BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a conference, held by the London School of Economics and Political Science, London, 21 March 2014.
Haruhiko Kuroda: How to overcome deflation Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a conference, held by the London School of Economics and Political Science, London, 21 March 2014. * * * Introduction It is indeed my honor to be given an opportunity today to speak at this conference hosted by the London School of Economics and Political Science. Just one year has passed since I became Governor of the Bank of Japan on March 20, 2013. In short, this past one year was one marked by the challenge of overcoming deflation. The word deflation might remind you of the price decline associated with rapid contraction of the economy during the Great Depression of the 1930s. Some might even look back to the much earlier episode of the downtrend in prices for more than 20 years that the United Kingdom experienced in the second half of the 19th century. What is deflation actually like? Why is deflation a problem? As I would expect that nobody here has actually experienced those past deflations, you might be able to conceive of answers to these questions, but it could be difficult to have a true sense of the reality of those situations. Therefore, in my speech today, I will talk about Japan’s experience of 15 years of deflation and how we are trying to overcome that. Let me first ask you a question. What is the average annual rate of decline in consumer prices in Japan in the past 15 years? The answer is minus 0.3 percent. Unlike the rapid and substantial price decline during the Great Depression in the 1930s, a feature of Japan’s deflation is that an extremely moderate price decline has continued for a long period. The unemployment rate was 5.5 percent at its worst and there has been no such scene as jobless people predominating in a town, as was the case in the Great Depression. This is not to say that there weren’t any problems simply because the decline in prices was moderate. If we were to regard the price decline during the Great Depression as a fierce and acute symptom, Japan’s deflation has come to show a symptom akin to a chronic lifestyle disease. Once an expectation that prices will fall becomes built-in among the public, real interest rates, which are obtained by subtracting expected rates of inflation from nominal interest rates, will increase. Of course, a central bank can cope with such a situation if it can lower nominal interest rates, but in Japan the policy rate had already been lowered to 0.5 percent in 1995 and there was little room to further reduce nominal interest rates. An increase in real interest rates restrains business fixed investment and household spending, and thus economic activity in Japan remained stagnant. In addition, under deflation, holding cash and deposits becomes a better choice than making investment, and incentives to launch new businesses by taking risks become weakened. In this situation, Japan’s economy lost vitality and the growth rate declined. It can be said that a moderate price decline has gradually undermined Japan’s economy. Therefore, what we should do to restore the vitality of Japan’s economy and let the economy grow in a sustainable manner is to achieve the 2 percent price stability target and overcome protracted deflation. As I will describe later, to overcome deflation, the Bank of Japan introduced last April quantitative and qualitative monetary easing, dubbed QQE – an unprecedented bold monetary easing – and has been pursuing this policy. Today, so as to enhance your understanding of the Bank’s initiatives to overcome deflation, I will address three questions. First, why has Japan’s economy been unable to overcome deflation? Second, how are we trying to get out of deflation? And lastly, how far have we come in the process of overcoming deflation? BIS central bankers’ speeches I. Why has Japan’s economy been unable to overcome deflation? As I mentioned earlier, deflation has been continuing in Japan since the late 1990s, but the economy has not been in recession during the whole period. Instead, a recovery phase of more than six years, from the beginning of 2002 to early 2008, marked the longest post-war economic recovery. Since 1999, to overcome deflation, the Bank adopted ahead of other central banks various unconventional policy measures, such as the zero interest rate policy, quantitative easing policy, a commitment to the duration of these policies, and purchases of risk assets. If we had named the commitment to the duration of the zero interest rate policy introduced in 1999 an eye-catching “forward guidance”, the Bank might have received an honor as the inventor of this policy tool. However, despite the tailwind in the real economy and considerable efforts by the Bank, Japan’s economy could not overcome deflation. What was lacking? To state the answer first, what lacked was the central bank’s strong and clear commitment to achieve its price stability target and its actions to work on inflation expectations through that commitment. To begin with, if we look into the causes of Japan’s price declines, various factors have had an effect at each point in time. To name several, these were an adjustment of excess capacity and employment after the bubble period, low-priced imports from emerging economies and firms’ low-price strategies, financial institutions’ nonperforming loan problems and financial system uneasiness, and an excessive appreciation of the yen. As actual prices declined due to those factors, deflationary expectations that prices will not rise but instead decline were generated among people. Subsequently, even if those factors that induced price declines diminished, once deflationary expectations became entrenched, people would make decisions and take actions on the assumption that prices would not rise. Through this process, deflationary expectations themselves created in a self-fulfilling manner an economy in which prices did not easily rise. Explained by using the jargon of economics, Japan’s economy is in a situation in which the Phillips curve, which expresses a negative relationship between inflation and unemployment, has shifted downward due to a decline in people’s inflation expectations. Even when the economy is trapped in such a situation, we can raise prices temporarily by rejuvenating economic activity through stimulative policies. However, if the Phillips curve remains shifted downward, the economy will eventually return to a deflationary state once economic activity declines over the business cycle. This is why Japan’s economy could not overcome deflation after all, despite experiencing an economic expansion several times while deflation was continuing. Having analyzed why protracted deflation occurs, let’s turn to the second question: what is required to get out of protracted deflation and achieve the 2 percent price stability target in a sustainable manner? As the problem lies in the fact that people have a deflationary sentiment that prices will fall, we have to dispel such sentiment. We have to convince people that a situation in which prices will increase by around 2 percent every year is nothing special, and change the economy to one in which people make decisions and behave based on that assumption. In other words, it is necessary to raise people’s expected rates of inflation to 2 percent and re-anchor them at that level. The Bank had repeatedly implemented various leading-edge policies. While a series of such policies stimulated economic activity, they fell short of showing a strong and clear commitment to achieve the price stability target by any means. As a result, these were insufficient to work on inflation expectations and failed to raise them. Therefore, even in the face of a temporary rise in prices, the rise was not sustained and the economy could not get out of deflation for a long period. II. How to overcome deflation Let me next talk about how the Bank is now trying to raise people’s inflation expectations and overcome deflation. It is clear from the results of past policies that deflationary sentiment that has been embedded under protracted deflation cannot be easily dispelled. There have been only a few examples. Looking back, one can immediately think of the U.S. New Deal Policy BIS central bankers’ speeches of the 1930s as an episode in which people’s inflation expectations substantially rose in a short period of time through policy measures. At the same period in Japan, a similar series of macroeconomic policy measures called the “Takahashi Economic Policy”, named after the finance minister who took the initiative, were implemented. In these policies, an exit from the gold standard enabled foreign exchange rates to adjust in line with actual economic conditions, and macroeconomic policies that combined aggressive fiscal and monetary policies were implemented. By contrast, the powerful monetary tightening by Chairman Volcker of the U.S. Federal Reserve (Fed) from the end of the 1970s to the beginning of the 1980s can be noted as an episode in which inflation expectations were substantially lowered. All these events are associated with the policy authorities’ strong will to drastically change the economic situation, and with a bold policy conversion that underpinned such will. Therefore, to convert people’s deflationary expectations and raise their expected rates of inflation, it is necessary to demonstrate the Bank’s strong resolution and commitment toward overcoming deflation and to implement decisive policy that is sufficient to achieve that goal. We also have to make the conversion of expectations happen under a zero lower bound for nominal interest rates. Taking these points into account, at the Monetary Policy Meeting on April 4 last year, the Bank introduced the unprecedented large-scale monetary easing policy of the QQE. It was a policy, upon strongly committing to achieve the 2 percent price stability target with a time horizon of about two years in mind, to increase the monetary base by an unprecedented amount of about 60–70 trillion yen to underpin the commitment. As a result, the monetary base will be doubled in two years. In addition, aiming to achieve the 2 percent price stability target, the Bank committed to continuing with the QQE as long as it is necessary for maintaining the target in a stable manner. The Bank clearly committed to achieving the 2 percent price stability target, with a time horizon of about two years in mind, and also to continue with the unprecedented large-scale monetary easing of the QQE as long as it is necessary for maintaining the target in a stable manner. We considered that such a combination would raise people’s inflation expectations in a forward-looking manner. We also assumed that, as a result, if actual prices start to increase, that would affect inflation expectations in a backward-looking manner as well. And with an increase in the number of people who believe in the Bank’s commitment, the forwardlooking influence would also be strengthened. Let me be more specific about the transmission mechanism of the QQE. Three transmission channels are assumed: containing interest rates and risk premiums through massive asset purchases, portfolio rebalancing, and raising inflation expectations. What I would like to focus on in particular is the channel starting from a rise in inflation expectations. As a rise in inflation expectations shifts the Phillips curve upward, under the same level of economic activity, the actual inflation rate will be higher. In addition, a rise in expected rates of inflation, if nominal interest rates rise by less than that, will lower real interest rates and stimulate economic activity. That is, if the Bank can contain nominal interest rates through massive asset purchases while raising expected rates of inflation, it can lower real interest rates. In the case of central banks in the United States and Europe, as inflation expectations have already been anchored at the price stability target, they have no choice but to reduce nominal interest rates in order to lower real interest rates. However, in the case of Japan, as inflation expectations have been below the level of the price stability target, there is room for lowering real interest rates through raising inflation expectations. A decline in real interest rates will stimulate business fixed investment and consumption, and raise the actual inflation rate by narrowing the output gap. Once prices start to rise, this will further induce a rise in inflation expectations, which in turn work on real interest rates to decline again. In such a manner, a virtuous cycle starting from a rise in inflation expectations will take hold. BIS central bankers’ speeches III. How far have we come? So, how far have we come toward the goal of achieving the 2 percent price stability target and overcoming deflation? To state the conclusion first, Japan’s economy has been following a path toward achieving the 2 percent price stability target as expected, and we are halfway there. The transmission mechanism of the QQE has been functioning as initially intended. According to various surveys and market indicators, we judge that inflation expectations have generally been rising. Due to the Bank’s massive purchases of government bonds, long-term interest rates have been hovering in a stable manner at low levels. In fact, in the face of a rise in U.S. long-term interest rates from below 2 percent to about 3 percent in relation to speculation about the Fed’s tapering of its asset purchases, Japan’s long-term interest rates have been stable and recently at around 0.6 percent. As a result, real interest rates have been declining. There are also changes in bank behavior. The year-on-year rate of increase in bank lending has gradually accelerated and has been around 2.5 percent. Lending has increased not only to large firms but also to small firms, for which the year-on-year rate of change has turned positive, suggesting that lending has become widespread to a variety of businesses. Partly reflecting this development in bank lending, the year-on-year rate of increase in the money stock has gradually been accelerating, hovering around 4 percent in recent months. In relation to this, last month, the Bank expanded lending facilities to support financial institutions’ initiatives to increase lending that are similar to the Funding for Lending Scheme of the Bank of England. The Bank of Japan will provide funds to financial institutions up to double the amount of their net increase in lending and, like the Long-Term Refinancing Operations of the European Central Bank, provide long-term funds. It will provide funds with a four-year fixed rate of 0.1 percent. While the Bank’s main engine of its monetary policy is the QQE, these facilities are designed to reinforce a transmission mechanism of the policy. We have been taking a stance of doing whatever we can to achieve the 2 percent price stability target. Partly due to the effects of the QQE, Japan’s economy has been growing above its potential growth rate led by domestic demand, with real GDP growth increasing year-on-year by 1.5 percent on average in 2013, and by 2.5 percent measured from fourth quarter to fourth quarter. On the employment front, the unemployment rate has declined to 3.7 percent, which is close to the structural unemployment rate of around 3½ percent. As for the outlook, Japan’s economy is expected to continue on a moderate recovery with a virtuous cycle among production, income, and spending at work. On the price front, the year-on-year rate of change in the consumer price index (CPI) excluding fresh food was minus 0.5 percent as of March last year, turned positive in June, and has been accelerating to mark plus 1.3 percent this January. It is still lower than that in the United Kingdom, but almost the same level as that in Germany and higher than that in most of the continental European countries. The rate of increase is likely to be around 1¼ percent for some time, subsequently return to the uptrend, and is likely to reach around the price stability target of 2 percent from the end of fiscal 2014 through fiscal 2015. Achieving an inflation rate of more than 1 percent in less than a year since the introduction of the QQE was beyond many people’s expectations. In fact, according to the ESP Forecast Survey, which compiles economists’ forecasts, the projection of the year-on-year rate of growth in the CPI for this January–March quarter as of March last year was only plus 0.4 percent. While we introduced the QQE with confidence in its effects, for many people this development in the CPI seemed to have been a positive surprise. When something occurs that differs from expectations, people have a strong incentive to change their past views and behavior. Our work to change deflationary expectations that have been entrenched over time as well as people’s behavior under such expectations has been progressing as expected, with the strong reinforcement of an actual rise in the CPI. BIS central bankers’ speeches As the consumption tax will be raised to 8 percent from 5 percent this April, it is expected that there will be a decline in demand after the tax hike following the front-loaded increase in demand prior to the tax hike. Based on the experience of the economy going into recession when consumption tax was raised last time, in 1997, there are some concerns over the outlook for the economy this time as well. However, looking back at 1997, the economy at one point recovered from a plunge following the consumption tax hike, but Japan’s financial system instability and an outbreak of the Asian currency crisis substantially affected the subsequent economic deterioration. By contrast, at present, Japan’s financial system has been maintaining stability and emerging economies in Asia have become more resilient due partly to an accumulation of foreign reserves and an establishment of safety nets. In addition, Japan’s employment situation is far more favorable than that in 1997. Taking these points into account, the Bank believes that, while Japan’s economy will temporarily decline immediately after the consumption tax hike, it will continue to grow above its potential growth rate as a trend with a virtuous cycle among production, income, and spending being maintained. Concluding remarks As I have mentioned, so far, with the QQE steadily exerting its intended effects, Japan’s economy has been following a path toward achieving the 2 percent price stability target as expected. Of course, we are only halfway there and will steadily pursue the QQE. As the economy is associated with upside and downside risks, we will examine them and make adjustments as appropriate in order to achieve the 2 percent price stability target. By firmly continuing with such policy, I am convinced that we can achieve the 2 percent price stability target and overcome deflation. In the past 15 years, Japan was not sleeping because it wanted to. It was only that, even if one person or one firm wanted to take on new challenges, rewards meeting such challenges could not be expected under a macroeconomic environment of persistent deflation. With the QQE and the government’s various initiatives, we have unlocked this “fallacy of composition”. Therefore, Japanese firms that originally were equipped with excellent technologies and human capital have started to take on new initiatives again, and the economy and prices have changed dramatically. We should not let this trend be reversed. To this end, we are making efforts with strong resolution. The day that Japan’s economy can contribute more and more to the global economy is at hand. BIS central bankers’ speeches
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Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shiga, 19 March 2014.
Takahide Kiuchi: Recent developments in economic activity, prices and monetary policy Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shiga, 19 March 2014. * I. Economic developments A. Overseas economies * * I would like to start my speech with a look at overseas economies. Overseas economies – mainly advanced economies – are starting to recover, although the performance remains lackluster in some parts and they are expected to recover moderately. Looking at the projections of global economic growth recently released by the International Monetary Fund (IMF), the growth for 2014 is projected to be at around 3.7 percent, mainly due to rises in growth rates of advanced economies. Looking at respective major countries and regions, the U.S. economy has continued to recover moderately. A downtrend was observed in some economic indicators around the turn of the year, but this likely is largely attributable to temporary factors such as winter snowstorms. As for the outlook, the pace of economic recovery is expected to gradually rise, led by domestic demand in particular, mainly as the fiscal drag continues to fade and because accommodative financial conditions are projected to be maintained. The European economy has been picking up after it emerged from a recession in 2013. Private consumption has been picking up moderately, with consumer sentiment continuing to improve, although the employment and income situation has remained severe. Business fixed investment has bottomed out. Although attention still needs to be paid to the point that there are various adjustment pressures, including the European debt problem, the economy is likely to continue picking up, mainly due to a pick-up in domestic demand that reflects improvement in business and household sentiment. Meanwhile, the Chinese economy has continued to see stable but somewhat lower growth than before. As for the outlook, although structural reforms by the Chinese government such as those to respond to the problem of excess production capacity may exert downward pressure on domestic demand, the economy is expected to maintain stable growth as the government will likely continue to pay consideration to economic activity as well as the employment situation, and as the environment surrounding exports will improve. On the other hand, some of the emerging economies other than China and commodity-exporting economies have continued to lack momentum. In some of these economies facing structural problems, economic activity has been notably weak and financial markets have been showing unstable movements since 2013. In India, the economy remains in a state of deceleration, particularly in domestic demand. Growth momentum in the ASEAN countries remains weak. Under these circumstances, I am paying attention particularly to developments in emerging and commodity-exporting economies, the prospects for the European debt problem, and the pace of recovery in the U.S. economy as risks to the outlook for overseas economies. B. Current state of and outlook for Japan’s economic activity and prices Japan’s economy has continued to recover moderately. According to the second preliminary estimate of the real GDP growth rate in the October-December quarter of 2013 released on March 10, 2014, which registered 0.2 percent on a quarter-on-quarter basis and 0.7 percent on an annualized quarter-on-quarter basis, the economy continued to increase at a pace considered to be above its potential for four consecutive quarters. Looking at each BIS central bankers’ speeches component, exports – which registered a small increase of 0.4 percent on a quarter-onquarter basis – are likely to have leveled off more or less recently, considering developments in real exports in January 2014. Business fixed investment has increased for three consecutive quarters on a quarter-on-quarter basis, and the pick-up has become evident as corporate profits have improved. While a front-loaded increase in demand prior to the consumption tax hike in April 2014 has recently been observed, private consumption has remained resilient as a trend with improvement in the employment and income situation. With regard to the outlook, Japan’s economy is expected to continue its moderate recovery as a trend, albeit with some fluctuations caused by the consumption tax hike. Exports are expected to increase moderately, mainly against the background of the recovery in overseas economies. Public investment is expected to trend upward for the time being and then become more or less flat at a high level. Business fixed investment is projected to follow a moderate increasing trend. Private consumption and housing investment, albeit with some fluctuations caused by the consumption tax hike, are expected to remain resilient as a trend, supported mainly by improvement in the employment and income situation. Meanwhile, prices have risen markedly in the past year. The year-on-year rate of increase in the consumer price index (CPI, for all items less fresh food, and the same hereafter) has been around 1–1/4 percent for three consecutive months through January 2014 – the first time since November 2008 that it has exceeded 1.0 percent. On a basis excluding food and energy, it has also registered high growth of 0.7 percent – the highest level since August 1998 – for two consecutive months through January 2014. Regarding the outlook, the yearon-year rate of increase in the CPI, excluding the direct effects of the consumption tax hike, is likely to be around 1–1/4 percent for some time. According to the Bank of Japan’s interim assessment released in January 2014 of the October 2013 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the median of the Policy Board members’ forecasts for the real GDP growth rate was 2.7 percent for fiscal 2013, 1.4 percent for fiscal 2014, and 1.5 percent for fiscal 2015. The median of their forecasts for the year-on-year rate of increase in the CPI, excluding the direct effects of the consumption tax hikes, was 0.7 percent for fiscal 2013, 1.3 percent for fiscal 2014, and 1.9 percent for fiscal 2015. II. Risks to the outlook for economic activity and prices Although there are both upside and downside risks to the Bank’s aforementioned baseline scenario regarding economic activity and prices in Japan, I personally pay closer attention to downside risks. The consumption tax hikes are unlikely to affect the ongoing moderate recovery trend, although they may temporarily cause greater fluctuations in economic activity. However, I am paying particular attention to developments in exports and consumption as downside risks to the economy. In addition, as revealed in, for example, the minutes of the Monetary Policy Meetings (MPMs), I personally hold a more cautious view of the outlook for prices compared with the forecasts in the baseline scenario. Let me share some of my considerations regarding the outlook with you. A. Developments in exports Exports have continued to slightly lack momentum. This reflects both external demand factors and other factors, and I consider that exports are likely to continue to lack momentum for some time. Regarding external demand factors, it must be noted that Asian economies that are Japan’s major export destinations still lack momentum. For example, looking at developments in the Chinese economy since the beginning of 2014, the Purchasing Managers’ Index (PMI) for manufacturing activity for February marked its lowest level since the middle of 2013, and, in parallel with the progress in implementation of measures to cope with structural problems, there are signs of sluggishness in the pace of increase in fixed asset investment. In addition, BIS central bankers’ speeches there is uncertainty regarding the outlook for the issue of shadow banking, and depending on the outcome of this, it could become an additional downside risk to the Chinese economy. There is also high uncertainty regarding some emerging and commodity-exporting economies facing structural problems. In these economies, a buildup of imbalances has progressed, such as accumulation of private-sector debt, due to excessive fiscal and monetary policy measures following the Lehman shock and to the increase in capital inflows to these economies based on excessive expectations for economic growth. I think these economies are currently undergoing an adjustment process. Therefore, the financial markets in these economies are likely to become unstable when market participants become concerned about the possibility that a reversal in the global flow of funds might occur in the process of normalization of the U.S. monetary policy, and this instability may become an additional downside risk to emerging economies. In addition, attention needs to be paid to developments in Ukraine, although it is difficult to predict the possible effects at present. On the other hand, in the U.S. economy, adjustments such as those in the housing market and of household debt have progressed. However, prolonged adjustments may have brought about an increase in the number of unemployed who have difficulties finding a new job, and also in the number of people who have problems participating in or returning to the labor force, leading to new structural problems such as persisting economic slack and a decline in the growth rate of labor productivity. Taking account of these possibilities, I am paying particular attention to the pace of recovery in the U.S. economy. Next, I would like to point out two possible factors contributing to the lack of momentum in Japan’s exports, other than the aforementioned external demand factors. The first is that structural factors – including the shift of Japanese firms’ production sites to overseas accompanying increased local procurement of parts by Japanese manufacturers – may be at work. According to recent research conducted by the Cabinet Office, manufacturers are expected to continue to increase the ratio of overseas production. This suggests that firms are more conscious of the low growth rate of domestic demand relative to that in external demand, rather than changes in foreign exchange rates. The second factor is that Japanese firms may be taking a cautious stance toward lowering foreign currency-denominated contract prices of exported goods. This could suggest that firms currently have a stronger tendency to enjoy a temporary increase in profits stemming from a rise in prices of exported goods denominated in yen, rather than to expand their overseas markets by lowering foreign currency-denominated contract prices. I will continue to pay attention to how these two factors will affect Japan’s exports. B. Developments in consumption Private consumption remains resilient and a front-loaded increase in demand prior to the consumption tax hike has also been observed recently. However, there are signs that consumer sentiment might be changing. For example, (1) the consumer confidence index deteriorated in February 2014 to its lowest level in two years and five months and (2) the overall diffusion index for future economic conditions in the Economy Watchers Survey dropped in February to its lowest level in two years and ten months, mainly due to a drop in the index of household activity. In particular, I think it is necessary to carefully monitor whether the momentum in private consumption will eventually weaken if the current declining trend in real wages continues. Let me elaborate on this point. At present, the number of employees is increasing while real wages decrease, and thus real compensation of employees in total is on a moderate increasing trend. However, there is a large gap between the year-on-year growth in real compensation of employees in total and in real private consumption: in the OctoberDecember quarter of 2013, the former showed only a moderate increase of 0.6 percent, while the latter increased by 2.3 percent. There seem to have been fairly strong expectations among the public since 2013 that, as the inflation rate rose, the rate of wage increases would eventually reach the same level. However, it must be noted that, if the public increasingly BIS central bankers’ speeches expects that the rate of wage increases will remain below the inflation rate for a protracted period, this could make consumer sentiment cautious, thereby negatively affecting the public’s consumption behavior. In relation to this point, let me now turn to developments in wages. Scheduled wages, or base salaries, remain on a declining trend, but supported by the improvements in corporate profits and in supply and demand conditions in the labor market, they are likely to stop declining at some point after the upcoming spring wage negotiations. However, many firms seem to remain cautious about significantly increasing the levels of monthly salaries – the so-called base salaries – due to concerns about future increases in fixed costs, while they are willing to use improved profits to reward their employees with a rise in lump-sum payments. This stance of firms is consistent with the fact that they remain cautious about increasing the number of regular employees. The active job openings-to-applicants ratio, which shows supply and demand conditions in the labor market, has exceeded 1.00, reaching 1.04 in January. However, supply and demand conditions in the labor market for regular employees do not seem to be so tight, and therefore it seems difficult to expect significant increases in their base salaries, which will be the subject of discussion during the wage negotiations. Considering that (1) most wage increases could be regular annual raises or a rise in lumpsum payments, although base salaries could rise to a certain level, (2) the proportion of nonregular employees – whose wages are not discussed in the wage negotiations – to total employment is increasing, and (3) the rates of wage increases in small firms and in the public sector are likely to be relatively low, the rate of overall wage increases could remain only moderate despite the temporary positive effects expected from the termination of the measures that reduced salaries of government employees to secure funds for reconstruction work after the Great East Japan Earthquake. If that turns out to be the case, and if the rate of nominal wage increases consequently falls below the rate of increase in the CPI excluding the effects of the consumption tax hike, consumers might increasingly expect that decreases in real wages will be protracted. Developments in wages therefore require careful monitoring. C. Outlook for prices The Bank’s outlook and the private sector’s expectations for prices for fiscal 2013 have been converging, but there is still a wide gap between them for fiscal 2014 and 2015. As for the outlook for prices, I take a more cautious view than the forecasts in the Bank’s baseline scenario, as evident from the fact that I formulated a proposal to change the expression regarding the outlook for prices in the October 2013 Outlook Report, although it was defeated by a majority vote during the MPM. Let me explain the background to this view. So far, the Bank’s quantitative and qualitative monetary easing (QQE) has produced positive effects on Japan’s economy by stimulating domestic demand and supporting the positive developments in economic activity. This has contributed to some degree to price rises through an improvement in the output gap. I personally take the view, however, that rises in the inflation rate to date have been caused mainly by changes in the foreign exchange rates, and that the trend in the pace of the price rises is more moderate if the effects of developments in the foreign exchange rates are eliminated. In addition, the rise in medium- to long-term inflation expectations remains moderate, as will be explained later, and the rate of wage increases may remain moderate for the time being. Therefore, I take a cautious view regarding the outlook for prices. The rate of inflation has risen markedly within a short period since 2013, but the Bank’s price stability target aims at creating a virtuous cycle in which wages and prices increase in a balanced manner with an upturn in economic activity, and at maintaining it stably. For this to happen, it is necessary that prices rise at a pace consistent with the increase in the growth potential of the economy. Given this, I consider that the price stability target of 2 percent is appropriate only when it is regarded as a medium- to long-term target. I will elaborate on this point later when I will explain my proposal regarding the conduct of monetary policy. BIS central bankers’ speeches Let me add that, as for firms’ responses to the consumption tax hike, there will likely be variation among different industries and sales strategies, in terms of such aspects as the degree to which they pass higher costs on to sales prices and the timing of price revisions. The price trend therefore may remain difficult to assess for a while. Bearing this in mind, I would like to monitor developments in prices closely. III. Conduct of monetary policy The Bank introduced QQE at the MPM held on April 3 and 4, 2013, with a view to achieving the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years. Under this new framework for monetary policy, the Bank conducts money market operations so that the monetary base increases at an annual pace of about 60–70 trillion yen. In order to realize this, the Bank purchases Japanese government bonds (JGBs) so that their amount outstanding increases at an annual pace of about 50 trillion yen. In addition, with a view to lowering risk premia of asset prices, the Bank purchases exchange-traded funds (ETFs) and Japan real estate investment trust (J-REITs) so that their amounts outstanding increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. In aiming to achieve the price stability target of 2 percent, the Bank has committed to continuing with QQE as long as it is necessary for maintaining the target in a stable manner. Almost one year has passed since the introduction of QQE. So far, it has exerted positive effects on Japan’s economy through a positive influence on the expectations of financial markets and of households and firms. Since the introduction of the policy, however, while supporting the concrete measures of QQE, I have continued to propose changing the expression in the Statement on Monetary Policy regarding the time frame for achieving the 2 percent price stability target and for continuing with QQE, although my proposal has been repeatedly defeated by a majority vote during the MPMs. Let me explain the background to my proposal, as well as my personal views on some points of discussion regarding the conduct of monetary policy. A. Issues to be considered regarding the price stability target Prior to the introduction of QQE, the Bank introduced the price stability target of 2 percent at the MPM held in January 2013. First of all, I would like to explain my thinking behind the price stability target from two perspectives. First, 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 line with this principle, “price stability” is defined as “a state where various economic entities including households and firms may make decisions regarding such economic activities as consumption and investments without being concerned about the fluctuations in the general price level.” It could be said that, by realizing such price stability, the Bank is responsible for creating in the medium to long term an environment in which the economy can achieve sustainable growth so that its growth potential will be realized to the maximum extent. In other words, I think that achieving price stability plays a role as an intermediate objective, or a yardstick, to achieve the ultimate goal of contributing to the sound development of the national economy. In my view, therefore, the most important thing in the conduct of monetary policy is not to pay attention solely to monthly movements in price indices, but to give due consideration to a wide range of developments in the overall economy in achieving price stability, and thereby achieve this ultimate goal. Second, the price stability target of 2 percent aims to maintain the 2 percent inflation rate in a stable manner. This is because price stability consistent with the sustainable growth of the economy must be sustainable over the medium to long term. Therefore, in order to achieve the price stability target of 2 percent, a temporary achievement of 2 percent in the observed inflation rate is not sufficient – it is necessary that the rate be stabilized at that level. In order BIS central bankers’ speeches to achieve this, households, firms, and financial markets need to act on the assumption that prices will increase by about 2 percent; in other words, that medium- to long-term inflation expectations be about 2 percent. So far, medium- to long-term inflation expectations have been mostly in positive territory as a trend, while actual prices have long been on a declining trend. Consequently, price stability has not been achieved, and thus the economy has been in an undesirable situation. This is the background to why it became necessary to introduce QQE. However, I think that medium- to long-term inflation expectations in Japan are mainly determined by supply side factors such as the potential growth rate and the labor productivity growth rate, rather than by the level of the Bank’s price stability target and the supply and demand balances in the goods, services, and labor markets. At least for now, I think that the 2 percent target is well above the level that is consistent with the economy’s growth potential. For example, although the observed inflation rate has risen markedly, recent various indicators suggest that the rise in medium- to long-term inflation expectations, such as for five to ten years ahead, remains moderate. Therefore, to achieve the price stability target of 2 percent, I think it is necessary that a wide range of economic entities make use of the benign economic and financial environment brought about by QQE and make continuous efforts to strengthen the economy’s growth potential. If medium- to long-term inflation expectations rise as a result of such efforts, it could become appropriate to set the target for the level of inflation at 2 percent, although I think that this will require considerable time. Due to the reasons I have explained so far, I have continued to propose at MPMs not to restrict the time frame for achieving the 2 percent price stability target to about two years, but to aim to achieve it in the medium to long term. Moreover, I think there will be room for a future review of the level of the price stability target that is currently set at 2 percent, considering future changes in the growth potential and medium- to long-term inflation expectations. B. Issues to be considered regarding QQE When the introduction of QQE was decided in April 2013, I supported the concrete measures of QQE because I considered that this would open up significant opportunities in terms of three aspects. First, the measures would provide an opportunity on the demand side to create a virtuous cycle by stimulating the economy. Second, they would offer an opportunity on the supply side to encourage the government’s growth strategy that contributes to strengthening the growth potential of Japan’s economy and its fiscal consolidation, as well as positive actions by firms and households. And third, the measures would afford an opportunity to return to the conventional interest rate policy in the future, as zero interest rates produce positive effects through an improvement in economic and price conditions. On the other hand, QQE entails considerable potential risks, in my view; for example, normalization of the measure will not be an easy process, and speculation that the Bank is engaged in financing fiscal deficits could increase. One cannot rule out the possibility that, under the current policy commitment, if financial markets increasingly view achieving the 2 percent price stability target in about two years as difficult, the Bank will be obliged to extend or strengthen its monetary easing driven by such external factors, even in a situation where it is judged that side effects outweigh positive effects on the economy. In this regard, my understanding is that the 2 percent price stability target can be consistent with the fundamentals of Japan’s economy only from a medium- to long-term perspective. I am therefore paying particular attention to the risk that, if the current large-scale monetary easing policy were to be protracted or such policy strengthened by additional measures, the associated side effects would instead outweigh the positive effects, and this would undermine economic stability in the long run. This is why I have proposed that the Bank aim to achieve the price stability target of 2 percent in the medium to long term and designate QQE as an intensive measure with a time frame of about two years. My proposal aims at securing an opportunity for the Bank to thoroughly examine, after a certain period of time, BIS central bankers’ speeches whether the side effects of QQE are not outweighing the positive effects and review the easing measures in a flexible manner depending on economic and financial conditions at the time. C. Monetary policy and structural reforms QQE itself is a powerful policy, but it will exert maximum effects when combined with various efforts by both the public and private sectors. Generally speaking, monetary policy can provide indirect support for structural reforms mainly by working on the demand side of the economy, but cannot substitute for such reforms themselves. For example, as I mentioned earlier, various measures on the supply side to strengthen the growth potential of the economy are necessary to increase the potential growth rate and the labor productivity growth rate. In relation to this, the possibilities of a decline in the potential growth rate and of a rise in the natural unemployment rate, for example, have recently become a hot topic of discussion in the United States and other major advanced economies. Due attention should be paid to the risk that excessive monetary easing without an accurate recognition of these structural changes could result in the accumulation of economic and financial imbalances. There is also a concern that, if excessive expectations on monetary policy increase, or if monetary easing is promoted beyond the appropriate scope of monetary policy, this may lead to losing momentum for advancing necessary structural reforms and instead exert negative effects on economic growth from a long-term perspective. In order to ensure that the effects of monetary easing fully take hold, the government’s efforts to secure confidence in fiscal sustainability are also essential. In a situation where the Bank continues to purchase a large amount of JGBs, if the government’s efforts to achieve fiscal consolidation through structural reforms were to weaken or such speculation were to permeate the financial markets – reflecting overly heightened expectations that stability in the bond market will be ensured by the Bank’s JGB purchases – confidence in fiscal sustainability could be undermined and long-term interest rates could rise. This in turn could worsen fiscal conditions and substantially constrain the effects of monetary easing. As specified in the joint statement by the government and the Bank released in January 2013, the implementation of fiscal consolidation measures is an important prerequisite for the success of QQE and is essential for Japan’s economy in overcoming deflation and achieving sustainable growth. D. Use of a wide range of policy measures 1. Loan support program In addition to powerful monetary easing through QQE, the Bank has established a fundprovisioning measure called the Loan Support Program to support initiatives to make the best use of accommodative financial conditions within efforts to increase bank lending and strengthen the growth potential of Japan’s economy. The program consists of two measures: the fund-provisioning measure to stimulate bank lending (hereafter the Stimulating Bank Lending Facility) and the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility). At the MPM held in February 2014, the Bank decided to increase the scale of the two facilities and extend the deadlines for new applications under these facilities, which were due to expire shortly, by one year. Specifically, under the Stimulating Bank Lending Facility, the maximum amount of the Bank’s fund-provisioning to each financial institution will be increased from the amount equivalent to the net increase in its lending to an amount that is twice as much as the net increase in its lending. As for the Growth-Supporting Funding Facility, the maximum amount of the Bank’s fund-provisioning under the main rules will be increased from 3.5 trillion yen to 7 trillion yen, and the maximum amount of its fund-provisioning to each financial institution will be increased from the current 150 billion yen to 1 trillion yen. Furthermore, under these BIS central bankers’ speeches facilities, financial institutions will be able to borrow funds at a fixed rate of 0.1 percent per annum for an extended duration; namely, for four years instead of one to three years at present. With these revisions, the Loan Support Program is expected to further promote efforts to increase bank lending and strengthen the growth potential of Japan’s economy, thereby complementing QQE and contributing to an improvement in the economy. I consider it desirable to aim at achieving economic conditions that are preferable from a medium- to long-term perspective by making use of various measures in a parallel manner, as I have explained, instead of relying too much on QQE, which has considerable side effects. 2. Conduct of monetary policy in view of the effects of interest rate policy An unconventional policy such as the asset purchase policy implemented under QQE can be regarded as an exceptional and somewhat temporary measure to generate upward momentum in economic activity and prices and affect the direction of such momentum under the zero lower bound on nominal interest rates. On the other hand, a conventional interest rate policy can be regarded as a usual, fine-tuning measure that is used when it is time to encourage economic activity and prices to reach desirable levels. My understanding is that, if the momentum of economic activity and prices becomes sufficiently strong as a result of the positive outcome of QQE and the expected rate of return rises, only with zero interest rates being maintained, the effects of monetary easing will be cumulatively increased by the conventional interest rate policy, and consequently stimulative effects on economic activity will take hold. In fact, in calculating Japan’s policy interest rate under the Taylor rule, 1 my recent estimates suggest that the rate has been shifting upward, from being in negative territory to 0 percent or almost in positive territory, reflecting the improvement in the output gap and the increase in prices since the introduction of QQE. Therefore, in my view, if the cumulative effects of monetary easing generated by maintained zero interest rates, in addition to easing effects of QQE, increase further going forward, one option is to gradually shift the focus of monetary policy conduct from the asset purchase policy to the zero interest rate policy, in view of the role of the two policy tools as well as the balance of their positive effects and side effects. Precisely because the unconventional policy is a new policy measure with a short history, its side effects in general could still have many unknown parts. In particular, in the future, in order to achieve the smooth normalization of monetary policy while maintaining financial market stability, I consider that aiming to make such a shift in the focus of monetary policy conduct, together with the government’s fiscal consolidation, will become the important requirement. The Taylor rule is a monetary policy rule under which the level of a benchmark policy interest rate is calculated based on a particular formula using, for example, the deviation of the observed inflation rate from the targeted inflation rate, and the output gap. BIS central bankers’ speeches
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Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the Japan Society, New York, 19 March 2014.
Takehiro Sato: Quantitative and qualitative monetary easing – importance of fiscal consolidation Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the Japan Society, New York, 19 March 2014. * * * Accompanying charts can be found at the end of the speech. Introduction Thank you, Mr. Harris, for your kind introduction. Distinguished guests and members of Japan Society. It is my great honor and real pleasure to speak to you today. As a member of the Policy Board of the Bank of Japan, I myself voted for quantitative and qualitative monetary easing (QQE) last April. It is my strong desire to ensure that it succeeds. At the same time, in the process of overcoming deflation, the Japanese government’s efforts for fiscal consolidation play a vital role. It is for that reason that I will talk about fiscal consolidation today. Today, I will first explain the current developments in Japan’s economy. I will focus on the meaning of the price stability target and stress the importance of flexibility in monetary policy. I will also talk about the effects of the price stability target on financial markets. Next, I will explain the importance of fiscal consolidation from a range of perspectives, including potential changes in the balance of payments and a saving and investment balance in Japan. In my speech, I will often refer to an optimistic scenario and a pessimistic scenario. The latter is intended to highlight the importance of the government’s efforts to ensure fiscal discipline. It is by no means intended to get bogged down in pessimism. I will then close my speech with some notes about the QQE and fiscal consolidation. I. Developments in Japan’s economy It has been almost a year since the Bank introduced the QQE last April (Chart 1). Economic activity and prices have been broadly in line with the baseline scenario presented in the Outlook Reports and interim assessments (Chart 2). In short, Japan’s economy is steadily pursuing its path to achieving the price stability target of 2 percent. Looking ahead, the effects of the consumption tax hike from 5 to 8 percent in April will be closely monitored. In my judgment, Japan’s economy is entirely different from that in 1997, when the consumption tax was lifted from 3 to 5 percent. Japan’s economy has become much more resilient against tax hikes. On the price front, the Bank’s policy board has made the following judgment. Excluding the direct effects of the consumption tax hike, the year-on-year rate of increase in the core CPI, which excludes volatile food, is likely to be around 1¼ percent for some time. Thereafter, it is expected to reach the price stability target of 2 percent from the latter half of fiscal 2014 to fiscal 2015, as the economy continues to grow at a pace above its potential growth rate. Based on such an outlook, the policy board has judged it appropriate to steadily pursue the QQE under its current guidelines of asset purchases. II. Price stability target and QQE A. Price stability target as a flexible framework Next, I will explain what we mean by the price stability target, introduced in January 2013 (Chart 3). BIS central bankers’ speeches Under the QQE, the Bank aims to achieve this target at the earliest possible time, with a time horizon of about two years. The policy framework of the price stability target is flexible, just like that adopted by major central banks overseas. Specifically, monetary policy requires long and variable time lags before its effects permeate the economy, and thereafter prices. To achieve a sustainable growth path in the context of price stability, monetary policy needs to be flexible. In other words, we examine the current conditions and the outlook for economic activity and prices. We also analyze various risk factors including the accumulation of financial imbalances. We take account of all these developments when we decide on monetary policy. That is what I mean by being flexible. Flexibility in monetary policy has been widely shared with other countries. Particularly in the aftermath of the global financial crisis, major overseas economies have become increasingly attentive to the flexibility of monetary policymaking. From that viewpoint, the price stability target is by no means a rigid and superficial framework which calls for the inflation rate to reach 2 percent with surgical precision. It is a flexible and practical framework that accommodates the needs arising from economic developments. Put differently, what the price stability target aims to achieve is not a situation in which only prices will rise. Rather, it aims to achieve an environment in which the improvement of the overall economy results in higher wages and then higher prices. In my view, in such an environment, some degree of latitude to the price stability target – both on the upside and downside – is naturally required. Furthermore, it is necessary to make an analysis from broader perspectives when assessing the extent to which the Bank has come close to achieving the target. That includes examining the recent developments in wages as well as the core CPI, an indicator that the policy board presents in its assessments. B. QQE and long-term interest rate I will now talk about the effects of the price stability target on financial markets. Under the QQE, the Bank puts strong downward pressure on nominal long-term interest rates through the massive purchases of JGBs. It also tries to raise people’s inflation expectations via the accumulation of the monetary base. The combination of the two will lower real long-term interest rates. That is an unprecedented challenge. There are different views on the extent to which the massive supply of the monetary base can have a real impact on people’s inflation expectations. Nevertheless, lifting inflation expectations is one of just a few remaining policy options under these circumstances. After nearly 15 years of deflation, the medium- to long-term inflation expectations have been around 1 percent and stayed low, compared to those in other advanced economies. Moreover, Japan has been faced with a zero boundary of nominal interest rates. Here, let me recap on how the QQE will work on nominal long-term interest rates through its transmission mechanism. Nominal long-term interest rates combine two elements: one is the average of future short-term rates; the other is premiums (Chart 4). Based on that understanding, the Bank has specified its forward guidance in order to produce these effects. First it will continue with the QQE, aiming to achieve the price stability target, as long as it is necessary for maintaining that target in a stable manner. That in effect will exert downward pressure on the average of future short-term rates. In addition, premiums will be prevented from widening through the massive purchases of JGBs with relatively longer maturities. The QQE thus relies on the mechanism in which the combination of the forward guidance and asset purchases will maintain nominal long-term interest rates at low levels. That is not different from what happens at other central banks, such as the Federal Reserve and the Bank of England, which also depend on similar unconventional monetary policy. Under such unconventional policy, nominal interest rates are likely to rise as the effects of the policy start to occur, preceding the improvement in the economy and prices. Referring to the elements that I have just explained, future short-term rates are likely to rise if the market judges that an exit from current easing policy is at hand. Admittedly, we need to follow a narrow path to achieve the objective under the QQE, but it is a challenge that we must meet. BIS central bankers’ speeches As I will explain shortly, there is a limit to the extent to which a central bank can control the nominal long-term interest rates. Therefore, the government’s efforts for fiscal consolidation are vital. They will become even more vital when deflation comes to an end and an eventual exit from deflation occurs. III. Importance of fiscal consolidation A. Overcoming deflation and change in environment surrounding fiscal policy Let me now explain why fiscal consolidation is important in order to overcome deflation. From an optimistic viewpoint, if the medium- to long-term growth expectations rise as a result of overcoming deflation, the fiscal structure remains solid despite a pick-up in nominal longterm rates. That is because tax revenue will increase as the nominal growth rate rises. The elasticity of tax revenue is generally high at the initial phase of economic expansion, and corporate tax is likely to contribute to a higher revenue. On the expenditure side, the pace of increase in the government’s interest payment costs will remain subdued for some time. That is due to the government’s debt management policy in which the average maturity has been extended, and the government has taken advantage of current easy monetary conditions. For reference, the average maturity of JGBs issued in fiscal 2014 will be eight years and five months. In light of weak credit demand under deflation, the government is now building a fiscal structure which is resilient against possible rate rises. Coupled with the effects of the QQE, the government’s borrowing costs have stayed stably at around 1 percent. By extending the maturity of JGBs, the government in effect has been able to buy time on the liability side (Chart 5). Such an optimistic view may entail a risk. The aging population will continue to put pressure on additional fiscal expenditure, such as increasing social security benefits. The aging will constrain the labor supply on the supply side, and change the demand structure of the economy as a whole. Unless the economy responds to a change in the demand structure, it will reduce the potential to grow. If growth expectations do not rise materially due to the aging, the fiscal structure will remain vulnerable. Taking account of such demographic changes, it is better to be conservative. In my judgment, the fiscal issue will remain even after we manage to overcome deflation. B. Recent developments in balance of payments Now, I will talk about Japan’s balance of payments. The current account surplus registered 3.3 trillion yen last year. In the years for which a comparison can be made, it was the lowest figure recorded after 1985 (Chart 6). Behind that, the trade surplus in electronic appliances almost disappeared and fuel imports increased materially after the suspension of nuclear power plants. On a quarterly basis, the current account balance registered a deficit for the first time in the October–December quarter last year, and is expected to remain in deficit in the January–March quarter. Having said all that, the deficit in the quarterly current account balances fundamentally reflects solid imports thanks to resilient domestic demand due to the front-loaded increase in demand prior to the consumption tax hike this April. Therefore, I do not expect the current account deficit to persist after the consumption tax hike. The deficit we see most recently is taking place under those somewhat unique circumstances. By contrast, according to the “balance of payments development stage theory”,1 the current account balance changes from a surplus to a deficit in the long run as a result of the demographic change. It looks as though the recent increase in fuel imports is accelerating Crowther’s “balance of payments development stage theory” explains long-term patterns of change in a country’s balance of payment structure as the economy advances from a debtor to a creditor country, and eventually to the one that liquidates its overseas assets. BIS central bankers’ speeches the change in the current account balance. The state of the economy – be it a trade surplus or deficit, or a current account surplus or deficit – is ultimately the result of people’s rational decision-making. It is irrelevant from the social welfare perspective. That leads me to conclude that it is not appropriate to say that a surplus is a good thing while a deficit is bad. Nonetheless, if the current account deficit continues, meaning that a domestic saving and investment balance will shift from a surplus to a deficit, there is a possibility that the advantage Japan has achieved by financing its deficits through ample domestic savings might change in the long run. C. Overcoming deflation, and saving and investment balance Let me now elaborate on the nexus between the saving and investment balance and the overcoming of deflation. I will start with the saving and investment balance under deflation. In Japan, excess savings have been decreasing in the household sector, whereas they have been increasing in the corporate sector (Chart 7). Putting those trends together, excess savings in the private sector as a whole have remained intact. Behind that, companies have made it a priority to downsize their balance sheets by repaying debts in light of harmful deflationary expectations. Put differently, deflation has led to excess savings in the private sector, and that has enabled the government to finance its debts with subdued borrowing costs. Thus, “deflationary equilibrium” has prevailed. The equilibrium is subject to change once the QQE succeeds and Japan’s economy overcomes deflation. Admittedly, it is not easy to predict what the saving and investment balance in the private sector will look like before and after deflation. In general, however, the propensity to import will rise by stimulating investment and spending. That will lead to an outflow of income overseas. Under such circumstances, domestic excess savings in the private sector are likely to shrink, if not a reversal from excess savings to excess investment. Looking at the corporate and household sectors separately, excess savings in the corporate sector will likely show a clear decline. That is because, after overcoming deflation, it will become rational for companies to change their strategies and increase their external debts to finance their investment. As for the household sector, economic theory says that the household savings rate will go down in an aging population. I note that it may not be the case if we take account of transfers from the government and the corporate sector (Chart 8). In my view, we should be mindful of a possible decline in domestic excess savings when the QQE succeeds and Japan moves out of the deflationary equilibrium. In light of the decline in excess savings, if the fiscal deficit does not change, the current account balance will register a deficit. We might no longer be able to finance all government debts with domestic savings. Then, overseas investors will ask for a higher premium, possibly driving the government’s borrowing costs even higher. To avoid being trapped in such a situation, or to mitigate the shock associated with that situation, it is vital that the government will continue with its sound fiscal management. That is important in terms of preventing the problem associated with shrinking excess savings from surfacing. Put differently, the government needs to show its firm commitment to fiscal consolidation. Moreover, the government needs to implement its path toward such consolidation in order to avoid leaving an impression with the market that it is not serious about the issue. The scenario that I have laid out contains a number of assumptions. In practice, the end of deflation will generate higher tax revenue as the nominal growth rate rises. That is obviously good for fiscal consolidation. Thus, I repeat that it is best to avoid getting trapped by pessimism. D. Domar’s theorem Fiscal sustainability generally means that the future outstanding amount of the government’s debts relative to GDP will not reach an unmanageable level. In theory, it can be summarized BIS central bankers’ speeches as the current outstanding amount of the government’s debts relative to GDP being equivalent to the discounted value of the current and future primary balances. However, we cannot derive a threshold value of the outstanding amount of the government’s debts relative to GDP and say that the fiscal situation is no longer sustainable beyond that value. After all, whether or not the fiscal situation is sustainable depends much on what the future primary balance looks like and how a wide range of economic entities expect such balance to change. Here, let me come back to the equation for determining fiscal sustainability. If an economy grows at rates above the interest rates, the government will be able to issue bonds forever despite the conditions specified in the equation. That is called Domar’s theorem. This theorem is often referred to when doing a back-of-the-envelope calculation to assess fiscal sustainability. In practice, the interest rates are likely to stay above the growth rates, and it has become common today to assess fiscal sustainability on the condition that Domar’s theorem does not hold. In my view, when assessing fiscal sustainability, the interest rates that should be compared with the growth rates are not in terms of long-term bond yields but rather the average cost of the government’s borrowing. The cost could be higher or lower than the growth rates of the economy. Indeed, the government’s borrowing costs have consistently been declining since the beginning of the 1990s, when long-term bond yields began trending downward. Most recently, those costs are around 1 percent, well below the nominal growth rates (Chart 1). Under such circumstances, the government has benefitted from an “interest rate bonus”. Looking at those situations from a pessimistic viewpoint, we may face “an interest rate onus”, where the government’s borrowing costs remain higher than the nominal growth rates. The Japanese government has already started taking measures to extend the average maturity of its debts. We will still have some time before the interest rate onus takes place, and in the meantime the government can make its efforts for fiscal consolidation. E. Overcoming deflation and the bank’s response The next topic concerns what policy response the Bank might take when we see the overcoming of deflation start to have an effect on long-term interest rates. After the success of the QQE, people’s medium- to long-term inflation expectations will be anchored at around 2 percent, and the Bank might possibly start moving toward an exit. Market participants will notice signs of change in economic activity and monetary policy. Under those circumstances, nominal long-term rates might start to adjust, well before the actual changes in policy. From a purely macroeconomic perspective, a change in nominal rates can be considered as the result of a change in people’s inflation expectations. Such a change may not be detrimental as long as real rates remain more or less the same. More optimistically, a higher tax revenue after the overcoming of deflation can be expected, and that will improve the fiscal situation. From a pessimistic viewpoint, an abrupt change in nominal rates might make the fiscal situation severer and possibly have an effect on the financial system. Somewhat ironically, the success in overcoming deflation might produce unfavorable spillover effects, given the significant size of the government’s debts. In an extreme case where there is a grave negative impact on financial stability, a central bank might have to choose either financial stability or price stability, no matter how strongly it is committed to price stability. Once a central bank can no longer pursue price stability in fear of fiscal sustainability, it might fall into a situation, known as “unpleasant monetarist arithmetic”.2 See Sargent and Wallace (1981) for details regarding “unpleasant monetarist arithmetic”. BIS central bankers’ speeches In my view, we must avoid such a pessimistic scenario from unfolding. To that end, the Bank has been stress-testing the robustness of Japan’s financial system, taking into account possible changes in the interest rate environment. Furthermore, it has urged financial institutions to reinforce their risk management and take measures to enhance profitability. In terms of its relationship with the government, the Bank pursues monetary policy to achieve the 2 percent price stability target. That includes the process through which it will eventually exit from the current easing policy. We simply cannot accept a situation in which a monetary policy decision is affected by the consideration of fiscal policy. There is no question about it. Once the financial environment changes, it is possible that people will pay attention to the relationship between the government and the central bank. Expectations for the central bank’s operation to support bond prices might rise. However, under free capital mobility, the central bank’s involvement will not solve the problem. To be concrete, even though the central bank increases its operation in the government bond market in order to suppress the government’s borrowing costs, the premiums might possibly rise according to the mechanism that I laid out today, when it is judged by market participants that the central bank’s operation will weaken fiscal discipline. Furthermore, if the market thinks that the rapid increase in the central bank’s balance sheet might cause inflation beyond the level judged appropriate, then the anticipated future short-term interest rates might rise. In short, it is the market judgment that matters rather than the central bank’s intention. Down the road, social security spending is expected to rise due to the aging. That spending in Japan is not significantly high relative to that in other economies at this moment. However, it is vital that the government makes seamless and tireless efforts to make sure that fiscal discipline remains firmly intact and there is no doubt in the market concerning the government’s intention toward fiscal discipline (Chart 9). F. Plausibility of financial repression Despite the government’s determination to achieve fiscal consolidation, it appears that there is still a view stating that the central bank should conduct monetary policy in consideration of the fiscal situation. Those who are obsessed with such a view claim that the central bank should continue its massive bond purchase operations in order to avoid the problem of fiscal concern. They insist that the central bank should be involved in such operations when long-term rates start to pick up around the time of an exit. Often referred to as “financial repression”, the intention here is to contain a possible pick-up in nominal rates through the central bank’s massive bond purchases in order to maintain fiscal sustainability. That reminds me of the “fiscal theory of price level (FTPL)”.3 The FTPL states that a fiscal stimulus is effective for price stability. However, it is implicitly based on the assumption that a central bank does financial repression. In other words, it supposes that the bond prices will be maintained despite an increase in government debts as a result of fiscal expansion. Otherwise, the private sector, which holds government bonds, will reduce its spending due to the adverse wealth effect and hence offset an increase in demand stemming from additional fiscal measures. Under such circumstances, the output gap will not improve and prices will not rise. That said, whether or not a central bank can control bond prices depends not on its intention but on market judgment. It is for that reason too that I emphasize the importance of fiscal consolidation. See Sims (1999), Christiano and Fitzgerald (2000a, b), Leeper (1991), Cochrane (2000), and Woodford (1996, 2001) for details regarding the fiscal theory of price level. BIS central bankers’ speeches Concluding remarks A. Government’s commitment for fiscal consolidation Now, let me sum up. In my speech today, I have repeatedly emphasized the importance of fiscal consolidation. Indeed, the Japanese government has already said that it will halve the deficit in the primary balance relative to GDP by fiscal 2015 from the level registered in fiscal 2010. Furthermore, it is committed to turning the primary balance from a deficit to a surplus by fiscal 2020. Those moves constitute an important part of the government’s commitment to fiscal consolidation and are now widely accepted by the international community. Accordingly, the government decided to raise the consumption tax from 5 to 8 percent in April; moreover, the tax rate is scheduled to be raised to 10 percent in October 2015. Down the road, we may hear more discussion concerning whether the consumption tax of 10 percent is enough to make the fiscal structure sustainable. Whatever the discussion might be, it is important to acknowledge that the government will take a crucial first step toward fiscal consolidation, given mounting social security spending. There is no question about that, and financial markets understand the government’s intention on that. B. QQE based on fiscal consolidation Recent long-term rates have been stable in light of signs of overcoming deflation. That is not just due to the effects of the Bank’s JGB purchases. It also hinges on the fact that market participants and businesspeople have full confidence in the government’s strong commitment to fiscal consolidation. That enables the Bank to conduct massive JGB purchases without being trapped in fiscal dominance. The Bank offers full support to the government’s commitment. The commitment for fiscal consolidation by the government is imperative so that the QQE – which is designed to overcome deflation – should not be perceived as the means for “financial repression”. At the same time, a problem will arise if the government creates a fiscal cliff, as epitomized by the enforcement of the Fiscal Structure Reform Act in the mid-1990s. In practice, a balanced approach may be required between a medium- to long-term commitment for fiscal consolidation and the short-term flexibility in policy. Even so, the government should ensure that it will not lose sight of the importance of fiscal consolidation and that it will reinforce its medium- to long-term commitment on that front. 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 References Christiano, Lawrence J. and Terry J. Fitzgerald, “Price Stability: Is a Tough Central Bank Enough?”, Economic Commentary, Federal Reserve Bank of Cleveland, 2000a. Christiano, Lawrence J. and Terry J. Fitzgerald, “Understanding the Fiscal Theory of the Price Level”, Economic Review, 36 (2), Federal Reserve Bank of Cleveland, 2000b. Cochrane, John H., “Money as Stock: Price Level Determination with No Money Demand”, NBER Working Paper, No. 7498, 2000. Leeper, Eric M., “Equilibria under Active and Passive Monetary and Fiscal Policies”, Journal of Monetary Economics, 27, 1991. Sims, Christopher A., “The Precarious Fiscal Foundations of EMU”, De Economist, 147 (4), 1999. Sargent, Thomas J. and Neil Wallace, “Some Unpleasant Monetarist Arithmetic”, Federal Reserve Bank of Minneapolis Quarterly Review, 5 (3), 1981. Woodford, Michael, “Control of the Public Debt: A Requirement for Price Stability?”, NBER Working Paper, No. 5684, 1996. Woodford, Michael, “Fiscal Requirements for Price Stability”, Journal of Money, Credit and Banking, 33, 2001. BIS central bankers’ speeches
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Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at the International Centre for the Study of East Asian Development (ICSEAD), Kitakyushu, 24 March 2014.
