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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting, held by the Naigai Josei Chosa Kai (Research Institute of Japan), Tokyo, 1 August 2014.
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Haruhiko Kuroda: Japan’s economy – achieving 2 percent inflation Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting, held by the Naigai Josei Chosa Kai (Research Institute of Japan), Tokyo, 1 August 2014. * * * Introduction It is my great honor to have the opportunity to address you today at the Naigai Josei Chosa Kai. 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. The last time I addressed you here was only a year ago. At that time, I mentioned that there was a positive turnaround in three areas since the introduction of QQE: in financial conditions, expectations, and economic activity and prices. Since then, QQE has been steadily having its intended effects, and the positive turnaround in the three areas has continued. Japan’s economy has been on a path suggesting that the 2 percent price stability target will be achieved as expected. Today, I would like to talk somewhat in detail about the Bank’s view concerning the current state of and outlook for economic activity and prices. In doing so, I will be referring to the interim assessment of the April 2014 Outlook for Economic Activity and Prices (Outlook Report) conducted at the Monetary Policy Meeting (MPM) in July. I will then talk about some topics concerning the price stability target of 2 percent. I. Current situation of and outlook for Japan’s economy Japan’s economy has continued to recover moderately as a trend despite a decline in demand following the consumption tax hike in April. The virtuous cycle among production, income, and spending has been continuing. Over the coming three years or so, Japan’s economy is expected to grow at a pace above its potential as a trend, although there are likely to be fluctuations in demand around the scheduled consumption tax hike next year. In the interim assessment of the April 2014 Outlook Report conducted at the July MPM, real GDP is projected to grow at 1.0 percent in fiscal 2014, 1.5 percent in fiscal 2015, and 1.3 percent in fiscal 2016 (Chart 1). There are two forces driving GDP growth on which these projections are based. One is the firmness of private consumption against the backdrop of an improved employment and income situation despite the consumption tax hike. The other is that favorable developments in the corporate sector have become more pronounced. Let me explain these two points in turn. Improvement in the employment and income situation and private consumption Let me start with the employment and income situation and developments in private consumption. In this regard, one more and more often hears about shortages of workers in various industries including food services and construction. As this example illustrates, the labor market has been steadily tightening. In fact, the active job openings-to-applicants ratio indicates that there are more jobs on offer than there are people applying. The ratio is now above the peak prior to the global financial crisis, reaching 1.10 in June this year, the highest level since June 1992 (Chart 2). In addition, the unemployment rate has declined to 3.7 percent. This is almost the same level as the structural unemployment rate, which is estimated to be around 3.5 percent. The year-on-year rate of increase in the number of regular employees has been around 1.5 percent (Chart 3). This tightening of the labor market has exerted upward pressures on wages (Chart 4). An increasing number of firms have raised base pay in the annual wage negotiations this spring, BIS central bankers’ speeches which was not seen in previous years. This effect has gradually been reflected in regular wages. You may have heard on the news that amid growing labor shortages hourly wages of part-time workers have been increasing, and this is borne out by the data, which show that the year-on-year rate of increase in hourly cash earnings of part-time employees has been accelerating. As a result, the annual rate of increase in nominal wages per employee has gradually accelerated. In addition, according to various surveys, summer bonuses are projected to exceed those of a year ago, and this will also put upward pressures on nominal wages. The year-on-year rate of increase in employee income – that is, nominal wages multiplied by the number of employees – has been around 2 percent, reflecting the aforementioned developments in employment and wages. Looking ahead, the rate of increase in employee income is likely to accelerate moderately, since labor market conditions are likely to continue improving as the economy recovers moderately. This improvement in the employment and income situation has been steadily working to underpin private consumption. Of course, the consumption tax hike has affected consumption, especially purchases of durable goods such as automobiles, which substantially increased prior to the tax hike as consumers “front-loaded” purchases. However, many department stores, food supermarkets, and food services firms, for example, report that the decline in consumption has been broadly in line with expectations, and the extent of the decline has been narrowing gradually. This suggests that private consumption continues to remain resilient as a trend. The Consumer Confidence Index bottomed out in April and has been improving for two consecutive months since then. The effects of the decline in demand following the consumption tax hike are likely to wane gradually from summer, partly due to an expected increase in summer bonuses. Given that the effects of the decline in demand following the consumption tax hike are expected to gradually wane, private consumption is likely to remain resilient underpinned by the increase in employee income. Nevertheless, since the effects of the decline in real income due to the consumption tax hike might gradually manifest themselves, the Bank will continue to carefully examine future developments. Firms’ proactive stance and business fixed investment The second driving force of Japan’s economic recovery is that favorable developments in the corporate sector have been continuing and recently have become more pronounced. Business sentiment has stayed at a highly favorable level despite the decline in demand following the consumption tax hike. The business conditions DI in the March Tankan survey – the Short-Term Economic Survey of Enterprises in Japan – prior to the consumption tax hike improved to plus 12, reaching the highest level since the November 1991 survey (Chart 5). This improvement reflects the front-loading of demand prior to the consumption tax hike. The future DI in the March Tankan showed a substantial decline to plus 1 due to the decline in demand following the consumption tax hike. However, despite deteriorating due to the consumption tax hike, the business conditions DI in the June Tankan still registered a value of plus 7. This is notably higher than the DI forecasted in the March Tankan. Moreover, this is the same level as in June 2007, prior to the global financial crisis, indicating that the DI remains at a favorable level. Thus, business sentiment has stayed at a favorable level even after the consumption tax hike, indicating that the stance of the corporate sector remains proactive. In addition, corporate profits have continued to improve. Corporate profit projections in the June Tankan survey show that the level of current profits in fiscal 2014 will remain at a level almost as high as in fiscal 2013. Moreover, the projections have been revised upward compared to those in the March survey. It appears that firms have started to become confident that their profitability will not be greatly affected by the consumption tax hike. This proactive stance and high profits of firms have favorably affected business fixed investment. In the GDP statistics, real business fixed investment has been registering a BIS central bankers’ speeches quarter-on-quarter increase for four consecutive quarters since the April-June quarter of 2013. Particularly the increase in the January-March quarter of this year was substantial at 7.6 percent (Chart 6). This was partly attributable to renewal demand stemming from the ending of support for some software programs and to the front-loading of demand for construction machinery prior to the strengthening of gas emission regulations. However, even excluding these temporary factors it can be said that business fixed investment has become firm. Moreover, a clear recovery can finally also be seen in business fixed investment in the manufacturing sector, which had been lagging. Business fixed investment is expected to follow an increasing trend against the backdrop of improving corporate profits, albeit with some fluctuations. In fact, the June Tankan survey shows that aggregate investment in fiscal 2014 is scheduled to increase, with large-scale enterprises planning to invest more than in recent years (Chart 7). In addition to the improvement in business sentiment and corporate profits, there are several factors that are conducive to an increase in business fixed investment. Let me point out three. First, firms’ accumulation of capital stock slowed because they restrained business fixed investment during the period of protracted deflation. Therefore, we are now in a situation in which business fixed investment is likely to increase from a cyclical perspective. The production capacity DI in the June Tankan survey indicates that the extent to which firms feel that they have excess capacity has steadily narrowed and that on an aggregate basis firms’ sense of having excess capacity has almost disappeared (Chart 8). As a result of past restraint in business fixed investment, capital stock has generally become older. There are cases in which such old capital stock hampers smooth production when firms try to increase their production levels. This will also boost business fixed investment, mainly renewal investment. Second, firms have been struggling to secure employees due to the tightening of the labor market, and wages have been increasing. On the other hand, firms’ funding costs for business fixed investment have been at low levels and financial institutions’ lending attitudes have been accommodative. We may therefore be gradually approaching a stage in which firms find it advantageous to invest in labor-saving machinery and equipment rather than to hire new employees. These investments will lead to a more efficient utilization of labor amid a tightening labor market and eventually raise labor productivity. Third, more than a year has passed since the correction of the excessive appreciation of the yen and firms have been reviewing the location of their global production bases. In the phase of yen appreciation after the global financial crisis, the share of firms’ overseas investment increased, and this trend continued for some time even amid the correction of the excessive appreciation of the yen. This is because firms need a certain period of time between the decision to invest at home or abroad and the actual subsequent implementation. Recently, there have finally been signs that firms are planning to increase the share of domestic investment. For example, some firms regard Japan as the base for the manufacturing of and research and development for strategically important products, as well as for improving production processes, and have been investing or planning investment in these areas. Overseas economies and Japan’s exports Let me turn to developments in exports. Exports have recently more or less leveled off despite the correction of the excessive appreciation of the yen (Chart 9). The relatively lackluster performance of exports is essentially due to cyclical factors, including the sluggishness in emerging economies with strong economic ties with Japan such as the ASEAN countries. At the same time, however, structural factors may have also played a certain role. Such factors include the accelerated relocation of production overseas by Japanese firms reflecting the appreciation of the yen and a decline in international competitiveness in sectors such as IT-related goods in which Japanese firms have traditionally had a competitive advantage. In addition, temporary factors putting downward pressure on exports seem to have had an impact through early spring, although this impact BIS central bankers’ speeches has been waning. Such temporary factors include the effects of the unusually severe winter weather in the United States and the fact that firms placed priority on domestic shipments in response to the front-loading of demand prior to the consumption tax hike. Future developments in exports to a great extent will depend on the performance of overseas economies, which are expected to continue to recover moderately, led by advanced economies. This is also confirmed by the World Economic Outlook by the International Monetary Fund: global economic growth, which slowed to 3.2 percent in 2013, is projected to accelerate gradually to 3.4 percent in 2014 and 4.0 percent in 2015 (Chart 10). Japan’s exports are likely to increase moderately due mainly to this recovery in overseas economies. In fact, this view is underpinned by the fact that the DI of overseas supply and demand conditions for products in the June Tankan survey has improved and that external demand for machinery orders has been on an increasing trend. II. Price developments and the path toward achieving the price stability target Current state of and outlook for prices Let me turn to price developments. The year-on-year rate of change in the consumer price index (CPI, excluding fresh food) was negative at minus 0.4 percent in April last year when QQE was introduced. It subsequently turned positive and, after excluding the direct effects of the consumption tax hike, reached plus 1.3 percent in June this year (Chart 11). The yearon-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. This is because, on the one hand, there will be inflationary pressure due to the improvement in the output gap as the economy recovers; on the other hand, upward pressure from import prices, mainly energy prices, will likely wane. Subsequently, the year-on-year rate of change in the CPI is expected to follow an upward trend again from the second half of this fiscal year and reach about 2 percent around the middle of the current projection period from fiscal 2014 through fiscal 2016, that is, in or around fiscal 2015. Thereafter, Japan’s economy is likely to gradually shift to a growth path that sustains the price stability target of 2 percent in a stable manner. In the interim assessment of the Outlook Report at the July MPM, projections for the year-on-year growth rate in the CPI (excluding fresh food) were plus 1.3 percent for fiscal 2014, plus 1.9 percent for fiscal 2015, and plus 2.1 percent for fiscal 2016, after excluding the direct effects of the consumption tax hikes (Chart 1). At the time of the introduction of QQE many did not expect the inflation rate to increase to the level we see now. However, the Bank’s projections have changed little since the April 2013 Outlook Report, published shortly after the introduction of QQE. QQE has been having its intended effects and prices have been rising as the Bank expected. The mechanism to raise inflation that we envisaged at the time of the introduction of QQE consists of the following elements. The first element was to dispel people’s deflationary mindset and raise inflation expectations by making a strong and clear commitment to achieve the price stability target of 2 percent at the earliest possible time and implementing large-scale monetary easing measures to underpin the commitment. The second element consisted of putting downward pressure on the entire yield curve through massive purchases of government bonds. Third, the first two elements would lower real interest rates – that is, nominal interest rates minus the expected rate of inflation – and provide strong stimulus to the economy. Fourth, with the resultant recovery in Japan’s economy, prices would rise and, as a result, inflation expectations would rise further. And finally, with the recovery in the economy, rising prices, and rising inflation expectations working in a mutually reinforcing manner, observed inflation and expected inflation were expected to rise as a trend to reach 2 percent in a stable manner. Currently, a growing number of firms are experiencing labor and capacity shortages, indicating an improvement in the output gap, and inflation expectations are rising. Reflecting BIS central bankers’ speeches these developments, the year-on-year rate of change in the CPI (excluding fresh food) has risen to the range of 1.0–1.5 percent. On the other hand, financial conditions are accommodative: 10-year government bond yields have been in the range of 0.5–0.6 percent, and interest rates on new bank loans have been at historic low levels of below 1 percent on average. Against this backdrop, the improvement in the output gap and the rise in inflation expectations are likely to continue, and CPI inflation is expected to approach the price stability target of 2 percent. However, if the outlook changes due to the manifestation of some risk factors and it is judged necessary for achieving the price stability target, the Bank will make adjustments without hesitation. I would like to emphasize that, under QQE, given the Bank’s clear and strong commitment to the 2 percent inflation target, it is a matter of course that the Bank will make adjustments if necessary to ensure the target is achieved. In the following, let me talk somewhat in detail about two factors that determine the future trend in inflation, namely, the output gap and medium- to long-term inflation expectations. Rising prices as a result of an improvement in the output gap Let me start with the output gap, which indicates the state of labor and capacity utilization. Currently, the economy is being led by domestic demand such as private consumption and public investment, and it is the nonmanufacturing sector that is at the forefront of the recovery. Since the nonmanufacturing sector is more labor-intensive than the manufacturing sector, this has resulted in a tightening of labor market conditions. In the construction, retail, and service sectors, some firms have found it difficult to expand their business due to labor shortages. According to the Tankan survey, excess capacity has almost disappeared. With the high level of capacity utilization, there have been more frequent disruptions of the smooth operation of production. All in all, the output gap has been moderately improving to reach around 0 percent recently and has turned positive in the January-March quarter of this year due partly to the front-loading of demand prior to the consumption tax hike (Chart 12). With the economy expected to continue growing at a pace above its potential, that is, with growth in demand exceeding growth in supply capacity, the positive output gap is likely to expand gradually. Therefore, inflationary pressure from the output gap is likely to steadily increase. Rising medium- to long-term inflation expectations Let me move on to inflation expectations. Medium- to long-term inflation expectations appear to have been rising on the whole (Chart 13). This, in turn, has started to affect wage and price setting. For example, as seen in wage negotiations this spring, the rise in inflation is increasingly being taken into account in wage setting between management and labor. Moreover, firms’ price-setting strategies have been changing. Under deflation, many firms pursued low-price strategies by putting priority on cost reductions since there had been a strong preference among consumers for low-priced products. Recently, however, an increasing number of consumers have been purchasing goods and services even at somewhat higher prices as long as their quality was in line with their price. In response, some firms have started to raise sales prices while increasing value added in terms of the quality and functionality of the goods and services they provide. In the output prices DI of the Tankan survey, until recently the share of firms responding that their output prices are “falling” exceeded that responding that their output prices are “rising;” however, in the June survey the two shares were identical (Chart 14). Thus, the mechanism in which the rise in observed inflation alters people’s inflation outlook and behavior, which in turn raises observed inflation, continues to operate. This means that people’s inflation expectations will likely follow an uptrend and inflationary pressure from the rise in inflation expectations will also increase. III. Discussion points regarding the price stability target of 2 percent We at the Bank believe that so far Japan’s economy has been on a path suggesting that the 2 percent price stability target will be achieved as expected. However, given that prices have BIS central bankers’ speeches risen due to the consumption tax hike, we often hear the question from consumers why, on top of that, the Bank is aiming at 2 percent inflation. In addition, with supply constraints such as labor shortages becoming more pronounced, some ask whether it is desirable to have inflation while growth remains low. Let me respond to these questions. Why aim at 2 percent? I said earlier that the year-on-year rate of change in the CPI (excluding fresh food) after excluding the direct effects of the consumption tax hike has been hovering at around 1¼ percent. However, the rate of change including the direct effects of the consumption tax hike was plus 3.3 percent in June, which was as high as the rate of increase in December 1990. Focusing on this point, some argue that it is not necessary to raise inflation further. However, it should be noted that the impact of the consumption tax hike on consumer prices is a “one-off” at the time of the hike, and the impact on the year-on-year rate of change in the CPI will disappear after one year. The Bank is not aiming at achieving the price stability target of 2 percent temporarily. What the Bank aims at is to achieve an economy in which inflation is about 2 percent on average year after year. In such an economy, people behave on the assumption that inflation is about 2 percent. This is the reason why the Bank judges the trend in prices excluding the direct effects of the consumption tax hike. Based on what I just mentioned, let me explain why we aim at 2 percent inflation. Japan’s economy has been suffering from deflation for about 15 years, since fiscal 1998. That being said, the average annual rate of change in terms of the CPI during that period was around 0 percent – specifically, it was minus 0.3 percent. However, since the change in the CPI is biased upward, it overstates actual inflation. Therefore, a CPI growth rate of 0 percent means that the economy is actually experiencing deflation. In addition, since interest rate levels in a deflationary environment tend to be correspondingly low, interest rates are likely to face the zero lower bound when the economy experiences a negative shock. This will limit room for monetary policy responses using short-term interest rates. Taking these points into account, it is now widely accepted around the world that it is desirable to target inflation somewhat above 0 percent. Many advanced economies, such as the United States, the euro area, and the United Kingdom, have set a target of about 2 percent. It could be said that this level has become a global standard. The Bank decided on the price stability target of 2 percent and announced it in January last year. The Bank subsequently introduced and has been pursuing QQE in order to achieve the 2 percent target at the earliest possible time and maintain it in a stable manner. Based on this unwavering determination and corresponding actions by the Bank, firms and households will be able to base their behavior on the assumption of 2 percent inflation. If the perception that inflation will be around 2 percent becomes entrenched, then people will expect inflation to return to about 2 percent in the medium to long term even if it temporarily fluctuates due to shocks to the economy. This is what is meant by “inflation expectations are anchored.” This is an important element to prevent the economy from falling into deflation or to avoid inflation rates from continuing to rise substantially beyond 2 percent. The Bank will continue to pursue its monetary policy aiming at achieving 2 percent inflation and anchor inflation expectations at that level. Achieving the 2 percent inflation target and Japan’s growth potential Next, let me talk about the growth potential of Japan’s economy. The potential growth rate of Japan’s economy – that is, the rate of growth at which Japan’s economy can grow in the medium to long term in a sustainable manner – has been declining due to such factors as the aging and decline of Japan’s population, as well as the slowdown in capital stock accumulation during the period of protracted deflation (Chart 15). Against this background, some have voiced the concern that Japan’s growth rate will not increase due to supply constraints such as labor shortages. Others have argued that it is not desirable to have inflation under low economic growth. BIS central bankers’ speeches These concerns should be considered by separating short-term economic developments and the medium- to long-term growth potential. In the short term, even if the expansion of specific industries or firms is constrained by supply-side problems, the economy as a whole can grow above its potential by raising utilization rates and improving the efficiency of labor and capital. The aforementioned projections by the Bank of economic activity and prices through fiscal 2016 are based on such assumptions. In the medium to long term, efforts to raise supply capacity are necessary, since the growth potential of the economy will be determined by supply capacity. In this regard, as a growth strategy to stimulate private investment, the government formulated the Japan Revitalization Strategy and revised it in June. The Bank strongly hopes that the government will push ahead with the steady implementation of the strategy and that private firms will actively respond. The Bank believes it important that, in parallel with its efforts to achieve the 2 percent price stability target, the various initiatives to strengthen Japan’s growth potential make steady progress. However, the Bank is of the view that, regardless of the pace of the rise in the potential growth rate, the price stability target of 2 percent should be achieved at the earliest possible time. The reason is not that the Bank believes it desirable to have inflation at any cost. Rather, the Bank believes achieving 2 percent inflation as soon as possible and anchoring inflation expectations at that level will elicit proactive behavior from firms and households. This in itself will then contribute to raising the growth potential of the economy. In a deflationary environment, firms had an incentive to hoard cash and became reluctant to take risks by investing in their business or in research and development. This is also one reason the potential growth rate declined. When firms’ and households’ inflation expectations are anchored at 2 percent, firms will have greater incentives to take risks. This, in turn, should help to raise the potential growth rate through improvements in productivity as a result of capital investment and research and development. In fact, this has already started to happen: capital investment and investment in research and development have been increasing amid the steady progress toward the price stability target of 2 percent since last year. By achieving the price stability target of 2 percent at the earliest possible time, the Bank is seeking to create an environment in which firms and households can get on with their economic activities. I would like to conclude my speech today by expressing my strong hope that Japan’s economy will regain its vitality and start to grow strongly again. 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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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, 23 August 2014.
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Haruhiko Kuroda: Deflation, the labor market, and QQE Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, 23 August 2014. * * * Introduction I am honored to have been invited to this policy symposium hosted by the Federal Reserve Bank of Kansas City. One of the key topics of the symposium is the cyclical and structural effects of the global financial crisis and the recovery from the crisis on the labor market in each country. To talk about Japan’s experience in this regard, however, I have to take you back to long before the crisis. Almost a quarter of a century ago, at the beginning of the 1990s, Japan suffered the burst of a major asset bubble, forcing firms and financial institutions to repair their balance sheets, which had been substantially impaired. From the second half of the 1990s, Japan experienced about 15 years of deflation. At the same time, Japan experienced rapid population aging at a pace that put it ahead of other countries. What problems have these developments given rise to in Japan’s labor market? How is Japan overcoming these problems and where is Japan’s economy headed? These are the issues I would like to talk about. I. The labor market under deflation The unemployment rate in Japan is now 3.7 percent. That means it has fallen to the level of the structural unemployment rate, which is estimated to be around 3.5 percent (Chart 1). The number of discouraged workers and hence what can be called hidden unemployment has also been decreasing. According to a business survey conducted by the Bank of Japan, the number of firms suffering from a shortage of workers has been exceeding that of firms suffering from an excess of workers (Chart 2). In fact, in some industries, a shortage of workers is now acting as a constraint on firms seeking to expand their business. This situation is quite different from that in the United States and Europe, where unemployment is the problem. However, this does not mean that all is well and there are no concerns regarding Japan’s labor market. Although Japan’s labor market is now on its way to escape from the problems brought about by the aforementioned balance sheet adjustments and prolonged deflation, there still remain important challenges to be addressed. In what follows, let me share with you Japan’s experience concerning changes in the labor market brought about by the protracted deflation and their macroeconomic consequences. In the 2000s, reflecting increasing deflationary pressure, firms were unable to raise sales prices. Faced with stagnant sales, firms resorted to cutting expenses, including labor costs, to secure profits. Efforts to restrain labor costs first took the form of a shift to the use of nonregular employees. The share of part-time workers in total employees consistently increased in the 1990s following the burst of the asset bubble at the beginning of the decade, and the increase continued unabated in the 2000s (Chart 3). Efforts to restrain labor costs also took the form of restraining wages. Wages of non-regular employees are largely determined on an ad hoc basis and fluctuate reflecting changes in supply and demand conditions. By contrast, wages for regular employees are largely determined based on long-term implicit contracts. In the face of protracted deflation and severe labor conditions, employees were put at a disadvantage and accepted employers’ demand to reduce wages rather than lose their job. Thus, unlike in the United States and Europe, where unemployment tends to increase during a recession, in Japan unemployment did not increase substantially, but instead wages declined considerably. The year-on-year rate of change in wages was above that in the BIS central bankers’ speeches consumer price index (CPI) until the late 1990s, but has generally been below it since then (Chart 4). Consequently, on a macro basis, Japan’s labor share declined noticeably in the 2000s. Although the labor share fluctuated considerably during and immediately after the global financial crisis, the average for the decade was lower than that for the 1990s (Chart 5). Furthermore, deflation significantly affected firms’ investment behavior. The prospect of deflation reduced the discounted present value of investment returns and lowered firms’ investment appetite. In addition, it led firms to hoard cash to prepare for potential losses in the future. As a result, firms, which used to be net investors, turned into net savers and have stayed in that position (Chart 6). Following the burst of the asset bubble, Japanese firms were forced to save in order to reduce excess debt. However, they continued to save even after the excess debt problem had been resolved in the 2000s. Particularly in recent years, net saving in the corporate sector has become much larger than net saving in the household sector. This change of firms into net savers has thrown the economy into a contractionary equilibrium through the paradox of thrift. If firms use profits obtained through wage cuts to build up internal funds rather than for investment, aggregate demand in the economy will shrink. And since a decline in aggregate demand will lower corporate profits, firms will be forced to cut wages further. This is a typical example of the fallacy of composition. The vicious cycle of declining wages and declining aggregate demand was initially set in motion by the balance sheet adjustments following the burst of the asset bubble, but it became entrenched due to the spread of deflationary sentiment. II. Quantitative and qualitative monetary easing and the labor market Let me now turn to how Japan is in the process of escaping from this state of contractionary equilibrium. If uncertainty and concern over the future were the cause of the decline in wages, then for wages to rise, it is necessary that both employers and employees see brighter prospects for the future. Therefore, the first step is to change Japan’s economy from one suffering from stagnation under deflation to one that grows sustainably under moderate inflation. In this regard, the Bank of Japan’s quantitative and qualitative monetary easing (QQE), which I explained in detail at this symposium last year, has been producing its intended effects. And as a result of these effects, Japan’s labor market situation has shown improvement, as mentioned earlier. However, closer inspection shows that the Japanese labor market still suffers from some of the problems that arose during the period of deflation. For example, there has been no reversal in the growing reliance on part-time workers. In fact, the recent increase in the number of workers is due mainly to an increase in the number of part-time workers (Chart 7). In general, in the early stages of economic recovery, it is demand for marginal workers such as part-time workers that increases first. In addition, the current economic recovery is led by the nonmanufacturing sector, where the share of part-time workers is higher than in the manufacturing sector. Furthermore, the continuing shift to a service economy means that demand for part-time workers has increased over time. That being said, most recently, there has been an acceleration in the increase in the number of full-time workers, which is a welcome sign. This shift from growing demand for marginal labor such as part-time workers to growing demand for permanent workers suggests that firms’ growth prospects have started to improve. If economic growth is sustained and thus underpins firms’ growth prospects, Japan is likely to experience a full-fledged increase in the number of full-time workers. A more troublesome problem is that wage-setting practices have changed during the prolonged period of deflation. Because of low labor mobility due to relatively widespread lifetime employment, wages of regular employees in Japan tend to reflect labor market conditions only insufficiently, at least in the short term. Therefore, some kind of mechanism, a “visible hand,” is necessary for wages to rise. Prior to the period of deflation, the so-called BIS central bankers’ speeches spring offensive of the practice of simultaneous wage negotiations between management and labor at major firms in spring served as such a mechanism for negotiating wage increases. However, as deflation continued, this mechanism stopped working effectively. That is, firms needed to cut wages in order to reduce costs against the background of falling prices, while it was rational for workers to accept a decline in wages in exchange for job guarantees. As a result, in the past decade or so, the practice of raising base wages through the spring offensive had more or less disappeared. This spring, however, has seen increases in base wages and/or bonuses not only among large firms but also among small and medium enterprises, partly reflecting calls by the government. For wages to increase at an appropriate pace in the future, it is necessary to have some kind of coordination mechanism to bring about wage increases. In such a mechanism, the Bank of Japan’s price stability target can serve as a benchmark for firms in their wage setting. That is, once the Bank has succeeded in firmly anchoring inflation expectations at 2 percent, this could provide the basis on which wage negotiations between management and labor are conducted. Firms and households can then base their economic decisions firmly on the expectation that prices will rise at a rate of around 2 percent. Thus, creating an appropriate wage-setting mechanism plays an important part in anchoring inflation expectations at 2 percent. Concluding remarks I have so far talked about the effects of balance sheet adjustments and deflation on the labor market, but there is one topic I have yet to touch on. This is an issue that concerns the supply of labor, namely, demographic changes. Reflecting the aging of Japan’s population, the labor force participation rate has been on a downtrend, and serious labor shortages are likely to emerge in the future. The downtrend in the labor force participation rate is due to Japan’s demographic composition and therefore does not come as a surprise. However, until recently, this did not manifest itself in the form of labor shortages, since labor demand has been sluggish, so that the problem was not sufficiently addressed. Fortunately, during the current economic recovery, labor force participation rates, in particular those of women and the elderly, have been rising (Chart 8). It is critical to ensure that this phenomenon is not a cyclical one, but becomes permanent by creating a work environment favorable to women and the elderly in order to mitigate labor force shortages over time. Utilization of foreign workers also deserves consideration. Another way to mitigate future labor shortages is to prompt investment in labor-saving technology and research and development for such investment. All of these issues are incorporated in the government’s growth strategy. If, despite the delays, the strategy is implemented in a steady fashion, Japan’s economy will regain its vitality and achieve sustained growth. I have talked about Japan’s labor market, focusing on the effects of balance sheet adjustments, deflation, and demographic changes. While some of these problems are unique to Japan, the issues I discussed may nevertheless be of relevance for the challenges faced by other countries today or in the future. I hope that Japan’s experience can provide a helpful reference 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
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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, in Yamaguchi Prefecture (held in Shimonoseki), 29 July 2014.
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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, in Yamaguchi Prefecture (held in Shimonoseki), 29 July 2014. * * * I. Developments in economic activity and prices A. Overseas economies I would like to start my remarks with a look at developments in economic activity and prices. The Bank of Japan’s current assessment is that overseas economies – mainly advanced economies – have been recovering, albeit with a lackluster performance still seen in part. The average of real GDP growth rates of major countries and regions weighted by value of exports from Japan decelerated substantially to a range of 1.0–2.0 percent in the January–March quarter of 2014, although it had continued to register growth of above 4.0 percent until the latter half of 2013. The growth rate of the U.S. economy for the April–June quarter of 2014 is scheduled for release tomorrow evening – on July 30 – and rates for other economies will be released subsequently. Overseas economic growth seems to be accelerating moderately on the whole. This is because many economic indicators since April, particularly those of the United States and other advanced economies, have improved, and such positive effects appear to be spreading to some of the emerging economies through export channels. I will now look at individual countries and regions. The U.S. economy registered negative growth in the January–March quarter of 2014 for the first time in three years, due partly to the unusually severe winter weather. Since then, however, a rebound in a number of economic indicators has been observed, such as a steady improvement in the employment situation. As for the outlook, the economy is likely to gradually accelerate its pace of recovery, led mainly by private demand, albeit with uncertainties such as the size of slack that remains in the labor market. The euro area economy is recovering moderately, registering positive growth for four consecutive quarters. Financial markets have been stable as turmoil arising from the European debt problem has subsided, and private consumption and firms’ production activity have been recovering moderately. For the time being, I will pay attention to the effects of further monetary easing by the European Central Bank (ECB) in June, including the introduction of a negative interest rate. The situation in Ukraine and Russia also warrants attention. The Chinese economy has continued to see stable growth, as shown by the fact that the year-on-year growth rate for the April–June quarter, which was released in July, registered 7.5 percent. The economy has faced downward pressure, such as a slowdown in the real estate market, as authorities have been progressing with structural reforms. On the other hand, the slowdown in growth momentum observed since the beginning of the year has come to a halt due partly to the economic stimulus measures that the authorities have been implementing since the spring. As for the outlook, the Chinese economy is likely to continue to see stable growth, albeit at a slightly slower pace. Emerging and commodity-exporting economies – mainly the ASEAN economies that are Japan’s major export destinations – have continued to lack growth momentum. However, the positive effects of recovery in advanced economies have spread to some emerging economies. Moreover, as the financial markets have been calm on the whole, a pick-up in domestic demand has been observed in some Asian countries. If such developments BIS central bankers’ speeches continue, emerging and commodity-exporting economies should gradually show an improving trend, although a high degree of uncertainty remains. In the World Economic Outlook released by the International Monetary Fund (IMF) in July, the growth rate of the overall global economy for 2014 was revised slightly downward – affected by the deceleration in the January–March quarter – but the projection of the growth rate accelerating toward 2015 remained unchanged. The Bank likewise expects that the global economy will moderately increase its growth rate. This is mainly because, as the Chinese economy is continuing to see stable growth – albeit at a slightly slower pace – positive effects of the firm recovery in advanced economies will gradually spread to emerging economies. B. Japan’s economic activity and prices 1. Current situation a. Economic activity Now I will discuss Japan’s economic activity and prices. The Bank’s current assessment is that 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. Looking at developments in private consumption since April 2014, despite the decline I just mentioned, many firms have indicated that the degree of the decline has been broadly in line with expectations. In terms of sentiment, the consumer confidence index, which had been relatively weak for some time, has improved for two consecutive months. Yet a wide range of indicators should continue to be monitored closely, as the adjustments in some aspects of housing starts and of automobile sales may be somewhat prolonged, and a decline in real wages could gradually affect consumption as a whole. As for business fixed investment, some indicators of machinery investment showed a decline following the substantial increase in the January–March quarter of 2014, but business fixed investment plans are strong in the June Tankan (Short-Term Economic Survey of Enterprises in Japan) – released at the beginning of July – suggesting that firms are maintaining a positive attitude. Business fixed investment is therefore likely to continue on a moderate increasing trend. Exports have been leveling off more or less, with a continued lack of momentum. This is largely attributed to the negative growth rate of the U.S. economy in the January–March quarter and the sluggishness in emerging economies – including ASEAN economies with strong ties to Japan’s economy. However, it is likely that structural factors have also been at work, such as the shift of Japanese firms’ production sites to overseas accompanying their increased local procurement. The GDP growth rate for the April–June quarter, which is scheduled to be released in August, is likely to register a considerable negative figure due to the effects of the decline in demand following the front-loaded increase prior to the tax hike. However, the Bank considers that a virtuous cycle of the economy has been operating firmly, together with a clear improvement in the employment and income situation, and therefore Japan’s economy has continued to recover moderately as a trend. b. Prices With regard to prices, the year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food, or the so-called core CPI, was 1.3 percent for June, excluding the direct effects of the consumption tax hike. The rate of increase has recently been hovering at around 1¼ percent, with the waning of upward pressure from energy-related prices generally offsetting the effects of price rises in other items. BIS central bankers’ speeches 2. Outlook for economic activity and prices In terms of the outlook for Japan’s economy, exports are expected to increase moderately while domestic demand is likely to maintain firmness. In this situation, a virtuous cycle among production, income, and spending is likely to be maintained. Therefore, the economy is expected to continue its moderate recovery trend, and the effects of the subsequent decline in demand following the front-loaded increase prior to the consumption tax hike are expected to wane gradually. The year-on-year rate of increase in the CPI is likely to be around 1¼ percent for some time, and follow a rising trend again from the second half of fiscal 2014. The Bank compiles and releases the Policy Board members’ forecasts for economic activity and prices on a quarterly basis. Looking at the medians of the members’ forecasts released in July, the real GDP growth rate is projected to be 1.0 percent for fiscal 2014, 1.5 percent for fiscal 2015, and 1.3 percent for fiscal 2016. Japan’s economy is expected to continue growing at a pace above its potential rate, which is assumed to be around 0.5 percent. 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 projected to be 1.3 percent for fiscal 2014, 1.9 percent for fiscal 2015, and 2.1 percent for fiscal 2016. The Bank judges that it is likely to reach around 2 percent – the price stability target – around the middle of the projection period, which runs through fiscal 2016. 3. Points that require attention In terms of Japan’s economic activity and prices for the time being and near future, I am paying close attention to the following points. The first is developments in private consumption. For the time being, close watch should be kept on whether private consumption, which has been driving Japan’s recovery so far, will overcome the effects of the decline in demand following the front-loaded increase prior to the consumption tax hike and return to a recovery path as expected from the July–September quarter of 2014. Let us look at movements in the CPI (all items less imputed rent)1 – a price index that reflects actual household consumption expenditures and is used to deflate such figures as wages. The year-on-year rate of increase for June 2014 was 4.4 percent, more than 1 percentage point above the core index, which is behind the recent substantial decline in real wages. As for recent developments, the rate of increase – after reaching 1.9 percent in November 2013 – remained around 2 percent through June 2014, excluding the direct effects of the consumption tax hike. For private consumption to remain resilient in such circumstances, it is vital to have an increase in expectations for future income growth. Factors such as increases in summer bonuses are expected to support private consumption for now, but in the future developments in labor supply and demand conditions are likely to become the key. Turning to labor supply and demand-related indicators, the unemployment rate has declined to around 3.5 percent, and the active job openings-to-applicants ratio continues to improve as a trend, exceeding 1.00. If the tightening trend continues in labor supply and demand conditions, this could help underpin consumption because of growing confidence regarding job security and expectations for wage increases. Moreover, in the medium to long term, firms’ efforts to boost productivity in response to labor shortages, such as investment aimed Imputed rent is a concept for evaluating owner-occupied homes – which do not involve actual payments and receipts of rent – in terms of general market prices, on the assumption that such homes are rented and thus generating production and consumption of services similar to homes and rooms rented in the usual way. In international comparisons, this concept is very useful in compensating for the difference in housing costs derived from varying home ownership rates. However, such rent is not an actual expenditure from households’ perspective. BIS central bankers’ speeches at labor saving, are likely to lead to a strengthening of Japan’s growth potential. Wage increases accompanying growth in labor productivity are expected to occur in the future. Indicators of labor supply and demand conditions are effective in demonstrating firms’ confidence about the future, and for this reason I will pay careful attention to monthly changes, including developments in job openings. The second point for attention is the price-setting behavior of firms. Movements to pass the past increase in costs onto prices have been spreading steadily, as shown by the fact that in the June 2014 Tankan the diffusion index (DI) improved for output prices (the proportion of firms responding that output prices “rise” minus the proportion of those responding that they “fall”). In particular, the DI for small nonmanufacturing firms moved into net “rise” territory for the first time since 1991. The DI for input prices also continued to be in net “rise” territory, suggesting that a certain degree of potential pressure to raise output prices remains. Whether such pressure will materialize as a rise in sales prices depends on economic developments. Therefore, I will pay attention to whether the price-setting behavior of firms becomes even more active after overcoming the effects of the decline in demand following the front-loaded increase prior to the consumption tax hike. The third point for attention is developments in exports. The environment surrounding exports is expected to gradually improve, as the global economy – mainly advanced economies – recovers. On the other hand, structural factors, such as the shift of Japanese firms’ production sites to overseas, are likely to continue exerting downward pressure on exports. Moreover, there is uncertainty about the extent to which the past depreciation of the yen will boost export volume. In the medium to long term, it is hoped that Japanese firms will make progress in developing and supplying new high-value-added products, which in turn will lead exports. For the time being, however, I am paying attention to whether exports will turn to a moderate increase mainly against the background of the recovery in overseas economies. II. The bank’s monetary policy A. Quantitative and Qualitative Monetary Easing (QQE) and its effects Thus far, I have outlined developments in economic activity and prices. In what follows, I will discuss the Bank’s monetary policy. With a view to achieving the 2 percent price stability target at the earliest possible time, the Bank introduced QQE in April 2013. Since then, it has continued large-scale monetary easing, increasing the monetary base at an annual pace of about 60–70 trillion yen. To this end, the Bank is purchasing Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 50 trillion yen. It is also purchasing exchange-traded funds (ETFs), Japan real estate investment trusts (J-REITs), corporate bonds, and CP. As for its future monetary policy stance, 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. Almost a year and four months have passed since QQE was introduced. During this time, Japan’s economy has recovered moderately as a virtuous cycle of economic activity has operated steadily. Prices have followed a rising trend, mainly reflecting a rise in import prices and an improvement in the aggregate supply and demand balance, or the output gap. Moreover, sufficient monetary easing effects have spread to financial conditions and financial markets. Financial conditions have been extremely accommodative. As for firms’ funding costs, the average contract interest rates on new loans and discounts have been at historic low levels and the issuance spreads for CP and corporate bonds have also been low. Funding conditions for firms are extremely favorable; according to the June 2014 Tankan, BIS central bankers’ speeches which was released at the beginning of July, firms’ perception of financial institutions’ lending attitude and financial positions of firms improved, including those for small firms. Regarding financial markets, yields on 10-year JGBs have continued to be extremely low in the range of 0.5–0.6 percent. 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. The U.S. dollar/yen rate has been above the 100 yen level, and the Nikkei 225 Stock Average has recently been moving above the 15,000 yen level. B. Loan support program2 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 lending and strengthen the growth potential of Japan’s economy. 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. At the Monetary Policy Meeting held on February 17 and 18, 2014, the Bank decided to enhance the program, including by increasing the scale of the program and extending its application period. The Bank expects that the enhancement will further promote financial institutions’ actions as well as stimulate firms’ and households’ demand for credit. C. The bank’s price stability target Under the monetary policy I have described, the Bank considers that Japan’s economy has been following the path toward achieving the 2 percent price stability target. Recently, questions have often been asked regarding the criteria and approaches for judging whether the price stability target is achieved and whether the target is maintained in a stable manner. I would like to take this opportunity to offer some thoughts on this matter. As the Bank announced when it introduced the price stability target in January 2013, the target has been set in terms of the year-on-year rate of change in the CPI. With regard to the CPI, the CPI for all items is naturally of prime importance as a price index that comprehensively covers goods and services consumed by households and to which the general public is accustomed. On the other hand, looking at the CPI for all items alone could lead to a misjudgment of the underlying trend of inflation, because this CPI includes items that temporarily show large fluctuations, such as fresh food. In this regard, the CPI for all items less fresh food, or the core CPI, is considered to be the most useful index to identify the trend of the CPI for all items. The Bank in fact uses the year-on-year rate of change in the core CPI when referring to the forecasts of prices presented in the Outlook for Economic Activity and Prices, in which it outlines its thinking on the future conduct of monetary policy. Other indices that demonstrate the underlying fluctuations in the CPI include the CPI (all items less food and energy) and the CPI (10 percent trimmed mean).3 These indices aim at identifying the underlying fluctuations in the overall CPI by excluding certain items. At the same time, however, they eliminate a certain proportion of items consumed by households, and thus differ somewhat from price indices that comprehensively reflect the structure of household consumption. For example, food expenditures in Japan account for a larger proportion of household consumption expenditures than in other countries; the CPI (all items The Loan Support Program consists of two measures: the fund-provisioning measure to stimulate bank lending and the fund-provisioning measure to support strengthening the foundations for economic growth. The 10 percent trimmed mean is obtained by rearranging year-on-year rates of individual price changes in ascending order, excluding items corresponding to both the upper and lower 10 percent tails of weights and then taking weighted averages of the remaining items. BIS central bankers’ speeches less food and energy) of Japan covers 68 percent of the total items, which is nearly 10 percentage points below the 77 percent coverage in the United States. In terms of the effects on economic activity, it is also necessary to monitor developments in the CPI (all items less imputed rent), which – as I mentioned earlier – reflects household consumption expenditures and is used to deflate such figures as wages. As illustrated, each price index is not necessarily perfect for grasping the underlying trend of the overall CPI or the effects on economic activity. I think you would agree that it is not appropriate to judge whether the price stability target is achieved solely by examining the core CPI, for example. In my view, the achievement of the price stability target should always be judged comprehensively by examining the CPI for all items, the core CPI, and other pricerelated indicators to identify changes in the underlying trend of the overall CPI. The same basically holds true for judging whether the target is maintained in a stable manner. There are no quantitative criteria or specific indicators to assess such conditions. Whether the target is maintained in a stable manner should be judged comprehensively by closely monitoring developments in a wide range of price-related indicators and sufficiently examining and assessing the current situation and the outlook for economic activity and prices. III. Toward the sustainable growth of Japan’s economy Thus far, I have talked about the Bank’s monetary policy. Japan’s economy has been following a path toward overcoming deflation. In this situation, a trend in which the output gap is positive (representing excess demand) – has begun to take root, albeit with some fluctuations due to the consumption tax hike. This trend is seen in the tightening of labor supply and demand conditions. Given that slack in the economy has shrunk, as widely recognized, it has become increasingly necessary to strengthen supply capacity in order for Japan’s economy to raise its growth potential in the medium to long term. An economy’s growth potential, from a relatively longer-term perspective, depends on the growth in capital stock and labor input, as well as improvements in productivity through innovation and the like. This indicates that it is private economic entities that play the most important role in efforts to strengthen growth potential and pursue the growth strategy. At the same time, to strengthen growth potential, it is essential to build an environment that enables private economic entities to unleash their creativity and “animal spirits” by (1) increasing the labor participation of women and the elderly, (2) eliminating restrictions to market entry, and (3) carrying out regulatory and institutional reforms. In promoting such an environment from a macroeconomic perspective, the government plays a critical role. In June 2014, the Cabinet decided the new Japan Revitalization Strategy and Basic Policies, which aim to revitalize Japan’s economy. I strongly expect that efforts based on these measures will proceed steadily. 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, Ishikawa, 10 September 2014.
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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, Ishikawa, 10 September 2014. * * * Accompanying slides can be found at the end of the speech. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Ishikawa 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 Kanazawa Branch. The Bank of Japan decided on the price stability target of 2 percent in terms of the year-onyear rate of change in the consumer price index (CPI) in January last year. The Bank then in April introduced aggressive monetary easing called quantitative and qualitative monetary easing (QQE) to achieve the price stability target. The Bank has been pursuing QQE since then. One year and five months have passed since the Bank introduced QQE, and the policy has been having its intended effects so far. The impact of QQE is expected to become stronger going forward, making it particularly important for the Bank to ensure the public fully understands its policy. Today, before exchanging views with you, I would like to explain the current situation of and outlook for Japan’s economy. I will then talk about the background behind QQE. I. Current situation of and outlook for Japan’s economy A. Economic activity Let me start by explaining the current situation of and outlook for Japan’s economic activity. Japan’s economy has continued to recover moderately as a trend, although a decline in demand following the front-loaded increase prior to the consumption tax hike can be observed. The GDP statistics released this week show that after growing strongly at a rate of 1.5 percent quarter-on-quarter in the January–March quarter, real GDP fell substantially, by 1.8 percent, in the April–June quarter (Chart 1). Because of the large decline in the April–June quarter, there appears to be some skepticism whether the economic recovery remains intact. However, since the increase in demand in the January–March quarter was very large as consumers brought purchases forward, it was only to be expected that the subsequent decline in demand and hence in real GDP in the April–June quarter would also be large. What matters is the mechanism underlying the economic recovery and not temporary factors, and the Bank judges that the virtuous cycle of economic activity remains firmly intact in both the household and corporate sectors. Let me first touch on the virtuous cycle in the household sector and then move on to the virtuous cycle in the corporate sector. Household sector Looking at the environment facing the household sector, the labor market continues to improve steadily. The unemployment rate in July registered at 3.8 percent, while the active job openings-to-applicants ratio was 1.10, and both have thus returned to the levels prior to the global financial crisis (Chart 2). The employment conditions DI in the June Tankan Survey – the Short-Term Economic Survey of Enterprises in Japan – shows that more and more firms, particularly in the non-manufacturing sector, feel that there is a labor shortage. BIS central bankers’ speeches The year-on-year rate of increase in the number of regular employees has been around 1.5 percent (Chart 3). With the labor market becoming tighter, hourly cash earnings of part-time employees have been increasing on a year-on-year basis. Moreover, scheduled cash earnings have increased slightly, indicating that the impact of base pay raises in the annual wage negotiations this spring is starting to appear in the data, and non-scheduled cash earnings and summer bonuses have increased. Against this background, the year-on-year rate of change in monthly cash earnings of full-time employees has been positive. As a result, the annual rate of increase in the nominal wage per employee has gradually accelerated. Finally, employee income – that is, nominal wages multiplied by the number of employees – has been growing at around 2 percent year-on-year for some months, and the rate of growth further accelerated in July. With the employment and income situation improving steadily, private consumption has remained resilient as a trend, and the effects of the decline in demand following the consumption tax hike have gradually begun to wane. In interviews, some firms expressed the view that since the front-loading of purchases – especially of durable goods such as automobiles – had been very large, the subsequent decline was also likely to be prolonged. However, many department stores and food supermarkets, for example, report that the margin of the decline in demand has been narrowing gradually. Looking ahead, the labor market is likely to continue tightening as the economy continues to recover and, as I will discuss later, corporate profits are expected to improve and inflation expectations are likely to increase. Therefore, the year-on-year rate of increase in nominal wages is expected to gradually show a clear uptrend. Against the backdrop of these employment and income developments, the virtuous cycle of economic activity in the household sector is expected to remain in place. Nevertheless, the Bank will continue to carefully examine how the decline in real income that the consumption tax hike has brought about affects households’ spending behavior. Corporate sector Next, I will explain the virtuous cycle in the corporate sector. Exports have shown some weakness and the recovery in exports has been delayed. That being said, as I will explain later in more detail, exports are expected to head for a moderate increase. Despite the sluggishness in exports, the virtuous cycle in the corporate sector has remained in place. In fact, corporate profits have continued to improve. Looking at listed companies’ results for the April–June quarter of this year, consolidated profits have continued to rise, mainly due to the good performance of overseas sales, and have generally been at favorable levels. Business sentiment has also remained favorable on the whole, although it temporarily deteriorated – particularly in the non-manufacturing sector – due to the effects of the decline in demand following the consumption tax hike. Business sentiment among large manufacturing firms has remained on an upward trend despite the weakness in exports, reflecting the fact that profitability continues to be favorable. With corporate profits continuing to improve and business sentiment being generally favorable, business fixed investment, particularly in the non-manufacturing sector, has increased moderately. Moreover, even in the manufacturing sector, which had been lagging, a clear recovery in business fixed investment can be observed (Chart 4). With corporate profits continuing their improving trend, business fixed investment is projected to follow a moderate increasing trend as the effects of monetary easing grow stronger through the decline in expected real interest rates. The June Tankan survey shows that aggregate investment in fiscal 2014 is scheduled to increase. Therefore, the virtuous cycle of economic activity in the corporate sector is expected to remain intact against the backdrop of the improvement in corporate profits and favorable business sentiment. BIS central bankers’ speeches Outlook for and concerns about economic activity Japan’s economy is expected to continue its moderate recovery trend, since the virtuous cycle of economic activity in both the household and corporate sectors is likely to remain in place, as I just mentioned. At the July Monetary Policy Meeting (MPM), the Bank conducted an interim assessment of the April 2014 Outlook for Economic Activity and Prices (Outlook Report) through fiscal 2016. Looking at the median of the Policy Board members’ forecasts, real GDP is projected to grow at 1.0 percent in fiscal 2014, 1.5 percent in fiscal 2015, and 1.3 percent in fiscal 2016 (Chart 5). Regarding the outlook for economic activity, a potential concern is developments in exports. As I just mentioned, Japan’s exports have shown some weakness. The recent weakness in exports is essentially due to cyclical factors, mainly the sluggishness in emerging economies. At the same time, the unexpectedly large slowdown of the U.S. economy in the January–March quarter of this year due to the unusually severe winter weather seems to have affected exports with a lag, putting downward pressure on them through early spring. In addition, a possible structural factor why the recovery in Japan’s exports has lagged behind the recovery in overseas economies that may have played a certain role is the accelerated relocation of production overseas by Japanese manufacturing firms. Looking ahead, with structural problems such as fiscal and current account deficits persisting in some emerging economies, economic growth in emerging economies, and particularly growth in domestic demand, is expected to remain subdued for the time being. On the other hand, growth in the advanced economies such as the U.S. and European economies is expected to accelerate, while the Chinese economy is expected to continue to register stable growth. Growth in these economies will likely spread to emerging economies, so that the growth rate of overseas economies overall is expected to accelerate gradually. This is also confirmed by the World Economic Outlook Update published in July by the International Monetary Fund: global economic growth, which slowed to 3.2 percent in 2013, is projected to accelerate gradually to 3.4 percent in 2014 and 4.0 percent in 2015 (Chart 6). Therefore, the cyclical factors responsible for the weakness in exports so far are likely to gradually disappear and exports are expected to head for a moderate increase. In addition, from a somewhat longer-term perspective, the correction of the excessive appreciation of the yen in the past will mitigate downward pressure on exports by decelerating the pace of relocation of production overseas. B. Price developments Let me turn to price developments. The year-on-year rate of increase in the CPI (excluding fresh food) excluding the direct effects of the consumption tax hike was plus 1.3 percent in July. Thus, Japan’s economy is on course to achieving an inflation rate of 2 percent – the price stability target – as expected (Chart 7). When assessing price developments, it is important to bear in mind that monthly figures for the CPI tend to fluctuate and that trend inflationary pressure is determined by two factors: improvements in the output gap and rising inflation expectations. To assess trend inflation, it is necessary for the Bank to carefully examine these two factors. As I mentioned, Japan’s labor market has tightened, and firms’ excess capacity has almost disappeared as capacity utilization has increased. As a result, the output gap has been improving moderately and recently reached around 0 percent (Chart 8). Moreover, as I will explain later, medium- to long-term inflation expectations appear to be rising on the whole. The year-on-year rate of increase in the CPI is expected to accelerate moderately, along with increasing wages, against the backdrop of rising inflation expectations as well as improvements in the output gap, given that Japan’s economy is expected to continue growing at a pace above its potential. Specifically, the inflation rate is expected to be around 1¼ percent for some time, since upward pressure from energy-related goods, particularly petroleum products, will likely wane. Subsequently, with the output gap remaining positive BIS central bankers’ speeches and medium- to long-term inflation expectations rising, the year-on-year rate of change in the CPI is expected to follow an uptrend again and reach about 2 percent around the middle of the current projection period from fiscal 2014 through 2016, that is, in or around fiscal 2015. Looking at the median of the Policy Board members’ forecasts in the interim assessment of the Outlook Report at the July MPM, projections for the year-on-year growth rate in the CPI (excluding fresh food) are plus 1.3 percent for fiscal 2014, plus 1.9 percent for fiscal 2015, and plus 2.1 percent for fiscal 2016, after excluding the direct effects of the consumption tax hikes (Chart 5). II. Conduct of monetary policy A. What is QQE? For the remainder of my speech I would like to focus on several points concerning the Bank’s conduct of monetary policy. The QQE policy the Bank has been pursuing since April last year has two major pillars (Chart 9). The first pillar is a commitment to achieve the 2 percent price stability target as swiftly as possible. Specifically, the Bank clearly pledged 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. As the wording quantitative and qualitative indicates, these actions involve an expansion of the quantity and changes in the quality of assets on the balance sheet of the Bank. The quantitative aspect refers to the substantial increase in the amount of money provided by the Bank to the financial system, that is, the increase in the monetary base, through purchases of various assets, in particular Japanese government bonds (JGBs). The qualitative aspect refers to the purchase of riskier assets. The Bank started to include purchases of government bonds with longer remaining maturities. In order to affect risk premiums on assets, the Bank has also increased the amounts of purchases of exchangetraded funds (ETFs) and Japan real estate investment trusts (J-REITs). B. Transmission channels of QQE Many of you may be interested in the channels through which QQE with its two pillars affects the real economy and to what extent the effects of QQE have spread through the economy. Let me explain the transmission channels of monetary easing. A key transmission channel is the lowering of expected real interest rates (Chart 10). Expected real interest rates are nominal interest rates actually observed in financial markets or over the counter less the rate of inflation people expect. While nominal interest rates can be observed, expected real interest rates are the rates economic entities anticipate taking into account price changes. QQE aims at putting downward pressure on nominal interest rates through large-scale purchases of long-term government bonds and purchases of other assets while raising the expected rate of inflation. The aim is therefore to lower expected real interest rates, that is, nominal interest rates less the expected rate of inflation. If economic entities’ expected real interest rates fall, this will stimulate demand in the real economy in a number of ways (Chart 11). For example, when real interest rates decline, people will shift their portfolios from cash, deposits, and fixed-income securities – which will have become relatively less attractive – to equities and tangible assets such as land and housing, or to foreign currency-denominated assets with higher returns. The resulting rise in equity prices and the appreciation of foreign currencies will stimulate private consumption through wealth effects. BIS central bankers’ speeches In addition to the decline in expected real interest rates, other factors such as an increase in consumption, a rise in stock prices, and the depreciation of the yen, will encourage firms to be more proactive in their business fixed investment. The depreciation of the yen is also expected to give rise to an increase in exports. With an increase in demand through these channels, the shortage of demand in the economy will be eliminated, prices will rise, and overcoming deflation will be in sight. Further increases in production due to growing demand will lead to an increase in labor income through improved labor market conditions and, in turn, further raise private consumption. The resulting increase in corporate profits will lead to an increase in firms’ business fixed investment. This chain of developments leads to a virtuous cycle in the economy. C. Effects of QQE In the economy, monetary policy has so far been having its intended effects through the transmission channels I have explained. On the one hand, nominal interest rates, including long-term government bond yields, have been stable, while, on the other hand, economic entities’ inflation expectations have been rising on the whole, as I will explain in a moment. Therefore, expected real interest rates – that is, nominal interest rates minus the expected rate of inflation – have been declining. This, in turn, has boosted private demand, such as consumption and investment, raising aggregate demand in the economy as a whole. Economic growth in fiscal 2013 jumped to 2.3 percent following slow growth between only 0 and 1 percent in the two preceding years. Against this background, the year-on-year rate of change in consumer prices has been increasing as a trend toward around 2 percent – the price stability target. Corporate sector output has been increasing in response to the rise in aggregate demand, and labor demand has been increasing accordingly. Since nominal wages have been on an uptrend along with the increase in the number of workers, employee income as a whole has been rising, underpinning domestic demand. Therefore, QQE has been having its intended effects, and the effects of monetary easing are expected to further strengthen with the virtuous cycle among production, income, and spending being sustained. When talking about these developments on previous occasions, I have sometimes heard the concern that real wages may actually be declining, since nominal wages cannot keep up with the increase in inflation. In response, I have been saying that it is necessary to be patient and to watch the policy effects over a period of time, since the effects unfold in a certain order. From firms’ perspective, it is not easy to reduce the number of regular workers once increased and it is difficult to reduce wages once raised. Therefore, in general, increases in employment tend to start in the form of additional non-regular workers being hired, and wage increases tend to take the form of increases in special cash earnings such as bonuses or in non-scheduled cash earnings. While the year-on-year rate of change in scheduled cash earnings had been on a downtrend reflecting the increase in the share of part-time workers in total employment, scheduled cash earnings stopped declining in May this year and started to increase in June. Real wages had been declining until recently. However, excluding the direct effects of the April consumption tax hike, the year-on-year rate of change in real wages turned positive for full-time workers in June and for part-time workers in July (Chart 12). Once future economic prospects and the outlook for firms’ profits become more favorable as the virtuous cycle among production, income, and spending continues, it is likely that wages will rise steadily in line with or above the rate of inflation. For this to happen, it is important to BIS central bankers’ speeches continue with the appropriate conduct of monetary policy measures to achieve the price stability target in a stable manner. D. Inflation expectations and prices As mentioned earlier, in order to put downward pressure on expected real interest rates it is necessary to work on people’s inflation expectations. Under 15 years of protracted deflation, there was a growing share of younger people who had never experienced inflation, and the view that prices will not rise had become entrenched in people’s mindset. Dispelling such a deflationary mindset and changing people’s expectations so that they expect moderate inflation is quite a difficult challenge. That is why the current large-scale monetary easing had become necessary. Various surveys and market indicators point to a general uptrend in people’s inflation expectations (Charts 13 and 14). This can be attributed to the fact that the impact of QQE on inflation expectations has been spreading. In addition, this uptrend also reflects an increase in the number of people who had been reluctant to believe that Japan would experience inflation until they saw it and who are now adjusting their expectations. Such skeptics have adjusted their expectations due to the rise in actual inflation reflecting the improvement in the output gap. This tendency is likely to become stronger going forward. The rise in inflation expectations, moreover, has the effect of directly raising actual inflation through an additional channel distinct from the boost to aggregate demand through lower expected real interest rates. Specifically, when people expect future inflation, their price and wage setting will be based on such expectations, thus adding inflationary pressure. In this context, it is useful to refer to the concept of the Phillips curve, which illustrates the relationship between economic activity and inflation. Recently, inflation has clearly been above the level suggested by the Phillips curve derived from data for the period of deflation (Chart 15). In addition to a move along the Phillips curve due to the improvement in economic activity, this may reflect an upward shift in the Phillips curve due to upward pressure on the curve itself stemming from the rise in inflation expectations. E. The depreciation of the yen and inflation On this basis, the Bank believes that the price stability target of 2 percent will be achieved, as I mentioned earlier. Of course, there are some skeptical voices. For example, some argue that the current rise in inflation is the result of a rise in the price of imports, especially energy, due to the depreciation of the yen, so that once such exchange rate effects dissipate, the pace of inflation should slow down. However, statistical analysis for the period prior to the introduction of QQE shows no significant relationship between changes in the exchange rate of the yen and inflation in Japan (Chart 16). That is, a depreciation of the yen does not necessarily lead to inflation. Let me briefly explain why this is the case. Assuming that all else remains equal, a rise in the prices of imports due to a depreciation of the yen or other factors indeed creates upward pressure on prices. At the same time, however, the resulting negative income effect will reduce the demand for imports and other goods and services, which, in turn, will exert downward pressure on the prices of imports and other goods and services. For example, if gasoline prices rise, you may try to drive less or reduce your purchases of other products. A clear relationship between the yen-dollar exchange rate and the year-on-year rate of change in consumer prices can only be observed in the short period after the introduction of QQE (Chart 17). This suggests that current inflation has not been brought about merely by the depreciation of the yen. Instead, it appears that QQE has triggered certain mechanisms resulting in price increases that were not seen during episodes of monetary easing in the past. BIS central bankers’ speeches How a rise in prices of specific goods and services reflecting, for example, a depreciation of the yen ultimately affects aggregate demand and aggregate prices depends on the interaction of the various mechanisms. Thus, there is no one-to-one relationship between changes in the prices of specific goods and services and the price level overall. In other words, one cannot forecast macro-level changes simply by adding up micro-level changes. In the end, to forecast price developments at the macro level, analyses from a macro perspective are necessary. Specifically, it is essential to examine the output gap, that is, how much demand there is relative to the supply capacity of the economy as a whole. The main factor underlying the current level of inflation is the growing demand in the economy as a whole, and the effects of monetary policy played a certain role in the growth in demand. Because of such demand pressure, firms have been able to smoothly pass on increases in costs as well as the consumption tax hike to higher sales prices. F. QQE and strategies to raise the growth potential With monetary policy having its intended effects and the output gap improving, firms have gradually started to face supply constraints such as shortages in labor and capital stock that had not surfaced under deflation. Japan’s unemployment rate increased from 3–4 percent in the mid-1990s to 5–6 percent in the 2000s, despite the fact that the working age population has been shrinking since 1996. On the other hand, more recently, the economy has been facing a labor shortage, which, given the decline in the number of workers, is what one would expect under normal circumstances. Thus, one could say that Japan’s economy is gradually returning to a much more normal situation, in which the unemployment rate falls as the number of workers shrinks. Due to the decline in the working age population, as well as a slowdown in productivity growth and sluggish business fixed investment, Japan’s potential growth rate is estimated to have declined to around 0.5 percent. Now that the improvement in the output gap has brought challenges on the supply-side to the fore, this is a good time to make efforts to raise the growth potential by increasing the capital stock and pursuing growth strategies such as measures to respond to the decline in the working age population and to promote innovation through regulatory and institutional reforms. The reason I refer to the importance of strengthening growth potential here is not that it is a necessary condition for achieving the price stability target. The price stability target of 2 percent can be achieved through the appropriate conduct of monetary policy, regardless of the level of potential growth rate. If aggregate demand grows due to monetary easing, workers will work more efficiently, while the improvement in business sentiment will lead firms to take risks and invest in capital stock and to promote technological innovation. This, in turn, is likely to raise the growth potential to some extent. However, such monetary easing alone will not be sufficient to achieve the government’s target of “real economic growth of about 2 percent on average for 10 years” and can only provide a supplementary boost to Japan’s growth potential. To achieve the government’s target, it is necessary to raise Japan’s growth potential by pushing ahead with drastic structural reforms through a growth strategy. In a deflationary recession, it is difficult to push ahead with such structural reforms, since there is bound to be strong resistance against policy measures that, for example, seek to increase competition through deregulation, due to the severe economic pain such measures would bring about. Therefore, monetary policy to overcome deflation and maintain inflation at about 2 percent in the medium to long term is a necessary condition to promote structural reforms in order to raise the potential growth rate. This has been my view even since before I became Deputy Governor of the Bank. BIS central bankers’ speeches Based on these considerations, the Bank will continue to strive to pursue appropriate monetary policy measures on its own accord to achieve the price stability target of 2 percent at the earliest possible time. Concluding remarks In concluding, let me touch on the economy of Ishikawa Prefecture. Ishikawa Prefecture is a manufacturing region and there are a number of firms that have unique technologies of worldwide prominence. In addition, there are many vigorous small and medium-sized enterprises (SMEs) in Ishikawa Prefecture, and the prefecture has a disproportionate share in the list of 300 of Japan’s Exciting Monozukuri (Manufacturing) SMEs released by the Ministry of Economy, Trade and Industry. Moreover, with regard to human resource utilization, Ishikawa Prefecture comes first in Japan in terms of the employment rate of women, and the overall employment rate is also relatively high. The economy of Ishikawa Prefecture has been recovering moderately, although it has been affected by the subsequent decline in demand following the front-loaded increase prior to the consumption tax hike. With the employment and income situation improving, private consumption has been moderately picking up as a trend. Business fixed investment has increased as corporate profits have improved steadily. Meanwhile, public investment has been at a high level, and housing investment appears to have stopped weakening, despite the decline in demand following the consumption tax hike. Reflecting these developments in demand, industrial production has been hovering at a high level and the employment and income situation has improved. Therefore, a virtuous cycle of economic activity has been operating. Given this assessment of the regional economy, I hope that the extension of the Hokuriku Shinkansen line to Kanazawa in March 2015 will further boost economic activity in the region on both the tourism and the business front. With regard to tourism, an increasing number of visitors are expected to come to this region, and there has been an increase in the building and renovation of hotels and other commercial facilities to respond to this increase in demand. Regarding business, firms have been launching initiatives such as developing new sales networks and tapping new customers as well as promoting the relocation of enterprises to the region from outside the region. Moreover, I have heard that – taking advantage of the clustering of the textile industry in this region – industry, the prefectural administration, and academics in coordination have launched initiatives to develop new materials made from carbon fibers. I have also heard that initiatives aiming to promote new industries such as aircraft-related industries and medical and nursing services have been implemented. I sincerely hope that, with the extension of the Hokuriku Shinkansen line to Kanazawa, the region will enjoy further growth in the future through the strengthening of joint efforts between the public and the private sector in a wide range of areas to boost the economy of the region. 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 Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 16 September 2014.
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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, 16 September 2014. * * * Accompanying charts can be found at the end of the speech. Introduction It is my great pleasure to have the opportunity today to exchange views with a distinguished gathering of business leaders in Osaka. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the Bank of Japan’s branches in Osaka, Kobe, and Kyoto. In April last year, the Bank 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. When I spoke to you last November, I said that under QQE there was a positive turnaround in areas such as economic activity, financial markets, and people’s sentiment and expectations. Since then, QQE has continued to steadily exert its intended effects. The year-on-year rate of change in the consumer price index (CPI, excluding fresh food) was minus 0.4 percent in April last year when QQE was introduced, but it has improved since then, recently registering 1.3 percent excluding the direct effects of the consumption tax hike. Japan’s economy has thus 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 the Bank’s view on the current situation of and outlook for economic activity and prices as well as the Bank’s monetary policy management. I. Economic activity in Japan and abroad Current situation of and outlook for Japan’s economy Let me start by discussing the current situation of and outlook for Japan’s economic activity. Japan’s economy has continued to recover moderately as a trend, although a decline has been observed in demand following the front-loaded increase prior to the consumption tax hike. The GDP statistics (second preliminary estimates) released last week showed that real GDP in the April-June quarter of 2014 fell substantially at a rate of 7.1 percent on an annualized quarter-on-quarter basis (Chart 1). However, this decline followed the frontloading of demand in the January-March quarter, in which real GDP had grown significantly at a rate of 6.0 percent. To exclude such fluctuations, when we compare real GDP in the January-June period this year with that in the July-December period last year, the annualized growth rate was 1.0 percent. Therefore, on average, Japan’s economy has continued to grow at a pace above its potential. More specifically, the employment and income situation has continued to improve steadily, and household sentiment has been improving, although the decline following the front-loaded increase prior to the consumption tax hike is still observed, and exports as well as industrial production have shown some weakness. Moreover, firms have maintained a proactive stance on investment due mainly to their favorable business performance. In this way, a virtuous cycle from income to spending has been operating steadily in both the household and corporate sectors. With this mechanism intact, Japan’s economy is expected to continue its moderate recovery trend, and the effects of the decline in demand following the front-loaded increase are expected to wane gradually. Next I will discuss the household and corporate sectors, respectively. BIS central bankers’ speeches Household sector: resilient private consumption In the household sector, private consumption has remained resilient as a trend with the employment and income situation improving steadily. With regard to durable goods such as automobiles and household electrical appliances, the recovery from the decline has dragged on reflecting the large degree of front-loading of purchases. On the other hand, sales at department stores and supermarkets have followed a recovery trend on average. Moreover, consumption of services has been resilient, as seen for example in food service and outlays for travel, where the effects of the consumption tax hike have been limited. Although developments in consumption after the consumption tax hike vary by item and bad weather may have adversely affected developments in some regions, the effects of the decline in demand following the tax hike have gradually begun to wane on the whole. Looking ahead, with the employment and income situation continuing to improve steadily, private consumption is expected to remain resilient. With regard to the household sector, it is claimed that wage increases have failed to keep pace with inflation and real wages have declined, putting downward pressure on private consumption. On this point, it is important to distinguish between an increase in the inflation rate resulting from the consumption tax hike and trend inflation. With the year-on-year rate of increase in the CPI since April this year having been pushed up temporarily due to the consumption tax hike, the year-on-year rate of increase in nominal wages has been lower than that in the CPI. However, the consumption tax hike was scheduled in advance, and it is not an additional factor putting downward pressure on economic activity and prices. Even since before the tax hike in April this year, the Bank’s outlook for economic activity and prices has factored in the two rounds of consumption tax hikes. While the hikes will adversely affect real income, such effects on households’ spending behavior might be mitigated to some extent as confidence is enhanced in the sustainability in the government’s fiscal conditions and the social security system. Looking at the recent income situation of households, employee income has been increasing about 2 percent year on year, exceeding the inflation rate, which is hovering at around 1¼ percent excluding the direct effects of the consumption tax hike (Chart 2). Specifically, the year-on-year rate of change in scheduled cash earnings turned positive reflecting a rise in base pay by many firms – the first increase in many years. In addition, special cash earnings have clearly risen due mainly to an increase in summer bonuses. Furthermore, the number of employees has been growing. Looking ahead, with the economy recovering moderately, the employment situation is expected to maintain its improving trend, exerting further upward pressure on wages, and therefore employee income is likely to continue increasing moderately. Underpinned by this improvement in the employment and income situation, private consumption is expected to remain resilient, and the effects of the decline in demand following the front-loaded increase are expected to wane further. Corporate sector: moderate increase in business fixed investment Turning to the corporate sector, industrial production has recently shown some weakness, particularly in durable goods, such as automobiles, and construction goods, both of which have been significantly affected by the decline following the front-loading of purchases. Exports have been lacking momentum due mainly to a delay in the recovery of overseas economies, as I will explain later in more detail. Even in this situation, corporate profits and business sentiment have been favorable, and firms have maintained their proactive stance on business fixed investment. In fact, the corporate profits of listed companies for the AprilJune quarter appear to have surpassed projections. Surveys point to favorable business sentiment, and firms are planning to increase their business fixed investment – mainly investment in Japan – from the previous year. While it is claimed that growth in business fixed investment can no longer be expected due to Japanese firms’ accelerated relocation of production overseas, I hold the view that we are now in an environment supporting an increase in such investment (Chart 3). The reasons are BIS central bankers’ speeches as follows. First, as a result of restrained investment for some years, capital stock has become outdated and this has hampered smooth production in some cases, prompting increasing demand for renewal investment. Second, wages have risen due to the labor shortage while interest rates for borrowing to finance business fixed investment have been at low levels. Therefore, it might have become more advantageous for some firms to invest in labor-saving machinery and equipment than to hire new employees. Third, nearly two years have passed since the correction of the excessive yen appreciation, and it appears that Japanese firms have started again to invest in improving the domestic bases of their businesses, particularly for research and development. Against this backdrop, as corporate profits are expected to continue improving on the whole, the virtuous cycle from income to spending is likely to operate steadily, and business fixed investment is expected to continue its moderate increasing trend. Exports and overseas economies As I just mentioned, domestic demand is expected to remain firm. On the other hand, external demand has continued to lack momentum (Chart 4). This is due not only to cyclical factors including sluggishness in global economies such as emerging economies, but also to structural factors such as the accelerated relocation of production overseas by Japanese manufacturing firms. Nevertheless, as the cyclical factors are expected to become favorable – particularly with the accelerating growth of overseas economies (mainly advanced economies) – exports are expected to head for a moderate increase, especially those of high-value-added products. In fact, there are signs of a pick-up in exports, with an uptrend in external demand for machinery orders – a leading indicator of exports of capital goods and parts – and an improving trend in the forecast diffusion index of overseas supply and demand conditions for products as shown in the Tankan (Short-Term Economic Survey of Enterprises in Japan). Of course, such an outlook for exports is based on the assumption that overseas economies will continue to recover. While there are concerns including geopolitical risks in some parts of the world, the global economy is likely to continue recovering, led by advanced economies, since economic recovery in the United States has become increasingly evident. In the World Economic Outlook Update published in July by the International Monetary Fund, annual global economic growth – which slowed to 3.2 percent in 2013 – is projected to accelerate gradually to 3.4 percent in 2014 and 4.0 percent in 2015 (Chart 5). Looking at individual countries or regions, in the U.S. economy, firmness in the household sector has been spreading to the corporate sector and a pick-up in business fixed investment recently became evident. These developments are likely to lead to an increase in demand for some capital goods and parts – in which Japan enjoys a competitive advantage – and therefore deserve attention when we consider the outlook for Japan’s exports. In the euro area economy, a disinflationary trend – as seen in the decline in the year-on-year growth rate in consumer prices to 0.3 percent – is a matter of concern. However, international markets’ views on the European debt problem remain stable and the European Central Bank implemented a series of additional monetary easing measures in June and September. This background supports the view that the euro area economy will basically continue to recover, albeit moderately. In China, the economy is expected to maintain stable growth at around the current pace, since the government plans to give due attention to the economic recovery, such as by providing economic stimulus measures both on the monetary and fiscal fronts, although an adjustment in the real estate market has persisted. While other emerging economies and commodity-exporting countries have continued to lack growth momentum as a whole, positive effects of the recovery in advanced economies are expected to spread gradually. In the meantime, some geopolitical risks, including those in Ukraine and Iraq, still warrant attention. BIS central bankers’ speeches Therefore, the Bank’s baseline scenario is that overseas economies – mainly advanced economies – are likely to continue to recover, and Japan’s exports are expected to head for a moderate increase. II. Price developments in Japan Let me turn now to price developments in Japan. As I mentioned at the outset, the year-on-year rate of increase in the CPI (excluding fresh food) – which was minus 0.4 percent in April last year when QQE was introduced – subsequently turned positive and increased further to around 1¼ percent recently (Chart 6). These developments reflect an improvement in the output gap and a rise in inflation expectations. The output gap has been improving at around 0 percent – the long-term average – with Japan’s economy continuing to grow at a pace above its potential as a trend, although the effects of the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike have been observed. Inflation expectations appear to be rising on the whole, albeit with monthly fluctuations. With the year-on-year rate of increase in the CPI (excluding fresh food) continuing to exceed 1 percent, a shift is observed in firms’ price-setting strategy, from a low-price strategy to one of raising sales prices while increasing value-added. As for wage setting, as seen in annual wage negotiations this spring, the rise in inflation is increasingly being taken into account in wage negotiations between management and labor. This improvement in the output gap and the rise in inflation expectations are expected to continue. Therefore, the year-on-year rate of increase in the CPI, which is likely to be around 1¼ percent for some time, is expected to subsequently follow an uptrend again from the second half of this fiscal year and reach about 2 percent – the price stability target – around the middle of the current projection period from fiscal 2014 through 2016. III. Monetary policy management toward achieving the price stability target of 2 percent Finally, let me discuss the Bank’s monetary policy management. The Bank has been pursuing QQE, aiming to achieve a state in which the 2 percent inflation rate is maintained in a stable manner. In this state, the inflation rate will be around 2 percent when the economy is at a normal level. That is, firms will be able to base decisions on an assumption of about 2 percent inflation when they consider how to set prices and when management and labor negotiate wages. If such an economy is achieved, economic entities will act based on an expectation that inflation will return to about 2 percent sooner or later – even if the economy faces temporary downward pressure on prices and wages due to, for example, a downturn in economic activity. Therefore, the risk of falling into deflation, where prices and wages continue to decline, will be lowered. As I mentioned, Japan’s economy has been on a path suggesting that the price stability target of 2 percent will be achieved as expected. We are only halfway there, however, and 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. If the outlook changes due to the manifestation of risk factors and it is judged necessary for achieving the price stability target, the Bank will make adjustments without hesitation. I would like to conclude my speech today by assuring you that, through the Bank’s monetary policy management, the prolonged deflation will be overcome and an economy based on a moderate inflation rate of 2 percent will be achieved. Thank you. 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 held by the International Bankers Association of Japan, Tokyo, 29 September 2014.
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Haruhiko Kuroda: The role of foreign financial institutions in Japan’s financial system Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the International Bankers Association of Japan, Tokyo, 29 September 2014. * * * Introduction Thank you for having me at this event commemorating the 30th anniversary of the International Bankers Association of Japan or the IBA Japan. The IBA is a business association for foreign banks, securities firms, and other associated financial services firms operating in Japan. Since its establishment in 1984, the IBA has been making a substantial contribution to economic and financial developments in Japan. I wholeheartedly honor the 30th anniversary of the IBA Japan and pay respect for its constant efforts to date. To start with, let me look back on the developments in the cross-border integration of financial markets and the role foreign financial institutions have been playing during the 30 years since the IBA Japan was established. Then, I will touch on the importance of financial system stability from a central bank’s perspective, and close my speech by briefly explaining the Bank of Japan’s monetary policy management. Financial globalization and financial system stability The establishment of the IBA in 1984 coincided with the publication of the report by the joint Japan-U.S. working group on the yen/dollar exchange rate, financial and capital market issues. The report of the working group included the liberalization of, and the entry of foreign financial institutions into, Japan’s financial markets, as well as the development of the Euroyen market in order to promote, so to speak, the opening of Japan’s financial markets to the rest of the world. In the 30 years since the publication of the report, the globalization of the economy and the financial system has progressed significantly. With the globalization of the financial system and the growing cross-border integration of financial markets, the role played by foreign financial institutions in Japan has been quite significant. Many foreign financial institutions that have started business one after another in Japan have been playing a leading role in Japan’s financial markets in various aspects, including the adoption of new financial technologies, the development of new markets, and the introduction of advanced risk management methods. In addition, they have played an important role in tightly linking financial markets across borders. The economic and financial globalization has proceeded rapidly in recent years first in advanced economies, then involving emerging economies. Naturally, such developments are part of the process of increasing the interdependence of financial systems in different countries. In case there is a shock in a market, its effects will spread globally and immediately. That suggests that financial system stability needs to be achieved on a global basis, not in each individual country. In fact, the global financial crisis triggered by the collapse of Lehman Brothers has made it clear that the impact of the manifestation of a risk in globalized markets can be severe and spread to a wide range of areas. Although Japan’s financial system was relatively robust when the crisis struck, it was not immune to the crisis. Looking back at the situation, there was a large impact on Japan’s financial markets. That included heightened concern over counterparty risk in the money market, the distortion of pricing in financial markets due to a liquidity shortage, and a decline in the functioning of the CP and corporate bond markets. BIS central bankers’ speeches Unfortunately, there are not a few foreign financial institutions that had to cut back their activities in Japan following the crisis. Stability and functioning of the financial system It has become a shared recognition on a global basis that, to avert the reemergence of a financial crisis, it is important to analyze and assess the risks in the entire financial system as well as to take adequate measures to prevent systemic risk from manifesting itself. It is the so-called emphasis on a macroprudential perspective. Various international forums such as the Financial Stability Board and the Basel Committee on Banking Supervision are vigorously examining the substantial reform of international financial regulation. In line with those developments, individual countries have been independently strengthening regulations and substantially reviewing the supervisory system on financial institutions. One of the aspects of a stronger macroprudential approach both on regulatory and supervisory fronts might be to clean up individual problems that have surfaced in the process of the global financial crisis. The cleaning up includes ensuring the soundness of individual financial institutions, solving the too-big-to-fail problem and thereby preventing the moral hazard problem, and avoiding taxpayers’ burden in the resolution of failed financial institutions. During the past decades, financial business has become increasingly sophisticated and complex, financial systems have globalized, and financial markets have integrated across borders. In this context, we should pay more attention to another aspect, to strengthen the financial system as a whole on a global basis. Therefore, it is critical to bear in mind the interconnectedness of financial institutions through market transactions and to gauge more extensively overall changes in financial institutions and financial markets that compose the financial system. On that basis, it is also critical to implement a wide range of initiatives to maintain financial system stability. In implementing the initiatives to enhance the stability of the financial system, we should not ignore initiatives to enhance its functioning so that the system can firmly support sustainable economic growth from the financial side. It appears that financial institutions’ role to support firms’ innovation and growth strategy from the financial side, is only bound to become larger in the future. Financial institutions play a variety of roles in encouraging firms’ growth, such as developing new financial products corresponding to social changes, providing efficient settlement services and risk-hedging measures, as well as supporting M&As and reorganizations of firms. It is extremely important for financial institutions to enhance such roles constantly. Going forward, from a perspective of supporting Japan’s economic growth from the financial side, I strongly hope that foreign financial institutions will continue to implement new initiatives while responding to changes in the surrounding environment. While taking account of changes including financial and economic globalization, the Bank of Japan will continue to make efforts to strengthen the functioning of Japan’s financial markets by enhancing payment and settlement services, including the development of the new Bank of Japan Financial Network System, the so-called BOJ-NET, and the extension of its operating hours, and by participating in initiatives to improve market practices, while closely cooperating with market participants. A macroprudential perspective for a central bank Now, let me further talk on the issues of financial stability and a macroprudential perspective for a central bank while taking into account their relationship with monetary policy. Monetary policy aims at ensuring price stability and does not aim at ensuring the stability of the financial system. However, there is a close relationship between monetary policy and the stability of the financial system. To begin with, monetary policy has a substantial impact not only on price stability but also on financial system stability through its effects on financial intermediation and various asset prices. For example, central banks in advanced economies BIS central bankers’ speeches have been pursuing ultra monetary easing through unconventional monetary policies to achieve price stability while responding to the economic downturn after the global financial crisis. In that situation, investment in high-risk assets such as high-yield bonds and emerging economies’ bonds and stocks has been expanding considerably against a backdrop of declining volatility in interest rates, stock prices, and foreign exchange rates, as well as investors’ search for yields. Since the effects of monetary policy are transmitted to the real economy through the financial system, financial system stability is the basis for monetary policy that aims at ensuring price stability. If the functioning of the financial system declines, the effects of monetary policy will decline to that extent. If by any chance the functioning of the financial system is significantly impaired due to a financial crisis, it will be certain to see an adverse impact on price stability through a plunge in economic activity. In any event, central banks cannot be unconcerned about the stability of the financial system. Nowadays, while a macroprudential perspective has attracted attention in the context of regulating and supervising financial institutions, it is not at all new for central banks. Traditionally, central banks possess the Lender of Last Resort function. While that takes the form of central bank lending to individual financial institutions, its aim is to secure the stability of the financial system and it is not to bail out a single financial institution. In the global financial crisis, the Bank of Japan and other central banks responded to a rapid contraction of the markets by providing liquidity to the markets as a whole through open market operations, such as purchases of assets like CP and corporate bonds as well as unlimited fund provisioning to the markets. Those responses are often called a central bank’s functioning of Market Maker of Last Resort. And it can also be said to be a policy that is clearly associated with a macroprudential perspective. It safeguards financial system stability through dealing not with the liquidity provision to individual financial institutions but directly with a decline in overall market liquidity. In considering a central bank’s initiatives in a macroprudential aspect, it is often argued that there may sometimes be a trade-off between a central bank’s objectives of ensuring price stability and ensuring financial system stability. That point has been discussed at home and abroad and the jury is still out, but at least one can point out that history does suggest that substantial imbalances in financial and economic activity emerge through a feedback loop in which changes in the output gap and changes in the financial cycle reinforce each other. That is evident when you look back on the global financial crisis and the burst of the bubble in Japan in the 1990s. There have been many discussions on how to deal with substantial imbalances including a bubble: to what extent such changes could be gauged in advance and preemptive measures could be taken, or what measures should be implemented in response to the imbalances. In any event, the recognition has become widespread that the financial cycle could lead to significant changes in the economy as a whole. Even at normal times, it is important to appropriately grasp the conditions of the financial system in monetary policy management. Analysis and assessment on risks in the financial system Taking those points into account, the Bank examines risks in the financial system in establishing the guidelines for monetary policy. In establishing the guidelines for monetary policy, the Bank assesses the economic and price situation from two perspectives. The first perspective concerns examining whether the outlook for economic activity and prices in the coming two years or so suggests that the economy is on a path toward sustainable growth with price stability. At the same time, the second perspective, based on a longer-term viewpoint, concerns examining the risks that the Bank considers to be the most relevant to monetary policy management in achieving sustainable growth with price stability. This second perspective includes the examination of risks in the financial system as one element of medium- to long-term risks. Japan’s financial system currently maintains stability and has substantial resilience against shocks. Capital bases of financial institutions have been adequate on the whole, given that BIS central bankers’ speeches the accumulation of capital has continued while the amount of risk borne by financial institutions has increased only slightly. Developments in financial intermediation show no indication of overheating or excessively bullish expectations. In the future, the globalization of the economy and transformation of industrial structures could lead to changes in the financial intermediation function and the risk profile of the financial system. In addition, financial and economic developments at home and abroad would affect financial institutions’ performance in securities investments. The effects of various environmental changes on financial system stability will continue to warrant attention. Analyses that form a basis for the Bank’s assessment of risks in the financial system as a whole are semiannually published as the Financial System Report. The next issue will be published in mid-October and I hope you will have a chance to read it. Concluding remarks Let me conclude by briefly touching on the Bank’s monetary policy management. Although a decline following the front-loaded increase in demand prior to the consumption tax hike still remains and there has been some weakness in exports and industrial production, a steady improvement in the employment and income situation has been continuing and household sentiment has been improving. Firms have been maintaining their proactive stance for business fixed investment as corporate profits have improved. The virtuous cycle from income to spending has been operating steadily in both the household and corporate sectors, and Japan’s economy is expected to continue its moderate recovery trend and the effects of the decline in demand following the consumption tax hike are expected to wane gradually. The year-on-year rate of change in the consumer price index, excluding volatile food and the direct effects of the consumption tax hike, is expected to be around 1¼ percent for some time. It is expected to subsequently follow an uptrend again from the second half of this fiscal year and reach about 2 percent around the middle of the current projection period from fiscal 2014 to 2016. Quantitative and qualitative monetary easing, dubbed QQE, has so far been producing its intended effects. 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. If the outlook changes due to the manifestation of risk factors and it is judged necessary for achieving the price stability target, the Bank will make adjustments without hesitation. I have high hopes that foreign financial institutions will continue to play the significant role they have played in Japan’s economy in the past 30 years and will contribute to the robust growth of Japan’s economy in the future. With such hopes, let me conclude my speech today. Thank you. BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Economic Club of New York, New York, 8 October September 2014.
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Haruhiko Kuroda: Japan’s economy – responding to cautious views Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Economic Club of New York, New York, 8 October September 2014. * * * Introduction Thank you for your kind introduction. I am greatly honored to have the opportunity today to speak at the Economic Club of New York. In April last year, the Bank of Japan introduced quantitative and qualitative monetary easing, dubbed QQE. One and a half years have passed since then, and QQE has been producing its intended effects. The year-on-year rate of change in the consumer price index, or the CPI, excluding volatile food, which was minus 0.4 percent in April last year, has recently become around 1¼ percent excluding the direct effects of the consumption tax hike. Japan’s economy has been on a path suggesting the 2 percent price stability target will be achieved as expected. Meanwhile, cautious views concerning Japan’s economy seem to be spreading, with the consecutive releases of somewhat weak economic indicators after the consumption tax hike in April. That being said, the Bank’s assessment is that with the mechanism of economic recovery operating steadily, Japan’s economy is expected to continue its recovery, weathering the temporary slowdown in economic growth due to the consumption tax hike. Today, I will talk about the current situation of Japan’s economy under QQE and future challenges. I. QQE and the recovery of Japan’s economy The mechanism of QQE Let me start by discussing briefly the mechanism of QQE. QQE consists of two pillars. One is a strong and clear commitment to achieve the price stability target of 2 percent at the earliest possible time and the other is a large-scale monetary easing to underpin the commitment. Specifically, inflation expectations will be raised through a strong and clear commitment to achieve the price stability target and at the same time, downward pressure will be put on the entire yield curve through massive purchases of government bonds. As a result, real interest rates will decline, thereby stimulating private demand such as business fixed investment, private consumption, and housing investment. There will be upward pressure on prices if private demand increases and the output gap, in other words the slack of the economy as a whole, narrows. If actual inflation rates accelerate, expected inflation rates will rise and the aforementioned series of processes will be reinforced. The mechanism of QQE has so far been operating as anticipated. 10-year government bond yields have been in the range of 0.5–0.6 percent in recent months. An average commercial bank lending rate on new loans has declined to a historic low level of around 0.8 percent. At the same time, medium- to long-term inflation expectations gauged from the Consensus Forecasts have climbed to 1.6 percent. Thus real interest rates have clearly been negative up to long-term ones. In a nutshell, with QQE producing its intended effects, a virtuous cycle from income to spending has been operating steadily as a high level of confidence is maintained in both the household and corporate sectors. BIS central bankers’ speeches Effects of the consumption tax hike In contrast to the view that I just mentioned, there has recently been concern that Japan’s economic recovery might have been losing momentum, reflecting the recent weak economic indicators due partly to the effects of the consumption tax hike. In particular, the GDP statistics released last month showed that real GDP in the April-June quarter fell substantially at a rate of 7.1 percent on an annualized quarter-on-quarter basis, garnering people’s attention. The substantial decline in the April-June quarter followed the front-loaded demand in the January-March quarter, in which real GDP had grown significantly at a rate of 6.0 percent, and thus was expected in advance. Excluding such fluctuation of the front-loaded increase and the subsequent decline in demand prior to and after the consumption tax hike, the annualized growth rate of real GDP in the January-June period this year over the JulyDecember period last year is 1.0 percent. It is not necessarily a high growth rate, but exceeds Japan’s potential growth rate, which is estimated to be around 0.5 percent. As I will discuss in the following, since the virtuous cycle of economic recovery has been operating steadily, the growth rate of real GDP in the July-September quarter is expected to return to the clearly positive one. The virtuous cycle in both the household and corporate sectors Next, let me explain the mechanism of economic recovery in both the household and corporate sectors. In the household sector, with QQE producing its intended effects, the output gap has improved substantially, and the economic slack has almost been absorbed. The labor market has been tight, and the unemployment rate was 3.5 percent, declining to roughly the same level as the structural unemployment rate. If I borrow the terminology used by the Federal Reserve Board and the Bank of England, in Japan, there is almost no slack in the labor market and spare capacity in firms and the labor market is zero. Those developments have also been putting upward pressure on wages. On wages’ front, the practice of increasing base pay annually, which had been lost during the period of deflation, was revived for the first time in more than a decade in wage negotiations between management and labor this spring. An increase in nominal wages has been evident since this spring, and along with a steady increase in the number of the employees, employee income has increased above 2 percent year on year. The recent decline in private consumption is due to the temporary decline in demand following the consumption tax hike, and as the effects of such decline wane, private consumption is likely to remain resilient with the employment and income situation improving steadily. In fact, the latest economic indicators show that the effects of the decline following the consumption tax hike have been waning, except for durable goods including automobiles. Some people view a statistical negative growth in real wages as a problem, but it is due to a one-time increase in the inflation rate resulting from the consumption tax hike. The consumption tax hike was scheduled in advance, and it is not an additional factor putting downward pressure on economic activity and prices. While the year-on-year rate of increase in the CPI has been around 1¼ percent excluding the direct effects of the consumption tax hike, that in nominal wages has been in the range of 1–2 percent and that in employee income has been above 2 percent recently. The recent developments in nominal wages have been mostly consistent with those suggested by the wage Phillips curve, which shows the historical relationship between the wage growth rate and the unemployment rate. Unlike in the United States, we don’t see a phenomenon in Japan that the wage increase falls short of what has been suggested by the level of the unemployment rate. With those in mind, there is no reason to believe that developments in wages will adversely affect Japan’s economic activity. BIS central bankers’ speeches Let me move on to the corporate sector. Corporate profits have continued to improve, with the ratio of current profits to sales for major firms exceeding the level prior to the global financial crisis. In the current economic recovery, some people point to the sluggishness in exports. It is affected partly by the structural changes including relocation of production sites overseas. Corporate profits on a global basis have been favorable. As shown in the September Tankan survey released last week, business sentiment as a whole has maintained its favorable level, despite being affected by the decline in demand following the consumption tax hike. It suggests that many firms basically regard the decline in demand following the consumption tax hike as a temporary one. Reflecting the favorable corporate performance, stock prices have remained resilient. In that situation, firms have been taking a positive stance in their business fixed investment plans, and it has remained unchanged in the latest Tankan survey. The increase in business fixed investment might be attributable to several factors. Corporate profits have been favorable and financial conditions have been accommodative. As a result of restrained investment for some years, capital stock has become outdated, prompting increasing demand for renewal investment. There is also increased demand for investment in laborsaving machinery and equipment due to the labor shortage I mentioned before. Therefore, Japan’s economy is expected to continue growing at a pace above its potential as a trend since the virtuous cycle from income to spending has been operating steadily in both the household and corporate sectors. Price developments Next, I will talk about the price developments in Japan. Trend inflation is considered to be determined by the output gap of the economy as a whole and inflation expectations. As for the output gap, with the labor market tightening as I mentioned before, the slack has been almost absorbed. Looking at the developments since the introduction of QQE, inflation expectations have been rising on the whole, albeit with monthly fluctuations. Against such a backdrop, the year-on-year rate of change in the CPI, excluding volatile food, which was minus 0.4 percent in April last year, has recently become 1.1 percent excluding the direct effects of the consumption tax hike. The CPI inflation has more or less leveled off in a narrow range of around 1¼ percent for eight months since the beginning of this year. Looking at such leveling-off inflation rates, some view that increasing momentum for the CPI inflation has been lost after accelerating strongly last year. The leveling-off CPI inflation is due to the dissipating base effect. The effects of yen depreciation and the energy price increase that exerted upward pressure on consumer prices in the previous year have been falling off, compared with a year earlier. By contrast, trend inflation rates have continued to increase steadily. In fact, the developments in the inflation rates so far have been mostly in line with the Bank’s projection. The fact that the inflation rate has not declined too much but remained resilient despite the dissipating base effect suggests that the improvement in the output gap and the rise in inflation expectations have been working as trend inflationary pressure. Looking ahead, the output gap and inflation expectations are expected to continue improving. Since the dissipating base effect is expected to run its course, the year-on-year rate of increase in the CPI is expected to follow an uptrend again from the second half of this fiscal year and reach about 2 percent, that is, the price stability target, in or around fiscal 2015. II. Bank’s monetary policy management and Japan’s growth potential In this way, Japan’s economy has been on a path suggesting that the 2 percent price stability target will be achieved as expected. Yet, we need to raise inflation rates and inflation expectations further toward 2 percent and thus we are only halfway there. The Bank will BIS central bankers’ speeches 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 risk factors and it is judged necessary for achieving the price stability target, the Bank will make adjustments without hesitation. Let me emphasize that our commitment is result-oriented. It means that the Bank will continue with QQE to achieve the target, and the Bank will make adjustments if necessary so that the target will be achieved. In closing, let me talk about Japan’s growth potential. As I have mentioned earlier, Japan’s potential growth rate is estimated to be around 0.5 percent. Japan’s potential growth rate in the late 1990s that is estimated to be about 2 percent has thereafter been declining gradually due to such factors as aging, the declining population, and the slowdown in capital stock accumulation during the period of protracted deflation. Those facts are well recognized, and both government and private entities are making efforts to raise the potential growth rate. As a growth strategy to stimulate private investment, the government formulated the Japan Revitalization Strategy and revised it in June. The Bank strongly expects that the measure will be steadily carried out, and thereby firms will aggressively undertake initiatives. Raising medium- to long-term economic growth potential is basically an issue of the supply side of the economy and thus monetary policy does not play a main role in that regard, but it can make important contributions. That is, by dispelling the deflationary mindset. When the deflationary mindset is widespread, cash hoarding and maintaining the status quo are considered rational. Proactive behaviors by taking risks do not result in rewarding a sufficient return. In fact, under the period of protracted deflation, firms have become reluctant to take risks, such as investing in capital stock and in research and development, resulting in a decline in the potential growth rate. Dispelling the deflationary mindset and creating an economy, in which private entities can act based on an assumption of 2 percent inflation, will lead to reviving the animal spirits of firms that were lost in the prolonged deflationary period and thereby enhancing growth potential. That is evident if you recall that positive developments have become widespread among firms since last year as prices started to rise. The Bank will firmly support such positive developments through achieving the price stability target of 2 percent at the earliest possible time. While some question whether it will be desirable to increase prices when the potential growth rate is low, my answer will be a clear “yes.” Overcoming deflation and raising growth potential is not an issue of which comes first. Overcoming deflation is an important prerequisite for raising growth potential. The Bank will achieve the price stability target of 2 percent. In that situation, I am convinced that Japan’s economy will achieve a higher potential growth rate. 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 the 2014 Autumn Annual Meeting of the Japan Society of Monetary Economics, Tokyo, 18 October 2014.