Kikuo Iwata: Quantitative and qualitative monetary easing and Japan’s recent economic and financial developments Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at the International Centre for the Study of East Asian Development (ICSEAD), Kitakyushu, 24 March 2014. * * * Accompanying charts can be found at the end of the speech. Introduction I express my thanks for having such a large audience gathered from Kitakyushu and other regions, and also for giving me an opportunity to speak in front of you. About a year ago, I was appointed as Deputy Governor of the Bank of Japan, on March 20, 2013. In the 40 years up to that time, I had been teaching in college while studying as an economist within academia, and in the latter half of those years I consistently emphasized that the biggest challenge for Japan’s economy was to overcome deflation at the earliest possible time, and that the role of monetary policy to that end was critical. On April 4, 2013, shortly after the current governor and deputy governors, including myself, assumed their duties, the Bank of Japan decided to introduce an unprecedented scale of accommodative monetary policy called quantitative and qualitative monetary easing (QQE), and so far, it has been pursuing the policy as scheduled. Today, I will explain the aim of the QQE in light of recent developments in Japan’s economy. To understand the QQE, it is necessary to gain your understanding of the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) that the Bank aims at – or, in other words, the Bank’s inflation targeting policy – and the thinking behind the policy. Let me start with this point (Chart 1). I. Price stability target A. Why is deflation problematic? I mentioned earlier that overcoming deflation at the earliest possible time was the biggest challenge for Japan’s economy. While deflation is “a persistent decline in prices”, it often seems to have been used to refer to “a situation in which the economy is in a vicious cycle of price decline and recession” – that is, the same meaning as “deflationary recession”. In terms of sentiment toward spending in everyday life, you might often think that a decline in prices is a favorable thing. As prices of various goods and services decline, you can get more at the same price. What is the problem (Chart 2)? Decline in aggregate demand due to deferred spending At the outset, we need to acknowledge the difference between prices in general and those of individual goods and services. As for the former, there are indicators such as the CPI and the domestic corporate goods price index. Price stability that the Bank aims at is defined by the CPI. The CPI shows changes in the total amount of expenditure required to purchase the equivalent goods and services purchased by households at a given time, which is called the “reference period”. The CPI is calculated by giving a value of 100 for the reference period and comparing prices of the observation period with those of the reference period. Inflation is defined as a situation BIS central bankers’ speeches in which the CPI persistently rises; on the contrary, deflation is defined as a situation in which the CPI keeps falling. A price rise or fall of individual items such as vegetables and television sets does not constitute either inflation or deflation. Keeping that in mind, let me now explain what the consequence of a persistent decline in general prices – rather than price declines in individual goods and services – will look like. To be sure, a decline in prices itself will have the effect of raising your real income. However, a persistent decline in prices means that the more you wait, the more goods and services you can get at the same price. In other words, it means that the value of cash and deposits increases just by holding them. Thus, firms and households will hoard money as much as possible and defer actions that are associated with spending, such as consumption and investment. Put in the jargon of economics, aggregate demand will decline. That is a problem. If aggregate demand declines and sales of goods and services decrease, firms will reduce production to a level consistent with the decline in sales. As corporate profits will decline and employee income will fall accordingly, people’s consumption and housing investment – as well as firms’ business fixed investment – will further stagnate. Namely, aggregate demand will further decline, and that will induce a further decline in price levels. Thus, the economy will be trapped in a vicious cycle of price declines and recession (Chart 3). Increase in effective debt burden In addition, as a decline in prices means that the value of money for goods and services will increase, for those who borrow money, the value of money that they will have to repay in the future will increase. Thus, that represents an increase in the effective debt burden. It might be easier to understand if you consider a case in which you have a mortgage. As the amount to be repaid is fixed while wages and real estate prices decline due to deflation, you feel the debt service burden gradually increase. The effective burden of debt you already have will become heavier and, even for future borrowings, somewhat more than nominal interest rates suggest. Therefore, firms and households will become cautious about borrowing money. In addition, households and firms that have already borrowed will try to repay their debts as soon as possible, even by restraining their consumption and investment. Thus, housing investment and firms’ business fixed investment will stagnate and aggregate demand will become compressed, thereby resulting in a vicious cycle of recession and price declines (Chart 3). B. Why is stable and moderate inflation desirable? By contrast, in an environment of stable and moderate inflation, for example, in a case where the CPI rises about 2 percent year-on-year, the mechanism that is a reversal of what I have just explained under deflation will work (Chart 4). Increase in aggregate demand due to rejuvenated spending Namely, if you can envisage that prices will rise, many of you might wish to purchase things that you can buy as much as possible before the prices rise. A front-loaded increase in demand ahead of the consumption tax hike next month has often been referred to these days, and a similar mentality works in a consistent manner. Of course, like perishables, there are a number of goods that cannot be purchased in advance, and most services cannot be brought forward. Here, I am just talking about the trends as a whole. BIS central bankers’ speeches Unlike a consumption tax hike, which is a one-off event that alters prices at a certain point of time, the price level will gradually rise. Therefore, the incentive to bring spending forward will not work as powerfully as in the case of a front-loaded increase in demand ahead of the tax hike, but rather slowly and constantly. As spending in terms of consumption and investment is stimulated due to the future price outlook, aggregate demand in the economy as a whole will increase. Sales of goods and services will rise and firms will expand their production to a level consistent with the increased sales. As corporate profits improve and employee income increases, consumption and housing investment, as well as firms’ activity – including business fixed investment – becomes further rejuvenated. In other words, aggregate demand will further increase and prices will rise accordingly. A virtuous cycle of a buoyant economy and inflation will be generated (Chart 4). Costs of rapid inflation As a matter of course, what I have in mind here is stable and moderate inflation, not unexpected rapid inflation or so-called hyperinflation. As you are well aware of, hyperinflation is the last thing we want. If a rise in wages and pensions cannot keep up with rapid inflation, your real income will decline and the real value of cash and deposits saved will also decline rapidly. Through reducing the effective debt service burden of past debt, an unexpected income transfer, so to speak, from creditors to debtors will occur, in which creditors will lose and debtors will gain. By contrast, in case you wish to newly borrow money, the lender will require a high interest rate in preparation for future high inflation, making your fund-raising difficult. If rapid inflation goes on, there is the need to frequently revise the prices of goods and services. As it becomes ever more difficult to envisage future manufacturing costs and selling prices, firms will not be able to even prepare their production plans. The economy will tumble into turmoil. Therefore, what the Bank is aiming at is that stable and moderate inflation continues, and not by any means generating hyperinflation (Chart 4). C. Advantages of inflation targeting policy In order to achieve stable and moderate inflation, what kind of policy will be desirable? One answer is a policy framework called inflation targeting. The Bank has been pursuing monetary easing under the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI. That can be understood as a typical example of inflation targeting policy (Chart 5). Enhancing policy credibility and predictability Inflation targeting policy has a number of advantages. To begin with, as the policy contains a specific numerical target for the future inflation rate, it can be judged objectively whether the target has been met. Through enhanced transparency, a central bank’s obligation to be accountable with regard to policy judgment and the status of achieving the target will become crucial. That will create a situation in which credibility in monetary policy is likely to be enhanced. As it becomes easier to forecast price levels, various economic entities can conduct economic activity on the basis of such forecasts. The predictability of future prices will be further reinforced as credibility in monetary policy becomes enhanced (Chart 5). BIS central bankers’ speeches Preventing hyperinflation About the Bank’s policy, some demonstrate concern that when the time comes for the Bank to stop monetary easing, it might be difficult to do so due to pressure from financial markets or the government, and that eventually leads to inducing hyperinflation. The adoption of inflation targeting also is effective against such concern. The reason for that is that the inflation targeting policy is a device to hold a specific numerical target for the future inflation rate and make a commitment to achieving a situation that generates neither inflation above the target rate nor deflation. Though the inflation targeting policy has often been discussed in Japan as a measure to overcome deflation, it was originally adopted in countries like New Zealand in the 1980s that suffered high inflation. I would like you to understand that, in case the economy should overheat and the inflation rate should rise well above the 2 percent price stability target, the Bank has already made a commitment to taking appropriate measures in line with the framework of inflation targeting policy. I should stress that, in line with the mission stipulated in the Bank of Japan Act, the Bank will conduct monetary policy based on its judgment and responsibility while facilitating communication with the government (Chart 5). II. Aim of the QQE and the current situation of Japan’s economy So far, I have explained the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI; namely, the so-called inflation targeting policy and the thinking behind that. Now, I will talk about the contents and effects of the QQE, which was introduced as a policy to achieve the 2 percent price stability target, by also taking into account the current state of Japan’s economy. A. What is the QQE? The QQE consists of two pillars (Chart 6). The first pillar is the commitment under which the Bank will achieve the price stability target of 2 percent as soon as possible. The Bank has made a clear commitment that it “will achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years”. The second pillar is to engage in actions that embody the commitment specified in the first pillar. As exemplified by the phrase “quantitative and qualitative monetary easing”, those actions are to increase the “quantity” of the Bank’s balance sheet and change the “quality” of its asset purchases. An increase in quantity requires massively increasing the amount of money the Bank directly supplies to the financial system – this is called “the monetary base” – at an annual pace of about 60–70 trillion yen. Measures to increase the monetary base are mainly through the purchases of Japanese government bonds (JGBs), and the Bank will purchase JGBs so that their outstanding amount will increase at an annual pace of about 50 trillion yen. A change in quality requires purchasing assets with a higher risk profile. Among the JGBs, the Bank has started purchasing those with longer remaining maturities. In addition, it has increased the amounts of purchases in exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) in order to reduce risk premiums on assets. BIS central bankers’ speeches When we decided to introduce the QQE last April, we used the expression “a new phase of monetary easing both in terms of quantity and quality”. The Bank has been pursuing monetary easing in exactly that manner, at an unprecedented scale. B. Working on expected real interest rates While the QQE consists of those two pillars, as far as its transmission channels are concerned, the most important factor of all in terms of having an effect on the economy is lowering expected real interest rates. The following explanations will become somewhat complicated, but please bear with me (Chart 7). Expected real interest rates are obtained by subtracting the expected rates of inflation from the nominal interest rates actually observed in financial markets or over the counter. While nominal rates – that is, objective interest rates – are visible, expected real interest rates are those that people forecast subjectively, based on their respective price projections, and thus various rates exist on a person-by-person basis. Viewed from the borrowers’ side, real interest rates are equivalent to borrowers’ subjective expectations regarding their real costs of borrowing, taking into account price changes, when they borrow money at a certain nominal interest rate. Consequently, the lower the expected real interest rates of an economic entity, the more subdued the entity expects its real cost of borrowing to be. The QQE has the effect of reducing nominal interest rates and the effect of lifting each economic entity’s inflation expectations, and both will exert downward pressure on expected real interest rates, which are derived from subtracting the expected rates of inflation from the nominal rates (Chart 8). C. Spillover effects on the real economy If many economic entities lower their expected real interest rates, that will stimulate demand in the real economy in a number of ways. For example, when real interest rates decline, investment in cash, deposits, and fixedincome securities (excluding inflation-indexed bonds) becomes less attractive; thus, people will shift their portfolios from those financial assets to equities and tangible assets such as land and housing, or to foreign currency-denominated assets with higher returns. The rise in equity prices and the appreciation of foreign currencies will stimulate private consumption through the wealth effect (Charts 9 and 10). In addition to the decline in expected real interest rates, other factors – including an increase in consumption and an improvement in export conditions due to the depreciation of the yen – will encourage firms to be more aggressive in their business fixed investment (Charts 11 and 12). According to the Business Outlook Survey, conducted jointly by the Cabinet Office and the Ministry of Finance, the index of business conditions for large enterprises will decline to minus 9.8 in the April–June quarter but is expected to rise to plus 8.3 in the July–September quarter. That of small and medium-sized enterprises follows more or less the same pattern with that of large enterprises (Chart 13). While that may be partly due to statistical peculiarities, it suggests that firms anticipate a subsequent decline in spending after the consumption tax hike in April 2014 as a result of the front-loaded increase in spending to be relatively short-lived. If a shortage of aggregate demand in the economy as a whole is eliminated through an increase in demand such as private consumption and investment, price levels will naturally rise. In fact, the recent developments in the CPI show that Japan’s economy is following a path toward overcoming deflation as expected (Chart 14). BIS central bankers’ speeches Production increases as demand expands, and thus employment conditions will also improve. That does not suddenly result in a rise in wages and bonuses, but tends to first lead to an increase in the number of employees, mainly non-regular employees. Nevertheless, due to an expansion in corporate profits and tightness in the labor market, the income each employee receives will gradually increase (Chart 15). If employee income as a whole increases in such a manner, that will further elevate the consumption of households, including those that have not benefited from the wealth effect through a rise in stock prices or the appreciation of foreign currencies. An increase in corporate profits will increase business fixed investment. Those increases in demand will again lead to an increase in income. An improvement in fiscal conditions due to an increase in tax revenue and an improvement in pension financing caused by a rise in asset prices will also alleviate people’s concern about the future as a whole, and thereby exert positive effects on the economy. In such a manner, by overcoming deflation starting with the QQE, a virtuous cycle of the economy is expected to continue (Chart 16). D. Outlook up to fiscal 2015 As for the outlook, Japan’s economy is expected to continue with a moderate recovery as a trend, supported by an improvement in the employment and income situation, while it is expected to be affected by the front-loaded increase and the subsequent decline in demand prior to and after the consumption tax hike. As for prices, the year-on-year rate of increase in the CPI, excluding the direct effects of the consumption tax hike, is likely to be around 1¼ percent for some time. After that, it is expected to gradually return to the rising trend and is likely to reach around the 2 percent price stability target toward the end of fiscal 2014 through fiscal 2015 (Chart 17). Concluding remarks Let me conclude my remarks by touching on the economy of Kitakyushu (Chart 18). Kitakyushu’s economy was long stagnant after the Lehman shock, but it has gradually been improving in the region’s main force – the manufacturing sector – partly on the back of a correction in the yen’s appreciation. Recently, an improvement has started to spread from large to medium- and small-sized firms, and the regional economy has been recovering moderately on the whole. Historically, Kitakyushu prospered since the Meiji Period, centering on the Chikuho coalfield and Moji Port, and by utilizing this location advantage, a government-managed steelworks started operation in Yahata in 1901. For reference, while the Kitakyushu branch of the Bank of Japan marked its 120th anniversary last year, the precursor of that branch – namely, the Saibu branch – was established around that time, in 1893. Kitakyushu has represented Japan’s modernization, and despite a number of difficulties, it has thrived and subsequently has been improving and evolving. As a result of many years of tremendous efforts, Kitakyushu has established itself as one of the prominent industrial areas in Japan – with electrical machinery and the automobile industry, in addition to the steel industry – as well as a base for international trade with Asian and other countries. Other than on the industrial front, Kitakyushu City has become one of the world’s environmental cities, and recently was selected as a “model city for green growth” by the Organisation for Economic Co-operation and Development (OECD), and as a “future city” by the Japanese government. In addition, the government has decided to recommend “local industrial heritage sites of the Meiji period”, which include Yahata steelworks-related facilities in Kitakyushu, to the United Nations Educational, Scientific, and Cultural Organization BIS central bankers’ speeches (UNESCO) as candidates for World Heritage sites this fiscal year. This region has started to grab the spotlight in industrial tourism. As global competition intensifies in the years ahead, the path Kitakyushu follows might not be a smooth one. However, this region has a strong industrial base, including manufacturing technology and human resources, which has been established over many years. This region also has well-developed traffic and distribution systems, with a 24-hour airport and the starting point of the East Kyushu Highway that extends to Miyazaki City scheduled to be opened in fiscal 2014. While fully utilizing those strengths, I strongly believe that Kitakyushu’s economy will further grow and develop into the future. 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 BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Saitama, 26 February 2014.
Koji Ishida: Economic activity and prices in Japan and monetary policy Speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Saitama, 26 February 2014. * * * I. Monetary policy A. Introduction of the price stability target and the joint statement by the government and the Bank of Japan First, I would like to describe the status of the Bank of Japan’s monetary policy conduct in January 2013. At the Monetary Policy Meeting (MPM) held on January 21 and 22, 2013, the Bank decided to introduce the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI). At the same time, it released a joint statement with the government, which clearly stated that the government and the Bank would strengthen their policy coordination and work together to overcome deflation early and achieve sustainable economic growth with price stability. In the statement, the Bank announced that, under the price stability target, it would pursue monetary easing and aim to achieve this target at the earliest possible time. Concurrently, the government announced that it would not only flexibly manage macroeconomic policy but also formulate measures for strengthening the competitiveness and growth potential of Japan’s economy, and promote them strongly. The government also announced that it would steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management. B. Quantitative and Qualitative Monetary Easing (QQE) Now I would like to talk about the Bank’s current monetary policy measures. At the MPM held on April 3 and 4, 2013, the Bank introduced QQE to achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years. The features of this new monetary policy measure are as follows. First, with a view to pursuing quantitative monetary easing, the Bank changed the main operating target for money market operations from the uncollateralized overnight call rate to the monetary base, which is the total amount of money the Bank directly supplies to the economy. On this basis, the Bank is increasing the monetary base – defined as the sum of banknotes in circulation, coins in circulation, and current account deposits held by financial institutions at the Bank – at an annual pace of about 60–70 trillion yen. Second, the Bank is purchasing Japanese government bonds (JGBs) as the primary means of increasing the monetary base, so that their amount outstanding will increase at an annual pace of about 50 trillion yen. Moreover, the average remaining maturity of the Bank’s JGB purchases has been extended from slightly less than three years to about seven years – equivalent to the average maturity of the amount outstanding of JGBs issued. Third, in addition to JGBs, with a view to lowering risk premiums of asset prices, the Bank is purchasing exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at an annual pace of about 1 trillion yen and 30 billion yen, respectively. And fourth, the Bank will continue with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary to maintain the target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. So far, I have explained the basic framework of QQE. Almost a year has passed since QQE was introduced in April 2013. The amount outstanding of the monetary base has increased from 138 trillion yen at the end of 2012 to 202 trillion yen at the end of 2013, and has been accumulating smoothly toward 270 trillion yen, the amount projected at end-2014. The BIS central bankers’ speeches amount outstanding of JGBs has also been accumulating smoothly toward 190 trillion yen, the amount projected at end-2014, increasing from 89 trillion yen at the end of 2012 to 142 trillion yen at the end of 2013. C. Loan support program In addition to implementing QQE, the Bank has been employing the Loan Support Program to promote financial institutions’ use of the large scale monetary base – supplied by the Bank through its aggressive monetary easing – for their efforts to increase the amount of bank lending and strengthen the growth potential of Japan’s economy. At the MPM held on February 17 and 18, 2014, the Bank decided to double the scale of the Loan Support Program and to extend its application period by one year. The Loan Support Program consists of two measures: the fund-provisioning measure to stimulate bank lending (hereafter the Stimulating Bank Lending Facility) and the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility). Specifically, under the former, the Bank decided to enable financial institutions to borrow funds from the Bank up to an amount that is twice as much as the net increase in their lending. As for the latter, the Bank decided to double the maximum amount of its fund-provisioning under the main rules from 3.5 trillion yen to 7 trillion yen. Under these facilities, financial institutions will be able to borrow funds at a fixed rate of 0.1 percent per annum for four years. Thus far, the Loan Support Program has supported financial institutions’ efforts to increase the total amount of their lending and has produced positive effects as a catalyst in regard to firms’ and financial institutions’ efforts to strengthen the foundations for Japan’s economic growth. The Bank expects that the enhancements made at the February MPM will further promote financial institutions’ actions as well as stimulate firms’ and households’ demand for credit, with a view to encouraging banks’ lending and strengthening the foundations for economic growth. D. Developments in financial conditions and financial markets Reflecting such policy measures, financial conditions in Japan are accommodative. Firms’ funding costs have been hovering at low levels, with long-term average contract interest rates on new loans and discounts recording a historic low. Issuing conditions for CP and corporate bonds have also been favorable. In addition, in a situation where the year-on-year rate of change in bank lending continues to increase, loans provided by shinkin banks have also been recording year-on-year positive growth since summer 2013. Firms have continued to see financial institutions’ lending attitudes as improving. Firms’ financial positions have also improved regardless of firm size. This was evidenced by the diffusion index for financial positions of small firms: the proportion of firms responding that their financial positions were “easy” exceeded the proportion of those responding that they were “tight” for the first time since the bubble period of the early 1990s. Turning to developments in financial markets, yields on 10-year JGBs – the benchmark longterm interest rate – have been stable at a low level of around 0.6 percent as the Bank proceeds with its JGB purchases. Given that the year-on-year rate of increase in the CPI is currently around 1¼ percent, long-term real interest rates are presumed to be in negative territory. As for foreign exchange rates, the yen has been depreciating, albeit with some fluctuations. Stock prices have been trending upward. Meanwhile, according to the money stock statistics, the growth rates of investment trusts and pecuniary trusts have been at high levels, indicating that money holders such as households have been increasing their risk assets. As I have described, accommodative financial conditions seem to have recently been effectively stimulating private demand, and such conditions appear to be forming the basis BIS central bankers’ speeches for Japan’s economy to overcome the negative effects of the consumption tax hikes and for a virtuous cycle among production, income, and spending to operate firmly. II. Developments in economic activity and prices A. Overseas economies Next, I will talk about developments in economic activity and prices. Overseas economies – mainly advanced economies – are starting to recover, although the performance remains lackluster in some parts. The growth rate of the global economy in 2014, released in January by the International Monetary Fund (IMF), is projected to accelerate to 3.7 percent from 3.0 percent for 2013. Naturally, the growth rates in emerging and commodity-exporting economies are higher than those in advanced economies. However, advanced economies are projected to show stronger growth momentum than emerging and commodity-exporting economies in 2014, compared to a year earlier. Among advanced economies, the growth rate of the U.S. economy is projected to accelerate in 2014 compared to the previous year. Inevitably the growth rate of the U.S. economy in the January–March quarter of 2014 will be adversely affected by the record winter snowstorm since December 2013. However, in a situation where balance-sheet adjustments in the household sector seem to have mostly been completed and the fiscal drag has faded, production and private demand are expected to remain firm and the economic recovery is expected to become widespread from the spring. With regard to the employment situation, although some current data showed weakness reflecting the effects of the winter snowstorm, the improving trend remained, as evidenced by a declining trend in the unemployment rate. As for the euro area, in 2014 the economy is projected to emerge from negative growth. Concerns persist over further disinflation, but business and household sentiment continues to improve in a situation where financial markets have stabilized, and production has been picking up, albeit moderately. Whereas improvements are observed in advanced economies as I described, the situation varies among emerging and commodity-exporting economies. First, the Chinese economy has continued to see stable growth, albeit at a slower pace than before, maintaining a yearon-year growth rate of 7.5–8.0 percent in the October–December quarter of 2013. The Purchasing Managers’ Index (PMI) for manufacturing activity has recently shown some weakness, but the Chinese economy is expected to basically maintain stable growth at around the current pace under state control. Among other emerging and commodityexporting economies, economic developments in the NIEs are picking up, particularly in exports, as the effects of the economic recovery in advanced economies spread to them. In contrast, growth momentum in the ASEAN countries has remained weak because of their relatively limited ability to profit from the recovery in advanced economies. In particular, there are concerns about the impact of unstable political situations in some of these countries on trade with Japan, for example. Among emerging and commodity-exporting economies, some of them – which have structural vulnerabilities such as current account deficits – saw nervousness in their markets at one point as the Federal Reserve proceeded to reduce the pace of its asset purchases, but the situation recently regained stability. B. Japan’s economic activity and prices 1. Current situation a. Economic activity Now, I will discuss Japan’s economic activity. BIS central bankers’ speeches The Bank’s current assessment is that Japan’s economy has continued to recover moderately. Moreover, a front-loaded increase in demand prior to the consumption tax hike has recently been observed. Real GDP for the October–December quarter of 2013, released on February 17, 2014, showed quarter-on-quarter growth of 0.3 percent, representing the fourth consecutive quarter of positive growth. By component, private demand for the quarter, including private consumption and business fixed investment, recorded a higher growth rate than in the July–September quarter. As for private consumption, consumption of goods such as durable goods increased partly reflecting the front-loaded increase in demand prior to the consumption tax hike amid the improvement in the employment and income situation evidenced by the increase in winter bonus payments. Business fixed investment, which had previously been lacking momentum compared to firms’ annual fixed investment plans and the improving trend of their profits, rose noticeably at last in the October–December quarter. In contrast, exports have lacked momentum to date despite the recovery trend in overseas economies, mainly advanced economies, and movements in the foreign exchange market. As imports grew substantially, net exports continued to significantly push down the GDP growth rate, as they had in the July–September quarter. Although only a handful of economic indicators have been released for the period starting in January 2014, the seasonally adjusted number of new passenger-car registrations – a consumption-related indicator – increased rather substantially by 6.9 percent for January on a month-on-month basis, suggesting the possibility that the front-loaded increase in demand prior to the consumption tax hike is becoming pronounced. Meanwhile, real exports for January declined by 2.3 percent overall, presumably due to a drop in exports to China. Indices of industrial production for January, which reflected these developments in domestic and external demand, are scheduled for release on February 28. According to the Survey of Production Forecast in Manufacturing released in January, production for January was expected to show relatively stronger growth led by production to meet domestic demand. b. Prices Regarding developments in prices, the year-on-year rate of increase in the CPI (all items less fresh food) for December 2013 climbed from the previous month to 1.3 percent. Through the latter half of 2013, rises in prices of energy-related items such as petroleum products – reflecting movements in crude oil prices and foreign exchange rates – contributed to the rise in prices. However, price increases have gradually been observed in other items recently, while private consumption has remained resilient, indicating that such increases are steadily becoming widespread. In fact, the year-on-year rate of increase in the CPI (all items less food and energy) rose to 0.7 percent for December 2013, representing the strongest growth since August 1998. 2. Outlook for economic activity In terms of economic activity, while domestic demand, particularly private consumption, is likely to maintain firmness as external demand is expected to increase – albeit moderately – a virtuous cycle among production, income, and spending is likely to be maintained. As for prices, whereas the upward contribution from price movements in energy-related items is likely to diminish gradually, the boosting effect of an improvement in the aggregate supply and demand balance accompanied by an economic recovery is expected to spread. Consequently, the year-on-year rate of increase in the CPI (all items less fresh food), excluding the direct effects of the consumption tax hike, is likely to be around 1¼ percent for some time. As I mentioned, Japan’s economy is likely to continue a moderate recovery as a trend, while it will be affected by the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike. For the time being, I will pay attention to the following points. BIS central bankers’ speeches a. The effects of the consumption tax hike The first point for attention is the effects of the consumption tax hike. The front-loaded increase in demand prior to the consumption tax hike has already been observed to a considerable extent in durable consumer goods, mainly houses, passenger cars, and white goods. If the scale of the front-loaded increase in demand is greater than expected toward the end of fiscal 2013, the subsequent decline in April and beyond will be all the more substantial. It is inevitable that the consumption tax hike will have adverse effects on households’ real income. Nevertheless, while the economy as a whole will be underpinned by the government’s economic measures, an increase is likely in exports and business fixed investment – which have lacked momentum to date. Therefore, even if the economy temporarily posts negative growth for the April–June quarter of 2014, the recovery trend itself is unlikely to dissipate. Meanwhile, I consider it necessary to carefully assess the underlying trend of various indicators scheduled for release over the period through the first half of fiscal 2014, given that they are likely to show large fluctuations, both upward and downward, due to the consumption tax hike. b. Risks for overseas economies and developments in exports The second point for attention is risks for overseas economies and developments in exports. Overseas economies – mainly advanced economies – are starting to recover, but a high degree of uncertainty is likely to remain over the outlook for some emerging and commodityexporting economies with structural vulnerabilities such as fiscal and current account deficits. Although the markets are currently calming down, it is necessary to monitor whether such risks in these economies will materialize and affect the global economy. Exports are expected to offset a temporary fallback in demand that is likely to be observed from April 2014 following the consumption tax hike, and are expected to play their traditional role as the trigger of a virtuous economic cycle. However, they lack some momentum at the moment. As background to this lack of momentum, a number of issues have been raised for discussion concerning both cyclical and structural problems, such as the pace of the recovery in overseas economies and the shift of manufacturing firms’ production sites to overseas. I am also monitoring whether exports, which have significant spillover effects on business fixed investment, will act as a driving force of Japan’s economy as expected from fiscal 2014 onward. c. The employment and income situation The third point for attention is developments in the employment and income situation of households. With regard to the recent situation, supply and demand conditions in the labor market have continued to improve steadily, as shown by the fact that the active job openingsto-applicants ratio rose to 1.03 in December 2013. Employee income has also picked up moderately because, while total cash earnings per employee have generally bottomed out, the year-on-year rate of increase in the number of regular employees has expanded. For domestic demand, particularly private consumption, to maintain its firmness concurrently with a rise in prices, it is essential that the virtuous cycle of improvement continue in the employment and income situation supporting consumption. I intend to monitor the results of this spring’s wage negotiations and the extent to which employee income as a whole improves, including the degree to which the number of employees increases. BIS central bankers’ speeches III. Achieving the price stability target A. Forecasts for prices through fiscal 2015 Thus far, I have outlined the Bank’s assessment of Japan’s recent economic activity and prices. Based on this assessment, the Bank compiled and released the Policy Board members’ forecasts for economic activity and prices through fiscal 2015. In terms of the medians of the members’ forecasts for prices, the year-on-year rate of change in the CPI (all items less fresh food) is expected to register 0.7 percent for fiscal 2013. Excluding the effects of the consumption tax hikes, it is projected to reach 1.3 percent and 1.9 percent for fiscal 2014 and 2015, respectively. It is likely to reach around 2 percent – the price stability target – toward the latter half of the projection period, that is, through fiscal 2015. B. The price stability target and price indices The Bank judges that the basic indicator used to express the price stability target must be a price index that comprehensively covers goods and services consumed by households and that the general public at large is accustomed to. To this end, the Bank views the CPI for all items as important. However, since the CPI for all items can be affected by temporary fluctuations of some of its components, the Bank uses the CPI (all items less fresh food) to identify the underlying trend of inflation; fresh food is excluded from the index because it is a highly volatile component. To grasp the underlying trend in the CPI, the Bank also examines reference indices such as the CPI (all items less food and energy), the Laspeyres chain index (all items less fresh food), and the 10 percent trimmed mean. As for other price indices, the CPI (all items less imputed rent) is used as a deflator to convert nominal figures into real ones in statistics relating to household consumption expenditures. This price index was adopted because it was considered to be the one most suitable for measuring actual household consumption expenditures, given that imputed rent on owner-occupied homes is not actually paid. In the long run, each of these price indices shows the same movements as the overall index, but at each point in time they could move somewhat differently, reflecting temporary factors. For example, the year-on-year rates of growth for December 2013 in the CPI (all items less fresh food) and the CPI (all items less food and energy) were 1.3 percent and 0.7 percent, respectively – as I mentioned earlier – while that in the CPI for all items was 1.6 percent, the Laspeyres chain index (all items less fresh food) was 1.2 percent, the 10 percent trimmed mean was 0.8 percent, and the CPI (all items less imputed rent) was 2.0 percent. The Bank judges it necessary to assess price developments comprehensively by monitoring a wide range of price indices such as those just mentioned. It seeks to achieve the price stability target at the earliest possible time and maintain it in a stable manner. In this way, it seeks to fulfill its mission of “achieving price stability, thereby contributing to the sound development of the national economy”, as stipulated in the Bank of Japan Act. 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, Okayama, 10 April 2014.
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, Okayama, 10 April 2014. * * * Accompanying charts can be found at the end of the speech. Introduction Thank you for giving me this opportunity to exchange views with people representing Okayama Prefecture, who have taken time to be here despite their busy schedules. Please allow me to express my gratitude for your cooperation with the activities of the Bank of Japan’s Okayama Branch. Today, I will review economic activity and prices in Japan, whose economy has been recovering moderately, and then discuss the Bank’s monetary policy. My concluding remarks will touch briefly on the economy of Okayama Prefecture. Following my speech, I would like to listen to your views on the actual situation of the local economy and to your candid opinions. I. Recent developments in economic activity and prices A. Continued moderate recovery in Japan’s economy Japan’s economy returned to a moderate recovery path in mid-2013 and has continued to recover moderately as domestic demand has been firm (Charts 1 and 2). I will elaborate on the recent developments related to Japan’s economy. Overseas economies – mainly advanced economies – are starting to recover, although the performance remains lackluster in some parts of emerging economies. With regard to developments in overseas economies by region, the U.S. economy remains on a moderate recovery, although effects of a winter snowstorm are still observed. With the fiscal drag having subsided, the recovery trend in the economy is gradually becoming widespread. The pick-up in the European economy is clear, as evidenced by the continued pick-up in domestic demand and given that signs of recovery are being observed in exports. The Chinese economy continues to see stable growth on the back of firm domestic demand. In addition, the authorities’ stance that they will continue to pay consideration to economic activity while progressing with structural reforms is affirmed particularly by the fact that the Chinese government set the GDP growth target for 2014 at around 7.5 percent, the same level as the previous year. Regarding the NIEs and the ASEAN countries, while economic activities in the NIEs are picking up, growth momentum in some ASEAN countries remains weak. Against this backdrop, Japan’s economy has continued to recover moderately, as a virtuous cycle driven primarily by domestic demand continues to operate. As for external demand, Japan’s exports have leveled off more or less, due in part to the effects of a winter snowstorm in the United States and to somewhat weak economic developments in some emerging countries. In terms of domestic demand, on the other hand, public investment has continued to increase and the pick-up in business fixed investment has become increasingly evident as corporate profits have improved. As for the employment and income situation, supply and demand conditions in the labor market have continued to improve steadily, as evidenced by the continued rise in the job openings-to-applicants ratios and decline in the unemployment rate to around 3.5 percent, and employees’ compensation has also picked up moderately. Private consumption and housing investment have remained resilient, with improvement in the employment and income situation, albeit with some fluctuations due to BIS central bankers’ speeches the consumption tax hike. Industrial production has been on a moderate increasing trend, reflecting these developments in demand both at home and abroad. Meanwhile, business sentiment has continued to improve, as evidenced by the March 2014 Tankan (Short-Term Economic Survey of Enterprises in Japan). As for the outlook, Japan’s economy is expected to continue its moderate recovery as a trend, while it will be affected by the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike (Chart 3). Regarding overseas economies, as growth in advanced economies is expected to gain momentum over time, the NIEs and the ASEAN countries are likely to head toward stability, and their pace of growth as a whole will gradually accelerate. In this situation, Japan’s exports are likely to pick up moderately. As for domestic demand, public investment is likely to stay at a high level and business fixed investment is projected to follow a moderate increasing trend as corporate profits continue on their improving trend. Private consumption and housing investment are expected to remain resilient as a trend, albeit with some fluctuations. In this situation, industrial production is expected to follow a moderate increasing trend. The key to sustainable economic recovery is developments in private consumption and nonmanufacturing. I will elaborate on this point later in my speech. Meanwhile, risks to the outlook include developments in the emerging and commodityexporting economies, the prospects for the European debt problem, and the pace of recovery in the U.S. economy. Compared to the previous year, taking the U.S. economy as an example, uncertainty about the fiscal problems has receded significantly; in terms of monetary policy, the Federal Reserve has begun reducing the pace of its asset purchases. Accordingly, I view risks to the outlook as generally balanced. B. Sustainability of economic recovery The main feature of the current economic recovery is that it is driven not by exports but by consumption and nonmanufacturing activities. The recovery in consumption is not due merely to increased consumption of high-end goods and services supported by a rise in stock prices. An underlying factor is progress with efforts to boost potential demand in areas related to ordinary consumption and nonmanufacturing. Firms’ profitability has been increasing, and this seems to have brought about a recovery trend in the employment and income situation. 1. Current economic recovery driven by consumption and nonmanufacturing Let me first examine the current economic recovery that has been driven by consumption and nonmanufacturing. Figures for private consumption expenditure, exports, business fixed investment, and public investment indicate that the pattern of the former recovery, driven by exports, can be clearly observed in the expansionary phase of 2002 to 2008 (Chart 4). Although exports have subsequently recovered from the sharp drops following the Lehman shock and the Great East Japan Earthquake, they have been more or less flat in the longer run. In contrast, consumption expenditure has shown steady growth, albeit with various effects, and has posted even higher growth since the start of 2012. The improving trend in consumption is evident even when compared with developments in business fixed investment and public investment. Business fixed investment – which, like exports, previously led the economic recovery – has recently been showing a small pick-up. Public investment has finally exhibited a marked increase since the April-June quarter of 2013. The fact that consumption has been posting increasingly higher growth in the initial phase of economic recovery – without being accompanied by increases in exports and 4 business fixed investment at home – deserves special mention. Breaking down the improvement in private consumption into goods and services, both have been showing increasingly higher growth over the past few years (Chart 5). A further breakdown of goods consumption into “the sum of semi-durable goods and non-durable BIS central bankers’ speeches goods,” such as clothing and food, and “durable goods,” such as automobiles and furniture, indicates that the former has remained more or less flat while the latter has continued to increase significantly following the Lehman shock (Chart 6). This suggests that, within private consumption, services consumption and durable goods consumption in particular have been the driving force of economic recovery these past few years. It is evident that the current economic recovery has also been driven by nonmanufacturing activities (Chart 7). Before the Lehman shock and the earthquake disaster, nonmanufacturing activities moved in almost the same direction as those in manufacturing, with manufacturing leading the way. Since 2012, when the effects of the earthquake disaster mostly dissipated, the level of nonmanufacturing activities has marked an apparent increase, while manufacturing activities have been lackluster. A further intensification of global competition can be pointed to as part of the background behind the fact that it has been difficult for exports and domestic manufacturing activities to realize an upward bounce. Manufacturing firms in particular are further increasing their production, procurement, and fixed investment in overseas countries where there is demand. This may be acting as a burden for exports and business fixed investment at home (Chart 8). In this situation, however, firms have been steadily enhancing their ability to make profits on a global basis. An increase in the consolidated profits of firms will contribute to the rise in stock prices, and an improvement in Japan’s net income from the rest of the world, or income balance, will be an important source of increasing national savings and net external assets (Chart 9). These developments will support Japan’s economic growth. 2. Progress with efforts to boost potential demand Exactly what kinds of activities have supported the recovery driven by consumption and nonmanufacturing? Efforts to stimulate potential demand have been spreading to a wider range of nonmanufacturing sectors, such as retailing, eating and drinking services, tourism, transport activities, and construction. More specifically, they range from active openings of new convenience stores and shopping malls, construction of apartments for the elderly, home-delivery service, and online shopping, to the building of new advanced distribution centers. These efforts can be categorized into (a) developing and providing services for the rapidly increasing number of senior citizens to increase their life expectancy and promote a better quality of life, (b) working to boost the demand of foreign tourists, and (c) providing new services for firms and individuals to meet more sophisticated or diverse needs. These efforts are made to produce higher value-added goods and services backed by primary demand. Each of these efforts may appear tiny in magnitude but can be long-lasting and sustainable, and they are spreading to many segments of the overall economy. Some of them are also inducing business fixed investment that embodies new technology. In fact, the profitability (the ratio of current profits to sales) of nonmanufacturing firms has been on an increasing trend over the past few years (Chart 10). Coupled with the latest increase in profitability of manufacturing firms, the profitability of firms as a whole has been contributing to efforts to improve productivity and strengthen the growth potential of Japan’s economy as well as to improve people’s outlook for their permanent income. Concurrently, further accommodative financial conditions – such as lower long-term interest rates, higher stock prices, and the yen’s depreciation – have strongly supported these efforts. The annual growth rate of bank lending turned positive at the end of 2011, and has been rising steadily since then. 3. Changing employment and income situation Heightened activity in the nonmanufacturing sector has altered the employment and income situation. The labor demand of nonmanufacturing firms has been increasing as a trend, and a labor shortage is particularly evident at small firms (Chart 11). Firms have started to raise wages for part-time workers and to allow for a shift in employment from non-regular employment to regular employment. In addition, the outcome of the spring wage negotiations BIS central bankers’ speeches suggests, in not just a few cases, possible increases in monthly wages and bonus payments as well as other lump-sum payments. Firms also face challenges in promoting new participation in the labor force, which has led to a rise in the employment rate of female spouses and the labor force participation rate of women (Charts 12 and 13). An increase in part-time and low-paid workers could result in a decline in wages per worker. It should be noted, however, that this trend partly reflects workers’ own preferences about management of their household chores and child rearing. If people who previously had concentrated on household chores and child rearing join the labor force, they will increase the economy’s supply capacity, bringing additional income to households. Sustained improvement in the employment situation for non-regular employees is expected to spill over to regular employment and contribute to its stabilization. 4. Sustainability of economic recovery driven by consumption Let me summarize what I have discussed thus far. First, from the supply side of the economy, firms – mainly in nonmanufacturing – have progressed with new measures to find potential consumer demand, creating higher value-added and increasing business fixed investment. This has supported the foundation of profitability and productivity improvement, thereby strengthening the growth potential of Japan’s economy. Regarding labor market aspects such as the employment and income situation, firms’ labor demand has grown broadly, while the household labor supply has been increasing, prompted by voluntary labor force participation by women. An increase in labor demand accompanied by improvement in supply should bring about a significant rise in the number of employees, a moderate pick-up in wages, and a recovery trend in total employees’ compensation. From the demand side, the creation of higher value-added and a better outlook of households for employment and income will lead to a rise in the trend in consumption expenditure. Enhancing firms’ ability to make profits overseas will also increase national savings and net assets, thereby supporting consumption activities over a longer period of time. Taking these three aspects together, a self-sustaining economic recovery driven by consumption and nonmanufacturing will likely persist. In this situation, even if there are temporary fluctuations in the economic growth rate and adverse effects on households’ disposable income due to the consumption tax hikes, Japan’s economy is likely to continue growing, as a trend, at a pace higher than its potential growth rate. C. Increasing upward pressure on prices On the price front, the continued economic recovery driven by consumption has heightened inflationary pressure (Chart 14). The year-on-year rate of increase in the consumer price index (CPI, all items less fresh food) has risen to 1.3 percent, and price rises have been observed not only in energy-related goods but also across a wide range of items. On a basis excluding food and energy, the rate of increase has risen to 0.8 percent. With regard to the outlook, the rate of increase in the CPI (all items less fresh food), excluding the direct effects of the consumption tax hike, is likely to be around 1-1/4 percent for some time. As the background to this situation, we note that firms have started to raise prices by setting higher markups and more directly passing through their costs to prices in a situation where demand for goods and services keeps increasing. This means that the same increase in demand will generate higher inflation, which makes the Phillips curve steeper (Chart 15). In particular, consumer demand for services and durable goods has kept increasing, and this seems to be exerting upward pressure on overall prices (Charts 5 and 6). In fact, these developments have begun to be seen in a wide range of consumption goods and services. A detailed examination of items that comprise the CPI reveals that the number of items for which prices have risen year on year has increased steadily while those for which BIS central bankers’ speeches prices have declined has decreased steadily (Chart 16). A self-sustaining, long-lasting economic recovery driven by consumption is likely to exert upward pressure on prices for a wider range of goods and services. Medium- to long-term inflation expectations are likely to rise accordingly. II. Monetary policy A. Framework for the conduct of monetary policy In January 2013, the Bank set the “price stability target” at 2 percent in terms of the year-onyear inflation rate of the CPI, and made a clear commitment to achieving this target at the earliest possible time. In April of that year, the Bank introduced quantitative and qualitative monetary easing (QQE) to achieve the target at the earliest possible time, with a time horizon of about two years (Charts 17 and 18). Let me now explain the policy framework of QQE. First, the Bank conducts money market operations so that the monetary base will increase at an annual pace of about 60–70 trillion yen. Second, it purchases Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 50 trillion yen, and the average remaining maturity of the Bank’s JGB purchases will be about seven years. Third, it purchases exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. And fourth, for CP and corporate bonds, the Bank continued with these asset purchases until their amounts outstanding reached 2.2 trillion yen and 3.2 trillion yen, respectively, by end-2013, and it has maintained these amounts outstanding. Clearly, these measures are drastic both in terms of the overall quantity and the quality of assets purchased. The Bank will continue with QQE, which consists of the measures I have just cited, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. As a result, calculated on a stock basis, the monetary base and the amounts outstanding of JGBs as well as ETFs are projected to almost double in two years. The ratio of the monetary base to nominal GDP is expected to increase to about 56 percent by end-2014. This not only stands out in comparison with the other advanced economies, but also is more than three times larger than the ratio before the Lehman shock. The amounts outstanding of the monetary base and JGBs at end-March 2014 stood at about 220 trillion yen and about 154 trillion yen, respectively. At each Monetary Policy Meeting, the Bank decides on whether to continue these drastic measures both in terms of quantity and quality, and has been steadily pursuing aggressive monetary easing. B. Key characteristics of QQE Let me highlight three key characteristics of QQE. First, rather than adopting an incremental approach, the Bank took all-out measures necessary to overcome deflation. Second, the Bank showed its determination by committing to achieve the price stability target at the earliest possible time, with a time horizon of about two years. And third, the Bank decided to continue with QQE as long as it is necessary for maintaining the 2 percent price stability target in a stable manner. As guidance for the future path of monetary policy, while demonstrating its determination by indicating a timeframe of “about two years,” the Bank decided to link the continuation of monetary easing with the policy target under QQE by committing to continuing with QQE “as long as it is necessary for maintaining the 2 percent price stability target in a stable manner,” and thus incorporated elements of an open-ended framework. The guidance possesses a BIS central bankers’ speeches state dependent aspect since QQE will respond accordingly to the status of economic activity and prices. By incorporating elements of an open-ended framework, a “stabilizing mechanism” is expected to operate. Specifically, if market participants anticipate that the economic and price outlook will weaken compared to the baseline scenario, they will expect an extension, and thereby a strengthening, of monetary easing. This will be factored into the new outlook and in turn help to achieve the target. It is difficult to make a real-time analysis of the policy effects of QQE. However, QQE seems to provide strong support for Japan’s economic recovery from the financial side, as I have just described. Thus far, Japan’s economic activity and prices are developing in line with the Bank’s Policy Board members’ median forecasts – in other words, with real GDP growth at 1.4 percent and 1.5 percent in fiscal 2014 and 2015, respectively, and CPI inflation excluding the effects of the consumption tax hikes at 1.3 percent and 1.9 percent in those years (Chart 3). Meanwhile, market participants and economists seem to have a conservative outlook. Regarding the price outlook in particular, the ESP Forecast Survey indicates that prices are expected to rise at around 1 percent in both fiscal 2014 and 2015, which presents a gap in comparison with the Bank’s forecasts. This seems to mainly reflect the difference in views on the degree of a rise in the medium- to long-term inflation expectations and of the price passthrough behavior by firms. In this regard, the Bank will continue to provide a thorough explanation of the thinking and mechanism behind its outlook. Regarding the effects of unconventional monetary easing, empirical studies have been conducted on Japan’s quantitative easing (QE) policy, which took place from 2001 to 2006. Empirical results based on a time-series approach imply that the QE policy boosted production through such transmission channels as a rise in stock prices and the depreciation of the yen. The current QQE is expected to have more powerful policy effects than the previous QE, given the significant expansion of the Bank’s balance sheet, the extension of duration on the asset side, the introduction of a clear price stability target, and the forward guidance broadly linked to the target. C. Measures to strengthen the transmission effects of QQE: enhancement of the loan support program To support full use of the accommodative financial conditions by firms and households, the Bank has been employing the Loan Support Program. At the Monetary Policy Meeting held on February 17 and 18, 2014, the Bank decided to double the scale of the Loan Support Program and to extend its application period by one year (Chart 19). The Loan Support Program consists of two measures: the fund-provisioning measure to stimulate bank lending (hereafter the Stimulating Bank Lending Facility) and the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility). Specifically, under the Stimulating Bank Lending Facility, the Bank decided to enable financial institutions to borrow funds from it up to an amount that is twice as much as the net increase in their lending. As for the Growth-Supporting Funding Facility, the Bank decided to double the maximum amount of its fund-provisioning under the main rules from 3.5 trillion yen to 7 trillion yen. It also decided to increase the maximum amount of its fund-provisioning to each financial institution from 150 billion yen to 1 trillion yen. Under these facilities, financial institutions will be able to borrow funds at a fixed rate of 0.1 percent per annum for four years. Thus far, the Loan Support Program has supported financial institutions’ efforts to increase the total amount of their lending and has produced positive effects as a catalyst in regard to firms’ and financial institutions’ efforts to strengthen the foundations for Japan’s economic growth. The Bank expects that the enhancements made at the February Monetary Policy BIS central bankers’ speeches Meeting will further promote financial institutions’ actions as well as stimulate firms’ and households’ demand for credit, with a view to encouraging banks’ lending and strengthening the foundations for economic growth. These enhancements will reinforce the transmission effects of QQE. In order to strengthen the growth potential of Japan’s economy, in addition to efforts made by the private sector, it is critical that the government take action. The joint statement of the government and the Bank, released in January 2013, asserts that the government will strongly promote measures for strengthening the competitiveness and growth potential of Japan’s economy by carrying out bold regulatory and institutional reforms. It also expressly states that the government will steadily promote measures to establish a sustainable fiscal structure and ensure the credibility of fiscal management. I strongly expect that the government will steadily proceed with these measures. Concluding remarks: the economy of Okayama prefecture My concluding remarks will touch on the economy of Okayama Prefecture. The industrial structure of Okayama Prefecture has an advantage in monozukuri, or manufacturing, which accounts for about 30 percent of gross prefectural production. Petroleum, chemical, and iron and steel products, as well as automobiles, are supplied to other regions and overseas mainly from the Mizushima industrial complex located in the southern part of Okayama Prefecture, which is one of the major industrial complexes in Japan. With the cooperation of industry, government, and academia, as well as of financial institutions, the prefecture has recently been working aggressively to foster new industrial clusters, such as electric cars and aircraft, which are linked to a wide range of industries and have growth potential. Besides manufacturing, thanks to a favorable geographical condition of lying between the Chugoku and Shikoku regions, there has recently been an increase in the building of distribution centers and shopping malls with the aim of transferring goods and attracting people from throughout those regions. To take advantage of the power of the shopping malls to draw customers and thus boost the local economy, the prefecture has been working to redevelop surrounding communities by making road improvements and enhancing cooperation among retailers there. Moreover, the prefecture has many outstanding characteristics. First of all, the fine, warm weather makes the prefecture not only a favorable place to harvest crops, thereby making it known nationwide as a peach- and grape-producing region, as well as to nurture rich forests, but also a suitable place to generate electricity from solar power. Second, the solid ground and low risk of tsunami have promoted the construction of large-scale data centers. Third, the accumulation of high-level general hospitals in the prefecture has been contributing to the development of the medical and nursing care industry. And fourth, abundant tourism resources offer, for example, world-class scenic spots for sightseeing, such as Okayama Korakuen Garden and Kurashiki Bikan Area, as well as “B-grade gourmet dishes,” or local casual food items, which have become widely known and have helped revitalize the local economy. To further fulfill the potential of tourism resources, aggressive efforts have been made to strengthen cooperation with relevant organizations and boost PR promotion, such as increasing opportunities for the Prefectural Governor to promote these resources. Through efforts to make use of these characteristics and advantages, as well as foster new areas with growth potential, I expect that the economy of Okayama Prefecture will achieve further growth. The Bank will continue to provide support as much as possible as the central bank, so that efforts in each economic sector of the prefecture will pay off. 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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Keynote speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the 2014 International Conference, held by the International Association of Deposit Insurers, Asia-Pacific Regional Committee, Tokyo, 23 April 2014.
Hiroshi Nakaso: What the lost decades left for the future Keynote speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the 2014 International Conference, held by the International Association of Deposit Insurers, Asia-Pacific Regional Committee, Tokyo, 23 April 2014. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website Introduction Ladies and gentlemen, it is my pleasure to address the distinguished audience attending the International Association of Deposit Insurers (IADI) Asia-Pacific Regional Committee (APRC) International Conference held here in the historic city of Kyoto. Today, I want to trace history a little bit in an attempt to find out what can be learned from the so-called Lost Two Decades in Japan. The ordeal that Japan’s economy has undergone since the bursting of the asset bubbles in the early 1990s was initially dismissed as a uniquely Japanese experience with limited implication for the rest of the world. But the subsequent global economic and financial development suggests it was, in fact, in no way unique. The challenges that the Bank of Japan faced during the Lost Decades in endeavoring to restore financial stability and overcome deflation have provided significant lessons, some of which have created the guideposts for the future. Among the insights obtained, I want to pick up on three issues that I think are of particular relevance in the current context and for the audience in this room. These are the mission to overcome deflation, the mechanism to contain a financial crisis, and the role of a central bank as the Lender of Last Resort. I. Overcoming deflation Zero lower bound on nominal interest rates and deflationary equilibrium The first issue is the mission to overcome deflation. Since the financial crisis in the 1990s, Japan’s economy is said to have fallen into deflationary equilibrium, in which prices decline gradually and persistently. Let me start with a look at this deflationary equilibrium. Prices continued to decline principally because a large shock brought by the financial crisis affected Japan’s economy and the output gap widened. Nowadays, there is no need to explain how a financial crisis damages the real economy through erosion of financial intermediation. However, at the time, this mechanism seems to have been grossly underestimated. After entering the 2000s, the downward pressure was compounded by a new shock of a declining labor force, and this has been putting further downward pressure on the economy. However, deflation ought not to continue if a central bank is able to sufficiently lower nominal interest rates in the face of such large shocks. In this regard, the critically important factor is whether a central bank faces the zero lower bound or not. Chart 1, which I borrowed from a paper by President Bullard of the Federal Reserve Bank of St. Louis, shows this in a simplistic manner. 1 In the chart, the nominal interest rate and the inflation rate in a steady state will be determined when the line describing the Fisher relation – which shows the relation among nominal interest rates, real interest rates, and inflation rates – crosses the Bullard, J. (2010): “Seven Faces of ‘The Peril’,” Federal Reserve Bank of St. Louis Review, September/October, pp.339–352. BIS central bankers’ speeches line representing the central bank’s policy reaction function. A central bank’s policy reaction function would have a positive slope as the central bank would react to a declining inflation rate by lowering interest rates. However, as the central bank cannot lower nominal interest rates below 0 percent, the reaction function becomes horizontal when nominal interest rates are at 0 percent, as shown in the chart. Then, the two lines cross twice, creating inflationary equilibrium on the right side of the chart and deflationary equilibrium on the left side. When strong downward pressure is added to the economy, an inflationary equilibrium might shift down toward a deflationary equilibrium. If actual figures for Japan, the United States, and Europe are plotted on the chart, one can see that Japan’s economy has been hovering around deflationary equilibrium (Chart 2). These topics of the zero lower bound on nominal interest rates and deflationary equilibrium were initially considered unique to Japan and taken up as the subject of intellectual curiosity by only a fraction of academics. However, since the Lehman crisis, as central banks in major advanced economies have come to face similar problems, these issues have prompted the policymakers to refocus on Japan’s experiences, from which they sought to draw practical lessons. Escaping from deflationary equilibrium Another lesson is that, once the economy falls into deflationary equilibrium, it is difficult to overcome that situation. In order to get out of deflationary equilibrium, a sufficient escape velocity needs to be provided to the economy. What is extremely important in this regard is to employ all policy measures in the arsenal. As for monetary policy, the Bank of Japan introduced a decisive measure of quantitative and qualitative monetary easing in April last year. At the same time, as for fiscal policy, the government launched an expansionary policy partly through a supplementary budget while taking due account of long-term fiscal sustainability. In escaping from deflationary equilibrium, in my view, monetary and fiscal policies that were independently conducted under inflationary equilibrium need to be pursued with a different approach. In this regard, the joint statement of the Bank and the government announced in January last year may have been playing an important role as a coordination device that enables the collective conduct of monetary and fiscal policies. Thanks to these measures taken, the latest figures in Chart 2 suggest that Japan’s economy has gradually but steadily been escaping from deflationary equilibrium. Having said that, we are only halfway to achieving the 2 percent inflationary equilibrium. In view of this, what warrants attention are effects of the consumption tax hike from this April. While there are some goods, like automobiles, that seem to face a larger increase in demand ahead of the tax hike compared with the previous consumption tax increase in 1997, we would like to wait for an accumulation of data to judge the overall effects on private consumption (Chart 3). Personally, I believe that Japan’s economy as a whole is resilient enough to absorb the effects of the consumption tax hike. The major reasons for this are continued improvement in employment and income conditions and the absence of problems that existed in the previous 1997 tax hike. In particular, the critical difference is that, while the financial intermediation function that supports economic activity was broken due to the domestic financial crisis, which was at its peak in 1997, the financial system is in sound, robust shape this time around. Put differently, the absence of a financial system problem corresponds to the fact that problems such as debt overhang, excess capacity, and excess employment that had haunted the economy at that time have been resolved thanks to subsequent efforts by firms (Chart 4). The Bank will steadily pursue quantitative and qualitative monetary easing to make sure we put an end to this deflation. As we have said repeatedly, should the outlook for economic activity and prices change due to some risk factors, the Bank will make adjustments as necessary. While overcoming this deflation is the Bank’s manifest mission, for Japan’s economy to move to a sustainable growth path, it is crucial to inspire private economic entities’ BIS central bankers’ speeches entrepreneurship and dynamism in order to reinforce the growth potential of the economy. In this regard, I strongly expect that the government’s growth strategy will be steadily implemented. Now let me bring you to the second issue: the mechanism to contain a financial crisis. II. Mechanism to contain a financial crisis Financial system stability and the role of a central bank Smooth financial intermediation under a stable financial system is a prerequisite for achieving sustainable economic growth with price stability. Stability of the financial system is also needed to secure the effectiveness of monetary policy. This is because the financial system is a major policy transmission channel, in that monetary policy is carried out through measures such as open market operations that have financial institutions as their counterparts. In the Bank of Japan Act, contributing to the maintenance of stability of the financial system is stipulated as the Bank of Japan’s purpose, along with achieving price stability. Against such a backdrop, through its on-site examinations and off-site monitoring, the Bank has been striving toward accurately gauging the business conditions of financial institutions. In addition, while utilizing the information of individual financial institutions obtained through such processes, the Bank seeks to gain a holistic view on the soundness of the entire financial system. The points to be checked include whether there is a widespread accumulation of financial imbalances such as an excessive expansion in credit aggregates or leverage as well as an excessive rise in asset prices, which are assessed from a macroprudential perspective. 2 The examination of financial imbalances has become one of the important exercises under the current monetary policy framework in Japan. Lessons learned from Japan’s experience The efforts to secure financial system stability from the micro- and macro-perspectives I have just mentioned aim at early detection of a source of crisis and preempting its materialization. Despite such efforts, we cannot eliminate the probability of a crisis. Therefore, it is critical to establish an effective mechanism that can minimize the spread of damage in case a crisis occurs. In this regard, Japan’s experience of the financial crisis of the 1990s may provide many lessons, because it was a painful case that allowed seeds of problems to grow into a full-scale systemic crisis, during which about 180 depositary institutions failed. There were multiple reasons why this had to be the case. In what follows, I want to point to three basic causes, acknowledging the fact that wisdom came only after the event. Hopefully, these will provide those countries that are in the process of designing and establishing a mechanism to contain a financial crisis with valuable insights. a. Delay in authorities’ recognition of the situation The first cause was a delay in authorities’ recognition of the situation. In 1992, the size of nonperforming loans announced by the government was 8 trillion yen in total for 21 major banks. At the time, the effects of nonperforming loans on the financial system were not considered to be so serious. For example, a 1992 Economic White Paper stated that nonperforming loans were not a critical problem for banks’ management as those were only a part of banks’ total loan amount of 351 trillion yen and accounted for a small portion of their total assets, and as banks had about 17 trillion yen of unrealized gains on securities. This The Bank of Japan publishes the Financial System Report semiannually, with the objective of comprehensively analyzing and assessing the stability of Japan’s financial system and facilitating communication with concerned parties in order to ensure such stability. BIS central bankers’ speeches statement ultimately diverged significantly from the actual figure of the banking sector’s cumulative losses in the ensuing 10 years, which turned out to be as much as 100 trillion yen, or about 20 percent of GDP (Chart 5). This example was not limited to Japan. Concerning losses associated with the U.S. subprime mortgage problem, which triggered the recent financial crisis, the U.S. authorities initially announced that these totaled about 50 to 100 billion dollars. Ultimately, the amount bloated to several hundred billions. Amid the vortex of a crisis, authorities tend to yield to wishful thinking. We need to bear in mind again the need to expect the worst and plan for the best when the financial system faces preliminary tremors. A delay in recognition also held true in terms of the gravity of the effects that nonperforming loan problems had on the economy. After the bursting of the bubble, the authorities were aware of the possible impact of a decline in real estate prices on management of individual financial institutions. However, macroeconomic consequences of eroded financial intermediation and the resultant tighter monetary condition – in recent terminology, a negative feedback loop between the financial system and the real economy – had been underestimated, if not disregarded. b. Lack of recognition of the nature of systemic risk The second cause was a lack of recognition regarding the nature of systemic risk. Japan’s financial crisis in the 1990s took hold with the resolution of two Tokyo-based credit cooperatives in December 1994. At the time, a wide range of financial institutions were perceived to be facing the common problem of mounting nonperforming loans. Therefore, even though these two credit cooperatives were small in size, there was a risk that the failure could drive the entire financial system into turmoil, as the problems with the failed institutions were easily associated with those faced by the surviving ones – for example, people would ask themselves, “if those credit cooperatives failed, why can’t others?” Then came November 1997. In a single month, now remembered as Dark November, as many as four financial institutions including internationally active ones failed in succession. Sanyo Securities, a middle-ranking securities firm, was among those that failed. It defaulted on borrowing from the call market, the core of the interbank market. The amount of the default by this nondepositary financial institution was only about 8.3 billion yen – a fraction compared with the market size. But as that was the first-ever default in the call market, it sent a shockwave through market participants, and every one of them had a gnawing suspicion that those to whom they lent money might fail anytime. As a result, the call market contracted sharply and the market intermediation function was lost. When there is increased vulnerability of the financial system, even the failure of a small financial institution or non-depositary financial institution can induce a contagious systemic shock. At the time, there was a general lack of recognition about the mechanism through which a shock develops into a systemic crisis. c. Lack of effective safety nets The third cause was a lack of effective safety nets. It would have been more desirable if an effective framework had been in place in normal times that could both contain moral hazard and avoid systemic risk in a balanced manner. However, in reality, the creation of such a framework lagged behind the unfolding crisis. This delayed the resolution of problem financial institutions and resulted in an escalation of the crisis. In Japan’s financial crisis of the 1990s, policy responses were based on the principle that all depositors, including uninsured ones, should be fully protected in order to preclude a depositors’ run. To cover the cost of the deposit protection, the failed financial institution’s capital would first be used. The residual amount was supposed to be covered by financial assistance from the Deposit Insurance Corporation of Japan (DICJ). However, under the primitive legal framework of that time, the amount of available financial assistance in a bank failure was limited to covering only the insured. Therefore, to collect the cost needed for full deposit protection including uninsured deposits, the only option left was to rely on voluntary BIS central bankers’ speeches contributions from financial institutions – a method later called the consortium method. Although this method worked for a while, it soon reached a limit, as the number of failures soared and the cost of deposit protection consequently bloated. This led to legislation that removed the ceiling of financial assistance from the DICJ. But the source of the enhanced support was deposit insurance premiums collected from the financial industry. This was little different from the consortium method, in the sense that it was the financial industry that had to bear the burden anyway. With the financial strength largely exhausted, there was naturally a limit to what the industry could bear. In other words, the crisis had escalated to the extent that injection of public funds, the only remaining financial resource, was considered imminent and necessary. But political difficulties prevented that from taking place in a timely manner. Indeed, the discussion on public funds injection was not unsealed 3 until Japan experienced the so-called Dark November of 1997, at which point the crisis became visible in the eyes of everyone. This finally paved the way for the use of public funds. 4 However, establishing safety nets amid escalation of the crisis was a painful process. It was only after May 2003, 5 almost six years after Dark November, when we finally felt that the crisis was gradually waning. Japan’s safety nets that evolved while coping with the crisis As a member of the policy authorities at the time, I sometimes wonder what could have been different if public funds had been injected a little earlier. At the same time, however, it should be appreciated that the safety nets for Japan’s financial system have developed into solid ones as a result of a series of evolving steps taken while coping with the actual crisis. The current safety nets in Japan are equipped with a framework of investor protection for each business category. As for depositary financial institutions, a framework is now in place that allows, if a case is judged to be systemic, for exceptional measures to be taken to reinforce the capital position of a bank, including an option for temporary nationalization. In addition, a piece of legislation last year introduced a framework intended to cope with market-induced-type systemic risk that could be triggered by such non-bank institutions as securities firms and insurance companies. Thus, I think I can say that Japan’s safety nets have evolved to become comprehensive ones that cover a wide range of financial institutions and can be considered to represent the culmination of past actual financial crisis management measures. In that regard, our safety net arrangements have a lot to offer, and to which countries overseas can make reference. Of course, Japan’s system as it stands does not fit every country exactly. Needless to say, it is desirable to establish frameworks that suit the financial and legal systems of respective countries while utilizing universal elements underlying Japan’s system. The discussion on public funds injection in Japan was sealed in 1995 after an episode of injecting taxpayers’ money amounting to 685 billion yen to resolve the housing loan corporation (HLC) problem in 1995 – the so-called Jusen Problem. HLCs were non-bank financial institutions. In Japan’s financial crisis, there were two major cases of capital injection using public funds. The first case was in March 1998, when capital of 1.8 trillion yen was injected to 21 major banks based on the former Act on Emergency Measures for Financial Functions Stabilization. The second injection took place in March 1999 based on the Act on Emergency Measures for Early Strengthening of Financial Functions. Based on the asset quality assessment, a total of 7.5 trillion yen in capital was injected into 15 banks. In May 2003, public funds were injected into Resona Bank based on Article 102 of the revised Deposit Insurance Act and, triggered by this, stock prices that had long been stagnant gradually started to rise. BIS central bankers’ speeches III. Central bank as the Lender of Last Resort Scope of the Lender of Last Resort and the safety nets The third and final issue I will address today is the role of a central bank as the Lender of Last Resort. In coping with financial crises, a central bank’s Lender of Last Resort function has also played an important role. This is a function in which a central bank provides funds to a financial institution facing a temporary liquidity shortage in order to prevent systemic risk from materializing. In carrying out this function – through the so-called special loans – the Bank of Japan has required, including during the crisis period, that four conditions be fulfilled. Specifically, first, there must be a strong likelihood that systemic risk will materialize. Second, there must be no alternative to the provision of central bank funds. Third, all responsible parties are required to take clear responsibility to avoid moral hazard. And fourth, the financial soundness of the Bank of Japan should not be impaired. Of these, the fourth principle entails an inherently difficult problem. As was the case with the failure of Sanyo Securities and many other cases, a financial crisis typically surfaces in the form of liquidity shortage with a solvency problem lurking in the background. What is troubling is that, at an early stage of the crisis, it is quite difficult to differentiate the liquidity problem from the solvency problem. The traditional wisdom is that the Lender of Last Resort support should be confined to “illiquid but solvent” institutions, but in practice this is not easy. This is why a central bank serving as a Lender of Last Resort runs the risk of credit losses. If the central bank’s funds become unrecoverable, its financial soundness will be impaired. If, as a result, speculation arises that the central bank’s policy judgment might be affected, policy effectiveness could be undermined. Furthermore, losses incurred by the central bank might ultimately lead to taxpayer burden through reduced transfers to the government. The problems that I have just mentioned will be even more acute when safety nets are underdeveloped. A central bank will be forced to make the decision of whether to dare take risk and exercise its Lender of Last Resort function in order to avoid a crisis despite the possibility of incurring losses. In Japan, during the 1990s, in the absence of frameworks to cope with systemic risk triggered by non-bank securities firms and with capital shortage of depositary institutions, the Bank of Japan intentionally took on the risk and provided special loans to fulfill its mission to secure stability of the financial system. However, this ended in the painful result of incurring credit losses of more than 200 billion yen. Today, as mentioned earlier, comprehensive safety nets are installed, and the DICJ has a broadened capacity to provide funds including capital injection. Accordingly, the scope of the Bank of Japan’s role has become substantially narrower relative to that in the 1990s, and is basically confined to back financing toward the DICJ. Going forward, it will become important to strengthen coordination among related parties under the new framework so that crisis management measures can be activated promptly in the event of crisis outbreaks. New dimensions of the Lender of Last Resort a. Market Maker of Last Resort The central bank’s Lender of Last Resort function seems to have reached a new stage. During the recent global financial crisis, it has become clear that systemic risk can be magnified through mutually reinforcing declines in funding and market liquidity in light of increasingly deepening and interconnected financial markets. After the market turmoil in the summer of 2007, heightened counterparty concerns among market participants drove the markets to become dysfunctional. In response, central banks embarked on restoring market function by providing liquidity to the markets as a whole through open market operations. Specifically, after the collapse of Lehman Brothers in September 2008, the Federal Reserve (Fed) provided funds to issuers of CP and holders of asset-backed securities (ABS). Meanwhile, in Japan, the corporate sector was directly hit by the crisis because the market liquidity of their funding sources dried up. To address the adverse market condition, the Bank BIS central bankers’ speeches of Japan took the exceptional steps of making outright purchases of CP, asset-backed commercial paper, and corporate bonds. More recently, in response to market fragmentation that became serious in the euro area on the back of the sovereign debt problem, the European Central Bank (ECB) carried out a large-scale fund provisioning through its threeyear Longer-term Refinancing Operations (LTROs) on a full allotment basis, aiming at restoring market function. As these measures substitute for the intermediation function of the markets, we can probably say that a central bank’s Lender of Last Resort function has evolved to encompass the role of Market Maker of Last Resort. b. Global Lender of Last Resort The recent global financial crisis demonstrated that systemic risk can spill over across national borders and have a global dimension. The deepening of globalization had prompted financial institutions to broaden their intermediation activities into non-home currencies. This suggests that home central banks may have to confront the challenges arising from liquidity crises in non-home currencies. In the first place, provision of liquidity in non-home currencies is in no way an easy task for the home central bank to implement in a timely manner given the potential size needed, time difference, and other operational constraints. During the recent financial crisis, U.S. dollar liquidity shortage became an acute concern, especially among European banks, which had expanded their dollar intermediation activities. In response, the ECB and Swiss National Bank each entered into swap arrangements with the Fed at the end of 2007 to obtain dollars to be fed through to financial institutions operating in respective markets. Other major banks, including Japanese ones, had also expanded dollar intermediation. Therefore, the Bank of Japan, the Bank of England, and the Bank of Canada joined the swap arrangements with the Fed after the collapse of Lehman Brothers. Triggered by the sovereign debt problem in Europe, this arrangement was reinforced in 2011 to become a network of bilateral swap arrangements that provides the six participating central banks with access to the yen and major currencies other than the US dollar, 6 should a liquidity crunch occur in these currencies (Chart 6). The arrangement has now become a permanent measure. This provision of non-home currencies under central bank cooperation embodies the role of Global Lender of Last Resort. As I have described, while the essential nature of a central bank’s Lender of Last Resort function remains unchanged, specific ways of exerting the function have evolved, and new dimensions have been added to it. More than ever, central banks now face the need to enhance collective efforts to improve crisis management skills in order to better withstand future shocks. Concluding remarks Ladies and gentlemen, let me now conclude. The Japanese experience tells us that a negative feedback between the real economy would come into play once financial stability is undermined, and that, for this reason, we need to have a good set of crisis prevention and crisis management measures in place. Today, I have focused on the latter, but let me reiterate that crisis prevention tools such as financial regulation and macroprudential policies are no less important. In dealing with the financial crises of the recent past, we also have recognized that a central bank’s Lender of Last Resort function remains an important tool that needs to be constantly refined to meet the potential challenges arising from globalization. Two decades may seem a mere instant in history for a city like Kyoto that has survived more than one thousand years with a myriad of historic events. But the past two decades were so These six banks are the Bank of Japan, the Fed, the ECB, the Bank of England, the Bank of Canada, and the Swiss National Bank. So far, the arrangements have not been used to provide funds other than in U.S. dollars. BIS central bankers’ speeches eventful that I am sure it will long be remembered in the history of economy and finance. We have learned a lot and may have become a little wiser, but so many things remain to be explored. We can never regain the two decades that have elapsed. But we can make full use of the insights obtained during the period in fulfilling our mission of bringing the economy back on track toward sustained growth and in contributing to building up effective safety nets to underpin financial stability in Japan as well as in other countries. Only when these tasks are done can we probably say, perhaps with a little bit of relief, that the spell the Lost Decades cast on us is at last broken, and that not everything was lost after all. Thank you very much for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Annual Tokyo Conference, hosted by the Center on Japanese Economy and Business (CJEB), Columbia Business School, Tokyo, 15 May 2014.
Haruhiko Kuroda: Toward overcoming deflation Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Annual Tokyo Conference, hosted by the Center on Japanese Economy and Business (CJEB), Columbia Business School, Tokyo, 15 May 2014. * * * Accompanying charts can be found at the end of the speech. Introduction It is my great honor to deliver a speech at this conference hosted by the Center on Japanese Economy and Business of Columbia Business School. The topic of this conference – “Restoring the Japanese Economy” – is of considerable significance and I have no doubt that the proposals presented here will be of benefit to Japan’s economy in the future. In my speech, I will talk about the Bank of Japan’s initiatives toward overcoming deflation and the outlook for economic activity and prices. In closing, I will touch on Japan’s growth potential, which is a key issue for “Restoring the Japanese Economy”. I. Effects of quantitative and qualitative monetary easing and outlook for economic activity and prices In April last year, the Bank introduced quantitative and qualitative monetary easing, dubbed QQE, aiming to achieve a price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. About a year has passed since then and QQE has been having the intended effects. Through a clear commitment to promptly achieving the price stability target and large-scale monetary easing, people’s inflation expectations have been rising on the whole. On the other hand, massive purchases of government bonds by the Bank have kept 10-year interest rates at a low level, which is currently about 0.6 percent. As a result, real interest rates have been negative and have continued to decline, thereby stimulating economic activity. Japan’s economy has continued to grow, led by domestic demand, and the year-on-year rate of change in the consumer price index (CPI) excluding fresh food has risen from minus 0.5 percent in March last year to plus 1.3 percent in March this year (Chart 1). Going forward, it is likely that a virtuous cycle of economic activity will be maintained as domestic demand will continue to remain firm and exports are expected to increase, albeit moderately. Therefore, Japan’s economy is likely to continue growing at a pace above its potential as a trend, although it will be affected by fluctuations in demand associated with the two rounds of consumption tax hikes. According to the projections in the recently released Outlook for Economic Activity and Prices (Outlook Report), real GDP is expected to grow by 1.1 percent in fiscal 2014, 1.5 percent in fiscal 2015, and 1.3 percent in fiscal 2016 (Chart 2). With regard to the outlook for the CPI excluding fresh food, the year-on-year rate of increase after eliminating the direct impacts of the consumption tax hikes is likely to be around 1¼ percent for some time. The reason is that upward pressure from import prices – mainly from energy prices – will wane through around summer while trend inflationary pressure – due mainly to an improvement in the output gap – will increase, and these two factors will likely more or less offset each other. Subsequently, as trend inflationary pressure continues to grow, the year-on-year rate of increase is expected to follow a rising trend again from the second half of this fiscal year, and reach around 2 percent around the middle of the projection period, which is from fiscal 2014 through fiscal 2016. Thereafter, the rate of increase is likely to edge up as medium- to long-term inflation expectations will converge to BIS central bankers’ speeches around 2 percent and the output gap is expected to continue expanding in positive territory. According to the Outlook Report, the year-on-year rate of change is expected to be plus 1.3 percent in fiscal 2014, plus 1.9 percent in fiscal 2015, and plus 2.1 percent in fiscal 2016 (Chart 2). Hence, Japan’s economy is likely to achieve an inflation rate of around 2 percent, and thereafter gradually shift to a growth path that sustains such inflation in a stable manner. II. Issues regarding the outlook for economic activity Let me next talk about issues concerning the outlook for the real economy and prices – specifically, two concerning the real economy and two concerning prices. Effects of the consumption tax hike and the sustainability of domestic private demand With regard to the real economy, the first issue – and perhaps the one of immediate interest for you – is the effects of the consumption tax hike. The front-loading of demand prior to the tax hike through the end of March was quite substantial (Chart 3). When the consumption tax was last raised in April 1997, the economy subsequently fell into recession. There are some concerns that this might happen again. However, looking back at the economic situation at the time, following the decline in demand after the tax hike, the economy showed signs of recovery in the July–September quarter. What moved the economy back into recession was the outbreak of the Asian currency crisis in the summer of that year and the failure of a number of Japan’s major financial institutions in November. Unlike then, emerging economies today are much more resilient to adverse shocks and Japan’s financial system is stable. In addition, this time around, the economic recovery maintains its momentum as shown in favorable business sentiment, and the employment situation, as measured in terms of the unemployment rate, is also firm. This will have a positive effect on both current labor income and the outlook for future labor income – and hence permanent income – and is therefore expected to underpin private consumption. According to interviews with firms, the decline in consumption following the front-loading of demand has been broadly in line with expectations so far. Therefore, real GDP growth is expected to show a clear decline in the April–June quarter, but the effects of the decline in demand after the tax hike will dissipate thereafter, and the economy is expected to return to a growth path above its potential from summer. Recovery in exports The next issue is developments in exports. Since exports have been lacking momentum despite the correction of the excessive appreciation of the yen, some have argued that Japanese firms’ global competitiveness has declined (Chart 4). However, recent developments in exports have basically been due to cyclical factors such as the sluggishness in emerging economies with close economic ties with Japan, such as the ASEAN countries, although structural factors such as the acceleration in the relocation of production overseas by Japanese manufacturers are likely to have also played a certain role. In addition, especially in the first quarter, temporary factors have likely put downward pressure on exports. Examples include the fact that firms placed priority on domestic shipments in response to the front-loading of demand prior to the consumption tax hike and the effects of the unusually severe winter weather in the United States. Therefore, once growth in overseas economies rises and the effects of these temporary factors diminish, exports are likely to start increasing again, albeit moderately. Meanwhile, the correction in the appreciation of the yen might slow the pace of the relocation of production overseas in the future, given that there is a considerable lag between the decision to relocate production and the actual start of production overseas. Therefore, concerning this structural factor, too, developments may move in the direction of underpinning exports. BIS central bankers’ speeches III. Issues regarding the outlook for prices As I explained, Japan’s economy is likely to continue growing above its potential. However, growth in fiscal 2013 and 2014 is likely to turn out somewhat lower than previously expected due to the delay in the recovery in exports. Despite these downward revisions, the year-onyear rate of change in the CPI for fiscal 2013 turned out as projected and the outlook remains unchanged. The output gap has been steadily narrowing mainly due to the tightening of labor market conditions as projected, and the rise in medium- to long-term inflation expectations seems to have started to influence actual wage and price settings. Let me elaborate on these two points. The output gap and prices First, on the output gap. The current recovery has been led by domestic demand, and business conditions in nonmanufacturing in particular have been improving. As domestic demand tends to have large stimulative effects on employment, this has led to a further tightening in labor market conditions. For example, the unemployment rate is approaching the structural unemployment rate and the active job openings-to-applicants ratio is now at the same level as the peak reached before the global financial crisis (Chart 5). The employment conditions DI in the Bank’s Tankan survey revealed that more and more firms feel that there is a labor shortage. This tightening of labor market conditions has started to influence wages. In the regular annual wage negotiations this spring, the number of firms that raised not only bonuses but also base pay increased substantially. In addition, more and more firms, especially in nonmanufacturing, feel that they have insufficient capacity. While estimates of the output gap are subject to a considerable margin of error, the gap seems to have narrowed to close to 0 percent, which is the past long-term average, reflecting the increased utilization of labor and capital (Chart 6). As for the outlook, it is likely that the tightening of labor market conditions will become more pronounced as the economy continues to grow above its potential, and inflationary pressure from wages and the output gap is likely to steadily strengthen. I will touch on what implications this might have in the last part of my speech. Medium- to long-term inflation expectations Next, according to various surveys and market indicators, medium- to long-term inflation expectations appear to be rising on the whole (Chart 7). As I mentioned at the outset, the year-on-year rate of change in the CPI excluding fresh food has been plus 1.3 percent for four consecutive months. Except for the period after the previous consumption tax hike in 1997 and the surge in global commodity prices around 2008, this is the first time since 1993 that the CPI has risen by more than 1.0 percent yearon-year several months in a row. With firms and households experiencing these price increases, their inflation expectations are changing in an adaptive manner. In this situation, medium- to long-term inflation expectations are likely to follow an increasing trend and gradually converge to around 2 percent – the price stability target. These developments seem to have started to influence actual wage and price settings. As mentioned earlier, an increasing number of firms are raising base wages and some firms recently have changed from a strategy that puts first priority on low prices to one that aims at raising sales prices while increasing value-added. Regarding the CPI for April, an issue of key interest has been whether firms have been able to pass on the consumption tax hike by raising sales prices in line with the tax hike, and the index for Tokyo, which is released ahead of the nationwide index, suggests that this is indeed the case. BIS central bankers’ speeches The Phillips curve Let me summarize this price rise mechanism in terms of the Phillips curve, which illustrates the relationship between the output gap and inflation. This relationship is shown in Chart 8, with the red dots representing the four positions observed over the past year. While it is difficult to gauge the shape and position of the Phillips curve on a real-time basis, we find that the red dots lie above the Phillips curve based on observations for the past 18 years. Thus, taking into account the aforementioned rises in various indicators of inflation expectations and changes in wage- and price-setting behavior, the chart suggests that two things appear to have happened: we seem to have moved upward along the Phillips curve, reflecting a boost in inflation due to the improvement in the output gap, and the Phillips curve appears to have shifted upward due to a rise in inflation expectations. It is likely that these developments will continue and the inflation rate will follow a path toward achieving the price stability target of 2 percent. IV. Monetary policy management and the growth potential of Japan’s economy As I have mentioned, QQE has been having the intended effects. Therefore, I believe it is important to continue with QQE as long as it is necessary for maintaining the price stability target of 2 percent in a stable manner. On that basis, should the outlook change due to certain risk factors the Bank, if necessary, will make adjustments without hesitation in order to achieve the price stability target. What I would like to emphasize here is our strong commitment to achieving the price stability target of 2 percent. If Japan’s economy follows a path toward the 2 percent target as we have projected, we will steadily pursue the current QQE. If not, we will make adjustments so as to achieve the 2 percent. In closing, let me briefly touch on the growth potential of Japan’s economy. The Bank’s QQE policy aims at escaping from a protracted deflationary equilibrium and achieving an economy in which people act on the assumption of inflation of about 2 percent. What has been happening in Japan’s economy for the past 15 years is that declines in product prices led to a decline in firms’ sales, which led to a further decline in prices through compressed wages and stagnant consumption, resulting in a vicious cycle. In such a deflationary economy, it is only rational for individual firms or persons to maintain the status quo, or to prefer cash, and therefore they did not consider it worth the risk, relative to the potential rewards, to embark on new business ventures. What we are aiming at is to break through this “coordination failure” and revive people’s animal spirits. This will be an important element in raising growth expectations and the growth potential. However, there is another important element to consider. As mentioned earlier, given that slack in the economy has shrunk, as seen in the tightening of labor market conditions, it also has become clear that it is imperative to strengthen supply capacity in order for Japan’s economy to grow in the medium to long term. Growth in the aggregate supply capacity of Japan’s economy has been declining due partly to a declining trend in population and aging, as well as the slowing accumulation of capital stock under deflation. These trends, however, did not manifest themselves in the form of labor shortages or supply capacity constraints because demand had been weak. Yet, in the past year or so, with the increase in demand thanks to large-scale monetary easing, fiscal spending, and the rejuvenation of private-sector activities, the supply capacity constraints that were lurking below the surface have now become apparent. In my view, with the supply capacity constraints having surfaced, this will be a golden opportunity to resolve the medium- to long-term challenges facing Japan’s economy. These challenges, of which the public is well aware, include enhancing productivity through regulatory and institutional reforms, raising the labor participation of women and the elderly as well as utilizing high-skilled foreigners, and putting public finances and the social security BIS central bankers’ speeches system on a sustainable footing. However, even though these challenges are well understood, it was difficult to gather sufficient momentum to address them. When there is excess labor and job security is at issue, it is difficult to win support for policy measures to enhance labor participation. Even though people knew that raising labor participation would eventually become an issue due to demographic trends, they tended to think that there was no need to tackle it immediately. Since the serious labor shortages that have now become evident in some industries are due to temporary phenomena such as the high level of public works and the effects of the front-loading of demand, it may not be appropriate to regard the current labor shortages as entirely linked to medium- to long-term challenges. Having said that, given the demographic trends, there is no doubt that labor supply will be an issue in the near future in various forms. Therefore, we should use the ongoing problem of labor shortages as an impetus for a broader discussion on how to raise Japan’s growth potential. In fact, the government has put forward a growth strategy covering a wide range of areas and has been making efforts to accelerate its implementation. I believe that this is the final and most important element in addressing Japan’s challenges and the one that links the topic of my speech, “Overcoming Deflation”, and the topic of this conference, “Restoring the Japanese Economy”. 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
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Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a Newspaper Editorial Writers' Meeting, Kyodo News, Tokyo, 26 May 2014.
Kikuo Iwata: Quantitative and qualitative monetary easing and Japan’s recent economic and financial developments Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a Newspaper Editorial Writers’ Meeting, Kyodo News, Tokyo, 26 May 2014. * * * Introduction Thank you for providing me with an opportunity to speak in front of this large group of columnists. Today, I want to explain the content and basic thinking behind quantitative and qualitative monetary easing (QQE) introduced by the Bank of Japan in April last year. I will also touch on the role-sharing between our monetary policy and the growth strategy being implemented by the government. I. Inflation targeting policy and deflation A. Downside of deflation Let me ask two basic questions. Why is deflation problematic, and why did the Bank adopt an inflation targeting policy? Deferring spending and decline in aggregate demand Deflation, which can be defined as a persistent decline in prices, causes economic stagnation through several routes (Chart 1). First, if prices decline persistently, one can purchase more goods and services with the same amount of money as time passes. In other words, the value of cash and deposits will rise simply by hoarding them; thus, firms and households will defer their investment and spending. Consequently, this will lead to a decline in aggregate demand. Such a decline will make firms reduce their production activity at a level consistent with the drop in sales. Corporate profits will deteriorate and employee income will fall accordingly, and these factors will contribute to a further decrease in spending, housing investment, and firms’ business fixed investment. All this will lead to yet another decline in aggregate demand, which will induce a further drop in prices. Hence, a vicious cycle of price declines and stagnation prevails. Increase in effective debt burden A persistent decline in prices means that the value of money for goods and services will increase. For those who borrow money, the value of money that they will have to repay will increase. This represents an increase in the effective burden of debt. Thus, firms and households will become cautious about borrowing money. The effective burden of debt brought about by money that has already been borrowed will become heavier, weighing on consumption and investment. As a result of shrinking aggregate demand, a vicious cycle of price declines and stagnation will prevail once again. Such a mechanism can also be referred to as “debt deflation”. Excessive appreciation of the yen A persistent decline in prices means continued appreciation in the value of the yen; that is, the value of money to buy goods and services. If deflation only takes place in Japan, it will BIS central bankers’ speeches lead to a rise in the yen’s value against foreign currencies; hence, the appreciation of the yen will prevail. The excessive appreciation of the yen will generate negative effects on the export sector through a decline in international competitiveness in prices and a decline in the value of foreign currencies exchanged in the yen. Moreover, it will raise the cost of labor and capital, compared with overseas economies; thus, the production sites of Japanese firms will shift to overseas and inward investment in Japan will stagnate. This, in effect, will reduce the employment opportunities in Japan and generate a decline in growth rates. Owing to these developments, through the excessive appreciation of the yen, deflation will exert negative effects on Japan’s economy. B. Merit of stable and moderate inflation By contrast, in an environment of stable and moderate inflation – for example, in a case where the consumer price index (CPI) rises about 2 percent year-on-year – a mechanism that is a reversal of what I have just explained under deflation will work (Chart 2). Namely, if one can envisage that prices will rise, an incentive to spend and invest as early as possible will consistently be at work. With stimulated spending activity and an increase in aggregate demand within the economy, firms will boost their spending activity to a level consistent with a rise in sales. Modifying the inflation differentials with trading partners will lead to an adjustment in excessive appreciation of the yen. Moreover, narrowing the differentials of inflation expectations with other economies will contribute to the stability of foreign exchange rates. In this way, corporate profits will start to improve and employee income will increase. Thus, spending and housing investment by households as well as business fixed investment by firms will be rejuvenated further. A steady increase in aggregate demand will lead to a persistent rise in prices; henceforth, a virtuous cycle of economic recovery and rise in prices will be generated. C. Advantages of inflation targeting policy In order to achieve stable and moderate inflation, what kind of policy will be desirable? One answer is a policy framework called inflation targeting. The Bank has been pursuing monetary easing under the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI. This can be understood as a typical example of an inflation targeting policy (Chart 3). Enhancing policy credibility and predictability An inflation targeting policy has a number of advantages. To begin with, as the policy contains a specific numerical target for the future inflation rate, it can be judged objectively whether the target has been met. Through enhanced transparency, a central bank’s obligation to be accountable with regard to policy judgment and the status of achieving the target will become crucial. This will create a situation in which credibility in monetary policy is likely to be enhanced. As it becomes easier to forecast price levels, various economic entities can conduct their activity on the basis of such forecasts. The predictability of future prices will be further reinforced as credibility in monetary policy becomes enhanced. Preventing hyperinflation Regarding the Bank’s policy, some raise concern that, when the time comes for the Bank to change the course of monetary policy, it might be difficult to do so due to pressure from BIS central bankers’ speeches financial markets or the government, and this eventually leads to inducing hyperinflation. The adoption of inflation targeting is effective in terms of alleviating such concern. The reason for this is that an inflation targeting policy is a device to hold a specific numerical target for the future inflation rate and make a commitment to achieving a situation that generates neither inflation above the target rate nor deflation. Though an inflation targeting policy is often discussed in Japan as a measure to overcome deflation, it was originally adopted in the 1980s in countries that suffered high inflation, such as New Zealand. I would like you to understand that, in case the economy should overheat and the inflation rate should rise well above the 2 percent price stability target, the Bank will take appropriate measures in line with the framework of an inflation targeting policy. This has already been made as a firm commitment. I should stress that, in line with the mission stipulated in the Bank of Japan Act, the Bank will conduct monetary policy based on its judgment and responsibility while facilitating communication with the government. II. Quantitative and qualitative monetary easing Now, I will talk about the content and transmission mechanism of the QQE, which was introduced as a policy to overcome deflation. A. Two pillars of the QQE The Bank set the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI. It has been pursuing bold monetary easing policy, called the QQE, in order to achieve this target since April 2013 (Chart 4). The QQE consists of two pillars (Chart 5). The first pillar is the commitment under which the Bank will achieve the price stability target of 2 percent as soon as possible. The Bank has made a clear commitment that it “will achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years”. The second pillar is to engage in actions that embody the commitment specified in the first pillar. As exemplified by the phrase “quantitative and qualitative monetary easing”, these actions are to increase the “quantity” of the Bank’s balance sheet and change the “quality” of its asset purchases. An increase in “quantity” means increasing the monetary base at an annual pace of about 60–70 trillion yen, mainly by massively purchasing Japanese government bonds (JGBs). A change in “quality” refers to purchasing assets with a higher risk profile. Among JGBs, the Bank has started purchasing those with longer remaining maturities. In addition, it has increased the amounts of purchases in exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) in order to reduce risk premiums on assets. B. Transmission mechanism The most important factor in the QQE’s transmission channels is to lower expected real interest rates (Charts 6 and 7). Expected real interest rates are obtained by subtracting the expected rates of inflation by economic entities from the nominal interest rates actually observed in financial markets or over the counter. Viewed from the borrowers’ side, real interest rates are equivalent to borrowers’ subjective expectations regarding their real costs of borrowing, taking into account price changes, when they borrow money at a certain nominal interest rate. BIS central bankers’ speeches By committing clearly to achieving the inflation target and taking bold monetary easing actions that underpin such commitment, one can generate the effect of raising inflation expectations. On the other hand, while short-term nominal interest rates are close to zero percent, one can generate the effect of restraining the rise in long-term nominal rates by massively purchasing JGBs. Consequently, the combination of restraining the rise in nominal rates and raising inflation expectations will provide downward pressure on expected real interest rates that are derived as a difference between the two. If firms and households lower their expected real interest rates, this will stimulate demand in the real economy in a number of ways. For example, when real interest rates decline, people will shift their portfolios from cash, deposits, and fixed-income securities to equities and tangible assets such as land and housing, or to foreign currency-denominated assets with higher returns. The rise in equity prices and the appreciation of foreign currencies will stimulate private consumption through the wealth effect (Charts 8 and 9). In addition to the decline in expected real interest rates, other factors – including an increase in consumption and an improvement in export conditions due to the depreciation of the yen – will encourage firms to be more aggressive in their business fixed investment (Chart 10). A shortage of aggregate demand within the economy as a whole will be eliminated through an increase in demand such as private consumption and investment, and thus price levels will naturally rise. This will further raise inflation expectations toward the price stability target; hence, a virtuous cycle prevails. Those who are skeptical of the Bank’s ability to achieve the price stability target often say that the 2 percent target cannot easily be achieved unless there is further depreciation of the yen. Nonetheless, as I just explained, the main driver in the QQE’s transmission mechanism is to generate the virtuous cycle by raising inflation expectations and improving the output gap. By no means is it intended to rely on a rise in import prices backed by the yen’s depreciation. If the rise in the CPI since the beginning of the QQE last April stems from the cost-push inflation triggered by the rise in import prices on the back of the weaker yen, then the real GDP should have declined and an unemployment rate should have risen. We should have been in stagflation by now. Looking at the economy, the real GDP growth rate was negative for two consecutive quarters (–0.6 percent and –0.8 percent in the second and third quarter of 2012, respectively) shortly before Abenomics was announced. Since the fourth quarter of 2012, however, it has registered positive growth for six quarters in a row. Thus, the real GDP growth has marked a big jump from 0.7 percent in fiscal 2012 to 2.3 percent in fiscal 2013. As for the unemployment rate, it has come down to 3.6 percent in March 2014 from 4.1 percent in March 2013, shortly before the introduction of the QQE. The unemployment rate of 3.6 percent is equivalent to the level registered in July 2007 before the Lehman crisis. This leads me to conclude that the rise in inflation we observe after the QQE is characterized by demand-pull rather than cost-push, as it accompanies an expansion of the real GDP and an improvement in employment. In Japan, in the midst of prolonged deflation since the latter half of the 1990s, people’s inflation expectations declined and deflationary expectations were firmly embedded in society. One of the striking features of the QQE is that it sets the overcoming of such deflationary expectations by working directly on people’s expectations, or the lifting of their inflation expectations, at the center of policy effects. BIS central bankers’ speeches C. Current assessment It has been a year and two months since the Bank introduced the QQE. So far, the QQE has been exerting its intended effects. Looking at the survey results that summarize the views of a wide range of economic entities as well as break-even inflation, observed in the JGB market, inflation expectations in Japan have been rising on the whole. In addition, nominal rates, including those of JGBs, have remained stable at low levels (Chart 11). Under such accommodative financial conditions, Japan’s economy has been recovering moderately, accompanying a virtuous cycle among production, income, and spending. On the price front, the year-on-year rate of change in the CPI, excluding fresh food, had been below zero percent for a prolonged period of some years, but finally has risen to around 1¼ percent (Chart 12). As such, Japan’s economy has been steadily following a path toward realizing the price stability target of 2 percent – that is, a path to overcome deflation – and we are now getting an increasingly better response under the QQE (Charts 13, 14, and 15). III. Monetary policy and economy’s growth potential A. Growth strategy and monetary policy: respective roles Lastly, I wish to touch on an issue of the relationship between the Bank’s monetary policy and the growth potential of Japan’s economy. As we all know, Japan has engaged in macroeconomic policy that combines bold monetary policy, flexible fiscal policy, and a growth strategy to encourage private investment. Under such mix of policies, the role of monetary policy is in essence to overcome deflation and achieve the price stability target of 2 percent. That said, we can streamline the relationship with the economy’s growth potential as follows (Chart 16). The first role of monetary policy is to stimulate aggregate demand through bold monetary easing, close the negative output gap, and return the economy to a path toward achieving potential growth. It can be said that the aim is to end the vicious cycle between deflation and stagnation by overcoming deflation. During the course of closing the negative output gap after the introduction of the QQE, the potential growth rate is expected to rise to some extent as employees will be able to work more efficiently and firms with improved sentiment will take more risk, increase their capital stocks, and become more innovative. At the same time, in order to raise the potential growth rate even further, it is not the role of monetary policy but that of the government which is equipped with policy tools including regulatory reform. This leads me to say that the second role of monetary policy is to set out an environment necessary for the government to embark on the growth strategy and raise potential growth by overcoming deflation. Unless the economy exhibits favorable performance, structural reform to raise its efficiency and dynamism as well as lift its productivity cannot proceed. This is because, under a deflationary slump, the pain caused by promoting competition through deregulation encounters strong resistance. One often refers to “creative destruction”, but under deflation there is no creation after destruction. Furthermore, even though structural reform is making progress under the growth strategy, it is supply-side policy that enhances the production capacity of Japan’s economy. Unless there is aggregate demand to meet such new capacity, it will end up aggravating the deflationary pressure. It is for this reason too that monetary easing needs to alleviate deflationary pressure stemming from structural reform. BIS central bankers’ speeches B. Further challenges If the government policy for the growth strategy and accompanying measures in the private sector are delayed, and the strengthening of growth potential does not proceed, it is possible that the achievement of the price stability target will bring about an economy with low real growth rates under mild inflation. I must emphasize that it is already a significant achievement to end the deflation that had lasted for a long period, but this is not enough to rejuvenate Japan’s economy. The Bank has high expectations that the government will continue to make further progress in its growth strategy in order to strengthen the growth potential of Japan’s economy. It may be that, as a result of progressing with structural reform under the growth strategy, the potential growth rate may rise, worsen the output gap temporarily, and put downward pressure on prices. Nevertheless, the Bank will continue with the QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. Thus, it can address such downward pressure on prices. We will steadily pursue the QQE with a view that Japan’s economy will be able to grow at a higher rate in an environment of a stable inflation rate of about 2 percent. 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 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 in Okinawa (held in Naha), 29 May 2014.