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Ryuzo Miyao: Japan’s economy and monetary policy Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at the 2014 Autumn Annual Meeting of the Japan Society of Monetary Economics, Tokyo, 18 October 2014. * * * Accompanying charts can be found at the end of the speech. Introduction It is a great honor to be invited to the 2014 Autumn Annual Meeting of the Japan Society of Monetary Economics. Both the Bank of Japan and I have been deeply indebted to the Society over the years. In the four and a half years since I took office as a Policy Board member of the Bank – how time flies – the global economy has faced strong headwinds caused mainly by the sovereign debt crisis in Europe, the fiscal cliff in the United States, and the Great East Japan Earthquake in Japan. Central banks in advanced countries have adopted their own unconventional monetary policy, stepping further into uncharted territory. The Bank of Japan, for its part, introduced quantitative and qualitative monetary easing (QQE) in April 2013 and has been conducting further aggressive monetary easing. I am aware that there are various views and opinions in academia about the initiatives by the Bank and other major central banks. Discussions and research have been actively underway. As a central banker who came from academia, I too have been asking myself the following questions. First, economic recovery has been driven by consumption in Japan for about the past two years. Why consumption, and why now? What is the driving force behind this? Can such recovery be sustained? Second, contrary to what many people had expected, the rate of increase in the consumer price index (CPI) has been rising steadily since 2013. What is the driving force for that? Firms increasingly have been passing on costs to sales prices, but why is this happening now? Third, views are divided among those in academia with regard to the effects of the unconventional monetary policy, such as the purchases of Japanese government bonds (JGBs). How should we respond to skeptical views about the policy effects, stating, for example, that (1) the policy by itself does not produce any effects in ordinary times, but it appears effective only because some market participants believe so; and (2) such policy will only cause a temporary asset price bubble, and thus make the economy unstable? In finding my own answers to these questions, I realized that such answers critically depend on an assessment of the potential strength of the supply side of the economy; namely, its growth potential, profitability, and capacity to generate income. Needless to say, it is essential to accurately gauge the situation on the supply side of the economy in discussing the mechanism of economic recovery and its sustainability, as well as the effects and challenges of monetary policy. Bearing that in mind, I have emphasized in my past speeches that the main feature of the current economic recovery in Japan is that it has been primarily driven not by exports, like in typical recovery phases in the past, but by consumption and nonmanufacturing activities, and that the driving force has been the heightened strength of the supply side from the standpoint of several aspects. 1 Specifically, in the corporate sector, various positive efforts have been For details, see, for example, Ryuzo Miyao, “Economic Activity and Prices in Japan and Monetary Policy,” Speech at a Meeting with Business Leaders in Okayama, Bank of Japan, April 10, 2014. BIS central bankers’ speeches made in and outside Japan, and these have bolstered nonmanufacturers’ profitability as well as manufacturers’ ability to make profits through globalization; firms’ demand for labor has generally risen and the employment and income situation has continued to improve; and the household labor supply has been increasing, with voluntary labor force participation by women and the elderly. The Bank has been conducting QQE, in order to achieve the price stability target of 2 percent. As I will address in detail later, if the potential strength of the economy heightens, the 2 percent price stability target will be achieved more smoothly in a well-balanced manner, with a sustainable economic recovery, and price stability will be maintained. Moreover, with the heightened strength of the economy, monetary policy will be more effective while potential negative side effects – such as financial imbalances – will likely be suppressed. If the decisive measures promote further effects, a virtuous cycle may start to operate that encourages positive efforts of firms and households as well as a structural transformation in the economy, which would further heighten the strength of the economy. Today, I would like to reexamine the improvements on the supply side of Japan’s economy. Based on that, I will then address some issues regarding monetary policy. At the end of my speech, I will touch upon points to keep in mind regarding Japan’s economic and price developments. I. Recent developments in economic activity and prices and improvements on the supply side A. Continued moderate recovery in Japan’s economy Japan’s economy has continued to recover moderately as a trend, although some weakness, particularly on the production side, has been observed, due mainly to the effects of the subsequent decline in demand following the front-loaded increase prior to the consumption tax hike. Real GDP for the April-June quarter of 2014 fell substantially at a rate of 7.1 percent on an annualized quarter-on-quarter basis. However, this decline followed the front-loading of demand in the January-March quarter, for which real GDP had grown significantly at a rate of 6.0 percent (Chart 1). To exclude such fluctuations, when we compare real GDP for the January-June period of 2014 with that for the July-December period of 2013, the annualized growth rate was 1.0 percent. Therefore, on average, Japan’s economy has continued to grow at a pace above its potential and the recovery trend has been maintained. Japan’s output gap has continued to improve as a trend. The Bank’s estimated figures for the output gap turned positive in the January-March quarter of 2014 and were close to 0 percent in the April-June quarter. Thus, the output gap has generally disappeared. The weighted average of the production capacity DI and employment conditions DI in the September 2014 Tankan (Short-Term Economic Survey of Enterprises in Japan) also confirms this improvement (Chart 2). Next, I will move on to price developments. The year-on-year rate of increase in the CPI (all items less fresh food, excluding the direct effects of the consumption tax hike) has strengthened its uptrend from 2013 and has improved to around 1¼ percent recently. This uptrend can also be confirmed by the CPI figures for all items excluding food and energy (Chart 3). These developments reflect the improving trend in the output gap mentioned earlier and a rise in inflation expectations. The medium- to long-term inflation expectations according to Consensus Forecast, for example, have turned to a rising trend from 2013 (Chart 4). The main feature of the recent economic recovery is that it is driven by consumption and nonmanufacturing activities, and this trend can still be observed (Chart 5). The typical pattern of past recovery phases, driven by exports, can be clearly observed in the expansionary phase of 2002 to 2008, but exports have subsequently been more or less flat in the longer run. Business fixed investment has been increasing moderately, albeit with fluctuations, but BIS central bankers’ speeches the pace has been gradual in comparison with the expansionary phase in the mid-2000s. In contrast, consumption has consistently followed an increasing trend, albeit with various effects, and has posted even higher growth since the start of 2012. Consumption expenditure for the April-June quarter of 2014 saw a large drop of 19 percent on an annualized quarteron-quarter basis, reflecting the effects of the decline in demand following the front-loaded increase prior to the consumption tax hike; however, after smoothing out the fluctuations, consumption expenditure for the period of January-June 2014 compared with that of JulyDecember 2013 declined by a much slower pace of 0.8 percent. Private consumption has remained resilient as a trend with the employment and income situation improving steadily, and the effects of the decline in demand following the front-loaded increase have been waning on the whole, albeit unevenly. It deserves special mention that consumption – which has been posting increasingly higher growth – has been the driving force of economic recovery over the past two years or so without being accompanied by notable increases in exports and business fixed investment, which had previously been the driving factors of economic recovery. At the same time, it is evident that the current economic recovery has also been driven by nonmanufacturing activities (Chart 6). Looking at economic developments since 2012 – when the effects of the earthquake disaster mostly dissipated – the level of nonmanufacturing activities has continued to increase, while that of manufacturing activities has turned to a pick-up after having dropped. Although the decline in demand following the front-loaded increase prior to the consumption tax hike has recently been somewhat large, it seems the improvement in nonmanufacturing activities is being maintained as a trend. B. Improvements on the supply side The fact that the economy has continued to recover, mainly in consumer demand, reflects improvements in the various aspects of the supply side; in other words, the potential strength of the economy. In the corporate sector, various positive efforts have progressed at home and abroad and firms’ profitability has increased further (Chart 7). Manufacturing firms are further accelerating their efforts toward optimizing their global-based activities, such as through increasing their production, procurement, and fixed investment as well as hiring local management and staff in overseas countries where there is demand. Efforts to stimulate potential demand have been spreading to a wider range of nonmanufacturing sectors. In Japan, these efforts range from the building of new advanced distribution centers, expansion of home-delivery service and online shopping, to active openings of new convenience stores and shopping malls. There also have been active moves to strengthen the economy’s growth potential by capturing local demand overseas, such as development of overseas business in the retail, wholesale, and service industries as well as acquisition of firms. Labor and employment conditions have also continued to improve as a trend. On the back of proceeding with their positive efforts, firms are increasing their demand for labor and their stance on employment is becoming active (Chart 8). Looking back on the past year, a sense of labor shortage among nonmanufacturing firms has heightened further, and labor supply and demand conditions at manufacturing firms have also tightened, recently turning to a state of labor shortage. In terms of the quality of employment, firms have gradually been making a shift to hiring part-time workers as full-time, regular workers, mainly based on the need to secure competent human resources (Chart 9). As for wage developments, the year-on-year rate of change in scheduled cash earnings has turned positive due to a rise in base pay at many firms, and special cash earnings have also steadily increased, due mainly to a rise in summer bonus payments. As a result, employee income – that is, wages per employee multiplied by the number of employees – has been increasing by about 2 percent year on year (Chart 10). With regard to labor supply conditions, the labor force participation rate that had been on a declining trend, mainly due to the demographic situation, bottomed out in 2012 and is moving BIS central bankers’ speeches toward a pick-up (Chart 11). Breaking down the labor force participation rate by gender and age, the rising trend in the participation rate of women is particularly prominent, and an increasing trend is also becoming evident in recent years for men, especially in the age category of 65–74 years (Chart 12). This seems to reflect initiatives taken by firms amid a general sense of labor shortage to encourage the participation of female workers by introducing flexible working systems such as shorter working hours, and also to promote the employment of the elderly in order to pass on their skills and knowledge to younger workers. However, it will be necessary to wait for data to accumulate for some time before making a judgment on whether such improvements in the labor force participation rate are mainly temporary and cyclical ones, brought about by the economic recovery, or due to sustainable and structural changes. If the latter is the case to some degree, then the amount of potential labor input is expected to bottom out and the potential growth rate to turn upward, accordingly. Many researchers would agree that estimation of the potential growth rate entails technical difficulties. 2 In many economic analyses, trend components, which are extracted from the actual economic data using methods such as the Hodrick-Prescott (HP) filter, are often used as proxies for the potential series of economic variables. However, it is difficult to estimate the recent figures for these potential series, particularly those toward the end of the sample period, on a real-time basis. Let us now take a look at Chart 11. It shows that the trend estimates of the labor force participation rate have declined over the past year or two. However, it should be noted that, if the recent increase in labor force participation that I explained earlier is sustainable and structural, we should be able in the future to look back and confirm that the actual trend in the labor force participation rate has already stopped declining; as a result, it is quite conceivable that the potential growth rate will be revised upward. Thus, careful monitoring of such a possibility is required. 3 I have so far examined improvements on the supply side of the economy from the standpoint of aspects such as corporate profits, demand for labor, employment and wages, and labor supply. In all of these aspects, it is commonly observed that improvements became distinct from around 2012. That is to say, against the background of positive efforts by firms and households, it has become evident that the economy’s capacity to generate income – as represented by corporate profits, employee income, and labor force participation – has increased on the whole. This supports the view that, as a result, expectations for permanent income in the economy as a whole have improved and, in addition, anxiety and uncertainty regarding future employment conditions have decreased considerably, which has led to economic recovery driven by consumption. In other words, it can be explained that, from around 2012, the improvement in the potential strength of the supply side of the economy has been the driving force of the sustainable recovery in domestic demand, particularly consumer demand. Given these factors, let us now take a look at the estimates of the potential growth rate of Japan’s economy (Chart 13). The potential growth rate per capita seems to have stopped declining in around 2010, and has been more or less flat thereafter. Although estimates of the potential growth rate should be judged with some latitude, at least the observations so far suggest that the potential growth rate over the past year or two may be revised upward in a few years’ time. I consider that, in order to assess the supply conditions of the economy, For the estimation approaches of the potential growth rate and related issues, see, for example, “Developments in the Aggregate Supply and Demand” on pages 36 and 37 of the April 2014 issue of the Outlook for Economic Activity and Prices released by the Bank. Normally, an upward revision of the potential growth rate or potential GDP figures will exacerbate the output gap. However, with improvements on the supply side of the economy, the output gap may improve and upward pressure on prices may heighten if demand increases in the somewhat longer term at a pace exceeding growth in supply capacity. I will elaborate on this point in section I.C. BIS central bankers’ speeches particularly the recent ones, it is important not to solely rely on the estimates of the potential growth rate, but to make a comprehensive assessment taking into consideration the actual situation of firms and households. C. Increasing upward pressure on prices When improvements on the supply side of the economy lead to a sustainable increase in domestic demand, particularly consumer demand, upward pressure on prices is likely to increase. Let me explain this from a theoretical viewpoint. First, given the standard analysis based on aggregate supply and demand curves, improvement on the supply side shifts the aggregate supply curve (or the Phillips curve) to the right. In this case, economic activity improves while upward pressure on prices weakens. However, if, at the same time, aggregate demand increases in a sustainable manner, the aggregate demand curve shifts to the right, thereby increasing upward pressure on prices. It is purely an empirical question as to which of the two factors – the shift of the supply curve or of the demand curve – outweighs the other. An empirical analysis using Japan’s data that examined the effects of an increase in total factor productivity (productivity shock) showed that the effects of an increase in upward pressure on prices caused by the increase in demand outweigh those of an increase in supply; thus, an improvement on the supply side leads to an improvement in the output gap and causes a modest increase in prices. 4 Second, when sales of goods and services increase sustainably in line with firms’ strategy of creating differentiated products and higher value-added, their price-setting behavior might become more active. In other words, in a situation where demand is expected to increase sustainably, firms will be able to charge higher markups (profit margins) or pass production costs more directly on to sales prices. If these developments are structural, this will steepen the Phillips curve, which will also increase upward pressure on prices. Third, it is likely that a mechanism will operate through which improvements on the supply side increase people’s medium- to long-term inflation expectations. If people expect that economic activity and sales will continue to improve, their inflation expectations will increase – considering, for example, the Phillips curve relation in the future. This mechanism is called forward-looking expectation formation of the New Keynesian Phillips curve. Improvements on the supply side thus increase people’s somewhat long-term inflation expectations, and in turn shift up the intercept of the Phillips curve. In fact, medium- to long-term inflation expectations have been increasing gradually (Chart 4). Developments in medium- to long-term inflation expectations seem to largely correlate with those in the potential growth rate per capita that I explained earlier, with the exception of the most recent period (Chart 13). In a situation where these mechanisms work in combination, it is possible to say, as suggested from Chart 3, that upward pressure on the consumer price inflation rate has been increasing. In other words, mechanisms such as (1) sustainable improvement in the output gap and increasing expectations for future improvement, (2) firms’ increased ability to pass costs on to sales prices, and (3) a rise in medium- to long-term inflation expectations have all contributed to heightening upward pressure on overall prices. I should note that, as a different kind of logic to explain the recent rise in prices in Japan, some argue that prices have risen due to the constraint of sluggish supply. How should we explain this argument? I consider the key to be whether the supply capacity of the economy is actually increasing. Price rises that are not accompanied by improvements on the supply side will restrain growth in demand and thus prevent economic activity from expanding. Looking at the recent situation in Japan, however, improvements on the supply side have See Ryuzo Miyao, Makuro Kinyu-Seisaku no Jikeiretsu Bunseki (Time-Series Analysis of Macroeconomic Monetary Policy), Chapter 8, Nikkei Inc., 2006, pp. 209–245 (available in Japanese). BIS central bankers’ speeches become clear over the past year or two; in fact, demand has been increasing sustainably. Specifically, (1) demand for goods and services and for labor has been increasing sustainably at a pace exceeding growth in supply capacity; (2) production of goods and services has been increasing, and the employment situation has been improving; and (3) prices as well as wages have been rising moderately. Given these observations, I think that it is difficult to attribute the recent price rises to sluggish supply or supply constraints. II. Conduct of monetary policy The recent macroeconomic performance that I have described so far will also create a desirable situation with regard to conducting unconventional monetary policy. As I will explain, if the potential strength of the economy heightens, the 2 percent price stability target will be achieved more smoothly in a well-balanced manner, with a sustainable economic recovery, and price stability will be maintained. Moreover, with the heightened strength of the economy, greater policy effects will be produced while potential negative side effects – such as financial imbalances – will likely be suppressed. A. The 2 percent price stability target In January 2013, the Bank released a joint statement with the government and introduced a price stability target of 2 percent in terms of the year-on-year inflation rate of the CPI, making a clear commitment to achieving this target at the earliest possible time. Looking back at the situation around that time, some notable progress was made in terms of external factors: downside risks to the global economy caused by the extremely strong headwinds – such as the sovereign debt crisis in Europe and the fiscal cliff in the United States – had subsided in the latter half of 2012, and thus uncertainties had diminished to a considerable degree. Given these developments, the Bank showed its determination to attain sustainable economic growth in Japan in coordination with the government, aiming to overcome deflation and dispel deflationary sentiment at the earliest possible time. The Japanese people expect to have price stability that is achieved not by a mere price hike, but by a moderate rise in prices brought about by balanced and sustainable economic growth together with improvements in employment, wages, and corporate profits. The Bank set the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI based on the recognition that the inflation rate consistent with price stability on a sustainable basis would rise as efforts by a wide range of entities toward strengthening growth potential and competitiveness of the economy made progress. In fact, steady progress has been made in a variety of initiatives toward strengthening growth potential and improving the supply side, with strong support from the financial side through QQE. Japan’s economy has continued to recover in a well-balanced manner as employment, wages, and corporate profits have improved in a sustainable manner, and the year-on-year rate of change in the CPI has been increasing gradually toward the 2 percent price stability target. B. The role of QQE In April 2013, the Bank introduced QQE to achieve the 2 percent price stability target at the earliest possible time, with a time horizon of about two years. With the aim of achieving the target, the Bank decided to continue with QQE, as long as it was necessary for maintaining that target in a stable manner. QQE is mainly composed of three important components: a large expansion of the monetary base (at an annual pace of about 60–70 trillion yen); large-scale purchases of JGBs (at an annual pace of about 50 trillion yen) with an extension of the average remaining maturity (to about seven years); and an increase in the purchase of risk assets. It also incorporates elements of an open-ended framework that links the continuation of such large-scale BIS central bankers’ speeches monetary easing with its policy target. That is, the Bank has committed to continuing with QQE “as long as it is necessary for maintaining the 2 percent price stability target in a stable manner” without restricting the time frame or the total amount in advance. This commitment seems to have helped create further accommodative financial conditions by exerting a strong influence on market expectations about future monetary policy. The effects of QQE are more likely to materialize if the potential strength of the economy heightens. Specifically, given an increase in firms’ profitability, extremely accommodative financial conditions will drive their positive efforts and risk-taking activities, thereby further heightening economic stimulus effects. Large-scale purchases of JGBs can exert downward pressure on longer-term interest rates and upward pressure on asset prices. If fundamentals such as corporate profits improve at the same time, asset price rises will become more sustainable and justified. As a result, potential negative side effects – such as heightened financial imbalances – will likely be suppressed. In addition, if some decisive measures produce further positive effects in a situation where the potential strength of the economy heightens, positive efforts of firms and households, business fixed investment, and a structural transformation in the economy will be stimulated further. This may then accelerate a virtuous cycle that further bolsters the potential strength of the economy and the effectiveness of the policy measures. The economic recovery in Japan seems to have strengthened its sustainability, as corporate profits have been on an improving trend and potential strength has heightened further through the implementation of the measures in 2013. An improvement in corporate profits can be seen in Japan and in the United States while aggressive monetary easing continues and stock prices remain on a rising trend in both countries. It is likely that firms’ positive efforts to improve profits have been encouraged further by the extremely accommodative financial conditions (Chart 14). Concluding remarks Let me conclude by touching on the outlook for the economy and price developments in Japan. Japan’s economy is expected to continue on its moderate recovery trend, and the effects of factors such as the decline in demand following the front-loaded increase prior to the consumption tax hike are expected to wane gradually. Supported by the accommodative financial conditions, improvements on the supply side and the sustainable recovery trend of the economy, as well as the moderate improving trend in inflation expectations, are likely to continue. The economy is therefore expected to follow a path toward achieving the 2 percent price stability target in a balanced manner, accompanied by improvements such as in employment, wages, and corporate profits. On the other hand, as for private consumption, the effects of factors such as the decline in demand following the front-loaded increase have somewhat lingered in terms of the consumption of durable goods, and therefore the pace of recovery warrants a certain degree of attention. In order for the improvements in economic activity and prices to continue in a wide range of areas, it is important that the positive effects of the increase in corporate profits spread throughout the economy – including households and small and medium-sized firms – by way of increases in wages and employment, a raise in delivery prices paid to suppliers, or other channels. The Bank has committed to continuing with its aggressive monetary easing, as long as it is necessary for maintaining the 2 percent price stability target in a stable manner. It also will continue to examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate to achieve the price stability target. In standing by its commitment and clarifying its policy stance, the Bank will further encourage positive initiatives taken by a wide-range of economic entities from the financial side. The Bank is therefore determined to fulfill its responsibility toward achieving sustainable economic growth through price stability. 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 the Japan Society, London, 12 November 2014.
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Takehiro Sato: Macroprudential policy and initiatives by the Bank of Japan Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the Japan Society, London, 12 November 2014. * * * Accompanying charts can be found at the end of the speech. Introduction Thank you, Mr. Fraser, for your kind introduction. Distinguished guests and members of the Japan Society, I am truly honored to have this opportunity to speak to you. Today, I will talk mainly about the Bank of Japan’s initiatives on the prudential front, focusing on macroprudential policy rather than microprudential. Microprudential policy aims to ensure the financial soundness of individual financial institutions. By contrast, macroprudential policy aims to ensure the stability of the financial system as a whole by analyzing and assessing risks within that system and formulating, based on the findings, institutional designs and policy responses to mitigate such risks. Microprudential measures to prevent the failure of individual financial institutions are important in that they can address signs of risk that will threaten the stability of the entire financial system. Based on the efficacy of microprudential measures, macroprudential measures focus on avoiding a situation in which vulnerability arising from the interaction among the real economy, financial markets, and financial institutions makes the entire financial system unstable. A central bank conducts monetary policy with the aim of achieving price stability, and monetary policy is not directly aimed at ensuring financial system stability. However, as I will explain later, there is a close relationship between monetary policy and financial system stability. Once the functioning of the financial system is significantly impaired following the bursting of a bubble, the effects of monetary policy will be largely restrained. It is becoming clear through recent studies that an economic trough following a financial crisis tends to become deeper and last longer than troughs arising from different situations.1 Taking that into account, there has been a growing tendency worldwide to place greater emphasis on macroprudential policy since the global financial crisis. The Bank of Japan has been placing emphasis on a macroprudential perspective in its conduct of monetary policy since before the crisis. In today’s speech, I will share with you my views on the issues regarding the implementation of macroprudential measures, and then elaborate on the Bank’s initiatives on the macroprudential front. Lastly, I will touch on the recent conduct of monetary policy by the Bank of Japan. I. Issues involved in implementing macroprudential measures As I mentioned earlier, macroprudential policy aims to ensure the stability of the financial system as a whole by analyzing and assessing risks within that system and formulating, based on the findings, institutional designs and policy responses to mitigate such risks, with particular attention paid to the interaction among the real economy, financial markets, and financial institutions. In view of the experience of the global financial crisis, in addition to the For details, see Òscar, Schularick, and Taylor (2011). BIS central bankers’ speeches analysis and assessment of risks in the overall financial system, a macroprudential perspective has been actively adopted worldwide in institutional designs and policy responses. For example, countercyclical capital buffers (CCBs) are to be introduced, as stipulated in the Basel III requirements. They aim to limit financial institutions’ excessive risk taking by requiring an increase in their capital at the time of credit expansion. They also are expected to function as a buffer when losses are actually incurred. Other types of policy measures aim at containing systemic risk arising from credit expansion and overheating of demand by imposing direct regulations on credit expansion by financial institutions, such as limits on total credit supply, loan-to-value (LTV) caps, and debt-to-income (DTI) limits (Chart 1). Some countries and regions have already introduced those measures and have produced policy effects.2 In Japan, such macroprudential measures were taken in the past. One example is the quantitative ceiling on banks’ real estate loans, which was set in 1990 to contain the excessive growth in bank lending to the real estate sector by keeping the growth rate of such loans to a level equal to or below that of total bank lending. Regardless of how the ceiling was categorized at that time, it now can be considered a macroprudential measure.3 The measures I have mentioned so far are regarded as typical macroprudential measures. However, other measures – that is, those which already have been implemented, such as on-site examinations and inspections of individual financial institutions and oversight of payment and settlement systems – should also be conducted, taking into account a macroprudential perspective, in cooperation with the relevant parties. Let me turn to the issues regarding the implementation of macroprudential measures. I believe there are three (Chart 2). First, it is important to implement – with appropriate timing – policy measures that are considered effective, among a wide range of choices, in containing financial imbalances that have been identified at that time. In that regard, an empirical study shows that a failure to get the timing right can push down the average level of economic activity and increase its volatility.4 It has been pointed out that the implementation of the quantitative ceiling on banks’ real estate loans in 1990 was too late to contain excessive hikes in land prices when it was necessary, and instead, once land prices turned to a decline, the policy implementation ended up accelerating the decline in land prices.5 To be sure, it is recognized that the timing of the implementation is of critical importance, but it seems that there is still not enough understanding as to how to identify financial imbalances, which is the premise of such implementation. That might be because the buildup of imbalances that threatened the financial system and the ensuing collapse occurred through different mechanisms in each instance in the past. At any rate, it is a significant challenge to first gauge on a real-time basis whether the imbalances that could lead to systemic risk are emerging within the financial system, and then to judge the timing of policy implementation. Second, and related to the first issue, there is difficulty of communication to the public at the time of policy implementation. It is difficult to prove “in advance” the rightness of the policy authorities’ judgment about emerging signs of financial imbalances. The difficulty in noticing the signs of financial imbalances with certainty at the same time suggests the difficulty in persuasively arguing for the need for a policy response to such signs. Even though the financial authorities are able to judge, based on their analysis and experience, that signs of For example, a CCB framework has already been established in Switzerland, and loan-to-income (LTI) and LTV caps for new residential mortgages have been introduced in the United Kingdom and New Zealand, respectively. For details, see Nelson and Tanaka (2014). For details, see Kawata et al. (2013). For details, see Bank for International Settlements (2012). BIS central bankers’ speeches financial imbalances are clear, they might be unable to gain sufficient support from stakeholders at an early stage regarding the need for a policy response. Or, if the authorities wait until the buildup of financial imbalances becomes clear in many people’s eyes, the timing of policy implementation could be too late. At one point, in international discussions following the global financial crisis, there were divided views. One view was that it was necessary to identify financial imbalances in advance as early as possible and address them. The other view was that it was difficult to identify such imbalances in advance, and therefore it was enough to address them after the bursting of a bubble actually occurred. That division suggests the difficulty in policy judgment and communication mentioned in the first and second issues. At present, many countries design their institutions and policy frameworks with the intent to work to identify financial imbalances as early as possible and take action, although there is some degree of difference among countries. Third, it is also difficult to find a way to prevent the leakage of policy effects. Regulatory arbitrage is one example. Even though regulated banks reduce their lending in response to certain measures, policy effects could be offset if reduced lending amounts are provided instead by non-regulated financial institutions such as shadow banking institutions. The same was true for Japan’s quantitative ceiling on banks’ real estate loans, which I mentioned earlier. If regulations are to be imposed on a wide range of shadow banking institutions to minimize the leakage of policy effects, cooperation among several other authorities is considered to be necessary. Without full cooperation, policy effects might be diminished. There also could be a vicious cycle in which advancements in financial technology give rise to new financial products that are not subject to regulation. The authorities will respond to that by expanding the scope of regulation, but other new products will still emerge. In the future, it may become necessary to facilitate international regulatory coordination under free capital mobility. II. The Bank’s initiatives on the macroprudential front With those three issues in mind, I will now elaborate on the Bank’s initiatives on the macroprudential front. In Japan, reflecting the emergence of the asset bubble in the late 1980s and its subsequent bursting, a number of measures were taken from the late 1990s to the early 2000s. Those measures include the establishment of the Financial Services Agency (FSA), the amendment of the Bank of Japan Act with a clear statement of its on-site examinations, and the formulation of a crisis management framework. At present, on the basis of those, the FSA – which is legally authorized to conduct industry-wide supervision and inspections – and the Bank – which contributes to financial system stability, such as through the “lender of last resort” function – take the initiative in carrying out macroprudential policy. They fulfill their respective functions in monitoring risks and financial imbalances in the entire financial system. The Bank regularly releases the Financial System Report, which analyzes and assesses the stability and functioning of the financial system as a whole. The Bank began its release back in 2005, before the global financial crisis occurred. Since then, this semiannual report has been released to convey the Bank’s thinking on risks and issues facing Japan’s entire financial system. Through this release, the Bank works to grasp risks in the financial system as a whole, and to share a common understanding with a wide range of participants in the system, including financial institutions. I think this process is fundamental to identifying financial imbalances at an early stage and implementing, with appropriate timing, measures that are considered to be effective in containing risks. In relation to the three issues I mentioned earlier, there are two key points. First, it is important to improve the quality of the assessment of financial developments so that macroprudential measures can be implemented with appropriate timing. Second, it is also important to increase the scope of analysis to cover not only banks but also the entire financial system. BIS central bankers’ speeches From that viewpoint, the results of various analyses are set out in the Financial System Report. As an example, let me introduce the Financial Activity Indexes (FAIXs) (Chart 3). The Bank began their compilation in 2012. The FAIXs aim to detect, as early as possible, overheating in financial activity that could lead to systemic risk. They are a selection of 14 financial indicators, such as the total credit-to-GDP ratio and the land prices to GDP ratio, and measure how far individual indicators deviate from their historical trends. The Financial System Report provides overheating or overcooling assessments of individual indicators in a “heat map” format, where red shading shows that the indicator in question is tilted toward overheating, blue indicates overcooling, and green represents everything in between. Through a comprehensive analysis and assessment of these indicators, the Bank works to gauge the accumulation of macro financial imbalances. Of course, the heat map is not perfect. Let me offer the example of the total credit-to-GDP ratio, which is a typical indicator of the financial cycle (Chart 4). It is difficult to grasp the underlying trend of the ratio, given the overwhelming magnitude of the emergence and bursting of the asset bubble from the late 1980s to early 1990s in Japan. The financial cycle is long and unstable, and the associated recovery in robustness of the financial system requires time. Therefore, for this kind of financial cycle indicator, it is ultimately a matter of judgment as to how long the deviation from the underlying trend should be accepted. Although there are such issues to be considered, the FAIXs are a useful tool for gauging the buildup of financial imbalances. In the Financial System Report, in addition to presenting the FAIXs, the Bank conducts macro stress testing (Chart 5). Through such testing, it aims to analyze the degree of accumulation of risks in the entire financial system and the uneven distribution of risks among financial institutions, and then utilize such analysis in its policy judgment. Macro stress testing assesses the degree of resilience of the financial system assuming that severe stress occurs in the real economy and financial markets. First, by devising stress scenarios, the testing enables to some extent assessment of how an unprecedented shock would affect the entire financial system. Second, an industry-wide analysis using the same scenario enables the identification of an uneven distribution of risks in the financial system. In conducting macro stress testing at the Bank, particular emphasis is placed on the importance of working to bring together economic analysis skills accumulated so far and data/knowledge obtained from individual financial institutions through the process of on-site examinations and off-site monitoring. For example, when assuming stress scenarios, the Bank focuses on risk factors that are considered to be the most important at that particular point in time. Before the Lehman shock, when the global economy overheated and newly established real estate firms actively developed real estate projects in Japan, the Bank conducted stress testing focusing on credit risk in lending to real estate-related sectors. When concern about the European sovereign debt crisis heightened, the Bank assessed its spillover impact by taking account of co-movements in domestic and international financial markets, and also conducted stress testing against foreign currency liquidity risk based on the assumption that the foreign currency funding markets had become dysfunctional. Most recently, the Bank has conducted an analysis by assuming scenarios involving an economic downturn of approximately the same magnitude as that observed at the time of the Lehman shock and an approximately 2 percentage point rise in long-term interest rates leading to an economic downturn. As noted, in the Financial System Report the Bank clarifies risks and challenges for Japan’s financial system by examining a number of indicators. It examines a wide range of indicators and conducts various analyses, and ultimately makes a discretionary judgment as to whether the implementation of measures is indeed necessary. With a view to analyzing and assessing financial system stability and making use of macroprudential measures, close cooperation between the FSA and the Bank is also important. In that regard, the two entities together established in June 2014 a task force with the aim of holding regular joint meetings to exchange views on financial stability, with participants including the FSA Commissioner and the Bank’s Deputy Governor. The FSA and the Bank have been exchanging views frequently at various levels and maintaining close cooperation, and the meetings will further strengthen such cooperation. BIS central bankers’ speeches III. The relation between monetary policy and macroprudential policy Now let me turn to the issue of how much a central bank should involve itself in macroprudential policy. As is the case here in the United Kingdom, having experienced the recent financial crisis, a central bank’s involvement in ensuring the stability of the financial system has strengthened globally. The Bank of Japan Act stipulates that the purpose of the Bank is to carry out currency and monetary control as well as to contribute to the maintenance of the stability of the financial system, and therefore the Bank is responsible for taking care of both tasks equally (Chart 6). Looking back, the following two cycles have often synchronized: the cycle of economic activity, or the output gap, and the financial cycle – in other words, the buildup of financial imbalances and their collapse. That is because of a feedback loop in which changes in the output gap and changes in the financial cycle have reinforced each other, leading to larger changes for both. In Japan, monetary policy and macroprudential policy are therefore considered to be complementary. The Bank’s activities on the macroprudential front are in line with its mission as stipulated in the Bank of Japan Act, just like its microprudential activities, such as on-site examinations and off-site monitoring. Based on that, the Bank also allocates considerable management resources to conduct prudential policy that aims to ensure the stability of the financial system, as well as monetary policy that aims to maintain price stability. Even if monetary policy and macroprudential policy are considered to be complementary to each other in the long run, depending on the economic phase, there may be cases in which asset prices surge under low inflation. Therefore, in the short run, where there is a trade-off between price stability and financial system stability, the question over which one a central bank should place greater emphasis on when taking action may well become an issue of debate. One approach to that issue would be a policy framework based on a dictionary-like ordering. That is, as long as price stability – an objective of the highest priority – has been met, a central bank can pursue its other objectives. For example, in advanced economies in general, where prices have been maintained at low levels as a trend, financial system stability is sometimes viewed as more important than price stability, which is considered to have been achieved already. That would sound reasonable, considering that a large-scale formation of financial imbalances and their collapse, just like the one observed before and after the Lehman shock, occurred when price stability had generally been maintained. On the other hand, in the case of Japan, since deflation persisted for a prolonged period, one might take the view that, for the time being, a higher priority should be placed on price stability than financial system stability. The background to this view could include the fact that risk-taking activities of financial institutions have been limited, even in a low-interest rate environment, and that a buildup of financial imbalances has not been observed so far. I would not reject that way of thinking, but I am personally uncomfortable with accepting the dichotomy between monetary policy for price stability and macroprudential policy for financial system stability. That is because the dichotomy is seemingly easy to understand, but it is not always valid in every circumstance. Of course, there are cases in which responses are possible under such a dichotomy. However, let us assume a situation in which the financial cycle is not sufficiently contained, leading to a feedback loop in which changes in the output gap and changes in the financial cycle reinforce each other. In that case, it inevitably becomes necessary to make use of not only macroprudential policy but also monetary policy, which has far-reaching effects. As in the case of the policy responses made after the bursting of the bubble economy in Japan, if monetary policy measures are taken only after fluctuations in the financial cycle have become substantial, there is a risk that policy responses will become extremely difficult to implement at that point. Therefore, what is desirable for a central bank is to give a certain consideration not only to the output gap but also to containing the financial cycle when pursuing monetary policy. BIS central bankers’ speeches Based on that view, the Bank of Japan’s monetary policy is conducted within a framework in which the Bank examines various risk factors, including those related to financial imbalances, in addition to the assessment of the current developments and outlook for economic activity and prices, from the perspective of achieving sustainable growth with price stability. When too much priority is placed on short-term price stability, there is a risk that the financial system will become unstable in the future, which in turn could undermine medium- to longterm price stability. On the other hand, when too much emphasis is placed on financial system stability, confidence in a central bank’s efforts toward achieving price stability could deteriorate. In order to avoid falling into such situation, a central bank needs to conduct monetary policy in a balanced manner. IV. The Bank’s recent conduct of monetary policy Lastly, I will briefly touch on the Bank’s recent conduct of monetary policy. At the Monetary Policy Meeting (MPM) held on October 31, 2014, the Policy Board decided to expand quantitative and qualitative monetary easing (QQE). As I cast a dissenting vote on this decision, I may be in a delicate position to talk about this policy change. However, I take this opportunity to explain the policy decision and provide my views to the best possible extent. The Bank’s assessment is that Japan’s economy has continued to recover moderately as a trend, despite being affected by the consumption tax hike in April 2014, and is expected to continue to do so. Although weakness remains in exports, production, and some indicators relating to consumption, the mechanism for economic recovery has been steadily maintained on the back of the firm employment and income situation as well as resilient household and business sentiment. On the price front, somewhat weak developments in demand following the consumption tax hike and a substantial decline in crude oil prices have been exerting downward pressure recently. A temporary weakness in demand has already started to wane, and the decline in crude oil prices will have positive effects on economic activity from a somewhat longer-term perspective and eventually will push up prices. Nevertheless, if the current downward pressure on prices remains, albeit in the short term, there is a risk that conversion of the deflationary mindset, which has so far been progressing steadily, might be delayed. To pre-empt manifestation of such risk and to maintain the improving momentum of expectation formation, the Bank judged it appropriate to expand QQE, with an aim of offering kind of insurance. Regarding the monetary base, the Bank will conduct money market operations so that it will increase at an annual pace of about 80 trillion yen. That is an addition of about 10–20 trillion yen compared with the past. To that end, the Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen. Compared with the past, it is an addition of about 30 trillion yen. The Bank also tripled the amount of some risk asset purchases, compared with the past (Chart 7). The effects of QQE have a tendency to become stronger in a cumulative manner with the progress in asset purchases by the Bank. Those effects have already become clearly evident in both the front and back ends of the yield curve, and are expected to strengthen further with the progress to be made in such purchases. With regard to my own view on the policy decision that I have mentioned, I refrain from providing details at this point, as the minutes of the MPM have not been released at this stage. However, as I have been presenting my personal views on the meaning of “achieving the price stability target of 2 percent” and of the time frame “as long as it is necessary for maintaining that target in a stable manner,” I take this opportunity to reconfirm them. The price stability target is set based on the consumer price index (CPI) for all items, but I do not think that QQE can be considered to have accomplished its mission simply when the rate of increase in the CPI reaches 2 percent on a year-on-year basis. The price stability that the BIS central bankers’ speeches Bank aims to achieve should be a situation in which prices rise with an improvement in wages in a well-balanced manner, amid favorable overall economic conditions both in terms of the real economy and the asset market. To that end, it is important that people’s mediumto long-term inflation expectations – which are said to have consistently remained lower than those in other leading countries – be raised to and re-anchored at around 2 percent, comparable to the level in the United States, so that people’s behavioral pattern will be based on the assumption of around 2 percent inflation. Fortunately, people’s short-term inflation expectations appear to be rising on the whole from a somewhat longer-term perspective, in part because the year-on-year rate of increase in the core CPI, excluding the effects of the consumption tax hike, has continued to be stable at around 1¼ percent. In re-anchoring medium- to long-term inflation expectations, it is conceivable that people revise their expectations not only in a backward-looking manner based on the rise in short-term inflation expectations, but also in a forward-looking manner considering, for example, developments in wage revision. In that regard, the result of wage revision this year marked an important step toward a breakthrough in changing people’s pessimistic expectations that base salaries will not rise under deflation. Regarding wage negotiations next year, three-way discussions among the government, employers, and labor unions are taking place under the government’s initiatives. I expect that they will lead to actual wage increases and exert a positive effect on the formation of people’s inflation expectations, thereby having favorable effects on medium- to long-term inflation expectations. To be sure, the time frame for continuing QQE is based on the idea of forecast targeting – namely, as long as it is necessary for maintaining the target in a stable manner. The price stability target is expressed in terms of the year-on-year rate of increase in the CPI for all items. Considering the aim behind this, I think it will remain important to focus on the formation of people’s inflation expectations – as I have mentioned earlier – and to carefully examine future developments in a wide range of price indicators including those relating to wages. It should be noted that there is no silver bullet for estimating people’s medium- to long-term inflation expectations on a real-time basis, and therefore the necessity of continuing QQE should be judged by the Bank’s Policy Board at each MPM. Thank you. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches References Bank for International Settlements, Committee on the Global Financial System, “Macroprudential Instruments and Frameworks: A Stocktaking of Issues and Experiences,” CGFS Papers No. 38, 2010. ——, Committee on the Global Financial System, “Operationalising the Selection and Application of Macroprudential Instruments,” CGFS Papers No. 48, 2012. Bank of Japan, Financial System Report, October 2014. ——, “The Bank of Japan’s Initiatives on the Macroprudential Front,” October 2011. ——, Financial System and Bank Examination Department, “Nippon Ginko no Makuro Sutoresu Tesuto: Shinyou Risuku Tesuto to Kinri Risuku Tesuto no Kaisetsu (Macro Stress Testing at the Bank of Japan: Stress Testing Focusing on Credit Risk and Interest Rate Risk),” BOJ Reports and Research Papers, August 2012 (available only in Japanese). Ishikawa, Atsushi, Koichiro Kamada, Kazutoshi Kan, Ryota Kojima, Yoshiyuki Kurachi, Kentaro Nasu, and Yuki Teranishi, “The Financial Activity Index,” Bank of Japan Working Paper Series No. 12-E-4, 2012. Ito, Yuichiro, Tomiyuki Kitamura, Koji Nakamura, and Takashi Nakazawa, “New Financial Activity Indexes: Early Warning System for Financial Imbalances in Japan,” Bank of Japan Working Paper Series No. 14-E-7, 2014. Jordà, Òscar, Moritz HP. Schularick, and Alan M. Taylor, “When Credit Bites Back: Leverage, Business Cycles, and Crises,” NBER Working Paper No. 17621, 2011. Kawata, Hiroshi, Yoshiyuki Kurachi, Koji Nakamura, and Yuki Teranishi, “Impact of Macroprudential Policy Measures on Economic Dynamics: Simulation Using a Financial Macro-Econometric Model,” Bank of Japan Working Paper Series No. 13-E-3, 2013. Kinefuchi, Hikaru, Mizuki Yanagisawa, Naoya Kikuta, and Kei Imakubo, “Makuropurudensu Seisaku Shudan wo Meguru Saikin no Giron (Recent Discussions on Macroprudential Measures),” Bank of Japan Review Series No. 12-J-13, 2012 (available only in Japanese). Kitamura, Tomiyuki, Satoko Kojima, Koji Nakamura, Kojiro Takahashi, and Ikuo Takei, “Macro Stress Testing at the Bank of Japan,” BOJ Reports and Research Papers, October 2014. Nelson, Benjamin, and Misa Tanaka, “Dealing with a Banking Crisis: What Lessons Can Be Learned from Japan’s Experience?” Bank of England, Bank of England Quarterly Bulletin, 54 (1), 2014, pp. 36–48. Nishimura, Kiyohiko G., “Macro-Prudential Policy from an Asian Perspective,” remarks at the High-Level Seminar on Macro-Prudential Policies co-sponsored by the People’s Bank of China and the International Monetary Fund, Bank of Japan, 2010. 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, Nagasaki, 12 November 2014.
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Ryuzo Miyao: Economic activity and prices in Japan and monetary policy Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Nagasaki, 12 November 2014. * * * The charts can be found at the Bank of Japan’s website. Introduction Thank you for giving me this opportunity to exchange views with people representing Nagasaki 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 Nagasaki 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 Nagasaki 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 has continued to recover moderately as a trend, although some weakness, particularly on the production side, has been observed, due mainly to the effects of the subsequent decline in demand following the front-loaded increase prior to the consumption tax hike (Chart 1). I will elaborate on the recent developments related to Japan’s economy. Overseas economies – mainly advanced economies – continue to recover, although a lackluster performance has still been partly seen (Chart 2). Specifically, the recovery in the U.S. economy is increasingly taking hold, as household spending has been firm, reflecting a favorable employment situation, and such movements are spreading to the corporate sector. The European economy continues on its moderate recovery trend, supported mainly by the resilience in private consumption, although the adjustment pressure associated with the debt problem remains and a downtrend in the inflation rate has been observed. The Chinese economy has continued to grow stably on the whole, due mainly to an improvement in external demand and the stimulus measures by the government, albeit under downward pressure from an overhang in supply capacity in the manufacturing sector and adjustments in the real estate market. The NIEs have been improving somewhat due to a rise in exports to the United States, although differences by country stand out. On the other hand, the ASEAN economies as a whole have been lacking growth momentum despite an improvement in exports and private consumption. Reflecting this situation, Japan’s economy has continued to recover moderately as a trend. Regarding external demand, exports have been relatively weak on the whole recently, due to such factors as the continued weakness in exports to the ASEAN economies, the sluggish growth in exports to China, and the materialization of the effects of downward pressure on exports to the United States resulting from the expansion of overseas production, mainly by automakers. Meanwhile, public investment maintains its high level, mainly due to the effects of the early implementation of the initial budget for fiscal 2014. As for the corporate sector, business sentiment and corporate profits have generally maintained favorable levels despite being affected by the decline in demand following the front-loaded increase. As a result, business fixed investment has been on a moderate uptrend, albeit with some fluctuations. In BIS central bankers’ speeches the household sector, private consumption has been resilient as a trend, with the employment and income situation improving steadily. It can be assessed that private consumption has been affected mainly by the decline in demand following the front-loaded increase, and the effects, which were clearly seen in the April-June quarter of 2014, have been waning on the whole when excluding the somewhat prolonged impact on sales of durable goods such as automobiles and household electrical appliances, as well as housing investment. 1 Reflecting this situation, industrial production declined substantially in the AprilJune quarter and has been showing some weakness thereafter due in part to inventory adjustments, mainly in durable goods and construction goods. On the price front, the year-on-year rate of increase in the consumer price index (CPI, for all items less fresh food and excluding the direct effects of the consumption tax hikes) has generally been around 1¼ percent in the first half of fiscal 2014. The rate of increase in the CPI less food and energy has been in the range of 0.5–1.0 percent (Chart 3). B. Outlook for economic activity and prices I will now turn to the baseline scenario of the outlook for economic activity and prices in Japan from fiscal 2014 through fiscal 2016 and its underlying mechanism (Chart 4). 1. Outlook for economic activity With regard to the outlook for economic activity, as domestic demand is likely to maintain firmness, exports are expected to head for a moderate increase, and a virtuous cycle from income to spending is likely to be maintained in both the household and corporate sectors. I will elaborate on the background to this outlook. First, overseas economies 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. In particular, the U.S. economy is expected to gradually accelerate its pace of recovery as the firmness in the household sector spreads to the corporate sector. In this situation, exports are expected to head for a moderate increase partly because of foreign exchange rate developments. Japanese major exporting firms’ continued efforts to increase production and procurement on a global basis could contribute to restraining the pace of increase in exports. On the other hand, further improvements are expected in two areas: exports of goods, such as capital goods and electronic parts and devices, that maintain high competitiveness, and travel credit, a component of services in the current account, in accordance with an increase in the number of foreign visitors to Japan (Chart 5). 2 Second, on the back of improvements on the supply side of the economy, the resilient trend in consumption is likely to be maintained. 3 Although it warrants attention that consumption of durable goods and other goods has been affected by the decline in demand following the front-loaded increase for a somewhat prolonged period, it deserves special mention that consumption – which has been posting higher growth – has been the driving force of Demand-side statistics, such as the Family Income and Expenditure Survey, show that there has been some weakness in recent developments in private consumption that cannot be explained by the decline in demand following the front-loaded increase. For example, developments in household nominal income exhibited by the Family Income and Expenditure Survey have shown a substantial downward deviation from those in total cash earnings shown in the Monthly Labour Survey, and this could be attributable to sample bias. There has been an increasing number of foreign visitors to Japan with diverse backgrounds and interests, and efforts to capture their various demands for sightseeing have been progressing. For specific details of the situation in each region, see the October 2014 issue of the Regional Economic Report released by the Bank (only the summary of the report is available in English). For a more detailed explanation of the improvements on the supply side of the economy, see Ryuzo Miyao, “Japan’s Economy and Monetary Policy,” Speech at the 2014 Autumn Annual Meeting of the Japan Society of Monetary Economics, Bank of Japan, October 18, 2014. BIS central bankers’ speeches economic recovery over the past two years or so without being accompanied by notable increases in exports and business fixed investment, which had previously been the driving factors of economic recovery (Chart 6). Meanwhile, there have been improvements in the various aspects of the supply side, or in other words, the potential strength of the economy, and the economy’s capacity to generate income – as represented by corporate profits, employment and income, and labor force participation – has been increasing on the whole with the progress in positive efforts by firms and households (Charts 7 through 9). Since this basic trend will likely continue, expectations for permanent income in the economy as a whole will improve and anxiety and uncertainty regarding future employment conditions will decline further. The recovery trend in consumption will therefore be maintained. 4 Third, the decline in crude oil prices since summer 2014 will positively affect the real economy in terms of both corporate profits and households’ real income (Chart 11). The decline in crude oil prices to date seems to be attributable to both the demand factor of slack in global demand and the supply factor of production increases in, for example, the United States. It is difficult to make an accurate forecast of developments in crude oil prices, but based on the assumption that these prices will start to rise moderately from the current level in line with the pace of growth in the global economy, the positive effects exerted through the underpinning of corporate profits and household income are expected to materialize to a certain degree, while downward pressure on the year-on-year rate of change in the inflation rate will remain for the time being. Fourth, financial conditions are likely to become more accommodative. As the Bank steadily pursues quantitative and qualitative monetary easing (QQE), which was expanded on October 31, 2014, upward pressure on nominal long-term interest rates will likely be contained and asset prices accordingly will be underpinned, together with improvements in fundamentals such as the accelerating pace of recovery in the U.S. economy and the improving trend in corporate profits in Japan. These factors will support the accommodative financial conditions as a whole, and such a trend is likely to strengthen (Chart 12). Based on these assessments, a virtuous cycle of economic activity will be maintained, supported by a firm increase in domestic demand and a moderate increase in exports of goods and services, and the economy is expected to continue growing at a pace above its potential, while fluctuations in demand stemming from the scheduled second consumption tax hike are anticipated in fiscal 2015. 2. Outlook for prices In assessing price developments, it is necessary to consider the following three aspects: the aggregate supply and demand balance (the output gap), which shows the utilization of labor and capital; medium- to long-term inflation expectations; and import prices. First, the output gap, estimated by the Bank, has recently been around zero, which is the historical average, despite being affected by the front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike (Chart 13). Firms seem to regard the decline in demand as temporary, and are maintaining their positive hiring stance. More firms have faced insufficient capacity, mainly in nonmanufacturing. Therefore, a trend in which the output gap will be positive (in excess demand) is likely to take root, and from Firms’ stance toward research and development investment is also important in assessing the potential strength of the supply side of the economy. Survey results show that major firms in Japan have been making active efforts in research and development investment recently (Chart 10). Although most of this investment is not currently covered in the estimates of GDP, it is likely to steadily push up GDP, and in turn the potential growth rate of the economy. Research and development investment is a component of GDP in the 2008 System of National Accounts (SNA), a new framework of the SNA, and in the United States and the European Union, where the 2008 SNA has already been introduced, such investment has pushed up GDP. In Japan, work is in progress for the 2008 SNA to be adopted in 2016. BIS central bankers’ speeches fiscal 2015 onward, the gap is expected to move further into excess demand territory and upward pressure on prices is likely to steadily increase. Second, medium- to long-term inflation expectations appear to be rising on the whole from a somewhat longer-term perspective, and are likely to gradually converge to around 2 percent – the price stability target – as the Bank pursues QQE, which was expanded on October 31, 2014 (Chart 14). Third, as for import prices, while the recent depreciation of the yen will exert upward pressure on consumer prices, a decline in international commodity prices, including crude oil prices, will exert downward pressure on consumer prices. In particular, the effects of the decline in crude oil prices – based on the outlook for these prices, to which I referred earlier – will continue to exert a considerable degree of downward pressure on consumer prices until around summer 2015, as these effects will spread to electricity and gas prices, in addition to prices of petroleum products such as gasoline (Charts 11 and 15). Considering the above points, the year-on-year rate of increase in the CPI (for all items less fresh food and excluding the direct effects of the consumption tax hikes) is likely to reach around 2 percent in or around fiscal 2015. I personally hold the view that the rate of increase in the CPI will likely be kept at around the current level of around 1 percent until summer 2015, mainly because downward pressure associated with the decline in crude oil prices will contain upward pressure on prices. Thereafter, the rate of increase is likely to accelerate gradually toward the second half of fiscal 2015 and reach around 2 percent – the price stability target – in or around that half, as the effects of the decline in crude oil prices will dissipate and the output gap will continue expanding in positive territory (Chart 16). 3. Balance of risks Risks to the Bank’s aforementioned baseline scenario regarding economic activity include the following: developments in overseas economies, particularly the U.S., European, and emerging economies, and their effects on Japan’s exports; the effects of the two rounds of consumption tax hikes; and firms’ and households’ medium- to long-term growth expectations. Risks regarding prices include developments in medium- to long-term inflation expectations, in the output gap, and in import prices. I view these upside and downside risks to economic activity, as well as to prices, as generally balanced. II. Monetary Policy A. Expansion of QQE At the Monetary Policy Meeting held on October 31, 2014, the Bank decided to expand QQE, in order to ensure that the price stability target of 2 percent would be achieved at the earliest possible time (Chart 17). Specific measures of the expansion are as follows. First, the Bank will accelerate the annual pace of increase in the monetary base from about 60–70 trillion yen to about 80 trillion yen. Second, it will increase purchases of Japanese government bonds (JGBs) so that the amount outstanding of its holdings will be increased by about 30 trillion yen from an annual pace of about 50 trillion yen to about 80 trillion yen. The average remaining maturity of the Bank’s JGB purchases will also be extended from the former period of about seven years to a flexible range of about seven to ten years. Third, the amount outstanding of the Bank’s holdings of risk assets such as exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) will be tripled to an annual pace of about 3 trillion yen and about 90 billion yen, respectively. The Bank will make ETFs that track the JPX-Nikkei Index 400 eligible for purchase. The Bank introduced a price stability target of 2 percent in terms of the year-on-year inflation rate of the CPI in January 2013, as well as QQE in April 2013, to achieve the target at the earliest possible time, with a time horizon of about two years. With the aim of achieving the BIS central bankers’ speeches target, the Bank decided to continue with QQE, as long as it was necessary for maintaining that target in a stable manner. More than one and a half years have passed since the introduction of aggressive monetary easing, and in the meantime it has strongly supported the recovery in economic activity from the financial side. As a result, the year-on-year rate of change in the CPI, which was minus 0.5 percent in March 2013 immediately before introducing QQE, is now around 1¼ percent. To be sure, weak developments in demand following the consumption tax hike and the substantial decline in crude oil prices have been exerting downward pressure on prices, and the year-on-year rate of increase in the CPI slowed to 1.0 percent in September. A temporary weakness in demand has already started to wane, and a decline in crude oil prices will have positive effects on economic activity from a somewhat longer-term perspective and push up prices. Nevertheless, if the current downward pressure on prices remains, albeit in the short term, there is a risk that conversion of the deflationary mindset, which has been progressing steadily so far, might be delayed. Deflation has continued for a protracted period in Japan and, unlike countries such as the United States, where inflation expectations have already been anchored at around 2 percent, Japan is in the process of raising, to around 2 percent, the inflation rate that the general public perceives as representing price stability. In this process, if the actual rate of increase does not accelerate – even for a short term – there is a risk that the momentum for inflation expectations thus far will lose steam. It is also necessary to pay attention to the point that adaptive expectation formation – where the inflation rate for previous periods affects people’s formation of the expected inflation rate – is prominent to some degree in Japan. To prevent the manifestation of such risks and maintain the improving momentum of expectation formation, the Bank judged it appropriate to expand QQE and decided such expansion. Before the expansion, JGB purchases had been conducted with an average remaining maturity of about seven years; as a result, there had been a substantial decline in yields in the somewhat short-term zone, while yields in the somewhat longer-term zone remained at relatively higher levels. Now that the average remaining maturity has been extended and set within a flexible range, this will put further downward pressure on interest rates across the entire yield curve. Furthermore, in order to conduct flexible JGB purchases, the Bank decided to announce the monthly schedule and details of JGB purchases for the following month on the last business day of each month. 5 B. Effects and costs of the expansion of QQE I would now like to explain how I assessed the expected effects as well as the potential costs and risks of the expansion of QQE before voting in favor of the decision. Let me first describe the effects of the expansion of QQE. With the introduction of QQE in April 2013, which has put further downward pressure on interest rates across the yield curve and strongly influenced asset prices, financial conditions in Japan have become more accommodative, and this has strongly supported improvements in corporate profits, employment, and wages. Amid increasing capacity of firms and households to generate income and a widening acknowledgment of the prospects for a sustainable improvement in demand, upward pressure on prices has been increasing. 6 A baseline scenario for the outlook for economic activity is that a virtuous cycle from income to spending will be maintained, and improvements on the supply side of the economy, which represent the See “Outline of Outright Purchases of Japanese Government Bonds,” released by the Bank on October 31, 2014. For more details of the increasing upward pressure on prices and the effects of QQE so far, please refer to Ryuzo Miyao, “Japan’s Economy and Monetary Policy,” Speech at the 2014 Autumn Annual Meeting of the Japan Society of Monetary Economics, Bank of Japan, October 18, 2014. BIS central bankers’ speeches potential strength of the economy, are expected to progress steadily in areas such as firms’ profitability and households’ labor supply. In this situation, the expansion of QQE is expected to produce stronger effects. Specifically, given an increase in firms’ profitability, extremely accommodative financial conditions will drive their positive efforts and risk-taking activities, thereby further heightening economic stimulus effects. Large-scale purchases of JGBs can exert downward pressure on longer-term interest rates and upward pressure on asset prices. If fundamentals such as corporate profits improved at the same time, asset price rises will become more sustainable and justified. With the heightening strength of the economy, the recent expansion of QQE will promote sustainable increases in spending and is expected to produce sustainable policy effects (Chart 12). So, how should we assess the potential costs and risks of the expansion of QQE? For example, regarding the risk that expansion of unconventional easing measures, such as the purchases of JGBs, will only cause a temporary asset price bubble and thus make the economy unstable, I think that the key is whether the expansion of such measures is coupled with improvements in the growth potential of the supply side and in firms’ competitiveness, and whether a structural transformation in the economy – such as restructuring of unprofitable businesses – will, after being postponed, be stimulated. On this point, as I have emphasized on many occasions, I judge that this risk has been mitigated, since firms’ positive efforts to heighten the potential strength of the economy have progressed steadily and this trend is likely to continue. As I have just explained, asset price rises that accompany improvements in fundamentals become more sustainable and justified, and the potential negative side effect of accumulation of financial imbalances will likely be suppressed. For the same reason, I consider that the risk of economic rejuvenation being delayed – in other words, the risk that monetary easing would allow funds to circulate among firms, including nonviable firms – will likely be mitigated to a certain degree. That is, if firms’ ability to proceed with the postponed disposal of the negative legacies and business succession increases as decisive measures produce further positive effects, and if such measures strongly support these firms’ efforts, business fixed investment, a structural transformation in the economy, and economic rejuvenation are likely to progress. 7 As a result, I think that this may then accelerate a virtuous cycle that bolsters the potential strength of the economy and the effectiveness of the policy measures. The economic recovery in Japan seems to have strengthened its sustainability, as corporate profits have been on an improving trend and potential strength has heightened further through the implementation of the measures in 2013. Corporate profits have increased while monetary easing has been strengthened and stock prices remain on a rising trend, and a similar situation has been observed in the United States (Charts 12 and 18). Given these improvements, it is likely that firms’ positive efforts to improve profits and strongly proceed with a structural transformation of unprofitable businesses have been encouraged by the extremely accommodative financial conditions. I think that the expansion of QQE strongly supports such efforts. It is not always evident ex ante whether strong monetary easing stimulates firms’ positive efforts and a structural transformation of businesses. However, if the Bank takes risks and consequent rises in asset prices and other factors increase firms’ strength, this will strongly support (1) the risk-taking activities of firms that have been willing to strengthen the growth potential of the economy, and (2) efforts toward a structural transformation by firms that previously have been unwilling and postponed such a move. As a result, firms’ profitability and competitiveness are expected to strengthen. In fact, such effects seem to have been observed steadily, at least so far, as suggested by the improving trend in corporate profits. BIS central bankers’ speeches C. Prospects for an exit Some argue that it has become more difficult to envisage an exit from monetary easing due to the expansion of QQE. However, I do not completely agree with this argument. Let me explain my thinking behind this view. One of the important aims of the expansion of QQE was that the 2 percent target would likely be achieved earlier than would be the case without such expansion, and that it would provide a better outlook for the feasibility of achieving the target. Due to the expansion of QQE, I personally think that it is quite probable that the 2 percent target will be achieved in a balanced manner – accompanying improvements in corporate profits, employment, and wages – in the second half of fiscal 2015. In fact, I expect that the rate of inflation will accelerate from summer 2015, with the waning effects of the decline in crude oil prices in 2014 (Chart 16). If this scenario materializes, it will become possible in the second half of fiscal 2015 to expect with greater certainty that the 2 percent target will be achieved in a stable manner. Consequently, with the expansion of QQE, I see it as highly likely that there will be a start to discussions of a specific exit strategy – for example, how to slow the pace of asset purchases, just as the Federal Reserve had been doing until recently, and how to take steps to return to an interest rate policy – in the second half of fiscal 2015, when the 2 percent target will likely be achieved. Nominal interest rates are formed based on the outlook for economic activity and prices as well as term premiums. The Bank has been exerting downward pressure on interest rates with purchases of JGBs. However, if upward pressure on interest rates strengthens in line with improvements in economic activity and prices, interest rates may stop declining or even start rising even if the Bank continues to purchase JGBs. At the Monetary Policy Meeting held on October 31, 2014, the Bank carefully examined the outlook for economic activity and prices. It assessed that downside risks to prices had increased and thus it had become necessary to take additional policy action. With a clear commitment to supporting the economic recovery in the form of implementing drastic additional easing at this juncture, when a virtuous cycle is being maintained, stronger effects of the policy can be expected. As a result, it may be possible to achieve the 2 percent target and start discussing an exit strategy sooner – to be specific, as early as in the second half of fiscal 2015. After carefully examining the expected effects as well as costs and risks, I judged it appropriate to decide in favor of the additional easing. D. Significance of the joint statement of the government and the bank I would now like to call attention to the significance of the joint statement of the government and the Bank on overcoming deflation and achieving sustainable economic growth that was released in January 2013. The main points of the statement are as follows. (1) The Bank, based on the recognition that efforts by a wide range of entities toward strengthening the competitiveness and growth potential of Japan’s economy will make progress, sets the price stability target at 2 percent in terms of the year-on-year rate of change in the CPI, and will aim to achieve this target at the earliest possible time. (2) The government will not only flexibly manage macroeconomic policy but also formulate measures for strengthening the competitiveness and growth potential of Japan’s economy – including all possible decisive policy actions, such as carrying out bold regulatory and institutional reforms and better utilizing the tax system – and promote them strongly. In addition, in strengthening coordination between the government and the Bank, the government will steadily promote measures aimed at establishing a sustainable fiscal structure. It is clearly expressed in the statement that the Bank and the government will jointly make these efforts toward the same end. The Bank decided on the additional easing to show its BIS central bankers’ speeches heightened determination to overcome deflation early and achieve sustainable economic growth with price stability in line with the statement. The Bank strongly expects that the government’s efforts will also continue to progress vigorously and steadily in line with the statement. Concluding remarks: the economy of Nagasaki prefecture My concluding remarks will touch on the economy of Nagasaki Prefecture. For hundreds of years, Nagasaki has been an international hub of cultural exchanges and open to the world, as epitomized by Dejima – an artificial island that was the only place authorized by the government for direct trade and exchange between Japan and the outside world during the Edo period. While nurturing a unique regional culture, Nagasaki has played a major role in the modernization and development of monozukuri, or manufacturing, mainly in heavy industry such as shipbuilding. In addition to such history and tradition, it is blessed with ample tourism resources, such as remote islands, hot springs, and fresh agricultural and marine products, as well as an appealing food culture. In the shipbuilding industry, which is a key industry of the prefecture, the “Year 2014 Problem” – referring to a situation whereby a substantial decline in order backlogs for new shipbuilding might result in empty docks in 2014 – had been a matter of concern until about two years ago. However, it now seems that, due to the depreciation of the yen and a rise in the reputation of Japan’s energy-saving, high-quality ships, the shipyards in Nagasaki have regained their competitiveness and seen an upswing in demand. Now, they face shortages of workers and staff due to the continuing high operating ratio. In another key industry, tourism, there are two sets of candidate sites in Nagasaki for placement on the UNESCO World Heritage List under the category of culture. Specifically, in 2014, “Churches and Christian Sites in Nagasaki” was added as a candidate by the government, following the endorsement of “Sites of Japan’s Meiji Industrial Revolution” in 2013. To promote tourism in Nagasaki, various measures have been taken to attract visitors from home and abroad; for example, it has one of the world’s top three nightscapes, and the construction of the Nagasaki route of the Kyushu Shinkansen bullet train is heading toward completion in 2022. Given these factors, I expect that the prefecture will have a golden opportunity to increase its number of visitors. Meanwhile, the population in Nagasaki, particularly in remote islands, has been declining, and, above all, the prefecture faces continuing outflows of young people to other prefectures. Moreover, I have heard that there are other challenges. Specifically, the weakening of business bases for various local industries – such as fisheries, as evidenced by a decline in catches – and for small firms has yet to show any improvement. Needless to say, these are common problems that many other regional economies in Japan face. The Nagasaki prefectural administration has implemented measures to address these problems. To raise the income of residents in the prefecture so that young people can enjoy living in the region, the prefecture has been making efforts to capture external demand, mainly from Asian neighbors, such as by actively promoting the arrival of international cruises, while further strengthening the competitiveness of manufacturing and tourism as well as agriculture, forestry, and fisheries, all of which have advantages and are the pillars of the local industries. In support of such initiatives, I have heard that lively discussions have been held at Nagasaki Summit, organized through an industry-academia-government collaboration, and this has been playing a critical role in the revitalization of local economy and communities. The joint efforts toward attracting external demand and tapping domestic demand have been steadily bearing fruit. We at the Bank wish you every success in these efforts and will continue to provide support as much as possible as the central bank. BIS central bankers’ speeches
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Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Paris Europlace Financial Forum, Tokyo, 25 November 2014.
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Hiroshi Nakaso: The potential impact of large-scale monetary accommodation Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Paris Europlace Financial Forum, Tokyo, 25 November 2014. * * * Introduction It is a great honor to have this opportunity to speak today before the Paris Europlace Financial Forum. In my remarks, after touching on the latest action taken by the Bank of Japan to expand quantitative and qualitative monetary easing, dubbed the QQE, I would like to share my views on the potential impact of large-scale monetary accommodation on the functioning of financial markets, with a special focus on Japan. Monetary policy in major economies Let me begin with our monetary policy. In April last year, the Bank of Japan introduced the QQE to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. The main objectives of the QQE have been to dispel a view that took root among people over a long period of deflation that prices would not rise – in other words, a deflationary mindset – and to create a situation in which households and firms behave on the assumption that prices would moderately increase. Specifically, in terms of the policy transmission mechanism, we intend to raise inflation expectations through a strong and clear commitment to achieve the price stability target of 2 percent, and at the same time to exert downward pressure across the entire yield curve through massive purchases of government bonds. As a result, real interest rates will decline, thereby stimulating such private demand components as business fixed investment, private consumption, and housing investment. The upward pressure on prices will grow stronger as demand increases and the output gap narrows accordingly. Rises in actual inflation rates will be translated into higher expected rates of inflation and thus lower real interest rates. This will reinforce the virtuous cycle as the economy is provided with additional stimulus. Since its inception, the QQE has been producing the intended effects, and Japan’s economy has steadily followed a path towards the achievement of the price stability target of 2 percent. In fact, the year-on-year rate of change in the consumer price index (CPI) excluding fresh food, which stood at minus 0.5 percent in March 2013 immediately before introducing the QQE, subsequently turned positive and moved up to reach above 1 percent by the end of last year. In recent months, however, a couple of developments on the price front have attracted our attention. First, the decline in demand following the consumption tax hike has been somewhat protracted in durable consumer goods including automobiles, as well as in housing investment. Second, crude oil prices have declined substantially after the summer. These factors have contributed to slowing the CPI inflation rates, which had hovered in the range of 1.0–1.5 percent since the end of the last year, down to 1.0 percent in September. Of the two factors, the temporary weakness in demand associated with the consumption tax hike has already started to wane. Meanwhile, the decline in crude oil prices will have positive effects on economic activity and push up prices over the longer-run. Nevertheless, given the fact that Japan’s economy is currently in a transition process of converting the deflationary mindset, prolongation of the current downward pressure on prices, albeit temporarily, was BIS central bankers’ speeches judged to run the risk of delaying the process. To prevent such risk from materializing and to maintain the improving momentum of expectation formation, we decided to take preemptive actions to expand the QQE at the Monetary Policy Meeting held on October 31 (Chart 1). Specifically, we decided to accelerate the pace of buildup in the monetary base by about 10–20 trillion yen to “an annual increase of about 80 trillion yen.” In order to carry this out, we will increase the amount outstanding of the holdings of Japanese government bonds (JGBs) by about 30 trillion yen to “an annual increase of about 80 trillion yen.” At the same time, we decided to extend the average remaining maturity of the JGB purchases by about three years at maximum to “about 7–10 years.” The purpose of the measures is to leave operational flexibility to buy JGBs from across the maturity zones and thus effectively compress the entire yield curve in line with market conditions, whereas the downward pressure on the yield curve has been rather uneven thus far, with substantial declines in rates on the shorter end while rates on the longer end remain relatively high. In addition, as for exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs), the increases in the amounts outstanding of the Bank’s holdings will be tripled in both cases. The latest decision to expand the QQE will further strengthen the policy transmission mechanism that I mentioned at the outset. The decision is also intended to demonstrate and confirm our strong and unequivocal commitment to achieve the price stability target. As we just heard from Governor Noyer, the European Central Bank has stepped up its monetary easing. And in the United States, the Federal Reserve concluded its asset purchase program but has maintained the view that the policy rate is likely to be kept at a near-zero level for a considerable time. The unconventional monetary easing measures, taken by the central banks to address unprecedented challenges facing the economies, are often said to have had unintended, and even unfavorable, impacts on the functioning of financial markets. My quick response is that I do not fully agree. Although I do share the views that massive monetary easing would indeed have a considerable impact on the market and that central banks should be vigilant against market developments, thus far serious impairment of the market function has not been observed. In the rest of my remarks, I would like to elaborate on why I think this is the case by focusing on three topics: “search for yield” activities, negative interest rates, and market liquidity. “Search for yield” activities First I would like to address a frequently cited remark that unconventional monetary stimulus could destabilize financial markets and the economy at large by encouraging “search for yield” activities among investors and thus creating financial imbalances. As one of their transmission channels, unconventional monetary policy measures including the QQE aim to promote portfolio rebalancing by investors and thus push down the risk premium in prices of various asset classes. In this regard, one can say that a rise in asset prices and a decline in volatility are intended effects of the QQE. In this context, I would stress instead that we should be mindful of the risk that “search for yield” activities enter into a self-fulfilling cycle and destabilize the markets and the economy. The combination of higher prices and the lower volatility of an asset induces investors to overvalue liquidity of the asset and drive up prices. This could in turn invite another round of investment, raising asset prices in a self-fulfilling manner. In addition, if a rise in asset prices creates overly bullish expectations among non-financial entities such as the corporate and household sectors, it could trigger excessive risk-taking behavior in these sectors as well. Thus far, we have not observed signs of self-fulfilling, overheated price movements in Japan’s financial markets. This is evidenced by occasional price adjustments reflecting factors such as geopolitical events, changes in the outlook on global economies, and policy changes in major economies. We also regularly check, in the Financial System Report, a “heat map” of financial activity indexes that helps us to gauge the macro conditions of BIS central bankers’ speeches financial activity by combining a host of indicators in both the financial and non-financial sectors (Chart 2). The indexes, with few parts in red, suggest that currently no signs of financial imbalances are observed. Having said this, we will of course continue looking carefully for any signs of overheating in the financial markets. Negative interest rates Another development attracting attention in Japan’s financial markets is seen in the negative interest rates of some financial products. The rates for treasury discount bills (T-Bills) declined to negative territory in September and remained there for most of the time since then (Chart 3). The payment of negative interest on securities sounds counter-intuitive and thus may prompt concern that Japan’s financial markets are suffering a serious malfunction. If we look into the details of each transaction, however, we can see plausible reasons why investors have accepted negative interest rates. Let me briefly mention a few cases where investors would buy T-Bills at negative interest rates. Commercial banks have an incentive to hold a certain amount of liquid short-term assets for the purpose of liquidity and duration risk management. Among various types of these assets, investors often prefer T-Bills because they are not only eligible collateral for borrowing from the Bank of Japan but also most suitable as collateral pledged against other money market and derivative transactions. Under the QQE, yields of liquid short-term assets have already approached zero across the board, and therefore even a small premium added to T-Bills could easily push their rates below zero. Foreign investors have also played an important role in driving yen rates into negative territory. Since the summer of 2014, U.S. dollar funding rates implied in foreign exchange swaps have risen, as the net demand for dollars in the foreign exchange swap market has increased (Chart 3). This means that foreign investors with dollar cash liquidity can convert dollars into yen via a foreign exchange swap contract and borrow yen at a much cheaper rate. Since yen money market rates are already at almost zero, the yen funding cost for these investors would most likely turn negative. They can take advantage of the negative funding cost by investing in T-Bills even with negative rates. This investment strategy can still capture a reasonable margin if the yen swap costs are deeper in the negative. Market participants attribute higher dollar premium to both demand and supply factors. On the demand side, Japanese investors have shifted part of their portfolios into foreign currencydenominated assets following the QQE, which has boosted demand for dollars in the foreign exchange swap market. On the supply side, market participants point out that the lending attitudes of dollar providers have turned less accommodative ahead of the expected initiation of the Fed’s tightening. Furthermore, not a few participants attribute this development partly to stricter international financial regulations, but the validation of this claim requires further exploration. In sum, T-Bill rates have been pushed down to a negative level because they gather investor demand for a number of technical reasons, while yen short-term interest rates have already been as low as a near-zero level across the board. In this sense, negative interest rates represent the very effect of powerful monetary easing under the QQE. Market liquidity Lastly, I would like to turn to the issue of market liquidity. As I pointed out, putting downward pressure on the yield curve by absorbing JGBs from the market is a factor comprising the core mechanism of the QQE. Therefore, it seems fairly natural for the QQE to have certain impacts on price formulation and transactions in the market. Meanwhile, since the introduction of the QQE, market participants have often raised a concern that the massive purchase of JGBs under the QQE will impair the functioning of the JGB market. We have been aware that such concern has mounted following the recent expansion of the QQE. In what way should we address such concerns? BIS central bankers’ speeches A complexity in this topic is that the term “market liquidity” could be used differently depending on the context. Indeed, there is no established and exclusive definition of market liquidity. However, this definition by the Bank for International Settlements appears to be widely known and accepted: “A liquid market is a market where participants can rapidly execute large-volume transactions with a small impact on prices.” A quick look at a few indicators along this line gives a somewhat encouraging picture of market liquidity. Transaction volume in JGB futures has been largely unchanged since the launch of the QQE (Chart 4). The ratio of daily price range to turnover, which approximates the price movement per transaction during the day, has remained stable at a low level, indicating there is just enough market liquidity (Chart 5). All in all, these indicators appear to suggest that activity in the JGB market has not been affected significantly by the QQE. Nonetheless, there are a number of reasons why we cannot be sanguine about the functioning of the JGB market. For instance, our market intelligence has found episodes suggesting signs of deterioration in the functioning of the JGB and related money markets that were not detected from statistical data. An example is the occasional difficulty in borrowing on-the-run JGB. Besides, not a few participants point out that the JGB market functioning is undermined in the sense that the market has been overly focused on monetary policy as the factor driving prices instead of the outlook for the economy and inflation, which would otherwise be the fundamental determinant. This implies that a change in market expectations in the future course of monetary policy could exert a stronger impact on the markets. Although this is not an issue of market liquidity per se, it is certainly a factor that we should take into consideration when observing market developments. Against this background, the Bank of Japan has been engaged in intensive dialogue with a wide range of market participants to grasp the state of market functioning. As an effort along this line, we have just announced several initiatives to enhance this dialogue, including the introduction of a quarterly Bond Market Survey of market participants’ views on the functions of the bond market. We intend to publish the survey results. Concluding remarks The pursuit of unconventional monetary actions, that are meant to be “powerful” as Governor Noyer suggests, would inevitably boost the central bank’s presence in the financial markets and create a resulting tradeoff between the intended policy consequences and the functioning of financial markets. To minimize the potential side effects on market functioning, the central bank should be committed to continuous dialogue with the market, so that it can share its views on its policy intention and its outlook for the economy and inflation, as well as accurately grasp participants’ views on market developments. The Bank of Japan has been, and will continue to be, committed to these efforts. Thank you very much for your kind 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 a meeting with business leaders, Nagoya, 25 November 2014.
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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, 25 November 2014. * * * Introduction It is my great pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in the Chubu region. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the Bank of Japan’s Nagoya Branch. In April last year, the Bank introduced the 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 2 years. The introduction of the QQE aimed at changing the deflationary mindset, which has taken root amid prolonged deflation, and at converting the economy from being in a deflationary shrinking equilibrium to being in an expanding equilibrium through creating a situation where people base their behavior on the assumption that prices rise moderately. During the year and a half since then, conversion of the deflationary mindset has been progressing steadily. The economy has continued to see moderate recovery, and the year-on-year rate of change in the consumer price index (CPI) has moved from negative territory to around 1¼ percent. Nevertheless, the rate of increase in the CPI has slowed somewhat of late due, for example, to somewhat weak developments in demand following the consumption tax hike and a substantial decline in crude oil prices, and there has been a risk that conversion of the deflationary mindset might be delayed. The Bank’s expansion of the QQE at the end of last month aims to preempt the manifestation of this risk and to maintain the improving momentum of expectation formation. Today, I would first like to review Japan’s economic and price developments, and then touch on the thrust of the expansion of the QQE. I. Developments in economic activity and prices To begin with, let me talk about developments in Japan’s economic activity and prices. Real economy Some weakness in Japan’s economy has remained, particularly on the production side, against the background of inventory adjustments brought by the effects of a decline in demand following the front-loaded increase prior to the consumption tax hike. The real GDP growth rate declined substantially in the April-June quarter and was minus 1.6 percent in the July-September quarter on an annualized quarter-on-quarter basis (Chart 1). However, as an underlying trend, a virtuous cycle in which an increase in households’ and firms’ incomes leads to an increase in their spending seems to be operating firmly. First, with regard to the household sector, labor market conditions have been improving steadily, as seen in the unemployment rate declining to around 3.5 percent, which is roughly the same level as the structural unemployment rate (Chart 2). In this situation, the rate of increase in wages has climbed moderately, registering around 1 percent (Chart 3). With an increase in the number of employees, employee income has been rising in the 2–3 percent range. Amid the steady improvement in the employment and income situation, private consumption has been resilient as a trend, and the effects of the decline in demand following the front-loaded increase have been waning on the whole. Moving on to the corporate sector, some weakness in production has remained, but there are prospects for further progress in inventory adjustments – mainly in industries relating to the BIS central bankers’ speeches production of durable consumer goods including automobiles, as well as to housing – by the end of the year. Moreover, business sentiment has generally stayed at a favorable level (Chart 4). As seen in firms’ business plans in the September 2014 Tankan (Short-Term Economic Survey of Enterprises in Japan), plans for sales and profits were revised upward and there also were plans to increase business fixed investment (Chart 5). On this basis, the Bank has judged that Japan’s economy has continued to recover moderately as a trend. Prices Let me turn to prices. The year-on-year rate of change in the CPI excluding fresh food, which was minus 0.5 percent in March 2013, immediately before introducing the QQE, subsequently turned positive and has risen to around 1¼ percent excluding the direct effects of the consumption tax hike (Chart 6). The determinants of the underlying trend of prices are the output gap and inflation expectations. Since the current economic recovery is led by domestic demand, which tends to have large stimulative effects on employment, the output gap has been steadily improving, particularly on the labor front, and has recently been around zero, which is the past long-term average (Chart 7). Judging from indicators obtained from the markets and various survey results, inflation expectations appear to be rising from a somewhat longer-term perspective, albeit with fluctuations (Chart 8). Such developments in inflation expectations have been influencing firms’ wage setting and price strategies. Namely, labor unions requested an increase in wages, taking into account a rise in the inflation rate, at the labor-management wage negotiations this spring, and rises in base pay were revived for the first time in more than a decade. Another example is a shift in firms’ price-setting strategy, from a low-price strategy to one of raising sales prices while increasing value-added. The conversion of the deflationary mindset has been steadily progressing. II. The expansion of the QQE However, the year-on-year rate of increase in the CPI excluding fresh food, which peaked at 1.5 percent in April 2014, slowed to 1.0 percent in September. Weakness in demand following the consumption tax hike and the substantial decline in crude oil prices since summer has been exerting downward pressure on prices. It should be noted that the effects of the decline in demand following the front-loaded increase prior to the consumption tax hike have already started to wane and that the decline in crude oil prices will have positive effects on the economy of Japan, which is a commodity-importing country and will push up prices from a somewhat longer-term perspective. Nevertheless, if the current downward pressure on prices remains, albeit in the short term, there is a risk that conversion of the deflationary mindset might be delayed. On this point, in countries like the United States where inflation expectations already have been anchored around the price stability target, medium- to longterm inflation expectations are less susceptible even if actual inflation rates change to some extent due to temporary factors such as developments in crude oil prices. This is because people believe that the inflation rate will eventually revert to the price stability target under a central bank’s monetary policy management. In Japan, by contrast, we are in the middle of trying to drastically change the deflationary mindset through the QQE, and medium- to longterm inflation expectations have been en route to 2 percent. Therefore, in contrast with countries like the United States, we should assume that inflation expectations in Japan are more susceptible to changes in the actual inflation rate. Inflation expectation formation is an essential part of the transmission mechanism of the QQE that the Bank envisages. Namely, the starting point of its effects is to convert people’s deflationary mindset and raise their inflation expectations with the Bank showing its strong and clear commitment to achieving the price stability target of 2 percent. At the same time, the Bank tries to lower real interest rates by exerting downward pressure across the entire BIS central bankers’ speeches yield curve through massive purchases of Japanese government bonds (JGBs), thereby stimulating private demand such as business fixed investment, private consumption, and housing investment. If private demand increases and the output gap improves, prices will rise and inflation expectations will be further pushed up. As illustrated, there are two engines that will raise inflation expectations. One is the Bank’s strong commitment to achieving the price stability target of 2 percent, and this has changed inflation expectations in a forward-looking manner. The other is the fact that, as a consequence, the actual inflation rate has risen to around 1¼ percent from negative territory. This has raised inflation expectations in a backward-looking manner. In this sense, if a pause in the actual price increase becomes protracted as a result of the decline in crude oil prices, which is a desirable phenomenon over time, the momentum of backward-looking expectation formation might lose steam. Consequently, if achievement of the 2 percent inflation is questioned, there is a risk that the transmission mechanism of the QQE might be weakened on the whole. Therefore, the Bank has considered it necessary to pursue monetary easing more powerfully under the QQE, as well as to reiterate its unwavering resolution to achieving the price stability target of 2 percent at the earliest possible time through its action. Based on this line of thought, the Bank decided to expand the QQE at its Monetary Policy Meeting held on October 31 (Chart 9). Specifically, the Bank decided upon the following measures. First, it will accelerate the pace of increase in the monetary base by about 10–20 trillion yen, from “an annual pace of about 60–70 trillion yen” to “an annual pace of about 80 trillion yen.” Second, the Bank will increase its asset purchases in order to accelerate the pace of increase in the monetary base. As for JGBs, the amount outstanding of the Bank’s holdings will be increased by about 30 trillion yen from “an annual pace of about 50 trillion yen” to “an annual pace of about 80 trillion yen.” The average remaining maturity of the Bank’s JGB purchases will be extended by about 3 years at maximum to “about 7–10 years.” The decision this time is expected to exert further downward pressure across the entire yield curve. Third, as for exchange-traded funds (ETFs), the increase in the amount outstanding of the Bank’s holdings will be tripled from “an annual pace of about 1 trillion yen” to “an annual pace of 3 trillion yen,” and also tripled for Japan real estate investment trusts (J-REITs) from “an annual pace of about 30 billion yen” to “an annual pace of about 90 billion yen.” In addition, the Bank will make ETFs that track the JPX-Nikkei Index 400 eligible for purchase. These measures aim to preempt the manifestation of a risk that conversion of the deflationary mindset might be delayed, and to maintain the improving momentum of expectation formation. Going forward, 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. It will examine both upside and downside risks to economic activity and prices, and if it is judged necessary for achieving the price stability target, the Bank will make adjustments without hesitation. This policy stance remains unchanged. III. Outlook for economic activity and prices under the expansion of the QQE Let me now turn to the Bank’s outlook for economic activity and prices under the expansion of the QQE, based on the Outlook for Economic Activity and Prices (Outlook Report) released at the end of October. On the real economy front, while the Bank steadily carries out the recently expanded QQE, a virtuous cycle from income to spending is expected to be maintained in both the household and corporate sectors as domestic demand, such as private consumption and business fixed investment, is likely to remain firm and exports are expected to head for a moderate increase. Therefore, Japan’s economy is likely to continue growing at a pace above its potential growth rate, which is estimated to be around 0.5 percent or lower, as a trend. Put in BIS central bankers’ speeches terms of the median of nine board members’ forecasts of the real GDP growth rate, this was 0.5 percent for fiscal 2014, 1.5 percent for fiscal 2015, and 1.2 percent for fiscal 2016 (Chart 10). On the price front, as I just explained, with Japan’s economy continuing to grow at a pace above its potential, the output gap is expected to stay on its improving trend and continue to advance within positive territory. Due partly to the Bank’s measures decided on October 31, medium- to long-term inflation expectations are expected to gradually converge to around 2 percent – the price stability target. On the back of developments in the output gap and inflation expectations, the year-on-year rate of increase in the CPI (excluding fresh food and the direct effects of the consumption tax hikes) is likely to be at around the current level for the time being, subsequently accelerate gradually, and reach around 2 percent – the price stability target – in or around fiscal 2015. This outlook for prices has not changed from the one in the April 2014 Outlook Report. In terms of the median of the board members’ forecasts of the year-on-year rate of increase in the CPI excluding fresh food, this was 1.2 percent in fiscal 2014, 1.7 percent in fiscal 2015, and 2.1 percent in fiscal 2016 (Chart 10). Concluding remarks The most important point I want you to understand with regard to the expansion of the QQE is that the Bank strongly commits itself to achieving the price stability target of 2 percent at the earliest possible time and maintaining it in a stable manner. Against this background, I expect firms to make decisions and engage in economic activity based on the assumption of 2 percent inflation. Conversion of the deflationary mindset and the rise in inflation expectations, which the Bank is trying to achieve through the QQE, do not only mean a rise in figures of the markets’ break-even inflation rates or of economists’ survey results. Rather, such changes should also occur in the minds of business leaders like you and be reflected in actual decision-making and behavior. After the protracted deflation, such changes have gradually started to take place and, in my view, this is what you recognize the most. What you likely have in mind as firms’ price-setting strategy and employment and wage management must be quite different from two years ago. The rise in base pay this spring, which was made for the first time in many years, is a prime example of this. In this sense, I have great interest in developments in wages and price settings through spring of next year. Moreover, in the process of converting the deflationary mindset, hoarding cash and deposits will become costly. As a corporate strategy, using their profits in a more productive manner is imperative. Among others, investment in facilities and human resources, as well as reestablishment of supply chains including subcontractors are possible options. At the same time, this would be a part of the process of having the fruits of the correction of the yen appreciation and of overcoming deflation spread through the whole economy. Such progress should not be stopped now. To achieve the price stability target, the Bank has been taking “action” and will continue to do so. I would like to conclude my speech by expressing my expectations for your “action” that looks toward the situation for the economy after overcoming deflation. 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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Keynote speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the 9th Asia Banking CEO Round Table, Tokyo, 25 November 2014.
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Hiroshi Nakaso: Toward innovative payment and settlement systems Keynote speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the 9th Asia Banking CEO Round Table, Tokyo, 25 November 2014. * * * Introduction Thank you for your kind introduction. Distinguished guests, friends, and colleagues. It is my great pleasure to speak at the 9th Asia Banking CEO Round Table. Today’s theme is “Operating in a New World: Digitisation and Disruptions in Banking.” Initially, I was somewhat puzzled by the word “disruptions,” but soon realized that disruption is only a prerequisite to creation. Banks can generate new value-added by discarding old business models and embarking on innovative challenges. Now, the questions are: What is the role of central banks in accelerating such innovation? What can we central bankers do to help banks steer through new challenges? How can we work together with the financial community to maximize the benefits of households and businesses? These are all very deeply rooted in the fundamental purpose of central banking; that is, to contribute to the sound development of the national economy. Today, I will explain our efforts toward creating innovative payment and settlement systems. In my view, the future payment and settlement infrastructure should offer an environment that facilitates the smooth delivery of the Japanese yen and Japanese government bonds (JGBs) anywhere and anytime. This is what I would call the ubiquity of the Japanese yen and JGBs. As a guardian of the national payment and settlement systems, the Bank of Japan (BOJ) will cooperate with bankers, market participants, and central bank colleagues overseas to make the unprecedented a reality with ideas that are innovative if sometimes disruptive, to borrow a word from today’s main theme of the round table. Please note that the views expressed today are mine, not necessarily those of the BOJ. The plan of my talk is summarized on slide 1. First, I will consider where we currently stand and what we can expect for the future. Next, I will elaborate on four major areas in which we are exerting efforts toward better payment and settlement systems. After that, I will briefly touch on recent developments in Japan’s economy and the conduct of monetary policy under the quantitative and qualitative monetary easing. Lastly, I will make my concluding remarks. I. Where do we stand and what do we expect for the future? Following the Asian currency crisis in 1997–98, the region has seen remarkable performance. Asian economies and financial markets have been expanding at a healthy pace. As you can see on slide 2, according to the IMF, the average GDP growth rate of Asian emerging economies since 2000 marked 8.0 percent, whereas that of advanced economies was merely 1.8 percent. Likewise, on slide 3, when we compare the capital inflows into Asia and other leading economies, big gyrations in capital flow were observed before and after the Lehman crisis. The capital flows to the euro area and the United States changed their course from inflow to outflow. Despite this development, capital has flowed into Asia steadily. On the back of such performance, a number of initiatives have taken place in the region to build a safety net, thereby raising its capacity for crisis management. These initiatives are namely (i) the Chiang Mai Initiative (CMI), (ii) the Asian Bond Fund (ABF), and (iii) the Asian Bond Markets Initiative (ABMI). We all know that, after the Lehman crisis, the region has remained resilient and the safety net has effectively prevented risk from permeating it. Let me briefly elaborate on these initiatives. The CMI is a set of international swap arrangements in the region, having started from a network of bilateral arrangements and now BIS central bankers’ speeches developed into a common multilateral arrangement. The Chiang Mai Initiative Multilateralization (CMIM) is a multi-lateral currency swap contract covering all ASEAN+3 members. The objective of the CMIM is twofold: first, to address balance of payment and short-term liquidity difficulties in the region; second, to supplement the existing international financial arrangements. In July this year, the CMIM was amended by doubling its total size from 120 billion to 240 billion U.S. dollars, and by introducing a precautionary line in order to strengthen the regional safety net. As for the ABF, this concerns the enhancement of bond markets in Asia. The Asian Bond Fund 1, often referred to as ABF-1, invested in U.S. dollardenominated bonds issued by sovereign and quasi-sovereign borrowers in some EMEAP (Executives’ Meeting of East Asia and Pacific Central Banks) economies, while ABF-2, launched in December 2004, invested in domestic currency bonds rather than U.S. dollardenominated bonds. Lastly, the ABMI, started in 2003, aims to develop efficient and liquid bond markets in Asia, so that savings in the region can be better utilized for investments in the region. Under this initiative, the ASEAN+3 economies have set up a forum to explore the possible establishment of cross-border securities settlement infrastructure, which I will come back to later. What is the objective of these initiatives? The CMIM set up the safety net in the region, while the ABF put in place a keystone for the primary bond market and the ABMI has been aimed at fostering regional securities settlement infrastructure. As I said, Asia is a region that has registered the fastest growth in the world, and it continues to enjoy high growth potential. The role of banks will become even more important down the road, as they contribute to facilitating balanced growth in the region. There are two channels through which banks can contribute. The first is reinforcing their lending activity in business areas with growth potential. The second is enhancing payment services and reinforcing payment infrastructure. In the following, I will focus on the latter role expected of banks today. As a central bank, we need to work together with banks to ensure that they contribute to the balanced growth of the region. I find it particularly important that central banks lay the foundation for banks so that they can exert the utmost efforts to demonstrate their intermediary function. I say this because we provide an infrastructure with finality for the yen and JGBs. As I summarized on slide 4, banks can complete payments and settlements by resorting to the central bank’s services. “Central bank money,” consisting of cash and central bank deposits, constitutes the most intrinsic foundation and underpinning of the nation’s financial system by providing a settlement chain in collaboration with “commercial bank money.” Let me paraphrase what I mean by this. A central bank issues money and delivers it to end users, such as households and businesses, through the network of banks’ branches and ATMs. Likewise, non-cash payments are provided to the end users through the nation’s payment and settlement systems in collaboration with banks. It is evident that the central bank’s money and its payment and settlement services furnish the national economy with the “ultimate finality” of payments and settlements. Raising the standard of our services will incentivize banks to improve their payment services to their customers, thereby creating an environment conducive to sustainable growth and a stable financial system. This leads me to say how important it is for central banks to be involved in the functioning of the payment and settlement system and to provide settlement finality. The enhancement of payment services is driven by the need to make the best use of innovative information technology and related skills. I believe this is well captured in today’s main topic of the round table. Frankly speaking, however, I have an impression that nonbanking institutions have recently been playing an active role in providing innovative means of payment. On slide 5, the amount and volume of settlements through non-banking institutions – which are exemplified by credit cards, electronic money, and debit cards – are compared with those through banking institutions, which are summarized under the headline of the Zengin System. The Zengin System is an online network that links banks nationwide and processes customers’ fund transfers in real time all over Japan. The evidence suggests BIS central bankers’ speeches that payment instruments provided by non-banking institutions have far outpaced the Zengin System both in terms of amount and volume. As another example, take the emergence of Bitcoin. It may well be that Bitcoin excels in facilitating access to the global markets and securing users’ anonymity, so that customers find it more convenient to use Bitcoin for payment rather than settling transactions through conventional means of payment in the banking system. We central bankers should consider carefully how we can ensure the proper functioning of the traditional transmission channel of monetary policy while Bitcoin and other virtual currencies continue to be used in the world. One possible solution that addresses the Bitcoin issue is enforcement action. New regulation may curtail its further usage. Nevertheless, payment services provided by banks have a comparative advantage over those provided by non-banking institutions, because a central bank can complement banks’ services by providing a payment instrument with finality. Such funding is not readily available to non-banking institutions. Owing to this, improving the convenience of banks’ payment services and encouraging better access to those services appear to be the most essential ways of responding to a number of challenges triggered by non-banking institutions’ innovative activities. The network of a central bank and banks constitutes the core of payment infrastructure, but from the central bank’s perspective, we need to make incessant efforts to ensure that those banks have a firm footing with regard to the provision of payment services, and that they make efforts to ground their presence in the payment system. II. Major initiatives in Japan Next, I would like to explain major initiatives that are underway in Japan in the context of banking and non-banking activity. It is understandable that much attention is being paid to the conduct of monetary policy, but a central bank plays no less a crucial role in building the most important infrastructure for the economy. That is, to enhance the payment and settlement infrastructure. It is fair to say that the central bank’s payment services provide a pivotal underpinning for the conduct of monetary policy. Without the smooth settlement of funds among banks and other financial institutions, we cannot contribute to the stability of Japan’s financial system either. History shows that central banking has been involved in the functioning of payment and settlement much longer than in the operation of monetary policy. The term “central banking” comes from the fact that this has long been at the center of the payment and settlement infrastructure. As the central bank of Japan, the BOJ also runs the payment and settlement systems in funds transfers and JGBs. Thus, it is our supreme responsibility to ensure that central bank money, which possesses ultimate finality, as I mentioned, is used in places where it should be used. Based on such understanding, I would like to elaborate on four areas in which we have been making extensive efforts. As summarized on slide 6, these are namely (i) cross-border collateral arrangements between central banks, (ii) the T+1 project for JGB settlement, (iii) possible cross-border expansion of the yen and JGBs, and (iv) the improvement in retail payment services. It is important to recognize that these will contribute to enhancing the ubiquity of the Japanese yen and JGBs. The first area aims at enhancing the convenience of banks and businesses through the central banks’ cooperation. All the rest are challenging to the banking industry, but the reward it eventually will get will be worthwhile. All areas would enable financial transactions that are not currently available. From the central banks’ perspective, the implication derived from those innovative measures is exciting. Minimizing the unsettled funds and facilitating the ubiquity of the yen and JGBs will open a new frontier in financial services. With that in mind, let me now explain the four major initiatives in turn. BIS central bankers’ speeches A. Cross-border collateral arrangements with central banks in Asia The first initiative is cross-border collateral arrangements with Asian central banks, with which the BOJ has been collaborating. Specifically, with the Bank of Thailand, the BOJ established in 2011 a framework in which Thai Baht liquidity could be provided by the Bank of Thailand against JGBs and the yen as collateral. A similar arrangement was established with the Monetary Authority of Singapore in 2014, and agreed upon in principle with Bank Indonesia in 2013. As shown on slide 7, under such arrangements, the central bank in a host country – in this case, the Bank of Thailand – provides liquidity in its own currency to banks against JGBs as collateral. The BOJ plays the role of a custodian to receive JGB collateral from those banks. All these arrangements allow eligible banks – both Japanese banks and other banks operating in respective countries – to obtain liquidity in local currencies from central banks to which JGBs are submitted as eligible collateral. Thus, those banks have additional sources of local currencies from local central banks under stressed funding conditions. Such arrangements are beneficial to their customers (e.g., firms), which will be able to maintain stable borrowings in local currencies from their banks. In sum, financial cooperation with central banks in Asia will contribute to the stability of financial systems as well as development of our economies. It also can be regarded as an important cornerstone for the BOJ to germinate its initiatives to ensure the ubiquity of JGBs. B. T+1 project for JGB settlement The BOJ also has been working with market participants to improve the safety of JGB settlement. For example, we implemented online processing of JGB settlement as early as 1990. We also embarked on various initiatives including a delivery-versus-payment (DVP) mechanism in which a delivery of securities takes place if, and only if, payment occurs. Lastly, we have collaborated closely with market participants to introduce a central counterparty (CCP) for JGB transactions. As for the latter, the Japan Securities Clearing Corporation (JSCC), after a merger with the Japan Government Bond Clearing Corporation (JGBCC) in October 2013, has become a CCP for JGB cash transactions, in which it plays the role of a buyer to every seller as well as the role of a seller to every buyer. Thus, the JSCC provides guarantees for JGB settlements even in the case of a default by market participants. In the course of advancing measures to improve the safety and efficiency of JGB settlements, the collaboration between the BOJ and market participants has been one of the most important elements. In this context, another initiative that the BOJ has been working on is to shorten the time lag between the execution of JGB trading and settlement. At present, the JGB settlement cycle is T+2 for both standard outright transactions and special collateral repo transactions, and T+1 for general collateral repo transactions. As you can see on slide 8, we have been working with market participants to shorten such settlement cycles, from T+2 to T+1 for both standard outright transactions and special collateral repo transactions, and from T+1 to T+0 for general collateral repo transactions to ensure improvement of the safety in JGB markets. In fact, the Working Group on Shortening of JGB Settlement Cycle, which was set up under the auspices of the Japan Securities Dealers Association, identified three overarching principles for shortening the JGB settlement cycle. The first was to reduce the settlement risk. The longer the time lag between trading and settlement, the more unsettled positions accumulate; hence, the settlement risk rises. By containing such a build-up of unsettled positions, we can effectively mitigate the settlement risk. The second principle was to enhance the liquidity, safety, and efficiency of the JGB market. The JGB market – the largest financial market in Japan – provides a benchmark that facilitates the transactions of other financial assets such as corporate bonds and CP. Shortening the settlement cycles will make it smoother for banks to raise funds against JGB BIS central bankers’ speeches collateral. In effect, this will in turn provide investors with a variety of short-term investment opportunities. The last principle for the shortening of JGB settlement cycles was to maintain and reinforce the international acceptance of JGBs. As for the outright transactions, T+1 has already been achieved in the United States and the United Kingdom. In Asia, Singapore has also moved to the T+1 platform. In these economies, shortening of the cycles has often been discussed in the context of maintaining a competitive edge against peers overseas. Based on these principles, market participants are now aiming to achieve T+1 for JGB transactions as early as 2017. This is also a part of efforts to achieve the ubiquity of JGBs. By the end of spring 2015, members of the working group will come up with a more concrete timetable to achieve T+1, and we are actively providing support on that front. On this point, I am particularly heartened by the fact that the shortening of settlement cycles is not simply motivated by the reduction of the settlement risk. Market participants also regard this as a means to enhance investment opportunities through the internationalization of the yen and JGBs. As Japan is in the first set of time zones, it is beneficial to tackle a move toward a shorter settlement cycle. The shorter cycle is an integral part of the initiative to achieve advanced and market-wide development of straight-through processing (STP). The shorter cycle will also help galvanize Tokyo’s position as a global financial center as it becomes a frontrunner of financial networks. C. Possible cross-border expansion of the Yen and JGBs The third initiative concerns possible cross-border expansion of the yen and JGBs. Under this initiative, the BOJ will provide a cross-border payment network by anchoring payment and settlement systems. 1. Extension of the operating hours of the BOJ-NET Specifically, as shown on slide 9, the BOJ has already announced that it will extend the operating hours of the BOJ-NET until 9 pm JST from February 2016. This will generate a longer overlap of the operating hours not only between Japan and Asian countries but also between Japan and European countries. Consequently, new financial services will become available, such as overseas remittance services in yen by customers, same-day foreign exchange transactions – or T+0 transactions – between banks, and the usage of JGBs as collateral to raise foreign currencies and post as eligible collateral to overseas CCPs to meet margin requirements. Beyond extending the operating hours of the new BOJ-NET, additional proposals are currently being considered. These include measures such as global access and a crossborder link in Asia to enhance the ubiquity of the yen and JGBs. 2. Global access Starting with global access, as shown on slide 10, this allows the BOJ-NET participants that physically have a presence in Japan and hold current accounts at the BOJ to set up their BOJ-NET terminals in their overseas locations, whereby staff members can operate the terminals. For example, if a Japanese bank sets up its BOJ-NET terminal in its London base, it can post JGBs as collateral to a European CCP in London. Alternatively, if a Japanese bank sets up its BOJ-NET terminal in its Bangkok base, it can carry out same-day remittance of its customers’ funds from Thailand to Japan. Although much needs to be examined beforehand, the requests from Japanese and foreign banks have been heard and global access could significantly improve the convenience of the yen and JGBs. 3. Cross-border linkage The second measure concerns enabling cross-border linkage between the BOJ-NET and systems overseas. Allowing the BOJ-NET to be connected with its overseas counterparts can introduce a DVP mechanism for JGB transactions, in which the delivery of JGBs can be BIS central bankers’ speeches made simultaneously with funds transfers. For example, as shown on the left side of slide 11, the DVP mechanism for foreign securities’ transactions can be used. A Japanese bank (Bank A) can make yen funding available to a foreign bank (Bank B) that provides foreign securities as collateral to the Japanese bank overseas. Alternatively, as shown on the right side of the slide, a Japanese bank (Bank A) can also provide JGBs as collateral to a foreign bank (Bank B), which can provide foreign currency funds to the Japanese bank overseas at the same time. By linking the BOJ-NET with those systems overseas, we can facilitate such DVP transactions, and this will again contribute to enhancing the efficiency and convenience of the yen and JGBs. In this regard, we are currently continuing discussions with Asian peers concerning regional settlement infrastructure that promotes cross-border securities transactions in the region. 4. ASEAN+3 initiatives The kind of cross-border linkage that I have illustrated will contribute to stable daily funding in foreign currencies on an ongoing basis. What kind of technological innovation can make this come true? A possible answer is currently being discussed in the ASEAN+3 countries. They created a forum in which the establishment of cross-border linkage in the region is currently being explored. More concretely, the set-up of a cross-border link between the securities settlement system in one country and the central bank’s real-time gross settlement (RTGS) system in another has been discussed, as shown on slide 11. Such cross-border linkage will enable market participants to settle foreign-currency funding transactions against domestic assets as collateral on a DVP basis. If this means of funding, which is known as crosscurrency repos, becomes available on an ongoing basis, it will contribute to improving the safety and efficiency of financial transactions in the entire region. D. Improvement in retail payment services: 24/7 services and financial EDI The last initiative that I want to mention is the improvement of retail payment services. We are particularly interested in two issues. First, whether to realize real-time payments between end users on a 24/7 basis; second, to enhance linkage between remittance information with payment information to achieve financial Electronic Data Interchange (EDI). 1. 24/7 services As for the 24/7 services in retail payments, let me step back and explain where we currently stand in Japan. As you can see on slide 12, the Zengin System, which is at the core of the Japanese payment system, has long been regarded worldwide as one of the most advanced systems in the field of retail payment. It already allows for near real-time payment services during the daylight hours of working days. More recently, however, some countries, including Singapore in our region, have developed 24/7 retail services. These offer near real-time payment services 24 hours a day, 7 days a week; hence, they are known as 24/7 services. We also have seen similar services being offered in countries like the United Kingdom and Sweden. In light of such progress in overseas economies, it has become a must in Japan to elevate bank transfers to a comparable level of convenience and efficiency in terms of service availability. This would ensure smooth operation of retail payment services to underpin business and household activities. 2. Financial EDI Slide 13 presents another issue that we are interested in: realizing financial EDI. As you know, businesses have started to electronically exchange remittance information, such as purchases and sales orders, by taking advantage of internet technologies. An arrangement to link such remittance information with payment information – namely, information related to a beneficiary’s bank account and the payment date – and to exchange both remittance information and payment information together is called financial EDI. BIS central bankers’ speeches The question is: What is the benefit to businesses in adopting financial EDI? In the short run, they incur costs associated with developing IT systems that accommodate standardized formats to exchange data electronically. However, in the medium to long run, they can enjoy the benefits of raising the efficiency of their operation. For example, firms will be able to automate the reconciliation of payment information with remittance information; thus, they no longer need to rely on manually processing accounts receivable. Looking at the Japanese situation, the Zengin System moved its platform to the 6th generation in November 2011, and one of the new features at that time was to accept the ISO 20022 XML format as an option for transfer messages. Nevertheless, because the adoption of this format is not an obligation and it requires coordination among a wide range of stakeholders, neither banks nor customers have taken advantage of the new format. From the viewpoint of maintaining competitiveness against their peers overseas, Japanese firms would need to articulate the means through which to reduce costs by realizing financial EDI as well. To be fair, the Japanese Bankers Association has already started looking into the issues of whether to extend the operating hours of the Zengin System and how to make use of financial EDI within the Japanese context. It is expected to release the results of its study by the end of this year. These initiatives show that Japanese banks have started taking measures to build infrastructure surrounding retail payment systems as a foundation to underpin their basic payment services. III. Japan’s economy and monetary policy Thus far, I have focused on the rather technical issues concerning payment and settlement systems. However, given the continued interest in our monetary policy, and particularly in the latest action we have taken, I want to spend a few minutes on monetary policy at this point. In April last year, the BOJ introduced the Quantitative and Qualitative Monetary Easing Policy, dubbed the QQE, to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about 2 years. The main objectives of the QQE have been to dispel a view that took root among people over a long period of deflation that prices would not rise – in other words, a deflationary mindset – and to create a situation in which households and firms behave on the assumption that prices would moderately increase. Specifically, in terms of the policy transmission mechanism, we intend to raise inflation expectations through a strong and clear commitment to achieve the price stability target of 2 percent, and at the same time to exert downward pressure across the entire yield curve through massive purchases of government bonds. As a result, real interest rates will decline, thereby stimulating such private demand components as business fixed investment, private consumption, and housing investment. The upward pressure on prices will grow stronger as demand increases and the output gap narrows accordingly. Rises in actual inflation rates will be translated into higher expected rates of inflation and thus lower real interest rates. This will reinforce the virtuous cycle as the economy is provided with additional stimulus. Since its inception, the QQE has been producing the intended effects, and Japan’s economy has steadily followed a path towards the achievement of the price stability target of 2 percent. In fact, the year-on-year rate of change in the consumer price index (CPI) excluding fresh food, which stood at minus 0.5 percent in March 2013 immediately before introducing the QQE, subsequently turned positive and moved up to reach above 1 percent by the end of last year. In recent months, however, a couple of developments on the price front have attracted our attention. First, the decline in demand following the consumption tax hike has been somewhat protracted in durable consumer goods including automobiles, as well as in housing investment. Second, crude oil prices have declined substantially after the summer. These factors have contributed to slowing the CPI inflation rates, which had hovered in the range of 1.0–1.5 percent since the end of the last year, down to 1.0 percent in September. BIS central bankers’ speeches Of the two factors, the temporary weakness in demand associated with the consumption tax hike has already started to wane. Meanwhile, the decline in crude oil prices will have positive effects on economic activity and push up prices over the longer-run. Nevertheless, given the fact that Japan’s economy is currently in a transition process of converting the deflationary mindset, prolongation of the current downward pressure on prices, albeit temporarily, was judged to run the risk of delaying the process. To prevent such risk from materializing and to maintain the improving momentum of expectation formation, we decided to take preemptive actions to expand the QQE at the Monetary Policy Meeting held on October 31, as shown on slide 14. Specifically, we decided to accelerate the pace of buildup in the monetary base by about 10–20 trillion yen to “an annual increase of about 80 trillion yen.” In order to carry this out, we will increase the amount outstanding of the holdings of JGBs by about 30 trillion yen to “an annual increase of about 80 trillion yen.” At the same time, we decided to extend the average remaining maturity of the JGB purchases by about 3 years at maximum to “about 7–10 years.” The purpose of the measures is to leave operational flexibility to buy JGBs from across the maturity zones and thus effectively compress the entire yield curve in line with market conditions, whereas the downward pressure on the yield curve has been rather uneven thus far, with substantial declines in rates on the shorter end while rates on the longer end remain relatively high. In addition, as for exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs), the increases in the amounts outstanding of the BOJ’s holdings will be tripled in both cases. The latest decision to expand the QQE will further strengthen the policy transmission mechanism that I mentioned. The decision is also intended to demonstrate and confirm our strong and unequivocal commitment to achieve the price stability target. Conclusion Let me conclude. The BOJ endeavors to put an end, once and for all, to deflation and bring the economy back on track towards sustained growth. In the meantime, as I explained to you today, upgrading the financial and payment infrastructure is also an important part of our mission. We have been taking a number of steps to bring the Japanese payment and settlement systems to the forefront. Specifically, the BOJ would encourage the enhancement of retail payment systems and examine the ways to realize payments and settlements using the new BOJ-NET for cross-border transactions in yen or JGBs. The initiatives are part of our priorities for fiscal 2014–18, which show our determination to progress toward the ubiquity of the yen and JGBs by incorporating the latest technologies. I believe the initiatives will also promote the internationalization of the yen, which has long been on the policy agenda but with limited results thus far. At the same time, I know that our efforts have to extend beyond national borders if we are to upgrade the financial and payment infrastructure in the entire Asia Pacific region. Hence, collaboration with market participants and other central banks in the region is essential. Given the globalized and integrated nature of financial markets of today, only through collective exercises can we jointly benefit from new ideas and innovation with respect to the financial and payment infrastructure. The new initiatives would pave the way to further innovation in the banking sector, enhance the safety and efficiency of financial markets, and underpin the real economy. It is encouraging in this regard to see that ambitious talks among the relevant authorities in Asia are already under way. We are committed to playing a key role because we know too well that without prosperity in the region, there will be no growth for Japan. Let me end my remarks by reiterating our commitment to contributing to the joint works with our colleagues in Asia to ensure that the region continues to foster prosperity long into the future. 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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bank of japan
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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, Hiroshima, 26 November 2014.