Sayuri Shirai: Japan’s economic activity, prices, and monetary policy – relationships between the output gap, prices, and wages Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders in Okinawa (held in Naha), 29 May 2014. * I. * * Introduction Good morning, everyone. It is a great honor to have this opportunity to visit Okinawa Prefecture and meet with local representatives here. I am really looking forward to learning from you about this region through an exchange of views. I would also like to express my sincere gratitude for your cooperation with the activities of the Bank of Japan's Naha Branch. Let me briefly provide an outline of my speech. First, I would like to talk about the Bank's baseline scenario of the outlook for economic activity and prices in Japan for the projection period from fiscal 2014 through fiscal 2016, in line with the April 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report). Next, I would like to shed light on the concept of aggregate supply and demand balance (hereafter the “output gap”) and explain my view of how that is related to prices and wages. Afterward, I look forward to hearing your candid opinions about the contents of my speech as well as your thoughts about the situation facing the local economy. II. Outlook for economic activity and prices I will begin by describing the current condition of Japan’s economic activity and prices, the Bank’s outlook for economic activity and prices (the baseline scenario) based on the Outlook Report, followed by the upside and downside risks to that baseline scenario. My views will be also touched upon. After that, I would like to explain the Bank’s communication policy, with some references to improvements made in the Outlook Report. A. Outlook for economic activity and upside and downside risks Japan’s economy has continued to recover moderately as a trend, although the subsequent decline in demand following the front-loaded increase prior to the consumption tax hike has been observed. In the Outlook Report, the Bank revised downward its projected economic growth rate for fiscal 2013 – as compared with the projections made in October 2013 and January 2014 – owing mainly to sluggish export performance. However, a virtuous cycle of economic activity has been operating steadily since domestic demand has been firm. Weak exports reflect a shift in production locations abroad, a decline in Japanese firms’ international competitiveness, and weak recovery in the global economy. In addition, there were temporary factors, such as deceleration in U.S. economic activity due to the adverse effects of the unusually severe winter weather and firms’ stance of placing priority on domestic shipments in response to the front-loaded increase in demand prior to the consumption tax hike. In this respect, I raised doubts about the Bank’s overall risk assessment regarding the baseline scenario of the outlook for economic activity in its October 2013 Outlook Report. The Bank concluded that upside and downside risks were “balanced,” but I proposed that it should mention that attention should be paid to the downside risks, mainly because there was a high degree of uncertainty regarding the recovery in exports. I think that the cause of my concern has in fact materialized. Meanwhile, domestic demand remains firm. This is led mainly by labor-intensive nonmanufacturing, supported by public investment, housing investment, and private consumption, thereby tightening labor market conditions and also effectively wiping out a sense of excessiveness in production capacity. Taking these facts into account, the Bank BIS central bankers’ speeches judges that the economy has been recovering steadily in line with the Bank’s baseline scenario. According to the Bank’s baseline scenario of the outlook for economic activity, domestic demand is likely to maintain firmness. Exports are expected to increase, albeit moderately, as overseas economies particularly advanced economies are expected to moderately increase their growth rates. Thus, a virtuous cycle among production, income, and spending is likely to be maintained (Chart 1). Meanwhile, the accommodative monetary environment will continue to support economic activity. Moreover, firms’ and households’ medium- to long-term growth expectations are expected to rise moderately against the backdrop of progress in the government’s growth strategy, as well as firms’ initiatives toward improving productivity and their tapping of potential domestic and external demand. Therefore, the economy is likely to continue growing at a pace above its potential as a trend throughout the projection period. My outlook for economic activity is more or less in line with the Bank’s baseline scenario. However, my projections of the real GDP growth rates are somewhat lower than the median of the Bank’s Policy Board members’ forecasts throughout the projection period. The rate of economic growth is expected to temporarily turn negative in April–June 2014 owing to the adverse impact of the consumption tax hike. But subsequently, the growth rate will likely rise at a very moderate pace, and will likely remain above its potential growth rate throughout the projection period. The upside and downside risks to the Bank’s baseline scenario regarding the economy mentioned in the Outlook Report include the following: (1) developments in exports; (2) the effects of the consumption tax hikes; (3) firms’ and households’ medium- to long-term growth expectations; and (4) fiscal sustainability in the medium to long term. The Bank assesses that these risks are balanced as a whole. As for my own overall risk assessment related to the economy, the downside risks remain somewhat greater than the upside ones, although the degree of downside risks has lessened to some extent compared to October 2013 and January 2014. First, there is the risk that the rate of increase in exports will be more moderate than projected. There is a possibility that the U.S. economic recovery pace will be slower than projected as a result of sluggish performance in the housing sector and relatively slow recovery in the employment conditions for long-term unemployed workers and involuntary part-time workers. Tepid performance in emerging economies, disinflation in the euro area, and geopolitical problems should also be monitored closely. Second, there is a risk of domestic private consumption becoming weaker. Since it is estimated that the rate of nominal wage increases will remain below the CPI-based inflation (including the effects of the consumption tax hikes) throughout the projection period, it is possible that real income may decrease and that consumer sentiment as well as households’ medium- to long-term expectations for growth and income may not improve. On this front, I disagreed four times in row with the Bank’s risk assessment, which appeared in the public statements released after the Monetary Policy Meetings (MPMs) held in January through early April this year. This disagreement reflects my concerns that the public statements referred only to developments in overseas economies as a risk factor, and did not mention the pace of improvement in the employment and income situation in Japan, even though it was pointed out in the October 2013 Outlook Report. However, the April 2014 Outlook Report clearly stipulates the effects of the consumption tax hikes as a risk factor by almost reinserting the related description included in the October 2013 Outlook Report. The current report also refers to consumer sentiment as an additional new factor (as well as the employment and income situation and developments in prices) with regard to the transmission channel of how the consumption tax hikes may affect private consumption. I take these points as indications that my concerns were confirmed and shared by the Policy Board. BIS central bankers’ speeches B. Outlook for prices and upside and downside risks The current price developments show that the year-on-year rate of increase in the CPI (all items less fresh food) has been expanding, and recently has been around 1¼ percent. 1 Major factors determining inflation rates are the output gap, medium- to long-term inflation expectations, and import prices. Developments in these factors reveal that the output gap has been improving and appears to have reached around the past long-term average of about 0 percent. Medium- to long-term inflation expectations appear to have been rising on the whole. As for import prices, upward pressure – mainly from the rise in energy prices – has already begun to weaken somewhat. According to the Bank’s baseline scenario of the outlook for prices, the year-on-year rate of increase in the CPI (excluding the direct effects of the consumption tax hikes) is likely to be around the current 1¼ percent for some time, follow a rising trend again from the second half of fiscal 2014, and “reach around 2 percent around the middle of the projection period.” Thereafter, Japan’s economy is expected to gradually shift to a growth path that sustains such inflation in a stable manner (Chart 2). Over the same period, as the adverse impact of the consumption tax hike wanes, the output gap will continue to improve thereby providing an upward pressure on prices, while medium- to long-term inflation expectations will remain on a moderate rising trend on the whole. The upward pressure arising mainly from the rise in imported energy prices is likely to wane around this summer, reflecting developments in international commodity prices and weakening lagged effects of the yen’s depreciation. Regarding my own outlook for prices for fiscal 2014, I project that the year-on-year rate of increase in the CPI may somewhat decelerate by this summer owing to the declining impact of energy prices and the base effect from fiscal 2013, although it should remain at above 1 percent. The rate of inflation will then begin to rise again from October–December 2014. However, this will be a gradual move given that it will likely take some time for households’ medium- to long-term inflation expectations to show a steady rise – an indicator implies that they are currently remaining roughly constant (Chart 3). Thus, the rate of inflation will likely be more moderate than the Bank’s baseline scenario. My outlook for the period during and beyond fiscal 2015 is that the year-on-year rate of increase in the CPI will reach an average of approximately 1½ percent or a little higher in fiscal 2015, and the inflation rate of 2 percent is likely to be reached toward the end of the projection period. Thereafter, Japan’s economy is expected to gradually shift to a growth path that sustains such inflation in a stable manner. Over the past year (when the projection period was from fiscal 2013 through fiscal 2015), my outlook was that “the rate of CPI inflation will rise closer to 2 percent toward the end of fiscal 2015” and thus I considered that it was barely in line with the Bank’s baseline scenario – described as “reaching around 2 percent toward the latter half of the projection period” of fiscal 2013 through fiscal 2015. This is why I did not oppose the baseline scenario in the past. However, with the projection period extended to fiscal 2016, I considered that the description of the price outlook should clarify the timing when the Bank’s “price stability target of 2 percent” will be achieved, rather than providing an expression – namely, “around 2 percent” – that contains a degree of latitude. 2 Assuming that the rise in the tax is fully passed on to prices of all taxable items, the direct impact of the consumption tax hike from 5 to 8 percent in April 2014 is estimated to raise the CPI (all items less fresh food) by 2 percentage points in fiscal 2014, because some items will not be affected. The impact in April is estimated to be 1.7 percentage points; this is because the former tax rate of 5 percent was applied to some public electricity and water charges in that month. At the MPM held on April 30, 2014, I submitted a proposal against the expression of the baseline scenario of the outlook for prices. My proposed new expression was that “the inflation rate of 2 percent is likely to be reached toward the end of the projection period as the Bank continues with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner.” This BIS central bankers’ speeches The upside and downside risks to the Bank’s baseline scenario regarding prices mentioned in the Outlook Report cover the following: (1) developments in firms’ and households’ medium- to long-term inflation expectations; (2) developments in the output gap; (3) the responsiveness of inflation to the output gap; and (4) developments in import prices. The risks to the price outlook are assessed as being largely balanced as a whole. My own overall assessment on risks to prices is that the risks remain tilted somewhat to the downside, although the degree of such downside risks has declined moderately compared with October 2013 and January 2014. The path toward achieving the 2 percent target seems broadly on track so far. However, there is uncertainty with regard to “the timing for achieving 2 percent” and thereafter “the timing to gradually shift to a growth path that sustains 2 percent in a stable manner.” In particular, I suggest that clear judgment on the timing to achieve 2 percent in a stable manner can be made only after examining the effects of the second round of the consumption tax hike. My aforementioned outlook for economic activity and prices assumes that quantitative and qualitative monetary easing (QQE) will continue during and beyond 2015 under the current framework. Under this current framework, the Bank will continue with QQE, aiming to achieve the price stability target of 2 percent as long as it is necessary for maintaining this target in a stable manner. What is important is that the Bank is conducting monetary easing with the aim of achieving 2 percent inflation in a stable manner with sustainable economic growth, rather than merely achieving 2 percent in a specific year and failing to meet the target in subsequent years. Under the Bank’s so-called flexible inflation targeting framework, I maintain the view that it will likely take longer than “two years” to achieve the 2 percent inflation – in order to avoid imposing excessive burdens on firms and households. Such a path seems desirable for Japan’s economy and is likely to lead smoothly to the next phase of maintaining 2 percent in a stable manner. I will explain later my views on the path toward achieving 2 percent with some background rationale. C. The Bank’s communication policy I would like to take advantage of this opportunity to report that several changes were made in the Outlook Report in terms of improving reader friendliness. The latest report now has a “summary” section. This section provides the structure of the report as well as a brief explanation on the examination from “two perspectives” in the context of meeting the price stability target: the baseline scenario (first perspective); and upside and downside risks to the baseline scenario (second perspective). Regarding these two perspectives, I submitted two different proposals in April and October last year suggesting revisions to the text to make the report easier to understand for the public. On this, I am glad to note that my proposal in October was incorporated in the latest report. This revision also reflected my repeated suggestion over the past years to insert a brief summary of the report. The Bank is now keen to steadily improve its communication, albeit at a rather gradual rate, particularly toward promoting the reader friendliness of its public documents. These improvements can be considered a good example of the Bank achieving its intention to strengthen its external communication: this was incorporated in the Bank’s Strategic Priorities for Fiscal 2014–2018, released in late March 2014, which describes the basic principles of the Bank’s business operations and organization. One of its key features is that the Bank expressed that it will engage in Bank-wide efforts to steadily fulfill its mission of expression seems more appropriate not only because it reflects my own outlook, but also because it is a better description of the Bank's baseline scenario. Regarding the latter, the median of the Policy Board members’ forecasts of the inflation rate is 1.9 percent for fiscal 2015 and 2.1 percent for fiscal 2016; so the projected year of achieving “2 percent” is fiscal 2016. Given that the Bank is committed to achieving “2 percent,” it is better to provide a clear focus on the timing when 2 percent will be reached, rather than providing an expression of “around 2 percent.” BIS central bankers’ speeches achieving the price stability target of 2 percent; the document gave priority to strengthening external communication to ensure broad public confidence. This new move reflects my call to place greater emphasis on external communication – stressed ever since I assumed my position as a Policy Board member. Especially in light of achieving the 2 percent target, public understanding is indispensable. Concrete actions specified in the report include the following: (1) making full use of information technology, for example through improvements to the Bank’s web site, and enhancing the in-house tours of its Head Office and branches; (2) strengthening the Bank’s communication with various people, firms, and economic organizations; (3) publishing the findings from its research and analysis in effective ways; and (4) supporting the activities of the Central Council for Financial Services Information and associated committees to promote financial literacy among the public. Related departments of the Bank have already prepared detailed plans to put the new strategic priorities into practice. Accordingly, the Bank will continue to do its best to implement the priority issues expressed in the Strategic Priorities. III. Output gap in Japan A shortage of demand for goods and services relative to supply capacity since the global financial crisis has been a major cause of the sustained mild deflation in Japan. This situation has recently improved as economic recovery has continued. Today, I would like to explain my view on the process of achieving the 2 percent target, with a focus on the “output gap” as a key word for understanding the background of the sustained mild deflation and recent improvement. A. Concepts of the output gap and its performance The output gap is a term that refers to the difference between aggregate demand and supply capacity. Usually, actual GDP is used as a proxy for aggregate demand, and potential GDP as a proxy for supply capacity. The Bank estimates potential GDP as the production level achieved under the current economic structure with an average utilization level of labor and capital stock. Generally, whether a country’s economic condition is in an upturn or a downturn can be judged on the basis of the level of aggregate demand relative to the level of supply capacity. If aggregate demand exceeds supply capacity with an average utilization level of labor and capital stock, excess demand prevails, and the sign of the output gap becomes positive. The converse is true for a negative sign of the output gap, implying a stagnant economic activity level. Meanwhile, a change toward this positive territory implies upward pressure on prices, and a change toward negative territory implies downward pressure on prices. In Japan, the rate of real GDP growth has exceeded that of potential growth since fiscal 2013, thereby contributing to a significant improvement in the output gap. Now, let us take a look at some indicators related to the output gap. Chart 4 exhibits (1) the estimates of the output gap by the Bank and (2) the composite indicator in the Bank’s quarterly Tankan (Short-Term Economic Survey of Enterprises in Japan). The Bank’s estimate reports an improvement from about minus 1 percent in July–September 2013 to nearly 0 percent in October-December 2013, suggesting that the output gap is more or less balanced. 3 Meanwhile, the Tankan composite indicator – the proxy for the output gap based on the extent of labor and capital stock utilized – is built as the weighted average of the diffusion indices (DIs) for the employment conditions and production capacity from the Bank’s Tankan. Positive figures of the composite indicator signify that firms find that their employment and production capacity are on the whole excessive, and negative figures mean a shortage. Chart 4 shows that the indicator turned negative in 2013, pointing to a shortage According to the Cabinet Office, the output gap is estimated to be about minus 1.5 percent for July-September 2013, about minus 1.6 percent for October-December 2013, and about minus 0.3 percent for January-March 2014. BIS central bankers’ speeches in employment and production capacity. It should be noted that the composite indicator gives equal weight to respondent firms. Given that the Tankan respondents are dominated by small firms, which face a shortage in employment and production capacity, the Tankan composite indicator tends to reflect such a shortage more strongly than the Bank’s estimate of the output gap. Taking these factors into account, it is fair to judge the output gap as currently being more or less balanced. B. Interpretation of output gap estimates There is a high degree of uncertainty with respect to estimates of the output gap. Care thus needs to be exercised in its interpretation – as evident in the fact that the output gap estimate by the Cabinet Office is in larger negative territory than that by the Bank for the same period. In this regard, I would like to point out four issues regarding the Bank’s estimation method of the output gap. First, estimation errors arise from different estimation methodologies and different data sources. Although actual GDP data are available from the “National Accounts” compiled by the Cabinet Office, there are no official data on potential GDP, and therefore institutions and researchers have to make their own estimates from various data on, for example, labor and capital stock. One distinctive feature of the Bank’s estimate is that the Bank derives its estimate of the potential growth rate by first determining the output gap and then applying the actual GDP growth data (Chart 5). 4 Conversely, the Cabinet Office first estimates the potential growth rate and then derives the output gap by applying the actual GDP growth data. Both estimates point to an improvement in the output gap from a long-term perspective. Second, different estimates on the rate of potential economic growth may lead to differences in output gap estimates. The Bank estimates Japan’s potential growth rate to be around 0.5 percent, while the Cabinet Office estimates this to be about 0.7 percent. The difference may have suggested a greater improvement in the output gap in the case of the Bank’s estimate.5 Moreover, according to the Bank’s estimate, the decline in Japan’s potential growth appears to have occurred since around the time of the global financial crisis. This may be attributable to the manner that the demographic trend and a decrease of capital stock due to physical disposal and wear are reflected in the estimate. Third, the impact of tightening labor market conditions can also be captured using the Bank’s output gap estimate. The output gap can be divided into labor input gap and capital input gap on the basis of resource utilization – just as with the Tankan composite indicator (Chart 6). If the labor input gap is positive, actual labor input exceeds average labor input, which indicates a labor shortage; if the labor input gap is negative, the converse is true. The labor input gap had already turned positive by October–December 2013. This reflects a continuous decline in average labor input, which was caused by a decrease in the number of employed people and labor hours. This trend has been augmented since 2012 by the retirement of the baby boomer generation reaching 65 years old. The labor shortage was exacerbated further by the rapid economic recovery since 2013 driven by labor–intensive nonmanufacturing. This observation is consistent with the following: (1) the Tankan’s employment conditions DI, which had already shifted to one of shortage; (2) the unemployment rate of 3.6 percent in February 2014, which approached the structural unemployment rate of around 3.5 percent; and (3) the positive growth trends in wages (Charts 7 through 9). The Bank applies the Hodrick-Prescott filter method to smoothen the rate of the total factor productivity (TFP) growth. Thus, there is no one-to-one relationship between the estimated rate of potential growth (Chart 5) and that derived from the output gap and the actual GDP growth data. Although different methodologies and data are used, both the Bank and Cabinet Office adopt the CobbDouglas production function approach and estimate the rate of potential growth by dividing into labor, capital stock, and Solow residual (TFP). BIS central bankers’ speeches Fourth, the Bank’s estimate also reflects a rising shortage in production capacity mainly in nonmanufacturing, as shown in a rapid improvement in its capital input gap. Chart 6 indicates that the capital input gap is presently in the vicinity of zero. The gap was nearly closed by a rise in the capital utilization ratio; this was achieved by economic recovery while business fixed investment has remained sluggish since the global financial crisis. In particular, the construction sector faces a shortage in production equipment and facilities. Moreover, a deficiency is also felt in information and communication services, reflecting growing use of information technology by the services sector, and in the distribution and retail sectors. These movements are consistent with the Tankan’s production capacity DI for nonmanufacturing, which points to a shortage in production capacity (Chart 10). In manufacturing, the capital utilization ratio also improved rapidly when firms faced a frontloaded increase in domestic demand prior to the consumption tax hike (Chart 11). Some firms had to postpone exports in order to prioritize domestic demand. C. Will the balanced output gap lead to immediate economic growth constraints? Now that the output gap is almost balanced in Japan, the next issue is whether this condition will impose a constraint on economic growth by creating a shortage in labor and capital stock across nearly all sectors and firms. I would first like to touch on this issue from the short- and medium-term point of view. Because the balanced output gap simply means that aggregate demand is roughly equal to a long-term average supply capacity, this would not immediately lead to growth constraints. However, if a firm encounters a rapid temporary increase in demand – as was the case with the front-loaded increase in domestic demand prior to the consumption tax hike in April 2014 – it may find difficulty in immediately hiring sufficient numbers of workers through want ads or in quickly reassigning existing production capacity and employees to specific production lines and services. This may adversely affect other firms, for example, in being unable to provide parts and materials or having insufficient delivery cars and drivers. This condition actually occurred among some firms and sectors in Japan until March 2014, but it seems to have improved somewhat since April. The output gap therefore seems to have improved in January–March 2014 and the opposite in April–June. If exports begin to rise at a moderate pace, there will be room for manufacturing to raise production without causing a severe labor shortage, owing to higher labor productivity than nonmanufacturing. The manufacturing industry, which faced declining employment from the early 1990s, managed to expand production by improving labor productivity until the global financial crisis. In addition, business fixed investment in manufacturing has been increasing gradually, and if the rate of increase exceeds that of physical disposal and depreciation costs, this will likely further raise capital stock and supply capacity (Chart 5). Moreover, improvement in skills and proficiency of workers will also contribute to an improvement in labor productivity and accordingly, if a mismatch between supply and demand of labor is reduced, this may open the possibility of lowering the structural unemployment rate. The rate was generally in the range of 2–3 percent in the 1980s; it rose to a peak of above 4 percent in the early 2000s before dropping moderately to the current level of around 3.5 percent (Chart 8). The structural unemployment rate appears to have risen on the backdrop of slow labor supply responses in adjusting to changes in the domestic demand structure driven by the progressive aging of the population and a steady decline in public investment. Over the Bank’s projection period, the potential growth rate is expected to rise from the current level of around 0.5 percent toward around 1 percent. This will occur mainly through an accumulation of capital stock, a moderate increase in the labor force participation ratio for women and the elderly, and further improvement in total factor productivity (TFP). At the same time, an economic growth rate exceeding the potential growth rate will expand the output gap into the positive territory, mainly in fiscal 2014 and fiscal 2015. The greater positive output gap will promote business fixed investment and an extension of working BIS central bankers’ speeches hours by part-time workers, thereby helping to raise further the potential growth rate. It is also expected that greater efforts will be made by the government to update existing institutions and tax systems aimed at promoting full-time employment, settling the issues of children on waiting lists for nursery schools, and promoting economic growth strategies. To summarize, Japan’s potential growth rate has declined in the aftermath of the global financial crisis, partly owing to the sluggish economic growth. Decline in the potential growth rate is commonly observed among other advanced countries. Going forward, Japan’s potential growth rate is expected to gradually rise toward about 1 percent, while the actual economic growth will exceed the potential growth rate. The output gap will be expected to improve from summer 2014 through fiscal 2015, and remain in the positive thereafter. D. Medium- to long-term challenges implied by the output gap I will now touch on the medium- to long-term challenges implied by developments in the output gap. The pace of aging will accelerate in Japan, and the labor shortage will likely intensify despite an increase in the labor force participation ratio for women and the elderly as well as in the number of full-time workers. Given that the elderly tend to increase demand for medical and nursery care, trips, and social expenditure, the economic structure will probably be tilted further to labor-intensive nonmanufacturing. This suggests that laborsaving initiatives will be needed in nonmanufacturing through the active use of information technology and robotics as well as promoting a business-friendly environment that supports competition, efficiency, and corporate governance. At the same time, comprehensive measures to deal with the declining population will become important. IV. Output gap, inflation expectations, and their relations to prices and wages Next, I would like to explain my views regarding two important key words in achieving 2 percent price stability target – the output gap and inflation expectations – and how they relate to price and wage developments. A. Relations between the output gap and prices: the Phillips curve An improvement in the output gap tends to exert upward pressure on prices. Such a positive relationship between the rate of change in prices and the output gap may be expressed using the Phillips curve. Chart 12 exhibits Phillips curves based on the CPI (for all items less fresh food) and on the CPI (for all items less food and energy) as variables for price changes on the vertical axis. Both Phillips curves were drawn based on two observation periods: (1) from 1998 Q1 to 2012 Q3 (from the period with a decline in wages to the period prior to the sharp depreciation of the yen and stock price hike); and (2) from 2012 Q4 to 2014 Q1 (from the period of the sharp depreciation of the yen and stock price hike to the present). The slope of the Phillips curve based on the CPI (for all items less fresh food) appears to have steepened sharply together with a rise in the intercept since October–December 2012. Among these changes related to the curve, the steepening of the slope indicates that prices are more prone to rise than before in response to a similar degree of change in the output gap (I will explain about the intercept later). This occurs when firms find it easier to raise their sales prices or pass their input costs on to their sales prices. The recent movement mainly reflects the sharp rise in imported prices as a result of a rapid and sharp depreciation of the yen, that has accompanied a corresponding rise in the prices of energy and other goods and services (Chart 13). In contrast, in the case of the Phillips curve based on the CPI (for all items less food and energy), a steepening of the slope is not clearly observed. This is attributable to the lesser impact of the yen’s depreciation: it is because this CPI omits food and energy prices that account for about 30 percent of the weight of the CPI (for all items less fresh food). In this sense, further steepening of the slope is expected to occur for the Phillips curve based on BIS central bankers’ speeches the CPI (for all items less food and energy) in order to achieve the 2 percent target. However, it seems that this process will take some time. B. Changes in firms’ deflation-oriented price-setting behavior It is known that the Phillips curve for Japan has flattened since the late 1990s. One contributing factor for this has been the decline in the frequency of price adjustments. Reflecting the sluggish economy, discount price setting by competitors, and the preference for lower prices by clients, firms were discouraged from raising their sales prices in the face of concerns over a possible loss of market share – even though a rise in production cost occurred. Currently, the situation signals the possibility that the price-setting environment of firms may be improving. As economic recovery continues and the inflation rate steadily increases at a moderate pace, the frequency of price adjustments increases, and thereby, the slope of the Phillips curve will likely steepen gradually. In this regard, the sharp increase in imported prices and the consumption tax hike appear to have provided opportunities for firms to raise their sales prices collectively. Some firms have begun to amend their past price-setting behavior. They have managed to continue increasing demand – even with higher sales prices – by offering higher value-added or innovative goods and services. An increase in the number of such firms may promote further steepening of the Phillips curve. However, the increase is likely to be gradual – as evidenced by the presence of divergent behavior among firms, some of which are still setting lower sales prices in stiff competition. This may suggest that it is a challenging task to change the price-setting behavior of firms, as demand has been decreasing amid the declining population, and it will take place gradually through firms’ greater efforts to develop innovative business models and their greater growth expectations. Developments in services prices will play an important role in achieving the 2 percent price stability target. In the past, the frequency of price adjustments was highest among energyrelated products and food, followed by goods; the prices of services were rarely adjusted. With energy-related products, food, and goods, the sales prices need to be adjusted frequently in response to changes in related imported commodities, materials, and input costs. Conversely, the prices of general services – accounting for about 40 percent of the components of the CPI (all items less fresh food) – were barely changed: the year-on-year rate of change was in a narrow range of plus 0.8 percent to minus 0.6 percent throughout the 2000s (Chart 13). Since October–December 2013, however, the prices of general services, such as those in the food services industry, have begun to rise due in part to the effects of the depreciation of the yen. I suggest a key question is whether the rising trend will continue. 6 C. Relationship between prices and wages Naturally, the next question is why services prices have hardly been adjusted. In general, services are labor intensive, and so wages account for a greater weight in the production cost. For this reason, sluggish wage developments seem to have contributed to reducing the need to adjust services prices, although this causal relationship may have occurred in two ways. Over the period since the 2000s, changes in cash earnings have remained at around 0 percent, and there appears to be a positive correlation between changes in cash earnings and changes in the CPI (all items less food and energy) (Chart 14). Nonetheless, such a House rent and imputed rent, which account for about 20 percent of the components of the CPI (all items less fresh food), are also important determinants of the price developments in Japan. These rents may be underestimated in the CPI due to the low frequency of price adjustment and to the absence of the quality adjustment on the age of buildings and earthquake-resistant structure. Imputed rent is included in the CPI and PCE deflator in the United States, while it is excluded from the HICP in the euro area. BIS central bankers’ speeches positive correlation does not necessarily hold if the observation is made on the industrial level (Chart 15). This can be understood more intuitively by taking a look at their development in the “levels” as opposed to year-on-year changes (Chart 16). In manufacturing, for example, the prices of goods (reflected in the CPI) have declined while cash earnings of full-time workers have been more or less unchanged. This suggests that an increase in labor productivity has partly enabled such a price decline. By contrast, in nonmanufacturing, services prices and cash earnings have both remained largely constant over the same period, as labor productivity was low. Meanwhile, the cash earnings of part-time workers have been on a rising trend since the mid-2000s, for both manufacturing and nonmanufacturing. As a result, the differences in hourly cash earnings between full-time workers and part-time workers have somewhat decreased, leading to the current hourly cash earnings of part-time workers to be roughly above 40 percent of those of full-time workers. This may reflect the shortage of part-time workers as a result of a steady shift in employment from full-time workers to part-time workers. This trend is especially seen in nonmanufacturing. Part-time workers, whose wages are relatively low, now account for over 30 percent in nonmanufacturing, whereas in manufacturing they account for less than half. Regarding the overall outlook for Japan’s prices and wages, a positive correlation between them is likely to hold – mainly driven by an increase in both wages and sales prices especially in nonmanufacturing. In general, the responsiveness of sales prices to wage changes is greater for part-time workers than full-time workers in the services industry (Chart 15). This is because the variable component of wages is greater for part-time workers, and so changes in their hourly wages have a more direct impact on services prices. As Japan's economy gradually shifts to nonmanufacturing, wage increases are expected to exert upward pressure on prices. Nevertheless, the pace of wage increases is, on the whole, likely to be faster than that of price increases (excluding the direct effects of the consumption tax hike), as will be discussed later. Let us now look at the Phillips curve with a wage version, which indicates the relationship between the rate of change in cash earnings and in the unemployment rate. Chart 17 presents the Phillips curve using the same observation period as the Phillips curve with inflation version. Steepening of the slope reflects the higher responsiveness of wage changes against the improvement in the unemployment rate. Recent movements of the curve, however, have not yet resulted in an apparent steepening of the slope. Going forward, the steepening of the slope is expected to occur gradually as the economy continues to recover and labor demand increases. D. Inflation expectations, prices, and wages Let me now talk about inflation expectations. The increase in inflation expectations will lead to an increase in current prices and wages if such an increase in inflation expectations is incorporated in the current price setting. A rise in inflation expectations is reflected as an upward shift of the intercept of the Phillips curves in both the CPI and wage versions (Charts 12 and 17). The upward shift of the intercept means that the rate of inflation is prone to rise even with the same level of the output gap in the former case, and that the rate of wage increase is prone to rise even with the same level of unemployment in the latter case. In this regard, the upward shift of the curve is observed in the Phillips curve for the CPI, but it is yet to be seen in that for wages. It is expected that the upward shift will occur further in the Phillips curve for the CPI (all items less food and energy) version, while the shift will begin to occur in the Phillips curve for the wage version. Medium- to long-term inflation expectations are more important indicators than short-term expectations. This is because the former are more stable, while the latter are more prone to current prices, such as prices of energy and daily necessities, and thus tend to be volatile. Thus, let us look at medium- to long-term indicators: the inflation outlook (excluding the direct effects of the consumption tax hikes) over the next five years for households and that over BIS central bankers’ speeches the next three and five years for firms. Chart 3 indicates that households’ inflation expectations have remained at around 2.0-2.5 percent since late 2011. Meanwhile, firms’ inflation expectations recorded 1.7 percent for both the next three and five years, according to a survey conducted in March 2014 as a part of the Tankan (Chart 18). 7 Going forward, inflation expectations are likely to rise to around 2 percent, thereby raising the actual prices and wages. E. Timing of achieving the 2 percent price stability target As noted earlier, I expect that the inflation rate of 2 percent is likely to be reached toward the end of the projection period. Related to this outlook, I will now summarize my views. • First, medium- to long-term inflation expectations appear to have been rising on the whole. However, some indicators have recently leveled off; in particular, households’ long-term inflation expectations have continued to level off since late 2011. These inflation expectations are expected to rise gradually, as moderate inflation becomes settled in society and if the 2 percent price stability target is more widely recognized by the public. • Next, it may take time for households to get accustomed to the environment of continued moderate inflation. Real wages (deflated by the CPI, including the direct impact of the consumption tax hikes) are expected to continue to decline throughout the projection period; pension payrolls are also expected to be restrained vis-à-vis price developments. Under these circumstances, households may continue to regard low prices as an important determinant in their expenditure decisions – as confirmed by the recent households’ survey. The rise in medium- to long-term expectations for growth and income – together with an alleviation of future concerns over fiscal conditions and the social security system – may gradually lead to a situation where mild inflation is more readily acceptable. • Such an attitude among households is likely to affect firms’ price-setting behavior. Until recently, many firms have found it easier to raise their sales prices since the yen’s depreciation and the consumption tax hike provided an opportunity for them to increase the prices of most of their products and services simultaneously and collectively. Nonetheless, price rises are likely to occur only gradually in the near future owing to discount price setting by some firms and preference for low prices by many households. This observation appears to be consistent with the Tankan’s results, which indicate only a moderate increase in firms’ own sales price outlook (Chart 18). • Wage increases stemming from a labor shortage are likely to generate upward pressure on services prices, but they will not necessarily raise sales prices in an equal proportion. For firms, it may take some time for a stable and positive relationship to emerge between increases in wages and increases in sales prices. Let me explain the last point in some detail. There are mainly three approaches that can be considered by firms in the face of permanent wage increases: (1) a response by raising labor productivity without generating upward pressures on sales prices; (2) a response by squeezing profit margins without causing an increase in sales prices; and (3) a response by raising sales prices, which is possible in a situation where demand grows for their goods and Although interpretation of the survey results requires caution since the survey was conducted for the first time, the decomposition by firm size reveals that small firms reported higher inflation expectations than large firms. This could be attributable to the following: (1) small firms tend to be more affected by high material and input costs; and (2) a great number of large firms may feel that only a moderate increase in their sales prices is feasible. BIS central bankers’ speeches services. Case (3) will thus lead to a stable rise in sales prices, whereas the increase in sales prices will be limited in cases (1) and (2). In the transition period toward the new price and wage environment, there will be divergent responses among firms. Some firms will attempt to engage in higher value-added businesses and raise productivity, thereby expanding their market shares. Others may fail to adopt such strategies and have to restructure their businesses, merge with other firms, or close. Thus, the above three cases are likely to coexist for some time. With regard to the overall economic perspective, the rate of wage increases will be roughly equivalent to the sum of (1) the rate of the aggregate price increases and (2) the rate of labor productivity growth. It is expected that the rate of productivity growth will improve toward around 1 percent or somewhat higher over the projection period. Accordingly, the rate of wage increases will exceed the rate of price increases (excluding the temporary effects of the consumption tax hikes) by this magnitude. I consider that the 2 percent inflation is likely to be reached toward the end of the projection period at a moderate pace that does not impose excessive burdens on firms and households. I consider that such a gradual path is likely to lead to a society where the 2 percent inflation is maintained in a stable manner and is desirable for Japan’s economy. This brings me to the end of my speech. Thank you very much indeed 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 BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Remarks by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a Panel Discussion at The Bank of Korea International Conference 2014, Seoul, 3 June 2014.
Kikuo Iwata: Japan’s growth potential and quantitative and qualitative monetary easing Remarks by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a Panel Discussion at The Bank of Korea International Conference 2014, Seoul, 3 June 2014. * * * Accompanying charts can be found at the end of the speech. My name is Kikuo Iwata and I am the Deputy Governor of the Bank of Japan. I would like to thank the Bank of Korea for giving me the opportunity to be part of this panel discussion. Before starting my remarks, let me extend my condolences for those lost in the recent ferry accident and offer my deep sympathies to their families. I would like to take this opportunity to offer you my thoughts on the relationship between the Bank of Japan’s monetary policy and the strengthening of Japan’s growth potential, which is the topic of this panel discussion. I. The Bank of Japan’s monetary policy A. Outline of quantitative and qualitative monetary easing Let me start by briefly explaining the monetary policy framework the Bank of Japan has been pursuing (Chart 1). The Bank has set a price stability target of 2 percent in terms of the year-on-year rate of increase in consumer prices. To achieve this target, the Bank since April 2013 has been pursuing aggressive monetary easing called quantitative and qualitative monetary easing, dubbed QQE. QQE has two major pillars. The first pillar is a commitment to achieve the 2 percent price stability target as swiftly as possible. Specifically, in addition to committing itself to the price stability target, the Bank provided a time frame, pledging that it would achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. The second pillar consists of underpinning the first pillar – the commitment – with specific actions. The main action is to double the monetary base in two years through massive purchases of government bonds, including those with longer remaining maturities. As the wording quantitative and qualitative indicates, QQE is a monetary easing policy that uses both an expansion of the quantity and changes in the quality of assets on the balance sheet of the Bank. B. The transmission mechanism of QQE A key transmission mechanism of QQE is the lowering of expected real interest rates (Chart 2). The clear commitment by the Bank to achieve the inflation target and the large-scale monetary easing to underpin that commitment will raise inflation expectations. In addition, with short-term nominal interest rates almost at 0 percent, the policy will exert downward pressure on expected long-term real interest rates by containing upward pressure on longterm nominal interest rates through the massive purchases of long-term government bonds. As a result of the stimulus provided by the decline in expected real interest rates, the output gap, which is thought to be the cause of deflation, will disappear. In addition, QQE is expected to give rise to a virtuous cycle in which closing the output gap will lead to a rise in observed inflation, which in turn will further increase inflation expectations toward the price stability target. BIS central bankers’ speeches Skeptics argue that achieving the 2 percent price stability target will be difficult without a further depreciation of the yen. However, the point of QQE is to achieve the target through the mechanism just mentioned, that is, through a virtuous cycle of a rise in inflation expectations and an improvement in the output gap. QQE does not rely on an increase in import prices due to depreciation of the yen. A key challenge in Japan is that, with deflation having taken hold since the second half of the 1990s, people’s inflation expectations have declined and deflationary expectations have become entrenched. Against this background, one of the core aims of QQE is to work directly on people’s inflation expectations to dispel deflationary expectations and raise people’s inflation expectations. C. The current state of Japan’s economy One year and two months have passed since the introduction of QQE. So far, QQE has been having the intended effects. Surveys on various economic entities and indicators such as break-even inflation rates observed in the government bond market suggest that Japan’s inflation expectations have been rising on the whole (Chart 3). As for nominal interest rates, yields on Japanese government bonds have been hovering stably at low levels. Against such accommodative financial conditions, Japan’s economy has continued to recover moderately accompanied by a virtuous cycle among production, income, and spending (Chart 4). Regarding prices, for example, the year-on-year rate of change in the consumer price index (CPI) excluding fresh food has moved from negative territory to 1.5 percent as of April, excluding the direct effects of the consumption tax hike (Chart 5). Therefore, Japan’s economy looks to be on course toward achieving the 2 percent price stability target, and we feel that developments under our policy are promising. II. The relationship between monetary policy and the government’s growth strategy So, what is the relationship between the Bank of Japan’s monetary policy and the growth potential of Japan’s economy (Chart 6)? The Japanese government has been pursuing a three-pronged strategy that comprises bold monetary easing, flexible fiscal policy, and a growth strategy that aims to spur private investment. These policies are often referred to as the three arrows of Abenomics. The role of monetary policy in this policy mix, in an immediate sense, boils down to overcoming deflation. However, it is also linked to Japan’s potential growth rate. The relationship between the two can be summarized as follows. The first role of monetary policy in this context, needless to say, is to stimulate aggregate demand through large-scale monetary easing, fill the output gap, and thereby bring Japan’s economy back to its potential growth path; in other words, to break the vicious cycle between deflation and recession by overcoming deflation. During the process of the output gap diminishing as a result of QQE, Japan’s potential growth rate is likely to rise to some extent. The reason is that workers will be able to work more efficiently, and capital investment will increase and technological innovation advance as firms, reflecting the improved business sentiment, become more willing to take risks. However, raising the growth potential further is not the role of the central bank and its monetary policy, but of the government and policy measures it can take, such as deregulation. Therefore, the second role of monetary policy is to prepare, by overcoming deflation, the environment necessary for the government to pursue economic structural reforms through its growth strategy to shift the potential growth path upward. BIS central bankers’ speeches Unless the economy is more or less in good shape, the government cannot promote structural reforms to enhance the efficiency and dynamism of the economy to raise productivity. The reason is that in a deflationary recession there will be strong resistance to the pain that pro-competition policy measures through deregulation might bring. You will have heard of the term creative destruction. When deflation continues, destruction will not be followed by creation. If structural reforms under the growth strategy make progress, these reforms are basically supply-side measures that increase the aggregate supply capacity of Japan’s economy. Such increases in supply capacity could result in generating deflationary pressure unless they are accompanied by corresponding increases in aggregate demand. Therefore, to mitigate any deflationary pressure stemming from structural reforms, support through appropriate monetary easing is indispensable. III. Future challenges While the Japanese government aims at achieving 2 percent growth in real GDP, if the growth strategy stalls and strengthening of the growth potential does not move ahead, achievement of the price stability target could lead to a low real growth rate with mild inflation. Of course, overcoming protracted deflation itself is a great achievement, but in terms of revitalizing Japan’s economy, it will not be enough. The Bank strongly hopes the government will further enhance its growth strategy in order to strengthen Japan’s growth potential. On the other hand, if the potential growth rate rises as a result of structural reforms under the growth strategy, the output gap might temporarily worsen, leading to downward pressure on prices. However, since the Bank, based on the aim of achieving the price stability target of 2 percent, will continue with QQE as long as necessary to ensure price changes remain in line with the target in a stable manner, such downward pressure on prices can be staved off. We at the Bank are optimistic that Japan will be able to achieve higher economic growth with a stable inflation rate of about 2 percent before long, and will continue to pursue our policy of QQE to that end. This concludes my remarks. Thank you for your attention. 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Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Oita, 5 June 2014.
Takehiro Sato: Recent economic and financial developments and monetary policy Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Oita, 5 June 2014. * I. * * Introduction Thank you for giving me this opportunity to exchange views with people representing the political, economic, and financial arena of Oita Prefecture. I would like to take this opportunity to express my sincere gratitude for your cooperation with the activities of the Bank of Japan’s Oita Branch. In today’s speech, I will begin by focusing on economic and financial developments in Japan and abroad, as well as the Bank’s recent monetary policy. I will then touch briefly on the economy of Oita Prefecture. Following my speech, I would like to hear your views on actual conditions in the local economy and on the Bank’s conduct of monetary policy. II. Recent economic and financial developments in Japan and abroad A. Developments in Japan’s economic activity and prices following the consumption tax hike Regarding recent developments in Japan’s economy, although statistics relating to production and sales for April 2014 indicate a reactionary decline in domestic private demand following the consumption tax hike, the economy seems to remain resilient as a trend. It should be noted that (1) some sentiment indicators are weak, although this was expected, and (2) a reactionary decline in demand following the front-loaded increase prior to the tax hike is somewhat hard to gauge due to supply-side constraints. Let me follow up on this latter point. In the automobile industry, for example, it is considered that a production decrease as a whole caused by the decline in demand will come to a halt in the July-September quarter of 2014. Nevertheless, according to anecdotal information, there are some concerns about a possible decline in that quarter and thereafter, because production for the April-June quarter is not expected to be much affected by the decline in demand following the front-loaded increase, as backlog orders from the January-March quarter had piled up due to supply-side constraints. This suggests that we need to remain cautious about this decline in demand, although there are many views that recent developments have generally been as expected. From a somewhat longer-term perspective, I consider the critical point to be the extent to which positive effects on the employment and income situation – such as the recent rise in base pay – will be able to offset negative effects of the decline in real disposable income that is caused by the tax hike. In this regard, the recent employee income situation can be understood as follows. On the one hand, the rate of increase in nominal wages has remained weak at around 0 percent on a year-on-year basis, given that scheduled cash earnings are depressed – reflecting the recent rise in the number of non-regular employees whose working hours are relatively short – despite the increases in non-scheduled cash earnings and special cash earnings. On the other hand, the total number of employees is boosted by the increase in non-regular employees; consequently, nominal employee income – which is calculated by multiplying nominal wages by the number of employees – has been increasing moderately at around 1 percent on a year-on-year basis (Chart 1). Considering that the recent movements toward raising base pay will likely increase scheduled cash earnings from this summer, and that a rise in base pay, should it be realized, will positively affect non-scheduled cash earnings and special cash earnings, it is natural to think that nominal employee income will increase at a somewhat BIS central bankers’ speeches accelerated pace. In my view, with this employment and income situation acting as a tailwind, Japan’s economy will remain resilient against the consumption tax hike. The consumer price index (CPI) figures since the consumption tax hike show that, excluding the effects of the tax hike, the year-on-year rate of increase in the CPI for all items less fresh food, or the core CPI, was generally around the previous month’s level, and this is also a supporting factor for the assessment of the underlying trend that I just mentioned (Chart 2). Prior to the release of the CPI figures, there was a lot of conflicting anecdotal information – such as price hikes exceeding the rise in consumption tax and price cuts through discount sales. It turned out, however, that the rise in consumption tax alone has basically been passed on to consumers. From another perspective, consumer demand can be regarded as having been resilient enough to accept the passing on of the rise in tax. Japan’s economy is expected to return to a moderate recovery trend from the summer, as the subsequent decline in demand following the front-loaded increase wanes. B. Understanding of coexistence of the weaker-than-expected economic growth rate and higher-than-expected prices Japan’s economy has decelerated from a high annual growth rate of around 4 percent in the first half of 2013 to around 1 percent in the second half (Chart 3). This is partly due to sluggish exports despite the yen’s depreciation, but a significant increase in imports should also be noted. Imports surged due to firm domestic demand as well as the front-loaded increase in demand prior to the consumption tax hike, thereby pushing down the headline GDP growth rate. However, focusing on domestic demand excluding net external demand, the economy did not see much of a slowdown given that this demand kept growing at around 3 percent on an annual basis throughout the calendar year. As GDP growth for the second half of 2013 was weaker than expected, this will have a smaller carry-over effect on GDP growth for fiscal 2014. Partly reflecting this technical factor, the median of the Policy Board members’ forecasts for 2014 presented in the April 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report) was revised downward, and there was also a downward revision to forecasts for fiscal 2013. However, the mechanism of economic recovery will be maintained in a situation where exports recover and domestic demand remains resilient as a trend (Chart 4). Regarding the April-June quarter of 2014, the contribution of net external demand to GDP growth is expected to turn positive, reflecting a decline in imports, and this will in turn act as a buffer against a decline in domestic private demand. As I will describe shortly, recovery of overseas economies – especially the U.S. economy, which is getting over the effects of the unusually severe winter weather and has started to return to a recovery trend – is expected to act as a tailwind for Japan’s economy. In the meantime, the core CPI for fiscal 2013, which was revised upward from the median of the Policy Board members’ forecasts in the January 2014 interim assessment of the Outlook Report, registered 0.8 percent on a year-on-year basis. The fundamental reason behind this upward revision to prices despite the downward revision to the GDP growth rate will be explained later. In what follows, I highlight the role of imports in this context. One factor contributing to the rise in the CPI is a rise in energy prices stemming from the yen’s depreciation. However, it is also the case that the year-on-year rate of increase in the CPI for all items less food and energy, or the core-core CPI, for April 2014 excluding the effects of the consumption tax hike registered 0.8 percent, which shows that prices other than those of energy have also been rising. In terms of price hikes for items other than energy and related goods, I am focusing on the price changes in digital appliances (Chart 5).1 Digital appliances refer to the following CPI items: TV sets, mobile audio players, electronic dictionaries, video recorders, personal computers (desktop type), personal computers (note type), PC printers, digital cameras, and video cameras. BIS central bankers’ speeches The CPI for digital appliances has risen by around 30 percentage points, from the range of minus 22–23 percent for February 2012 to the range of 6–7 percent for February 2014 on a year-on-year basis. This had an indispensable effect on the rise in the core-core CPI. As the background to this, it can be pointed out that prices of digital appliances had fallen to the bottom and fierce price competition in the household electrical appliances industry came to an end. It should not be overlooked that the halt in the price decline of digital appliances is attributable to the fact that prices of these products had become more susceptible to the effects of the yen’s depreciation with the increased import penetration ratio. A decline in competitiveness and pricing power in the industry in Japan can be pointed out as a reason behind such susceptibility. However, the CPI for digital appliances became more or less flat on a year-on-year basis in the March-April period of 2014 excluding the effects of the consumption tax hike as the yen’s depreciation paused, and the core-core CPI for the Kuarea of Tokyo in May declined by 0.2 percentage point from the previous month on the same basis. The effects of the halt to the yen’s depreciation trend on future developments in prices should be monitored carefully. C. Overseas economic and financial developments As I just mentioned, Japan’s economy is expected to continue growing at a pace above its potential as a trend due to the ongoing firm domestic demand, while it will be affected by the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike. The probability of this scenario will be enhanced by the moderate increase in exports led by the recovery of overseas economies, particularly advanced economies. In this regard, recent developments in overseas economies will support Japan’s economy through exports; for example, the U.S. economy has been recovering moderately, led by private demand, with the recovery becoming more widespread, and the euro area economy is also recovering moderately (Chart 6). With regard to the U.S. economy, the pace of recovery will accelerate gradually, mainly in private consumption, as the improvement in households’ balance sheets makes progress supported by the ongoing recovery trend of housing prices as a whole, and as the effects of fiscal drag fade. These positive effects will likely continue spreading to firms’ production activity, and thus the recovery trend of business fixed investment is likely to become more evident (Chart 7). Of course, the Federal Reserve’s (Fed’s) policy developments and their subsequent effects on global financial markets should be monitored as downside risks. In this regard, the end in autumn 2014 to the Fed’s asset purchase program has broadly been incorporated into the markets at this point. In addition, the statement by the Federal Open Market Committee (FOMC) has clarified the view that “it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends.” My understanding is that the Fed will communicate carefully with market participants in order to avoid bringing instability to financial markets. Regarding the euro area economy, there are various adjustment pressures associated with the excess debt problems in the public and private sectors. However, the economy is expected to continue recovering moderately supported by ongoing recovery in domestic demand, reflecting improvement in various economic entities’ sentiment (Chart 8). As just described, advanced economies are likely to recover moderately, led by the U.S. economy. Meanwhile, emerging and commodity-exporting economies will likely continue to lack growth momentum for the time being, especially in those economies that are restraining aggregate demand, such as by raising interest rates. Looking at the Chinese economy, domestic demand is likely to continue facing downside pressure amid ongoing progress in structural reforms. However, since the authorities have formulated concrete policy measures to underpin economic activity and external demand is expected to continue picking up, the economy is likely to maintain stable growth in general at around the current pace. BIS central bankers’ speeches From a somewhat longer-term perspective, however, there are concerns about the Chinese economy due to factors such as demographic changes (Chart 9). Labor supply and demand conditions seem to be tight, although the growth rate has fallen from double digits to the range of 7–8 percent. This implies the possibility that China’s potential growth rate is declining considerably. While the authorities have set the growth target at around 7.5 percent, some of them have said that some downward deviation from 7.5 percent is within the target range. It is better to take a conservative view that China’s growth rate is likely to be around 7.5 percent at its highest, despite the government’s measures to underpin economic activity. D. Risks to overseas economies The outlook for overseas economies that I have explained is subject to both upside and downside risks. Geopolitical risks such as the recent situation in Ukraine should be carefully monitored in the short run. In addition, I am personally concerned about the possibility of a disinflationary trend and decline in potential growth rates in Europe and the United States in the medium to long run (Chart 10). The euro area in particular should be carefully monitored as the disinflationary trend might be prolonged, mainly in peripheral countries. Several peripheral countries in particular are expected to continue facing downward pressure on wages in order to retain competitiveness under the appreciation of the euro, and the European Commission and the European Central Bank (ECB) have revised down their inflation forecasts for both this year and the next. Medium- to long-term inflation expectations both in Europe and the United States have been stable at around 2 percent, which is one of the reasons why the policy authorities in the euro area have taken the view that it will not enter stagnant deflation like Japan (Chart 11). However, Japan’s experience suggests the possibility that low inflation continuing for a long time changed people’s inflation expectations in a backward-looking manner, and thus medium- to long-term inflation expectations also lowered adaptively. In fact, as the disinflationary trend continues, short- and medium-term inflation expectations by economic entities and the markets have already started to decline somewhat in the euro area as well. If the stability in medium- to long-term inflation expectations is undermined, various policy actions are expected to be taken. The ECB has already revealed its policy stance that it will not hesitate to make use of unconventional measures to address the risk of prolonged disinflation, and I therefore am keeping a watchful eye on its future conduct of monetary policy. It should also continue to be noted that the financial system is still somewhat fragile in the euro area. In the United States, deflationary concerns have not been observed so far, and instead shortterm inflation expectations in the private sector have been revised upward. However, the inflation rate has recently been lower than the Fed’s forecast, partly reflecting the stable energy prices brought about by the shale revolution. Therefore, I feel it necessary to take into account the risk that the inflation rate will remain lower than the optimal level from a somewhat longer-term perspective. It also should be noted that an argument that raises concerns about secular stagnation of the global economy has attracted somewhat more attention. Lawrence Summers, for example, has argued that there is a possibility that the level of equilibrium real interest rate – or, the natural rate of interest – that is consistent with full employment has declined to the range of minus 2–3 percent in the United States since the late 2000s, as there has not been excess demand in the economy before and after the financial crisis, and because prices have been BIS central bankers’ speeches stable, with the actual GDP rate continuing to be far below the potential one.2 The argument regarding secular stagnation after the crisis seems reasonable, considering the experience in Japan – namely, that it continued to be difficult to boost demand, in part reflecting the financial crisis in the late 1990s and demographic changes since the 2000s. Paul Krugman previously noted that Japan’s equilibrium real interest rate had temporarily declined to around minus 4 percent.3 What is new about the arguments of Summers is that the equilibrium real interest rate has been declining for a long time, not temporarily, on a global scale, against the background of, for example, excess savings in countries with a current account surplus and the decrease in the nominal investment amount arising from declining capital goods prices. Leaving aside the question of whether the equilibrium real interest rate has actually been declining in negative territory for a long time, it seems plausible that growth momentum in the global economy has declined somewhat more than in a typical cyclical pattern, reflecting the prolonged downturn in demand, the deceleration in labor input, and the slowdown in technological innovation. As a background to this, for example, the forecast for global growth by the International Monetary Fund (IMF) has been consistently revised down, and growth rates in emerging economies are far lower than those before the Lehman shock. Assuming that the equilibrium real interest rate has declined due in part to the slowdown in the potential growth rate, and that weak growth in demand has started to become chronic in this situation, it becomes easier to understand the current disinflationary trend in advanced economies and the downward trend in inflation rates in emerging economies. However, we should avoid making a hasty conclusion. It is not easy to grasp the situation of the potential growth rate and the slack in the economy.4 There are various arguments over whether the decline in the inflation rate is solely attributable to a cyclical factor or is rooted in a structural one, as described earlier. It also is often difficult to distinguish a cyclical factor from a structural one. If the potential inflation rate has not declined much, the current disinflationary trend could simply reflect the slack in capital stock and in the labor market, and it is possible that disinflationary pressure will ease as the slack dissipates. As just described, the inflation outlook and its implication for macroeconomic policy could change depending on how to understand the current potential growth rate. Thus, I will continue to carefully monitor this matter. III. The conduct of monetary policy for the immediate future A. Interim review on quantitative and qualitative monetary easing Fourteen months have passed since the Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013. Looking at economic and price developments over this period, as mentioned earlier, economic growth has turned out to be somewhat lower than the Bank’s projection, due to developments in exports and imports, and prices have been higher than projected. Economic and price developments so far have been in line with the Bank’s For details, please view Lawrence Summers’ recorded Polak Annual Research Conference held by (http://www.imf.org/external/np/res/seminars/2013/arc/index.htm). See Paul Krugman, “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity 2, 1998, pp.137–205. There are many earlier studies on uncertainties regarding estimation of potential growth rates and slack in the economy. See, for example, Athanasios Orphanides, “Monetary Policy Rules Based on Real-Time Data,” American Economic Review, 91 (4), 2001, pp. 964–985. For examples of such estimation in Japan and the United States, see, respectively, Takuji Fueki et al., “Measuring Potential Growth in Japan: Some Practical Caveats,” Bank of Japan Review Series, No. 2010-E-1, 2010, and Mitsuhiro Osada et al., “Beikoku no Roudou Shijyou no Surakku nitsuite (The Slack in U.S. Labor Markets),” Bank of Japan Review Series, No. 2014-J-2, 2014 (available in Japanese). BIS central bankers’ speeches remarks at the IMF the in Fourteenth Jacques November projection on the whole. Thus, the Bank summarized in the April 2014 Outlook Report that QQE has been exerting its intended effects. The Bank’s Policy Board has judged it appropriate to steadily pursue QQE under its current guidelines. However, although prices are higher than projected, the transmission mechanism of QQE, such as progress in the so-called portfolio rebalancing and a rise in medium- to long-term inflation expectations, has not yet been observed to the extent the Bank initially intended. Of course, I have no intention of denying that the mechanism is working. In fact, some marginal changes have been observed; for example, financial institutions are gradually taking a more active risk-taking stance. However, the current price hike seems to be affected not only by the yen’s depreciation and the rise in energy prices but also by the fact that the economy – mainly on the employment front – is starting to reach the upper limit of supply capacity sooner than expected, as the economic recovery is led mainly by nonmanufacturing, for which labor productivity is lower than that in manufacturing. In what follows, I explain this matter. B. Mechanism of price hikes In the April 2014 Outlook Report, the mechanism of price hikes is explained as follows: the output gap, which shows the utilization of labor and capital, has been improving mainly on the labor front, reflecting firm domestic demand, which tends to have large stimulative effects on employment, and it appears to have reached around the past long-term average of about zero; in this situation, upward pressure on wages and prices due to the tightening of supply and demand conditions is likely to steadily increase. Actually, the bottleneck caused by the labor shortage can be observed widely, and its effects are reflected in the hourly pay of nonregular employees such as part-time workers. The effects of wage hikes easily penetrate prices, particularly in the services sector – which is relatively labor intensive – and such effects seem to have already appeared in services prices, such as for meals outside the home (Chart 5). Let me note that there are various approaches to estimating the output gap, and estimates are subject to a margin of error. However, in light of the overall macroeconomic information – such as tightness of the current labor conditions and the reduction in excess production capacity shown in the March 2014 Tankan (Short-Term Economic Survey of Enterprises in Japan) – it could be considered that the output gap, regardless of whether it has or has not reached about zero, has already narrowed to a considerable degree. This narrowing seems to be affecting prices to some extent. Nevertheless, it should be noted that this situation seems to reflect not only the demand-side pick-up but also supply-side constraints, and therefore attention needs to be paid to the possibility that the mechanism of economic and price recovery could be different from what the Bank initially aimed for. In other words, it is possible that the potential growth rate of Japan’s economy has declined, especially after the Lehman shock. This is because manufacturers’ stagnant fixed investment in Japan led to a slowdown in accumulation of capital stock, which in turn decreased labor productivity. Tight labor conditions, due to the recovery led mainly by nonmanufacturing, seem to be affected by lower labor productivity in nonmanufacturing compared to manufacturing (Chart 12). It is true that wage increases induced by tight labor conditions are a profit-squeezing factor and thus not preferable for firms. If corporate profits are constrained by labor costs, business fixed investment will be restricted and stock prices will be affected, and consequently wage hikes will not be sustainable. It is desirable to see wage increases that are in line with growth in labor productivity. In this regard, in achieving sustainable wage increases, it is indispensable to have a boost in labor productivity in nonmanufacturing, such as through investment aimed at labor saving. If such efforts toward improvement in labor productivity in nonmanufacturing feed back into manufacturing and a virtuous cycle in the overall economy is generated, the growth potential will be raised, thereby enhancing the probability of achieving the price stability target of 2 percent in the medium to long term. Currently, in my BIS central bankers’ speeches view, people’s perception of labor conditions is tighter than what is suggested by statistics, as labor shortages are being reported widely. It can be considered that Japan’s economy is at a critical point in terms of whether its growth will slow due to supply-side constraints or it steps up to a new stage of growth by leveraging such constraints as a driving force to further improve its labor productivity. C. Importance of flexibility in the conduct of monetary policy When the price stability target was introduced in January 2013, the Bank clearly stipulated that the conduct of monetary policy has to be flexible by examining various risk factors, including those related to financial imbalances, in addition to the assessment of current developments and outlook for economic activity and prices, from the perspective of achieving sustainable growth with price stability. The importance of flexibility in monetary policy is what I have been focusing on to date. Monetary policy requires long and variable time lags before its effects permeate the economy, and thereafter prices. Therefore, to achieve a sustainable growth path in the context of price stability, monetary policy needs to be flexible, taking into account future prospects. In other words, the Bank examines the current conditions and the outlook for economic activity and prices, and also analyzes various risk factors including the accumulation of financial imbalances. In addition, the Bank clearly commits to continuing with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. In my understanding, the timeframe for “maintaining that target in a stable manner” should be assessed on a forecast basis. In this regard, the price stability target is by no means a rigid and superficial framework that simply aims to raise the inflation rate to reach 2 percent temporarily. Rather, it is a flexible and practical framework that accommodates the needs arising from economic developments. As described in the minutes of the Monetary Policy Meeting held on April 30, 2014, my own view on the outlook for prices is somewhat more cautious than the majority view of the Bank’s Policy Board members. However, this does not mean that I am skeptical of QQE’s effects, nor does it mean that I deny the effectiveness of the QQE’s transmission mechanism. My understanding is that the price stability target is not a framework that calls for the inflation rate to reach 2 percent with surgical precision, but rather that it represents a flexible policy framework in which some degree of latitude – both upside and downside – should be accommodated. Based on this understanding, I see some flexibility with regard to the achievement of the 2 percent price stability target. On this point, what the price stability target aims to achieve is not a situation in which only prices will rise. Rather, it aims to achieve an environment in which the improvement of the overall economy results in higher wages and then higher prices in a well-balanced manner. It is necessary to avoid any misunderstanding that the Bank has been solely pursuing a pickup in prices without due attention to the economy. Let me turn to price indicators that are referred to in assessing the achievement of the price stability target. It is sometimes misunderstood that the degree of such achievement is merely assessed by using the core CPI, given that forecasts of the Policy Board members are made in terms of the CPI on this basis. In fact, the price stability target is set based on the CPI for all items, not the core CPI. However, this does not mean that the degree of achievement of the target is assessed only by using the CPI for all items. To evaluate price developments, it is necessary to appropriately understand the underlying trend of price changes by excluding temporary destabilizing factors. In doing so, the indicator that appropriately assesses price developments depends on each country’s economic structure. The Bank puts emphasis on the core CPI that excludes fresh food, which fluctuates largely due to such factors as the weather. This CPI is used for Policy Board BIS central bankers’ speeches members’ forecasts in the Outlook Report. To understand the underlying trend in prices, however, a wide range of indicators should be monitored carefully while fully taking into account characteristics of each indicator. Such indicators include not only the CPI for all items, the core CPI, and the core-core CPI, but also the CPI for all items less imputed rents – which represents a concept similar to the cost of living – as well as those relating to wages. It is important to note that monetary policy is not tied to specific indicators (Chart 13). D. Developments in long-term interest rates Next, I would like to talk about developments in long-term interest rates. Market participants’ price outlook has been lower than the Bank’s baseline scenario to date, and as a matter of fact, long-term interest rates have been stable at low levels partly due to asset purchases by the Bank. Future developments in long-term interest rates depend on market participants’ economic and price outlook, but I am paying close attention to whether the price situation and nominal long-term interest rates will develop in a consistent manner in a situation where the rate of increase in the core CPI excluding the effects of the consumption tax hike has been around 1¼ percent on a year-on-year basis for six consecutive months. Here, let me recap how QQE will work on nominal long-term interest rates through its transmission mechanism. Nominal long-term interest rates combine two elements: one is the average of future short-term rates and the other is premiums (Chart 14). Based on this understanding, the Bank has specified its forward guidance – namely, that it will continue with the QQE, aiming to achieve the price stability target, as long as it is necessary for maintaining that target in a stable manner. This in effect will exert downward pressure on the average of expected future short-term rates. In addition, premiums will be prevented from widening through the Bank’s massive purchases of JGBs with relatively longer maturities. However, under such unconventional policy, nominal interest rates are likely to face upward pressure as the effects of the policy start to appear, preceding the improvement in the economy and prices. Referring to the elements that I have just explained, expected future short-term rates are likely to rise if market participants judge that an exit from current easing policy is at hand. In the case of a rise in nominal long-term interest rates, even when a central bank increases its purchases of government bonds, or otherwise is put under pressure to increase such purchases, in order to suppress the government’s borrowing costs, the premiums might possibly rise if it is judged by market participants that the central bank’s purchases will weaken fiscal discipline. This is because, when the level of long-term interest rates is formulated, it is the market’s judgment that matters rather than a central bank’s intention. These arguments are hypothetical and can be regarded as simply the result of brain storming at this point. However, as the economy heads toward overcoming deflation, the effects will start to spread to long-term interest rates. At that point, the Bank’s monetary policy, including the process through which it will eventually exit from the current easing policy, should not be decided by giving consideration to fiscal sustainability, but instead be decided solely from the standpoint of achieving the 2 percent price stability target. In that sense, I would like to reemphasize that the government’s commitment to medium- to long-term fiscal consolidation plays an important role in ensuring the ultimate success of QQE. IV. Concluding remarks: economic activity in Oita Prefecture Economic activity in Oita Prefecture is somewhat more sluggish than that in Japan as a whole, which has been showing clear recovery. The share of manufacturing in this prefecture is larger than that in the country overall. Electronic parts and devices – which face a decline in orders due to increased competition with foreign manufacturers and to sluggish sales of final products – account for a large share of manufacturing in the prefecture. Accordingly, the industrial production index for this prefecture has been below that for the whole country as a trend, albeit with some fluctuations due to the front-loaded increase in demand prior to the BIS central bankers’ speeches consumption tax hike (Chart 15). Considering that Japan’s current economic recovery is characterized as being led mainly by nonmanufacturing, the large share of manufacturing in the prefecture’s industrial structure might be the reason for the sluggish recovery compared with that of the country as a whole. It also should be noted that positive developments have been spreading. Anecdotal information suggests that, although private consumption – mainly apparel, high-end goods, furniture, and household electrical appliances – has been affected by the reactionary decline in demand following the front-loaded increase prior to the consumption tax hike, the decline is not significant despite a larger-than-expected front-loaded increase in demand. Private consumption is therefore likely to remain resilient in a situation where labor supply and demand conditions continue to improve. Business fixed investment will likely expand significantly in nonmanufacturing, due, for example, to new construction of large distribution sites and to an extensive renovation of a new commercial complex, which will open at Kyushu Railway Company’s Oita Station. Such investment is also scheduled to start increasing in manufacturing owing to positive developments such as the establishment of new production lines for some new products, in addition to a rebound from the decline observed in fiscal 2013. From the medium- to long-term perspective, it is encouraging that the private and public sectors are making joint efforts that make the most of regional characteristics. I would like to give two examples. First, joint efforts have been made in the field of renewable energy. Oita Prefecture is a frontrunner in Japan in this field, being ranked first in terms of the selfsufficiency rate of such energy and taking second place in terms of the supply amount. After the Great East Japan Earthquake, entry into the power generation business using renewable energy sources in the prefecture has become active, due in part to the introduction of the country’s feed-in tariff scheme for renewable energy. In particular, geothermal power generation business is very active in Oita Prefecture, which is rich in hot spring sources and daily inflow of water, both of which rank number one in Japan. Substantial support for this power generation business is available; for example, the prefectural government and the private sector have jointly established a fund to encourage firms to start such business by utilizing the heat of hot springs. Second, joint efforts have also been made in the field of tourism. Oita Prefecture is rich in tourism resources, including some of the most popular hot spring sites in Japan, such as Beppu and Yufuin. With a view to taking advantage of such resources, the prefecture formulated the “Tourism Strategies” in 2012 and is actively doing promotion both in Japan and abroad under the slogan “‘OITA’ The Best Onsen (Hot Spring) Area in Japan.” In addition, there have been events such as the start of operation in October 2013 of the super luxury sleeper cruise train called the Seven Stars in Kyushu, or Nanatsuboshi, and the extension of the Higashi-Kyushu Expressway in fiscal 2014. These will likely promote an increase in the number of visitors. I hope the economic activity in Oita Prefecture will become more active through these various joint efforts of the private and public sectors. 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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 17th World Congress, hosted by the International Economic Association (IEA), Sweimeh, Jordan, 7 June 2014.
Haruhiko Kuroda: The practice and theory of unconventional monetary policy Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 17th World Congress, hosted by the International Economic Association (IEA), Sweimeh, Jordan, 7 June 2014. * * * Introduction It is my great honor to have the opportunity to deliver a speech at the 17th World Congress of the International Economic Association. The topic of this session, “Monetary Policy in A Post-Crisis World,” is currently one of the most critical topics for central banks around the world. Following the global financial crisis triggered by the collapse of Lehman Brothers, the Federal Reserve (Fed) and the Bank of England (BOE) introduced unconventional monetary policy measures such as quantitative easing and forward guidance, which in turn has given rise to a growing body of theoretical research on these measures. The Bank of Japan was the first central bank ever to adopt what is often referred to as unconventional monetary policy. In fact, the Bank started pursuing various unprecedented monetary policies such as a zero interest rate policy and quantitative easing policy ahead of other central banks at the end of the 1990s, that is, prior to the global financial crisis. And although this is not widely known, it was the Bank that first introduced forward guidance. Therefore, in today’s speech, with the title “The Practice and Theory of Unconventional Monetary Policy,” I would like to offer my take on the unconventional monetary policies pursued by the Bank of Japan, including the quantitative and qualitative monetary easing, dubbed QQE, introduced in spring last year, as well as the relationship between actual policies and theory. In concluding, I will touch on remaining challenges in the realm of monetary theory concerning unconventional policy. I. Ongoing moderate deflation and the limits of conventional monetary policy In talking about the circumstances of why the Bank adopted unconventional monetary policy ahead of other central banks, I have to start with developments in Japan’s economy and monetary policy in the 1990s. At the start of the 1990s, Japan experienced the collapse of its bubble economy and, associated with this, the deleveraging of financial institutions against the backdrop of a series of corporate failures and the impairment of financial institutions’ balance sheets. During this adjustment process, a vicious cycle took hold, with worsening economic conditions, increasing nonperforming assets, declining prices, and yen appreciation mutually reinforcing each other. As a result, both economic growth and inflation declined. In 1997, a large-scale financial crisis involving the failure of a number of major Japanese financial institutions erupted, and, in the summer of 1998, the inflation rate fell below 0 percent. In this situation, the Bank consistently lowered its policy rate, which had stood at 6 percent in August 1990, to close to zero at 0.25 percent in September 1998. Hence, deflation and the zero lower bound on nominal interest rates no longer were a theoretical possibility but became a reality. Early theory of unconventional monetary policy Taking the situation in Japan as a cue, Professor Paul Krugman in 1998 constructed a theoretical model of unconventional monetary policy offering a prescription of how to escape a liquidity trap.1 Specifically, he pointed out that Japan’s economy at the time was suffering Paul R. Krugman, “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity, 1998, No.2: 137–205. BIS central bankers’ speeches from a shortage of demand even at zero interest rates. He argued that the only way to overcome deflation was through monetary policy by substantially increasing the money supply and raising inflation expectations, thereby making real interest rates sufficiently negative. It appears that Professor Krugman’s model already incorporated elements of the unconventional monetary policy measures eventually adopted. However, given that in practice it is difficult for the central bank to directly control the money supply and that, moreover, the Bank was not sufficiently sure about the mechanisms through which monetary policy could influence expectations formation, the Bank did not put the theory straight into practice. II. Previous unconventional monetary policies – the Zero Interest Rate Policy (ZIRP), Quantitative Easing (QE), and Comprehensive Monetary Easing (CME) Introduction of the ZIRP Given a situation in which economic activity and inflation did not improve even though the policy rate had been lowered to 0.25 percent, the Bank discussed a series of unconventional monetary policy measures and put them into practice in stages. As a first step, in February 1999, the Bank introduced the zero interest rate policy (ZIRP), which guided the uncollateralized overnight call rate to around 0 percent by providing the market with more funds than necessary for financial institutions to meet their reserve requirements. Moreover, in April 1999, given that there was no room for further rate reductions, the Bank introduced qualitative forward guidance in order to flatten the yield curve by indicating the future expected path of the policy rate, stating that it would continue with the ZIRP until deflationary concern is dispelled. Then, in August 2000, judging that Japan’s economy was showing clear signs of recovery and that the downward pressure on prices stemming from weak demand had markedly receded, the Bank deemed that the economy had reached the stage where deflationary concern had been dispelled and hence lifted the ZIRP. However, toward the end of that year, Japan’s economy experienced a slowdown, mainly because of the effects of the burst of the dot-com bubble in the United States. Introduction of QE In response to this economic situation, the Bank in March 2001 introduced quantitative easing (QE), in which the operating target was the outstanding balance of current accounts at the Bank. At the same time, the Bank introduced the forward guidance that it would continue the policy until the annual rate of change in the consumer price index (CPI, excluding fresh food) registered zero percent or above in a stable manner. The Bank’s QE consisted of two features. The first feature is that it set the outstanding balance of current accounts, that is, reserves, which represent liabilities on the central bank’s balance sheet, as the policy target. The provision of reserves was achieved mainly through the expansion of short-term funds-supplying operations instead of massive purchases of long-term government bonds as currently undertaken by some central banks in the advanced economies. In that sense, the policy could be labeled pure reserve targeting. The increase in reserves appears to have had the effect of dispelling anxiety about the financial system. With the nonperforming loan problem worsening, the deterioration of the financial system from 2001 through 2002, when measured in terms of the number of failed financial institutions and the amount of disposed nonperforming assets, was comparable to that from 1997 through 1998, when Japan experienced the most acute phase of its financial crisis. In this situation, the provision of liquidity under QE by the Bank appears to have alleviated anxiety about the financial system and played an important part in avoiding a significant economic slowdown. Moreover, it appears that the lesson learned then – that the provision of ample liquidity by BIS central bankers’ speeches the central bank at a time of financial crisis can help to restore stability – has played a role in central banks’ response to the recent global financial crisis. The second feature of QE is that forward guidance was linked to the actual year-on-year rate of change in the CPI. Given that the lifting of the ZIRP in the previous year had given rise to the impression that the Bank had a deflationary bias, the Bank, in order to counter this impression, ventured to issue forward guidance with little room for discretion. As a result, the QE policy flattened the yield curve more than the ZIRP had done, and in this regard exerted substantial effects. In pursuing QE, the Bank gradually increased its target for current account balances from initially about 5 trillion yen (about 1 percent of nominal GDP) to about 30 to 35 trillion yen (about 6 to 7 percent of nominal GDP) in January 2004 while consistently taking the economic situation into account. The economy subsequently recovered and the year-on-year rate of change in the CPI turned positive, meeting the condition set out in the forward guidance – that QE would be pursued until the annual rate of change in the CPI (excluding fresh food) registered zero percent or above in a stable manner. In this situation, the Bank ended QE in March 2006 and raised the policy rate to 0.25 percent in July the same year. Japan’s economy continued to recover for some time after the termination of QE, but experienced a severe negative shock stemming from the global financial crisis in 2008 and the year-on-year rate of change in the CPI fell into negative territory again. Central banks’ responses to the global financial crisis and the Bank’s CME During and after the global financial crisis, central banks promptly and flexibly addressed liquidity shortages in financial markets by providing massive liquidity through various measures. In addition, given that the malfunctioning of financial systems exerted significant adverse effects on economic activity, a number of central banks adopted unconventional monetary policy measures as seen in the launch of massive purchases of government bonds by the Fed and the BOE. Against this background, the Bank started Comprehensive Monetary Easing (CME) in October 2010. As the name suggests, the Bank purchased a comprehensive range of assets – not only government bonds but also credit products such as CP and corporate bonds, equity financial products such as Exchange-Traded Funds (ETFs) and Japan Real Estate Investment Trusts (J-REITs) – with the aim of directly lowering part of the yield curve up to three years and at compressing various risk premiums. Furthermore, in February 2012, almost at the same time that the Fed adopted an official inflation goal, the Bank introduced “the price stability goal in the medium to long term” and announced that it would set a goal in terms of the year-on-year rate of change in the CPI of 1 percent for the time being. Although these policies supported the economy by providing accommodative financial conditions, they were unable to change entrenched deflationary expectations among households and firms. Theories on the ZIRP and QE Let us look at developments in monetary policy theory at the time that the Bank was conducting the ZIRP and QE. Specifically, in 2003, Professor Michael Woodford and then IMF economist Gauti Eggertsson further developed Professor Paul Krugman’s theory and formulated a theory for policy measures that would be effective under deflation and the zero lower bound on nominal interest rates.2 They argued that the most important aspect is the management of the expectations of private entities and that, to that end, it is critical for the central bank to make a commitment that future monetary policy will be sufficiently accommodative. In this context, simply increasing the target amount of quantitative easing or Gauti B. Eggertsson and Michael Woodford, “The Zero Bound on Interest Rates and Optimal Monetary Policy,” Brookings Papers on Economic Activity, 2003, No.1: 139–233. BIS central bankers’ speeches diversifying the range of assets to be purchased would not bring about strong effects. They proposed that for the commitment to be effective it needs to be history dependent. To that end, the central bank should adopt a policy targeting a specific price level – price level targeting – and commit itself to continuing with the zero interest rate until the target is achieved. Based on this review of developments in monetary policy theory and looking back at the Bank’s policies in the past, I think two elements may have been lacking in those policies. The first element is a strong commitment to price stability. Forward guidance under the ZIRP was of a qualitative nature, stating that it would be continued until deflationary concern was dispelled. On the other hand, forward guidance under QE was quantitative in that it would be continued until the annual rate of change in the CPI (excluding fresh food) registered zero percent or above in a stable manner. In hindsight, however, the threshold of zero percent was too low. Moreover, the decision to lift QE turned out to be somewhat premature, even though it was the result of in-depth discussions about the economic situation and inflation at the time. In my view, this turn of events is the reason why the Bank has been unable to gain full credibility as a deflation fighter. As for the subsequent “price stability goal in the medium to long term,” the figure set as the goal for the time being was also low at 1 percent. As a result of the weak commitment to price stability, expectation management was not sufficient, and the Bank could not dispel the deflationary sentiment that had taken hold among private entities. The second element lacking in the past policies was extensive downward pressure on the entire yield curve. While the Bank succeeded in flattening the yield curve to some extent through forward guidance and purchases of long-term government bonds with remaining maturities of up to three years, it was not sufficiently successful in exerting downward pressure to lower the entire yield curve, including longer-term yields. Subsequent studies have shown that massive purchases of long-term government bonds by the Fed and the BOE during and after the global financial crisis have been effective and this could be considered as an example of central bank practice preceding theoretical developments. III. Introduction of a new phase of monetary policy – Quantitative and Qualitative Monetary Easing (QQE) Introduction of QQE In April last year, the Bank introduced a policy of quantitative and qualitative monetary easing, dubbed QQE, which incorporates these two elements. To reinforce the commitment to price stability, QQE includes the strong and clear commitment to achieve the price stability target of 2 percent within a time horizon of about two years and directly works on private entities’ inflation expectations. Moreover, to underpin the commitment, the Bank decided to pursue a new phase of bold monetary easing in both quantitative and qualitative terms, in which the Bank will double the monetary base – the money it directly provides – in two years and purchase massive amounts of Japanese government bonds (JGBs), including bonds with longer remaining maturities. QQE differs from past policies in that it seeks to actively influence private entities’ expectation formation. Under QQE, the Bank has been purchasing long-term government bonds with various remaining maturities in order to put downward pressure on the yield curve as a whole. We believe that through this measure we can encourage a further decline in interest rates and thereby further stimulate private demand. More than one year has passed since the introduction of QQE and it has been having the intended effects, leading to an improvement in financial markets, the real economy, prices, and expectations. With the clear commitment to promptly achieve the price stability target and with large-scale monetary easing, people’s inflation expectations have been rising on the BIS central bankers’ speeches whole. On the other hand, the Bank’s massive purchases of JGBs have kept 10-year government bond yields at a low level of about 0.6 percent. As a result, real interest rates have been negative and continue to decline, thereby providing stimulus to the real economy. Japan’s economy has been growing led by domestic demand. The year-on-year rate of change in the CPI excluding fresh food was minus 0.5 percent in March last year, but it has reached to plus 1.5 percent in April this year after eliminating the direct effects of the consumption tax hike. Hence, QQE has put into practice the mechanism common to the theories of Paul Krugman, Michael Woodford, and Gauti Eggertsson, which is to encourage a decline in real interest rates through raising inflation expectations and thereby stimulate the real economy. Concluding remarks – remaining challenges with regard to theory of unconventional monetary policy Let me conclude my speech by adding my own view concerning remaining challenges in the realm of monetary theory concerning unconventional policy. The experience of the global financial crisis has proven in practice that, even if central banks are faced with a large negative shock at the zero lower bound, they can support economic activity and maintain price stability through unconventional monetary policy. However, there remain unresolved issues concerning the effects and transmission mechanisms of unconventional monetary policy. One reason why there remain unresolved issues is that, to date, no central bank has exited from the unconventional policies pursued after the global financial crisis, meaning that there is no practical experience that would allow an assessment of unconventional policy as a whole. Another reason is that although expectations play an important role in unconventional monetary policy, the development of a theoretical underpinning concerning this role of expectations has been lagging. The importance of anchoring inflation expectations has been widely recognized and many central banks consider well-anchored inflation expectations as one measure to gauge the effectiveness of monetary policy. However, as yet there are no established theories on how inflation expectations should be brought back to the target once they have drifted downward. In particular, we do not have established theories that explain how inflation expectations can be raised at the zero lower bound and that suggest feasible policy measures to achieve this. I am looking forward to theoretical developments in the future, and in this regard, the experience with QQE must be useful. A deeper understanding of the effects and transmission mechanisms of “Monetary Policy in A Post-Crisis World,” namely, unconventional monetary policy, is important for both central banks and academia. I wish you every success and productive discussions. Thank you. BIS central bankers’ speeches Appendix: Monetary policy in Japan end of period, tril. yen monthly average, % End-2014 270 tril. yen Monetary base Call rate (overnight, uncollateralized, right scale) 2.5 End-2013 202 tril. yen End-2012 138 tril. yen 3.0 2.0 1.5 1.0 Projected 0.5 CY 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 0.0 Zero Interest Rate Policy (1999/2-2000/8) Quantitative Easing (2001/3-2006/3) Comprehensive Monetary Easing (2010/10-2013/4) Quantitative and Qualitative Monetary Easing (2013/4-) Source: Bank of Japan. BIS central bankers’ speeches
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Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Athens Symposium "Banking Union, Monetary Policy and Economic Growth", Athens, 19 June 2014.
Hiroshi Nakaso: The conquest of Japanese deflation – interim report Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Athens Symposium “Banking Union, Monetary Policy and Economic Growth’’, Athens, 19 June 2014. * * * Introduction It is my great pleasure to be able to take part in these discussions with such distinguished panelist. I hope you will forgive my presumption in borrowing the title of my remarks today from Nobel laureate Thomas Sargent’s influential book, ‘‘The Conquest of American Inflation’’.1 I would like to talk about the most important challenge facing the Bank of Japan at the moment, which is how to conquer deflation in Japan. However, before doing so, let me spend some time considering how we came to be struggling with this mild but persistent deflation. I. Deflationary equilibrium Japan’s CPI began to dip into negative territory in 1998, and remained there on the whole for the next 15 years. This deflation has two distinctive features. One is its long duration, which clearly sets it apart from the usual business cycle frequency. The other is its mildness. For most of the time, deflation has remained at less than minus 1 percent on a year-on-year basis, except for very short spells such as the period just after the Lehman crisis. Given the length of this deflation, some economists naturally argue that this is not a temporary disequilibrium phenomenon, but an indication that the equilibrium itself has shifted so that deflation prevails (Chart 1).2 I am inclined to believe that this is the case, and that the equilibrium shift was triggered by the two huge shocks that hit Japan simultaneously in 1997: the banking turmoil and the Asian currency crises. The combination of two such shocks would be a severe challenge to any monetary authority trying to protect its economy from the threat of serious deflationary pressures. The banking turmoil was a particularly severe blow in that the ability of the credit intermediary function of the banking sector to support economic recovery was seriously impaired, and this in turn exacerbated the deflationary threat. Worse still, there was very little room to cut the interest rate: the policy rate was already as low as ½ percent prior to these shocks hitting Japan. Given the magnitude of these negative shocks, the question arises as to why deflation was so mild in Japan. There may be several determining factors3 but I believe that a decline in potential growth played an important role. Even before we began to struggle with deflation, potential growth in Japan had started to show a secular decline due to both an ageing and a falling trend in population, as well as a slowdown in capital formation. Thus, potential growth is estimated to have dropped to current levels of as low as ½ percent from about 4 percent in the early 1990s (Chart 2). This is not good news in itself, but it does help prevent the negative output gap from widening. Sargent, T. J. (1999): The Conquest of American Inflation, Princeton University Press, Princeton. Benhabib, J., S. Schmitt-Grohe and M. Uribe (2001): ‘‘The Perils of Taylor Rules,’’ Journal of Economic Theory, 2001, 96 (1-2), pp. 40–69; Bullard, J. (2010): ‘‘Seven Faces of ‘The Peril’,’’ Federal Reserve Bank of St. Louis Review, September/October, pp.339–352. Another important hypothesis is that inflation has become less responsive to the output gap. BIS central bankers’ speeches II. Lessons learned What lessons can we learn from this experience? To avoid falling into deflationary equilibrium, especially in the face of huge negative shocks, I think that it is important for the authorities to adhere to the following three principles. First, we definitely need to avoid a financial crisis. In 1997, we lacked a solid safety net such as a deposit insurance system and a bank resolution mechanism that could effectively deal with a systemic disruption. We failed to stop a large-scale banking crisis because these institutional frameworks were not in place. It was only in the wake of this painful experience that we set up a robust system for the prevention and management of financial crises. Second, we need to keep a close eye on external events. In 1997, we underestimated the vulnerabilities of Asian economies and it took some time for us to realize the depth, magnitude and interconnected aspects of the Asian currency crisis. Third, anchoring inflation expectations is critical for monetary authorities. We must not become complacent about seemingly stable long-run inflation expectations. This is because inflation expectations are inherently difficult to measure accurately and are susceptible to downward shifts once low inflation is observed for a certain period of time (i.e. inflation expectations are formulated in an adaptive manner). We should be careful not to confuse the benefits of falling prices with necessary relative price adjustments. We need to maintain our credentials as deflation fighters as much as inflation fighters by showing clear and unequivocal commitment to overcoming deflation; should these credentials be lost, experience suggests that they are extremely difficult to regain. Furthermore, it is crucial that we show a ‘‘whatever-it-takes’’ stance to prevent inflation expectations from falling in the face of negative shocks. This is one of the motivations underlying the Bank of Japan’s quantitative and qualitative monetary easing. Moreover, as we have repeatedly stated, we will not hesitate to make any necessary adjustments to our monetary policy if downward risks to inflation materialize. Some observers have argued that Europe faces a significant risk of deflation, or at least low inflation. In my view, however, as exemplified by recent decisive action, the ECB has already made considerable progress in the three areas I have mentioned. III. Getting out from deflationary equilibrium The story so far has been about prevention, but, today, I also would like to talk about how far we have progressed in breaking free of the deflation trap (Chart 3). Inflation has risen steadily in Japan. Excluding food and energy, the April figure for CPI inflation is 2.3 percent, or around 0.8 percent if we subtract the effects of the hike in the consumption tax rate. Admittedly, this is still only halfway to achieving the target of stable 2 percent, but the situation has changed dramatically from when we started the quantitative and qualitative monetary easing about a year ago. As I have emphasized elsewhere,4 we need to provide a sufficient escape velocity to the economy in order to break free of deflationary equilibrium. To achieve this escape velocity, we need to employ all the policy measures in our arsenal. As for monetary policy, the Bank of Japan introduced its decisive quantitative and qualitative monetary easing measures, which comprise a strong commitment to price stability and the powerful suppression of the entire yield curve. As for fiscal policy, the government simultaneously launched an expansionary policy, partly through a supplementary budget, while taking due account of Nakaso, H. (2014): ‘‘What the Lost Decades Left for the Future,’’ Keynote speech at the 2014 International Conference held by the International Association of Deposit Insurers, Asia-Pacific Regional Committee, April 23, 2014. http://www.boj.or.jp/en/announcements/press/koen_2014/ko140423a.htm BIS central bankers’ speeches long-term fiscal sustainability. In trying to escape from deflationary equilibrium, I believe that the monetary and fiscal policies that used to be conducted independently under an inflationary equilibrium, need to be pursued using a different approach. The joint statement issued by the Bank and the government in January last year may have been playing an important role as a coordination device to enable the collective conduct of monetary and fiscal policies. This joint statement is an important foundation of Abenomics. Close cooperation between monetary and fiscal authorities can be observed not only in Japan, but also in other areas where unconventional monetary policy has been deployed.5 For instance, when the Bank of England introduced its Asset Purchase Facility, a letter from the Chancellor made it clear that the British government would provide an indemnity to cover any losses arising from the Facility. However, this close cooperation does not necessarily imply the loss of central bank independence for the following two reasons. First, a clear mandate of inflation targeting guarantees active monetary policy down the road. The zero lower bound on the nominal interest rate ties the hands of central bankers when it comes to deflation. As for inflation, central bankers can and should adjust policy rates flexibly if inflation is likely to stay above the stated target. Second, governments well understand the importance of fiscal prudence. In the recent G20 communiqué, the respective governments made a firm commitment to maintaining fiscal sustainability. As the second arrow of Abenomics, the Japanese government has already made an important step forward in this respect by raising the consumption tax rate in April this year. Presumably because of this commitment to fiscal sustainability, survey figures for long-run inflation forecasts in advanced economies have not increased to levels much above targeted inflation rates, although these figures are subject to considerable uncertainty, as I mentioned before. These forecasts for Japan have not yet reached even 2 percent, although they do seem to be on a steady rising trend. IV. Importance of raising potential growth Since I have talked about the first and the second arrows of Abenomics, let me touch upon the third arrow before concluding my presentation. As I mentioned, the decline in potential growth in Japan has limited the range of the negative output gap. Together with demand recovery, lower potential growth seems to be contributing to the recent rise in inflation through the tighter capacity constraint. In fact, the latest output gap is estimated to be largely balanced (Chart 4). We often hear anecdotes of capacity constraint, especially those related to labor shortages, partly because the current economic recovery is driven primarily by the non-manufacturing sector, which is inherently more labor intensive and thus absorbs more workforce than otherwise. Under these circumstances, raising potential growth is of vital importance. What we envisage by achieving price stability is the sound development of the national economy.6 In other words, stable inflation should be attained with robust growth, accompanied by healthy job creation and reasonable wage hikes. Low potential growth does not bode well for this scenario, even if, ceteris paribus, it contributes to raising inflation through the capacity constraint. Kohn, D. L. (2009): ‘‘Interactions between Monetary and Fiscal Policy in the Current Situation,’’ Speech at the Conference on Monetary-Fiscal Policy Interactions, Expectations, and Dynamics in the Current Economic Crisis, Princeton University, May 23, 2009. The Bank of Japan Act states ‘‘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.’’ (Article 2) BIS central bankers’ speeches This argues more imminently in favor of supply-side policies such as the third arrow of Abenomics. Ambitious labor market reforms, decisive deregulation and strong governance reforms are all supposed to raise potential growth effectively through increasing both labor and capital inputs, as well as by improving total factor productivity. They are indeed what the Japanese government intends to deliver, and I think it has made steady progress in this respect, including its revised growth strategy that will be announced by the end of this month. In the meantime, the success of our monetary policy in achieving the 2 percent price stability target would help the transition from deflationary equilibrium, where disinvesting and saving used to be considered virtues, to inflation equilibrium, where the revival of animal spirits generates fixed business investment that in turn contributes to elevating potential growth. Concluding remarks Perhaps we are getting a bit too far ahead of ourselves here. For us, the immediate challenge still remains how to deliver stable 2 percent inflation, and discussion of the situation after that may be premature at this stage. After all, there is no point counting our chickens before they are hatched. That is why I put ‘‘interim report’’ in the title of my presentation today, hoping that I can report to you ‘‘mission complete’’ someday, hopefully in the not too distant future. Thank you. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Keizai Doyukai (Japan Association of Corporate Executives) Members' Meeting, Tokyo, 23 June 2014.