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Sayuri Shirai: Japan’s economic activity, prices, and monetary policy – the medium-term outlook and the expansion of monetary easing Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hiroshima, 26 November 2014. * * * The charts can be found at the Bank of Japan’s website. I. Introduction Good morning, everyone. Today, I feel honored to have an opportunity to meet with local representatives here. Let me also express my sincere gratitude for your cooperation with the activities of the Bank of Japan’s Hiroshima Branch. In my speech, I would like to talk about the Bank’s baseline scenario described in the October 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report), as well as the Bank’s decision made on October 31 to expand quantitative and qualitative monetary easing (QQE). II. Outlook for economic activity and prices, and risk assessment I will begin by describing the current economic conditions and the Bank’s baseline scenario, followed by those for price developments, and then the upside and downside risks to the baseline scenario – all of which were presented in the Outlook Report. My own views will also be mentioned. The medium-term outlook is based on information available by endOctober, and incorporates the expected effects of the expansion of QQE. It also assumes the implementation of the second round of the consumption tax hike in October 2015 as stipulated in the current relevant law. Let me highlight three major changes related to the economic environment that have emerged since the interim assessment made in July this year. These are (1) a decline in a wide range of commodity prices, especially crude oil prices, from around July; (2) a moderate deceleration in the pace of economic activity in Europe and emerging economies, including China; and (3) increased volatility in global financial and capital markets triggered mainly by heightened geopolitical risk and changes in investor sentiment reflecting the normalization of the Federal Reserve’s monetary policy. A. Current situation of and outlook for economic activity Japan’s economy has continued to recover moderately as a trend, although some weakness has remained in consumption and production. The weakness is due mainly to a decline in domestic demand following the front-loaded increase before the consumption tax hike was implemented in April 2014, (2) somewhat weaker export developments, and (3) the effects of irregular weather during the summer. Corporate profits for fiscal 2014 remain high despite a sharp decline in domestic demand following the front-loaded increase, after rising significantly in fiscal 2013. Partly reflecting this, firms maintain a strong incentive to carry out business fixed investment; some of them, including small and medium-sized enterprises (SMEs), have actually adjusted upward their investment plans for fiscal 2014. In addition, the year-on-year change in nominal employee income (defined as the per capita nominal wage multiplied by the number of employees) has been on a rising trend, which continues to support consumption activity. According to the Bank’s baseline scenario of the outlook for economic activity, in the second half of fiscal 2014, private consumption is likely to remain resilient with the employment and income situation continuing to improve steadily; business fixed investment is projected to increase steadily; and exports are expected to head for a moderate increase as overseas economies recover. Therefore, a virtuous cycle among production, income, and spending is likely to be maintained in both the household and corporate sectors. The BIS central bankers’ speeches accommodative financial environment, which was strengthened further by the Bank’s recent decision on the expansion of monetary easing, will continue to support the economic recovery. Note that the outlook assumes a gradual increase in firms’ and households’ medium- to long-term growth expectations, as well as the potential growth rate, in line with progress in the government’s growth strategy and firms’ initiatives toward improving productivity and their tapping of potential domestic and external demand. As a result, the economic growth rates for fiscal 2015 through fiscal 2016 are projected to exceed the potential economic growth rates (Chart 1). My outlook for economic activity – which has consistently remained lower than the median of the Policy Board members’ forecasts throughout the projection period – was revised downward this time. My downward revision for fiscal 2014 was mainly due to the greaterthan-expected decline in private consumption caused by the consumption tax hike. At the time of the Bank’s interim assessment in July, many firms had judged that the adverse impact of the consumption tax hike was largely within their expectations. In reality, however, it turned out that an actual decline in domestic demand was greater in the April-June quarter this year; the recovery process since August has also been slower than expected. These developments can be attributed to not only a decline in real disposable income but also the bad weather and the limited wealth effects reflecting a sluggish performance of the stock market. In this regard, I had disagreed four times consecutively with the Bank’s risk assessment that was described in the Statement on Monetary Policy released immediately after each Monetary Policy Meeting (MPM) from January through early April this year. The disagreement reflected my concern that the Bank’s Statement on Monetary Policy 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 as a downside risk. It is now clear that this risk has materialized and played a major role in the downward revision to the Bank’s outlook. Nevertheless, private consumption recently started to recover gradually and the consumption level will likely recover to the level observed before the front-loaded increase by around the January-March quarter of 2015. Regarding exports, my risk assessment has also been consistently tilted downward because of concerns about sluggish external demand. This time, I revised downward my outlook on exports because the downside risk had materialized somewhat. However, since my outlook on imports was adjusted downward as well, the net impact on the trade balance is projected to remain limited. My projection is that the growth rates for both fiscal 2015 and 2016 will likely be much higher than the rate for fiscal 2014. However, they have been adjusted downward somewhat, mainly for private consumption, from my July interim assessment. This adjustment reflects my observation that the rate of increase in nominal employee income may slow down somewhat in fiscal 2015 and 2016 because of the following. (1) Slower growth in corporate profits for fiscal 2014 relative to that in 2013 – although still at a high level – may result in slower growth of nominal wages for regular workers in fiscal 2015. (2) A further expansion in employment is becoming increasingly difficult since unemployed workers have largely disappeared except for those caused by mismatches. (3) Additional labor hours generated by newly employed workers have been declining since many women and elderly people who are willing to work often prefer short-time working hours. (4) Current employment growth includes many non-regular workers whose wage growth remains limited, while there is a declining trend in employment growth among regular workers in manufacturing, whose productivity growth and thus wage growth have exceeded other sectors. Finally, (5) it is not yet confirmed whether households’ expectations regarding future income will follow a rising trend. The estimated potential economic growth rate has been repeatedly revised downward and currently remains below 0.5 percent (Chart 2). I judge that this decline reflects not only a BIS central bankers’ speeches deceleration in the growth of capital stock and the total factor productivity (TFP) but also a constraint on economic growth imposed by a labor shortage, which has become increasingly evident in the construction, restaurant, retail, transportation, and tourism sectors, notably among SMEs. The potential growth rate is expected to rise from fiscal 2015 mainly through an accumulation of capital stock, an improvement in TFP growth, and a reallocation of the labor force through restructuring of the corporate sector and a shift in existing business models toward ones that provide higher value added or goods and services that stimulate demand. It is also expected that greater efforts will be made by the government to reform the social security and tax systems, to promote female employment, resolve the problem of having too many children on waiting lists for nursery schools, and promote economic growth strategies – thereby contributing to the reduction of constraints on economic growth. To summarize my outlook, the potential growth rate will rise gradually toward about 1 percent over the projection period. Over the same period, economic growth is projected to be around or below the potential growth rate for fiscal 2014. Economic growth will likely be much greater than the potential growth rate for fiscal 2015, due to the adjustment process of returning to the conditions observed before the front-loaded increase in domestic demand prior to the consumption tax hike. Economic growth for fiscal 2016 is likely to moderately exceed the potential growth rate. B. Current situation of and outlook for prices Current price developments show that the year-on-year rate of increase in the consumer price index (CPI, all items less fresh food) declined from May 2014 and is recently around 1 percent. The major factors determining inflation rates are the aggregate supply and demand balance (the output gap), medium- to long-term inflation expectations, and import prices. The output gap turned positive to around 0.4 percent in the January-March quarter of 2014, but then dropped again into negative territory, to around minus 0.1 percent in the AprilJune quarter owing to the adverse impact of the consumption tax hike. The output gap is very recently improving slowly, reflecting mainly a continuous increase in employment. Medium- to long-term inflation expectations are rising on the whole from a somewhat longerterm perspective. As for import prices, upward pressure – mainly from the depreciation of the yen and the rise in energy prices – has already begun to weaken. 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 at around the current level for the time being, and subsequently accelerate gradually and reach around 2 percent around the middle of the projection period; that is, in or around fiscal 2015 (Chart 3). Thereafter, the CPI inflation is likely to edge up as medium- to long-term inflation expectations will converge to around 2 percent and the output gap is expected to continue expanding in positive territory. In other words, after achieving inflation of around 2 percent in or around fiscal 2015, Japan’s economy is projected to shift to a growth path that sustains such inflation in a stable manner. It is assumed that a trend in which the output gap will be positive is likely to take root in the second half of fiscal 2014 and thereafter is expected to move further into excess demand territory, thereby increasingly exerting upward pressure on prices, and that such positive price developments will help to raise medium- to long-term inflation expectations to converge to around 2 percent. Meanwhile, import prices will likely be pushed down by the recent declining trend in commodity prices on the one hand, and pushed up by recent developments in foreign exchange rates on the other. With regard to medium- to long-term inflation expectations, the Bank generally makes a judgment on the movements of the inflation expectations as a whole using a wide range of related indicators. This is because there is no single data set that represents inflation expectations and the indicators entail statistical problems, such as various biases, and exhibit divergent movements from each other. The Bank’s sample indicators include the inflation expectations of households, firms, economists, and Japanese government bond (JGB) market participants, as well as those inferred from market data such as the break-even BIS central bankers’ speeches inflation (BEI) rate and the inflation swap rate. The Bank regularly releases these data under the headline chart title “Inflation Expectations” in its Monthly Report of Recent Economic and Financial Developments as well as in the Outlook Report. Among the data, the most relevant indicators for the Bank are those projected more than one year ahead, which are regarded as representing medium- to long-term inflation expectations (Charts 4–1 and 4–2). As mentioned, the Bank projects that medium- to long-term inflation expectations will converge to around 2 percent, since this will sustain inflation at around 2 percent in a stable manner. Thus, the judgment as to whether medium- to long-term inflation expectations will converge is essential to realize the Bank’s baseline scenario. In this regard, it may be said that the Bank has already passed the halfway point on the path toward achieving the 2 percent price stability target, but it has not yet attained the goal. Chart 5 shows the longterm performance of inflation expectations based on economists’ survey data in Japan and the United States. In the United States, medium- to long-term inflation expectations (i.e., five years ahead) have remained stable and have been anchored at around 2 percent. By contrast, it is difficult to say that those of Japan have been anchored even at around 1 percent, accompanied by greater fluctuations compared with the United States. More importantly, it is clear that Japan was not able to avoid mild deflation even when medium- to long-term inflation expectations remained around 1 percent. This is why the Bank considers it important to raise inflation expectations above the current level of around 1 percent or so and is striving to stabilize them at around the 2 percent level to ensure that the economy overcomes deflation. Regarding my outlook for prices, I revised downward somewhat my projection for fiscal 2014 from my interim assessment in July; it also remains lower than the median of the Policy Board members’ projections. This downward revision reflects the following considerations. (1) The output gap improvement is likely to slow. (2) Some figures on medium- to long-term inflation expectations (such as those for households and those of some economists) remain leveled off, while others (such as BEI rates, inflation swap rates, those of JGB market participants, and corporate sector expectations related to changes in firms’ own sales prices) declined from around this summer; moreover, due to a decline in actual inflation rates from May this year, medium- to long-term inflation expectations are unlikely to exhibit a rising trend on a sustainable basis (Charts 4–1 and 4–2). Finally, (3) the lagged impact of a commodity price drop is likely to be reflected in the CPI. As a result of the revision, the rate of inflation will likely remain more or less at around 1 percent for the time being, then start to pick up gradually toward the first half of fiscal 2015 – suggesting some delay in the timing of a pick-up in inflation. My projection – for fiscal 2015 and 2016 was also revised downward – but very moderately – relative to my July interim assessment. The downward revision was small because the effects of the expanded QQE were incorporated. Without such a policy action, the downward revision would have been larger. This enabled me to maintain roughly the same outlook throughout the projection period: namely, that the inflation rate of 2 percent is likely to be reached toward the end of the projection period. Meanwhile, the Outlook Report describes the Bank’s baseline scenario as reaching around 2 percent around the middle of the projection period; that is, in or around fiscal 2015. However, I considered it better to replace this with the expression by the end of the projection period – since this better reflects the views of a greater number of Policy Board members, including myself. For this reason, I submitted a proposal to suggest such a replacement at the MPM held on October 31. Now, let me explain why my outlook has been consistently more conservative than the Bank’s baseline scenario. This is because I anticipate that the upward pressure from the labor shortage on wages will likely take place more gradually. Similarly, I judge that the upward pressure of improvement in the output gap as well as a rise in medium- to long-term inflation expectations on the inflation rate will emerge at a slower pace. In other words, a nation like Japan, given its rapid aging and low birth rate, may face somewhat limited potential domestic demand compared with other economies that enjoy more favorable BIS central bankers’ speeches demographics. Thus, the output gap improvement is unlikely to give rise to a rapid pace of wage increases and inflationary pressure compared with other economies. Moreover, I maintain the view that inflation expectations will rise gradually. Another thing I would like to point out is that, as I have mentioned in the past, a consumption tax hike will have a certain influence on the judgment on underlying price developments. For example, inflation will be pushed upward in accordance with the degree of the tax hike for the following twelve months. Thus, the Bank attempts to analyze the trend behavior of actual inflation by removing the direct effects of the consumption tax hike (Chart 3). Moreover, since short- and medium- to long-term inflation expectations will also be affected during the period prior to the tax hike, the Bank also takes into consideration figures that are obtained by mechanically excluding the direct effects of the tax hike (Chart 4–2). Of course, the tax hike also indirectly affects the inflation rate and inflation expectations through the real economy. But since it is technically difficult to remove these indirect effects of the tax hike, it should be noted that the Bank is removing only the direct effects for the sake of simplicity. Thus, in assessing whether medium- to long-term inflation expectations are likely to gradually converge to around 2 percent, this issue should be noted. In other words, the judgment needs to be made as to whether an increase in these expectations reflects the underlying trends based on the virtuous cycle among production, income, and spending – not the next anticipated tax hike. C. Upside and downside risks (risk factors) As described in the October 2014 Outlook Report, the upside and downside risks to the Bank’s baseline scenario of the outlook for economic activity include (1) developments in exports, (2) the effects of the consumption tax hikes, (3) firms’ and households’ mediumto long-term growth expectations, and (4) fiscal sustainability in the medium to long term. The Bank assesses these risks as being balanced. Meanwhile, the upside and downside risks to the Bank’s baseline scenario for prices cover (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 entailing substantial downside risks – and the overall risk assessment was revised downward from “being largely balanced” for the first time since the introduction of QQE. As for my risk assessment related to the economy, the downside risks remain somewhat greater than the upside ones. First, there is a risk that domestic private consumption will weaken because of a continuous decline in real disposable income and a potential deterioration in household sentiment. Second, there is a risk that heightened uncertainty regarding the outlook for the global economy and the tepid pace of the domestic economic recovery will result in lower exports and domestic business fixed investment. Third, households’ and firms’ medium- to long-term growth expectations may not rise if there is no progress in implementation of the government’s growth strategy or firms’ efforts to boost competitiveness. In my assessment on risks to prices, the risks remain tilted somewhat to the downside. In particular, I am paying close attention to the movements of households’ and firms’ mediumto long-term inflation expectations. In addition, it may take time for the slope of the Phillips curve – that is, the responsiveness of inflation to the output gap – to steepen. This is because it may take some time for firms to adjust their price-setting behavior in the new environment in which they can pass on the rise in production costs and wages to their sales prices. III. Expansion of quantitative and qualitative monetary easing I would now like to discuss the Bank’s latest policy action, namely, the expansion of QQE decided at the MPM held on October 31, together with my personal views. BIS central bankers’ speeches A. The Measures adopted under the expansion of QQE In the most important change, the Bank decided to accelerate the annual pace of increase in the monetary base – the main operating target for money market operations – from the pace of about 60–70 trillion yen to about 80 trillion yen (an addition of about 10–20 trillion yen). To achieve this target, the amount outstanding of JGB holdings will be increased from an annual pace of about 50 trillion yen to about 80 trillion yen (an addition of about 30 trillion yen). With a view to encouraging a further decline in interest rates across the entire yield curve, moreover, the Bank will conduct purchases of JGBs in a flexible manner in accordance with financial market conditions. In doing so, the average remaining maturity of the Bank’s JGB purchases will be extended from about seven years to about 7–10 years (an extension of about three years at maximum). In addition to JGBs, the Bank decided to increase the purchases of risk assets such as exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will be tripled and increase at an annual pace of about 3 trillion yen and about 90 billion yen, respectively. The Bank will also make ETFs that track the JPX-Nikkei Index 400 eligible for purchase. B. Reasons for expanding QQE: the bank’s view Having said this, let me discuss why the Bank decided on the expansion of QQE. As explained earlier, Japan’s economy has continued to recover moderately as a trend and is expected to continue growing at a pace above its potential. However, on the price front, due to some recent concerns, the Bank found it appropriate to take pre-emptive action to address them. Namely, the Bank was concerned that somewhat weak developments in demand following the consumption tax hike and a substantial decline in crude oil prices had been exerting downward pressure on prices. It is true that a temporary weakness in demand has already started to wane, and that the decline in crude oil prices will have positive effects on economic activity from a somewhat longer-term perspective – through improvements in the terms of trade and real disposable income – and will push up prices. Nevertheless, if the current downward pressure on prices remains, albeit in the short term, there is a risk that conversion of the deflationary mindset – which has so far been progressing steadily – might be delayed or reversed. To pre-empt manifestation of such risks and to maintain the momentum of inflation expectation formation, the Bank judged it appropriate to expand QQE. The reason behind the latest decision on the expansion was that the Bank considered Japan’s economy to be facing a critical moment in the process of conquering deflation and that its unwavering determination should again be conveyed. C. My views on additional monetary easing On this policy action, I voted for the expansion of QQE at the MPM held on October 31. While I would like to refrain from commenting on the details, since the contents of the discussion at the MPM as a rule should be disclosed only in the form of the minutes and transcript, let me discuss here my general views on monetary easing. As pointed out earlier, I have consistently held the view – since the introduction of QQE in April 2013 – that it will likely take longer than two years to achieve the 2 percent target in a sustainable manner. And as my outlook for prices, I have stated that the rate of CPI inflation will rise closer to 2 percent toward the end of fiscal 2015. In April 2014, I felt it important to express my outlook more precisely since the projection period was extended by one year through fiscal 2016 – even though there was no fundamental change in my outlook. Accordingly, I have described my outlook from this April as the inflation rate of 2 percent is likely to be reached toward the end of the projection period. Let me remind you 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. This approach is called a flexible inflation targeting framework. Under this framework, I have BIS central bankers’ speeches expressed my view that it is desirable to attempt to achieve the 2 percent target with a time span of more than two years to avoid imposing an excessive burden on firms and households. In line with this view, I made it clear this April that my outlook for economic activity and prices has assumed the continuation of QQE during and beyond fiscal 2015. On the continuation of QQE, I had considered that an annual pace of increase in the monetary base of about 60–70 trillion yen could be maintained at least until around April 2015. This time-line seemed appropriate, since the doubling of the monetary base – as clearly stipulated in the Bank’s public statement released on April 4, 2013 – was expected to be achieved only by around April 2015 under the annual pace of increase of about 60-70 trillion yen. Thereafter, one likely option would be a continuation of monetary easing with the same annual pace of increase in the monetary base in an open-ended form with the same composition of asset purchases. Alternatively, since I personally viewed that the 2 percent target would likely be reached by fiscal 2016, another possibility would be a greater focus on the continuation of monetary easing until around then, with potential modification of the composition of asset purchases. Last year, meanwhile, I referred to two potential cases for considering additional easing. The first was the case where downside risks to the Bank’s outlook for economic activity and prices materialized and it was necessary for the Bank to sharply revise downward its outlook. The second was the case where the Bank’s credibility over monetary policy conduct was at risk of being questioned by the public and the market. For example, there was the risk that the Bank was perceived as not doing enough to fulfill its commitment, a commitment that has been emphasized repeatedly since the introduction of QQE. That is, if the Bank’s outlook changes due to the manifestation of risk factors, the Bank will make adjustments without hesitation if this is judged necessary for achieving the 2 percent price stability target. In my view, together with the CPI inflation and some indicators related to medium- to long-term inflation expectations showing some decline, this time there was a higher likelihood that these two cases would materialize. To avoid this, I concluded that it was necessary to give first priority to ensure the path toward the 2 percent price stability target by means of additional action. By not acting, the Bank might risk its credibility. Such a circumstance would not only render my outlook infeasible but also undermine the feasibility of the 2 percent target itself. On the effectiveness of monetary policy, I have been thinking that it might be better to put a greater emphasis on monetary easing effects that promote the portfolio rebalancing channel, as I will explain later. Therefore, I expect that the additional easing, which lengthens the average remaining maturity of long-term JGBs and increases the purchases of risk assets, would further enhance the transmission channels of monetary policy. D. The transmission channels related to QQE Next, I would like to touch on the transmission channels of the Banks’s monetary easing. QQE aims to exert downward pressure on nominal and real long-term interest rates through a range of transmission channels, thereby lowering funding costs as well as raising asset prices. Ultimately, these changes are expected to boost the aggregate demand of firms and households, and raise the rate of inflation toward around 2 percent. Given that JGB purchases are the main instrument under QQE, I will briefly discuss the transmission channels with a focus on JGB purchases. To simplify the discussion, let me categorize the transmission channels into three types. The first transmission channel is called the signaling channel, in which the Bank transmits its future monetary easing policy stance to the public and the market through JGB purchases. This would possibly lower market expectations over the future path of short-term interest rates, thus lowering nominal and real long-term interest rates. The resultant decline in riskfree interest rates would likely raise the prices of securities and real estate; a decline in interest rates and an increase in the value of collateral would lower firms’ and households’ funding costs. The resultant decline in hurdle rates would also help expand the amount of BIS central bankers’ speeches business fixed investment made by each firm; an increase in a wide range of asset prices held by firms and households would promote business fixed investment and consumption. The greater soundness of financial institutions’ balance sheets and capital would likely promote greater risk-taking behavior, and thus, more active investment and lending domestically as well as abroad. This channel is likely to initially exert stronger downward pressure on nominal long-term interest rates, but as the rate of inflation begins to pick up, these interest rates are expected to rise gradually. The second channel is called the portfolio rebalancing channel, in which the Bank exerts downward pressure on the term premium and thus lowers nominal and real long-term interest rates. This channel aims to encourage financial institutions (and investors) to change the composition of their portfolios, thereby lowering funding costs and raising asset prices directly. When the Bank purchases JGBs from the market, the amount of JGBs held by financial institutions declines against the increase in their current account balances at the Bank. Since the current account balances and JGBs are incomplete substitutes, financial institutions would likely try to increase JGBs again and reduce their current account balances accordingly, leading to a decline in long-term interest rates. As a result, the financial institutions may find it more attractive to invest in other potentially riskier financial assets with relatively higher returns. The lower the substitutability between the current account balances and JGBs, the greater the portfolio rebalancing incentive. Moreover, the longer the remaining maturity of JGBs purchased by the Bank, the lower the substitutability between the current account balances and JGBs. In other words, the Bank’s purchases of longer-term JGBs would result in a decline in the net supply of these bonds circulating in the market, so that the average remaining maturity of JGBs transacted in the market would be shortened. This would lead to a decline in the term premium. Generally, the longer the average maturity of government bonds purchased by a central bank, the greater the downward pressure on the term premium. As a result, financial institutions would face a decline in the interest rate risk volume, which would enhance their capacity to take on greater risk and their incentive to invest in riskier assets. Initially, investment in riskier assets would be most likely to take place in financial assets with a high degree of substitutability for government bonds – such as corporate bonds and loans – or whose expected returns are highly correlated with those of government bonds. As increased investment in such assets results in a decline in their returns, financial institutions would be encouraged to invest in riskier assets with relatively higher returns – such as low-rated corporate bonds, stocks, real estate, investment trusts, and foreign investments. Through such a continuous process, an increase in a wide range of asset prices and a decline in funding costs in a range of markets are expected to materialize. The third channel is called the inflation expectation channel and focuses on increasing not only the actual rate of inflation but also medium- to long-term inflation expectations, so that real long-term interest rates are lowered. The first and second transmission channels are expected to raise the actual rate of inflation, thereby indirectly helping to raise the medium- to long-term inflation expectations. By contrast, the third channel stresses that the Bank’s purchases of JGBs with a commitment to continue until achievement of the 2 percent target could contribute to raising inflation expectations directly. An increase in inflation expectations would produce upward pressure on nominal long-term interest rates, but this would be contained partially by the downward pressure on the term premium. Therefore, it is judged that real long-term interest rates would decline. In addition to JGB purchases, the Bank purchases various types of risk assets. Thus, transmission channels other than those I have described are also present. Direct purchases of risk assets could thus be expected to directly influence risk asset markets. E. Chances to revitalize the Japanese economy Since the adoption of the 2 percent price stability target (based on the headline CPI) in January 2013, nearly two years have passed. The adoption of the 2 percent numerical target BIS central bankers’ speeches reflects the following factors. (1) The need to keep a sufficient buffer with regard to inflation to avoid the economy from falling into deflation again and also consider the upward bias problems inherent in CPI statistics. (2) The need to leave sufficient room for the conduct of flexible monetary policy by achieving a certain level of inflation to avoid the zero lower bound in recessionary phases. And (3) the need to set a target of around 2 percent, which is becoming a global standard in terms of a price stability target, to avoid the re-emergence of excessive appreciation of the yen. In addition, the 2 percent target is essential to realize a normal economic condition whereby positive rates of nominal GDP growth can be seen on a sustainable basis and thereby help to increase firms’ and households’ medium- to long-term economic growth expectations (Chart 6). It is important to realize that a continual decline in nominal GDP over the past 15 years is a highly unusual economic condition, rarely seen in other economies. Given that the rate of CPI inflation often exceeds the rate of annual change in the GDP deflator in Japan, there is a wide gap between the levels of these two indices. Thus, achieving about 1 percent CPI inflation appears inadequate to ensure trend movements of the nominal GDP growth rate in positive territory, and this is also one of the reasons why I judge that the Bank should aim at achieving 2 percent CPI inflation (Chart 7). Having said this, it appears that some among the public and the market feel uncertainty about the importance of achieving the 2 percent target, as well as the Bank’s policy intention. This is particularly because people are accustomed to the deflationary environment and the pace of nominal wage growth has not yet caught up with that of the price increase, partly owing to the consumption tax hike. This is even more so when some time is required to raise expectations for future income. Therefore, as I have emphasized several times in the past, it is essential for the Bank to boost the effectiveness of its communication strategy by explaining more clearly to the public and the market why it aims to achieve the 2 percent target and how this will improve people’s lives in the medium to long term. I will continue making further efforts in this regard. In addition, views that the effectiveness of QQE has waned tend to grow particularly when the economic data appear less favorable. However, it is clear that the Japanese economy is currently in far better shape than it was prior to the introduction of QQE. A virtuous cycle from income to spending, which is the driving force of the economy, is being maintained in the household and corporate sectors. Thus, it is crucial for the Bank to continue to stick to the 2 percent price stability target without any hesitation. Enhancing competitiveness and achieving sustainable economic growth require sensible risk-taking behavior on the part of all entities involved – firms, households, and financial institutions. However, the long-standing deflation-oriented mindset has discouraged such behavior. This is why the Bank has adopted its large-scale monetary easing policy with the aim of helping to generate the risk money necessary to energize the economy by transforming the mindset. I sincerely hope that all entities will take full advantage of the opportunity afforded by the highly accommodative financial environment generated by QQE to expand their efforts to produce innovative goods and services, which will lead to the tapping of potential demand and boosting of productivity, in concert with the economic growth strategy and structural reforms implemented by the government. Thank you for your kind attention. BIS central bankers’ speeches
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bank of japan
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Symposium for the 30th Anniversary of the Center for Financial Industry Information Systems, Tokyo, 2 December 2014.
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Haruhiko Kuroda: The evolution of payment and settlement systems and the role of central banks Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Symposium for the 30th Anniversary of the Center for Financial Industry Information Systems, Tokyo, 2 December 2014. * * * Introduction It is a great pleasure to have this opportunity to speak at the symposium commemorating the 30th anniversary of the Center for Financial Industry Information Systems (FISC). Since its establishment in 1984, the FISC has greatly contributed to strengthening the safety of the financial information system and improving the efficiency of financial services in Japan. As it marks its 30-year milestone, I would like to express my respect and gratitude for the work it has done over the years. For the past 30 years, the FISC has been engaged in enduring work such as developing industry guidelines and standards. These include “FISC Security Guidelines on Computer Systems for Banking and Related Financial Institutions” and “FISC Information System Audit Guidelines for Banking and Related Financial Institutions.” It also publishes its “White Paper on Financial Information Systems” every year. With new payment methods such as internet banking and electronic money making their appearance, maintaining the security of such payment methods has become an important issue. The FISC has also been active in addressing a number of challenges related to information systems by revising the industry guidelines or standards in order to address these issues. Furthermore, through its wideranging research, analysis, and publicity activities – including various surveys or the organization of study groups and seminars – the FISC’s efforts have significantly supported the development of payment and settlement systems, through which economic and financial transactions are “settled.” Today, under the title, “The Evolution of Payment and Settlement Systems and the Role of Central Banks,” I will outline these systems’ developments from the past to the future, and explain the present and future challenges to be tackled by the Bank of Japan while touching on the role of central banks within the systems. I. Evolution of payment and settlement systems Looking back over several decades at the history of payment and settlement systems in Japan, both efficiency and safety have significantly improved. To put this in perspective, certain periods from the middle of the 1960s to the beginning of the 1990s were ones when more emphasis was put on raising efficiency. Since then, the emphasis has shifted to enhancing the safety of the systems. Let me be more concrete. From the middle of the 1960s to the beginning of the 1990s, on the back of progress in financial liberalization and globalization as well as the increasing issuance of JGBs, it was difficult to manually process the large number of payment and settlement transactions. It was against this background that financial institutions implemented the online processing of settlement and dematerialization of securities certificates. As a result, the efficiency of payment and settlement systems significantly improved. The periods coincided with those in which major payment and settlement systems initiated their operations, including the Zengin Data Telecommunication System (Zengin System) in 1973, the Bank of Japan Financial Network System (BOJ-NET) in 1988, and the Japan Securities Depository Center’s system in 1991. BIS central bankers’ speeches During and after the 1990s, payment and settlement systems put priority on strengthening their safety by making use of the existing financial institutions’ computer systems and market infrastructures. From the 1990s to the beginning of the 2000s, efforts to reduce the settlement risks made significant progress against the backdrop of the Asian currency crisis and Japan’s financial crisis. The BOJ-NET introduced delivery-versus-payment (DVP) for JGBs in 1994 and real-time gross settlement (RTGS) in 2001. In 2002, major central banks jointly supported the launch of the payments of two different currencies on a paymentversus-payment (PVP) basis by Continuous Linked Settlement (CLS). By the middle of the 2000s, all other central counterparties (CCPs), including the current Japan Securities Clearing Corporation (JSCC), were established. After the global financial crisis in 2008, further initiatives were taken in order to enhance the safety of payment and settlement systems. These include the introduction of international regulations, such as the obligation to use the CCPs for standardized over-the-counter (OTC) derivatives and the publication of the Principles for Financial Market Infrastructures (PFMIs) jointly by the Committee on Payment and Settlement Systems (CPSS) of the Bank for International Settlements and the International Organization of Securities Commissions (IOSCO) in 2012. 1 The PFMIs were introduced with the intent to reinforce the global standards set during the first half of the 2000s. The question now is: What does the future of payment and settlement systems look like? Looking at the environment surrounding the current situation in Japan, economic activity continues to be globalized at a faster pace. For example, Japanese firms and financial institutions are increasingly deploying their operations in Asia, and businesses and households are diversifying their needs for payment and settlement services in light of rapid progress in information technology. In order to respond to these wide-ranging needs of end users, it is important that we take measures to improve the efficiency and convenience of these services while maintaining their safety. In overseas economies, we have witnessed that their payment and settlement systems are making some improvement. Major central banks have substantially extended the operating hours of their payment and settlement systems since the beginning of the 2000s. Moreover, in the United Kingdom, bank transfers have become available 24 hours a day, 7 days a week on a real-time basis since 2008. In Europe, a standard format for credit transfers and direct debits became obligatory this August as part of the initiatives taken by the Single Euro Payments Area (SEPA) to make euro payments faster and cheaper. Looking at the situation in Japan, a similar progress is also underway, including initiatives taken by the Japanese Bankers Association (JBA) and the Japanese Banks’ Payment Clearing Network (Zengin-Net) with the aim of enhancing the retail payment services. Going forward, it is important for a wide range of stakeholders to understand overseas developments and take measures as appropriate. II. Role of central banks in payment and settlement systems Before discussing the Bank’s initiatives in light of such circumstantial changes, let me now explain the role of central banks in payment and settlement systems. Payment services constitute the core of banking business. As “the bank of banks,” this is also true for a central bank, as it plays a pivotal role in payment and settlement systems. Moreover, central banks conduct monetary policy and fulfill their policy objectives, such as ensuring financial stability, through the provision of their banking services. In order to implement their policies effectively, payment services and those systems provide vital underpinnings. CPSS has been renamed as CPMI (Committee on Payments and Market Infrastructures). BIS central bankers’ speeches The first role of central banks in payment services is to provide the means of payment with finality. These include banknotes and current accounts held at central banks. In addition, central banks operate interbank payment and settlement systems in order to facilitate smooth online settlements of funds and JGBs between financial institutions. 2 Moreover, central banks are engaged in the oversight activities for payment and settlement systems provided by other entities to call for the enhancement of these systems as appropriate while taking account of the balance between safety and efficiency. Furthermore, they are involved in such activities as helping market participants formulate appropriate market practices spanning from execution to settlement. These activities are conducted from the viewpoint that payment and settlement systems provide the foundation for the stability of the financial system and the sound development of the economy. Looking to the future of payment and settlement systems, central banks are expected to contribute to economic growth and financial stability not only by improving their own payment services but also by helping financial institutions enhance services provided by those institutions. III. Bank of Japan’s initiatives: present and future Next, I would like to explain the Bank’s initiatives in four areas at present and in the future. They are namely (i) to build the New BOJ-NET and extend its operating hours, (ii) to consider improving cross-border transactions, (iii) to support enhancing retail payment services, and (iv) to support shortening the JGB settlement cycles. Let me explain these items in turn. A. New BOJ-NET and extension of its operating hours At present, the Bank is in the middle of building the New BOJ-NET. Since its inception in 1988, the environment surrounding the BOJ-NET has been changing dramatically. On the back of financial globalization and innovation in information technology, people involved in major payment and settlement systems around the world have been making efforts to strengthen the IT infrastructure to cope with the diversified needs in transactions and settlement. On the part of financial institutions, connecting their computer systems directly with the BOJ-NET has become widespread, and this enables those institutions to realize straight-through processing (STP). Moreover, a cross-border linkage among payment and settlement systems has become more widespread, as exemplified by the enlargement of cross-currency PVP transactions through the CLS and the cross-border linkage of securities settlement systems. It is against this background that the BOJ-NET needs to meet the diversified needs in response to the enlargement of the network structure and the globalization of financial transactions. The New BOJ-NET, which is due to be in full operation in October 2015, is based on several overarching principles. 3 First, we employ the latest information technology to enrich our services and improve convenience for our customers in the future. Second, the New BOJNET is designed to accommodate greater flexibility so that it can respond to ongoing and future banking needs and market developments. Last, but not least, it enhances accessibility, allowing longer operating hours, in light of the globalized financial markets to encourage interconnectedness among market infrastructures. As such, central banks provide “ultimate settlement” to the economy by assuring the provision of banknotes and current accounts (these means of payments with finality provided by central banks are called “central bank money”) to payment and settlement systems where financial institutions can effectively use them, when necessary. The full launch of the New BOJ-NET is planned to take place on October 13, 2015. BIS central bankers’ speeches In particular, as Japan is in the first set of time zones, we aim to contribute to invigorating financial markets and enhancing financial services by encouraging financial institutions to make the most of the longer operating hours of the New BOJ-NET. It is for that reason that the Bank decided to extend the operating hours until 21:00 from February 2016 after the New BOJ-NET starts full operation in October 2015, at which point its operating hours will be up to 19:00. 4, 5 Further extended operating hours are expected to be used by respective financial institutions at their own judgment. 6 At the forum toward making effective use of the New BOJ-NET, we have been discussing issues with major financial institutions and those institutions’ associations, such as covering the same-day cross-border settlements in the afternoon in Asia and in the morning in Europe. For example, the New BOJ-NET enables financial institutions to collect and distribute their customers’ funds between Japan and Asia within the same day, to allow JGBs to be posted to the CCPs overseas, and to increase cross-currency repos by posting JGBs as collateral in European markets. B. Improvement in cross-border transactions Looking further out, by taking advantage of the enhanced accessibility of the New BOJ-NET, we aim to build an infrastructure that facilitates the smooth delivery of the Japanese yen and JGBs anywhere and anytime. This is what I would call the ubiquity of the Japanese yen and JGBs. On this point, the ASEAN+3 economies have started discussing a possible cross-border linkage between the securities settlement system in one country and the funds settlement system in another with a view to establishing a cross-border securities settlement infrastructure in the region. The Bank is also participating in this discussion. In May this year, finance ministers and central bank governors agreed with the direction of developing an implementation roadmap of CSD-RTGS linkages in the medium term so as to make it possible to deliver securities smoothly and safely versus payment across borders. Further study and analysis on CSD-RTGS linkages is expected to be carried out by practitioners. 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 linkage between settlement infrastructures. Such cross-border linkage will enable market participants to settle foreign currency funding transactions against domestic sovereign bonds as collateral – this is known as crosscurrency repos – on a DVP basis by using safe central bank money. Facilitating smooth and safe cross-border settlement will be expected to contribute to enhancing the convenience and efficiency of the Japanese yen and JGBs, and eventually to raising the profitability of financial institutions. Developing an infrastructure that will enable the smooth delivery of the Japanese yen and JGBs anywhere and anytime will support the globalization of the yen – a longstanding challenge – from the settlement aspect. The Bank is committed to enhancing payment services by utilizing the renewed functionalities of the New BOJ-NET and to underpinning the The current operating hours on regular business days are 9:00–19:00 for Funds Transfer Services and 9:00-16:30 for JGB Services. The extension of the operating hours until 21:00 is planned to take place on February 15, 2016. Those operating hours are expected to be used by financial institutions that have current accounts or JGB accounts at the Bank’s Head Office. BIS central bankers’ speeches medium- to long-term growth of Japan’s economy from not only the monetary policy perspective but also the settlement perspective. C. Enhancement of retail payment services Next, I would like to talk about the initiatives taken to enhance retail payment services. Currently, the JBA and the Zengin-Net have started looking into the issues of extending the Zengin System’s operating hours and achieving financial electronic data interchange (EDI). These also were included in the revised Japan Revitalization Strategy, which was released by the Japanese government in June 2014. The Bank, as a provider of the settlement platform for interbank settlement in the Zengin System, will play an active role to support these actions taken by the JBA and the Zengin-Net. Extension of the Zengin System’s operating hours First, let me explain the extension of the operating hours of the Zengin System. The Zengin System is a system operated by the Zengin-Net, through which interbank payment instructions for bank transfers are processed in Japan. Since it started its operation in 1973, the Zengin System has allowed near real-time payment services during the daylight hours of working days, and has long been regarded worldwide as one of the most advanced retail payment services provided to customers. More recently, however, some countries have developed near real-time payment services available 24 hours a day, 7 days a week (known as “24/7 services”), beginning with the launch of the Faster Payments Service by the United Kingdom in 2008. Singapore also initiated Fast and Secure Transfers, called FAST, in March this year, and Australia is expected to launch 24/7 services in the second half of 2016. In the United States, the Federal Reserve has been playing an active role in enhancing payment services. In September 2013, the Federal Reserve Banks released the paper in which they identified the establishment of a ubiquitous system for near real-time payments as one of desired outcomes. In recent years, more and more consumers are making purchases through the internet. The use of credit cards and electronic money is also increasing, and new payment instruments such as payment via mobile phone are making their appearances one after another. If we look at the situation in Japan, the vast majority of people hold bank accounts, so bank transfers play a key role both as a payment instrument and as an infrastructure for other payment instruments. We expect this convenience of bank transfers to be enhanced through advances in information technology, which will lead to further innovation via competition with other means of payment, therefore allowing for the smooth operation of retail payment services to underpin business and household activities. The JBA and the Zengin-Net are currently considering the extension of the operating hours of the Zengin System in light of the need to facilitate better access to the end users, and are expected to release a final report on their decision by the end of this month. After the release of the report, the Zengin-Net is expected to give consideration on the details. The Bank will continue to support these initiatives in order to enhance retail payment services. Realization of financial EDI Another issue is the use of financial EDI. With regard to their purchasing, firms often opt for payments to be processed together at a certain future date instead of immediately. Therefore, they have to manually reconcile payment information with remittance information, which is a process called accounts receivable reconciliation. In particular, for industrial firms with a number of purchasing/selling transactions going on, this reconciliation involves large operating costs. Financial EDI is seen as a solution that will address this problem. EDI is a framework in which businesses electronically exchange remittance information, such as purchases and sales orders. Since remittance information can be in diverse formats, businesses are adopting a more flexible and extensible data format, called XML (eXtensible BIS central bankers’ speeches Markup Language) format, in realizing EDI, instead of the fixed-length data format currently used. If a framework were built in which remittance information could be attached to payment information, such as a beneficiary’s bank account or payment date information, firms would be able to automate accounts receivable reconciliation, thereby considerably enhancing the efficiency of payment-related operations. This framework that enables the link of payment information and remittance information is financial EDI. In Europe, with the aim of maximizing the benefits stemming from the single currency, a project is underway in order to achieve financial EDI, including the adoption of the XML format as a standardized data format. This is a grand project that has been worked on by stakeholders for more than 10 years. At present, banks have finished complying with the XML format, and are now providing their customers with services that convert the remittance information from the old format to the XML format, with a view to encouraging use of the new format. In Japan, the banking industry, led by the JBA and the retail industry, jointly conducted an experiment last month related to the use of financial EDI. Both industries and other stakeholders will collaborate to make further efforts to realize the utilization of remittance information in bank transfers. The Bank will again help promote these initiatives. D. Shortening of JGB settlement cycle The Bank also has been supporting market participants with regard to shortening the time lag between the execution of JGB trading and settlement. Back in 1984, when the FISC was established, there was no standard settlement cycle for JGBs, varying among each trade. From 1986 to 1987, the settlement cycle was standardized to within 10 business days from the trade date, with settlement only on particular days. 7 The settlement cycle was then shortened to T+7 in 1996, and to T+3 in 1997, each through rolling settlement, which became the standard settlement cycle for JGBs for 15 years. Apart from the United Kingdom and the United States, which had already realized T+1 settlement from an early stage, T+3 settlement had long been recognized as the international standard for the securities settlement cycle. However, since the financial crisis of autumn 2008, the world has been moving toward a shorter settlement cycle in order to reduce risks arising from unsettled positions. In Europe, the basic settlement cycle for a wide range of securities moved to T+2 this October. Meanwhile, in the United States, an industry-wide committee was established this October to facilitate the move toward T+2 settlement for trades in equities, corporate and municipal bonds, and unit investment trusts. 8 In April 2012, JGB trading moved to a shorter settlement cycle, from T+3 to T+2, for the first time in 15 years. In accordance with the global move, further efforts toward shortening of the settlement cycle are being made in Japan, with an aim of achieving T+1 for JGB outright transactions. Last month, the Working Group on Shortening of JGB Settlement Cycle, which was set up under the auspices of the Japan Securities Dealers Association, released the final version of “Grand Design towards Shortening of JGB Settlement Cycle (T+1)” (hereafter, “Grand Design”), revealing the challenge and strategies that could be taken for realizing T+1 settlement. In some cases, shortening the settlement cycle can be viewed as unprofitable, since the short-term merit is hard to see and large investment to streamline post-trade operations often Namely, these are the 5th, 10th, 15th, 20th, 25th, and the last day of each month. The Depository Trust and Clearing Corporation (DTCC) launched an industry steering committee in collaboration with other stakeholders such as the U.S. Securities Industry and Financial Markets Association (SIFMA) and Investment Company Institute (ICI). BIS central bankers’ speeches is required. In the medium to long run, however, the Japanese economy as a whole can greatly benefit not only from the reduction of settlement risks arising from unsettled positions, but also from the enhanced efficiency of settlement operations and through financial innovation. In that context, the Grand Design also identifies the reduction of operational risk through standardized operations and the development of STP as another aim of achieving T+1. Other issues, such as the creation of market-wide infrastructure for collateral management, as well as unifying the form of repo trades to the globally used repurchase agreement, are also discussed in the Grand Design, indicating that we can expect a strengthening of the global competitiveness of the JGB market and the expansion of related services. Furthermore, when JGB outright transactions move to T+1 settlement, it is envisaged that most repo transactions will move to T+0 settlement. This warrants attention, as it also means the development of a new large money market for same day funds transactions. While I am very grateful for the stakeholders’ unremitting efforts, we will continue to provide support toward achieving T+1 settlement. Conclusion Let me conclude. When developing payment and settlement systems, it is essential to capture and analyze the needs and risks of those systems from broader perspectives. In addition, it is important to build an infrastructure from the medium- to long-term perspective due to the fact that it usually takes considerable time from developing plans to managing the operation. I explained earlier today the measures taken in Europe for making use of financial EDI by utilizing XML formats. In Japan, the core payment and settlement systems – such as the BOJ-NET, the Zengin-System, and the system operated by the Japan Securities Depository Center (JASDEC) – have already incorporated such formats. We expect that financial institutions participating in those systems will make effective use of the formats to enhance the quality of services they provide. In light of such circumstances, the FISC is expected to act as a “catalyst of global knowledge,” by collaborating with relevant parties in Asia and the rest of the world, thereby steering the initiatives taken by financial institutions in our country. The FISC is also expected to play an important role in overcoming new challenges arising from information security, such as cyber-attacks. Currently, high attention has been paid around the globe to the cyber resilience of payment and settlement systems. In this regard, the Committee on Payments and Market Infrastructures of the Bank for International Settlements published a report last month titled, “Cyber resilience in financial market infrastructures.” As more and more security violations are being witnessed around the world, the serious influence of these is attracting much more attention, and new findings in terms of strategic decisions and technical options are being made. The FISC is again expected to play a key role in research, analysis, and public relations activities with regard to these issues. Before closing my remarks, I would like to pay great respect to the FISC for its enduring efforts over the past 30 years, and am sure that it will continue to play an important role in the various fields relevant to developing payment and settlement systems in our country. 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 a meeting with business leaders, Kochi, 4 December 2014.
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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, Kochi, 4 December 2014. * * * Introduction Thank you for giving me this opportunity to exchange views with people representing the political, economic, and financial arena of Kochi 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 Kochi 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 Kochi 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. I. Recent economic and financial developments in Japan and abroad A. Developments in the world economy As seen in the downward revision of the global growth projection by the International Monetary Fund in its October 2014 World Economic Outlook (WEO), the outlook for the economy has been generally cautious recently for Europe and some emerging economies (Chart 1). International commodity prices, including crude oil prices, have been weak, mainly due to concern over a global economic slowdown. A decline in international commodity prices is a tailwind for consumers – i.e., advanced economies – through an increase in purchasing power, but could exert downward pressure on commodity-exporting countries, mostly in emerging economies. I have been monitoring carefully how fluctuations in international commodity prices will affect the formation and distribution of income around the world, but it is uncertain whether growth in the world economy will strengthen, as projected in the October 2014 WEO, considering how much emerging economies have contributed to the recent world economic growth. Examining the situation by country and region, the U.S. economy has continued to recover steadily, led mainly by private demand, due to an expansion in household spending that reflects a steady recovery in employment. It is expected to gradually accelerate its pace of growth supported by a virtuous cycle. A recent decline in gasoline prices is also a tailwind for consumption. With this economic outlook widely shared by the public, the market has been focusing on the timing of monetary tightening – which is expected to be sometime in 2015 – and its pace (Chart 2). In Europe, by contrast, the adjustment pressure mainly associated with the debt problem remains and a downtrend in the inflation rate has been observed. Household and business sentiment has become cautious, as manufacturing in Germany – the core country of the region – saw a temporary drop during the summer, partly due to the economic deceleration in Russia. The German economy as a trend is expected to continue its moderate recovery, supported by a steady services industry, while production in the manufacturing sector has been more or less flat recently. However, uncertainties remain in France and Italy, which have lagged behind in structural reforms: the consequences of the debt problem and developments toward ensuring the soundness of the financial system warrant continued attention. It also seems necessary to consider the risks of prolongation of low inflation and materialization of deflation in the European economy (Chart 3). To address these risks, the European Central Bank (ECB) implemented additional monetary easing – including the BIS central bankers’ speeches introduction of a negative interest rate – in June and September 2014, and also showed its commitment to further implement monetary easing measures, if needed, at the Governing Council in November. However, the inflation rate in the euro area has not stopped declining clearly since that time. The ECB is aggressive in taking measures to address future risks, and I would like to keep a close eye on its policy actions and the effects. Some emerging economies, such as Russia and Brazil, have been experiencing stagflation driven by the decline in international commodity prices and the effects of the depreciation of currencies and monetary tightening. Differences remain in conditions among emerging economies. Let me touch on China. In proceeding with structural reforms, the authorities seem to value the quality of economic growth and accept marginal declines in the growth rate. While there are downside risks to the economy, due partly to weakness in real estate prices, their policy stance has not changed as they continue to address a further slowdown in growth and uphold economic activity by implementing small-scale economic packages. I understand that the monetary easing measure announced on November 21 underlines the authorities’ commitment to their policy stance. From a medium- to long-term perspective, the potential growth rate is expected to fall relatively sharply, reflecting the demographic situation, with not enough room for a rise; but from a short-term perspective, at least, the economy will generally follow a stable growth path, albeit with downside risks (Chart 4). To sum up, the world economy has been led by the United States, which has been on a relatively steady recovery trend, while the risks of a slowdown are being observed in Europe and emerging economies. However, as the interaction among economies worldwide strengthens, there is a high possibility that the currently steady U.S. economy will be affected by the slowdown in the European and emerging economies (Chart 5). In some other parts of the world, geopolitical risks have been mounting recently, and a spread of the virus infection in West Africa is considered as a new risk factor. B. Developments in global financial markets Global financial markets had been tied up in a Goldilocks situation until summer 2014, in which investors had been searching for yields under low volatility conditions. As the outlook for the world economy became cautious, however, a temporary heightening of investors’ risk aversion and an overall increase in market volatility were observed in early autumn. International commodity prices declined, as mentioned earlier, and long-term interest rates fell in reflection of flight to quality. Such risk aversion has waned recently, and stock prices are firm globally, but international commodity prices remain weak. It is difficult to judge whether these market movements are simply in reaction to the overheating seen until this summer or else imply a spread of the cautious views, such as the recent argument regarding secular stagnation. Interaction between markets during such movements is also hard to explain. However, one factor behind them seems to be the temporary unwinding of excessive optimism, in light of monetary tightening scheduled to be conducted by the Federal Reserve, and the continued effects of the unwinding in the international commodity markets. Another factor seems to be that market participants, particularly in the international commodity markets, are aware of the risk that the slowdown in the European and emerging economies could spread to the U.S. economy, which is leading the world economic growth at present. Let me add a few more things about the unwinding that I have just mentioned. Market volatility is on the rise, and it seems that the progress in international financial regulatory reforms has had an effect on it (Chart 6): with the implementation of the reforms, it is likely that major market makers’ risk-taking activities have been restricted, leading to a decline in the market’s risk-absorbing capacity and the overall liquidity. Such issues had been generally kept below the surface, while the central banks of major countries had supplied ample liquidity to support the market. However, market participants have become aware of these BIS central bankers’ speeches issues as the Federal Reserve began to convey information on its exit strategies to the public – that is, specifics of the measures with regard to raising the policy interest rate and reducing liquidity supply. As for the outlook, during the phase of monetary tightening, the effects on the market brought about by the regulations might be much stronger. Indeed, the regulations are necessary in order to prevent a large-scale financial crisis such as the Lehman shock from happening again. At the same time, however, it is desirable to maintain a balance when implementing regulations so as not to excessively hinder market participants’ risk-taking activities and the functioning of the market’s price formation mechanism. C. Developments in Japan’s economy With regard to Japan’s economy, some weakness has remained in consumption of durable goods – including automobiles – and housing investment, due mainly to the effects of the decline in demand following the front-loaded increase prior to the consumption tax hike, and weakness in consumption, such as of automobiles, has impacted the production side until recently. However, somewhat weak developments in exports have come to a halt, and the spread of mini-scale inventory adjustments – mainly in automobiles – to related sectors is likely to continue only for a short term. Furthermore, corporate profits have been favorable with the firm employment and income situation continuing, and the mechanism for economic recovery has been operating steadily; therefore, the economy is likely to follow a moderate recovery path as effects including those of the decline in demand following the front-loaded increase dissipate gradually (Chart 7). The economic outlook I have just mentioned may sound optimistic in a situation where the first preliminary estimate of the real GDP growth rate for the July-September quarter of 2014 was negative for the second consecutive quarter, and the coincident index within the indexes of business conditions has suggested a possible change in the underlying trend. I admit that the current firm employment situation does not necessarily suggest future firmness of the economy, because such indicators as those of employment are lagging indicators. In fact, the number of new job openings and the ratio of new job offers to applicants – both of which are leading indicators of employment – temporarily showed signs of peaking out toward summer as firms’ stance on employment seemed to have become cautious, reflecting somewhat prolonged production adjustments in manufacturing. Nevertheless, the past few Tankan surveys (Short-Term Economic Survey of Enterprises in Japan) indicate that a sense of labor shortage among firms has been around a level that has not been observed since the bubble period in the early stage of the 1990s, and manufacturers’ business sentiment remains resilient, although Japan’s production has been unfavorable (Chart 8). The resilience in business sentiment can be attributed in part to firms’ high consolidated profits, reflecting the favorable business performance of their overseas subsidiaries. Firms’ favorable performance on a consolidated basis seems to have been playing a complementary role to the recent weakness in exports. This may mean that a new pattern of generating income is strengthening, through the repatriation by Japanese firms of their overseas subsidiaries’ profits in the form of dividends (Chart 9). Although some weakness certainly remains in Japan’s economic indicators, I feel that it is necessary to make a more comprehensive assessment, taking into account the current globalization of firms. Risk factors to the outlook for Japan’s economy also warrant attention. The first factor is developments in exports. Japanese manufacturers are likely to continue shifting production sites to overseas – although the pace is slowing – amid uncertainty over whether overseas economies will steadily increase their pace of growth. Therefore, it is uncertain whether the recent further depreciation of the yen will support the recovery in exports. The second factor is the effects of the yen’s depreciation. While the decline in energy prices will raise the real purchasing power of households and firms, clearly exerting positive effects on Japan’s economy, the depreciation of the yen will become a downside factor in terms of trade for the nonmanufacturing industry, which accounts for a large share of GDP and is a driving force of BIS central bankers’ speeches the current economic recovery. The third factor is developments in household and business sentiment. Sentiment indicators – especially of manufacturing – had been resilient, despite the weakness in Japan’s economic indicators; however, sentiment now seems to have weakened, as evidenced by the fact that developments in the diffusion indices (DIs) in the latest Economy Watchers Survey have become more sluggish recently. Developments in these DIs warrant attention as these indices are leading indicators of the economy in the short term. Looking at the comments made by the survey’s respondents, those regarding the second round of the consumption tax hikes, irregular weather, and depreciation of the yen stand out. The effects of these factors on sentiment warrant attention. D. Developments in prices The year-on-year rate of increase in the consumer price index (CPI, for all items excluding fresh food and excluding the direct effects of the consumption tax hike) has been around 1¼ percent for almost a year, since end-2013, and despite the depreciation of the yen, it has been around 1 percent recently due to the effects of the decline in international commodity prices, including crude oil prices. These developments may be partly attributable to the fact that firms’ price-setting behavior was affected by the prolonged decline in demand following the front-loaded increase prior to the consumption tax hike (Chart 10). As for the outlook through around the first half of 2015, on the assumption that crude oil prices and foreign exchange rates will be more or less unchanged from the current level, the year-on-year rate of increase in the CPI could remain sluggish given the reversal of the price rise that occurred in the first half of 2014. I believe that the decline in international commodity prices implies a decrease in income transfers from Japan to commodity-exporting countries, which is clearly a positive factor for Japan’s economy and also for prices from a longer-term perspective. As far as supply-side statistics are concerned, the effects of the decline in demand following the front-loaded increase have almost dissipated, and such developments will likely have some positive influence on firms’ price-setting behavior, which had become somewhat cautious under the decline in demand. Regarding the mechanism of a price rise from a longer-term perspective, the Bank is focusing on production resources – namely, the utilization of labor and capital – as described in the recently released Outlook for Economic Activity and Prices. In particular, the recent labor shortage – or tight labor resources – seems to be exerting upward pressure on wages on the whole, and this seems to be affecting prices to a considerable degree. On this point, it can be expected in the immediate future that consumption will pick up in reflection of the winter bonuses, which are likely to be firm, and eventually have positive effects on prices. What is important for sustainable economic recovery and price stability is a wage increase that is in line with growth in labor productivity; furthermore, from a longer-term perspective, such an increase relies on firms’ stance toward business fixed investment. It can be considered that Japan’s economy continues to be at a critical point in terms of whether (1) it can further improve its labor productivity by leveraging tight labor market conditions as a driving force to stimulate investment aimed at labor saving, or (2) it will fail to significantly improve its labor productivity due to firms’ passive stance toward fixed investment, thereby making wage increases unsustainable. As for firms’ stance toward fixed investment, I would like to add that, although investment continues to be made mainly for replacement and maintenance, it is encouraging that their positive actions are being observed in investment to promote rationalization and labor saving, and in that for product upgrades (Chart 11). Reflecting recent developments in the foreign exchange market, some firms have begun to review the balance between domestic and overseas production. Firms’ decision on production network strategies is not directly affected by short-term factors such as exchange rate movements, because it is based on a longer-term outlook. It is therefore unlikely that they will start shifting production back to BIS central bankers’ speeches Japan immediately in response to the recent market developments. However, their decision may change as firms review the medium- to long-term outlook for the exchange rate, and as a result gain confidence that the yen will not appreciate to the extremely high levels seen in the past. II. Monetary policy for the immediate future A. Expansion of quantitative and qualitative monetary easing (QQE) At the Monetary Policy Meeting held on October 31, 2014, the Policy Board decided to expand QQE. As I cast a dissenting vote on this decision, I may be in a delicate position to talk about this policy change. I will therefore provide my views to the best possible extent. First of all, I judged that additional monetary easing was not necessary. This is because, in my view, the virtuous cycle of economic activity and prices is basically being maintained, as I have mentioned. For the time being, the year-on-year rate of increase in the core CPI will be in the range of around 1 percent to slightly below 1 percent, as the effects of a decline in energy prices outweigh the effects of the yen’s depreciation. This may suggest that the achievement of the 2 percent price stability target now seems to be somewhat far away. In my view, the Bank’s decision of additional monetary easing aims at offering a kind of insurance against such downside risks to prices. To be sure, I consider that the underlying trend in prices is more important than monthly fluctuations in price indicators. In this regard, the declines in international commodity prices, such as the recent decline in crude oil prices, will surely exert downward pressure on the core CPI. On the other hand, as I mentioned earlier, from a somewhat longer-term perspective it clearly will have positive effects on Japan’s economy by reducing income transfers. In assessing the degree of achievement of the price stability target, what is important is not to focus on monthly fluctuations in specific indicators but to examine a wide range of indicators in a forward-looking manner. For example, it is important to examine whether various economic entities such as firms and households will in fact form business plans or adapt their behavior toward consumption based on the assumption of around 2 percent inflation. More generally, it is important to examine whether people’s medium- to long-term inflation expectations – which, under the deflation that lasted for over 15 years, are said to have consistently remained lower than those in the United States – are projected to be reanchored at around 2 percent, comparable to the level in the United States (Chart 12). It should be noted, however, that medium- to long-term inflation expectations are not tied to specific economic indicators, and thus are difficult to measure. It might be possible to retroactively acknowledge developments in such expectations as changes in the intercept of the Phillips curve. However, one should be careful in assessing a real-time measurement – even if it can be done – with the estimation bias taken into consideration. After all, it seems that whether or not people’s medium- to long-term inflation expectations have changed or will change can only be judged qualitatively by, for example, behavioral patterns of various economic entities. In this regard, let me give an example of wage negotiations this fiscal year. Many firms raised their base pay for the first time since the Lehman shock. This was attributed not only to the government’s initiatives to realize wage increases, such as the setting up of three-way discussions among the government, employers, and labor unions, but also to efforts both by employers and labor unions. Specifically, as economic conditions changed, as seen in the rise in the inflation rate, both sides gave renewed attention to the ultimate goal of achieving wage increases that are in line with price increases – which had been almost forgotten under deflation – and this was reflected, albeit partly, in the actual wage increases. In light of this, QQE can be assessed as exerting certain effects. Obviously, if asked whether wage increases observed thus far are enough to re-anchor people’s medium- to long-term inflation expectations at 2 percent, I would say we are only BIS central bankers’ speeches halfway there. However, if developments in prices in the past fiscal year and the outlook for prices will be somewhat taken into consideration in the wage negotiations between management and labor unions toward the next fiscal year, thereby realizing a rise in base pay for two consecutive years, this in turn will lead to a greater breakthrough in changing people’s fixed idea that wages, base salaries in particular, will not rise under deflation – in other words, their deflationary expectations. I am therefore carefully monitoring developments in wage negotiations toward the next fiscal year. My understanding is that what is truly essential to achieve the price stability target is a rise in productivity through efforts by various entities to carry out structural reforms and the resultant increase in the potential growth rate of Japan’s economy. On this basis, the inflation rate would increase moderately and wages would continuously improve in line with the increase in productivity, and consequently people would enjoy benefits from the overcoming of deflation. B. Effects of QQE Second, attention needs to be paid to the diminishing marginal effects brought about by the expansion of QQE. Interest rates are expected to decline further owing to such expansion; however, considering that nominal interest rates are already at historical low levels while real interest rates are substantially negative, it is judged that the marginal upward pressure from such easing on economic activity and prices will not be large. Moreover, the effects of QQE will increase in a cumulative manner with the progress in asset purchases by the Bank. These effects have become clearly evident in both the front and back ends of the yield curve, and are expected to strengthen further with the progress to be made in such purchases. There seems to be insufficient need for the Bank to accelerate this development process by expanding QQE, considering the accompanying costs and benefits. Now, I would like to touch on the effects of QQE on interest rates. The Bank has committed to purchasing Japanese government bonds (JGBs) at an annual pace of about 80 trillion yen on a net basis – an amount substantially exceeding the planned amount of newly issued JGBs by the government. For this larger amount, the Bank consequently will directly or indirectly reduce the amount outstanding of JGBs in the markets. Partly due to financial regulations, many of the institutional investors holding JGBs have a compelling reason to do so as there is no better alternative, and therefore their preference for JGBs is strong. If the Bank conducts asset purchases in the form of decreasing the net amount outstanding of these investors’ holdings of JGBs, the effects – in terms of price formation in the market – will strengthen as the Bank’s purchases continue. That is, there will be a tendency for the price of JGBs to rise further and their interest rates to decline. In Japan’s money markets, the effects of asset purchases have become more clearly evident and interest rate formation frequently has been observed in negative territory. Regarding such formation, as arbitrage between the market rates and the interest rate of 10 basis points applied to the complementary deposit facility will work, the market rates will not decline significantly further into negative territory, unlike the situation for the ECB, which imposes a negative interest rate on excess reserves. However, it is necessary to carefully monitor whether such interest rate formation in the markets will create some kind of distortions on economic activity or lead to an accumulation of financial imbalances, or whether such formation will unexpectedly affect deposit rates as well as the broadly-defined settlement system, including money market funds and money reserve funds. C. The time frame for continuing QQE Third, the Bank has committed to continuing the newly expanded QQE in an open-ended manner, aiming to achieve the price stability target as long as it is necessary for maintaining that target in a stable manner. I have been of the view that the price stability target is 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. Therefore, I have been proposing that BIS central bankers’ speeches “as long as it is necessary for maintaining that target in a stable manner” – which is the wording on the time frame in the public statement – should be assessed as flexible targeting based on forecasts. Some may point out that such flexible targeting lacks transparency of the conduct of monetary policy. I believe that the expansion of easing this time was decided primarily because the Bank has committed to an outcome – that is, achieving the price stability target of 2 percent – based on such recognition. Central banks in major economies are similarly experiencing the tradeoff between transparency and flexibility in policy, and even if these central banks try to improve transparency, policy conduct based on a simple rule is not actually easy to accomplish. It seems that an important lesson can be drawn from the case of the Federal Reserve and the Bank of England, in that they have abandoned the rule based on economic indicators in deciding on policy changes and returned to a comprehensive assessment. A rule-based monetary policy seems easy to conduct at first, but various issues arise during the process, and I am therefore of the position that monetary policy conduct should be treated flexibly in considering future economic and price conditions. Prices reflect the state of the economy and are not a variable that can be directly operated by a central bank. Generally speaking, channels in which the effects of a central bank’s policy spread to prices are considered to be through a decline in interest rates, or via foreign exchange rates or asset prices – all of which are indirect channels. On this point, surgical precision with regard to aiming at a specific inflation rate within a specific time frame seems unreasonable, and if such an aim cannot be achieved, a central bank may be exposed to the risk that its credibility will be undermined. D. Importance of fiscal consolidation Lastly, I would like to again touch on the importance of fiscal consolidation, in view of the postponement of the second round of the consumption tax hikes. As mentioned earlier, the Bank has been conducting purchases of JGBs with an amount significantly exceeding that of newly issued JGBs by the government and working to raise people’s medium- to long-term inflation expectations. However, the final outcome depends on the commitment to fiscal consolidation by the government. Furthermore, whether or not such commitment is being fulfilled is judged neither by the government nor the Bank, but by the markets. If concern over the government’s commitment heightens in the markets, effects will materialize in the form of expansion in risk premiums in the JGB market; however, the Bank’s prescription for a response is limited (Chart 13). From a longer-term perspective, in the future process of finding an exit from QQE, the government’s efforts toward fiscal consolidation are indeed important to the Bank in terms of smoothly starting toward an exit. On this point, coordination between fiscal austerity policy and monetary policy was consequently established in the United States, and long-term interest rates are at lower levels as a trend relative to the levels seen at the time the Federal Reserve began conveying information on its exit strategies to the public. As I mentioned earlier, the declining trend in the level of long-term interest rates in major economies is due not only to fiscal austerity policy, but may also be affected by the argument regarding secular stagnation, and an assessment of the U.S. experience should be made with caution. On the point of coordination between fiscal and monetary policies, there seem to be some lessons to be learned. Concluding remarks: economic activity in Kochi prefecture My concluding remarks will touch on the economy of Kochi Prefecture. In terms of gross prefectural production, a feature of the industrial structure of Kochi Prefecture is that the share of manufacturing in this prefecture is smaller than that in the BIS central bankers’ speeches country overall, while the share of nonmanufacturing, such as the construction and services industries, is relatively large. The prefecture’s economy therefore is supported by domestic demand rather than exports. Thus, it had been stagnant for a prolonged period during the economic recovery phase in Japan during the 2000s, led by export industries. Since 2013, however, as with the country’s economy as a whole, the prefecture’s economy has continued to improve – led by domestic demand, particularly public investment – albeit with some differences in the degree of momentum and pace of improvement. Regarding recent developments, recovery in sales was disturbed by considerable losses – mainly in the retail, tourism, and agriculture industries – incurred from irregular weather during this summer through autumn. However, as the employment and income situation, which underpins private consumption, has stayed on an improving trend, and as business sentiment has been solid, the moderate recovery trend in the prefecture seems to be maintained (Chart 14). Nevertheless, from a longer-term perspective, there are concerns about market shrinkage and labor shortages in Kochi Prefecture, as it has been confronted with structural issues such as a low birth rate and aging population, as well as a declining population. These issues – which have been exacerbated by the prolonged economic stagnation – have arisen in the prefecture more than ten years earlier than in the rest of the country. In addition, there are momentous issues such as the implementation of measures in preparation for a massive Nankai Trough earthquake and tsunami, from which it is assumed there would be extensive damage. However, it is encouraging that efforts are being made from various quarters toward tackling these issues. For example, Kochi Prefecture is proceeding with the second Industrial Development Project, in which the private and public sectors are making joint efforts toward industrial development in a wide range of areas. The specifics of the efforts include the following: (1) strengthening local production for local consumption and for external sales; strengthening primary industry and promoting senary, or sixth-order industry; (3) nurturing new industries, such as those relating to disaster prevention and new energy sources; and (4) promoting the tourism industry with the intent to encourage more tourists to visit from other prefectures and overseas. I am greatly impressed with this strategy, which aims to generate sustainable development of industries in the prefecture under the brand Kochi-ke, or “the Kochi family,” by working to facilitate manufacturing and primary industry and by promoting external sales to other prefectures and overseas markets, amid concerns about the aging and declining population. Kochi Prefecture has produced many great historical figures, including patriot samurai in the closing days of the Tokugawa shogunate, and I have heard that it is a region where an enterprising spirit is rooted. I hope the economic activity in Kochi Prefecture will become more active through aggressive and bold cooperative efforts among industry, government, academia, and financial institutions. 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 the meeting of Councillors of Nippon Keidanren (Japan Business Federation), Tokyo, 25 December 2014.
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Haruhiko Kuroda: Welcome to the “2 Percent” Club 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 2014. * * * 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. This year, Japan’s economy has continued to recover moderately as a trend, albeit with fluctuations due to the front-loaded increase in demand prior to the consumption tax hike and the subsequent decline. Corporate profits have been improving significantly, and, as a whole, have maintained a favorable level around the peak before the global financial crisis (Chart 1). On the back of those, firms have become active on making business fixed investment and on employment. The active job openings-toapplicants ratio was 1.10 times, marking the highest level in 22 years – that is, since 1992 – and the unemployment rate has declined to around 3.5 percent, which is roughly the same level as the structural unemployment rate (Chart 2). Reflecting such tightening in labor market conditions, wages have been increasing moderately. On the price front, the year-on-year rate of increase in the consumer price index (CPI, all items less fresh food), excluding the direct effects of the consumption tax hike, has been around 1¼ percent since the end of last year (Chart 3). The underlying price developments have continued to improve, and inflation expectations have been rising on the whole from a somewhat longer-term perspective. Since the summer, somewhat weak developments in demand following the consumption tax hike and a substantial decline in crude oil prices have exerted downward pressure on prices. In that situation, the year-on-year rate of increase in the CPI has been slowing, and the rate was 0.9 percent in October. To preempt the manifestation of a risk that conversion of the deflationary mindset might be delayed and to maintain the improving momentum of expectation formation, the Bank of Japan decided at the end of October to expand quantitative and qualitative monetary easing (QQE). Japan’s economy is steadily en route to overcoming prolonged deflation and to achieving the price stability target of 2 percent. However, it is true that not a few have voiced that they cannot benefit from the economic recovery. In particular, we have been hearing that “those who are benefitting from the QQE seem to be only large firms and wealthy households that hold financial assets, thus the benefits do not seem to be spreading through the whole economy” and “even if deflation is overcome, making a living might actually become difficult unless wages rise in accordance with a price increase.” Japan’s economy is currently in the process of transition from a shrinking equilibrium under deflation to an expanding equilibrium under the 2 percent inflation. In the process in which such a major change occurs at a relatively high speed, it is inevitable that its effects arise differently depending on the sector, the firm size, and the income bracket. Even so, it is without question that Japan’s economy is heading for the better. I believe that none of those unsatisfied with the current economic situation thinks that the situation during the deflationary period was better. Today, I will elaborate as clearly as possible on what the economic state the Bank of Japan aims at would be like in comparison with the deflationary state. On that basis, I will explain how far we have proceeded and what challenges are left to be dealt with, going forward. I should say that overcoming deflation and achieving the price stability target of 2 percent will benefit not only some firms and financial asset holders, but also a wide range of sectors and a variety of people. BIS central bankers’ speeches I. What does the deflationary economy look like? In Japan, deflation – a situation in which prices keep declining – continued for 15 years since the latter half of the 1990s. In that situation, firms and households behave on the assumption that prices will not increase, or that prices will fall moderately. As a result, their spending behavior has become passive. Since firms could not expect an increase in sales, the top priority of management was to ensure profits and stabilize firms’ financial conditions by cost reduction – such as reducing the number of employees, wages, or expenses for materials – and by compressing business fixed investment as much as possible. However, cost reduction or investment reduction was nothing but equivalent to a decline in demand for goods and services of other firms, and as a result, the corporate sector as a whole could not increase profits. Firms’ cost reduction resulted in a decline in wages for households. Households were able to avert facing a surge in unemployment against the background of a tradition in Japan that people prioritize job security, but had to change their employment status from regular employment to non-regular employment or accept declines in wages (Chart 4). In that situation, the practice of an annual rise in base pay was lost. Salary increases every year were taken for granted among salarymen (corporate employees) through the first half of the 1990s, but younger people in their thirties or below have never experienced such an increase. Many households tried to restrain consumption as they could not expect an increase in income in the future. As the view that prices of goods gradually decline takes hold, there is an increasing tendency to postpone consumption. Against the background of those firms’ and households’ spending behavior, 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 continued. Although such a phenomenon under deflation can be analyzed from various aspects, from the perspective of macroeconomic policy, it can be understood as follows. The key is that monetary conditions did not become sufficiently accommodative since low inflation expectations took hold, coupled with an actual price decline, and thereby real interest rates remained high. As you understand, under deflation, although nominal interest rates in Japan have long been at a low level, firms must not have been willing to make fixed investment by borrowing money. When firms were forecasting that general prices or sales prices of their own products would decline, firms’ burden of paying interest rates remained large because, whatever low the nominal interest rates might become, the real interest rates would become higher than the nominal interest rates (Chart 5). By contrast, real rates of return on cash and deposits increased when prices were on a declining trend, since nominal interest rates of the deposits could not become negative (Chart 6). Under such circumstances, accumulating retained earnings mainly by cost reduction and hoarding them in cash and deposits became relatively more advantageous for firms as a form of “investment” than taking risks and making fixed investment. That was a rational behavior in a deflationary environment. In fact, cash and deposits held by firms increased substantially from 185 trillion yen in fiscal 1995 to 243 trillion yen in fiscal 2013. If expected real rates of return on fixed investment had been sufficiently high, extremely low nominal interest rates could have been still attractive for businesses. However, in Japan, with the potential growth rate declining rapidly since the middle of the 1990s, firms’ growth expectations declined substantially (Chart 5). In economic terms, the natural rate of interest, which is the real interest rate neutral to economic activity, declined. Standard economic theory implies that the degree of monetary accommodation is determined by to what extent real interest rates are lower than the natural rate of interest. In Japan, real interest rates remained high due to deflation expectations while the natural rate of interest declined due to a decline in the potential growth rate. As a result, despite the low nominal interest rates, monetary accommodation remained insufficient and could not sufficiently stimulate the economy. Firms’ unwillingness to invest despite low interest rates represented such a BIS central bankers’ speeches situation. The breakthrough to that is either decreasing real interest rates by increasing inflation expectations or raising firms’ expected returns and the natural rate of interest by enhancing the growth potential. Japan is now tackling both of them. The former corresponds to the QQE that the Bank has been pursuing and the latter corresponds to what firms have been tackling under the government’s growth strategy. II. Achieving the price stability target of 2 percent and transforming Japan’s economy Next, let me talk about the QQE. The mechanism of the QQE starts from showing the Bank’s strong and clear commitment to achieve the price stability target of 2 percent at the earliest possible time, and converting people’s deflationary mindset. Concurrently, the Bank has put downward pressure on the entire yield curve including longer-ends through its massive purchases of Japanese government bonds (JGBs) and has lowered nominal interest rates further. As a result, real interest rates have declined, which has generated a situation in which you must come to recognize that financial conditions are accommodative in not only nominal terms but also real terms. In such financial conditions, coupled with the effects of other policies, private demand has increased, the output gap has improved, and actual prices have increased. If firms and households experience actual price increases, they will come to realize that prices will increase and thus inflation expectations are expected to increase further. In the economy, in which the price stability target of 2 percent is achieved by pursuing this mechanism, the rational behavior of firms and households should not be to hoard cash and deposits, but to invest and consume. In a situation in which prices rise moderately, the real return on cash hoardings is negative. If firms accumulate retained earnings gained by cost reductions and hold them simply in cash and deposits, the value of those firms is impaired. It is imperative for firms to undertake strategic initiatives such as improving their production system, carrying out research and development, or securing and developing human resources. Capital management policies such as those related to dividend payments or share buybacks are also important. In short, the economy will revert to a normal economic environment in which a priority for business management is to explore the opportunities for investing and gaining profits that would exceed the costs of capital, and thereby to generate a firm-specific value-added. Such behavioral change for Japanese firms to become proactive will also lead to an increase in the growth rate of Japan’s economy from a medium- to longterm perspective. We have often heard a question why the inflation that the Bank aims to achieve is 2 percent, although it appears to be understood that deflation should be overcome. In a nutshell, most advanced economies regard as price stability the situation in which price indices annually rise by about 2 percent on average (Chart 7). Let me ask you a question. What was the average of the year-on-year rates of change in the CPI during the 15-year deflation period (fiscal 1998–2012)? The answer is merely minus 0.3 percent. Many people may feel that prices of goods and services should have declined more substantially. Although I am not going into a detailed discussion in the interest of time, the CPI has an upward bias and indicates inflation higher than the true inflation rate. Given that fact, people tend to recognize being in a considerably deflationary environment when the year-on-year rate of increase in the CPI has been around zero. By the same token, on the contrary to the common belief, the situation in which the CPI records a 2-percent increase on a year-on-year basis in a stable manner is not at all a situation in which prices are rising substantially. Rather, in such a situation, people would recognize that prices are more or less flat on the whole or that prices are rising very moderately. On the exchange rate front, given that the annual inflation of around 2 percent was achieved in other major countries in accordance with global standards while Japan continued to experience a deflationary situation, the yen continued to appreciate in nominal terms (Chart 8). It is in sharp contrast to the fact that, in the United Kingdom and Canada, where BIS central bankers’ speeches moderate price increases continue in the same degree as in the United States, the levels of the purchasing power parity – which reflects the difference of price increases between a country and another – remain almost constant and the exchange rates against the U.S. dollar remain around those levels. There is another view that the trend of the yen appreciation consistent with the difference in inflation rates between Japan and other countries is not a problem for firms, since firms’ competitiveness is, in theory, affected by the real exchange rates which take into account the difference in inflation rates. However, since what matters for businesses in terms of difference in costs between Japan and abroad is not differences in general prices, it would be close to firms’ recognition that even such an appreciation of the yen in nominal terms leads to difficulties in making business plans. If 2 percent inflation is achieved in Japan as in trading partners going forward, at least a risk of the appreciation of the yen brought about by the differences in inflation rates between Japan and abroad will become smaller. Under those circumstances, firms can make global investment plans from a viewpoint of the optimal allocation of management resources on the assumption that the exchange rates remain stable to some extent. III. Emerging from the deflationary economy Where are we in the process of the transition – from a shrinking equilibrium under deflation to an expanding equilibrium under the 2 percent inflation? Let me summarize the current situation of Japan’s economy again. In the corporate sector, profits have been improving, and firms’ positive stance on making fixed investment has been maintained in spite of a decline in demand after the consumption tax hike. Business plans, shown in the Tankan (Short-Term Economic Survey of Enterprises in Japan) released last week, indicate that fixed investment is planned to be increased steadily, with an upward revision in profits in a wide range of firms regardless of sector or size. Other survey results show that, as the excessive appreciation of the yen was corrected, there have been some developments that firms put more emphasis on domestic business fixed investment (Chart 9). In the household sector, nominal wages have been rising reflecting the tightening in labor market conditions. The year-on-year rate of increase in nominal wages in the first half of fiscal 2014 was 1.1 percent, and it is roughly the same level as the year-on-year rate of increase in the CPI for the same period excluding the direct effects of the consumption tax hike, which was 1.3 percent. Nevertheless, an increasing number of people argue that wage increases have failed to keep pace with inflation and the year-on-year rate of change in real wages has been negative. Such argument is based on the calculation using the CPI inflation including the consumption tax hike as a deflator of real wages. However, the effects of the consumption tax hike on the year-on-year rate of increase in prices will disappear in April 2015. Based on that, it is more reasonable to assess underlying developments in real wages by excluding the effects of the consumption tax hike. Since, on an aggregated basis, wages have been increasing and the number of employees has been rising, employee income has continued to increase at the pace around 2.0 percent on a year-on-year basis. Reflecting the steady improvement in the employment and income situation, private consumption has remained resilient as a trend, and the effects of the decline in demand following the front-loaded increase have been waning on the whole. Stock prices have increased substantially, exerting positive effects on firms’ fixed investment and households’ spending behavior. Conversion of the deflationary mindset has been progressing steadily, which has influenced firms’ wage setting and pricing strategy. At annual wage negotiations between management and labor this spring, an increase in wages was demanded taking into account actual inflation, and the practice of rises in base pay returned for the first time in more than a decade. Firms’ price-setting strategy has been shifting from a low-price strategy under deflation to that of raising sales prices while increasing value added. Moreover, some labor unions have decided to demand an about 2 percent increase in base pay for wage negotiations toward spring 2015. That is a landmark event in that the Bank’s price stability BIS central bankers’ speeches target is taken into consideration in labor-management wage negotiations. The Bank will continue to pay close attention to the progress in the negotiations with strong interest. In this economic and price situation, the Bank decided to expand the QQE at its Monetary Policy Meeting held on October 31 (Chart 10). Specifically, the Bank decided that it will accelerate the pace of increase in the monetary base from “an annual pace of about 60–70 trillion yen” to “an annual pace of about 80 trillion yen.” The annual pace of increase in the amount outstanding of the Bank’s holdings of JGBs will be raised by about 30 trillion yen to “about 80 trillion yen” and as for exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs), the increases in the amount outstanding of the Bank’s holdings will be tripled. Let me reiterate the background to the expansion. The year-on-year rate of increase in the CPI slowed after its peak in April this year. The background to this is somewhat weak developments in demand following the consumption tax hike and the substantial decline in crude oil prices since the summer. To avoid any misunderstanding, let me be clear that the additional easing was not a response to the decline in crude oil prices itself. Japan, a commodity-importing country, gains a large advantage from the decline in crude oil prices, especially when the decline is caused mainly by supply-side factors such as developments in oil-producing countries as it is this time. On the price front, while the decline in crude oil prices put downward pressure in the short term, it will lead to an improvement in the output gap and to an increase in underlying prices from a somewhat longer-term perspective. The reason for deciding on the additional easing despite this is that the Bank judged that we are still in the midst of converting the deflationary mindset and there is a risk that a slowdown in the actual rate of increase in the CPI might delay this conversion. Two engines have so far brought the conversion of the deflationary mindset. The first is the Bank’s strong commitment to achieve the price stability target of 2 percent at the earliest possible time and in a stable manner, and the second is the actual inflation that has been realized under the commitment. Although the decline in crude oil prices is desirable over time, if a pause in the actual price increase becomes protracted, the latter engine may be weakened. If this raises doubts on the achievement of 2 percent inflation, there may be a risk that the mechanism of the QQE as a whole will be weakened. Therefore, the Bank decided to pursue monetary easing more powerfully under the QQE, and to reiterate its unwavering resolution to achieve the price stability target of 2 percent at the earliest possible time through its “action.” Looking at responses in financial markets, it appears that the Bank’s resolution to achieve the price stability target of 2 percent at the earliest possible time has been well understood. I believe that many of you also understand it very well. I strongly expect that there will be positive effects of the expansion of the QQE on wage negotiations next spring and on firms’ price setting. If it is the case, conversion of the deflationary mindset under the QQE will keep going forward. That is the intended effect of the expansion of the QQE. Under those circumstances, the positive effects of the decline in crude oil prices will become clear. With the conversion of the deflationary mindset progressing, the decline in crude oil prices will gradually push up economic activity and the trend inflation, and the actual inflation rate will also increase as the short-term downward pressure on prices will dissipate. As I have mentioned earlier, the Bank aims to achieve the price stability target of 2 percent in a stable manner. In the economy in which the Bank’s aim is achieved, firms and households make decisions and take action based on the assumption of moderate inflation of 2 percent. We will pay close attention to how the conversion of the deflationary mindset will progress from such viewpoint in assessing developments in crude oil prices and their effects on inflation expectations. The Bank’s stance of monetary policy has been consistent since the introduction of the QQE. 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. It will examine both BIS central bankers’ speeches upside and downside risks to economic activity and prices, and make adjustments without hesitation if necessary to achieve the price stability target. Concluding remarks Before ending my speech, I will talk about what next year will be like as today is almost the end of the year. Firms can expect that corporate profits will be favorable on the back of the decline in commodity prices and the depreciation of the yen. Households can expect that nominal wages will increase. Real wages are also expected to recover since the inflation rate is likely to be at around the current level for the time being and the increase in prices attributable to the consumption tax hike will disappear in April 2015 on a year-on-year basis, although the year-on-year rate of increase in prices is affected by the future developments in crude oil prices. There seems to be a tailwind to Japan’s economy. In this situation, the challenge for next year is, as Chairman Sakakibara often mentions, that firms should change by taking advantage of such a favorable environment, so that the next virtuous cycle in the economy will be firmly in place. The “pie” that the entire economy can share is getting bigger. At this stage in which we are in the midst of the transition process, however, the pieces of the “pie” are unevenly distributed in favor of globally operating firms or financial asset holders. The fact is that profits of smalland medium-sized enterprises and household income are also becoming larger, compared with those during the period of deflation, and many people are gaining some benefits, but the size of benefits that firms and households gain differs, depending on the firm size, sector, and household income bracket. The issue is not simply a distribution of the “pie.” Whether the next virtuous cycle can be generated depends critically on how the “pie” is shared. If the spending propensity of economic entities which got a large piece of the “pie” is low, the next cycle will not operate. In this context, firms making high profits should use them to generate the next virtuous cycle. What I emphasize here is that firms’ using of profits in that manner not only has a positive impact on Japan’s economy, but also benefits themselves. Under the current financial conditions, for those who think that the price stability target of 2 percent will be achieved, real interest rates are extremely low and the expected return on fixed investment must be favorable. By contrast, for those who believe deflation will be here to stay, real interest rates remain high and their spending behavior will be restrained. After overcoming deflation, since those in the latter camp will become eager to spend, the competition for securing the labor force, for example, will become intensified. In addition, as a matter of course, financial conditions will be sooner or later neutral to the economy as 2 percent inflation is achieved in a stable manner. In sum, the favorable financial conditions in the transitional period will not be forever. This is a great chance, on a first-come-first-served basis. The environment surrounding firms is totally different between the economy in a shrinking equilibrium under deflation and the economy in an expanding equilibrium under the 2 percent inflation. The rule book for business will be rewritten. As widely believed, Charles Darwin, who claimed the theory of evolution, said “it is not the strongest of the species that survives, but the one that is the most adaptable to change.” Firms that are able to get ahead of a change in the environment promptly and to adapt to the economy in an expanding equilibrium will become the winners of the competition and enjoy prosperity in the new era. Thank you very much for your attention. I sincerely wish you a Happy New Year. 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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Special address by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at the ADBI-Japan-OECD High-Level Global Symposium, Tokyo, 23 January 2015.
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Kikuo Iwata: Financial education in Japan – challenges presented by the aging population and declining birthrate Special address by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at the ADBIJapan-OECD High-Level Global Symposium, Tokyo, 23 January 2015. * * * Introduction Good morning, ladies and gentlemen. I am Kikuo Iwata from the Bank of Japan. I am most pleased to have all of you here in Tokyo, to discuss financial education. I believe that sharing the insight and knowledge gained by some countries will benefit participants from other ones. I would like to thank the organizers and all involved. The Bank of Japan serves as the secretariat of the Central Council for Financial Services Information, which promotes financial education in Japan. As a member of the council, I feel that financial education has become increasingly important worldwide, particularly after the recent global financial crisis. I also think that country-specific factors and historical background have had considerable influence. Today, I would like to talk about financial literacy in Japan, including the current situation, challenges, and issues in promoting financial education. The country has been undergoing demographic changes, particularly of the aging population and declining birthrate. Indeed, it is aging more rapidly than most countries. I hope that our experience with addressing these financial literacy matters will offer you some insight. I. Need for financial literacy arising from demographic changes An aging population and declining birthrate represent the greatest social and economic issues in Japan. The average life expectancy is 80 years for men and 86 years for women, and the population’s longevity is one of the highest in the world. Over the past six decades, life expectancy has increased by more than 20 years for both men and women. While we should welcome the increase, maintaining one’s living standard over a longer retirement period has become a crucial issue. In addition, with the declining birthrate, the proportion of people aged 65 years and older is expected to rise to nearly 30 percent by 2020. Considering the large burden borne by the working-age generations, the role of public pensions will become smaller. In other words, each individual’s efforts to achieve financial independence in their retirement period have become more important. Encouraging elderly people to work longer is one important factor, but so is improving financial literacy. Starting lifetime planning while still young and reserving assets for retirement will help. II. Changes in financial behavior and challenges presented by the aging population and declining birthrate The need for improved financial literacy is gradually taking hold in Japan. In the council’s survey, we ask about the “purpose of holding financial assets.” The reply chosen most often had long been “preparation for illness and unexpected emergency.” But in 2013, this changed for the first time in its 60-year history to “funds for life during my retirement period.” This is symbolic for Japan, which has a well-developed public pension system. BIS central bankers’ speeches The financial behavior of Japanese people has changed accordingly. Households’ financial assets1 have increased by around 20 percent over the last decade; that is, the period before and after the global financial crisis. Notably, the amount held by people aged 60 years and older has reached 25 million yen per household. This is almost the same level as the “target amount of funds you regard as necessary” in the survey. Financial assets are being accumulated to ensure a stable living standard over an individual’s retirement period. However, there are worrisome signs that financial literacy associated with lifetime planning has been undermined. As I mentioned earlier, households’ financial assets have been growing. However, at the same time, the number of households that do not have such assets has been increasing recently. This trend has been observed in a wide range of income groups, including the highincome group. The backgrounds to this are varied, and problems related to financial literacy represent one of the factors. One example is a weaker awareness of the importance of lifetime planning. There are various concerns regarding children as well. In this affluent society that is undergoing demographic changes and rapid progress in technology, children could lose their sense of the value of money. For example, we have the so-called “six pocket problem.” This refers to a phenomenon in which a child is indulged with money given by the parents and grandparents of both the father and mother. Another is the “invisible money problem”; that is, a situation in which a child does not feel that they actually paid a price for something, given the increasing use of electronic money. In both cases, children have fewer opportunities to realize, through the first-hand experience of using physical money, that there are limits to the money we can spend. We must keep up with these developments, as lifestyles and values have become diverse and everyday life is more dependent on and convenient with technology. However, we still need to understand that there are limits to the goods we can own and the money we can spend, so as to make sure that we make appropriate choices on daily consumption, financial transactions, and lifetime planning. We need to be aware of significant financial literacy factors – namely, the scarcity of money and resources as well as lifetime planning. Creating such awareness through financial education is challenging, but we cannot avoid this task. Another issue that warrants attention is the rapid increase in financial fraud targeted at elderly people. I feel very sorry for the victims of such crimes. At the same time, the increase in financial fraud suggests that we need to strengthen the financial literacy of elderly people. The victims of financial fraud might have been caught off-guard. If they had had a little more financial literacy, they might not have been deceived. On the basis of our survey, we deem that elderly people generally have more confidence in their own financial literacy compared to other age groups. But in fact, they tend to have insufficient literacy. We should close the gap between high confidence and low literacy. We need to check and control daily payments, manage portfolios in line with lifetime plans, and always confirm the points to check when concluding a contract. Enhancing financial literacy in this way will be effective in guarding against financial fraud and, at the same time, for developing efficient asset formation. III. Initiatives taken in Japan In 2013, Japan’s Financial Services Agency compiled a report that showed the future direction of financial education, drawing on the experience of the global financial crisis. It proposed to emphasize literacy for financial behavior and focus on the basics of financial The financial assets here are financial instruments, including bank deposits and postal savings, that are held for investment or reserved for future use. Funds held for business purposes and daily use are excluded. BIS central bankers’ speeches literacy to make it easier to learn. Based on this report, our council has been working to set standards and specify the contents of financial education by age group, and has formulated the Financial Literacy Map.2 The council also provides easy-to-understand teaching materials, pamphlets, and DVDs in cooperation with financial industry groups and other relevant organizations. In particular, we have pamphlets for middle-aged and elderly people, who must consider how to maintain their living standard over their retirement period as an immediate, practical issue. In cooperation with relevant organizations, the council also gives lectures to university students that place emphasis on fostering decision-making ability. Through these activities, it has been promoting more effective financial education for working-age generations to prepare them for later years. In fiscal 2005, our council launched a campaign that aims to improve financial education at schools. It has developed the contents of such financial education by age group. The council also provides various teaching materials, including practical teaching cases for school children. Indeed, to promote financial education activities more effectively, it is important to provide necessary information to people who are not interested in lifetime planning. It is also necessary to devise ways of encouraging them to take appropriate actions so as to maintain lifetime financial independence. These are difficult tasks, but it is vital to make people understand, through easy-to-understand and accessible means, that financial literacy reduces risks in their future lives. It is also essential to communicate to the public in a more effective manner by using behavioral economics insights. Conclusion The Bank of Japan will continue to promote financial education through the activities of the council. We will maintain close cooperation with the Financial Services Agency and relevant organizations. Through our efforts, we hope that Japanese people can continue to live stable, affluent lives despite the aging population and declining birthrate. I would like to conclude my speech by expressing our commitment to stronger cooperation with those of you who have gathered here today from the OECD and various countries around the world. Thank you for your kind attention. Available only in Japanese. 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, Miyagi, 4 February 2015.
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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, Miyagi, 4 February 2015. * * * Accompanying slides can be found at the end of the speech. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Miyagi 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 Sendai Branch. It is almost four years since the Great East Japan Earthquake, which caused immense damage to the Tohoku region. I renew my deepest condolences to the victims of the earthquake and tsunami. In addition, I express my great respect to all of you who have made every effort to swiftly rebuild their businesses soon after the disaster and to reconstruct the cities thereafter. In visiting Sendai this time, I have come with an expectation to confirm the current state of the disaster-stricken areas and to listen in person to the recent business sentiment and the situation of rebuilding in various fields as well as your thoughts on the Bank’s policies and activities. Today, before exchanging views with you, I will briefly explain the recent economic developments at home and abroad, and then touch on some notable points regarding monetary policy. Following my speech, I would like to have your views on the actual situation of the local economy and your candid opinions about the Bank of Japan. I. The current situation of and outlook for Japan’s economy A. The current situation of Japan’s economy Japan’s economy has continued to recover moderately as a trend. Although the effects of the decline in demand after the consumption tax hike in April 2014 have still been seen in part, those effects have been waning on the whole. Before going into the details about the current situation of Japan’s economy, I will talk about the developments in overseas economies (the left table in Chart 1). The U.S. economy has continued to recover steadily, led by private demand. On the back of robust employment conditions, the household sector has increased consumption and housing investment. Business sentiment and production have maintained the momentum for improvement, and business fixed investment has continued to recover. As for the European economy, some weakness in the momentum for recovery has recently been seen in part, due mainly to concern over geopolitical risk. The Chinese economy has continued with a stable growth for now, underpinned by an improvement in external demand and the authorities’ measures to support economic activity, although there is concern over adjustments in the real estate market and over a slowdown in fixed asset investment in manufacturers. Other emerging economies as a whole have been losing steam, as an improvement has been seen in many countries and regions but economic stagnation in countries facing structural issues or political instability has been protracted. Specifically, the economies of the NIEs, ASEAN, and India have shown a pick-up or a slightly moderate recovery. By contrast, the economies of Brazil and Russia have remained increasingly lackluster due mainly to weak domestic demand. BIS central bankers’ speeches Let me turn to the recent developments in Japan’s economy amid such an external environment. Exports, which had been more or less flat, have shown signs of picking up (the right table in Chart 1). By region, exports to the United States and Asia have increased. As for the United States, exports of capital goods and parts used in overseas production sites have been increasing, and, as for Asia, exports of capital goods and parts as well as ITrelated goods have been increasing. With regard to domestic demand, in the corporate sector, business fixed investment has been on a moderate increasing trend as corporate profits have continued to improve. Due to the decline in demand following the consumption tax hike, inventory stocks increased and production declined. But as inventory adjustments have progressed in line with the picking up of final demand, production of late has bottomed out. In the household sector, against a backdrop of a steady improvement in the employment and income situation, private consumption has remained resilient as a trend. As for durable consumer goods, which were affected substantially by the effects of the decline in demand following the consumption tax hike, those effects have recently been waning. Housing investment, which continued to decline following the front-loaded increase, has recently started to bottom out (Chart 2). Looking somewhat in detail about labor market conditions, they have continued to improve steadily. The unemployment rate has recently been around 3.5 percent, which is at the same level as around 1997, and the active job openings-to-applicants ratio has risen to the highest level since 1992. The nominal wage per employee has risen moderately. The year-on-year rate of increase in both monthly wages per worker for full-time employees and hourly wages of part-time employees has accelerated at a moderate pace. Later, I will talk in more detail about this employment and income situation in the context of its implications for prices and monetary policy. With regard to the price developments, excluding the direct effects of the consumption tax hike, the year-on-year rate of increase in the consumer price index (CPI, all items less fresh food) was 0.5 percent for December 2014. B. Outlook for economic activity and prices The Bank of Japan releases the Outlook for Economic Activity and Prices semiannually in April and October. At the Monetary Policy Meeting held last month, the Policy Board members, as their interim assessment, revised their projections of real GDP and the CPI made last October. With regard to the outlook, Japan’s economy is expected to continue growing at a pace above its potential 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. Exports are expected to increase moderately mainly against a background of the recovery in overseas economies. As for domestic demand, business fixed investment is expected to continue with a moderate increasing trend with corporate profits following their improving trend. Private consumption is expected to remain resilient with the employment and income situation continuing to improve steadily, and the effects of the decline in demand after the consumption tax hike are expected to dissipate gradually. Reflecting those developments in demand both at home and abroad, industrial production is expected to resume its moderate increase. On the price front, the year-on-year rate of increase in the CPI, excluding the direct effects of the consumption tax hike, is likely to slow for the time being, reflecting the decline in energy prices. Meanwhile, the outlook for the underlying trend remains unchanged from that made last October, based on expectations that an improvement in the output gap continues as a trend and that the increasing trend in the medium- to long-term inflation expectations continues. Taking a closer look at various surveys, the expected inflation rates remain likely to accelerate steadily, despite the recent decline in crude oil prices (Chart 3). In this interim assessment, on the assumption that crude oil prices will rise moderately from the recent levels, the Bank expects that the year-on-year rate of change in the CPI is likely to accelerate gradually as the base effect of the falling crude oil prices dissipates and reach around BIS central bankers’ speeches 2 percent around the middle of the projection period; that is, in or around fiscal 2015. Thereafter, Japan’s economy is expected to shift to a growth path that sustains such inflation in a stable manner. Let me explain the outlook in specific figures (Chart 4). As for the median of the Policy Board members’ projections in this interim assessment, compared with those made in October 2014, real GDP growth for fiscal 2014 will likely be lower at minus 0.5 percent, but it will likely be higher at plus 2.1 percent for fiscal 2015, and at plus 1.6 percent for fiscal 2016 due mainly to the positive effects from the substantial decline in crude oil prices and the government’s fiscal stimulus package. With regard to the CPI, the outlook for the underlying trend remains unchanged. Compared with that made in October 2014, the year-on-year rate of increase will likely be lower toward fiscal 2015, due to the significant decline in crude oil prices, as already mentioned. That for fiscal 2016 will likely be more or less unchanged from the October forecast. Risks to such baseline scenario include developments in the emerging and commodityexporting economies, the prospects regarding the debt problem and the risk of low inflation being protracted in Europe, and the pace of recovery in the U.S. economy. II. Conduct of monetary policy Now, I will talk about monetary policy that the Bank pursues. In January 2013, the Bank set the price stability target of 2 percent in terms of the year-onyear rate of change in the CPI; in other words, the introduction of an inflation target. Toward achieving this target, the Bank has been implementing aggressive monetary easing called quantitative and qualitative monetary easing (QQE) since April 2013, and expanded the measure in October 2014. These measures aim at converting people’s deflationary mindset, which has been formed firmly amid the prolonged period of deflation, to the mindset that expects moderate inflation. That is, in other words, preparing a platform on which people can act on the assumption that prices continue to rise moderately. Therefore, in order to have the mindset convert proactively, I believe it is very important to thoroughly explain the Bank’s policy and deepen your understanding. A. Change in policy regime Whenever I am asked what the core of the QQE is, I answer that it is dispelling the deflationary mindset through a regime change (Chart 5). One who first discussed economic policy by using the term “regime” was Professor Thomas J. Sargent, who was awarded the Nobel Prize in Economics in 2011. Professor Sargent is famous for his studies in the field of rational expectations. He also presented a view on a mechanism of how fiscal and monetary policies will influence the real economy. Namely, he indicated that economic policies are effective because people will respond to a regime that the policy authorities rely on. A policy regime is a term that is difficult for a proper Japanese translation. Tentatively, you can consider that it means something like “a system of rules that form the basis of policy choice” or “a basic framework of thinking.” You can simply say “the rules of a game.” A regime change in a policy means that the system of rules that forms the basis of policy choice changes. People’s behavioral pattern depends on the rules of a game which people are participating in. If the rules change, people’s behavior will also change. Why is such a self-evident truth important to economic policy? That is because expectations and the behavior of various economic entities, such as households and firms, will depend on whether a regime change in BIS central bankers’ speeches policy was to take place. Reflecting such expectations and the behavior, the resulting policy effects themselves would completely be different. For example, suppose the policy authorities facing hyperinflation embark on monetary tightening. If such policy is not perceived to be a long lasting measure, inflation will not be reined in because households’ and firms’ expectations for a future course of prices do not change and they continue to behave based on the same assumption of high inflation. By contrast, if the policy authorities’ firm stance toward overcoming inflation would gain credibility, the credible policy stance will lead to a change in firms’ and households’ expectations for future policy path, together with their behavior based on that renewed expectations. Accordingly, inflation will be contained in a self-fulfilling manner. Practical examples could be found in the ending of hyperinflation in the European countries after the World War I and in the emerging process from the Great Depression in Japan and the United States in the first half of the 1930s. The Bank’s current monetary policy is rooted in the point of departure where it changed its past policy regime to a different regime characterized by a view that “overcoming deflation can be achieved through aggressive monetary easing because both inflation and deflation are ultimately monetary phenomena.” In the past, the Bank pursued various monetary easing measures as a front runner in monetary policy history, such as the introduction of zero interest rate policy and quantitative easing. Nevertheless, the Bank was not successful in getting out of deflation for a long time of more than 15 years. One reason might be that a policy regime of “deflation can be overcome through monetary policy” was not adopted, or, at the minimum, the Bank was not able to gain such credibility from private economic entities. Based on such bitter experience, through clearly hammering out a change in a policy regime, the Bank has currently been trying to dispel the deflationary mindset of households, firms, and financial institutions and to fundamentally alter their behavior. B. Transmission channels of the QQE For the policy regime change to gain credibility, a clear and tangible message needs to be delivered from the policy authorities. In the current monetary policy, (a) the Bank set a price stability target of 2 percent and strongly committed itself to achieve that target, and (b) the Bank has been powerfully pursuing the QQE as a tangible action. With those, a change in a policy regime has been taking place (Chart 6). As strong downward pressure has been exerted on nominal interest rates through massive purchases of long-term government bonds under the QQE, people’s expected real interest rates will be lowered, given that a change in a policy regime raises people’s inflation expectations (Chart 7). Expected real interest rates are subjective expectations of “what interest rates in real terms will be when future price changes are taken into account,” and will have various influences on people’s savings and investment behavior as well as asset prices. As you may know, financial markets have responded most vibrantly to such a policy regime change, and a rise in prices of risk assets, including stocks and foreign currencydenominated assets, has been stimulating private consumption through wealth effects (Chart 8). In addition, the correction of excessive yen appreciation has led to an upturn in profits of export-related firms mainly through an improvement in export profitability and to a marked increase in inbound tourism. Furthermore, prompted by a decline in expected real interest rates and an improvement in the income and financial footing, households and firms, which have been striving to increase BIS central bankers’ speeches savings and holding of cash and deposits based on their deflationary mindset, are expected to expand housing investment and business fixed investment. As explained so far, a transmission mechanism that the ongoing monetary policy intends to operate is that a rise in inflation expectations prompted by the policy regime change – as an ignition point – will expand aggregate demand through multiple channels. C. Reasons of the bank’s expansion of the QQE Given the aforementioned view, you could naturally understand why the Bank expanded the QQE at the end of October last year (Chart 9). The consumption tax hike in April last year brought about substantial fluctuations in the economy, that is, a front-loaded increase in demand immediately before the hike and a subsequent decline after the hike. As somewhat weak demand, mainly for durable consumer goods like automobiles, was protracted, a substantial decline in crude oil prices also exerted downward pressure on prices (Chart 10). Weakness in demand associated with the consumption tax hike already waned, and the decline in crude oil prices will likely, over time, have a favorable impact on Japan’s economy and work to put upward pressure on prices. However, as developments in actual prices and inflation expectations will mutually feed back, if there is downward pressure on actual prices, even for a short term, we should take a risk into account that it will delay the conversion of the deflationary mindset. To preempt manifestation of such risk and to maintain the improving momentum of expectation formation, it was necessary to expand the QQE. That was the judgment the Bank made at the end of last October. D. How to evaluate employment and wage developments As aggregate demand expands, ignited by a rise in inflation expectations, a virtuous cycle from production to income and spending operates, and thereafter, stable employment and an improvement in labor conditions would ensue. In that regard, as mentioned earlier, an improvement in the labor market conditions since last year, such as a sizable increase in the number of employees and a substantial improvement in the unemployment rate and the active job openings-to-applicants ratio, has not been interrupted even amid the seemingly lackluster real GDP growth due to the effects of the consumption tax hike (Chart 11). As for the increase in the number of employees, there is criticism noting that only non-regular employment was increasing in number while regular employment was not. However, that criticism seems to mix up a forward-looking development of “gradually increasing employment starting from non-regular employment,” which has been occurring as the pie of employment as a whole has been expanding, with a backward-looking development of “replacing regular employment with non-regular employment,” which had been seen in the past. It is natural that non-regular employment, which can be adjusted relatively flexibly, will increase at the early stages of economic recovery. At this stage, we should fairly value the achievement that many non-workers have gotten a job and become able to earn wage income. There is also a similar criticism regarding the continued uptrend in wages that a rise in nominal wages has not been keeping up with a rise in consumer prices and thus real wages have been declining. On that point, it will be necessary to distinguish price increases due to demand expansion from those due to the effects of the consumption tax hike. Excluding the negative contribution of the consumption tax hike, both real wages of full-time workers and real hourly wages of BIS central bankers’ speeches part-time workers have not that much declined from 12 months earlier (Chart 12). The yearon-year rate of change in real income of employees as a whole, excluding the effects of the consumption tax hike, has also been positive for nine consecutive months since March 2014 (Chart 13). Therefore, in my view, a fair assessment of real wages would be that “while both a wage per worker and labor income as a whole have been increasing to the extent that matches price increases brought about by demand expansion, those have yet to rise to offset also the effects of the consumption tax hike.” In the case of stimulating demand through monetary easing, normally, as a rise in prices precedes a rise in nominal wages, real wages will decline at initial phases. Because, however, there is a channel that a decline in real wages spurs firms’ labor demand, leading to an increase in employment and a decline in the unemployment rate, the declines in real wages at this point of time are not necessarily bad news. As employment conditions tighten, nominal wages will rise and downward pressure on real wages will start to wane. As workers will be able to work more efficiently along with production increases, labor productivity will rise. In such a manner, real wages will eventually start to increase (Chart 14). While monetary policy will surely influence the real economy, there is a sequence of steps for such influence to spread and thus it takes a certain length of time for the policy to come into full effect. In addition, Japan’s economy is in the midst of tackling a difficult issue of overcoming deflation of more than 15 years. I would request your patience, with a good hope, while the virtuous cycle – in which an improvement in income encourages spending, leading to a further expansion of production and income – would make more progress as we move forward. Concluding remarks In conclusion, let me touch on the economy of Miyagi Prefecture. The regional economy is recovering moderately, with the decline in demand affected by the consumption tax hike waning gradually. Somewhat weak developments in production will continue. Reflecting the demand resulting from rebuilding and reconstructing, public investment has been increasing and housing investment has remained at a high level, particularly for building public housing for people affected by the disaster. Business fixed investment has also continued to be on an increasing trend and private consumption has remained resilient on the back of an improvement in the employment and income situation. Looking at reconstruction in the disaster-stricken areas, I have recognized that while reconstruction has been steadily progressing, rebuilding day-to-day life and rehabilitation of livelihood are still half-way through. The pace of reconstruction differs between the regions and the difference between the regions seems to have been widening. At the root, there seems to be also a challenge that is common nationwide, namely, the declining population and aging. In addition, a labor shortage and prices of materials rising or remaining at high levels have been affecting not a little the progress in reconstruction in the disaster-stricken areas. How that will develop going forward also warrants due attention, in my view. I have heard that big events are scheduled for this year in Miyagi Prefecture. Sendai City will host next month the United Nations World Conference on Disaster Risk Reduction, the cumulative number of participants of which is expected to be more than 40,000, and has announced itself as a candidate for the 2016 Summit Meeting. The city has disclosed its plans to develop in the future as an international convention city as well as has aggressively been trying to tap inbound demand. An improvement and reinforcement of transportation infrastructure will be promoted. The JR Ishinomaki and Sengoku lines that have been cut off by the disaster are scheduled to be reopened throughout, the Tozai subway line is expected to open in Sendai city, and the privatization of the Sendai airport is being pursued. I expect that, triggered by those events and creating and tapping new demand, a stream of BIS central bankers’ speeches reconstruction will further accelerate and vitalization of the local economy will gain momentum. The Bank conducts an operation that provides long-term funds at a low interest rate to financial institutions that have business offices in the disaster-stricken areas in order to support their efforts to meet the demand for funds for rebuilding those areas. The Bank expects to continue to play a part in rebuilding and developing the region’s economy while carefully examining financial and economic developments, including those of the disasterstricken areas. Thank you. 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Remarks by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the 7th Japan Securities Summit, London, 11 February 2015.