Haruhiko Kuroda: Toward the early achievement of the 2 percent price stability target and sustainable growth of Japan’s economy Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Keizai Doyukai (Japan Association of Corporate Executives) Members’ Meeting, Tokyo, 23 June 2014. * * * Accompanying charts can be found at the end of the speech. Introduction It is my great honor to be invited to the Keizai Doyukai (Japan Association of Corporate Executives) Members’ Meeting and have the opportunity to address distinguished business leaders in Japan. In April last year, the Bank of Japan introduced quantitative and qualitative monetary easing (QQE) to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. More than one year has passed since then and QQE has so far been having its intended effects, with Japan’s economy on a path suggesting that the 2 percent price stability target will be achieved as expected. However, we are only half way there. The Bank will therefore continue with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. The topic I would like to talk about today is the Bank’s view concerning the current state of and outlook for economic activity and prices. Based on that, I will then talk somewhat in depth about the mechanisms based on which inflation is expected to increase toward 2 percent. In concluding, I will offer my views on the challenge of strengthening Japan’s medium- to long-term growth potential. I. Current situation of and outlook for economic activity and prices Economic activity Let me start with the economic situation. Domestic demand, including business fixed investment, remains resilient as a trend, although a decline in demand following the consumption tax hike in April this year – mainly in private consumption such as durable goods – can be observed. In this situation, along with the clear improvement in the employment and income situation, the virtuous cycle of economic activity has continued to operate steadily, and Japan’s economy has continued to recover moderately as a trend. Looking ahead, as domestic demand is likely to remain firm and exports are expected to increase moderately, the virtuous cycle among production, income, and spending is likely to be maintained. Therefore, for the next three years or so, Japan’s economy as a trend is likely to continue growing at a pace above its potential, although growth will be affected by fluctuations in demand associated with the two rounds of consumption tax hikes (Chart 1). For the above scenario to materialize, two factors are of key importance. The first is that exports, fuelled by a recovery in overseas economies, start increasing again. The second is that domestic demand, which has been driving Japan’s recovery so far, remains firm. Let me discuss these two factors in more detail. Exports and overseas economies The first key factor is developments in exports. Exports have recently remained more or less flat and have been lacking momentum despite the correction of the excessive appreciation of the yen (Chart 2). These trends in exports are essentially due to cyclical factors, including, for example, the sluggishness in emerging economies such as the ASEAN countries. At the BIS central bankers’ speeches same time, however, structural factors such as the increasing relocation of production overseas by Japanese manufacturers have also played a certain role. In addition, temporary factors have likely put downward pressure on exports. Examples include the fact that firms placed priority on domestic shipments in response to the front-loading of demand prior to the consumption tax hike and the effects of the unusually severe winter weather in the United States. Therefore, looking ahead, exports are likely to start increasing again, albeit moderately, once the effects of these temporary factors diminish and growth in overseas economies, including emerging economies, gradually picks up. Looking at the current situation of and outlook for overseas economies in more detail, overseas economies – in particular advanced economies such as the U.S. and European economies – are recovering, although economic performance remains lackluster in some emerging economies. As for the outlook, overseas economies are likely to continue to recover moderately. The International Monetary Fund (IMF) expects global economic growth, which fell to 3.0 percent in 2013, to accelerate gradually to 3.6 percent in 2014 and 3.9 percent in 2015 (Chart 3). Looking at individual countries or regions, the U.S. economy registered negative GDP growth in the January–March quarter due mainly to the unusually severe winter weather. However, since March, a number of economic indicators have rebounded as the severe winter weather waned, and the U.S. economy has returned to a moderate recovery trend, led mainly by private demand. Given the accommodative financial conditions, the pace of recovery is likely to accelerate gradually as improvements in the employment and income situation become more pronounced. In Europe, the year-on-year rate of change in consumer prices in the euro area, which has been struggling with structural problems such as excessive debt, has been less than 1 percent for more than six months, giving rise to concern over deflation. That being said, with business and household sentiment improving, forces to cyclically elevate economic activity have recently been at work and the economy has been recovering moderately, with GDP in the euro area registering positive growth for four consecutive quarters. The euro area economy is likely to continue recovering, reflecting not only the recovery in domestic demand, but also expected moderate improvements in external demand. As for the Chinese economy, the deceleration in growth observed since the beginning of the year appears to have come to a halt, and the economy is expected to continue growing stably at around the current pace due partly to the economic stimulus measures implemented by the government. Finally, other emerging economies and commodity-exporting economies will likely continue to lack growth momentum for the time being, but from a somewhat longer-term perspective growth is expected to gradually pick up against the background of the recovery in advanced economies. Nevertheless, looking at the outlook for advanced economies, which are expected to be the main driving force in the global economy for the time being, attention should be paid to the pace of recovery in the U.S. economy and the prospects for the European debt problem. In addition, it is necessary to keep an eye on issues such as excess production capacity and excess debt in China, developments in emerging and commodity-exporting countries that face structural problems such as a current account deficit or high inflation, and geopolitical risks emanating from some countries. Thus, there remain various uncertainties regarding the outlook for overseas economies, which all warrant vigilance. Sustainability of domestic demand Let me next talk about the sustainability of domestic demand, especially the current situation of and outlook for business fixed investment and private consumption (Chart 4). As for business fixed investment, while some argue that increases in investment cannot be expected due partly to the increased relocation of production overseas, recent figures show that investment has grown moderately. In the GDP statistics, for example, investment has registered quarter-on-quarter increases for four consecutive quarters. Quarter-on-quarter growth in the January–March quarter of this year, at 7.6 percent, was particularly high reflecting temporary upward momentum due to, for example, renewal demand stemming BIS central bankers’ speeches from the ending of support for some software programs and to the front-loading of demand prior to the strengthening of gas emission regulations. Looking ahead, since corporate profits are likely to continue improving, business fixed investment is projected to follow a moderate upward trend as firms seek to expand capacity on the back of increased capacity utilization and as monetary easing continues to underpin demand for investment. With regard to private consumption, the outlook crucially depends on the effects of the consumption tax hike. To consider these effects, they need be divided into two aspects. The first aspect is the short-term effects of the decline in demand following the front-loading of consumption prior to the tax hike, while the second aspect is the longer-term effects of the decline in real incomes as a result of the tax hike, which will materialize only gradually. Economic indicators released so far indicate a clear decline following the tax hike in purchases of durable goods such as automobiles, demand for which increased substantially prior to the tax hike. However, many firms indicate that the magnitude of the decline in consumption following the tax hike has been broadly in line with expectations and that private consumption continues to remain resilient as a trend. At this stage, it therefore appears that the effect of the decline in consumption due to the front-loading of demand is likely to start waning in the coming few months. As for the adverse effects through the decline in real incomes, the key will be to what extent improvements in the employment and income situation can alleviate these effects. With labor market conditions continuing to improve steadily, employee income is expected to continue rising moderately, and private consumption is likely to remain resilient. How the tax hike affects consumption is something we will continue to examine in the coming months. Prices Let me turn to price developments. The year-on-year rate of change in the consumer price index (CPI, excluding fresh food) was plus 1.3 percent for four consecutive months from December last year to March this year, and, after excluding the direct effects of the consumption tax hike, accelerated somewhat to plus 1.5 percent in April (Chart 5). Breaking down the year-on-year rate of increase shows that price increases have been seen in a wide range of items reflecting that Japan’s economy has continued to recover moderately, while energy-related goods have stopped pushing up the year-on-year rate of increase. With regard to the outlook, the year-on-year rate of change in the CPI after excluding the direct effects of the consumption tax hike is likely to be around 1¼ percent for some time, as upward pressure from import prices – in particular energy prices – will likely wane, while trend inflationary pressure – due mainly to the improvement in the output gap – will increase. Specifically, through the summer, the year-on-year rate of increase in the CPI is expected to slow to around 1 percent. Subsequently, as trend inflationary pressure continues to strengthen, the year-on-year rate of increase in the CPI is expected to follow an upward trend again from the second half of this fiscal year and reach around 2 percent – the price stability target – around the middle of the current projection period from fiscal 2014 through fiscal 2016, that is, in or around fiscal 2015. Thereafter, the rate of increase is likely to edge up, since medium- to long-term inflation expectations will converge to around 2 percent and the output gap is expected to continue expanding in positive territory (Chart 1). Hence, Japan’s economy is likely to achieve an inflation rate of around 2 percent and thereafter shift to a growth path that sustains such inflation in a stable manner. II. Path toward the price stability target of 2 percent The Bank’s outlook for prices I just outlined is fairly bullish compared to the average view of market participants and economists. Therefore, in the following, I would like to explain the mechanisms that, in the Bank’s view, underlie the increase in inflation toward 2 percent in a little more depth. To sum up in advance, we are of the view that upward pressure on prices will further increase in the future for the following two reasons. First, the output gap is likely to BIS central bankers’ speeches improve steadily and, second, medium- to long-term inflation expectations are likely to rise, which in turn will influence actual wage and price setting. Upward pressure on prices from the output gap Let me start with the output gap. A key characteristic of the current economic recovery is that it has been led by domestic demand such as public investment and private consumption. As a result, the nonmanufacturing sector has been playing a central role in the recovery. Since the nonmanufacturing sector is more labor-intensive than the manufacturing sector, this, on the whole, has led to a further tightening in labor market conditions. Those who are here today may be aware of this in your daily business. In terms of economic data, the unemployment rate has been approaching the structural unemployment rate, which is considered to be around 3.5 percent, and the active job openings-to-applicants ratio has risen to 1.08, which is the same level as the peak reached before the global financial crisis (Chart 6). This tightening of labor market conditions has started to influence wages, and, in the regular annual wage negotiation this spring, the number of firms that raised not only bonuses but also base pay has increased substantially. In addition to this increase in the utilization of labor, a growing number of firms, particularly in the nonmanufacturing sector, are experiencing capacity shortages, and the output gap has been narrowing moderately. While the level of the output gap is subject to a considerable margin of error, the gap seems to have narrowed to close to 0 percent, that is, the long-term average (Chart 7). As for the outlook, inflationary pressure from the output gap is likely to strengthen further, given that the economy is expected to continue growing at a pace above its potential. Upward pressure on prices from inflation expectations Let me next outline developments in medium- to long-term inflation expectations. According to various surveys and market indicators, inflation expectations appear to be rising on the whole (Chart 8). Looking at the mechanism behind this rise, it appears that, in the first instance, the Bank’s strong and clear commitment to overcome deflation through QQE, together with bold monetary easing to underpin this commitment, has affected expectations of economic entities, and inflation expectations started to rise. Subsequently, the actual increase in the inflation rate due to the narrowing of the output gap has then led to a further rise in inflation expectations. As mentioned earlier, the year-on-year rate of change in the CPI (excluding fresh food) has been above plus 1 percent. Except for the period of the surge in global commodity prices around 2008, this is the first time in the two decades since 1993 that the CPI has risen by more than 1 percent year-on-year for several months in a row. With firms and households experiencing these price increases, their inflation expectations have changed and have started to influence wage and price setting. As seen in the wage negotiations this spring, the increase in inflation has been taken into account in the wage negotiations between management and labor. In addition, a shift in firms’ price-setting strategies from strategies focusing on low prices to strategies seeking to raise sales prices while increasing value added can be observed. Given that the Bank continues to steadily pursue QQE and that inflation continues to be above 1 percent, medium- to long-term inflation expectations will likely follow an increasing trend, which will further reinforce inflationary pressure. Upward drift of the Phillips curve Although somewhat technical, let me summarize this price rise mechanism by using the concept of the Phillips curve (Chart 9). The Phillips curve depicts the relationship between the output gap and inflation, and illustrates the following mechanism: if economic conditions are favorable and the labor market and the market for goods and services are tight, inflation will rise. In the chart, the vertical axis depicts the inflation rate, while the horizontal axis depicts the output gap. The Phillips curve is assumed to be upward-sloping; that is, if economic conditions improve and we move to the right along the Phillips curve, the inflation rate will increase. Note that the inflation rate here depicts the year-on-year rate of change in BIS central bankers’ speeches the CPI excluding food and energy, both of which are likely to be affected by changes in the exchange rate of the yen. Let us first look back at the situation before the introduction of QQE. The green curve is based on data up to the first half of the 1990s, while the blue curve is based on data since the second half of the 1990s. Comparing these two, you can see that the Phillips curve shifted downward during the prolonged period of deflation. As a result, the relationship between economic activity and prices had become such that even when the output gap is zero – when the economy is in a normal state – inflation is about 0 percent. Under these circumstances, the view that prices will decline or not rise had become firmly entrenched among firms and households. QQE aims at drastically changing this deflationary mindset of firms and households and at raising inflation expectations toward 2 percent. In terms of the Phillips curve, this means that the Bank aims at shifting the Phillips curve upward, slightly above the green curve, so that the relationship between economic activity and prices is such that inflation will be 2 percent when the output gap is zero, that is, when the economy is in a normal state. Developments in the past year In light of this aim, how much progress have we made? Let us next look at changes since the introduction of QQE. The red circles in the chart illustrate developments over the past year and indicate the following. First, with the economy growing at a pace above its potential under QQE, the output gap has improved and we have moved to the right. Along with this, there has been upward pressure on prices. Second, the red circles are located above the blue Phillips curve for the deflation period. This suggests that inflation has been higher than can be explained solely by the improvement in the output gap. There are likely several reasons behind this. One is that the depreciation of the yen may have affected items in the CPI other than food and energy, which, as I mentioned earlier, are already excluded. Another reason is that factors that exerted strong downward pressure on wages and prices during the deflation period, especially in the mid-2000s, such as the increase in non-regular workers and inflows of low-priced imports from emerging economies, are unlikely to put further downward pressure on wages and prices. Yet another reason is that, under QQE, inflation expectations seem to have risen and the Phillips curve has started to drift upward. This is confirmed, as mentioned earlier, by developments in inflation expectations gauged through various surveys and market indicators as well as recent patterns in wage and price setting. It is difficult to clearly disentangle the contributions of these different factors. However, the fact is that we have seen inflation rates that are notably higher than anticipated by many people at the time of the introduction of QQE in April last year. Moreover, the very least we can say is that the relationship between economic activity and prices over the past year has been different from that seen previously. At the Bank, we believe that this is because QQE has been having its intended effects. Prices so far have been developing almost in line with the outlook for prices published by the Bank in April last year, so that in our eyes there has been no unexpected inflation. So far, CPI inflation has increased and reached around 1¼ percent according to the mechanisms we envisaged at the time of the introduction of QQE. With these mechanisms continuing to work, inflation is likely to approach the target of 2 percent. However, the aim of QQE is not to temporarily achieve 2 percent inflation but to maintain it at that level in a stable manner. To that end, it will be necessary for inflation expectations to converge toward 2 percent and to ensure that they stay there, that is, to anchor them. Put simply, we need to achieve a world in which people engage in economic activities based on the assumption that 2 percent inflation is a given. To reach this world, it is BIS central bankers’ speeches necessary to further raise both actual inflation rates and inflation expectations. This is the reason why I said earlier that we are only half way there. The Bank will therefore continue with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. If the outlook changes due to the manifestation of some risk factors, the Bank will make adjustments without hesitation if this is judged necessary for achieving the price stability target. III. Toward strengthening Japan’s medium- to long-term growth potential As I explained, Japan’s economy has been recovering moderately and is on a path suggesting that the 2 percent price stability target will be achieved as expected. Against this backdrop, discussions on labor shortages and supply capacity constraints have increasingly come to the forefront. Although the decline in the potential growth rate was clearly recognized as one of the key challenges facing Japan, this was overshadowed by concerns over excess labor and excess capacity, which were considered to be the most immediate problems, since demand was weak. However, the situation has changed in the past year or so. With the increase in demand thanks to large-scale monetary easing, fiscal spending, and the rejuvenation of private-sector activity, the supply capacity constraints that were lurking below the surface have now become apparent. In this situation, it seems to have become widely recognized that it is important to enhance supply capacity from a medium- to longterm perspective. In my view, with the supply capacity constraints having surfaced, this is a golden opportunity to push ahead with initiatives to address the challenges Japan is facing. Therefore, I would like to offer my view on the issue of Japan’s medium- to long-term growth potential. An economy’s medium- to long-term growth potential, in other words, the potential growth rate, depends on the growth in production factors, that is, capital and labor, as well as improvements in productivity through innovation and the like. Japan’s potential growth rate has been declining as a trend since the 1990s (Chart 10). Looking in more detail at the reasons for the decline in Japan’s potential growth rate, the deceleration in capital accumulation and in productivity growth in the 1990s played a major role. During this period, Japanese firms were weighed down by the need to resolve the so-called three excesses – excess labor, capital stock, and debt – that had piled up during the preceding bubble period and could not sufficiently respond to changes such as increasing globalization and the revolution in information and communication technology. In addition, the adjustment of excesses itself did not progress smoothly and inefficient parts of the economy were preserved. This to some extent led to a slowdown in the metabolism of the economy as a whole and a decline in productivity. In addition, the decline in labor input as a result of demographic trends and the decrease in working hours as the economy matured and shorter working hours became more common have put downward pressure on the potential growth rate. Protracted deflation and the additional shock of the global financial crisis led firms to defer fixed investment, so that growth in the capital stock has been subdued. As a result of these various factors that have successively exerted downward pressure on the economy, Japan’s potential growth rate has been declining since the 1990s and recently seems to have been hovering around 0.5 percent. What should be done to raise medium- to long-term growth potential? In short, it is critical to promote initiatives that address the aforementioned factors affecting the potential growth rate. Namely, it is essential to (1) encourage forward-looking investment by firms and increase the capital stock, (2) enhance labor supply capacity by raising the labor participation of women and the elderly as well as utilizing high-skilled foreigners, and (3) raise productivity through regulatory and institutional reforms. In this regard, the government has formulated a growth strategy, the Japan Revitalization Strategy, to stimulate private investment and has been implementing measures included in the Strategy. Taking into account subsequent BIS central bankers’ speeches discussions, the government is now in the process of revising the Japan Revitalization Strategy. The Bank strongly hopes that the government will push ahead with the steady implementation of its growth strategy. Concluding remarks In concluding, let me briefly touch on the relationship between strengthening the growth potential and monetary policy management. While initiatives to strengthen the growth potential are critical, these are medium- to long-term challenges. Some time is required for such initiatives to bear fruit and growth potential to actually rise. It is of course desirable that the potential growth rate increases steadily. However, even if the potential growth rate does not rise, this would not make it any more difficult for monetary policy to achieve the price stability target. I believe that by steadily pursuing QQE, the Bank can achieve the target of 2 percent based on the aforementioned mechanisms, that is, through improvements in the output gap and a rise in inflation expectations. The Bank’s mission to ensure price stability remains unchanged irrespective of the level of the potential growth rate. The Bank will pursue monetary policy management on its own accord to achieve the price stability target of 2 percent at the earliest possible time. While strengthening the growth potential is mainly the responsibility of the government and its growth strategy as well as private entities and their actions in response to the growth strategy, there may be ways in which the Bank can help. That is, in a deflationary environment, proactive initiatives such as conducting business fixed investment provided little reward in terms of the risks and returns for individual firms, and it was rational for firms to hoard cash and maintain the status quo. Changing the environment from one of deflation to one of 2 percent inflation will change firms’ incentives and can be expected to lead to a more proactive investment stance and greater efforts to raise productivity. Against this background, let me assure you again that the Bank will steadily pursue QQE and achieve the price stability target of 2 percent at the earliest possible time. I would like to conclude my speech by expressing the hope that the Bank’s policy conduct provides an environment that helps your firms to take proactive actions. 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 Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Joint Luncheon of the American Chamber of Commerce in Japan (ACCJ), the European Business Council in Japan (EBC), and the Swiss Chamber of Commerce and Industry in Japan (SCCI), Tokyo, 8 July 2014.
Hiroshi Nakaso: Japan’s economy and monetary policy Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Joint Luncheon of the American Chamber of Commerce in Japan (ACCJ), the European Business Council in Japan (EBC), and the Swiss Chamber of Commerce and Industry in Japan (SCCI), Tokyo, 8 July 2014. * * * Introduction It is my pleasure to have the opportunity to speak at the joint luncheon of the Swiss Chamber of Commerce and Industry in Japan, the American Chamber of Commerce in Japan, and the European Business Council in Japan – one of the events to commemorate the 150th anniversary of diplomatic relations between Switzerland and Japan. Since the 2008 global financial crisis, the economies of the United States and Europe have been sluggish and have yet to see a full-fledged recovery. Against this backdrop, the inflation rate in the euro area has been low and there are concerns that the euro area may face protracted disinflation. Japan suffered from deflation from the latter half of the 1990s, that is, preceding the global financial crisis, but under quantitative and qualitative monetary easing, dubbed QQE and introduced in April last year, Japan appears to have finally embarked on a path toward overcoming deflation. Today, I would like to talk about Japan’s experience under 15 years of deflation while referring to monetary policies in the United States and Europe since the global financial crisis. I. Japan’s deflationary equilibrium Since the latter half of the 1990s, Japan’s economy had been in a state of deflation, in which the year-on-year rate of change in the consumer price index (CPI) was either zero or slightly negative. A distinctive feature of Japan’s deflation is that it was moderate but persistent (Chart 1). The annual average rate of decline in the CPI from fiscal 1998 to fiscal 2012 was a meager minus 0.3 percent, but this decline went on for 15 years. It is difficult to clearly identify the causes of deflation. However, the situation in the latter half of the 1990s, when Japan’s economy fell into deflation, suggests the following. First, following the burst of the asset bubble at the beginning of the 1990s, firms and financial institutions were forced to repair their impaired balance sheets. However, financial institutions’ nonperforming assets continued to build up due mainly to protracted economic stagnation (Chart 2). In 1997, the financial crisis in Japan reached its peak after the successive collapse of major financial institutions. In this situation, the functioning of financial intermediation, which had already been impaired, was substantially damaged further. The erosion of financial intermediation acted as a negative shock to the real economy, so that it took even more time to make headway with balance sheet adjustments. It can be said that the financial system and the economy deteriorated through mutually reinforcing negative shocks. A similar adverse feedback effect, in which the burst of a bubble and ensuing balance-sheet adjustments acted as headwinds to the economy, could also be observed during the recession that followed the global financial crisis. Second, in response to the downturn of the economy following the burst of Japan’s bubble in the early 1990s and the decline in inflation, the Bank of Japan successively lowered the policy interest rate. The policy rate, which had stood at 6 percent in August 1990, was reduced to the then globally unprecedented level of 0.25 percent in September 1998 (Chart 3). As a result, conventional monetary policy tools had been almost exhausted by around 1997–98 when anxiety about the financial system due to the financial crisis reached its peak. As a result of the erosion of banks’ intermediation function, Japan’s economy fell into a BIS central bankers’ speeches situation in which the effects of monetary policy did not sufficiently feed through to the economy. Against the backdrop of these overlapping events, Japan’s economy fell into deflation. From the 2000s onward, the decline in the labor force due to demographic changes became an additional factor exerting downward pressure on the economy. Since deflation persisted, deflationary expectations became entrenched, and economic behavior based on the assumption that prices would not rise or would moderately decline took hold. As a result, the economy tumbled into a vicious cycle of declining prices, declining sales and profits, stagnating or falling wages, sluggish consumption, and further price declines. Such a situation can be called a deflationary equilibrium in that it becomes extremely difficult to escape once the economy becomes trapped in it. The longer deflation continues, the more difficult it becomes to overcome deflation. Therefore, what is critical is not to allow deflation to take hold for too long. This is one of the important lessons we have learned. II. The Bank of Japan’s unconventional monetary policies Prior to QQE As I just mentioned, the Bank of Japan lowered the policy rate to 0.25 percent in September 1998, reaching a situation in which the conventional monetary policy tool of setting the policy interest rate had been almost exhausted. In the jargon, Japan’s economy was facing the “zero lower bound on nominal interest rates.” However, economic activity and prices did not improve. In this situation, the Bank decided to embark on various unconventional monetary policy measures (Chart 4). I believe many of you have heard expressions such as “zero interest rate policy,” “quantitative easing,” “credit easing,” and “forward guidance.” These are names of unconventional monetary policy measures introduced by central banks in the United States and Europe after the global financial crisis. In fact, most of these policy measures were originally implemented in one form or another by the Bank of Japan ahead of other central banks in response to the 15 years of deflation since the latter half of the 1990s. Because of time constraints, I will skip discussing the specifics of the respective policies; but examining the policy responses taken prior to QQE highlights the following two points. First, the past policies have contributed to preventing Japan’s economy from falling into a deflationary spiral of continuing rapid economic deterioration and considerable price declines, by containing systemic disruption of the financial system and underpinning the economy. With financial institutions burdened with massive nonperforming loans, the financial system was under considerable stress. However, large-scale liquidity provision by the Bank had the effect of dispelling financial institutions’ anxiety about liquidity, and, as a result, prevented a severe credit contraction. One of the important lessons we have learned the hard way thus concerns how liquidity provision by central banks through their lender of last resort function can contribute to maintaining the stability of the financial system. I have shared this lesson from Japan’s experience with the central banking community, and it has been incorporated in the responses of the major economies to the 2008 global financial crisis. From immediately after the collapse of Lehman Brothers, central banks in the major economies provided large amounts of liquidity. In addition, they took coordinated action in providing U.S. dollar funds-supplying operations. In my view, the past policies by the Bank of Japan contributed not only to maintaining the stability of the financial systems, but also to underpinning the economy by providing accommodative financial conditions. In fact, Japan’s long-term interest rates remained at a low level in the range of 1–2 percent throughout most of the 2000s. Real GDP grew at an annual average rate of 1.5 percent between 2000 and 2007. In this manner, Japan’s economy avoided falling into a deflationary spiral. Second, however, Japan’s inflation rates continued to slide, despite the various unconventional monetary policies pursued by the Bank. In that sense, the Bank’s past BIS central bankers’ speeches policies were not sufficient to lift Japan’s economy out of deflation. So, what was lacking in those policies? In my view, two elements are worth noting. The first is the lack of a strong enough commitment to price stability. In hindsight, since the commitment in past policies was not sufficiently strong, the Bank was unable to dispel the deflationary expectations that had taken hold. The Bank was yet to introduce an explicit numerical price stability target at the time of quantitative easing (QE) between 2001 and 2006. Instead, it introduced forward guidance under QE, stating that QE would be continued until the annual rate of change in the CPI (excluding fresh food) registered zero percent or above in a stable manner, but the threshold of zero percent was perhaps too low. The second element that had been lacking is policies that have a sufficiently large impact. When an economy falls into a deflationary equilibrium, then – because it is a situation of equilibrium – sufficient escape velocity needs to be provided to the economy to get out of it. To that end, policies need to have a large impact. The Bank implemented policies that consisted of lowering short-term interest rates as close as possible to 0 percent and expanding the size of its balance sheet to close to 30 percent of nominal GDP, which back then was globally unprecedented in terms of scale. Nevertheless, the impact provided by those policies proved insufficient to allow the economy to escape from its deflationary equilibrium. Introduction of QQE Based on this experience, the QQE policy introduced in April last year was designed to overhaul the past policies (Chart 5). QQE has the following two features. One feature is a strong and clear commitment to achieve price stability. Specifically, the Bank has committed itself to achieving the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. This does not mean, however, that the Bank will end QQE in two years. The Bank also committed itself to continuing with QQE as long as it is necessary for maintaining that target in a stable manner. The other feature is large-scale monetary accommodation to underpin the commitment. In introducing QQE, the Bank decided to double the monetary base – the money it directly provides – in two years and, to achieve this, the Bank would purchase massive amounts of Japanese government bonds (JGBs), including bonds with longer remaining maturities. The Bank expects QQE to work via several transmission channels, and of these channels, raising inflation expectations is of particular importance. The salient feature of QQE is that it seeks to actively influence expectation formation. Not only is raising inflation expectations in and of itself critical in overcoming deflation, it also provides room for further monetary easing. At the time of introducing QQE, 10-year interest rates were below 1 percent and there was limited room for further reduction in nominal interest rates in Japan. But it is real interest rates – nominal interest rates minus the expected rate of inflation – that affect decisions with regard to business fixed investment and private consumption. While there was little room for lowering nominal interest rates in Japan, there was sufficient room for raising the expected rate of inflation, since it was quite low compared with the price stability target of 2 percent. Therefore, if the Bank can raise inflation expectations while keeping increases in nominal interest rates smaller than the rise in inflation expectations by putting downward pressure on nominal interest rates through large-scale purchases of government bonds, then real interest rates will decline. This will stimulate the real economy. Monetary policy in Japan, the United States, and Europe Next, let me compare monetary policy in Japan with that in the United States and Europe since the global financial crisis. The first thing to note is that monetary policy in the United States and Europe since the global financial crisis has been quite similar to the monetary policy pursued by the Bank since the 1990s. That is, central banks responded to the crisis by lowering policy rates as long as there was room for that (Chart 3). After reaching the zero lower bound, many central banks adopted policies to expand their balance sheets (Chart 6). BIS central bankers’ speeches However, since the economic and inflation situation in the United States and Europe differs from that in Japan, the challenges for monetary policy naturally differ. Although the economies of the United States, the United Kingdom, and the euro area are on a recovery trend, there does remain considerable slack in these economies, as seen in the still-high unemployment rates (Chart 7). In the jargon, the output gap remains negative. On the other hand, while actual inflation has been declining, medium- to long-term inflation expectations in these economies appear to have remained more or less anchored at about 2 percent (Chart 8). Given this economic and inflation situation, the challenge for monetary policy is how to stimulate the economy and lower the unemployment rate while keeping inflation expectations unchanged. By contrast, in Japan, the unemployment rate has declined to 3.5 percent, which is below the trough prior to the global financial crisis, and there is limited slack in the economy. On the other hand as I have explained, under 15 years of deflation, deflationary expectations became entrenched and medium- to long-term inflation expectations drifted down to a very low level. In such a situation, the policy challenge for us is how to raise inflation expectations. Taking this challenge into account, QQE focuses on directly working on inflation expectations. Meanwhile, Switzerland has been facing a challenge that differs from that in the United States, the United Kingdom, the euro area, and even Japan. Switzerland has seen a decline in inflation as a result of a decline in import prices due to the appreciation of the Swiss Franc. Therefore, the Swiss National Bank (SNB) set a ceiling for the Swiss Franc against the euro, stating that it would enforce the ceiling with unlimited interventions. The fact that the ratio of the SNB’s balance sheet to nominal GDP is higher than that of the Bank of Japan’s reflects the increase in its holdings of foreign currency denominated assets under this policy. III. Achievements under one year of QQE Developments in the past year More than one year has passed since the Bank introduced QQE. During this time, QQE has produced its intended effects, with Japan’s economy on track to achieving the 2 percent price stability target. Under the Bank’s large-scale purchases of government bonds, long-term interest rates have been stable at a low level and have recently been below 0.6 percent (Chart 9). Inflation expectations judged from break-even inflation rates calculated from the yield of inflation-indexed bonds and various surveys have been rising (Chart 10). As a result, real interest rates have declined, thereby stimulating private demand. Against this backdrop, the virtuous cycle among production, income, and expenditure has kept the growth momentum intact and Japan’s economy has continued to recover moderately. Real GDP growth has been positive for six consecutive quarters (Chart 11). On the inflation front, the year-on-year rate of change in the CPI (excluding fresh food), which was minus 0.5 percent when QQE was introduced, as of May this year has risen to plus 1.4 percent excluding the direct effects of the consumption tax hike. Two mechanisms are at work behind this rise in inflation. First, slack in the economy has declined and the output gap has improved. The output gap has narrowed and has recently reached close to 0 percent, that is, the long-term average (Chart 12). This mainly reflects the tight labor market conditions brought about by the fact that domestic demand, which tends to be directed toward more labor intensive activities than external demand and hence is associated with more substantial job creation, has been firm. In this situation, upward pressure on wages and prices has been increasing. Second, medium- to long-term inflation expectations have been rising, and that has started to affect actual wage and price setting. As mentioned at the outset, under deflation, it was rational to refrain from consumption and investment on the assumption that prices would not rise or would moderately decline, and such behavior took hold in Japan. As a result, the BIS central bankers’ speeches practice of incorporating inflation in base pay adjustments in annual wage reviews disappeared for quite a while under deflation. However, wage negotiations this spring saw a return to increases in base pay at many firms. Thus, the rise in inflation has started to be taken into account even in wage negotiations between labor and management. Going forward, trend inflationary pressure is expected to continue through the improvement in the output gap and the rise in inflation expectations. Thus, the year-on-year rate of change in the CPI is likely to reach about 2 percent – the price stability target – in or around fiscal 2015. Having said that, the road to achieving the price stability target is not necessarily going to be a straight one, since inflation is susceptible to various factors in the short term. In this regard, I would like to add that, especially through the summer, the year-on-year increase in the CPI is likely to decelerate temporarily, because the base effects of the depreciation of the yen and the rise in energy prices will likely dissipate, but is then likely to accelerate again thereafter. Criticisms from two viewpoints QQE has been criticized from two different viewpoints. Let me talk about my view on these criticisms. The first criticism is that the year-on-year rate of increase in the CPI is unlikely to reach about 2 percent – the price stability target – in or around fiscal 2015 as forecasted by the Bank. In fact, although many private sector economists have recently revised their inflation forecasts upward, these forecasts continue to be conservative compared to that of the Bank. Since QQE is an unprecedented policy, we understand that there remains skepticism regarding the policy’s effectiveness. However, looking at price developments over the course of the past year, the inflation rate has no doubt been much higher than many had forecasted at the time of the introduction of QQE in April last year. That is, inflation over the past year has been above levels suggested by the relationship between the output gap and inflation data for recent years. This implies that inflation expectations have been edging up. The Bank will therefore continue with QQE, aiming to achieve the price stability target, as long as it is necessary for maintaining that target in a stable manner. Of course, if the outlook changes and if it is judged necessary for achieving the price stability target of 2 percent, the Bank will make adjustments without hesitation. The second criticism focuses on potential difficulties related to exiting from QQE. In particular, there are concerns that, even after achieving the price stability target of 2 percent, the Bank might be obliged to continue its massive purchases of government bonds due to considerations of the fiscal situation. On the issue of exit, let me mention just two points. First, the Bank is pursuing QQE and purchasing government bonds solely to achieve the price stability target of 2 percent. The Bank has no intention to go beyond this objective and monetize government debt. Second, the Bank of Japan is the only central bank which has hands-on experience in exiting from unconventional monetary policy. At the time when the Bank exited from QE, which lasted from 2001 to 2006, I was responsible for market operations as the head of the Financial Markets Department of the Bank. While of course QE and QQE are different, in my view, the Bank already has an extensive range of operational instruments to exit from QQE. That being said, what I would like to emphasize is that the Bank is still in the midst of striving to achieve the price stability target of 2 percent at the earliest possible time, and exit policies should be designed depending on the then prevailing economic and inflation situation. Therefore, it would be premature to discuss the specifics of an exit at this stage. BIS central bankers’ speeches Concluding remarks Urgent need for strengthening growth potential Finally, let me talk about the medium- to long-term challenges facing Japan’s economy. I pointed out that one of the factors behind the rise in the year-on-year rate of change in the CPI is that the output gap has been narrowing and recently has reached around 0 percent, that is, the long-term average. This is mainly due to the increase in demand accompanying the moderate economic recovery. But from a somewhat longer-term perspective, it is also due to a decline in supply capacity in the economy. In fact, Japan’s potential growth rate has been on a downtrend since the 1990s (Chart 13). The potential growth rate is determined by the growth in labor input, capital input, and improvements in productivity through innovation and the like. Let me review the trends in these three sources of growth – labor input, capital input, and productivity – that underlie the downtrend in the potential growth rate. First, labor input has been substantially affected by demographic changes. While demographic changes due to aging can be seen in many advanced economies, such changes have been much more pronounced in Japan than elsewhere (Chart 14). These demographic changes have been one factor putting downward pressure on the potential growth rate through the decline in labor supply. Second, capital accumulation has slowed because Japanese firms were weighed down by the need to resolve the problem of excess capital stock during the process of adjusting their balance sheets following the burst of the bubble. In addition, protracted deflation reduced firms’ investment appetite and resulted in the deferral of business fixed investment. Third, productivity growth has also declined. One reason is that while concentrating on dealing with the aftermath of the bubble, Japanese firms were unable to adapt fully to major changes in the global economy such as advances in information and communication technology and intensified global competition. In addition, in the aforementioned deflationary equilibrium, innovation by firms was stifled and productivity growth thus subdued for a protracted period. Against this backdrop, for Japan’s economy to grow on a sustained basis, it is critical to address all three sources of growth. While it has been recognized for quite some time that strengthening the growth potential is a key challenge facing Japan’s economy, it was not seen as an urgent issue when demand was weak. In that sense, with supply capacity constraints having surfaced, now is a golden opportunity to address Japan’s longstanding challenge of raising the growth potential. Specifically, it is essential to (1) enhance labor supply capacity by raising the labor participation of women and the elderly as well as utilizing high-skilled foreigners, (2) encourage forward-looking investment by firms and increase capital stock, and (3) raise productivity through regulatory and institutional reforms. In this regard, it is critical that private entities and authorities push ahead with initiatives in their respective roles. Innovation occurs through actual business activities, and since it is firms that decide what to invest in, it goes without saying that initiatives by private entities are crucial. In addition, the role of authorities is also important, in that they need to provide an environment that encourages such initiatives. With a view to this, the government has formulated the Japan Revitalization Strategy, which aims to raise the growth potential, and has started implementing measures in the past year. The revised Strategy was announced last month. In my view, the government’s growth strategy, which includes measures to address all three sources of growth, is commendable. I strongly hope that the government will continue to implement the growth strategy unwaveringly. BIS central bankers’ speeches Concluding remarks The conquest of deflation in Japan is now in sight. We intend to achieve the price stability target of 2 percent at the earliest possible time by steadily pursuing QQE. If the economy can escape from its deflationary equilibrium and shift to one in which inflation of about 2 percent is sustained in a stable manner as we envisioned, that will revive the animal spirits of firms and households and promote proactive investment and innovations. This will in turn enhance the medium- to long-term growth potential of Japan’s economy. I believe this will also contribute to the development of the global 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 BIS central bankers’ speeches 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, Akita, 19 June 2014.
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, Akita, 19 June 2014. * * * I. Recent economic and price developments A. Japan’s economy and prices 1. Current state of and outlook for the economy I will begin by explaining the current state of and outlook for Japan’s economy. Since the start of fiscal 2014, a subsequent decline in demand following the front-loaded increase prior to the consumption tax hike has been observed, mainly in private consumption, such as of durable goods, but domestic demand including business fixed investment has remained firm as a trend. Therefore, a virtuous cycle of economic activity has been operating firmly, accompanied by steady improvements in supply and demand conditions in the labor market. In this situation, the economy has continued to recover moderately as a trend. Specifically, overseas economies – mainly advanced economies – are recovering, albeit with a lackluster performance still seen in part of emerging economies. Japan’s exports had been picking up as a trend through early autumn 2013, but since then have been leveling off more or less, partly due to temporary downward pressure, such as firms’ stance of placing priority on domestic shipments in response to the front-loaded increase in demand prior to the consumption tax hike and the unusually severe winter weather in the United States, in addition to the sluggishness in emerging economies. Looking at domestic demand, private consumption and housing investment have remained resilient as a trend with improvement in the employment and income situation, although a subsequent decline in demand following the front-loaded increase has recently been observed. Business fixed investment has increased moderately as corporate profits have improved; for example, on a GDP basis, it increased in the January-March quarter of 2014 for the fourth consecutive quarter, and thus is growing at an accelerated pace. Public investment continues to increase, due in part to the effects of various economic measures, and has more or less leveled off recently at a high level. As for the outlook, Japan’s economic growth rate for the April-June quarter is expected to temporarily decline due to the subsequent decline in demand following the front-loaded increase. However, the virtuous cycle among production, income, and spending is expected to be maintained, as private consumption is expected to remain resilient as a trend, reflecting improvement in the employment and income situation, and as exports and business fixed investment are expected to follow a moderate increasing trend. Therefore, although the economy will be affected by the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike, the recovery will not stall, and the economy is likely to continue growing at a pace above its potential as a trend. In the Bank of Japan’s April 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the median of the Policy Board members’ forecasts for the economic growth rate was 1.1 percent for fiscal 2014, 1.5 percent for fiscal 2015, and 1.3 percent for fiscal 2016. 2. Prices Next, I will talk about price developments. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food turned positive in June 2013, rose to 1.3 percent in December, and has recently been around 1¼ percent. The rate of increase for April 2014 registered 3.2 percent, and on a basis excluding the direct effects of the consumption tax hike, it marked 1.5 percent, which is somewhat higher than the rate for BIS central bankers’ speeches March. Given this, the tax increase appears to have been passed on to prices on the whole, on the back of resilient private consumption. As for the outlook, although the effects of the upward pressure from energy-related goods that are directly affected by foreign exchange rates are likely to subside through this summer, the year-on-year rate of increase in the CPI (all items less fresh food), excluding the direct effects of the consumption tax hike, is likely to be around 1¼ percent for some time. This is due to strengthening of the underlying upward pressure on prices on the back of improvement in the aggregate supply and demand balance, or the output gap. Thereafter, in a situation where the virtuous cycle of economic activity continues to operate, the upward pressure on wages and prices is likely to become stronger with the output gap following an improving trend, and medium- to long-term inflation expectations are also likely to rise. Thus, the rate of increase in the CPI is likely to reach around 2 percent – the price stability target – around the middle of the projection period, which is from fiscal 2014 through fiscal 2016. Specifically, in the Bank’s April 2014 Outlook Report, the median of the Policy Board members’ forecasts for the year-on-year rate of increase in the CPI (all items less fresh food, excluding the direct effects of the consumption tax hikes) was 1.3 percent for fiscal 2014, 1.9 percent for fiscal 2015, and 2.1 percent for fiscal 2016. B. Overseas economies I would now like to give an overview of overseas economies. These are expected to moderately increase their growth rates as advanced economies continue to see firm recovery and its positive effects gradually spread to emerging economies. According to the projections for global economic growth released by the International Monetary Fund (IMF) in April 2014 in its World Economic Outlook, global growth is projected to strengthen to 3.6 percent in 2014 and then to 3.9 percent in 2015, rising at a moderate pace to reach a rate exceeding its long-term average. Looking at respective major countries and regions, in the United States, real GDP for the January-March quarter of 2014 decreased from the previous quarter, mainly due to the effects of the unusually severe winter weather, but has returned to a moderate recovery trend. As for the outlook, the pace of recovery is expected to gradually rise, led mainly by private demand – such as firm private consumption – as accommodative financial conditions are expected to be maintained and fiscal drag is likely to weaken. The euro area economy is recovering moderately, registering positive growth for four consecutive quarters. Although faced with structural problems such as excess debt, it is expected to continue recovering moderately, supported in part by improvement in household and business sentiment. Regarding risks to the economy, close attention needs to be paid to a possible prolonged disinflationary trend and the effects of the situation in Ukraine and Russia. The Chinese economy continues to see stable growth, although it has been growing at a somewhat reduced pace, mainly in real estate-related areas. The Chinese authorities have taken the stance of continuing to pay consideration to economic activity while progressing with structural reforms, and already have taken some policy measures to underpin economic activity. In addition, external demand is expected to continue improving moderately, mainly in advanced economies, and thus the Chinese economy is likely to continue to see stable growth, albeit at a slightly slower pace. Meanwhile, some of the other emerging and commodity-exporting economies remain weak in a situation where they are facing issues regarding, for example, current account balance and inflation rates. These economies will likely continue to lack growth momentum for the time being, but are expected to gradually increase their growth rates due to positive effects of the recovery in advanced economies, on the assumption that global financial markets remain generally stable. C. Major issues surrounding the outlook for economic activity and prices Let me elaborate on several points that I think deserve particular attention in terms of realizing the outlook for economic activity and prices that I mentioned earlier. I will first touch BIS central bankers’ speeches on issues related to domestic demand, followed by those concerning external demand, and then prices. 1. Household spending and the employment and income situation I will first touch on household spending and its supporting pillar – the employment and income situation. Regarding household spending, it is important to examine the effects of the consumption tax hike in April 2014. Private consumption has remained resilient as a trend with improvement in the employment and income situation. The effects of the decline in consumption due to the front-loading of demand are likely to start waning from this summer. Since April, a clear decline following the tax hike has been observed, mainly in purchases of durable goods such as automobiles, demand for which increased substantially prior to the tax hike. So far, however, many firms have indicated that the degree of the decline in consumption following the tax hike has been broadly in line with expectations, and that private consumption continues to remain resilient as a trend. Furthermore, retailers, such as department stores and supermarkets, have indicated that the decline in consumption is gradually shrinking. Also, sales in the food service industry and outlays for travel remain steady. These views have been reflected in the Economy Watchers Survey. In the latest survey, the diffusion index (DI) for future economic conditions for two to three months ahead recovered to surpass 50, the borderline between improvement and deterioration. Of course, it is necessary to continue to carefully examine the upcoming results of this survey. As for the outlook, while the employment and income situation continues to improve, private consumption is likely to stay on an increasing trend, albeit at a moderate pace, partly due to active spending by the elderly – the baby-boomer generation in particular. Housing investment is expected to remain resilient as a trend, supported by improvement in the employment and income situation and accommodative financial conditions. In this way, a sustained improvement in the employment and income situation is the key to keeping private consumption and housing investment resilient. Taking a look at supply and demand conditions in the labor market, the unemployment rate has fallen to 3.6 percent and the active job openings-to-applicants ratio has risen to 1.08. These figures are both at around the most favorable levels marked before the Lehman shock. Furthermore, in the March 2014 Tankan (Short-Term Economic Survey of Enterprises in Japan), the DI for employment conditions (the proportion of firms responding that employment conditions are “excessive” minus the proportion of those responding that they are “insufficient”) for nonmanufacturing showed the largest negative figure since December 1992, and that for manufacturing turned negative, indicating a further tightening of supply and demand conditions in the labor market. An increasing number of firms – mainly in the construction and retail industries, which are increasingly experiencing a shortage of labor – are reviewing working conditions to secure sufficient human resources, leading to more women and the elderly joining the workforce. Although this recent addition to the workforce has mainly represented employees with short working hours, such as part-time workers, this development will likely affect demand through, for example, increased income, and eventually lead to a rise in the medium- to long-term growth potential of Japan’s economy. The tightening of supply and demand conditions in the labor market is starting to influence wages. Hourly cash earnings of overall employees have started to increase moderately, albeit with fluctuations. According to the currently available aggregate results of wage negotiations compiled by the Japanese Trade Union Confederation (Rengo), wage negotiations this spring are expected to result in a rise by firms, including small firms, of around 0.5 percent in base pay, and about 2.1 percent in overall wages. In addition, various surveys show that summer bonuses are likely to increase. As for the outlook, in a situation where Japan’s economy continues to grow at a pace above its potential, firms have shown more willingness to hire new recruits, including regular employees. Under such circumstances, it is likely that the labor supply and demand conditions will further tighten, and the unemployment rate is expected to continue declining to a level more or less close to the structural unemployment rate – a state in which excess labor force has disappeared. In this BIS central bankers’ speeches situation, it is increasingly likely that wages, as well as prices, will be put under upward pressure. 2. Business fixed investment I will now move on to business fixed investment. In order to achieve sustainable growth of the economy, it is important that improvements in corporate profits and increases in demand lead to firms’ active investment. Corporate profits for fiscal 2013 rose significantly. As for fiscal 2014, firms have relatively conservative fixed investment plans at present. However, supported by a moderate increase in exports and developments in the foreign exchange market, in addition to firm domestic demand, corporate profits are expected to continue their improving trend. Under these circumstances, business fixed investment is likely to follow a moderate increasing trend, given its noticeable growth on a GDP basis and the upward trend in machinery orders, which represent a leading indicator of machinery investment. Three factors are supporting the strength in business fixed investment. First is the improvement in investment profitability. The extent of the monetary easing stimulus to encourage investment is likely to strengthen, owing to a rise in the rate of return on capital due to improvement in economic activity, combined with the decline in real interest rates that mainly reflects a rise in inflation expectations. Second is the large potential demand. Business fixed investment, which has increased for four consecutive quarters, has just entered a recovery phase after dipping due to the effects of the Lehman shock and the Great East Japan Earthquake. Therefore, increased economic activity will easily encourage latent demand to materialize, such as for the maintenance and replacement of equipment. The third factor is a likely rise in firms’ medium- to long-term growth expectations, due partly to the positive initiatives to strengthen the competitiveness and growth potential of Japan’s economy, such as the government’s regulatory and institutional reforms and firms’ restructuring efforts. Looking at business fixed investment overseas, the last one to two years have coincided with the periods in which investment decisions that were made after the Lehman shock – when the yen appreciated – proceeded to the actual implementation phase. Thus, the ratio of overseas business fixed investment relative to domestic investment has increased rapidly. In view of recent movements in the foreign exchange market, however, the pace of increase is likely to decelerate somewhat. 3. Exports I would now like to talk about developments in exports. Exports have leveled off more or less, due partly to temporary downside pressure, such as the sluggishness in emerging economies, particularly the ASEAN economies, which are closely linked to Japan’s economy, and the effects of the unusually severe winter weather in the United States. Moreover, the recent weakness in exports is likely to be affected to some degree by structural factors such as an increasing shift by Japanese manufacturers to move production overseas. From a somewhat longer-term perspective, however, the correction in the appreciation of the yen to date is likely to ease downward pressure on exports by putting a brake on the shift to move production overseas. As for the outlook, exports are likely to start increasing, albeit moderately, as overseas economies – mainly advanced economies – recover moderately on the whole. It should be noted that exports might deviate either upward or downward, depending on future developments in overseas economies. Therefore, it is necessary to continue to closely monitor developments, such as in emerging economies, the European debt problem, and the U.S. economy. 4. Prices and inflation expectations I will now move on to developments in prices and inflation expectations. Excluding the direct effects of the consumption tax hike, the year-on-year rate of increase in the CPI (all items less fresh food) for April 2014 climbed to 1.5 percent. This was because, while the positive contribution from prices of energy-related goods that are directly affected by foreign BIS central bankers’ speeches exchange rates has peaked, improvements have become widespread for a broad range of items other than energy-related goods, including those in the services industry, such as accommodation charges, mainly on the back of an improvement in the output gap. On a basis excluding the direct effects of the tax hike, the year-on-year rate of change in the CPI for April, excluding prices of food and energy-related goods such as petroleum products, climbed to 0.8 percent from minus 0.8 percent for March 2013. Improvement has become pronounced, as the number of items for which prices have increased has been exceeding 50 percent of the total. As for firms’ price-setting behavior, interviews with firms and other relevant information have revealed that some firms have been successful in their efforts, such as to raise selling prices while increasing value-added and tapping new potential demand. Against this background, there seems to be a gradual increase in the responsiveness of prices to the output gap and in inflation expectations, including short-term ones. Let me note that the Bank, in the March 2014 Tankan, surveyed the inflation outlook of firms for the first time. Although there were disparities between the views of large firms and small ones, results showed that the outlook for general prices of all firms in all industries for one year ahead registered 1.5 percent on average, while those for three years and five years ahead were both slightly above 1.5 percent, indicating firms’ expectations of a further rise in inflation. Given the current tightening of labor supply and demand conditions, mainly in nonmanufacturing, inflation expectations of firms – as well as households – are susceptible to gaining upward momentum. It should be noted, however, that the actual rate of inflation does affect the medium- to long-term expected rates of inflation. If, through this summer, the upward momentum of the CPI weakens due to a fall-off of the effects of the weak yen and to a slack in supply and demand conditions resulting from the decline in demand following the consumption tax hike, due attention should continue to be paid to how this will affect inflation expectations, even during the process of the economy returning to a moderate recovery path from the summer. As I have explained, the Bank expects the inflation rate to increase gradually in a situation where economic activity will improve in a balanced and sustainable manner, accompanied by improvement in corporate profits and subsequent increases in employment, wages, and business fixed investment. Recently, while domestic demand remains firm, the output gap in Japan appears to have reached the past long-term average of about zero, reflecting factors such as a low birth rate and aging population working in the direction of reducing potential labor supply. In other words, supply-side issues have surfaced. Therefore, reinforcing supply capacity has become an important challenge with respect to raising Japan’s economic growth in the medium to long term and achieving sustainable growth. To this end, it is essential to steadily carry out measures to enhance productivity and thereby raise the growth potential of the economy, such as by providing job opportunities for women and the elderly to secure a sufficient labor force, encouraging firms’ active investment, and also implementing regulatory and institutional reforms. At the same time, it also is essential to continue creating demand to match the increased supply capacity. The government is accelerating implementation of its Japan Revitalization Strategy, which is designed to boost the growth potential, and in view of the discussions made after the introduction of the strategy, it is formulating a new growth strategy. The Bank, for its part, is actively proceeding with measures such as provision of funds to support strengthening of the foundations for economic growth. These endeavors will continue to be made steadily in an effort to address the issues facing Japan’s economy that I have explained, and medium- to long-term growth expectations of firms and households are likely to rise accordingly. BIS central bankers’ speeches II. Conduct of monetary policy A. Quantitative and Qualitative Monetary Easing (QQE) 1. Framework of QQE Next, I would like to turn to the Bank’s monetary policy. In order for Japan’s economy to overcome deflation as early as possible and achieve sustainable growth with price stability, the Bank introduced in January 2013 the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI. Then, in April of the same year, the Bank introduced QQE to achieve the price stability target at the earliest possible time, with a time horizon of about two years. With its steady continuation so far, QQE has been exerting its intended effects. The Bank has announced that it is committed to continuing with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. The specific measures of QQE are as follows. First, with a view to pursuing quantitative monetary easing, the Bank decided to increase the monetary base – which is the total amount of currency it directly supplies to the economy (the sum of banknotes in circulation, coins in circulation, and current account deposits held by financial institutions at the Bank) – at an annual pace of about 60–70 trillion yen, thus doubling it in two years. Second, to achieve this, the Bank has been purchasing Japanese government bonds (JGBs) so that their amount outstanding increases at an annual pace of about 50 trillion yen. In doing so, the Bank has been working on interest rates across the yield curve – including longer-term ones – setting the average remaining maturity of its JGB purchases at about seven years. And third, the Bank has been purchasing exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding increase at an annual pace of about 1 trillion yen and about 30 billion yen, respectively. In conducting QQE, the Bank keeps in mind two key transmission channels: (1) lowering real interest rates, which are obtained by subtracting expected rates of inflation from nominal long-term interest rates; and (2) the portfolio rebalancing effect, which encourages financial institutions and institutional investors to shift their asset portfolio toward lending and investment in risk assets such as stocks. In lowering real interest rates, the Bank first applies strong downward pressure on nominal long-term rates by tightening JGB market conditions through its massive purchases of JGBs. Then, through a clear explanation of its determination to achieve the price stability target at the earliest possible time and the continuation of massive purchases of assets underpinning this determination, it aims to raise inflation expectations by boosting people’s expectations that the economy will become revitalized. Consequently, real interest rates could be lowered if the extent of a pick-up in nominal rates is contained within the extent of a rise in inflation expectations. In other words, a decline in real interest rates would lessen firms’ and households’ interest burden relative to the improved corporate profits and household income, thereby helping to increase firms’ investment and households’ consumption. In order to achieve the price stability target, it is important – with this mechanism functioning effectively – to maintain the virtuous cycle in which prices rise moderately along with a balanced and sustainable improvement in economic activity that is accompanied by increases in corporate profits, employment, and wages. 2. Recent financial environment and the conduct of monetary policy I would now like to turn to the financial environment in Japan. With the steady continuation of QQE, financial conditions are accommodative. The monetary base has been increasing at a pace consistent with the Bank’s policy guideline of increasing it at an annual pace of about 60–70 trillion yen and has been at a high year-on-year growth rate of around 45 percent. Through the end of 2014, the Bank plans to increase the monetary base to a level as high as about 270 trillion yen, which is equivalent to about 60 percent of nominal GDP. BIS central bankers’ speeches In this situation, firms’ funding costs have been hovering at low levels. The average interest rates on new loans and discounts for both the short and long terms have been at historical low levels. In these circumstances, interest payments by firms have been at sufficiently low levels in relation to their profitability. Financial institutions’ lending attitudes as perceived by large as well as small firms, in addition to the financial positions of both sets of firms, have been on an improving trend. The levels of various DIs have been above the average for the period since 2000. Domestic demand for working capital by firms has been rising. There has also been an increase in demand for funds in sectors where there are prospects for growth, such as the medical and nursing business, and demand for funds related to corporate takeover activities. Against this backdrop, the year-on-year rate of increase in the amount outstanding of bank lending has been at around 2.5 percent, and the year-on-year rate of growth in the money stock has been in the range of 3.0–3.5 percent. Looking at financial markets in Japan, interest rates – both long- and short-term – have been at extremely low levels as the Bank continues with massive purchases of JGBs and other measures. Money market rates – including those on term instruments with longer maturities – have been below the 0.1 percent level. Long-term interest rates have been stable even in the face of temporary rises in such rates in the United States and Germany, and have been stable at around 0.6 percent on the whole. Japanese stock prices had risen through end-2013, reflecting the rise in U.S. and European stock prices and further depreciation of the yen. After the turn of the year, however, they declined and thereafter have been more or less unchanged, albeit with fluctuations. In the foreign exchange market, the yen depreciated against the U.S dollar through end-2013, and recently has been more or less level in the range of 101–103 yen. In this financial and economic environment, the Bank assumes that, amid a rise in observed price and wage inflation, people’s inflation expectations will rise further, and the effects of monetary easing brought about by a decline in real interest rates will continue to strengthen. In relation to developments in portfolio rebalancing, although growth in bank lending remains marginal relative to the substantial decrease in financial institutions’ holdings of government securities, bank lending growth is expected to gradually increase with the strengthening of the monetary easing effects, as a rise in business fixed investment has recently become evident. At present, the virtuous cycle continues to operate as the effects of QQE on economic activity are gradually becoming pronounced. Nevertheless, it is important to carefully examine economic developments and the effects of monetary policy, including the pick-up in economic activity after the decline in demand following the front-loaded increase prior to the consumption tax hike. Furthermore, as Japan faces serious fiscal imbalances, even by international standards, establishing a sustainable fiscal structure is a critical prerequisite for achieving sustainable growth of the economy. In this regard, the government has indicated that it aims to halve the primary deficit-to-GDP ratio by fiscal 2015 and achieve a surplus in the primary balance by fiscal 2020. Based on these targets, it is strongly expected that efforts toward fiscal consolidation will continue to proceed steadily. B. Loan support program Next, I will discuss the Bank’s Loan Support Program. To support full use of the accommodative financial conditions by firms and households, the Bank – in addition to implementing aggressive monetary easing measures – has established the Loan Support Program through which it provides long-term funds at a low interest rate to financial institutions. Specifically, the Bank has been providing funds through two measures that constitute the program: the fund-provisioning measure to stimulate bank lending (hereafter the Stimulating Bank Lending Facility) and the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the Growth-Supporting Funding Facility). At the Monetary Policy Meeting held in February 2014, the Bank decided to enhance the two facilities. BIS central bankers’ speeches Let me elaborate on the framework of these facilities. First, the Stimulating Bank Lending Facility aims to prompt financial institutions to take a more active lending stance and stimulate firms’ and households’ demand for credit. With this facility, the Bank provides funds to financial institutions up to an amount that is twice as much as the net increase in their lending at a fixed rate of 0.1 percent per annum for four years. There is no upper limit to the total amount of funds provided by the Bank under this facility. The amount outstanding of fund-provisioning under this facility is expected to reach about 13 trillion yen as of end-June 2014. According to the estimate made in February 2014 when the facility was enhanced, the amount outstanding of fund-provisioning under the facility is projected to be around 30 trillion yen if the growth rate of bank lending and the utilization rate of the facility remains more or less unchanged. I will now move on to the Growth-Supporting Funding Facility, which aims to support the flow of funds to growth sectors. With this facility, the Bank provides funds – at a fixed rate of 0.1 percent per annum for four years for yen-denominated funds – to financial institutions for their lending and investment to areas that are expected to contribute to strengthening Japan’s growth potential, such as medical and nursing care; environment and energy; agriculture, forestry, and fisheries; and tourism. The maximum amount of its fundprovisioning to financial institutions under the main rules and special rules is set as follows: 7 trillion yen under the main rules for financial institutions’ investments and loans amounting to 10 million yen or more; 500 billion yen under the special rules for financial institutions’ equity investments and asset-based lending (ABL), the latter of which uses assets such as accounts receivable and inventories as eligible collateral; 500 billion yen under the special rules for financial institutions’ small-lot investments and loans; and 12 billion U.S. dollars – equivalent to 1.2 trillion yen – under the special rules for a U.S. dollar lending arrangement using the U.S. dollar reserves already held by the Bank. Recently, with the virtuous cycle of economic activity continuing to operate, there has been a growing impetus among firms to make active investment. I expect that firms will increasingly make use of the accommodative financial conditions and thereby boldly seize new business opportunities. The Bank, for its part, will continue to provide firm support that enables them to meet their challenges. BIS central bankers’ speeches
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Shizuoka, 23 July 2014.