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Takehiro Sato: The Bank of Japan’s efforts toward overcoming deflation Remarks by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the 7th Japan Securities Summit, London, 11 February 2015. * * * Accompanying slides can be found at the end of the speech. I am truly honored to have this opportunity to be a panel member at the 7th Japan Securities Summit. Japan’s economy has continued to recover moderately as a trend with a virtuous cycle from income to spending operating steadily in both the household and corporate sectors. As for the outlook, it is expected to continue its moderate recovery trend. In the Bank of Japan’s January 2015 interim assessment of the Outlook for Economic Activity and Prices (hereafter the Outlook Report), the median of the Policy Board members’ forecasts for the growth rate for fiscal 2015 and 2016 were revised upward from the forecasts presented in the October 2014 Outlook Report, partly due to the drop in crude oil prices and the effects of the economic measures by the government. On the price front, the inflation rates in major countries, including Japan, have been declining as a trend mainly due to the recent drop in crude oil prices. Under those circumstances, central banks in major countries have a common concern that major economies are trapped in a feedback-loop – the decline in the inflation rates would lead to a fall in people’s mediumto long-term inflation expectations, and it would result in a further decline in the actual inflation rates. That is why the Bank decided to expand the QQE last October. As I cast a dissenting vote on that decision, I may not be an appropriate person to explain this policy. However, I share the Bank’s firm resolution to overcome deflation. In this session, I will share with you my views on the effects of the QQE, the Bank’s price stability target, and the importance of the government’s effort toward fiscal consolidation to ensure the ultimate success of the QQE. First of all, the effects of the QQE have been increasing in a cumulative manner with the progress in the asset purchases by the Bank. The Bank purchases the Japanese government bonds (JGBs) so that their amount outstanding increases at an annual pace of about 80 trillion yen. This amount, “about 80 trillion yen”, substantially exceeds the planned amount of new financial resource bonds by the government, which means that final investors decrease their outstanding holdings of JGBs. However, Japanese institutional investors’ preference for JGBs is strong partly in response to the international financial regulations, and partly due to a lack of attractive domestic investment opportunities. Therefore, as the Bank continues to purchase large-scale assets, that effect on the interest rate formation has been more strongly pronounced especially after the expansion of the QQE. In fact, the yield curve has flattened further, with the yield in the medium-term zone falling into negative territory albeit temporarily, and the super-long end of the yield curve also declining considerably. Meanwhile, an increase in the volatility of the interest rate has been observed recently. I have been monitoring carefully how that shape of the yield curve will influence a variety of asset prices and investors’ asset allocation as a policy effect. On the other hand, I have been monitoring the side effects – such as the effects on financial system stability, including the broadly-defined settlement system, and the market functioning. Also a smooth restoration of markets’ price discovery function will be an issue from somewhat a longer perspective, in the process of seeking for an exit from QQE, as the Bank purchases about 90 percent of the total amount of JGBs’ market issuance on a gross basis. Second, my understanding is that in the assessment of the achievement of the Bank’s price stability target, what is important is not to focus on the specific price indicators, but to examine whether various economic entities such as firms and households change their BIS central bankers’ speeches behavioral patterns based on the assumption of a certain level of inflation with monitoring a wide range of indicators including those related to wages carefully. It seems that there is no silver bullet for estimating people’s medium- to long-term inflation expectations, and therefore whether or not they have started to heighten their expectations, which have consistently remained lower than those in the United States and the Euro Area, can only be judged qualitatively from various economic entities’ behavioral patterns. In that regard, households have had an outstandingly sticky preference for extremely inexpensive goods and services under deflation. However, such preference is not so strong as that in the past, and firms’ price-setting behavior has also been changing in a positive manner. More importantly, a basic wage-setting mechanism – base salaries are revised in line with price increases, which was almost forgotten under deflation – has started to revive in labor-management wage negotiations. It could lead to a breakthrough in changing people’s fixed idea under deflation that base salaries would not rise. That would have positive effects on peoples’ medium- to long-term inflation expectations. In addition, my understanding is that what is essential to achieve the price stability target is a rise in productivity by the efforts of various entities to carry out structural reform and a resultant increase in the potential growth rate as well. On that basis, the inflation rate would increase moderately and wages would continuously improve in line with the increase in productivity, and consequently people would enjoy benefits from the overcoming of the deflation. The driving force for an increase in productivity is capital investment, and I expect that the recent tight labor market conditions are likely to act as a catalyst for the change of firms’ behavior. Third, securing the credibility of fiscal management is important in ensuring the ultimate success of the QQE. In that regard, 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. My understanding is that the government continues to make efforts toward fiscal consolidation in the fiscal 2015 budget draft. The Bank’s purchases of JGBs are curried out only in the context of the conduct of monetary policy and not in any way to finance the fiscal deficit. It is thanks to the government’s efforts toward fiscal consolidation that the Bank’s such explanation is persuasive. If market participants have concern over the government’s efforts toward fiscal consolidation, the effects of the QQE will be dampened, due to an expansion in risk premiums. Once risk premiums expand, it would be difficult to control. Some market participants mention that there is little room for the expansion in risk premiums in the JGBs market due to the Bank’s large-scale purchases. However, the expansion in risk premiums may not be limited to the JGBs market. The government’s efforts toward fiscal consolidation are likely to be important from a longerterm perspective as well, when the Bank achieves the price stability target and seeks for an exit from the QQE. The Bank expects that the government will continue to steadily promote measures aimed at establishing a sustainable fiscal structure. The QQE is a highly difficult policy. While containing a rise in nominal rates through the massive purchases of the JGBs, the Bank is trying to heighten the people’s inflation expectations which would result in lowering the real interest rates. My assessment is that the QQE has been exerting its intended effects so far. Positive changes have started to be observed in the asset markets and households’ and firms’ behavioral patterns. 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. It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. In my view, the criteria for such judgment is that whether various economic entities such as firms and households change their behavioral patterns based on the assumption of a certain level of inflation as I have stated earlier. Thank you. 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 National Press Club, Tokyo, 27 February 2015.
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Haruhiko Kuroda: Crude oil prices and price stability Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Japan National Press Club, Tokyo, 27 February 2015. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website. Introduction Today, I am very pleased to appear before the venerable Japan National Press Club. The Bank of Japan has been carrying out quantitative and qualitative monetary easing (QQE) to achieve a price stability target of 2 percent at the earliest possible time, with a time horizon of about two years. Amid this, Japan’s economy has continued its moderate recovery trend, with prices rising accompanying the increase in corporate profits and employee income. However, the year-on-year rate of increase in the consumer price index (CPI) has slowed recently, reflecting the substantial decline in crude oil prices since last summer. In that situation, some opine that the Bank should take some time to achieve the price stability target of 2 percent while others think that 2% inflation is hard for the Bank to achieve in the first place. Today, I will first briefly discuss the current situation of and outlook for Japan’s economy. Then I will explain the recent conduct of monetary policy, mainly the thinking behind the price stability target and policy responses to the decline in crude oil prices. I. The current situation of and outlook for Japan’s economy To start with, let me talk about the current situation of and outlook for Japan’s economy. Japan’s economy has continued its moderate recovery trend. Regarding the outlook, it is likely to continue growing at a pace above its potential given that exports are expected to increase moderately and that domestic demand is likely to remain firm. Positive effects from the decline in crude oil prices and the government’s stimulus package that was formulated at the end of last year are likely to boost such favorable developments. According to the Bank’s interim assessment in January of the October 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the Policy Board members’ forecasts of the real GDP growth rate was minus 0.5 percent for fiscal 2014, but 2.1 percent for fiscal 2015, and 1.6 percent for fiscal 2016 (Chart 1). I will discuss the following two key points in some detail. The first one is developments in exports and production in the corporate sector, and the second is developments in wages and private consumption in the household sector. Corporate sector: developments in exports and production Exports, which had been more or less flat for a long period despite the correction in the excessive appreciation of the yen, have finally been picking up recently (Chart 2). Looking at the developments by region, exports to the United States registered a sizeable increase, since capital goods and parts have increased in reflection of the recovery there in business fixed investment. Exports to Asia have also increased, mainly in IT-related goods and in capital goods and parts. With regard to the outlook, overseas economies, mainly advanced economies, are expected to continue recovering moderately, boosted partly by the decline in crude oil prices. According to the World Economic Outlook (WEO) Update published last month by the IMF, global growth, after registering 3.3 percent for 2014, is projected at 3.5 and 3.7 percent for BIS central bankers’ speeches 2015 and 2016, respectively. As a whole, it is expected to increase gradually, albeit with a downward revision relative to the October 2014 WEO (Chart 3). Looking somewhat closely at the developments in overseas economies by region, the U.S. economy is likely to be a driving force for global growth for the time being. Against the backdrop of a faster pace of increase in employment and a substantial decline in gasoline prices, private consumption has seen a firm increase. Since the firmness in the household sector has been feeding through to the corporate sector, the economy is expected to continue to recover solidly, led mainly by private demand. As for the European economy, momentum for the recovery has remained weak. Nevertheless, private consumption has been recovering steadily, albeit moderately, due in part to positive effects of the decline in crude oil prices, and exports have shown signs of picking up thanks to such effects as those of the depreciation of the euro. Against the background of those factors, a further slowdown in the economy has been staved off. Going forward, the European economy is expected to continue its recovery, albeit at a gradual pace, since effects of the successive monetary easing measures by the European Central Bank (ECB), such as the start to a purchasing of bonds issued by euro area central governments, are expected to underpin the recovery. The Chinese economy has been growing at a somewhat slower pace, but is likely to continue with generally stable growth underpinned by moderate improvement in external demand and the authorities’ measures to support economic activity. Emerging economies apart from China and commodity-exporting economies as a whole have continued to lose pace, but their pace of growth is likely to pick up gradually as the recovery in advanced economies exerts positive effects. Taking the above into consideration, Japan’s exports are expected to increase moderately, as overseas economies continue to see moderate recovery, mainly advanced economies. That said, due attention needs to be paid to various uncertainties such as the outcome of the debt problem in Europe, including the developments in Greece, developments in the emerging and commodity-exporting economies facing structural issues or political instability, and geopolitical risks. Against the backdrop of the pick-up in exports and resilience in private consumption as a whole, about which I will discuss in more detail next, production has been picking up due to the progress in inventory adjustments. Corporate profits have continued to improve, with the ratio of current profits to sales for major firms exceeding the level prior to the global financial crisis (Chart 4). In that situation, firms have maintained their positive stance in their business plans, and fixed investment is planned to be increased steadily following last fiscal year. Some firms have increased their share of domestic investment for this fiscal year, and it has been noticeable in media reports recently that firms that relocated production sites overseas amid the phase of the appreciation of the yen have started to attach importance to domestic production. Going forward, against the backdrop of a moderate recovery trend in the economy, an increase in exports, and the decline in crude oil prices, corporate profits are likely to continue improving and business fixed investment is projected to continue on a moderate increasing trend. Household sector: Developments in wages and private consumption Turning to the household sector, firms’ positive stance has led to a tightening in labor market conditions and, accordingly, an improvement in the employment and income situation. With regard to firms’ views on employment, even amid the sluggish economic recovery until last summer, the degree of labor shortage has risen further (Chart 5). In this situation, total cash earnings have risen moderately, albeit with fluctuations since last spring. Last year, the yearon-year rate of increase in scheduled cash earnings was positive, reflecting the revival of an increase in base pay at many firms, which had been lost for many years. This winter’s bonuses also increased solidly. On the back of the rises in total cash earnings and the number of employees, employee income has been rising moderately. Private consumption as a whole has remained resilient against the background of steady improvement in the BIS central bankers’ speeches employment and income situation. Sales of durable consumer goods such as household electrical appliances, which had been affected by the decline in demand after the consumption tax hike for a protracted period, have been on an improving trend since early autumn. Going forward, private consumption is expected to remain resilient with the employment and income situation continuing to improve steadily. As I have explained so far, with a virtuous cycle from income to spending likely to be maintained steadily in both the household and corporate sectors, Japan’s economy is expected to continue growing at a pace above its potential. II. The price stability target and quantitative and qualitative monetary easing Next, I would like to talk about monetary policy. To start with, I will explain the thinking behind targets for price stability in some depth, referring to examples of such targets in other major economies. A. Thinking behind targets for price stability Many central banks including the Bank of Japan have been implementing monetary policy, aiming to achieve an inflation rate of around 2 percent (Chart 6). For example, central banks in such countries as Japan, the United Kingdom, Canada, and New Zealand have set 2 percent inflation as a target, and in the United States, the Federal Reserve has set a longer-run goal for inflation at the same rate. In the euro area, the ECB has presented a quantitative definition of price stability and expressed it in a numerical way, which is below, but close to, 2 percent. While there are various ways of how this is expressed, conducting monetary policy that aims at around 2 percent inflation has become a global standard. Looking at developments in the CPI in these economies, even in the United States and the United Kingdom, where CPI inflation has been considered stable at the rate of around 2 percent, the rate has been moving in a rather wide range depending on the situation (Chart 7). In reality, the inflation rates in those economies have been centered at around 2 percent on average in the medium term. In other words, the inflation rate may move up and down according to cyclical factors such as the business cycle, fluctuations in commodity prices, and other factors. In such an environment, central banks have been conducting monetary policy to achieve the target level of inflation on average in the medium term, which often is equated with being over the business cycle. For example, during a press conference in January 2012 when the Federal Reserve announced its decision to adopt a longer-run goal for inflation at the rate of 2 percent, then-Chairman Bernanke said the following as part of his answer to a question: “‘medium term’ – which is, these targets are all medium term – is a flexible concept.” The Reserve Bank of Australia specifies that “the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 percent, on average, over the cycle.” In the case of New Zealand around the middle of the 1990s, when the central bank was strictly pursuing a target for price stability, its Policy Targets Agreement with the Minister of Finance included escape clauses, so to speak, or a range of events that would allow the central bank governor to be exempted from being held responsible for deviations from the target; for example, “shifts in the aggregate price level as a result of exceptional movements in the prices of commodities traded in world markets” and “a natural disaster affecting a major part of the economy.” In this way, each country views that the 2 percent inflation rate will be achieved on average over the business cycle. In line with this, what each central bank attaches importance to in conducting monetary policy are developments in medium- to long-term inflation expectations. This is because, if the medium- to long-term inflation expectations are anchored at around 2 percent – in other words, if firms and households act on the assumption that prices will increase by about 2 percent – it is likely that the target for price stability will be achieved on average in the medium term even if the inflation rate deviates from the target level as a result of being affected by the business cycle or temporary factors. BIS central bankers’ speeches This view on the conduct of monetary policy was reflected well in the different responses taken by the Federal Reserve and the ECB to the substantial decline in crude oil prices since last summer. In general, a decline in crude oil prices exerts downward pressure on prices in the short term, but year-on-year effects will dissipate going forward. Moreover, from a longerterm perspective, the decline induces a positive effect of increasing the real purchasing power in an oil-importing country, and will eventually push up prices. Therefore, if firms’ and households’ medium- to long-term inflation expectations are anchored at the target level, which central banks aim to achieve, and the general public perceives that prices will revert to 2 percent sooner or later even if they fall temporarily, monetary policy responses are judged unnecessary since trend inflation is unchanged. In fact, the Federal Reserve maintains its policy stance of starting a liftoff of the federal funds rate even in a situation where the headline CPI inflation clearly is declining in reflection of the effects of falling crude oil prices. As the background to this, the January Federal Open Market Committee (FOMC) statement illustrated a view that “survey-based measures of longer-term inflation expectations have remained stable” and that, as for the outlook for prices, “[i]nflation is anticipated to decline further in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate.” As for Europe, the ECB recently decided an additional easing measure that includes a start to the purchasing of bonds issued by euro area central governments. As the background to this, President Draghi pointed out that the weak headline inflation dominantly driven by the fall in oil prices could adversely affect medium-term price developments through the second-round effects on wage and price-setting. As a matter of fact, in Europe, in a situation where the momentum of economic recovery is weak, the inflation rates have declined to a negative figure for the first time in about 5 years due to the effects of the fall in crude oil prices, and some indicators have started to suggest a decline in the medium- to long-term inflation expectations. Therefore, Europe is faced with a situation in which the public’s perception that prices will increase by about 2 percent might be impaired, or in other words, a situation in which there is a risk that 2 percent inflation expectations might become de-anchored. The easing by the ECB was made in response to such risk. B. The reason for aiming at achieving the price stability target of 2 percent at the earliest possible time What I have outlined so far is the standard view on the target for price stability. The Bank’s price stability target is basically in line with that view. Nevertheless, the situation in Japan, on the basis of which monetary policy should be discussed, greatly differs from that in the United States and Europe. The challenge for the United States and Europe, on the one hand, is how to maintain inflation expectations, which already have been anchored at around 2 percent. On the other hand, the issue for Japan is to deliberately raise inflation expectations – which had been considerably below 2 percent during the years of deflation – through monetary policy. Looking at the situation in Japan, the year-on-year rate of change in the CPI had been in negative territory or slightly above zero since the second half of the 1990s up until before the introduction of QQE. In other words, over the business cycle, it has been at around 0 percent on average. Amid protracted deflation over this long period, medium- to long-term inflation expectations declined, and consequently, a sense that prices would not increase became entrenched. Under these circumstances, firms’ incentives to launch new initiatives through investing in business facilities and in research and development became reduced, because the holding of cash or deposits became a relatively better investment strategy. 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. In order to escape from such a situation, it has become necessary to pursue a policy that quickly and drastically changes firms’ and households’ mindset that prices will not increase. To that end, what was introduced as a BIS central bankers’ speeches prescription was QQE. This policy aims at creating an economic situation where prices increase at around 2 percent on average, as is the case with the United States and Europe, by raising people’s medium- to long-term inflation expectations to around 2 percent and re-anchoring these expectations at that level. The mechanism of QQE is expected to be as follows: first, inflation expectations will be raised through a clear commitment and through a large-scale monetary easing to underpin the commitment; second, concurrently, downward pressure will be put on nominal interest rates through massive purchases of government bonds, thereby decreasing real interest rates and stimulating private demand such as business fixed investment. Namely, to start this mechanism, the Bank aimed at first igniting inflation expectations. Raising inflation expectations by changing people’s deflationary mindset is itself an aim of overcoming deflation, and at the same time the key to implementing the mechanism of QQE. Considering the unique situation facing Japan and the prescription for it, importance is attached to a “time frame” during which the target should be achieved, compared with the target for price stability in other countries. If the Bank had simply stated that it would achieve 2 percent inflation at some point in the future and that it therefore expects firms and households to change their actions, would those entities, which had experienced deflation for a long time, change their actions in belief of such a vague promise? I doubt it. It is because the Bank presented a time frame of achieving the price stability target at the earliest possible time with a time horizon of about two years, and made a clear commitment that it will do whatever is necessary to achieve that target that the perception of inflation by firms and households started to change and the mechanism of QQE started to operate. This is why the Bank adheres to achieving 2 percent inflation “at the earliest possible time.” After the inflation expectations are anchored at 2 percent, as in the case of the United States, pushing back the inflation rate to 2 percent can be achieved in a more relaxed manner. However, to raise inflation expectations to 2 percent, it is necessary to have strong enough levels of speed and momentum to change people’s expectations. Deflationary equilibrium is a steady state, so there is gravity that pulls prices to the equilibrium. This is why deflation has been protracted for 15 years in Japan despite the cyclical economic fluctuations and monetary and fiscal stimulus measures. In order to escape from deflationary equilibrium, tremendous velocity is needed, just like when a spacecraft moves away from Earth’s strong gravitation. It requires greater power than that of a satellite that moves in a stable orbit. Reaching orbit at an altitude of 1 percent, for example, which is lower than that for satellites of other countries, is not enough. This is because satellites at a low altitude can be pulled back by gravity. An altitude of 2 percent is a global standard employed by each country, and this level is set in view of experiences of monetary policy around the globe; namely, an upward bias of the CPI, which indicates inflation higher than the true inflation rate, and a buffer at a level that prevents falling into deflation. In sum, the Bank’s price stability target as a framework is no different from the targets for price stability employed in other economies. What is distinctive in Japan’s case is that a stronger-than-usual measure is necessary in the phase of escaping from the deflationary equilibrium. The crux of QQE is to realize a rise in inflation expectations (or conversion of deflationary mindset) with sufficient speed and momentum through the Bank’s commitment to achieve the price stability target of 2 percent at the earliest possible time and through a monetary easing measure of an unprecedented scale. C. Assessing trend inflation For these reasons, the Bank aims at achieving the 2 percent inflation rate at the earliest possible time. In this regard, we occasionally are asked which price index we use as a guideline for arriving at that figure. The Bank, as many other central banks do, defines the price stability target as the headline CPI. However, it should be noted that achieving 2 percent temporarily will not suffice. The Bank aims at maintaining the inflation rate at BIS central bankers’ speeches 2 percent in a stable manner. Therefore, it is necessary to judge trend inflation by identifying factors that are prone to fluctuate in the short term – such as commodity prices, including crude oil prices, and prices of fresh food – from developments in the CPI for all items. In doing so, it should be noted that each price index has both advantages and disadvantages, and there is no single index that appropriately reflects trend inflation for any given economic situation. The Bank has been assessing the CPI from various aspects, including that for all items less fresh food, that for all items less food and energy, the trimmed mean CPI, and the ratio of increasing and decreasing items. On this basis, the Bank’s outlook for inflation presented in the Outlook Report and its interim assessment refers to the CPI for all items less fresh food, which has reflected trend inflation relatively well. Even so, as in the recent case of crude oil prices changing substantially, a problem arises that the outlook for inflation depends considerably on the assumption for the future path of crude oil prices. Against this background, in the January interim assessment, the Bank disclosed an assumption for the future path of crude oil prices, which was shared by all the Policy Board members in making their forecasts, as well as the contribution of energy items to the CPI based on this assumption, in an attempt to communicate the Bank’s assessment of trend inflation more clearly. In order to grasp trend inflation, a comprehensive assessment – based on examinations of various price indices, as well as the output gap and medium- to long-term inflation expectations and economic developments behind them – is necessary. Moreover, as for inflation expectations, it is important not only to monitor market-based indicators and surveys of firms, households, and economists, but also to analyze changes in the inflation rate perceived by the general public by examining firms’ and households’ actions, such as wage negotiations and firms’ price-settings. This is because thoughts and actions by firms and households, not by traders in financial markets, actually influence economic and price developments. D. Outlook for prices and monetary policy management To conclude my speech, I would like to talk about the developments in prices and monetary policy management on the basis of the view on prices I have mentioned thus far. The year-on-year rate of increase in the CPI for all items less fresh food for April 2014 had improved to 1.5 percent excluding the direct effects of the consumption tax hike, but its rate of increase slowed against the background of a substantial decline in crude oil prices since the summer, and the latest figure for the rate in January is 0.2 percent (Chart 8). In this situation, the Bank decided in October last year to expand QQE (the so-called additional easing). This decision was not made to respond to the decline in crude oil prices itself. It was made out of concern over a risk that the decline in crude oil prices affects inflation expectations through sluggish growth in the inflation rates, thereby delaying conversion of the deflationary mindset. As I mentioned earlier, a rise in inflation expectations is the start of the mechanism of QQE, and is also the key to its successful implementation. If people consider that the Bank is not serious about achieving the price stability target of 2 percent at the earliest possible time, QQE, which has been exerting intended effects so far, would not function properly anymore. Actually, the large reaction by markets after the additional easing suggests that the Bank’s determination may have been questioned earlier. In any case, however, I believe such doubt was cleared after the easing. Crude oil prices have been declining further even after October last year, but conversion of the deflationary mindset is proceeding steadily. Of the indices relating to inflation expectations, although market-based indicators such as the break-even inflation rates have declined in line with those in the United States and Europe, medium- to long-term inflation expectations have been maintained according to the results of surveys of economists. In terms of corporate behavior, negotiations between management and labor over a base pay increase seem to have progressed, and base pay is likely to rise for the second consecutive year this spring. We judge that, at the moment, manifestation of a risk that conversion of the BIS central bankers’ speeches deflationary mindset might be delayed has been prevented due to the easing measure in October. The output gap, which is another determinant of trend inflation, has been improving mainly on the labor front, as seen in the fact that the unemployment rate has declined to around 3.5 percent, and is likely to follow an improving trend with the economy expected to continue growing at a pace above its potential. In this sense, the decline in crude oil prices is a supporting factor. Therefore, trend inflation rates are expected to rise steadily going forward and, as the effects of the decline in crude oil prices on a year-on-year basis dissipate, the 2 percent CPI inflation is likely to be achieved. The timing of this could be either earlier or later to some extent, depending on future developments in crude oil prices; however, based on the assumption that crude oil prices are expected to rise moderately from the recent level, the CPI is likely to reach 2 percent in or around fiscal 2015 (Chart 1). Needless to say, the Bank maintains its policy stance that it will make adjustments as necessary without hesitation, when there are changes in trend inflation, in order to achieve the price stability target at the earliest possible time. The Bank will not respond to developments in crude oil prices themselves, but in conducting monetary policy, it will closely monitor how they affect inflation expectations – or, in other words, whether conversion of the deflationary mindset will nevertheless proceed. Thank you very much for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at the Daiwa Investment Conference Tokyo 2015, Tokyo, 4 March 2015.
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Ryuzo Miyao: Challenges in shaping modern monetary policy Speech by Mr Ryuzo Miyao, Member of the Policy Board of the Bank of Japan, at the Daiwa Investment Conference Tokyo 2015, Tokyo, 4 March 2015. * * * Accompanying charts can be found at the end of the speech. Introduction My five-year term of office as a Policy Board member of the Bank of Japan will end on March 25. During this period, various events took place both in terms of financial and economic developments at home and abroad as well as the conduct of monetary policy. It truly has been a turbulent five years. Today, drawing on the events and experiences gained during those years, I would like to focus on some of the challenges regarding the conduct of monetary policy. Specifically, I have three issues to address: (1) the effects of large-scale purchases of assets such as government bonds; (2) communication on monetary policy; and (3) the path toward achieving the 2 percent price stability target. After discussing these issues, I will share my views on central bank accountability. I. Effects of large-scale asset purchases One of the crucial issues of discussion on the recent unconventional monetary policy is how to assess the effects of large-scale purchases of assets such as government bonds. Some progress has been made in the research of such policy effects both on the theoretical and empirical sides, but there continues to be vigorous debate over the effects and costs, as well as over whether this policy should be implemented in the first place. In practice, large-scale asset purchases by central banks seem to have become common measures adopted in major advanced economies including the United States, Japan, and Europe. The Bank of Japan adopted quantitative easing from 2001 through 2006: at that time, this was regarded as a pioneering policy framework. Later, in response to the global financial crisis, various countries adopted quantitative easing and asset purchasing policies that have been advanced in terms of both the scale of purchases and the variety of assets. Details of the asset purchase measures adopted by the Federal Reserve, the Bank of Japan, and the European Central Bank (ECB) varied, but the common feature was that these banks all performed large-scale asset purchases and continued their operations in an open-ended manner. They have made a commitment to linking the time frame of such asset purchases with their policy targets. The Federal Reserve announced that it would continue its purchases of assets “until the outlook for the labor market has improved substantially in a context of price stability”; the ECB announced that it would do so “until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2 percent over the medium term”; and the Bank of Japan announced that it would continue such purchases “as long as it is necessary for maintaining the 2 percent price stability target in a stable manner.” Such open-ended asset purchases are very effective measures compared with those having specified periods, and they can produce stronger easing effects in terms of the following three points. First, by linking the duration of asset purchases with the policy target and not specifying the time frame in advance, an open-ended approach indicates central banks’ strong will and determination to achieve the target. In the case of the Bank of Japan’s conduct of quantitative and qualitative monetary easing (QQE), its strong and clear commitment to achieving the price stability target of 2 percent affects expected inflation rates, and at the BIS central bankers’ speeches same time, the large-scale purchases of Japanese government bonds (JGBs) exert downward pressure on the entire yield curve, bringing about lower real interest rates, and thereby stimulate private demand. In general, the open-ended approach clarifies the stance of maintaining the unconventional and large-scale policy measures for a considerable time. This would further ease financial conditions by exerting strong effects on long-term rates and asset prices, and accordingly improve corporate profits as well as employment and wage conditions. Second, by committing to conducting stronger easing for a longer period of time, an openended approach can exert positive effects on the supply side of the economy, through encouraging the private sector’s productive risk taking and entrepreneurship. For example, if such commitment supports changes in business structures and tapping new demand, and promotes business fixed investment that embodies new technology as well as research and development investment, it will be able to increase capital stock and heighten total factor productivity. Improvements on the supply side of the economy, and thus in the outlook for permanent income, can be expected to result in a sustainable increase in demand. 1 Third, since it is open-ended, markets’ expected duration of asset purchases can vary depending on a change in the economic outlook. Therefore, it contains a “stabilizing mechanism”; that is, even if market participants anticipate that the economic outlook will weaken compared to the baseline scenario, they also can expect an extension of the duration, which strengthens the easing effect and consequently helps the target to be achieved earlier. Next, let me compare the large-scale, open-ended purchases with forward guidance about policy rates, which is another unconventional measure that commits to maintaining a zero or extremely low interest rate for a longer period of time. Here, I would like to focus on my two main perspectives. The first perspective concerns effects on the financial environment such as long-term interest rates and asset prices. The large-scale government bond purchases not only can exert downward pressure on the term premium but also can influence the expected path of shortterm interest rates. When the purchases are conducted for a longer period, market participants are likely to interpret this as meaning that exceptional easing measures and, accordingly, a zero or extremely low interest rate policy also will be continued for a longer period, which could exert downward pressure on the expected short-term interest rates. This is the so-called signaling effect. On the other hand, forward guidance under the zero interest rate policy commits in advance to maintaining the zero interest rate into the future even when it seems appropriate to raise the policy interest rate, thereby lowering the expected path of short-term interest rates and exerting downward pressure on longer-term interest rates. However, there is a problem of time inconsistency with this commitment, because when an increase in interest rates does become appropriate, the commitment may be compromised in the end since it is appropriate to do so on an ex post basis. The signaling effect brought about by the large-scale, openended purchases is likely to work as a commitment device to restrain an inducement of time inconsistency. In this regard, this approach can exert a greater effect than forward guidance in creating accommodative financial conditions. U.S. policymakers also take notice of the following similar discussion: aggressive monetary easing improves firms’ fixed investment and research and development investment, as well as long-term unemployment, and this affects the aggregate supply of the economy as well as the medium- to long-term growth trend. Therefore, the economy can avoid a deterioration in the aggregate supply and growth trend after financial crises through such measures. See, for example, the following analysis by Federal Reserve Board economists: Dave Reifschneider, William L. Washer, and David Wilcox, “Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy,” Paper presented at the 14th Jacques Polak Annual Research Conference, International Monetary Fund, November 2013. BIS central bankers’ speeches My second perspective as regards the comparison between the two unconventional policy measures is the implication of the expansion of the monetary base. The open-ended purchases of government bonds imply that, on the liability side, the monetary base – especially reserve balances – will expand on a larger scale and for a longer period of time, whereas forward guidance does not have such a quantitative aspect. A theoretical analysis of such implication has been progressing recently among academics. From such a perspective, the economic effect of this can be explained as follows. As the government’s long-term liabilities are replaced by the central bank’s short-term liabilities, for the policy sector overall, comprising the central government and the central bank, the interest payment will be reduced. As a result, at least in this case, revenue from banknote issuance, or seigniorage, will be generated. On the assumption that the government’s fiscal expenditure plan will be unchanged, fiscal space equivalent to this seigniorage will be created in the government budget constraint. If such additional fiscal space then results in an increase in fiscal expenditure or in a tax cut, or make people expect that this will happen, it can stimulate the economy. 2 Such potential economic stimulus effects, due to an exchange of long-term government bonds and reserve balances, cannot be seen in forward guidance under the zero interest rate policy but are unique to large-scale, long-term balance-sheet policy that entails asset purchases. However, it should be noted that in the actual conduct of monetary policy, market participants might doubt that the use of additional fiscal space indicates a retreat from the government’s efforts to achieve fiscal soundness. In fact, the theoretical analysis is based on the preconditions that the government’s intertemporal budget constraint is satisfied and that its solvency will be achieved. I would like to emphasize that the Japanese government’s clear commitment to mid- to long-term fiscal reconstruction is critical and consistent with these preconditions in such theoretical analysis. As we have seen so far, the large-scale, open-ended asset purchases produce positive effects via the traditional transmission channels through which real interest rates affect economic activity, and also strengthen the effects produced by the improvements on the supply side of the economy. In addition, they are expected to restrain the time inconsistency brought about by forward guidance about policy rates. Furthermore, they theoretically might produce potential economic stimulus effects through seigniorage. The issue of how much this policy approach generates easing effects is also closely related to the timing and scale of the policy adjustment in the phase of normalization or tightening. Given that the policy to expand the monetary base has produced various economic stimulus effects through the aforementioned several mechanisms, adjusting or shifting from this policy, or providing policy guidance about such a move, should produce the opposite, tightening effects. When a central bank starts to discuss normalization of monetary policy, at which time it becomes very possible that the price stability target will soon be achieved, it will pursue appropriate adjustments including a combination of some measures such as adjusting policy rates and/or policy guidance. II. Monetary policy communication In implementing unconventional monetary policy, communication with the public has become increasingly important recently. Central banks have been making efforts to enhance The potential economic stimulus effects have been widely discussed in the recent theoretical research. See, for example, Willem H. Buiter, “The Simple Analytics of Helicopter Money: Why It Works – Always,” Economics 8, 1–53, 2014; and Jordi Gali, “The Effects of a Money-Financed Fiscal Stimulus,” CEPR Discussion Paper 10165, September 2014. Note that such theoretical analysis assumes the intertemporal budget constraint of the government and does not discuss the fiscal theory of the price level or the fiscal dominance. BIS central bankers’ speeches transparency and accountability by, for example, introducing policy targets with numerical values, clarifying their own policy approaches, and/or releasing their assessments of the outlook for economy activity. For modern central banks that have gained independence, it is essential to enhance transparency and accountability in order to maintain public confidence. Meanwhile, there are many challenges central banks face with regard to monetary policy communication. The first is the difficulty of policy communication when the economy is likely to be undergoing fundamental structural changes. For example, since the global financial crisis, the global economy has been burdened with debt reduction and balance sheet adjustment. The pace of economic recovery has been slower than had been expected, and forecasts for global economic growth, released by various organizations, have been revised downward repeatedly. One recent example was the International Monetary Fund, which reasoned that its downward revisions were due to weak business investment, notably in emerging economies. 3 As for Japan, the recent economic recovery has been driven by domestic demand, consumption in particular, rather than by exports, which may suggest that the country’s economic structure has been changing against the background of increasing globalization. These developments in the economy worldwide imply sustained structural changes, and considerable uncertainty regarding the outlook for economic activity. Moreover, there are many unpredictable risk factors, such as geopolitical risks, the political situation in Europe, and developments in crude oil prices. In communicating with the public about the outlook for the economy amid a situation of structural changes and various risk factors, it is more important to see whether the intended mechanism functions smoothly than to focus on specific numerical values. The second challenge is the balance between transparency and flexibility of the policy approach. Clarifying the future policy approach enhances the transparency and predictability of monetary policy. Such clarification may also strengthen the policy effects, just as in the case of forward guidance under the zero interest rate policy. However, if the information provided by a central bank is too specific, the public may, contrary to the central bank’s intention, focus solely on the specifics, which could lead to fluctuations in the market. This may impair the flexibility and credibility of the policy response. Such specifics include the announcement of particular economic indicators, numerical values, or time spans on which it bases its assessment. Indeed, central banks need to provide information about future policy responses based on a comprehensive assessment of a wide range of indicators and the basic mechanism of the economy, rather than on specifics – that is, specific economic indicators or specific numerical values. This is particularly true when the economy is undergoing fundamental structural changes or when there is heightened uncertainty regarding the outlook. In fact, as for forward guidance under QQE in Japan, the Bank adopts the following broad approach: “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.” This policy approach of making a comprehensive assessment under the constraint of the policy target is in itself the essence of a flexible inflation targeting framework within which “constrained discretion” can be exercised. Major countries including Japan currently adopt this policy approach based on the framework of flexible inflation targeting, and the significance of relying on a comprehensive assessment is likely to increase. See Chapter 1 in the World Economic Outlook released by the International Monetary Fund in October 2014. There has been vigorous debate over the deceleration in the pace of recovery in the global economy. It also has led to discussions about low productivity and continued shortages in demand – a situation referred to as “secular stagnation.” BIS central bankers’ speeches The third is the challenge specific to Japan regarding the policy target. The Bank aims to achieve the price stability target of 2 percent, while at the same time raising and re-anchoring the inflation rate that the general public perceives as representing price stability to the new policy target of 2 percent. Among advanced economies, only Japan faces this challenge, and the Bank should continue to make efforts to provide a thorough explanation about the feasibility. In January 2013, the Bank set the price stability target of 2 percent and jointly committed with the government to achieve this goal. Prior to this, the Bank had judged that the price stability goal was in a positive range of 2 percent or lower and had set a goal at 1 percent for the time being. The Bank now aims to achieve a higher target – to be precise, the upper limit of the previous goal – based on the recognition that efforts by a wide range of entities toward strengthening the competitiveness and growth potential of Japan’s economy will make progress. I will elaborate on this point later, but the fundamentals of Japan’s economy have been improving steadily and these developments are in line with the Bank’s recognition. It is very likely that the Bank will achieve the price stability target of 2 percent and, by maintaining that target in a stable manner, re-anchor the inflation rate that the general public perceives as representing price stability at around 2 percent. According to the Bank’s projections for economic activity and prices made in January 2015, the year-on-year rate of increase in the consumer price index is likely to reach around 2 percent in or around fiscal 2015. I personally hold the view that, although the precise timing for reaching 2 percent can be either earlier or later to some extent, the rate will likely rise close to 2 percent as a trend as downward pressure exerted by the decline in crude oil prices eventually will dissipate on a year-on-year basis. III. Path toward achieving the price stability target of 2 percent Let me explain once again the path toward achieving the price stability target that the Bank has in mind. The key question is whether the inflation rate will trend upward toward 2 percent together with a sustainable economic recovery. Let me discuss the sustainability of Japan’s economic recovery from a few perspectives. First, economic fundamentals have improved over the past two years or so – that is, the period during which the Bank has further enhanced monetary easing. This can be confirmed by the improvement, for example, in firms’ ratios of profits to sales, employee income, the quality of employment, and the labor force participation rate (Charts 1 through 3). Moreover, Japan’s net external assets have increased steadily, and its net income from the rest of the world has been on an increasing trend as a result of further global expansion by Japanese firms (Chart 4). In addition, the recent substantial fall in crude oil prices will considerably improve trading gains. All of these developments point to a rise in the economy’s capacity to generate income on a sustained basis. This sustained improvement in the capacity has been the source of recovery in Japan’s domestic expenditure. The increasing trend in business fixed investment is becoming clear against the background of favorable corporate profits (Chart 5). Household sentiment, which worsened due to the consumption tax hike, has stopped deteriorating, and consumption expenditure has been resilient (Chart 6). The economy’s capacity to generate income seems to be firm and the momentum of consumption maintained. An improving trend in domestic demand leads to sustainable improvements in the output gap, and labor supply and demand conditions continue to tighten as a trend. As a result, upward pressure on price and wage inflation rates as a trend is likely to increase. If the uptrend in prices is taken into account at the time of the wage negotiations in spring 2015, the cyclical mechanism observed in 2014 – in which wages and prices rise spirally – will be maintained. That is to say, in 2015, we will be experiencing the second round of a virtuous cycle among income, spending, prices, and wages. BIS central bankers’ speeches If positive initiatives – such as replacement investment that embodies new technology for business facilities, research and development investment, creating new value-added services, and tapping new demand – are further taken, total factor productivity (TFP) will rise and the increasing trend in income and spending will accelerate and be more sustainable. Under the expanded QQE, extremely accommodative financial conditions will continue to strongly support the virtuous cycle from the financial side. We expect that QQE will produce larger effects as Japan’s economic fundamentals improve. If the virtuous cycle of economic activity is sustained, a view that “around 2 percent inflation will continue with improvements in corporate profits, employment, and wages” will spread widely throughout the country, and a new inflation rate that the general public perceives as representing price stability will take hold. In the latter half of 2014, the price rise that includes the consumption tax hike might have been perceived only as an increase in costs, or incited concern over inflation amid the delay in economic recovery, thereby leading to deterioration in sentiment. What Japan needs to achieve, however, is a sustainable, mild inflation with the virtuous cycle of economic activity operating. It is vital that the virtuous cycle continue to operate in order for the conversion of the prolonged deflationary mindset to take place, and for people’s medium- to long-term inflation expectations to rise to around 2 percent and take root. In order to maintain the virtuous cycle of economic activity and dispel deflationary sentiment, the risk of a spreading of “the Keynes’ fallacy of composition” should be kept to a minimum. The fallacy of composition arises when an action taken by a firm or household that seems rational to the individual firm or household results in an undesirable outcome if all firms or households collectively take the same action. Individual firms may be reluctant to implement wage increases, including a raise in the level of base pay, that will lead to an increase in fixed costs, taking into account the competition among rival firms and the need to increase savings for future use. However, if many firms feel the same way and do not implement wage increases, household income will not increase and household sentiment will remain cautious, leading to sluggish spending. As a result, firms’ sales as a whole will be stagnant. If many households hold back their consumption to increase savings for future use, the overall income of the economy will be sluggish since the amount a person spends will be somebody else’s income. If many firms postpone the fixed investment that is necessary for their business or continue lowering their transaction prices in order to prepare for unexpected events and other uncertainties, the same problem will occur. Consequently, individual firms’ sales and individual households’ income will be sluggish, hindering the economy from becoming buoyant. In order to minimize the risk of the fallacy of composition spreading, aggressive policy measures already have been taken. Measures such as flexible fiscal policy, expansion of the monetary easing, and joint initiatives toward raising wages led by the government, the business community, and labor unions are all considered to avoid materialization of such risk. With economic fundamentals improving steadily, it is crucial that people spend, invest, and distribute money, keeping the economy moving by circulating money, rather than keep money in reserve. I believe it is necessary that more people become aware of the importance of preventing the fallacy of composition from materializing, and that firms and households must change their mindset to a further degree. Concluding remarks In shaping modern monetary policy, central banks face the considerable challenge of adopting new measures when the economy is likely to be undergoing fundamental structural changes. Communication with the public and the market will definitely be more difficult. However, central banks need to promote communication by providing a thorough explanation on their conduct of monetary policy, including the issues I have discussed, and by sharing the challenges we face. BIS central bankers’ speeches Financial markets pay extremely close attention to each and every word central banks release. They tend to show a strong reaction to the release of detailed information such as specifics in a numerical form. In any financial market, the Keynesian beauty contest, in which anticipation of others’ reactions will be taken more seriously than fundamentals, is sometimes in evidence. Therefore, overreaction in markets cannot always be avoided. In addition, central banks are directly intervening to a considerable scale in asset markets, where they had not heavily intervened in the past. Thus, markets’ behavior of always being looking-forward and trying to be one step ahead of others might become strengthened. All things considered, it is certain that central banks’ communication with the market and the public increasingly will have to be based more on the economic mechanism and the comprehensive assessment. The market will demand more clear and concrete information from central banks. Continuing to meet this demand, however, does not necessarily lead to enhancing economic welfare because it is difficult in practice to define the systematic policy reaction function. I believe that the desirable degree of central bank accountability is to offer judgment based more on a discretional comprehensive assessment while providing basic transparency. I hope this idea will be shared widely among the public and the market. BIS central bankers’ speeches BIS central bankers’ speeches 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, Gunma, 5 March 2015.