Hiroshi Nakaso: Japan’s economy and monetary policy Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Shizuoka, 23 July 2014. * * * Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Shizuoka Prefecture. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the activities of the Bank of Japan’s Shizuoka Branch. In April last year, the Bank of Japan introduced quantitative and qualitative monetary easing (QQE) to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. More than one year has passed since the Bank introduced QQE. Japan’s economy has been on a path suggesting that the 2 percent price stability target will be achieved as expected, although we are only halfway there. Today, before exchanging views with you, I would like to explain economic developments at home and abroad and give you my views on the outlook. I will then talk about the recent situation of and challenges for the financial system. Lastly, I will talk about the economy in this region. I. Current situation of and outlook for economic activity at home and abroad Current situation of and outlook for overseas economies Many of you might be interested in developments in overseas economies, since many manufacturing and exporting firms are clustered in Shizuoka Prefecture. Therefore, let me start by talking about developments in overseas economies. Overseas economies, particularly advanced economies such as the U.S. and European economies, have been recovering, although the economic performance of some emerging economies remains lackluster. As for the outlook, overseas economies are likely to continue their moderate recovery trend. The International Monetary Fund (IMF) expects global economic growth to accelerate moderately to 3.6 percent in 2014 and 3.9 percent in 2015 (Chart 1). Looking at individual countries or regions, the U.S. economy registered negative GDP growth in the January-March quarter due partly to the unusually severe winter weather. However, since spring, a number of economic indicators have rebounded, and the recovery trend in the U.S. economy, led mainly by private demand, has become more pronounced. Looking ahead, given that downward pressure on the economy through fiscal austerity will diminish and accommodative financial conditions will be maintained, the pace of recovery is likely to accelerate gradually. Recently, some have expressed the view that U.S. potential growth seems to have declined somewhat, that is, that the United States is suffering secular stagnation. However, at this stage there is no firm evidence to confirm this view and neither the Federal Reserve (Fed) nor private sector economists have notably revised down their forecasts for medium- to long-term growth rates (Chart 2). Turning to the European economies, the European debt problem has yet to be fully resolved, and the year-on-year rate of change in consumer prices in the euro area has been less than 1 percent for more than six months, giving rise to some concern over deflation. Moreover, a potential risk factor is the situation in Ukraine and Russia, which warrants due attention. That being said, as for the recent economic situation, household and business sentiment has improved due in part to additional monetary easing by the European Central Bank (ECB), with financial markets being stable. In fact, GDP in the euro area has registered positive growth for four consecutive quarters. While the euro area economy is likely to continue recovering moderately, the effects of structural problems such as the excessive debt I just mentioned warrant due attention. The robustness of the financial system in the European BIS central bankers’ speeches Union has been examined through the asset quality review (AQR) and stress tests, and the results are scheduled to be released in October this year. The outcome of these examinations holds the key to the outlook for the European economies. The Chinese economy continues to grow steadily, although the pace of growth has become somewhat slower than in the past. Looking at recent developments, real estate investment has continued to decelerate, and the economy has faced downward pressure as authorities have continued to pursue structural adjustments. That being said, the deceleration in growth appears to have come to a halt due partly not only to the economic stimulus measures implemented by the authorities since spring this year, but also to a pick-up in external demand. Meanwhile, what I am somewhat concerned about is the emerging economies, particularly those in Asia. While one should be careful not to lump emerging economies together, since their economic performance differs substantially across countries and regions, it seems that the NIEs and the ASEAN economies will continue to lack growth momentum for the time being (Chart 3). Because the NIEs and the ASEAN economies account for a large share of Japanese exports and Japanese firms have a large number of production sites in these economies, attention should be paid to the outlook for the Asian emerging economies together with developments in global financial markets. To summarize, it is expected that the Chinese economy will continue growing stably, albeit at a slightly slower pace, and that – from a somewhat longer-term perspective – the recovery in the advanced economies will gradually spread to emerging economies. Current situation of and outlook for Japan’s economy Let me move on to developments in Japan’s economy. While the economy has been affected by the front-loading of and subsequent decline in demand due to the consumption tax hike, it has continued growing at a pace above its potential as a trend. In the household sector, a decline in private consumption following the front-loading of demand prior to the consumption tax hike can be observed. However, the magnitude of the decline has been broadly in line with expectations prior to the consumption tax hike and private consumption has remained resilient, reflecting improvements in the employment and income situation. In this context, the Regional Economic Report released by the Bank on July 7 reported the effects of the consumption tax hike on private consumption across Japan, and all regions, including Shizuoka Prefecture, have maintained their assessment that private consumption as a trend has continued recovering. In the corporate sector, business fixed investment has clearly increased against the backdrop of the improvement in corporate profits. The recently released June Tankan survey (Short-Term Economic Survey of Enterprises in Japan) indicates that developments in business fixed investment plans are favorable, even in the manufacturing sector, which has been lagging. While domestic demand remains firm, exports have recently been sluggish. The sluggishness in exports is essentially due to the slow growth in overseas economies such as the emerging economies, as explained earlier. In addition, temporary factors, such as the effects of the unusually severe winter weather in the United States and the fact that firms prioritized domestic shipments in response to the front-loading of demand prior to the consumption tax hike, put downward pressure on exports until around early spring. However, even taking these factors into account, the pace of recovery in Japan’s exports has been slower than in the past when considering the pace of recovery in overseas economies and the exchange rate of the yen. In this regard, I would like to mention three points. The first point is that, since the global financial crisis triggered by the collapse of Lehman Brothers, global trade patterns have changed, and this may have had a negative effect especially on Japan’s exports. Looking at the decline in trade in advanced economies immediately after the global financial crisis, Japan was one of the countries whose exports declined the most, despite the fact that the fallout of the crisis on Japan’s financial system BIS central bankers’ speeches was relatively minor. It has been pointed out that this is due mainly to the fact that the decline in global demand triggered by the financial crisis was particularly pronounced for high valueadded products such as capital goods and durable consumer goods. As you know, high quality, high value-added products are a strength of Japan’s manufacturing sector. Reflecting this fact, the decline in global final demand hit Japan’s real economy, in particular the manufacturing sector, harder than other countries. This fact may also be a reason for the recent sluggishness of Japan’s exports. During the recent recovery phase, global business fixed investment has been notably slower to recover than in past recoveries, and this has substantially affected Japan’s exports. Recently, however, machinery orders statistics suggests that external demand has been on an increasing trend. If global investment demand starts to follow a recovery trend, this will accordingly have favourable effects on Japan’s exports. The second point is that Japanese firms’ global competitiveness has eroded, although there are different views on this point, since the concept of global competitiveness itself is the subject of considerable debate. Looking at exports from Japan by item, exports of IT-related goods as well as capital goods and parts, in which Japanese firms have traditionally had a competitive advantage, have been sluggish. While competition in markets for these goods has intensified due mainly to the rise of emerging economies, there still remain many areas, particularly in high value-added products, where Japanese firms retain global competitiveness. In fact, quite recently, exports of IT-related goods, particularly parts for high value-added products, seem to have been showing signs of a pick-up, which is a welcome development. The third point is the effect of the relocation of production overseas, particularly in the manufacturing sector. It is clear that during the period when the Japanese yen was overvalued, firms relocated production overseas and that this has resulted in structural change. However, given the time lag between the decision to relocate production and the actual subsequent shift of production, it seems likely that the correction of the overvaluation of the yen will restrain the pace of the relocation of production overseas going forward. Bearing these three points in mind, with global financial markets remaining stable and the recovery of overseas economies, including business fixed investment, gaining strength, it seems likely that the factors hampering Japan’s exports will gradually disappear. Therefore, real exports are expected to increase moderately. Of course, since exports as a whole have yet to pick up, continued attention without undue optimism is warranted. Based on the recent economic situations just outlined, the Bank at the Monetary Policy Meeting held this month conducted an interim assessment of the outlook for economic activity and prices through fiscal 2016 included in the Outlook for Economic Activity and Prices (Outlook Report) released in April this year. The assessment concluded that the outlook remained essentially unchanged from that in April. Namely, a virtuous cycle among production, income, and spending has been in place, and Japan’s economy as a trend is likely to continue growing at a pace above the growth potential. The year-on-year rate of increase in the consumer price index (CPI) after excluding the direct effects of the consumption tax hike is likely to be around 1¼ percent for some time, and reach around 2 percent in or around fiscal 2015 (Chart 4). Developments in prices and the Bank’s monetary policy Let me next talk about developments in prices. The year-on-year rate of increase in the CPI (excluding fresh food) in April and May this year, after excluding the direct effects of the consumption tax hike, registered plus 1.5 percent and 1.4 percent, respectively. Inflation remains on a moderate upward trend even after the consumption tax hike. Recently, there has been considerable focus on the monthly figures for the CPI. However, in terms of achieving the price stability target, more important than the monthly figures is whether the mechanism underlying the upward trend in inflation remains in place. The trend in inflation is determined by two factors, namely, the output gap of the economy and inflation expectations. BIS central bankers’ speeches With regard to the first factor, the unemployment rate and the active job openings-toapplicants ratio have recovered to the levels prior to the global financial crisis, and the capacity utilization rate has been increasing. The output gap seems to have recently exceeded 0 percent, that is, the long-term average (Chart 5). As for the outlook, with the economy expected to continue growing at a pace above its potential, the improvement in the output gap is likely to exert upward pressure on trend inflation. The second factor, inflation expectations, with which you may not be familiar, refers to the extent to which people expect prices to rise in the future. In Japan, with deflation continuing for nearly 15 years, the expectation that prices will not rise had taken hold. Breaking out of the status quo and achieving the price stability target of 2 percent in a stable manner means that firms’ and households’ behavior is based on the expectation of continued inflation of around 2 percent. In this regard, there have been signs of changes in corporate behavior, such as the fact that an increasing number of firms have raised base pay in the annual wage negotiations this spring, and that some firms have changed their price-setting strategy from putting priority on low prices to putting priority on quality and reflecting increases in costs in sales prices. In fact, according to surveys of households, firms, and economists, as well as market indicators, inflation expectations appear to be rising on the whole (Chart 6). The QQE policy introduced in April last year aims to raise trend inflation by bringing about an improvement in the output gap and encouraging a rise in inflation expectations with largescale asset purchases and a clear commitment. The policy has been having its intended effects. Under the Bank’s large-scale purchases of government bonds, long-term interest rates have been stable. At the same time, inflation expectations have been rising on the whole, so that real interest rates – that is, nominal long-term interest rates minus the expected rate of inflation – have declined, thereby stimulating private demand. As a result, the output gap has improved and inflation has accelerated. Looking ahead, with this mechanism at work, the year-on-year rate of increase in the CPI and inflation expectations are expected to increase. As I mentioned before, Japan’s economy is likely to achieve an inflation rate of about 2 percent in or around fiscal 2015, and thereafter gradually shift to a growth path that sustains such inflation in a stable manner. Therefore, the conquest of deflation in Japan is now in sight. We are, however, only halfway toward achieving the price stability target of 2 percent. The Bank will therefore continue with QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. But, as I have consistently said, if the outlook changes due to the manifestation of some risk factors, the Bank will make adjustments without hesitation if it is judged necessary for achieving the price stability target. II. Current situation in and challenges facing the financial system Let me next turn to the financial system. For Japan’s economy to achieve sustained growth, it is critical to enhance the functioning of financial intermediation, through which the financial system supports the economic activities of firms and households, while also maintaining the stability of the financial system. In what follows, let me explain the current situation in and challenges facing the financial system in terms of its stability and functioning. At present, there are no significant problems concerning the stability of the financial system. Japanese financial institutions as a whole have a sufficient capital base, and even if there should be a large domestic financial or economic shock, the likelihood that financial intermediation will be significantly impaired is very small. However, at the global level, following the experience of the global financial crisis, there have been calls to prepare for potential risks in international financial markets and the financial system in order to prevent any shocks from spreading. Against this background, requirements of financial institutions to ensure their soundness and improve their business BIS central bankers’ speeches management have become more stringent. Both international financial regulations such as Basel III and national regulations have been successively introduced and implemented, and discussions have been ongoing that could lead to internationally active financial institutions being required to hold more capital. The Bank of Japan is deeply committed to the aims underlying this review of international financial regulations, namely, to further strengthen the soundness and business management of financial institutions and to further enhance the stability of the financial system. At the same time, if such regulations excessively constrain financial institutions’ activities, this might hamper the smooth transmission of monetary policy effects or weaken the ability to provide support to the economy from the financial side, which warrants due consideration in designing specific regulations. In addition, the fact that institutions and circumstances surrounding the financial system differ across countries should be borne in mind. The Bank will actively participate in international discussions so that these will lead to the formulation of appropriate regulations taking account of the aforementioned considerations. Let me next touch on the functioning of the financial system. With economic activity and prices improving, firms’ demand for funds has also been increasing gradually and become more widespread in terms of industries and regions, and financial institutions are trying to actively respond to such demand. In this respect, we at the Bank judge that the financial system has been functioning steadily to encourage economic recovery. At the same time, the financial system is expected to play a more important role in supporting firms’ and regions’ initiatives to address the medium- to long-term challenges of a declining and aging population. I have heard that, also in this region, there are efforts to create new industries or industrial clusters, taking advantage of technologies accumulated in the past and of the highly developed transportation infrastructure. In addition, while the expansion of overseas business by local firms can be regarded as hollowing out, such overseas activities will lead to the growth of these firms through the expansion of sales networks and the greater international division of labor, and will deepen ties between regional economies and overseas economies, providing new business opportunities. I am convinced that regional financial institutions’ initiatives in new areas, such as supporting firms’ innovation and expansion of overseas business, will eventually lead to a revitalization of regional economies. Through its on-site examinations and off-site monitoring as well as seminars, the Bank will stand ready to help financial institutions’ initiatives to support firms in areas such as financial business practices, risk management, and the development of effective frameworks. Another topic I would like to touch on in relation to the functioning of the financial system in Japan is the enhancement of payment and settlement services. In order for Japan’s economy to achieve sustained growth, it is critical to enhance payment and settlement services in response to diverse settlement needs and globalized financial services. One of the issues included in the government’s revised growth strategy is the enhancement of funds and securities settlement at financial institutions and firms, while utilizing the extended operating hours of the Bank of Japan Financial Network System (BOJ-NET). The new BOJ-NET that the Bank has been developing should contribute to the revitalization of financial markets and the enhancement of financial services, with financial institutions making the most of the new BOJ-NET function. From this perspective, the Bank decided, for the time being, to extend the operating hours until 21:00 from February 2016 for financial institutions that hold current accounts at the Bank’s head office. It is up to individual financial institutions whether to use the new BOJ-NET during the extended operating hours and how to make the most effective use of it. BIS central bankers’ speeches In the process of examining the extension of operating hours, the Bank held a forum involving major market players and industry representatives. At the forum, various innovative ideas for taking advantage of the extended operating hours of the BOJ-NET were presented. These ideas include the same-day settlement of corporate customer transfers from their Asian bases to domestic bases and the same-day settlement of Japanese government bonds (JGBs) used as collateral in cross-currency repo transactions in Europe. Developing an infrastructure that will enable the settlement of the Japanese yen and JGBs, anytime, anywhere, will support the globalization of the yen – a longstanding challenge – from the settlement aspect. In providing financial and settlement services to firms that have expanded their businesses to Asia, I hope that individual financial institutions will make the most of the new BOJ-NET, leading them to further develop their own businesses. Other issues included in the revised growth strategy are the real-time processing of payments in bank transfers and the attachment of invoice information to payment messages. The provision of settlement services is one of banks’ core operations, and improvements in its infrastructure can lead to the provision of new services by banks to their corporate customers. I believe that the banking and industry community will discuss the specifics of these issues, and the Bank – together with the government – will support such discussions. Concluding remarks In concluding, let me touch on the economy of Shizuoka Prefecture. The economy of Shizuoka Prefecture has been recovering moderately. Against the backdrop of a moderate improvement in the employment and income situation, the decline in private consumption following the consumption tax hike has been broadly in line with expectations and there have recently been promising signs of improvement. In addition, due mainly to the good performance of businesses, business fixed investment has increased, while public investment has been hovering at a high level. These developments are backed up by the business sentiment indicator for the region in the June Tankan survey, and the economy in the region is likely to continue its improving trend. That being said, the recovery in Shizuoka Prefecture has been lacking vigor compared to the rest of the country. This is due mainly to the decline in production and exports in the region. Specifically, triggered by the yen appreciation in the wake of the global financial crisis, major manufacturing industries, such as the transport equipment and electrical machinery industries, have accelerated the relocation of production and, as a result, Shizuoka Prefecture’s manufacturing sector shipments have declined by about 4 trillion yen. Given this change in economic structure, the business sentiment of small and medium-sized enterprises remains generally gloomy. Against this background, the imminent challenge facing Shizuoka Prefecture is to create new industries to more than compensate for the decline in production and exports after the global financial crisis. I am quite encouraged to hear that promising and ambitious initiatives have already been launched. These include, for example, plans for new industrial clusters in the prefecture. For example, Pharma Valley in the east of the prefecture aims to gather firms from the medical and health care industries, Food Science Hills in the center of the prefecture aims to gather firms in industries related to functional foods contributing to the promotion of health, and Photon Valley in the west of the prefecture aims to gather firms from the optical and electronics industries. In addition, the Inland Frontier Policy aiming at inviting enterprises to areas along the Shin-Tomei Expressway, which is less susceptible to disaster risks, has been launched. Now is also a golden opportunity to promote the attractiveness of Shizuoka Prefecture as a tourist destination, with its history and culture, to people at home and abroad. Mt. Fuji, the most notable sight in Shizuoka Prefecture, was registered as a World Cultural Heritage in June last year, and an event commemorating Ieyasu Tokugawa, who was the first Shogun of BIS central bankers’ speeches the Tokugawa government and had a close relationship with Shizuoka Prefecture, 400 years after his death, is scheduled for next year. Moreover, the Rugby World Cup 2019 and the Tokyo 2020 Summer Olympic and Paralympic Games will be major events that are expected to bring various business opportunities to the regional economy, including the use of game stadiums, training camps for players and parties concerned, and accommodation for spectators. I am looking forward to seeing how Shizuoka Prefecture will seize these opportunities. Needless to say, for these opportunities to bear fruit, even stronger coordination among four groups of “players” is critical, namely, representatives of industries in the region, the administration that links parties concerned at home and abroad, academics and research institutions that provide the necessary technical seeds for the development of industries, and regional financial institutions to support these activities from the financial side. In this regard, the Council on an Industrial Growth Strategy for Shizuoka Prefecture, chaired by Governor of Shizuoka Prefecture Heita Kawakatsu, was established in March this year, providing a platform for the aforementioned four players to develop growth strategies for the region in a unified fashion. I have learned that concrete measures toward achieving structural change are scheduled to be compiled in autumn this year. I strongly hope that an effective growth strategy will be formulated and initiatives will be implemented swiftly under the strong leadership of related parties. The Bank of Japan is striving to achieve stable growth of Japan’s economy with QQE. In pursuing QQE, it is essential to carefully examine regional economies, including the performance of small and medium-sized firms, through the Bank’s nationwide branch network, including the Bank’s Shizuoka branch. In this respect, information that is kindly provided to us from industry and financial institutions in this region is invaluable. I would like to continue to seek your cooperation with respect to research and other activities of the Shizuoka branch. I sincerely hope that the various initiatives in Shizuoka Prefecture will bear fruit and the region will enjoy further growth in the future. Thank you. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Keynote address by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, to the National asset liability management conference, Singapore, 23 July 2014.
Sayuri Shirai: Recent monetary policy trends in advanced economies and the Asia-Pacific region Keynote address by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, to the National asset liability management conference, Singapore, 23 July 2014. * I. * * Introduction It is a great honor to visit Singapore and have the opportunity to give a keynote address at the National Asset-Liability Management conference. I have been a Bank of Japan (BOJ) Policy Board member since 2011, and am responsible for making decisions on monetary policy conduct with Governor Haruhiko Kuroda and other Policy Board members. Today, I would like to talk about the recent monetary policy trends in advanced economies and the Asia-Pacific region. In early January this year, I had the opportunity of giving a speech in Singapore on recent monetary policy developments in advanced economies and their relationship with emerging economies. Immediately after that, I was pleasantly surprised when Central Banking Publications, the organizer of today’s conference, kindly asked me to extend this line of thinking in the context of the Asia-Pacific region and give a speech today. While it is a challenging task to review the developments in this diverse region, I hope that my speech will provide a useful background to foster active discussions during this conference. I will begin with an overview of recent monetary policy in advanced economies (covering the United States, the euro area, Japan, and the United Kingdom). I will then focus on the AsiaPacific region by summarizing the features of monetary policy conduct and its related challenges over the past decade – covering nine economies (Australia, China, Indonesia, Malaysia, New Zealand, the Philippines, Singapore, South Korea, and Thailand). Finally, I will present my views on the region’s inflation performance and the direction of future monetary policy conduct. II. Recent monetary policy conduct features in advanced economies Since the outset of the global financial crisis, monetary policy conduct has changed dramatically in advanced economies. Let me highlight four features commonly observed among such economies: (1) adoption of a 2 percent inflation target; (2) stabilizing inflation expectations at around 2 percent; (3) unconventional monetary policy under the zero interest rate lower bound; and (4) an emphasis on financial stability and its relation to monetary and macroprudential policies. I will explain these features by discussing four central banks: the U.S. Federal Reserve, the European Central Bank (ECB), the BOJ, and the Bank of England (BOE), as shown in Chart 1. A. Adoption of a 2 percent inflation target First, all four central banks have adopted a medium-term inflation target or a numerical definition of price stability with a 2 percent, or close to 2 percent, convergence: their monetary policy mandates all include price stability. These central banks use headline inflation as a reference to their inflation targets (the Harmonised Index of Consumer Prices [HICP] for the ECB; the consumer price index [CPI] for the BOJ and the BOE; and the price index for personal consumption expenditures [PCE] for the Federal Reserve). The Federal Reserve, the ECB, and the BOJ also officially use the core PCE deflator, the core HICP, and BIS central bankers’ speeches the core CPI, respectively, as operational guides to examine the underlining price movements in monetary policy conduct.1 The BOE and the ECB were frontrunners in adopting price stability targets, and the current numerical targets were adopted in 2003, prior to the global financial crisis, while the Federal Reserve and the BOJ did so after the crisis in 2012 and 2013, respectively. Regardless of whether an inflation-targeting framework is officially implemented, the practices adopted are similar for each of the four central banks. These practices include adopting a numerical inflation target with clear mandates, the release of medium-term forecasts on future inflation and economic growth (generally for about three years), the presence of a committee that independently determines monetary policy, and various accountability requirements on achieving the target. These central banks all make policy decisions to align their inflation forecasts with their specific inflation target over the medium term (or medium to long term). In other words, they conduct a so-called “flexible inflation-targeting framework” that is defined by Professor Lars E.O. Svensson as monetary policy conduct that attempts to stabilize inflation around the inflation target and to stabilize the output gap around the sustainable level. Namely, monetary policy should be conducted flexibly with the aim of achieving the inflation target by taking into account various possible disturbances and their impacts on economic growth. This means conducting monetary policy so that a central bank’s inflation forecast gradually approaches its target in the medium term and inflation meets the target as a medium-term average. This approach is embedded in the monetary policy framework of the Federal Reserve because of its explicit dual mandate of price stability and maximum employment. In recent years, the realized inflation rates in some of these economies have been below the relevant target for some time (Chart 2). This seems to reflect declining energy prices, excessive employment and capital stock, exchange rate appreciation, and continued headwinds caused by the global financial crisis. Those headwinds include strengthened financial regulations, banks’ tight lending standards, the deleveraging process by firms and households, and the moderate pace of global economic recovery. As a result, some central banks seem to be finding it necessary to conduct monetary easing for longer periods than originally expected. B. Stabilizing inflation expectations at around 2 percent To achieve price stability, a central bank needs to stabilize the public’s inflation expectations at around its price stability target. If such expectations are well anchored, there is a tendency for inflation to converge to the target even after a deviation. In general, long-term inflation expectations are more important than short-term expectations, with the latter tending to be more volatile and sensitive to both commodity prices and the prices of frequently-purchased goods and services. The Federal Reserve, the ECB, and the BOE all claim that their longterm inflation expectations (e.g., five years ahead) remain well anchored at around 2 percent. This is confirmed for the United States and the euro area by economic forecaster data on long-term inflation expectations (Chart 2). On the other hand, long-term inflation expectations have exceeded the target for over five years in the United Kingdom because of various factors including exchange rate depreciation, energy price increases, a hike in the valueadded tax, and rises in various administered and regulated prices. However, its inflation expectations have started to fall recently since the highlighted effects have dissipated. These central banks have different “core” index definitions. The Federal Reserve defines it as “all items less food and energy,” the ECB defines it as “all items less energy, food, alcohol, and tobacco,” and the BOJ defines it as “all items less fresh food.” BIS central bankers’ speeches Situation in Japan and a conundrum regarding inflation expectations The BOJ adopted its 2 percent price stability target in January 2013, followed by the launch of quantitative and qualitative monetary easing (QQE) in April of the same year. These initiatives are aimed at overcoming the mild deflation that has lingered for 15 years in Japan. A distinct feature of the QQE is that it aims not only to achieve 2 percent inflation at the earliest possible time, but also to raise long-term inflation expectations from the current low level of around 1 percent to around 2 percent, and then stabilize them at around 2 percent. In this sense, the BOJ’s monetary easing objective differs from those of other central banks. These banks aim to increase aggregate demand and thereby support economic recovery, while maintaining the current situation where long-term inflation expectations are already stable at around 2 percent. Japan’s long-term inflation expectations (e.g., five years ahead) have averaged about 1 percent from 1995 to early 2014. This is somewhat perplexing since both realized inflation and short-term inflation expectations (e.g., one year ahead) remained consistently below long-term inflation expectations and often faced mild deflation. Relatively higher long-term inflation expectations may be attributable to the public’s long-held belief that prices will eventually rise; this is particularly relevant for those who experienced the oil crisis in the 1970s and the bubble period in the 1980s. Chart 2 also indicates that Japan’s inflation expectations are more volatile than those in the United States, the euro area, and the United Kingdom (before the global financial crisis). This suggests that Japan’s inflation expectations have not yet been anchored. Against this backdrop, QQE was meant to produce a regime change in monetary policy thereby raising realized inflation and inflation expectations toward 2 percent. This approach is similar (but conducted in a reverse manner) to that adopted by the then Federal Reserve Chairman Paul Volcker in 1979–1983. The recent rise in the realized inflation in Japan is largely attributable to the consumption tax hike from 5 percent to 8 percent in April 2014 (Chart 2). Even excluding this temporary effect, inflation is now around 1¼ percent and shows a steady rise from the recent bottom of minus 0.5 percent recorded in March 2013. The BOJ projects that inflation is likely to be around 1¼ percent for some time, and thereafter follow a rising trend again from the second half of this fiscal year. Similarly, a sharp rise in short-term inflation expectations (e.g., one year ahead) during 2013 mainly reflects this tax effect. Thus, a drop in expectations from over 2 percent to below 2 percent in April 2014 reflects an evaporation of the tax effect. On the other hand, since long-term inflation expectations (e.g., five years ahead) do not incorporate this tax effect, the recent signs of an increase are encouraging. Based on various indicators related to inflation expectations of households, firms, and market participants, the BOJ judges that long-term inflation expectations are generally on a moderate rising trend; however, whether this trend continues should be closely monitored, as these indicators show some different movements. It is clear that, since the QQE adoption, Japan’s economy has shown positive signs of moving out of deflation (Chart 2). Some firms seem to be increasingly confident about raising their sales prices by providing innovative products and services and thereby tapping demand. An increasing number of households appear to be enjoying employment and nominal income growth. Transforming the public’s deflation-oriented mindsets and their resultant risk-averse economic behavior will take some time, but positive developments are gradually but steadily spreading in the economy. Going forward, monetary policy should continue to support the transformation process and economic recovery. The government’s growth strategy to strengthen the potential of Japan's economy combined with firms’ initiatives mean that it is possible to first achieve the 2 percent price stability target and to subsequently sustain the 2 percent inflation in a stable manner. The expression “sustain the 2 percent inflation in a stable manner” is considered equivalent to the idea of stabilizing longterm inflation expectations at around 2 percent. In other words, in such a situation, inflation of around 2 percent would be realized as a medium-term average, as observed in other advanced economies. BIS central bankers’ speeches C. Unconventional monetary policy under the zero interest rate lower bound In the face of the zero lower bound on nominal interest rates, the four central banks have actively conducted “unconventional” monetary easing measures such as (1) large-scale purchase of various financial assets, (2) forward guidance over the future monetary policy stance, (3) longer-term liquidity provision facility, (4) long-term conditional lending, and (5) a negative interest rate charge on reserves (Chart 3). In what follows, I will briefly touch on the current initiatives taken by these four central banks. Measure (1): Large-scale purchase of various financial assets The Federal Reserve, the BOJ, and the BOE have performed large-scale asset purchase operations to exert downward pressure on their longer-term interest rates that remain in positive territory despite the policy rate reaching nearly zero. This policy is sometimes referred to as quantitative easing. While sovereign bonds are the major assets purchased, the Federal Reserve also purchases agency mortgage-backed securities (MBSs), and the BOJ purchases diverse assets (treasury discount bills [T-Bills], corporate bonds, CP, exchange-traded funds [ETFs], and Japan real estate investment trusts [J-REITs]). The Federal Reserve is currently reducing the amount of asset purchases at a measured pace, while the BOJ continues to purchase assets based at a pre-determined annual pace (a pace currently clarified until the end of 2014). The BOE is maintaining its outstanding asset holding amounts. Meanwhile, the ECB has taken a different approach by purchasing a limited amount of financial assets and sterilizing the amount of sovereign bonds purchased under its securities market program (SMP). In June 2014, the commitment to sterilizing those bonds purchased was suspended because inflationary concerns had dissipated. Moreover, the ECB decided to intensify preparatory work related to the outright purchases of asset-backed securities (ABSs) as a credit easing policy, rather than as a quantitative easing policy. Measure (2): forward guidance All four central banks have adopted forward guidance: this refers to a communication strategy undertaken by central banks to provide information to the markets and the public on their future monetary policy stances. Of the four, the Federal Reserve, the ECB, and the BOE apply forward guidance mainly to their respective short-term policy interest rates – the operational target for monetary policy – and provide guidance to the markets and the public about how long they expect to keep the current low interest rates. In contrast, the BOJ applies forward guidance to its QQE as a package, and not on its policy interest rate. This is because its operational target was shifted from the uncollateralized overnight call rate to the monetary base. Once the size of the annual pace of increase in the monetary base is set, the approximate increase in Japanese government bond (JGB) purchases is decided accordingly; hence, there is a close link between the monetary base and the amount of assets purchased. The BOJ then uses forward guidance to inform the markets and the public of its intention to maintain the monetary base increase and thus asset purchases in the future. Measure (3): Longer-term liquidity provision facility The ECB and the BOJ currently have longer-term liquidity provision facilities to assist the funding of financial institutions and to foster their lending activities to promote economic activity. The ECB is conducting longer-term refinancing operations (LTROs) with a fixed interest rate and a full allotment. The ECB previously offered LTROs with three year maturity terms in December 2011 and February 2012: currently, LTROs are available under a three month maturity term until December 2016. Meanwhile, the BOJ conducted several one-year liquidity operations during April and May 2013 to cope with the volatile JGB market. While liquidity operations with maturity levels of up to one year are still available, the BOJ currently mainly provides three-month operations. BIS central bankers’ speeches Measure (4): Long-term conditional lending The BOJ was the first central bank, under the zero interest rate lower bound, to introduce a long-term lending facility where the amount of lending to financial institutions is conditional on the increased lending by these institutions to the private sector. The aim is to promote lending activities by financial institutions. The BOJ currently operates two programs: (1) the fund-provisioning measure to support strengthening the foundations for economic growth (the Growth-Supporting Funding Facility) introduced in 2010 (provision of funds at a 0.1 percent fixed interest rate for up to four years, based on the increased lending and investment realized by the financial institutions toward strengthening the foundations for economic growth); and (2) the fund-provisioning measure to stimulate bank lending (the Stimulating Bank Lending Facility) introduced in 2013 (provision of funds for up to four years and of up to twice the net increase in the financial institutions’ lending without a limit). Subsequently, the BOE adopted the Funding for Lending Scheme (FLS) in 2012, allowing financial institutions to borrow U.K. Treasury bills at a low cost in exchange for all eligible collateral depending on their realized net lending to small and medium-sized enterprises (SMEs). Moreover, in June 2014, the ECB newly introduced Targeted LTROs by providing long-term funds (for a maximum of three to four years) to financial institutions up to a total of three times the net increase in private-sector lending excluding mortgages, with a fixed interest rate at 10 basis points plus the prevailing interest rate of the main refinancing operations (MROs). Measure (5): Negative interest rate charge on reserves The ECB introduced a negative interest rate (negative 0.1 percent) on excess reserves and lowered deposit facility interest rates to the same negative rate in June 2014, in conjunction with a cut in other policy interest rates. Meanwhile, the Federal Reserve and the BOJ maintain a positive respective 0.25 percent and 0.1 percent interest rate on excess reserves. The BOE applies a positive 0.5 percent rate on total reserves. In general, central banks maintain positive interest rates on (excess) reserves for various reasons, including maintaining the proper functioning of the interbank markets. If interest rates on reserves are negative, the interbank markets could shrink, and this could generate a situation where financial institutions are unable to promptly raise funds from the markets when most needed. Since the interest rate on reserves provides the floor for interbank market interest rates, keeping this rate in positive territory could mitigate large fluctuations in the interbank market rates. This enables a central bank to smoothly provide sufficient liquidity and to expand its balance sheet as a quantitative easing policy. Meanwhile, some expect positive aspects from introducing a negative interest rate, such as tackling exchange rate appreciation and lowering the bank lending rate. For example, in Denmark, Danmarks Nationalbank applied a negative interest rate on its certificate of deposit (CD) facility from July 2012 to April 2014 to fight massive capital inflows and to defend its peg against the euro under the Exchange Rate Mechanism II (ERM II). As a result, a positive effect was observed in leading to currency depreciation and maintenance of the peg. However, the lending rates were largely unaffected and the amount of lending actually dropped. D. Emphasis on financial stability and its relation to monetary and macroprudential policies The global financial crisis has led each country to place increased importance on macroprudential policy, given that stability in the financial system as a whole may not be achieved solely through the existing microprudential policies. This arises from the globally shared view that the “Great Moderation” period – which continued until the mid-2000s – successfully achieved general price stability but failed to prevent the global financial crisis. Macroprudential policy focuses on financial institutions and the markets (and their relationships) as major constituents of the financial system, as well as on the effects of the relationship between economic activity and the financial system. In this regard, central banks BIS central bankers’ speeches closely monitor macroeconomic and financial market developments, collect information regarding financial transactions, and function as the lenders of the last resort to individual financial institutions with the aim of ensuring financial system stability. Thus, the use of these specific skills, knowledge, and functions is considered effective in optimizing the effects of macroprudential policy. As a result, there is a growing consensus that central banks have an increasing role in macroprudential policies to maintain financial stability. However, there is an open question on the correct balance between macroprudential policy decisions and monetary policy decisions for a central bank. For example, monetary tightening, such as an interest rate hike, is generally an appropriate policy option, particularly when there are signs of heightened inflationary pressures or when rapid credit growth and asset price bubbles are emerging across sectors. This is even true in the case of containing an increasing risk of financial imbalances when the realized inflation has already been sustained at the target level or when long-term inflation expectations remain well anchored. However, problems may arise when a central bank is conducting monetary easing over a long period in a protracted downturn phase of the economy. In this circumstance, inflation may remain below the target for an overly long time and long-term inflation expectations may have begun to decline, while financial imbalances such as bubbles may have started to appear. In such a situation, a central bank needs to continue monetary easing to both fulfill its mandate to maintain price stability and avoid a loss of credibility by failing to meet the inflation target. The problem arises because such a policy may increase the risk of further credit growth and amplify asset bubbles and may thus create a dilemma. These issues are becoming relevant in recent years. Some advanced economies including Belgium, Norway, Sweden, Switzerland, and the United Kingdom appear to be facing a rapid increase in housing prices, while their CPI inflations remain low and/or below the inflation targets. Greater focus on macroprudential policy by the central bank community The above tradeoff between price stability and financial stability suggests that assigning too many objectives to monetary policy without allocating sufficient policy tools may be potentially problematic. Thus, the active use of macroprudential policy by central banks is widely considered as a first line of defense against emerging financial imbalances. Macroprudential policies are measures that affect the behavior of financial institutions, and the Committee on the Global Financial System (CGFS) considers that they can be classified into (1) capital-based measures, (2) liquidity-based measures, and (3) asset-side measures.2 Capital-based measures include countercyclical capital buffers (CCBs) that are incorporated in the Basel III framework and sector-based capital buffers. Liquidity-based measures include a liquidity ratio, a limit on net open positions in foreign currencies, and a reserve requirement. Asset-side measures include credit volume controls, a loan-to-value (LTV) ratio (mainly applied for housing and real estate loans), a debt-to-income (DTI) ratio, and various taxes related to real estate transactions. Of these, there is a focus on CCBs as a practical macroprudential measure in some advanced economies. While CCBs are scheduled to be applied in each country in 2016, Switzerland took thelead by instituting their activation from July 2012, where the Federal Council makes CCB decisions based on the Swiss National Bank recommendations. The CCBs can either be applied as aggregate based and/or sector based; and the sector-based capital buffers of 1 percent was applied for residential mortgages in February 2013, and subsequently doubled to 2 percent in June 2014. On the institutional aspect of conducting macroprudential policy, the United Kingdom has made a substantial institutional reform. Its Financial Policy Committee (FPC) was established within the BOE to conduct macroprudential policy, while its Monetary Policy Committee (MPC) continues to engage in monetary policy. The FPC seems to be currently seeking The Committee on the Global Financial System, “Operationalising the Selection and Application of Macroprudential Instruments,” CGFS Papers, No. 48, 2012. BIS central bankers’ speeches specific means to encourage coordination with the MPC. The MPC has recently expressed increasing concerns over the surge in housing prices and the expansionary trend in mortgages in the low interest rate environment, and considers that macroprudential policy should be used as a first line of defense to mitigate the related systemic risks. The CCBs are considered to be important macroprudential measures, and in May 2014, the FPC was given responsibility for setting the CCB rate by the government. In line with its new responsibility, the FPC decided to set the rate at zero percent in June 2014. In the same month, the FPC also made recommendation to the Prudential Regulation Authority (PRA) to apply a DTI-ratio-like measure on residential mortgages. Meanwhile, the European Union (EU) has learned the lesson that the lack of a cross-border banking monitoring and management system resulted in a delayed, inadequate response to the crisis. This promoted the move toward the Banking Union. In a major step, the Single Supervisory Mechanism (SSM) will commence operations in November 2014, with the ECB playing a supervisory role in monitoring the soundness of major banks. Moreover, the EU established a union-level body known as the European Systemic Risk Board (ESRB) in 2010, where the president of the ECB serves as the head of the Board and other members include governors of national central banks, a representative of the European Commission, and senior officers of relevant regulatory institutions in the region. The ESRB’s task is to identify risks related to the financial system and to provide recommendations to national regulatory authorities when necessary. In the United States, the Financial Stability Oversight Council (FSOC) – whose members include the Chairman of the Federal Reserve – was established in 2010 as an institution responsible for monitoring the potential risks related to financial stability and for making recommendations to the Federal Reserve on prudential regulations and supervision. In Japan, the Financial Services Agency (FSA) – the primary financial regulatory authority – and the BOJ decided in June 2014 to hold a semi-annual joint meeting to exchange views on financial stability. This move reflects the coordinated efforts to promote financial system stability by making contributions in their respective fields of responsibility. In this regard, the BOJ conducts on-site examinations and off-site monitoring of individual financial institutions, and thereby carries out various analyses on financial system stability and related risks from macroprudential perspectives. The BOJ also publishes a semi-annual Financial Stability Report. Use of liquidity-absorbing operations to maintain financial stability While macroprudential policies are generally considered as the first line of defense against financial imbalances, there has recently been an increasing focus on the application of an interest rate on excess reserves and/or reverse repurchase agreements as another possible method of containing the ample liquidity circulating in the money market.3 As a central bank is able to set such an interest rate on its own, it may be able to control bank reserves and thus, can possibly affect the stability of the financial system by encouraging financial institutions to hold ample liquidity with the central bank. Importantly, a central bank can implement this measure while retaining the ability to affect the short-term interest rate, so that a tradeoff in terms of price and economic stabilization goals can be limited. The application of these tools is actively debated in the United States recently in the context of a smooth exit policy to normalize market interest rates while maintaining abundant liquidity within the Federal Reserve. At the same time, using these tools to maintain abundant excess reserves for long periods is also considered to be potentially useful to contain excessive investment and lending by banks and thus prevent asset price bubbles. See, for example, Joseph E. Gagnon and Brian Sack, “Monetary Policy with Abundant Liquidity: A New Operating Framework for the Federal Reserve,” Peterson Institute for International Economics, Policy Briefs No. 14–4, January 2014; and John C. Williams, “Financial Stability and Monetary Policy: Happy Marriage or Untenable Union?,” a presentation to the Deutsche Bundesbank Conference in Germany, June 5, 2014. BIS central bankers’ speeches III. Changes in monetary policy conduct in the Asia-Pacific region Now, I would like to turn to the Asia-Pacific region covering nine economies. Following the East Asian economic crisis of 1997–1998, many central banks in the region shifted away from the rigid dollar peg system and at the same time, their monetary policy frameworks also changed. As a result, there is some degree of convergence with regard to their monetary policy conduct, although there is still considerable diversity. I would like to highlight five common features: (1) a growing emphasis on price stability; (2) the highly-flexible inflationtargeting framework; (3) allowing greater movements in the exchange rates; (4) a low policy interest rate in the face of large capital inflows; and (5) extensive use of macroprudential policy to maintain financial stability. A. Growing emphasis on price stability All of the region’s central banks emphasize price stability or, in other words, the maintenance of low and stable inflation as their monetary policy objective. The central banks in New Zealand, the Philippines, Singapore, South Korea, and Thailand specify price stability as their monetary policy mandate. The Reserve Bank of Australia (RBA) encompasses three mandates (stability of the domestic currency, full employment, and the economic prosperity and welfare of the Australian people), with these objectives being expressed in practice by the inflation target. The Bank Indonesia (BI) defines rupiah stability as the stability of general prices; in practice, maintaining low and stable inflation is considered the primary monetary policy objective. Similarly, the mandate of Bank Negara Malaysia (BNM) is to maintain monetary stability or ringgit stability that is thought to be preserved by price stability. The objective of monetary policy in China is to maintain renminbi stability. Regardless of differences in terms of how to express the mandate, all nine central banks equally emphasize the importance of achieving price stability. Six economies (Australia, New Zealand, South Korea, Thailand, the Philippines, and Indonesia) attempt to achieve price stability by officially adopting an inflation-targeting framework that will be explained later (Chart 4). China pursues price stability through its monetary aggregate target (M2) and Singapore uses an exchange rate anchor. The International Monetary Fund (IMF) classifies Malaysia in a category with no explicitly-stated nominal anchor but rather monitors various indicators in conducting monetary policy. All central banks, with the exception of those in Malaysia and Singapore, provide numerical inflation targets. China sets an inflation target for each year in approximately March of the relevant year, with the target for 2014 being 3.5 percent. Other central banks provide inflation targets under the inflation-targeting framework that will be explained next. B. The highly-flexible inflation-targeting framework In the Asia-Pacific region, six central banks have adopted an inflation-targeting framework. New Zealand and Australia were regional frontrunners, adopting it after experiencing high inflation rates in the 1970s and early 1980s. New Zealand was the first to develop the framework in 1988, subsequently followed by Canada (1991), the United Kingdom and Australia and Sweden (1993). These moves were motivated by two considerations: (1) ensuring that the inflation that had started to decelerate in the second half of the 1980s would continue to be contained; and (2) the statistical relationship between monetary stock (or exchange rates) and inflation had become unstable, making it necessary for these central banks to adjust their monetary policy frameworks. In East Asia, South Korea was the first to adopt the inflation-targeting framework in 1998, followed by Indonesia and Thailand (2000), and the Philippines (2002) (Chart 5). In particular, South Korea, Indonesia, and Thailand were forced to abandon the de facto U.S. dollar peg policy because of massive speculative attacks during the East Asian economic crisis, providing them with an opportunity to review their monetary policy frameworks. The Philippines shifted from monetary-targeting to inflation-targeting, following global trends and based on the need to demonstrate a firmer commitment to controlling inflation to the public. BIS central bankers’ speeches Main features of the inflation-targeting framework Of the six central banks that have adopted the inflation-targeting framework, five use the headline CPI as reference to inflation targets, with Thailand using the core CPI (Chart 6). Many central banks assess the underlying inflation trend by monitoring the core CPI as well. Each of the six relevant central banks now places importance on short-term policy interest rate and uses it as the main operational target for monetary policy. As a first mover, New Zealand initially adopted a relatively rigid framework and attempted to meet price stability within a short time span. However, such a tight monetary policy led to a sharp appreciation of the New Zealand dollar and forced substantial adjustment burdens on the export and import substitution sectors. Consequently, New Zealand decided to increase flexibility over time by allowing a deviation from the inflation target range of 1–3 percent and meeting the target range on average over the medium term. Its 1–3 percent target range has been fixed since 2000. In addition, since 2012, its inflation target definition has been clarified further by adding the expression “with a focus on keeping future average inflation near the 2 percent target midpoint” to the existing 1–3 percent target range. Similarly, Australia’s inflation target range of 2–3 percent is also defined as a medium-term average. In East Asia, South Korea set its inflation target range for 2013–2015 at 2.5–3.5 percent under a medium-term inflation-target setting system adopted in 2004 (prior to that, it set an inflation target annually). In 2012, Indonesia set its inflation target range at 4.5 percent ±1 percentage point for 2012–2014, and 4 percent ±1 percentage point for 2015. Thailand narrowed its inflation target range from 0.0–3.5 percent to 0.5–3.0 percent in 2009, and thereafter has maintained this target, although its validity is examined every year. The inflation target range in the Philippines is set at 4 percent ±1 percentage point for 2011–2014 and at 3 percent ±1 percentage point for 2015–2016 under a medium-term inflation-target setting system adopted in 2010 (prior to that, it set an inflation target annually). Why is the inflation-targeting framework more flexible than in advanced economies? The above observations suggest that the inflation-targeting frameworks in the Asia-Pacific region are more flexible than those adopted in the advanced economies described earlier. Particularly, greater flexibility is demonstrated by (1) an adoption of an inflation target range rather than an inflation target point, (2) the acceptance of relatively large deviations from the inflation target, and (3) the use of relatively frequently-reviewed inflation targets – rather than fixed inflation targets – in South Korea, Indonesia, Thailand, and the Philippines. The greater flexibility in the region relative to advanced economies may reflect several factors: (1) the difficulty in pinpointing an optimal inflation rate, partly due to the rapid structural changes and the evolving stages of economic developments; (2) a greater fluctuations in the economy caused by volatile commodity prices and exchange rates; and (3) the need to use the target range to prevent the public from forming the impression that meeting the inflation target is prioritized at the expense of economic growth. C. Allowing greater movements in the exchange rates Since the East Asian economic crisis, South Korea, Indonesia, and Thailand have abandoned the rigid U.S. dollar peg system. Other economies in the Asia-Pacific region have also increased flexibility in their exchange rate arrangements. Overall, their exchange rates have become more volatile and it now seems that none of the economies in the region target specific levels of exchange rates against the U.S. dollar (Chart 6). Shifting toward more flexible exchange rate arrangements In the inflation-targeting economies, IMF classifications consider that Australia and Japan are adopting free-floating exchange rate arrangements with no foreign exchange market interventions, similar to the United States, the euro area, and the United Kingdom (Chart 4). The exchange rate arrangement in New Zealand was generally regarded as free floating, but was reclassified as floating because small interventions were made to dampen the sharp BIS central bankers’ speeches appreciation of the New Zealand dollar since 2012. The arrangements in South Korea, Thailand, and the Philippines are also classified as floating with each having more frequent interventions than New Zealand. Meanwhile, Indonesia is regarded as having a less flexible arrangement than these economies. It is classified as having a so-called crawl-like arrangement because the rupiah has followed a depreciating trend against the U.S. dollar within a margin of less than 2 percentage points since June 2012. The IMF regards the Indonesian arrangement as a de facto exchange rate anchor to the U.S. dollar. Indonesia’s preference for a stable exchange rate may reflect the need to stabilize the prices of imported and exported commodities, as well as to preserve the value of foreign debt denominated in the U.S. dollar. Some studies point out that the inflation-targeting frameworks in South Korea, Thailand, and the Philippines have resulted in higher volatilities in the exchange rates. Moreover, the degree of volatility in these economies was found to be larger than that in advanced economies.4 Regarding economies without an inflation-targeting framework, Singapore and China have adopted a crawl-like arrangement (Chart 4). In Singapore, the Singapore dollar follows an appreciating trend against a basket of currencies within a 2 percent band since 2011. This arrangement is often referred to as a BBC (basket, band, and crawl) targeting; the content of the BBC is regularly adjusted. Because of its country-specific features (the small economic size, the high degree of trade and financial openness, and the high degree of import penetration), the BBC targeting is considered to work better than the short-term policy interest rate targeting to achieve price stability in Singapore. Meanwhile, China has gradually enhanced the flexibility in its exchange rate policy and has widened the interbank trading fluctuation band of the renminbi exchange rate against the U.S. dollar. For example, the most recent move was a widening of the band from ±0.5 percentage point of the daily central parity released by the China Foreign Exchange Trade System to ±1 percentage point in April 2012 and further to ±2 percentage points in March 2014. In addition, in early July 2014, the State Administration of Foreign Exchange (SAFE) announced that it will permit banks to set their own exchange rates for the renminbi against the U.S. dollar in deals with their clients. Malaysia shifted from a rigid U.S. dollar peg to a more flexible arrangement in 2005 that does not belong to a specific exchange rate arrangement and is now categorized by the IMF as other managed arrangement. The flexibility in Malaysian exchange rate policy has been enhanced remarkably (Chart 6). D. Low policy interest rate in the face of large capital inflows Since the early 2000s, capital inflows to the Asia-Pacific region have increased rapidly in the form of bond investments with a wide range of entities increasing their bond issuance. Particularly, local-currency denominated bonds saw a remarkable increase, helping to offset a slowdown in bank loans. This increase partly reflected the active issuance of government bonds to finance the post-crisis expansionary fiscal policy. The maturity of both government and corporate bonds has lengthened, even during and after the global financial crisis. These developments are partly attributable to the initiatives by the governments and central banks in the region to foster local currency-denominated bond markets – such as the Asian Bond Markets Initiative (ABMI) and the Asian Bond Fund (ABF). Greater linkages between local bond markets and global bond markets The development of local currency-denominated bond markets help to improve the transmission mechanism of monetary policy. This supports the increasing use by central banks in the region of short-term policy interest rates as major operational targets in open market operations – shifting away from the traditional tool of controlling aggregate credit Siok K. Sek, Cheau P. Ooi, and Mohd. T. Ismail, “Investigating the Relationship between Exchange Rate and Inflation Targeting,” Applied Mathematical Sciences, Vol. 6, No. 32, 2012, pp. 1571–1583. BIS central bankers’ speeches volume and the frequent use of reserve requirements. As financial markets develop, it is likely that a cut in the short-term interest rate will affect longer-term interest rates more smoothly and thereby enhance the effects of monetary policy. The development of local currency-denominated bond markets has also enabled the region to reduce double mismatches (maturity and currency mismatches between assets and liabilities), thereby improving the balance sheets of the bond issuers – i.e., governments, firms, and financial institutions. The development of bond markets has also strengthened linkages with global financial and capital markets. As a result, the region has become more susceptible to movements in global market interest rates and the herding behavior of foreign investors. Some foreign investors tend to adjust their long positions relatively quickly by selling their holdings of securities issued by economies in the region when interest rate volatility suddenly rises. Moreover, some foreign investors take short positions over exchange rates to hedge their positions over securities. As a result, it is sometimes the case that the exchange rates depreciate suddenly without accompanying large-scale actual capital outflows and that the rate fluctuations expand. The fostering of domestic bond markets with an increased number of domestic institutional investors may help to enhance the resilience of the economy to various shocks, but this will probably take some time. Low policy interest rate and “follow-the-leader behaviour” Large-scale capital inflows are often motivated by interest rate differentials. This move seems to have been amplified by the aforementioned cross-border money market and bond market linkages. While bringing various favorable effects to the region, capital inflows put their central banks in a trade-off regarding the decision to set short-term policy interest rates. That is, on the one hand, an increase in the short-term policy interest rates (either as a result of tight monetary policy or of foreign exchange market intervention followed by sterilization) helps to lower inflationary pressures, but may invite a new round of capital inflows by foreign investors in search of higher yields. Such an increase may also damage exporting sectors through a sharp appreciation of their domestic currencies. On the other hand, a decline in the short-term policy interest rates (either as a result of monetary easing or of unsterilized foreign exchange market intervention) helps exporting sectors through the lower volatility of foreign exchanges and the limited appreciation of their domestic currencies. However, such a decline may increase inflationary pressures and cause real estate bubbles and financial imbalances. Taking this trade-off into account, some economies in the region tend to choose the latter option – namely, a decline in the policy interest rates – reflecting concerns over volatile exchange rates and an excessive appreciation (or misalignments). This is because high exchange rate volatility often leads to heightened volatility in output that in turn may well amplify the vulnerability of the economy. A volatile exchange rate also results in financial institution balance sheet fluctuations, thereby possibly destabilizing the financial intermediary functions. Consequently, some central banks that face large capital inflows tend to set lower short-term policy interest rates than normal – or lower than the interest rates that would have been adopted on the basis of certain monetary policy rules (such as the Taylor rule).5 This phenomenon is referred to as “follow-the-leader behaviour” in terms of setting short-term policy interest rates, since central banks in the region tend to set their short-term policy interest rates in line with the low interest rates set by major central banks in advanced economies – even if such policy interest rates may not necessarily be in line with domestic inflationary developments. This may lead to negative short-term interest rates in real terms. Chart 7 shows that some economies in the Asia-Pacific region maintained positive interest See Dong He and Robert N. McCauley, “Transmitting Global Liquidity to East Asia: Policy Rates, Bond Yields, Currencies and Dollar Credit,” BIS Working Papers, No. 431, 2013. BIS central bankers’ speeches rates in real terms before the global financial crisis, but have shifted to negative interest rates in real terms after the crisis. The shift is likely to be a response to a lower global interest rate and large capital inflows. Implications for the inflation-targeting economies In relation to the six inflation-targeting economies in the Asia-Pacific region, Australia and New Zealand have generally maintained positive short-term interest rates in real terms, except for some periods. In Australia, the real short-term interest rate has recently been negative. Meanwhile, in South Korea, Thailand, the Philippines, and Indonesia, real shortterm interest rates have occasionally become negative, and these rates have been at a low level as a trend since around 2010 when large capital inflows began to take place. Some studies show that the policy interest rates in Australia, Indonesia, Thailand, and the Philippines have been lower than the interest rates derived by the Taylor rule over the period.6 A similar relationship was observed after the global financial crisis in New Zealand and South Korea. These results imply that, depending on the situation, price stability might sometimes be compromised over exchange rate stabilization. As a domestic interest rate tends to be adjusted in response to a foreign interest rate, a central bank may be prevented to some extent from performing an independent monetary policy, which is suggested by the international finance trilemma. E. Extensive use of macroprudential policy to maintain financial stability Central banks in the Asia-Pacific region pay particular attention to financial stability. In Australia, the Governor of the RBA chairs the Council of Financial Regulators (CFR) that was established in 1998, and discusses macroprudential issues with other regulators. In South Korea, the Macroeconomic and Financial Committee (MFC) was established in 2012, with the Deputy Governor of the Bank of Korea (BOK) participating as a committee member. The MFC exchange views regarding the implementation of macroprudential policy with relevant regulatory authorities. In Malaysia, BNM established the Financial Stability Executive Committee (FSEC) at the bank in 2010, as a monitoring and coordinating committee on financial stability with all relevant supervisory agencies. In contrast to advanced economies, some economies in the Asia-Pacific region have been using macroprudential policy long before the global financial crisis. This is because such policy has been considered necessary to contain volatile capital inflows and the resultant financial imbalances. As mentioned earlier, macroprudential measures can be classified into (1) capital-based measures, (2) liquidity-based measures, and (3) asset-side measures. Some economies in the region use a mixture of the three measures, and while they are potentially useful when capital inflows are intermediated through cross-border banking activities, they might be less effective if capital flows take place through unregulated financial institutions. Despite the availability and use of a wide range of tools in the region, as yet there is no international consensus regarding their effectiveness. IV. Inflation performance in the Asia-Pacific region and future policy issues Now, I would like to examine inflation performance in the region and touch on the future direction of monetary policy conduct. See Andrew Filardo, “Ensuring Price Stability in Post-Crisis Asia: Lessons From the Recovery,” BIS Working Papers, No. 378, 2012. BIS central bankers’ speeches A. Performance of realized inflation and inflation expectations The Asia-Pacific region shows a more moderate inflation compared with the 1990s. In recent years, inflation has declined somewhat in some of these economies owing to a decline in global energy prices, the slack in global economies, and weak domestic demand. Inflation performance in the inflation-targeting economies Regarding the inflation-targeting economies, realized inflation underwent an occasional large deviation from the inflation target range over the period (Chart 8). In New Zealand and Indonesia, the deviation tended to exceed the upper range of the target, suggesting the presence of high upward inflationary pressures. Australia, South Korea, and the Philippines experienced deviations both from the upper and lower ranges, while Thailand had few deviations except for some periods. Since 2012, inflation in New Zealand and the Philippines has sometimes declined below the bottom of their respective target ranges, and inflation in South Korea has continued to stay below the bottom range of the target. By contrast, inflation in Indonesia has recently exceeded the upper range of the target – reflecting temporary factors such as a cut in fuel subsidies, upward inflationary pressures in food products, and new regulations related to imported foods. Some studies have pointed out that the inflation volatility in Indonesia further increased subsequent to the adoption of the inflation-targeting framework.7 This is partly explained by the extensive use of administered prices to contain inflation prior to the adoption of the inflation-targeting framework. Overall, an examination of the six economies shows that inflation tends to eventually converge to the target range even after experiencing a deviation from it for some time (Chart 8). To judge the progress in the monetary policy conduct under the inflation-targeting framework, one way is to examine whether their long-term inflation expectations have stabilized and remain within the inflation target range. In general, long-term inflation expectations (e.g., five years) have become more stabilized than short-term expectations (e.g., one year) for all six economies that adopt the framework (Chart 8). Short-term inflation expectations have been more volatile in general and often deviate from the target range since they tend to reflect global commodity and food prices as well as the prices of frequently-purchased goods and services.8 Long-term inflation expectations have become stabilized at around 2–3 percent in Australia, New Zealand, South Korea, and Thailand. While inflation expectations of the first three economies remain within the target range, those of Thailand have risen moderately since 2010 and have slightly exceeded the upper range of the target since end-2010. Inflation expectations in the Philippines and Indonesia have been higher than in these four economies, but have stabilized at around 4 percent and around 5 percent, respectively, within the target range. Their relatively high inflation expectations may be due to a persistent supply shortage in foods, beverages, and energy. On the whole, the inflation-targeting economies appear to have succeeded in anchoring their inflation expectations. These results suggest that inflation tends to converge to the long-term inflation expectation level, so that any deviations from the target range are not sustained. Another way to judge the effectiveness of the monetary policy conduct under the inflationtargeting framework is to examine whether a decline in inflation persistence (or the extent of dependence of current inflation on past inflation) is observed. Some studies point out that such declines are actually observed among five of the inflation-targeting economies (with the Andrew Filardo and Hans Genberg, “Targeting Inflation in Asia and the Pacific: Lessons from the Recent Past,” in The International Financial Crisis and Policy Challenges in Asia and the Pacific, BIS Papers, No. 52, 2010. See, for example, Jun II Kim and Jungick Lee, “How Important Are Inflation Expectations in Driving Asian Inflation?” in Globalisation and Inflation Dynamics in Asia and the Pacific, BIS Papers, No. 70, 2013. BIS central bankers’ speeches exception of Indonesia), compared with the 1990s. Such a decline in inflation persistence has not materialized for the non-inflation-targeting economies; hence, the results may imply the effectiveness of the inflation-targeting framework in the region. Other studies highlight that inflation persistence in Australia, New Zealand, and South Korea is lower than in the other inflation-targeting economies in the region, and that such low inflation persistence in these three countries could be attributable to the relatively large sizes of their economies, their relatively developed financial systems, and/or the high degree of policy priority given to price stability.9 Inflation performance in the non-inflation-targeting economies Inflation performance has also improved in the non-inflation-targeting economies (Chart 8). China’s inflation dropped drastically in the late 1990s, and has thereafter maintained a more stable level than previously. Malaysia’s inflation performance has somewhat stabilized with the exception of the period immediately subsequent to the global financial crisis. The inflation environment became somewhat volatile in Singapore in the wake of the global financial crisis, shifting from low inflation or mild deflation to somewhat higher inflation. Regarding long-term inflation expectations, in China these have stabilized at around 3 percent with both short- and long-term inflation expectations stabilizing and becoming closer in recent years. In Malaysia, long-term inflation expectations have stabilized at around 2–3 percent. Singapore’s inflation has fluctuated somewhat largely, but its inflation expectations have remained stable at around 2 percent. The relatively stable inflation expectations of these economies may imply that their monetary policy conducts are placing a higher priority on price stability. Differences between inflation-targeting and non-inflation-targeting economies The six inflation-targeting economies regard short-term policy interest rates as their operational target for monetary policy. This is confirmed by the observation that the policy interest rates are relatively responsive to actual inflation developments (Chart 7). Nevertheless, the policy interest rates tend to remain low after the global financial crisis or during massive capital inflows. This may reflect the follow-the-leader price setting behavior mentioned earlier. Meanwhile, China and Malaysia, the two non-inflation-targeting economies, also use shortterm policy interest rates. However, these economies do not adjust their policy interest rates as frequently as inflation-targeting economies and therefore, such rates in these economies have remained flat. Thus, inflation and real policy interest rate movements frequently tend to exhibit an inverse movement like a mirror image. This may be because China and Malaysia also use various tools other than policy interest rates. For example, both countries often adjust the reserve requirements to control inflation, while China also uses window guidance, credit volume controls, and deposit-to-loan ratio requirements. The reserve requirement is regarded as a liquidity-based measure under macroprudential policy and is frequently used by many emerging economies as a counter-cyclical measure against business and financial cycles. Regardless of the measures used, all of the economies in the region have generally managed to stabilize long-term inflation expectations. Thus, it can be said that these economies have been more or less successful in terms of achieving price stability. Stephan Gerlach and Peter Tillmann, “Inflation Targeting Matters in Asia,” Column published on VoxEU.org, Centre for Economic Policy Research, 2010; Andrew Filardo and Hans Genberg, “Targeting Inflation in Asia and the Pacific: Lessons from the Recent Past,” in The International Financial Crisis and Policy Challenges in Asia and the Pacific, BIS Papers, No. 52, 2010. BIS central bankers’ speeches B. Future possible direction of monetary policy conduct As mentioned earlier, one issue regarding monetary policy in the Asia-Pacific region is how to mitigate the business cycles that are amplified by the monetary policy conduct. Some of the monetary policy conduct of the region could occasionally be pro-cyclical – i.e., monetary policy strengthens economic cycles, with accommodative monetary policy during a period of capital inflows and high economic growth, and with tight monetary policy during a period of capital outflows and sluggish economic growth. This could possibly be a source of deviation from the inflation target for a longer period than anticipated. As a potential way to address this problem, the inflation-targeting economies in the region may increasingly align their frameworks to those of advanced economies, in terms of target flexibility and design. In this regard, should they wish to consider a shift from an inflation target range to a target point, the experience of the United Kingdom could provide a useful guide.10 The country shifted from a target range – which it had introduced in October 1992 – to a target point in 1995, primarily to eliminate any ambiguity relating to the inflation rate (and inflation expectations) at which a central bank should conduct monetary policy. There appeared to be a “range bias” in 1992–1995 when there was an inflation target range of 1–4 percent: inflation expectations derived from the yield curve were stuck at the top of the range. It appears that there were increasing concerns over a possible misunderstanding, as if policy makers considered any level within the range to be indifferent. After the shift to an inflation target point, inflation expectations fell steadily as range bias was ironed out. New Zealand has already moved in this direction by emphasizing the midpoint of 2 percent in their inflation target range. Elements of an inflation-targeting framework, such as (1) whether the inflation target should be expressed in a target range or a target point, (2) whether the target should be reviewed relatively frequently or fixed, and (3) whether the inflation target is set to be achieved within a pre-fixed term or the (fixed) inflation target is set to be achieved over the medium term on average, should be determined by each economy based on their specific economic and financial market circumstances. Economies in the region may wish to consider whether the changes in their inflation-targeting framework design may lead to smaller and shorter deviations from the inflation targets and to more stable long-term inflation expectations. In this regard, the previous experience of the inflation-targeting economies in the region may provide a guide for the non-inflation-targeting economies to tackling the various issues they may face. These initiatives may require adjustments in the economy and the financial markets and thus will take some time. On this point, one of the key necessary adjustments includes development of hedging tools to deal with exchange rate fluctuations in the region, as well as of deeper financial and capital markets. In addition, it has been pointed out that some economies in the Asia-Pacific region have reduced their vulnerabilities to exchange rate movements, and thus gradually mitigated their need to stabilize exchange rates.11 Moreover, as the national income levels of these regional economies increase, the weight of consumption (particularly in services) rises, and thus these economies become less affected by exchange rate fluctuations. In some Asia-Pacific economies, an increasing number of firms and financial institutions are becoming multinationals. Firms and financial institutions are diversifying their settlement currencies for economic transactions and their funding sources, and are mitigating impacts from the exchange rate fluctuation. In such economies, price stability may be steadily achieved See Andrew Haldane, “Targeting Inflation: The United Kingdom in Retrospect,” a presentation made at the IMF Seminar held in Rio de Janeiro, Brazil on May 3–5, 1999. In the United Kingdom, moreover, not reaching the 2 percent target is considered to be equally as bad as exceeding the target, and in cases where the actual inflation is not in the 1–3 percent range, the Governor of the BOE must send a public letter to the Chancellor of Exchequer to explain the reason and to give the planned means of addressing the situation. See, for example, Michael B. Devereux and James Yetman, “Globalisation, Pass-Through and the Optimal Policy Response to Exchange Rates,” BIS Working Papers, No. 450, 2014. BIS central bankers’ speeches through reviewing their inflation-targeting framework based on the accumulated lessons of other economies. V. Conclusions on the monetary policy conduct in the Asia-Pacific region Let me now summarize my views on the monetary policy conduct in the Asia-Pacific region. • First, central banks of the region have focused more on price stability than on exchange rate stability in the aftermath of the East Asian economic crisis. Specifically, six central banks took the lead on this by adopting an inflation-targeting framework with a clear numerical inflation target. The realized inflation and inflation expectations of these economies have gradually shown a downward trend in line with their targets compared with the 1990s. While there are occasional large deviations from the inflation target range, these have not been sustained for a long period. This suggests that inflation has a tendency to converge to the long-term inflation expectation level, which has remained largely within their target ranges. In most economies, their long-term inflation expectations appear to be converging to around 2–3 percent. • Overall, the monetary policy conduct in the region shows some degree of convergence, and increasingly entails the elements commonly observed in advanced economies. Going forward, the region’s inflation-targeting economies may possibly share more common features with advanced economies through further alignments. The design of an inflation-targeting framework, such as (1) whether the inflation target should be expressed in a target range or a target point, (2) whether the target should be reviewed relatively frequently or fixed, or (3) whether the inflation target is set to be achieved within a pre-fixed term or over the medium term on average, should be determined by each economy based on its specific economic and financial market circumstances. Nevertheless, the experiences accumulated in other economies may provide some useful guidelines. • Second, the region allows greater exchange rate movements compared with the 1990s. However, the degree of flexibility varies widely -- ranging from free floating to a de facto exchange rate anchor to the U.S. dollar. Like many non-inflation-targeting economies, some inflation-targeting economies continue to intervene in the foreign exchange market. • Third, the region often faces large capital inflows partly owing to the interest rate differentials. Developments in domestic bond markets have generated many benefits for the region, but have also enhanced linkages with global financial and bond markets, thereby inducing changes in capital flows. The resultant greater volatility of exchange rates and overvaluation of the currency, and their adverse impacts on the economy have been pointed out as serious concerns. As a result, some economies occasionally set a low policy interest rate in response to a decline in the global interest rate. • This, however, might lead to a greater positive output gap in the economic expansionary phase, thereby overheating the economy and promoting rapid credit growth and increasing inflationary pressures. This may not only amplify the boombust business and financial cycles, but also deteriorate the current account balance. It may also incur the risk of undermining a central bank’s credibility by failing to fulfill its price stability mandate in the inflation-targeting economies. Going forward, economies in the region may need to prepare for more volatile interest rate movements in the face of global interest rate hikes as the global economy gradually recovers. This in turn may provide these economies with more room to conduct an independent monetary policy. BIS central bankers’ speeches • Fourth, to cope with excessive capital flows and associated accumulation of financial imbalances, economies in the region frequently use a wide range of macroprudential policy measures. Their effectiveness depends largely on countryspecific economic and financial market circumstances. Questions such as what macroprudential measures should be taken to cope with financial imbalances, or what is the correct balance between macroprudential policy and monetary policy, remain unsettled, and an international consensus has not yet been formed. • Going forward, further discussions are expected among central banks, regulatory institutions, and other policy makers on the issue of how to achieve price stability, sustainable economic growth, and financial stability. I hope that such discussions, through sharing each other’s experiences and lessons learnt from the past, will lead to some useful insights into monetary policy conduct implications. This concudes my speech. Thank you very much for your kind attention. 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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 4th Bank of Thailand Policy Forum, Bangkok, 24 July 2014.
Haruhiko Kuroda: Asia’s contribution to the global economy – prospects and challenges for the transition to domestic demand-led growth Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 4th Bank of Thailand Policy Forum, Bangkok, 24 July 2014. * 1. * * Introduction Governor, distinguished guests, ladies and gentlemen, Thank you for inviting me to the 4th Bank of Thailand Policy Forum. It is a great honor to address such distinguished guests who are leading the Thai economy. I would like to extend my heartfelt gratitude to Governor Prasarn Trairatvorakul for giving me this valuable opportunity. Thailand was the first Southeast Asian nation to establish diplomatic relations with Japan, and the year 2017 will mark the 130th anniversary of this significant event. The two countries have been engaged in active cultural exchange at least since the Ayutthaya dynasty. In more recent years, our two nations have established close ties as important economic partners, providing support to each other in times of difficulty. The Bank of Japan received generous donations from the Bank of Thailand and the Bank’s staff to help the victims of the Great East Japan earthquake in 2011. All of us at the Bank of Japan remain deeply grateful for this kindness. I learned about these donations immediately after I became Governor of the Bank and felt deep reverence for and strong gratitude to our friends in Thailand. I would like to take this opportunity to renew our thanks. Thailand is a key base in Southeast Asia for the economic activities of Japanese firms, of which more than 1,500 are members of the Japanese Chamber of Commerce in Bangkok. Last year, Japan was Thailand’s largest importing trade partner, and its third largest export destination. The very close ties between the two countries are shown in the results of a survey conducted by the Ministry of Foreign Affairs of Japan, where 97 percent of the people in Thailand regarded Japan as a friendly nation. Today, I would like to share with you my views on Asia’s contribution to global economy. These views are based on my 16 months’ experience as Governor of the Bank of Japan, and my 8 years as President of the Asian Development Bank before that. I. A change in growth model for the Asian economies Even when growth in the major advanced economies slowed considerably following the global financial crisis, the Asian economies continued to register solid growth. Moreover, the region’s economies have contributed significantly to the recovery and subsequent growth of the global economy. The Asian economies accounted for two-thirds of the recent growth of the global economy (Chart 1). The Asian economies have benefited greatly from sophistication of global supply chains and trade liberalization. Exports have played a leading role in the region’s high economic growth. Asia’s industrial base was built upon the combination of foreign capital and a plentiful, diligent, well-educated labor force. This industrial base has boosted export-led growth in Asian economies. In recent years, however, domestic demand, primarily consumption, has also begun to play an increasingly important role. This is not only China, India, and Indonesia, with the largest populations in the world, but other Asian economies too. Asian economies have enjoyed rising income levels and have seen the emergence of a middle consumer class that actively purchases goods and services from around the world. A virtuous cycle among production, income, and spending in the region has given rise to growing domestic demand, which has contributed to the growth of the global economy. This BIS central bankers’ speeches suggests that a more balanced growth model is emerging in Asia, to replace the conventional model of export-led growth that depended on demand from advanced economies (Chart 2). II. Fundamental background to the expansion of domestic demand Rising domestic income levels created an affluent and aspiring middle class during the phase of demographic dividend with an increase in the proportion of the working-age population. This is the fundamental background to the expansion in domestic demand in the Asian economies. First, many rural residents moved to more developed urban areas. This increase in labor supply led to an increase in aggregate supply capacity and to improved export competitiveness. The improvement in household incomes, especially for residents in urban areas, has led to a rise in consumption and an increase in aggregate demand. Second, the growth of the middle class boosted demand for higher value-added goods and services. In response to this increased demand, there was parallel progress in the supply side. Wider use of foreign technology in production facilities of domestic industries, for instance, brought improvements in productivity. However, some medium- and long-term challenges need to be addressed to ensure a smooth transition to a well-balanced economic growth that combines both exports and domestic demand. These challenges include demographic changes, as well as the risks of excessive credit expansion under high economic growth and destabilization of the financial system. Let us consider some possible countermeasures to these challenges, based on Japan’s experience. III. Demographics and domestic demand: Japan’s experience Japan is in the midst of dealing with some significant demographic challenges of an ageing population and a decline in the overall size of the population. In Asia, China and Korea are next in line to phase out of demographic dividend into demographic onus. Thailand is not far behind. Let me talk about the experience of Japan. The transition from demographic dividend to demographic onus brings with it a series of problems. Perhaps the most pressing of these problems are a decline in the potential growth rate, a deterioration in the fiscal balance, and intergenerational income transfers. These problems put downward pressure on the growth of domestic demand. In Japan, the potential growth rate has been pushed down by a decline in labor input. There are two reasons for this decline. First, the number of workers has declined due to demographic changes. Second, working hours have become shorter as the economy has matured. Firms’ slow response to demographic changes has contributed to sluggish growth in aggregate capacity to supply goods and services that reflect the changing environment. The demographic onus has also led to deterioration in fiscal deficits, impairing the pension and health-care insurance systems. Delays in reforms to these social security systems have increased the burden on future generations and raised the issue of intergenerational income transfers. There has been a growing consensus in Japan that greater efforts are needed to address the adverse effects of demographic changes. These efforts are expected to provide new growth momentum for Japan’s economy. For example, there has been progress in initiatives to raise the labor participation rate of women and the elderly, to address the decline in the number of workers. There have also been initiatives to attract more highly-skilled foreign workers. Firms are also making headway in areas such as retail, tourism, medical and nursing services in an effort to provide goods and services for the elderly and families with small children. While demographic changes can be predicted quite accurately, reversing them is extremely difficult. However, as is often the case when problems seem too serious or difficult, initiatives BIS central bankers’ speeches to address those problems tend to be put off. Although Japan’s working-age population started to decline in the mid-1990s, concrete action was taken only after the total population started to decline in the latter half of the 2000s. Japan’s experience thus suggests that it is crucial not only to debate the challenges posed by the demographic onus, but also to take the necessary action at an early stage. Prompt action is needed to preserve the growth momentum of the domestic demand-led economy in Asia. IV. Global monetary accommodation and domestic credit growth High economic growth is often associated with an increase in domestic credit. The current growth in domestic demand in Asian economies is mainly driven by domestic structural factors such as the increase in the middle consumer class. But, it has also been reinforced by a combination of global monetary accommodation and the concomitant expansion in domestic credit. History tells us that bubbles often arise when people’s expectations become bullish due to the experience of continued high growth and domestic demand expansion. Examples of such situations where domestic demand growth became excessive and ill-balanced are now all too familiar. We saw this in the bubble economy in Japan, in the housing bubble in the United States, and in the overheating in real estate markets in peripheral European countries. These economies eventually fell into financial crises. And the symptoms were common in each case: a rapid increase in credit and an emergence of euphoria based on the belief that the country had entered a new phase. There is also the danger of an unsustainable increase in domestic credit reliant on short-term foreign borrowings. This is due to the lack of deep domestic financial markets. The current global accommodative financial conditions raise the possibility of unhealthy global capital flows into Asian economies. Such capital flows could result in the build-up of distortions and risks in the financial systems of these economies. For example, several economies have seen considerable increases in real estate prices partly due to foreign capital inflows. Needless to say, if there were a substantial decline in real estate markets, nonperforming assets could pile up in the financial sector. Such a scenario could hamper growth substantially and for a prolonged period, depending on the magnitude of the problem. To prevent such distortions and risks from building up, commercial banks and financial supervisory authorities need to enhance their credit risk management capacity. They need to instill a credit culture in which credit is proactively managed in response to changes in the environment. These actions could be effective throughout Asian economies. Another possible course is to use macroprudential policy. While discussions on macroprudential policy continue, particularly in the United States and Europe, some Asian economies have already gone ahead and introduced them. For instance, the Bank of Thailand has implemented policy measures such as LTV limits for mortgage loans. Further improvements in financial infrastructure are also crucial; for example, in accounting practices, corporate governance, and the judicial system. At the same time, authorities should make efforts to further develop domestic financial markets so that financial intermediaries can make effective use of domestic savings. The appropriate mix of these policy measures may differ from country to country, depending on each country’s policy objectives and financial system. Still, it is important for any economy to pursue sound macroeconomic policies as well as efforts to enhance the robustness of its domestic financial system. There are some key factors to pursue so that Asian economies can continue to enjoy domestic demand-led growth. The first is efforts to prevent any excessive expansion of credit with help of appropriate prudential policies. The second is actions to ensure that the financial system remains sufficiently robust to withstand any economic shocks. The third is to maintain the resilience of the financial system to be restored after any damage from such shocks. BIS central bankers’ speeches V. Initiatives to improve regional safety nets Such strengthening of the domestic financial system will also help to prepare for shocks generated abroad. Concerns have been expressed regarding the impact of monetary policy in advanced economies on international capital flows. There was a period of market volatility after May last year due to heightened speculation about a withdrawal of monetary easing measures in the United States. During that period, some countries suffered large capital outflows. These are countries where structural vulnerabilities such as current account or fiscal deficit were a concern. This highlights the importance of addressing structural weaknesses from a medium- to long-term perspective. It is also important to establish regional safety nets to prepare for possible external shocks. Regional safety nets increase confidence in a country’s financial system and economy, and reduce the threat of a financial crisis. A prime example of such a regional safety net in the Asian region is the Chiang Mai Initiative Multilateralisation (CMIM). This initiative, involving the ASEAN countries, together with China, Japan and Korea, has been expanded to provide a backstop in case any of the countries faces a short-term liquidity shortage. The role that safety nets play may also be affected by changes in the activities of firms and financial institutions in Asia. With Asia no longer serving as a production base for exports only, but also representing a major consumer market, global firms have been actively expanding in Asian markets and have been localizing their businesses. For instance, in order to capture the growing domestic demand in Asian economies, Japanese manufacturing firms have been increasing local production. Japanese firms also have been focusing on local consumers in a wide range of businesses, including retail and other services. In response to these developments, Japanese banks have been making efforts to further localize their Asian business. For firms expanding their businesses in Asia, securing stable funding in the local currency is becoming a challenge. To meet this challenge, it is important to establish ways in which firms can obtain local funds from banks. Development of domestic financial markets can provide banks with stable access to liquidity and underpin their provisioning of funds to firms. This will not only contribute to stabilizing the domestic financial system in Asian economies, but also create a virtuous cycle encouraging the entry of more global firms and the localization of their businesses. The challenge for central banks is to nurture a sound banking system that ensures secure funding and fosters liquid interbank markets. The availability of local currency funding differs across countries, depending on the stage of development of money markets and of funding tools using collateral. The Bank of Japan has agreed on cross-border collateral arrangements with other Asian central banks as one of the backstops for developing financial markets in this region (Chart 3). For example, with the Bank of Thailand, the Bank of Japan has already established a framework providing Thai Bahts to financial institutions against Japanese government securities and Japanese Yen as collateral. In running a regional safety net, it is important to monitor carefully the regional financial and economic conditions. It is also necessary to share relevant information among the region’s countries in a timely manner. Information on macroeconomic policies and the challenges that each country faces should be exchanged on a regular basis. At the same time, it is essential to create a network of swift information sharing and rapid response to sudden changes in international financial markets. To help strengthen such cooperation among central banks, the Bank of Japan has been actively participating in the Executives’ Meeting of East AsiaPacific Central Banks (EMEAP), together with the Bank of Thailand and other Asian central banks. BIS central bankers’ speeches Concluding remarks Compared with European countries, Asian countries are much more diverse in terms of their economic and social makeup, so that the challenges of managing the economy vary significantly. At the same time, however, Asian economies face challenges similar to those of other economies, including the advanced economies. Therefore, active discussion in the region to share the experience and wisdom in Asian economies can also be beneficial to other regions. Asian countries can make a substantial contribution to the global economy not only by achieving sustainable growth that balances both domestic and external demand, but also by playing an active role in discussions toward global challenges. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hyogo, 31 July 2014.
Takahide Kiuchi: Recent developments in economic activity, prices and monetary policy Speech by Mr Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hyogo, 31 July 2014. * I. * * Economic developments I would like to start my speech with a look at developments in Japan’s economy. It has continued to recover moderately as a trend, although a subsequent decline in demand following the front-loaded increase prior to the consumption tax hike has been observed. With regard to the outlook, the economy is expected to continue its moderate recovery trend, and the effects of the subsequent decline in demand are expected to wane gradually. In the Bank of Japan’s interim assessment in July of the April 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the forecasts for the economic growth rate and year-on-year rate of increase in the consumer price index (CPI, all items less fresh food, and the same hereafter) are broadly in line with the April forecasts. A. Domestic demand Looking at domestic demand, private consumption has remained resilient as a trend, although a subsequent decline in demand following the front-loaded increase prior to the consumption tax hike has recently been observed. For example, sales at department stores increased markedly in the January–March quarter of 2014 due to the front-loaded increase in demand; they fell back considerably in April compared to that quarter as a result of the subsequent decline in demand, but a pick-up has been observed since May. In addition, judging from interviews with firms and other relevant information, there are indications that the degree of the subsequent decline in demand has been broadly in line with expectations. As for the employment and income situation, supply and demand conditions in the labor market have continued to improve steadily, as evidenced by the fact that the active job openings-to-applicants ratio for June reached the highest level since June 1992. Supported mainly by the improvement in the employment and income situation, private consumption is expected to remain resilient, and the effects of the subsequent decline in demand following the front-loaded increase are expected to wane gradually. The improving trend in business fixed investment has become increasingly evident. According to the second preliminary estimates of GDP statistics for the January–March quarter of 2014, real business fixed investment showed a quarter-on-quarter increase of 7.6 percent; thus registering a significant rise for the first time in almost two years. This appears to reflect, to a considerable extent, temporary factors such as renewal demand for PCs in line with the ending of support for software; nevertheless, the uptrend in business fixed investment was reaffirmed by the fact that real business fixed investment increased for four consecutive quarters. Business fixed investment is likely to fall back temporarily in the April–June quarter following the substantial increase in the previous quarter, but is projected to follow a moderate increasing trend as corporate profits continue their improving trend. B. Exports and overseas economies On the other hand, exports have recently leveled off more or less. The slow growth in exports is basically due to the weakness in emerging economies, including ASEAN economies that have strong ties with Japan’s economy. In addition, a greater-than-expected slowdown in the U.S. economy in the January–March quarter of 2014, mainly due to the effects of the unusually severe winter weather, as well as continued movements mainly by Japanese BIS central bankers’ speeches automakers to expand their overseas production through the year, may be exerting downward pressure on exports with a time lag. Regarding the environment surrounding exports, overseas economies – mainly advanced economies – have been recovering, albeit with a lackluster performance still seen in part. Looking at movements by major region, in the U.S. economy, the moderate recovery – led mainly by private demand – is becoming firm, aided in part by improvement in the employment situation as the effects of the unusually severe winter weather have dissipated. The European economy has been recovering moderately, with business and household sentiment continuing to improve, although the employment and income situation remains severe. The Chinese economy continues to see relatively stable growth, albeit at a somewhat lower level than before. Meanwhile, some emerging economies apart from China and commodity-exporting economies continue to lack momentum on the whole, although signs of improvement have started to be seen in some economies. As for the outlook, overseas economies are expected to recover moderately, led mainly by advanced economies – the United States in particular. This is expected to gradually exert positive effects on Japan’s export environment. C. Prices Next, I would like to talk about price developments in Japan. The year-on-year rate of increase in the CPI has been around 1¼ percent. The rate of increase was 1.3 percent for four consecutive months from December 2013 through March 2014 and, on a basis excluding the direct effects of the tax hike, marked 1.5 percent for April, 1.4 percent for May, and 1.3 percent for June. The fact that the rate of increase has been generally at around the same level even after April suggests that the tax increase has been passed on to prices on the whole, on the back of resilient private consumption. With regard to the outlook, the year-on-year rate of increase in the CPI is likely to be around 1¼ percent for some time, as upward pressure from import prices – in particular energy prices – will likely wane, while underlying inflationary pressure – due mainly to the improvement in the output gap – will increase. II. Major points to be considered with regard to the outlook for economic activity and prices As I have mentioned, earlier this month, the Bank made an interim assessment of the prospects for economic activity and prices through fiscal 2016 presented in the April 2014 Outlook Report. As for the Bank’s baseline scenario regarding economic activity, I personally pay attention to the existing risk both on the supply and demand sides that may lead to a weaker-than-expected economic growth rate, although the economy is expected to continue recovering moderately. As for prices, I also hold a more cautious view of the outlook compared with the forecasts in the baseline scenario. Let me share some of my considerations regarding the outlook with you. A. Output gap and potential economic growth rate The Bank estimates that the output gap in Japan turned positive for the first time in almost six years since 2008, to 0.6 percent for the January–March quarter of 2014. While such estimates are subject to a considerable margin of error, they have been in line with developments in the weighted average of the diffusion indices for production capacity and employment conditions in the Bank’s Tankan (Short-Term Economic Survey of Enterprises in Japan). Therefore, we can view as confirmed that supply and demand conditions in the economy are gradually tightening further. In particular, a clear tightening trend of supply and demand conditions in the labor market has been observed, as evidenced, for example, by the fact that the active job openings-to-applicants ratio for June 2014 was at a high level, as I BIS central bankers’ speeches mentioned earlier, and that the unemployment rate – which has been hovering at a low level of around 3¾ percent recently – registered 3.7 percent the same month. On the other hand, the potential growth rate of the economy remains at a low level, and therefore supply-side constraints are likely to eventually surface if the economy continues to grow at the current pace. This suggests that, although such constraints will contribute to pushing up wages and prices temporarily, the real economic growth rate might not rise easily. B. Exports Although exports were expected to increase from April due to an expansion of firms’ spare capacity for exports following the tax hike, they have continued to lack momentum so far. Rather, from a somewhat longer-term perspective, it seems that real exports are not just experiencing temporary weakness, but have been mostly unchanged on average since the Lehman shock. This seems to reflect the following developments. Due to the Lehman shock, appreciation of the yen, Great East Japan Earthquake, and other factors, risks to the crossborder supply chain system became apparent, and this triggered changes in the structure of production and trade, particularly in Asian economies; in this process, the responsiveness of exports to overseas demand has declined significantly. Moreover, it has been pointed out that, since the global financial crisis, the pace of increase in trade has been declining relative to the pace of growth in the global economy. These developments in Japan’s exports could also be associated with such a change in the structure of the global economy. As for developments in overseas economies that are a key determinant of Japan’s export environment, I am paying utmost attention to the risk of weaker-than-expected growth for the Chinese economy. It seems to be stable recently, mainly due to the stimulus measures, but if the growth rate declines due to adjustments in the real estate market, this will have negative effects on peripheral Asian economies and in turn on Japan’s export environment. C. Private consumption Although it will still take considerable time to accurately determine the effects of the consumption tax hike on private consumption, it is very likely that the decline in consumption following the front-loaded increase in demand prior to the tax hike will be relatively shortlived. It should be noted, however, that the scale of the temporary decline in consumption was considerable. On a seasonally adjusted quarter-on-quarter basis, sales at retail stores for the January–March quarter of 2014 increased by 3.9 percent, but declined by 7.0 percent for the April–June quarter. Moreover, according to the Family Income and Expenditure Survey, on a quarter-on-quarter basis, real consumption expenditures for the January–March quarter increased by 4.6 percent, but declined by 9.4 percent for the April–June quarter. Let us now examine developments in income in relation to those in consumption. For the January–March quarter, the year-on-year rate of change in real compensation of employees registered minus 0.6 percent, which was significantly lower than the 3.7 percent increase in real private consumption. In a situation where real wages per employee are likely to continue declining for the time being, the pace of improvement in real compensation of employees is likely to be moderate. In such a case, the uptrend in private consumption may weaken, leading to a slower rise in the inflation rate. Thus, careful monitoring of future developments is required. Nevertheless, I personally consider that, even if the uptrend in private consumption weakens slightly, this will not necessarily have negative effects on the economy in the long run. This is because a significant imbalance is currently observed among the paces of increase in the variables of prices, wages, and private consumption; for example, real wages seem to be continuing to decline, even on a basis excluding the temporary effects of the tax hike. In such a situation, if weaker growth in private consumption restrains the rise in the inflation rate, it is expected that real wages will increase and private consumption will continue growing BIS central bankers’ speeches moderately at a pace in line with this wage increase. If demand increases in this way at an appropriate pace in a situation where supply-side constraints are beginning to be acknowledged, a more balanced and prolonged economic recovery, albeit moderate, will likely be achieved. D. Outlook for prices As for the outlook for prices, I take a more cautious view than the forecast in the Bank’s baseline scenario. Therefore, I formulated a proposal to change the expression regarding the outlook for prices in the April 2014 Outlook Report, although it was defeated by a majority vote during the Monetary Policy Meeting. Specifically, I proposed to change the expression that the year-on-year rate of increase in the CPI “is likely to be around 1¼ percent for some time, follow a rising trend again from the second half of this fiscal year, and reach around 2 percent around the middle of the projection period” to a new expression that it “is likely to remain generally stable around the current level over time”. I consider that, for the time being, developments in prices will depend mainly on the balance between strengthening of trend inflationary pressure – due mainly to the improvement in the output gap – and waning of upward pressure from import prices. On this point, there seems to be uncertainty regarding whether the upward pressure on prices that reflects the improvement in the output gap will outweigh the price decline caused by a fall-off of the effects of the weak yen. This is because (1) it remains uncertain how much the tightening of labor supply and demand conditions will contribute to pushing up overall wages and (2) consumers might find it difficult to accept firms’ passing on of increases in wages to sales prices, unlike in the case of a passing on of increases in materials prices to sales prices. Of course, we cannot rule out the possibility that the rates of increase in wages and prices will be higher than expected against the background of factors such as stronger-thanexpected tightening of supply and demand conditions. In such a case, however, the rise in the inflation rate will likely lack sustainability given that the growth rate of the economy would not rise easily, due to its limited growth potential, and that the economy would become unstable. In addition, it is difficult to expect that medium- to long-term inflation expectations will increase in a stable manner in such a case. Therefore, I do not think that such a situation will lead to achieving the price stability target, whereby the Bank aims at maintaining the inflation rate at around 2 percent in a stable manner. III. Conduct of monetary policy In April 2013, the Bank introduced quantitative and qualitative monetary easing (QQE) with a view to achieving the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI at the earliest possible time, with a time horizon of about two years. In aiming to achieve the price stability of 2 percent, the Bank has committed to continuing with QQE as long as it is necessary for maintaining the target in a stable manner. More than one year has passed since the introduction of QQE. So far, it has been exerting its intended effects. Since the introduction of the policy, however, while supporting the concrete measures of QQE, I have continued to propose (1) not to restrict the time frame for achieving the 2 percent price stability target to about two years, but to aim to achieve it in the medium to long term and (2) to designate QQE as an intensive measure with a time frame of about two years, and thereafter to review the monetary easing measures in a flexible manner, although my proposal has been repeatedly defeated by a majority vote during the Monetary Policy Meetings. Let me explain the background to my proposal, as well as my personal views on some points of discussion regarding the conduct of monetary policy. A. Developments in three gaps I have supported the concrete measures of QQE because I considered that they would open up significant opportunities in terms of three aspects. First, the measures would provide an BIS central bankers’ speeches opportunity on the demand side to create a virtuous cycle by stimulating the economy. Second, they would offer an opportunity on the supply side to encourage the government’s growth strategy that contributes to strengthening the growth potential of Japan’s economy and its fiscal consolidation, as well as positive actions by firms and households. And third, the measures would afford an opportunity to restore the effectiveness of the conventional interest rate policy, as zero interest rates produce stimulative effects on the economy through an improvement in economic and price conditions. In this regard, I consider that QQE has already made considerable achievements, judging from developments in the following three gaps. First, when the economy faces a shortage of demand, it is generally regarded that the role of monetary easing measures is to close the negative output gap by stimulating the economy from the demand side. As I explained earlier, the negative output gap in Japan seems to have closed for the first time in almost six years, according to the Bank’s estimate. Second, the gap between the observed inflation rate and the medium- to long-term expected rates of inflation has narrowed. Until recently, although the medium- to long-term expected rates of inflation had generally been in positive territory as a trend, observed prices had long been experiencing a mild decline. Consequently, price stability was not achieved, placing the economy in an undesirable situation. However, observed prices have risen markedly since 2013. I personally take the view, however, that rises in prices to date have been affected significantly by the temporary factor of the weak yen, and that the underlying trend in the observed inflation rate that mainly reflects improvement in the economic environment is more moderate. Still, the gap between the underlying trend in the observed inflation rate – on a basis excluding the effects of the weak yen – and the medium- to long-term expected rates of inflation seems to have narrowed to a considerable extent. Third, it is estimated that (1) reflecting the narrowing of the output gap and the rise in prices, the level of the policy interest rate derived from the Taylor rule has recently been on a rising trend; and thus (2) the negative gap between the actual short-term interest rates – which are virtually at around zero percent – and the derived policy interest rate has turned positive and has been widening. This suggests the possibility that the effects of zero interest rates might strengthen gradually. B. Price stability target and medium- to long-term inflation expectations As I have explained, developments in economic activity and prices have been on an improving trend. However, to achieve the price stability target of 2 percent, I think that it is necessary that a wide range of economic entities make use of the benign financial environment brought about by QQE and make continuous efforts to strengthen the economy’s growth potential. I personally hold the view that, even if such efforts proceed smoothly, it will require considerable time for the growth potential to increase sufficiently. For this reason, since the introduction of QQE, I have continued to propose at Monetary Policy Meetings not to restrict the time frame for achieving the 2 percent price stability target to about two years, but to aim to achieve it in the medium to long term. The price stability target of 2 percent aims to maintain the 2 percent inflation rate in a stable manner, and not to merely reach it temporarily. In order to achieve this, it is a necessary condition that firms’ and households’ medium- to long-term inflation expectations – on which basis they carry out their economic activities – increase to about 2 percent and remain stable at that level. I think that medium- to long-term inflation expectations in Japan are mainly determined by supply-side factors such as the potential growth rate and the labor productivity growth rate, rather than by the level of the Bank’s price stability target, the supply and demand balances in the goods, services, and labor markets, and the current developments in the observed inflation rate. Therefore, I think that it is natural that the level of a price stability target should vary by country. At least for now, I think that the Bank’s 2 percent target – although close to the average among advanced countries – is well above the level that is consistent with the growth potential of Japan’s economy. In Japan, as a result of an BIS central bankers’ speeches increase in short-term inflation expectations reflecting the rise in observed prices, financial market data indicate that medium- to long-term inflation expectations have also increased moderately. However, I think that there is still a substantial divergence from the 2 percent level. On the other hand, QQE entails considerable potential risks, in my view; for example, normalization of the measure will not be an easy process, and speculation that the Bank is engaged in financing fiscal deficits could increase. My understanding is that the 2 percent price stability target can be consistent with the growth potential of Japan’s economy only from a medium- to long-term perspective. I am therefore paying particular attention to the risk that, if the current large-scale monetary easing policy were to be protracted or such policy strengthened by additional measures, the associated side effects would instead outweigh the positive effects, and this would undermine economic stability in the long run. In this regard, one cannot rule out the possibility that, under the current policy commitment, if financial markets increasingly view achieving the 2 percent price stability target in about two years as difficult, the Bank will be obliged to extend or strengthen its monetary easing driven by such external factors, even in a situation where it is judged that side effects outweigh positive effects on the economy. This is why I have proposed that the Bank aim to achieve the price stability target of 2 percent in the medium to long term and designate QQE as an intensive measure with a time frame of about two years. My proposal aims at securing an opportunity for the Bank to thoroughly examine, after a certain period of time, whether the side effects of QQE are not outweighing the positive effects and review the easing measures in a flexible manner depending on economic and financial conditions at the time. C. Strengthening growth potential and monetary policy Strengthening the growth potential of Japan’s economy has long been recognized as a key issue, and its necessity has been acknowledged more strongly of late, reflecting recent discussion that the economy might face supply-side constraints as the supply and demand balance continues to improve steadily. In order to raise the growth potential of the economy, it is necessary for firms to make technological innovations, as well as active fixed investment, so that such innovations lead to increased productivity. It is important that the government, for its part, make efforts to take measures, for example, to increase labor supply and proceed with regulatory reforms that will lead to tapping of potential demand and increasing value-added. In addition, in order to encourage firms to make active fixed investment in Japan and increase the economy’s growth potential through accumulation of capital stock, it is necessary to take measures to increase firms’ medium- to long-term expectations for the growth rate of domestic demand. From such a viewpoint, it is also important to address structural issues such as (1) population decline, which can hinder expansion of domestic demand in the medium to long term; and (2) massive government debt. Efforts toward achieving fiscal consolidation are extremely important not only in terms of increasing firms’ medium- to long-term expectations for the growth rate of domestic demand, but also in terms of improving the environment in which the effects of QQE will be maximized and of enabling smooth normalization of QQE in the future. Basically, such improvements on the supply side of the economy are to be made through efforts by the government and firms. On the other hand, monetary policy – for which the intrinsic function is to work on the demand side of the economy – can provide indirect support for such efforts by providing a benign financial environment. In this regard, in a situation where supply-side constraints are likely to become increasingly binding as a trend, I consider it also necessary to carefully monitor, from the viewpoint of maintaining the stability of the economy, whether there will be concern over overheating. In light of the Bank’s principle that monetary policy shall be “aimed at achieving price stability, thereby contributing to the sound development of the national economy”, I think that achieving prolonged economic recovery, albeit moderate, while at the same time increasing the labor productivity BIS central bankers’ speeches growth rate and the potential growth rate, will lead to an increase in real income and improvement in the quality of people’s lives. Meanwhile, it should be noted that, in the course of proceeding with structural reforms, the growth potential of the economy will increase and the general price level that is stable and consistent with the growth potential will rise in the medium term. In the short term, however, prices might face downward pressure, for example, when those in certain industries decline due to deregulation. Bearing this in mind, I think that the conduct of monetary policy with a price stability target has to be very flexible. D. Price stability target and two perspectives Under QQE, the Bank purchases assets on an unprecedented scale. Therefore, it is necessary to be particularly vigilant against various potential risks; for example, the possibility of such purchases leading to a buildup of financial imbalances. In this regard, the Bank conducts monetary policy, based on the framework of assessing economic activity and prices from two perspectives, in the context of the price stability target. The first perspective is examining, as regards economic activity and prices over the next two years or so, whether the outlook deemed most likely by the Bank follows a path of sustainable growth under price stability. The second perspective is examining, in a longer term, various risks that are most relevant to the conduct of monetary policy aimed at achieving sustainable economic growth under price stability. In particular, financial imbalances will be examined as a risk that will significantly impact economic activity and prices when they materialize, although the probability of their emergence is not necessarily high. It is fair to say that this framework was formulated in light of the lessons learned regarding the monetary policy conduct during the bubble period of the latter half of the 1980s. That was when policy action to address the accumulation of financial imbalances had been delayed in a situation where attention was focused on stable general prices at the time, and policy measures to achieve economic stability in the medium to long term were not sufficiently implemented. I think that the assessment of economic activity and prices based on this framework has become increasingly important as the Bank pursues QQE. E. Communication with the markets Monetary policy produces positive effects through changes in market developments and in financial institutions’ behavior. Accordingly, in order to enhance the effectiveness of monetary policy, communication with the markets is very important. In particular, as many central banks in advanced economies are currently conducting unconventional policy, better communication with the markets has become the common challenge facing each economy. In relation to this, a notable example has recently been observed in the United States, where the process of normalizing monetary policy has already been initiated, and in the United Kingdom, where normalization is starting to be considered. Specifically, the central banks in both countries were forced in a short period of time to make modifications in their forward guidance that seemed to aim at avoiding a large increase in the long-term interest rate, as such an increase could cause instability in the economy and the financial system. In the United Kingdom, the unemployment threshold for future policy interest rate hikes was maintained, but its significance was reduced substantially. In the United States, the unemployment threshold was abandoned. What is common in both countries is that monetary policy has shifted toward referring to many economic indicators. This can be interpreted as meaning that the intrinsic feature of the forward guidance of “strongly influencing expectations” has weakened, and that there has been a move to return to the conventional policy measure of “comprehensive assessment” that emphasizes the degree of freedom and flexibility in the conduct of policy. BIS central bankers’ speeches As illustrated, central banks in advanced economies that conduct unconventional policy are still finding a way to achieve better communication with the markets. The Bank, for its part, needs to continue to facilitate effective communication while paying close attention to the experiences of the other economies. F. Combined use of two policy tools It is my understanding that an unconventional policy such as the asset purchase policy implemented under QQE is effective as a temporary tool to generate upward momentum in economic activity and prices and affect the direction of such momentum under the zero lower bound on nominal interest rates. On the other hand, a conventional interest rate policy can be regarded as a usual, fine-tuning tool that is used when it is time to encourage economic activity and prices to reach desirable levels. In a situation where the unconventional policy has already been effective to a reasonable extent, accommodative financial conditions are starting to further strengthen as policy effects generated by maintained zero interest rates are gradually added to the effects of QQE. On the other hand, precisely because the unconventional policy is a new policy measure with a short history, its side effects in general could have many unknown parts. Moreover, it would probably take considerable time for monetary policy to be normalized with the unwinding of the unconventional policy – the main component of which is the asset purchase policy. Thus, a forward-looking policy stance is required to achieve the smooth normalization of monetary policy while maintaining financial market stability. Taking these factors into account, if developments in economic activity and prices continue to steadily follow an improving trend, I think that it will be necessary in the future to examine the option of gradually starting to shift the focus of monetary policy conduct from the asset purchase policy to the zero interest rate policy, in view of the role of the two policy tools as well as the balance of their positive effects and side effects. BIS central bankers’ speeches
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