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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, Gunma, 5 March 2015. * * * I. Developments in economic activity and prices A. Current situation of and outlook for economic activity at home and abroad I would like to start my speech with a look at developments in economic activity and prices. Japan’s economy has continued its moderate recovery trend. The first preliminary estimate of the real GDP growth rate for the October-December quarter of 2014 – which was released in February 2015 – was 2.2 percent on an annualized quarter-on-quarter basis, and thus turned positive for the first time in three quarters. Industrial production also has turned positive in the October-December quarter on a quarter-on-quarter basis for the first time in three quarters, and recently recovered to the level of the peak prior to the consumption tax hike in April 2014. With regard to the outlook, industrial production is expected to increase moderately, reflecting the developments in demand both at home and abroad on which I will elaborate shortly, and the economy is expected to continue its moderate recovery trend. Looking at domestic demand, private consumption as a whole has remained resilient with the employment and income situation improving steadily, although recovery in some areas has been sluggish. As for durable consumer goods, which had exhibited a notable decline in demand following the front-loaded increase prior to the consumption tax hike, the number of new passenger-car registrations almost bottomed out in the July-September quarter of 2014, and since then has shown some signs of picking up, albeit with large fluctuations in the number of small cars with engine sizes of 660cc or less. Sales of household electrical appliances in real terms have tended to pick up at a moderate pace, as they have registered a quarter-on-quarter increase for two consecutive quarters since the July-September quarter. As for the employment and income situation, which underpins private consumption, labor market conditions have continued to improve steadily and employee income has risen moderately. Looking at recent developments, the unemployment rate has declined to around 3.5 percent and the active job openings-to-applicants ratio has been above 1.0. Scheduled cash earnings on a year-on-year basis have been on a positive trend as well, mainly due to the effects of the rise in base pay in spring 2014, and such earnings as a whole have been picking up. As for the outlook, employee income is expected to continue increasing moderately, in line with the recovery in economic activity and business performance. Underpinned by this employment and income situation, private consumption is expected to remain resilient. Business fixed investment has been on a moderate increasing trend. The aggregate supply of capital goods on a basis excluding transport equipment – a coincident indicator of machinery investment – has been on a moderate uptrend, with the fluctuations smoothed out; it was temporarily flat in the July-September quarter of 2014, but rose again in the October-December quarter. Machinery orders on a basis excluding orders for ships and those from electric power companies – a leading indicator of machinery investment – have been increasing since the July-September quarter, and business fixed investment plans are generally favorable as well. Taking these factors into account, business fixed investment is projected to continue a moderate increasing trend as corporate profits follow their improving trend. BIS central bankers’ speeches 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, the U.S. economy has continued to recover, led by domestic demand, since the firmness in the household sector has been feeding through to the corporate sector, together with the effects of monetary easing and the decline in crude oil prices. Momentum for the recovery in the European economy has remained weak, although a further slowdown has been staved off. As for the Chinese economy, stable growth has continued as a trend; however, growth momentum has recently slowed with downward pressure from excessive capital stock in the manufacturing sector and adjustments in the real estate market. Apart from China, emerging and commodity-exporting economies as a whole have continued to lose pace. In this situation, Japan’s exports have been picking up. Real exports, after turning positive in the July-September quarter of 2014 on a quarter-on-quarter basis, have risen for two consecutive quarters. As for the outlook, exports are expected to increase moderately (1) as overseas economies are likely to continue recovering moderately, led mainly by advanced economies – the United States in particular – although there are risks such as the outcome of European debt problem, including the situation in Greece, and (2) on the back of the enhancement of competitiveness and somewhat of a shift back from overseas production to domestic production due to the yen’s depreciation. Turning to price developments, the year-on-year rate of increase in the consumer price index (CPI, all items less fresh food, and the same hereafter) has been slowing, mainly reflecting the significant decline in crude oil prices since autumn 2014. The rate of increase for January 2015 – the latest figure available – was 0.2 percent. With regard to the outlook, the rate of increase is likely to slow for the time being, reflecting the decline in energy prices. B. Outlook through fiscal 2016 So far, I have illustrated recent developments in economic activity and prices. Let me now turn to the Bank’s interim assessment of the October 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report), which was made in January 2015. In this assessment, the Bank revised the forecasts for economic activity and prices through fiscal 2016. According to the median of the Policy Board members’ forecasts, the real GDP growth rate is projected to be minus 0.5 percent for fiscal 2014, which is lower than the forecast presented in the October 2014 Outlook Report. However, the rate is projected to be 2.1 percent for fiscal 2015 and 1.6 percent for fiscal 2016, which is higher in both cases than the forecasts presented in October, and the economy is likely to grow at a pace clearly above its potential. This upward revision reflects the significant decline in crude oil prices and the effects of the government’s economic measures. With regard to the CPI, the outlook for the underlying trend is unchanged from the October forecasts, but the year-on-year rate of increase will likely be lower toward fiscal 2015, due to the significant decline in crude oil prices. The rate of increase for fiscal 2016 will likely be more or less unchanged from the October forecast. This is because the year-on-year rate of increase in the CPI is projected to accelerate gradually as the effects of the decline in crude oil prices dissipate on a year-on-year basis, on the assumption that Dubai crude oil prices will rise moderately from 55 U.S. dollars per barrel. II. Major points to be considered with regard to the outlook for economic activity and prices Although I share the view that the economy will continue recovering moderately, I hold a more cautious view on the outlook for economic activity and prices compared with the forecasts in the baseline scenario in the Outlook Report that I just mentioned. Let me share some of my considerations regarding the outlook with you. BIS central bankers’ speeches A. Growth potential of Japan’s economy Now let us look at the potential growth rate of Japan’s economy, which represents – from the supply side – the pace of growth that is consistent with the economy’s growth potential. According to the Bank’s estimates, the rate has recently been in the range of 0 to around 0.5 percent, and thus remains at a low level. The potential growth rate is unlikely to rise markedly in the short term, considering, for example, that the pace of firms’ accumulation of capital stock remains moderate, although business fixed investment has turned to an increasing trend. On the other hand, the Bank’s estimates of the output gap in Japan have generally been at the neutral level of around zero recently. The output gap is also at a favorable level on an international comparison using the estimates made by the Organisation for Economic Co-operation and Development (OECD). Labor market conditions remain very tight. Of course, such estimates are subject to a considerable margin of error. However, if, under these circumstances, the economy continues to grow at a pace well above the potential growth rate, supply-side constraints such as labor shortages will become more pronounced. In my view, stable economic and price conditions are most likely to be maintained, as Japan’s economy will probably continue growing moderately at a pace that does not diverge considerably from the potential growth rate. B. The decline in crude oil prices and the global economy The decline in crude oil prices facilitates income transfers from oil-producing countries to oilconsuming countries. The net effect of the decline will likely tend to be positive in terms of the global economy as a whole due to the difference in price elasticity of demand between these countries. Nevertheless, financial markets often shift to a “risk-off” mode. This is probably because the decline in crude oil prices is associated with signs of oil-producing countries’ currency depreciation and of the heightening in their economic and fiscal risks. Another reason seems to be that market participants are still uncertain about the extent of positive effects stemming from the crude oil price decline. In measuring the extent of these effects, the degree to which the decline in crude oil prices will benefit the U.S. economy warrants attention. In this regard, the decline in such prices might not push up private consumption by as much as anticipated due to structural changes in the United States such as an increase in energy efficiency. The fall in crude oil prices could also lead to a reduction in fixed investment in the oil-related industries and to a decline in U.S. exports because of weaker-than-expected overseas economic growth, including that of oil-producing countries. Besides, it should be noted that the International Monetary Fund (IMF) revised downward its latest forecast for global growth from the previous forecast. The downward revision is mainly attributable to investment weakness caused by diminished expectations about medium-term growth in many advanced and emerging economies, despite the expectation for positive effects of the decline in crude oil prices. Taking these factors into account, I am personally paying closer attention to downside risks to overseas economies, developments in which are a key determinant of Japan’s exports. C. Private consumption Relatively weak developments have been observed in indicators of consumer sentiment since summer 2014, although these indicators have recently shown some signs of improvement. Behind this, there seems to be concern over a decline in real wages caused by the divergence between the rate of increase in prices and that in wages. In this regard, in a situation where the inflation rate has recently shown a declining trend, if increases in wages, including those in base pay, are realized this coming spring, as happened last spring, the divergence between the two rates will narrow or dissipate; this in turn will exert positive effects on consumer sentiment, and hence on private consumption. However, even if major firms raise their base pay to a reasonable degree, the rate of increase in scheduled cash earnings within the overall economy could diverge from that in the base pay of these firms. Here are some of the reasons. First, developments in wage increases by small firms also BIS central bankers’ speeches determine the course of wages in Japan. Second, many non-regular employees are not eligible for base pay increases. And third, the uptrend in the proportion of non-regular employees, for whom wage levels are relatively low, has in part exerted downward pressure on the average wage level. On this basis, despite a continuing trend of improvement in labor market conditions, the pace of improvement in real income will likely remain moderate and private consumption will probably continue to increase at a moderate pace that is consistent with the pace of increase in real income. D. Outlook for prices Regarding the outlook for prices, in the October 2014 Outlook Report, I formulated a proposal to change the expression that the year-on-year rate of increase in the CPI is likely to reach around 2 percent in or around fiscal 2015. Since then, I have maintained a more cautious view than the forecast in the Bank’s baseline scenario. Considering the relationship between the price outlook and the output gap in light of the Phillips curve, in order for the year-on-year rate of increase in the CPI to reach around 2 percent, it is necessary that the rate respond relatively clearly to an improvement in the output gap – that is, the steepening of the slope – and that the Phillips curve shift upward, reflecting a rise in medium- to long-term inflation expectations. It should be noted that the negative output gap has narrowed significantly since the introduction of quantitative and qualitative monetary easing (QQE) in April 2013 and has generally stayed at the neutral level for the past nearly one year, and the depreciation of the yen has progressed over this period. However, the pace of increase in prices remains moderate, even in terms of the CPI for all items less food and energy, which is not susceptible to the decline in crude oil prices. Assuming this situation continues, even if the effects of the decline in crude oil prices dissipate and the output gap improves further, the pace of increase in prices is likely to remain moderate. III. Conduct of monetary policy At the Monetary Policy Meeting held on October 31, 2014, the Bank decided to expand QQE. Specifically, the Bank decided to (1) accelerate the annual pace of increase in the monetary base from about 60–70 trillion yen to about 80 trillion yen, (2) increase its Japanese government bond (JGB) purchases so that the amount outstanding of its holdings would be increased from an annual pace of about 50 trillion yen to about 80 trillion yen, and (3) triple the annual paces of increase in the amounts outstanding of its holdings of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). Some Policy Board members held an opposing view regarding the expansion of QQE, but its implementation ultimately was decided by a majority vote. I cast a dissenting vote on that decision because I considered that the positive effects that could be brought about by the expansion would not be worth the accompanying costs and side effects, in a situation where QQE had already exerted a reasonable effect and, judging from the growth potential of Japan’s economy, economic and price conditions had generally regained stability. I have continued to cast a dissenting vote at the subsequent Monetary Policy Meetings, considering that it was appropriate for the Bank to change the guidelines for money market operations and asset purchases back to those employed before the expansion of QQE. The idea behind this is closely related to the proposal I have been submitting at each meeting since the introduction of QQE – that is, (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. Next, I will express my personal views on some points of discussion regarding the conduct of monetary policy, as well as the background to my proposal. BIS central bankers’ speeches A. Price stability target The Bank’s price stability target of 2 percent aims to maintain the inflation rate of around 2 percent in a stable manner. In order to achieve this, it is necessary that firms’ and households’ medium- to long-term inflation expectations – on which basis they carry out their economic activities – be stable at about 2 percent. However, there is still a substantial divergence from that level. In my view, medium- to long-term inflation expectations in Japan are mainly determined by supply-side factors such as the potential growth rate. Therefore, to achieve the price stability target of 2 percent, it is necessary that a wide range of economic entities make effective use of the benign economic and financial environment brought about by QQE and make continuous efforts to strengthen the economy’s growth potential. I hold the view that, even if such efforts proceed smoothly, it will require considerable time for the target to be achieved. This is why 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. It is important that monetary policy consistently provide indirect support for these efforts to strengthen the economy’s growth potential by maintaining accommodative financial conditions. As I mentioned earlier, the output gap has been around zero recently, due in part to the effects of monetary policy – which has a function of working on the demand side of the economy – while the potential growth rate remains at a low level. In this situation, if monetary easing is strengthened excessively to push prices higher in the short term than levels justified by the economy’s growth potential, this could in turn impair the stability in economic activity, and hence in prices. In order to ensure both the sound development of the national economy and credibility in the conduct of monetary policy, I consider it desirable to make the time frame for achieving the price stability target flexible, thereby achieving prolonged economic recovery, albeit moderate, while at the same time providing support from the financial side for steady progress in efforts to increase the productivity growth rate and the potential growth rate. Meanwhile, the growth potential of the economy will likely increase as efforts to strengthen the foundations for economic growth make progress, and so will the price level that is sustainable and consistent with the growth potential. It should be noted that, in the short term, however, prices might face downward pressure, for example, when those in certain industries decline due to deregulation, which represents one such effort. This is one of the reasons why I consider that the conduct of monetary policy with a price stability target has to be flexible. B. Expansion of QQE When the Bank introduced QQE in April 2013, I supported the concrete measures of QQE, judging that the scale was one in which the associated positive effects would just about outweigh the side effects when confined to a certain time period. Since the time of introduction, however, I have considered that, if such large-scale monetary easing policy were to be protracted or such policy strengthened, the associated side effects would instead outweigh the positive effects, and this would heighten the risk of undermining economic and price stability in the long run. Therefore, in considering the expansion of QQE, I judged that the accompanying positive effects would not be worth the costs and side effects. With regard to possible positive effects of the expansion of QQE, even if additional measures further lower interest rates, room for a further decline in real interest rates – which generates policy effects – is considered to be small, as nominal interest rates are already at historically low levels and inflation expectations are less likely to rise not only in Japan but also worldwide. It also should be noted that, although QQE could probably elicit reasonable effects through people’s expectations at the time of introduction, additional measures are likely to only have limited effects through this channel compared with when it was introduced. BIS central bankers’ speeches On the other hand, in terms of the costs and side effects of the expansion, a possible further impairment of market functioning and possible effects of a further decline in interest rates on financial institutions’ profits and on their intermediation function warrant particular attention. For example, if liquidity in the JGB market were to decline drastically, the market would become less resilient against negative shocks and thereby become unstable more easily, such that volatility would increase. In addition, the Bank has raised the pace at which it purchases JGBs so that their amount outstanding will increase at an annual pace of about 80 trillion yen, implying that it is purchasing a large proportion of the JGBs issued on a flow basis. Therefore, there is concern about a higher potential risk that such a move will be perceived as effectively financing fiscal deficits. I also believe that even greater attention should be given to a risk that the mechanism of maintaining fiscal discipline through interest rates will be impaired, reflecting overly heightened expectations that the stability in the JGB market will be ensured by the Bank’s JGB purchases. When the credit ratings of JGBs were downgraded in December 2014, the JGB market showed no notable reaction, but should this suggest an impairment of market functioning – which is supposed to reflect the fiscal condition – then the situation requires attention. Considering that the JGB market serves as the basis for a range of price formation in financial and asset markets, it is necessary to be fully vigilant against the risk of a buildup of various types of financial imbalances in a situation where the Bank’s presence becomes overwhelming in the JGB market and interest rates remain at very low levels. It also should be noted that, if interest rates decline further, this could add to difficulty for institutional investors that place priority on gaining stable interest income in finding favorable investment opportunities and discourage them from selling their JGB holdings. I consider that the feasibility of continuing JGB purchases into the future warrants attention, even though it seems technically possible to continue such purchases for some time. C. Achieving fiscal consolidation and maintaining financial system stability To ensure the smooth conduct of QQE, efforts to achieve fiscal consolidation are crucial. The Bank’s large-scale JGB purchases are solely conducted for the purpose of achieving the price stability target. However, if the credibility of fiscal management were to wane and QQE to become widely perceived in financial markets as financing fiscal deficits, this could entail a risk that the effects of QQE will be constrained by a rise in interest rates brought about by an increase in risk premiums. Particular attention therefore should be given to this as a potential risk, because fiscal conditions are severe in Japan compared with other countries. Fiscal consolidation is also extremely important with regard to achieving the smooth normalization of monetary policy in the future. Judging whether QQE will succeed or not in the end depends on whether monetary policy can follow a smooth path toward normalization while maintaining a stable economic and price environment. In order to achieve this, not only securing the credibility of fiscal management that I mentioned earlier but also ensuring financial system stability is highly significant. In the future, when the time comes for the Bank to seek to normalize monetary policy with a view to ensuring price stability, it should avoid falling into a situation where it is forced to shift its policy priority from ensuring price stability to stabilizing the financial system by maintaining stability of interest rates, with a view to ensuring stability of the financial system – one of the Bank’s missions along with that of achieving price stability. The Bank is therefore required to conduct monetary policy with utmost deliberation so that financial institutions’ profit base would not be impaired for a protracted period, or that their resilience to the risk of a rise in interest rates would not decline noticeably. In order to properly monitor economic and price developments as well as the financial system in a well-balanced manner, I consider it necessary for the Bank to continue its policy conduct flexibly, giving greater consideration to its policy framework of “two perspectives.” Specifically, the first perspective is examining, as regards economic activity and prices over BIS central bankers’ speeches the next two years or so, whether the outlook deemed most likely by the Bank is reasonable judging from the growth potential of Japan’s economy at each point in time. In this regard, the inflation rate that the Bank should aim at achieving through monetary policy over roughly the next two years is expected to climb gradually, as the economy’s growth potential rises along with the progress in structural reforms. That rate could possibly reach around 2 percent eventually; however, I consider it important to conduct monetary policy taking into account that the appropriate level at this point is still lower than 2 percent. The second perspective involves examining, over 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 doing so, it is important to not focus too much on short-term developments in economic activity and prices but to pay close attention to an emergence of financial imbalances and thereby aim to achieve economic and price stability in the long run. D. Making effective use of a wide range of policy tools It is my understanding that an unconventional policy such as the asset purchase policy implemented under QQE can be regarded as an exceptional and somewhat 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. The Bank’s current asset purchase policy, which continuously increases the amount outstanding of its asset holdings, has the effect, by its nature, that as long as the Bank continues with the purchases, accommodative financial conditions will be strengthened in a cumulative manner as the amount outstanding of its asset holdings increases. Compared with other policy tools, it will likely take considerable time for monetary policy to be normalized with the unwinding of QQE. Therefore, it is important to implement QQE in a forward-looking manner while fully taking into consideration the manifestation of its medium- to long-term effects. 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, instead of temporarily generating strong momentum for economic activity and prices. My assessment of the current situation is as follows: QQE has already exerted a reasonable effect. In addition to this, in a situation where prices – which had long been on a declining trend – have started to increase against the background of improvement in economic conditions, and the underlying trend in prices has been unchanged thereafter, policy effects generated by maintaining virtually zero interest rates are being added to the effects of QQE. Furthermore, with a view to encouraging firms and households to make full use of the accommodative financial conditions, the Bank established the Loan Support Program and has been providing long-term funds at a low interest rate. At the Monetary Policy Meeting held on January 19 and 20, 2015, the Bank made the following decisions regarding the program, which was due to expire shortly: (1) extending it by one year; (2) introducing a new framework for enabling financial institutions that do not have a current account at the Bank to use the program through their central organizations; and (3) with regard to the main rules for the fund-provisioning measure to support strengthening the foundations for economic growth under the program, increasing the maximum amount of funds that the Bank can provide to each financial institution from 1 trillion yen to 2 trillion yen, and also increasing the maximum amount outstanding of its fund-provisioning as a whole from 7 trillion yen to 10 trillion yen. As I mentioned earlier, whether QQE will succeed or not in the end depends on whether monetary policy can follow a smooth path toward normalization while maintaining a stable economic and price environment. To this end, I personally consider it important for the 13 Bank to continue to provide consistent support from the financial side to achieve desirable economic and price conditions in the medium to long term, while simultaneously making effective use of a range of policy tools based on its assessment of economic and price developments from its policy framework of “two perspectives.” In this regard, taking into consideration the nature of QQE that I mentioned earlier, I think that it will be necessary at BIS central bankers’ speeches some point to examine the option of gradually starting to shift the focus of monetary policy conduct from the asset purchase policy to other policy tools. 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, Ehime, 9 March 2015.
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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, Ehime, 9 March 2015. * * * Accompanying charts can be found at the end of the speech. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Ehime 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 Matsuyama Branch. The Bank thinks that it is of overriding importance for Japan’s economy to overcome protracted deflation and attain sustainable growth. To achieve this, the Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013 and expanded it in October 2014. Under this policy, Japan’s economy has been making steady progress toward achieving the price stability target of 2 percent. Nevertheless, some have expressed doubts, arguing that it will be difficult to achieve 2 percent inflation in about 2 years, or that if inflation is generated artificially, this would undermine people’s standard of living. Today, I would like to talk about recent economic developments in Japan and then explain the Bank’s monetary policy conduct and price developments. I hope this will also help to dispel the doubts I just mentioned. I. Current situation of and outlook for economic activity at home and abroad To start with, let me talk about the current situation of Japan’s economy. The decline in demand following the consumption tax hike has had somewhat prolonged effects on the economy, especially on sales of durable consumer goods such as automobiles and household electrical appliances reflecting the large extent of front-loading of purchases. However, Japan’s economy has continued its recent moderate recovery trend, with a virtuous cycle from income to spending operating steadily in both the household and corporate sectors. I will discuss the current situation of and outlook for overseas economies and business operations, the household sector, and the corporate sector in order. Overseas economies and Japan’s exports First, overseas economies, led by advanced economies, have been recovering on the whole, although performance in some parts remains lackluster. With the decline in crude oil prices likely to exert a positive effect, overseas economies, led mainly by advanced economies, are expected to continue recovering moderately, and positive effects of the recovery are expected to gradually feed through to emerging economies and commodity-exporting economies. In this context, it is worth noting that in the World Economic Outlook (WEO) Update published in January, the IMF revised its outlook for the world economy downward due to the deceleration of global growth to date, but it maintains its view that global growth will increase gradually: after registering 3.3 percent in 2014, global growth is expected to reach 3.5 percent in 2015 and 3.7 percent in 2016 (Chart 1). Japan’s exports – after showing some continued weakness despite the depreciation of the yen – have been picking up recently, increasing for two consecutive quarters (Chart 2). The depreciation of the yen now, with a delay, appears to be starting to have a positive effect on export volumes. Regarding the outlook, exports are expected to increase moderately against the background of the continued moderate recovery in overseas economies. BIS central bankers’ speeches Employment and income situation and household spending Turning to the household sector and starting with the employment and income situation, labor market conditions have continued their steady improvement. The unemployment rate has declined to around 3.5 percent, which is roughly the same level as the structural unemployment rate, and the active job openings-to-applicants ratio now stands at 1.14, marking the highest level since April 1992 (Chart 3). Against the background of this tightening in labor market conditions, the year-on-year rate of increase in total cash earnings per employee has been accelerating moderately, albeit with fluctuations (Chart 4). Given these developments in employment and wages, employee income has risen moderately. Against the background of steady improvement in the employment and income situation, private consumption as a whole has remained resilient, although recovery in some areas has been sluggish (Chart 5). Housing investment, which saw large front-loading prior to the consumption tax hike, has started to bottom out. Meanwhile, consumer confidence, which had become increasingly cautious since last summer, has recently bottomed out (Chart 6). The employment and income situation is likely to continue to improve steadily, since wages are expected to rise in the annual wage negotiations this spring. Amid this situation, private consumption is expected to remain firm and housing investment is projected to regain its firmness. Corporate profits and developments in fixed investment Finally, let me turn to the corporate sector. Corporate profits have continued to improve thanks partly to the depreciation of the yen to date. Looking at the Financial Statements Statistics of Corporations by Industry, coupled with an increase in sales, the ratio of firms’ current profits to sales has recently reached around 5 percent for all industries and firms of all sizes – a high level that exceeds that prior to the global financial crisis (Chart 7). Corporate profits are expected to continue to be on an improving trend as falling crude oil prices and the yen’s depreciation to date are likely to contribute to pushing up profits. With corporate profits improving, business fixed investment has been on a moderate increasing trend (Chart 8). As for the outlook, with corporate profits continuing to be on an improving trend, business fixed investment is likely to continue following a moderate improving trend against the background that (a) the sense among firms that they have excess capital has been waning, (b) firms are expected to increase labor saving investment due to the tightening of labor market conditions, and (c) with the depreciation of the yen, Japanese firms appear to have started to increase the share of fixed investment at home. In fact, with regard to the last point, at the meeting of general managers of the Bank’s branches in January there were reports of cases where firms were increasing their production and fixed investment at domestic bases against the backdrop of the yen’s depreciation. Production decreased for two consecutive quarters in the April-June quarter and the JulySeptember quarter last year, but due in part to subsequent progress in inventory adjustments, it started to increase again in the October-December quarter and continued to increase in January this year (Chart 9). Against the backdrop of an increase in final demand, production is expected to moderately increase going forward. Therefore, with a virtuous cycle from income to spending operating in both the household and corporate sectors, Japan’s economy has continued its moderate recovery trend. Going forward, this virtuous cycle is likely to continue operating with the fall in crude oil prices to date and the government’s economic stimulus working as boosting factors, and thus Japan’s economy is expected to continue its moderate recovery trend. In terms of the Bank’s Policy Board members’ forecasts released in the January interim assessment of the October 2014 Outlook Report for Economic Activity and Prices (hereafter the Outlook Report), the real GDP growth rate was projected to be minus 0.5 percent in fiscal 2014, but 2.1 percent in fiscal 2015, and 1.6 percent in fiscal 2016 – in other words, it was expected to grow above the potential growth rate, which is estimated to be around 0.5 percent or lower (Chart 10). BIS central bankers’ speeches II. Japan’s price developments and monetary policy I will next talk about the Bank’s conduct of monetary policy and the price situation in Japan. As I mentioned at the outset, the Bank, in order to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about 2 years, introduced QQE in April 2013 and expanded it at the end of October 2014. Aim of quantitative and qualitative monetary easing Let me summarize the transmission mechanism of QQE. The starting point of the mechanism is converting people’s deflationary mindset and thereby raising inflation expectations through the strong commitment by the Bank to achieve the 2 percent target. At the same time, the Bank has been exerting downward pressure on nominal interest rates through its massive purchases of JGBs in order to encourage a decline in real interest rates and stimulate private demand such as business fixed investment. The idea is that, together with the increase in inflation expectations, this will lead to an increase in inflation rates. This might give rise to the question why it is necessary not only to stimulate aggregate demand but also to raise inflation expectations. The reason is that the price stability that the Bank ultimately aims at is not one that is achieved temporarily but one that is achieved on a sustainable basis. If aggregate demand is stimulated, inflation may rise to temporarily reach 2 percent, but will not be sustained in a stable manner as long as people make decisions or engage in economic activity on the basis of low inflation. By contrast, if medium- to long-term inflation expectations rise to 2 percent, that is, people make decisions and engage in economic activity based on the assumption of 2 percent inflation, the inflation rate will gravitate to 2 percent even if it fluctuates due to business cycles and changes in commodity prices. That is, over the cycle, prices will hover at around 2 percent on average. To this end, in order to sustain the price stability target of 2 percent in a stable manner, it is necessary for inflation expectations to rise to 2 percent and be anchored at that level. Expansion of quantitative and qualitative monetary easing Based on this aim, QQE has been producing its intended effects and the year-on-year rate of change in the CPI (excluding fresh food) increased from minus 0.5 percent immediately before the introduction of QQE to a range of 1.0–1.5 percent through summer last year (Chart 11). Meanwhile, people’s inflation expectations also increased on the whole and there was steady progress in dispelling the deflationary mindset (Chart 12). However, since summer last year, due mainly to the substantial decline in crude oil prices as well as somewhat weak developments in demand after the consumption tax hike, the yearon-year rate of increase in the CPI has slowed (Chart 11). If this situation had continued, there was a risk that conversion of the deflationary mindset, which has so far been progressing steadily, might be delayed. If this risk had manifested itself, this would have interfered with the transmission mechanism of QQE, which starts with the rise in inflation expectations. To preempt the manifestation of such risk and to maintain the improving momentum of expectation formation, the Bank expanded QQE in October. Let me explain in more detail. In the short term, falling crude oil prices will lower inflation, but in the longer term, they will have a positive effect on economic activity in an oil-importing country like Japan and hence push up prices. The reason is that the fall in energy prices will lead to a rise in corporate profits and households’ purchasing power; that is, Japan’s terms of trade improve. Given that Japan’s crude oil imports in fiscal 2013 amounted to almost 15 trillion yen, a back-of-the-envelope calculation shows that with the decline in crude oil prices from about 100 dollars per barrel up until last summer to the recent level of about 50 dollars per barrel, the oil price decline represents an increase in annual income to Japan’s economy of more than 7 trillion yen. This is why, from a longer-term perspective, falling oil prices will have a positive effect on economic activity and will push up prices. Thus, other things being equal, the fall in crude oil prices will initially lead to a decline in the inflation rate BIS central bankers’ speeches but the inflation rate will then start to rise once the impact of falling oil prices on the year-onyear rate of change in prices dissipates. Therefore, if falling oil prices lower inflation but inflation expectations remain unaffected and inflation keeps heading toward 2 percent as a trend, there is no need to respond through monetary policy. On the other hand, if falling crude oil prices do affect medium- to long-term inflation expectations and it is judged difficult to achieve 2 percent inflation in the future, a monetary policy response will be necessary. As I mentioned, the Bank did not embark on additional easing as an automatic response to falling crude oil prices; rather, with the yearon-year rate of increase in the CPI being sluggish due mainly to falling oil prices, the Bank carried out additional easing to preempt the manifestation of any risk that the conversion of the deflationary mindset might be delayed and the underlying trend in inflation be adversely affected. Assessing the underlying trend in inflation In conducting monetary policy, it is critical to accurately assess the underlying trend in inflation. So, how should developments in the underlying trend in inflation be assessed? While inflation reflects temporary fluctuations such as those in commodity prices, the underlying trend in inflation is determined by the output gap and medium- to long-term inflation expectations. Therefore, in order to assess the underlying trend in inflation, it is critical to evaluate these two factors. Medium- to long-term inflation expectations are reflected not only in market-based indicators, such as the break-even inflation rate gauged from inflation-indexed bonds, or in data from various surveys of firms, households, and economists. Instead, since the term “inflation expectations” refers to the inflation rate expected by the general public – and hence expectations underlying people’s decisionmaking and economic activity – inflation expectations are reflected in everyday economic activities such as firms’ price-setting behavior, wage negotiations between management and labor, and households’ consumption patterns. Looking at wages, base pay increased for the first time in a long time in last year’s annual spring wage negotiations between management and labor based on the assumption that general prices would increase. In addition, instead of simply searching for low-priced goods, consumers have started to purchase somewhat higher-priced goods provided that the quality matches the price, and firms’ price-setting stance has changed accordingly. These developments provide evidence of a rise in inflation expectations, indicating that there has been steady progress in changing the deflationary mindset. In examining price indicators, it is necessary to monitor not a single index but various indicators to assess the underlying trend in inflation. The Bank has been examining indicators such as the headline CPI, the CPI less fresh food (the so-called core CPI), the CPI less food and energy (the so-called core-core CPI), the trimmed mean CPI, which excludes highly volatile items, and the ratio of the number of items that registered a price increase to that of items that registered a price decrease. The Bank even analyzes developments in each CPI item component as necessary. In presenting the projections for prices, the Bank uses the CPI (excluding fresh food) as an indicator that tends to represent the underlying trend in inflation adequately under normal circumstances. However, this index includes energy prices and thus will temporarily decline when, as currently the case, crude oil prices have been declining substantially, so that it becomes difficult to assess the underlying trend in inflation using only this index. Therefore, in the January interim assessment, in addition to the forecasts for the CPI (excluding fresh food), the Bank showed the estimated contribution of energy items to the index. Future price developments and monetary policy Based on what I have explained so far, let me talk about the outlook for prices. The year-onyear rate of increase in the CPI (excluding fresh food), after 0.9 percent in fiscal 2014, in the January interim assessment of the Outlook Report is projected to be only 1.0 percent in fiscal BIS central bankers’ speeches 2015 due to the effects of the substantial decline in crude oil prices to date (Chart 10). Nevertheless, we are of the view that the underlying trend in inflation will rise steadily. Specifically, the output gap, which determines the underlying trend in inflation, is likely to continue improving as Japan’s economy continues to grow above potential as a trend. In addition, inflation expectations will also likely rise steadily. In fact, at the annual spring wage negotiations between management and labor this year, labor unions have requested larger wage increases than those of last year and firms’ management has generally taken a positive stance toward such an increase. Since work patterns have become more diverse, an increase in wages can take various forms such as an increase in base pay, bonuses, or various allowances, but whatever form it takes, the transformation of people’s deflationary mindset is likely to make further progress if total wages actually rise. In addition, on a yearon-year basis, the effect of the decline in crude oil prices falls away after a year. Therefore, while the year-on-year rate of change in the CPI (excluding fresh food) is likely to be small in the first half of fiscal 2015 due to effects of the decline in crude oil prices to date, assuming that crude oil prices will rise moderately from their current level, it is expected to accelerate in the second half of fiscal 2015 as the effect of the fall in crude oil prices dissipates, and is expected to reach around 2 percent in or around fiscal 2015. Subsequently, for fiscal 2016 the year-on-year rate of increase in the CPI (excluding fresh food) is projected to reach 2.2 percent as the economy continues to grow above the potential growth rate and the output gap improves in positive territory. Since crude oil prices have recently been fluctuating substantially, the 2 percent inflation rate, depending on developments in crude oil prices, may be achieved somewhat sooner or later than envisaged. That said, however, let me reiterate that in our view, what matters is the underlying trend in inflation. Going forward, 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. Of course, the Bank will make adjustments as necessary to achieve the price stability target at the earliest possible time, if there are changes in the underlying trend in inflation. Regional economies after the 2 percent target has been achieved As explained, the Bank believes that the price stability target of 2 percent can be achieved through continuing with QQE. On the other hand, some have argued that QQE may lead only to higher inflation, which would undermine people’s standard of living. Therefore, let me talk about why it is necessary to aim at 2 percent. Under deflation, the real value of cash and deposits increases simply by holding them. Therefore, hoarding cash and deposits becomes a better investment than actual investment. In Japan, as a result of protracted deflation, firms’ investment in business facilities and in research and development remained restrained, which deprived the economy of potential growth and led to a loss of vitality. Such subdued business fixed investment is one reason that Japan’s potential growth rate has been on a declining trend (Chart 13). However, in an economy in which prices rise steadily at a rate of 2 percent, the situation changes drastically. That is, since the real value of cash and deposits will erode over time, firms need to make effective use of their funds in hand in the form of investing in business facilities and in research and development as well as recruiting and developing human resources. Proactive behavior such as venturing into new business areas will also increase. Such developments will enhance firms’ competitiveness and productivity, and consequently result in restoring the vitality of Japan’s economy as well as raising the growth potential. Japan’s economy as a whole will likely expand accompanied by a virtuous cycle among income, spending, and production. What the Bank is aiming at is not to reach a state in which only prices rise, but one in which the economy expands with corporate profits and wages rising, and the price stability target of 2 percent is achieved. At present, Japan’s economy is still in the process of overcoming protracted deflation. The gains from the improving economic situation differ substantially between large and small firms and between urban and regional areas rather than being evenly spread. Going forward, BIS central bankers’ speeches as the economy as a whole continues to grow with the virtuous cycle continuing to operate, corporate profits and employee income are likely to improve further and the gains of the economic recovery are expected to spread. Of course, achieving the price stability target of 2 percent in itself will not solve the challenges regional economies face and raise their growth. Population decline and aging are progressing more rapidly in regional than in urban economies, necessitating medium- to long-term initiatives to raise growth in the regions. Economic growth is determined by the growth rate of the population and the growth rate of per capita value added. As for the population growth rate, there were only eight prefectures, among them Tokyo and Aichi, in which the population increased in the year to October 2013. In addition, regional areas relatively have a higher population share of those aged 65 or older and a lower working-age population share – those aged 15–64 – than urban areas. Wages reflect value added per worker, and there are only five prefectures – all in metropolitan areas – in which wages are above the national average: Tokyo, Kanagawa, Aichi, Kyoto, and Osaka. It is not going to be easy to stem the population decline and achieve a population increase in regional areas while the population of Japan as a whole continues to fall. This means that it is necessary to first raise the productivity of firms located in the regions and enhance the value added that they produce. In fact, regional areas could take a number of initiatives to enhance value added in ways that differ from those of metropolitan areas, such as combining primary, secondary, and tertiary industries into “a sixth industry,” product branding, and using local history, culture, and the natural environment to promote tourism. Rising productivity will enable firms to raise wages, which in turn could lead to a virtuous cycle encouraging people to stay in or move to regional areas, since regional areas in fact offer many attractions, such as allowing people to live close to their workplace and to live in an environment that facilitates raising children. As mentioned earlier, in an economy in which the price stability target of 2 percent is sustained in a stable manner, it is advantageous to make effective use of cash and deposits for investment or human resource development rather than hoarding them. The Bank would like to reach this point as soon as possible and support firms’ initiatives. In addition, the Bank decided in January to extend the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth and the Fund-Provisioning Measure to Stimulate Bank Lending by one year and to increase the maximum amount of funds for the former. Concurrently, the Bank decided to introduce a new framework for enabling financial institutions that do not have a current account at the Bank and thus were not eligible, such as credit cooperatives and agricultural cooperative associations, to use these fund-provisioning facilities through their central organizations. I hope that these facilities will be used extensively for the development of regional economies. Conclusion In concluding, let me touch on the economy of Ehime Prefecture. Looking at the current state of the economy of Ehime Prefecture, while private consumption has been somewhat slow to pick up, overall, a virtuous cycle from income to spending has been operating just as in Japan as a whole, with production at a high level and the employment and income situation improving steadily. In addition, partly due to falling crude oil prices, corporate profits have generally been favorable. However, as I mentioned earlier, the gains from the economic recovery have been unevenly distributed in terms of industries and firm size. Specifically, reflecting the depreciation of the yen, there have been significant improvements in orders and profits in shipbuilding, maritime industries, and other manufacturing industries with a global presence, whereas improvements in business sentiment have remained moderate in the pulp and paper industry as well as among many nonmanufacturing small firms due mainly to the increase in input prices. BIS central bankers’ speeches There are also various initiatives to boost Ehime’s economy. There have been encouraging examples. The “Imabari towel” product branding is famous for its considerable success and the industry has made a remarkable comeback. Recently, shipbuilding firms have built new large-scale docks, and some firms in the region have enhanced their production and research and development bases in the region. In addition, firms have also been active in expanding sales channels through cooperating with administration and financial institutions. The united efforts by related parties will substantially contribute to raising the productivity of the regional economy. In the tourism sector, there were ambitious initiatives last year incorporating cycling and the arts into existing tourism resources to enhance the profile and attractiveness of the region, such as “Setouchi Shimanowa 2014” in areas around the Shimanami Kaido bicycle path and “Dogo Onsen Art” in Dogo Onsen. In addition, Shikoku region was featured in the web version of the well-known Michelin Green Guide, boosting the region’s international profile. While tourists from abroad tend to concentrate on metropolitan areas, Hokkaido, and Okinawa, promoting the region’s attractions not only to domestic but also to overseas tourists has the potential to substantially boost the regional economy. Furthermore, the regional revitalization plan of Saijo City was the only plan in Shikoku region to be designated as a model of vitalization of the local economy. Regarding the vitalization of the local economy, the government asked prefectures and municipalities to establish during fiscal 2015 their own long-term vision to overcome population decline and formulate regional versions of the government’s comprehensive strategy for vitalizing local economies. Ehime Prefecture, with a population that is declining and aging faster than Japan’s population as a whole, will also need to implement comprehensive policy measures to raise the value added of regional industries in order to increase the productivity of the regional economy and to attract those in their prime of life or raising children to the prefecture. I believe that specific initiatives will be considered through further cooperation between the administration and the private sector, and the Bank’s Matsuyama Branch will conduct analyses of the regional economy so as to contribute to such examination as much as possible. In closing, I wish all the best for the further development of the regional economy. 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
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Foreign Correspondents' Club of Japan, Tokyo, 20 March 2015.
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Haruhiko Kuroda: Quantitative and qualitative monetary easing – theory and practice Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Foreign Correspondents’ Club of Japan, Tokyo, 20 March 2015. * * * Accompanying charts can be found at the end of the speech. Introduction It is my great honor to have the opportunity to speak today at the Foreign Correspondents’ Club of Japan. With the European Central Bank (ECB) having started its asset purchase program, most of the major central banks, including the Federal Reserve and the Bank of England (BOE), now have adopted quantitative easing (QE). If I may borrow the words of Professor Takatoshi Ito, a friend and someone I greatly respect, “we are all QE-sians now.” That being said, the economic and price situation against which QE has been introduced, as well as the policy transmission mechanism assumed, differ among countries and regions. Today, I would like to clarify the characteristics of the Bank of Japan’s current quantitative and qualitative monetary easing (QQE) by focusing on similarities to and differences with the QE introduced by other central banks. I will further explain how QQE has been producing the intended effects. I. The theory behind QQE Similarities and Differences between QE and QQE I just mentioned that “we are all QE-sians now.” What brought us into this situation is the global financial crisis in 2008. The U.S. and European economies deteriorated considerably due to the global financial crisis and unemployment increased substantially, so that central banks had to stimulate the economy through monetary easing. Initially, central banks in Europe and the United States responded to the crisis by using the traditional policy tool of lowering short-term interest rates, but since the economies deteriorated quite significantly, those rates soon approached the zero lower bound (Chart 1). Facing the zero lower bound on short-term nominal interest rates, central banks were therefore confronted with the question of how to proceed with further monetary easing. The Federal Reserve’s and the BOE’s answer was to introduce QE. QE mainly aims at stimulating the economy by lowering long-term interest rates, which still had room to fall, through massive purchases of government and other bonds by the central bank. The Bank’s QQE is similar to QE in that it aims to encourage long-term interest rates to decline through massive purchases of government bonds. QQE, however, has another element: to drastically change the deflationary mindset that had taken hold amid the prolonged deflation. In order to understand this point, it is necessary to correctly diagnose the problems ailing Japan’s economy and identify appropriate remedies. Japan’s economy had been suffering from deflation since the mid-1990s, with the year-onyear rate of change in the consumer price index (CPI) being about zero or slightly negative. A key feature of deflation in Japan was that it was mild but persistent: the average of the year-on-year rates of change in the CPI from fiscal 1998 to fiscal 2012 was only minus 0.3 percent, but the deflationary situation lasted for a decade and a half (Chart 2). Japan got mired in deflation due to a variety of factors, including balance sheet adjustments by firms and financial institutions following the bursting of the asset price bubble, the inflow of lowpriced goods from emerging economies, and the excessive appreciation of the yen. BIS central bankers’ speeches Whatever the reasons may be, a key problem that arose is that, as prices continued to fall due to these factors for a prolonged period, a deflationary mindset took hold among the public – that is, the belief became entrenched that prices would not increase but continue to steadily decline. Once this deflationary mindset had taken hold, people engaged in economic activity assuming that deflation would continue. As a result, the economy fell into a vicious cycle of a decline in prices, a decline in sales and profits, stagnant wages and consumption, and a further decline in prices. Moreover, under deflation, the real value of cash and deposits increases with the decline in prices. Therefore, hoarding cash and deposits becomes a relatively better investment strategy than actual investment, discouraging firms from taking risks and investing in business facilities and in research and development to launch new businesses. In this way, deflation in Japan perpetuated itself in a self-fulfilling manner and the growth potential continued to decline. In order to overcome this situation, it is necessary to change the entrenched view that “prices will not rise” and achieve a state in which firms and households act based on the assumption that “prices will rise moderately every year.” In the economic jargon, people’s view on how prices will develop in the future is called inflation expectations. And although inflation rates tend to fluctuate – reflecting not only the business cycle but also temporary factors such as changes in commodity prices – they are likely to do so at around the level of inflation expectations on average, if medium- to long-term inflation expectations are anchored at a certain level. A numerical definition of what central banks consider as price stability based on a specific price index is about 2 percent in terms of the year-on-year rate of change in the CPI; this has become the global standard in recent years. While I will not go into detail due to time constraints, this figure – 2 percent – takes into account the upward bias in the CPI, that is, the tendency of the index to overstate inflation, and provides a buffer allowing to sufficiently lower real interest rates should the economy deteriorate. For Japan’s economy to overcome deflation, it was necessary to dispel the deflationary mindset and raise inflation expectations – which had declined to about 0 percent – to about 2 percent and re-anchor expectations at that level. Changing people’s expectations is the main aim of QQE. The theory behind QQE Attempting to change people’s mindset and perceptions through monetary policy is not without historical precedent. For example, while the direction of desired change was the opposite of that in Japan, the Federal Reserve under Chairman Paul Volcker was successful in the late 1970s to early 1980s in substantially lowering inflation expectations, which had been ratcheting upward, through powerful monetary tightening (Chart 3). Since both unemployment and inflation were surging at the time, such stringent monetary tightening created both political and social challenges. Despite such difficulties, however, it was quite clear to Chairman Volcker what policy steps he had to take to lower inflation expectations: he had to pursue strong monetary tightening by substantially raising short-term interest rates to contain inflation. On the other hand, while QQE would not aggravate unemployment, it faced another problem, namely that the tools for monetary easing were limited, given that shortterm interest rates were close to the zero lower bound. The thinking behind QQE is as follows. First of all, as I discussed earlier, given that shortterm interest rates had declined to zero, the Bank, like the Federal Reserve and the BOE, decided to put downward pressure on long-term interest rates through massive purchases of government bonds. The Bank then focused on the fact that what influences economic activity is not nominal but real interest rates, that is, the interest rate level obtained by subtracting inflation expectations from nominal interest rates. In this regard, the fact that inflation expectations in Japan were well below the price stability target of 2 percent provided a way to break through the BIS central bankers’ speeches deflationary mindset: if the Bank could raise inflation expectations, real interest rates would fall, stimulating economic activity by firms and households. In this sense, raising inflation expectations is both an objective of QQE and, at the same time, the key to implementing the QQE transmission mechanism to overcome deflation. This raises the question of how people’s deflationary mindset can be changed and inflation expectations can be raised. For firms and households with a deflationary mindset to start thinking that “from now, we will act based on the assumption that prices will rise by about 2 percent every year,” it is necessary above all that the central bank fully commits itself to achieving 2 percent inflation. Based on these considerations, the Bank committed itself to achieving the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years, and to maintaining the target in a stable manner. And as a means to this end, the Bank introduced large-scale monetary easing in the form of QQE. A decline in real interest rates can be expected to stimulate private demand such as business fixed investment, private consumption, and housing investment. Such an increase in private demand in turn reduces the output gap, that is, the amount of slack in the economy as a whole, thereby putting upward pressure on prices. And once people actually experience inflation, this will boost their confidence in the Bank’s commitment, leading to a further rise in inflation expectations and reinforcing the aforementioned processes, forming a virtuous cycle. This is the mechanism through which QQE aims at raising inflation and inflation expectations to 2 percent. II. The practice of QQE Effects of QQE So far, I have talked about the theory of QQE, but to what extent has this policy actually been exerting any effects? First of all, as a result of the Bank’s massive purchases of Japanese government bonds (JGBs), long-term interest rates have further declined. Ten-year JGB yields have recently been around 0.4 percent (Chart 4). Moreover, the average interest rate on new loans has declined to historic lows of about 0.9 percent. In addition, people’s perception of inflation has clearly changed. Various indicators of medium- to long-term inflation expectations show clear increases since the introduction of QQE. For example, the figure presented in the Consensus Forecast was 0.8 percent in October 2012 but has risen to 1.5 percent of late. Therefore, real interest rates, including longer-term ones, have become clearly negative. Also, people and businesses feel that, in their daily life, the inflation environment has been changing substantially. Let me cite two noteworthy examples. First, the year-on-year rate of change in the CPI has been positive for 20 months since June 2013. This is the first time since 1998 that people have experienced inflation for such a long period. It means that this is the first time ever for people in their 20s or younger to experience rising prices. Second, since last year, nominal wages have been rising. Of particular note is that during the annual wage negotiations last spring, the so-called spring offensive, base pay rose for the first time in about 20 years, and rising base pay is likely to be seen in increasingly many firms this year. Both examples represent landmark changes for Japan, which has experienced deflation for such a long period. While the word “deflation” – defure in Japanese – had become part of everyday conversation, recently the term can rarely be heard. Furthermore, this momentum toward overcoming the deflationary mindset has continued even amid the decline in CPI inflation reflecting the effects of falling crude oil prices. Looking at indicators of inflation expectations, while market-based indicators such as the break-even inflation rate – as in Europe and the United States – have declined, various surveys of BIS central bankers’ speeches economists and households suggest that medium- to long-term inflation expectations continue to be on an upward trend. We believe this is because the Bank’s expansion of QQE last October – undertaken as a preemptive response to the risk that falling crude oil prices could affect wage negotiations and price-setting by lowering inflation expectations – has been effective. As I have explained, QQE has been exerting its intended effects and it seems safe to say that QQE works both in theory and practice. The Bank believes that it can achieve the price stability target of 2 percent by continuing to steadily pursue QQE going forward. In the following, I will offer my view on the economic and price situation in more detail, and explain why I think that QQE will lead to the realization of the price stability target of 2 percent. Economic and price situation Let me start with economic activity. The corporate sector is buoyant. Profits have continued to improve and have reached new peaks (Chart 5). The decline in crude oil prices will further benefit the sector by reducing costs. In addition, exports and production have been picking up. In this situation, firms have maintained their positive investment stance and their demand for labor has remained strong. Against the backdrop of the strong demand for labor in the corporate sector, labor market conditions remain tight and Japan is close to full employment. Specifically, the unemployment rate has declined to around 3.5 percent, which is roughly the same level as the structural unemployment rate (Chart 6). The tightness in labor market conditions has been exerting upward pressure on nominal wages, which are expected to continue rising. Against the backdrop of this steady improvement in the employment and income situation, private consumption as a whole has been firm. In this situation, downward pressure stemming from the decline in demand following the consumption tax hike has been waning. The decline in crude oil prices will also have a favorable effect on private consumption. Given the various tailwinds to economic activity, the Bank expects Japan’s real GDP growth in fiscal 2015 to be about 2 percent. In the Bank’s January interim assessment of the October 2014 Outlook Report for Economic Activity and Prices, the real GDP growth rate was projected to be 2.1 percent in fiscal 2015 and 1.6 percent in fiscal 2016 (Chart 7). In the current improving economic situation, the output gap has improved substantially mainly due to the tightening of the labor market. It has become about 0 percent, that is, close to the long-term average. Going forward, with Japan’s economy continuing to grow above its potential growth rate, which is estimated to be around 0.5 percent or lower, the output gap is expected to further improve. In addition, as mentioned earlier, medium- to long-term inflation expectations have remained on an uptrend. The underlying trend in inflation has been increasing as its two determinants, namely, the output gap and medium- to long-term inflation expectations, are improving. However, in terms of the year-on-year rate of increase in the CPI excluding fresh food stripping out the direct effects of the consumption tax hike, inflation has slowed since last summer due mainly to the substantial decline in crude oil prices and registered 0.2 percent in January (Chart 8). Going forward, the rate of increase is expected to be about 0 percent due to the effects of the decline in energy prices and is likely to remain at that level for the time being. However, the underlying trend in inflation is expected to continue to steadily increase in the future. Therefore, as the effects of falling crude oil prices on the year-on-year rate of change, that is, the base effect, dissipate, CPI inflation will accelerate and achieving 2 percent CPI inflation will come in sight. Based on the assumption that crude oil prices will rise moderately from their recent levels, CPI inflation is expected to reach 2 percent in or around fiscal 2015 (Chart 7). The timing of this could be somewhat sooner or later than envisaged depending on developments in crude oil prices. However, if it is clear that the timing in which the 2 percent target will be achieved depends mainly on fluctuations in BIS central bankers’ speeches energy prices, market participants will not draw any unwarranted conclusions with regard to monetary policy, as they know that the base effect caused by changes in energy prices will eventually disappear. Needless to say, the Bank maintains its policy stance that it will make adjustments as necessary without hesitation, when there are changes in the underlying trend in inflation, especially in developments in inflation expectations, in order to achieve the price stability target at the earliest possible time. III. The government’s growth strategy and the bank’s monetary policy To conclude my speech, I would like to talk about strengthening the growth potential of Japan’s economy. Japan’s potential growth rate has been on a declining trend since the 1990s (Chart 9). Reasons include demographic trends such as the decline in the workingage population as well as regulatory and institutional factors that have hindered corporate activities and impeded competition. In order to raise the growth potential, it is necessary to remove such factors that hamper private entities’ proactive economic activities. Consequently, it is encouraging that various regulatory and institutional reforms have steadily been implemented through the government’s growth strategy. In this context, I would like to highlight that overcoming deflation itself will contribute to raising Japan’s growth potential. Investment and innovation in the private sector are key to economic growth, and the role of the government’s growth strategy is to create an environment in which firms can thoroughly pursue business opportunities. In addition, overcoming deflation and achieving an economy and society in which economic entities take action on the assumption of 2 percent inflation will revive firms’ and households’ animal spirits. If that happens, people will start to take more risks and invest in new ventures, which in turn is likely to give rise to innovations. With firms and households becoming more proactive, it will become even clearer which regulatory and institutional aspects have hampered growth. I think one of the reasons why only some progress has been made in regulatory and institutional reforms is that the momentum toward reforms was lacking as private entities were not sufficiently proactive. The emergence of real needs for reforms will be a major driving force to push ahead with regulatory and institutional reforms. Under QQE, the deflationary mindset is steadily being dispelled. The Bank aims to contribute to strengthening the growth potential of Japan’s economy through its continued efforts through QQE and by achieving the price stability target of 2 percent at the earliest possible time. Concluding remarks Today, I have talked about the challenges facing Japan’s economy and the characteristics of QQE as a remedy for those challenges. The greatest lesson from Japan’s experience is that the best is not to fall into deflation in the first place, since there is the danger that, once the economy has fallen into it, deflation becomes protracted. If there is a risk of deflation, policy authorities should make every effort to prevent the economy from falling into it. Having said that, even if the economy becomes trapped in deflation, it is possible to overcome deflation through innovative monetary policy. By succeeding in getting the economy out of deflation through QQE, the Bank hopes to provide a case in point. If the Bank can show that even if the economy falls into deflation, there are policy measures to escape from it, this will strengthen confidence in central banks’ ability to achieve their price stability targets, which reinforces their ability to anchor inflation expectations. Well-anchored inflation expectations, in turn, help to prevent the economy from falling into and becoming trapped in deflation in the first place. In this regard, success of the Bank’s QQE has important implications not only for Japan’s economy but also for monetary policy around the globe. Thank you very much for your attention. 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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, Kanagawa, 26 February 2015.
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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, Kanagawa, 26 February 2015. * * * I. Developments in economic activity and prices A. Overseas I would like to start my remarks with a look at developments in economic activity and prices, in and outside Japan. On overseas economies – mainly advanced economies – the Bank of Japan’s current assessment is that they have been recovering, albeit with a lackluster performance still seen in part. The average of real GDP growth rates of major countries and regions, weighted by value of exports from Japan, has been posting higher growth, due mainly to a pick-up in the U.S. economy, after decelerating to 1.7 percent in the January-March quarter of 2014. As for the outlook, the projections of global economic growth, released by the International Monetary Fund (IMF), have been revised downward repeatedly, but the projection of the growth rate gradually accelerating toward 2016 is unchanged. The Bank likewise expects that the overall global economy will moderately increase its growth rate, as advanced economies will continue to enjoy a recovery and the positive effects will gradually spread to emerging economies. Taking a closer look at developments by region, the U.S. economy has continued to see solid recovery, led mainly by private demand. According to U.S. employment statistics for February 2015, the number of employees has been increasing by more than 200 thousand people on a seasonally adjusted month-on-month basis for eleven consecutive months, and the unemployment rate has been hovering at a low level. In this situation, consumer sentiment has been on an improving trend. Although wage increases have been somewhat weak, the economy is likely to continue to see solid recovery, as private consumption continues to increase on the back of the improvement in the employment situation and of low gasoline prices. The euro area economy has maintained its moderate recovery, as seen in the fact that the real GDP growth rate has been positive for seven consecutive quarters, and the slowdown in its growth momentum observed since spring 2014 has come to a halt. As for the outlook, the economy is likely to maintain its recovery, albeit at a moderate pace, mainly because the depreciation of the euro and monetary easing by the European Central Bank (ECB) are likely to contribute to underpinning the economy, although close attention should continue to be paid to factors such as the risk of low inflation becoming protracted and the effects of the situation in Ukraine and Russia. As for the Chinese economy, the year-on-year growth rate of real GDP for the OctoberDecember quarter of 2014 was 7.3 percent, unchanged from the previous quarter. The economy has generally maintained its stable growth, although its momentum has somewhat slowed due to downward pressure associated with structural reforms. As for the outlook, the Chinese economy is likely to basically continue to grow stably, although attention should be paid to an overhang in supply capacity in the manufacturing sector and to the adjustment pressure in the real estate market, mainly in local cities. Emerging economies as a whole have remained lackluster in terms of growth. Looking at developments in the East Asian region, which is closely tied with Japan’s economy, while the NIEs have been improving on the whole, mainly due to a pick-up in domestic demand, the ASEAN economies have been lacking growth momentum. As for the outlook, emerging BIS central bankers’ speeches economies as a whole are likely to gradually increase their growth rates as advanced economies, particularly the United States, have positive effects on them, triggering a pick-up in domestic demand. B. Japan 1. Current situation Now I will discuss developments in economic activity and prices in Japan. The Bank’s current assessment is that the economy has continued its moderate recovery trend. The growth rate of real GDP for the October-December quarter turned positive, registering 2.2 percent on an annualized quarter-on-quarter basis, following the negative growth for two consecutive quarters after the consumption tax hike in April 2014, mainly due to the decline in demand following the front-loaded increase prior to the tax hike and to adverse weather conditions. A look at developments in each demand component shows that business fixed investment has been on a moderate increasing trend, while exports have been picking up noticeably and private consumption has remained resilient in a situation where the effects of the decline in demand following the front-loaded increase have been dissipating. Given these developments, I hold the view that, having emerged from the pause in the first half of fiscal 2014, the economy has started to show signs of returning to a moderate recovery path. Although a limited number of economic indicators has been released with regard to developments since the beginning of 2015, real exports for January showed a clear pick-up of 5.0 percent from the previous month, mainly due to an increase in exports of automobiles to the United States. Meanwhile, as for private consumption, the number of new passengercar registrations for January declined slightly, while indicators of consumer sentiment, which had been relatively weak since 2014, have been bottoming out recently. With regard to prices, the year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food, excluding the direct effects of the consumption tax hike, is around 0.5 percent. The rate of increase has recently been slowing, mainly due to a fall in the prices of petroleum products caused by the decline in crude oil prices. On a basis excluding food and energy, the rate of increase in the CPI had been slowing marginally, mainly reflecting the weakness in consumption during the summer of 2014, but for December, it is unchanged from the previous month. 2. Outlook Japan’s economy is expected to continue its moderate recovery trend. On the price front, the year-on-year rate of increase in the CPI is likely to slow for the time being, reflecting the decline in energy prices. Meanwhile, risks to the outlook include developments in the emerging and commodity-exporting economies, the prospects regarding the debt problem and the risk of low inflation rates being protracted in Europe, and the pace of recovery in the U.S. economy. The Bank compiles and releases the Policy Board members’ forecasts for economic activity and prices on a quarterly basis. Looking at the medians of the members’ forecasts released in January 2015, the real GDP growth rate is projected to be minus 0.5 percent for fiscal 2014, 2.1 percent for fiscal 2015, and 1.6 percent for fiscal 2016. 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 projected to be 0.9 percent for fiscal 2014, 1.0 percent for fiscal 2015, and 2.2 percent for fiscal 2016. Compared with the forecasts made in October 2014, real GDP growth will likely be lower for fiscal 2014, but higher for fiscal 2015 and 2016, due mainly to the positive effects from the substantial decline in crude oil prices and the government’s economic measures. With regard to the CPI, the outlook for the underlying trend is unchanged; the year-on-year rate of increase will likely be lower toward fiscal 2015, due to BIS central bankers’ speeches the significant decline in crude oil prices, but that for fiscal 2016 will likely be more or less unchanged at above 2 percent, due mainly to the waning of downward pressure. 3. Keys to assessing the outlook Thus far, I have briefly outlined the current situation of and outlook for economic activity and prices. In what follows, I will discuss the three keys to assessing the outlook. a. Effects of the decline in crude oil prices The first is the effects of the decline in crude oil prices on the global economy and prices. Although crude oil prices have been rising slightly recently, they have generally been at a level substantially below their peak observed around June 2014. The following factors have been pointed to as the background to the substantial decline in crude oil prices: oil supply factors, such as the decision of a group of major oil-exporting countries to maintain their production levels despite the rise in production of other oil, such as shale oil in the United States; and a decline in demand for crude oil due to economic deceleration in emerging and European economies, for example. These factors combined are likely to have had an impact on the decline in crude oil prices. In terms of the effects of the decline in crude oil prices on Japan’s economy, as is being discussed widely, I believe that the net effect of this is likely to be positive in terms of economic activity, brought about by an improvement in corporate profits and a rise in households’ real purchasing power. On the price front, the price declines in energy – including the drop in the price of crude oil – are likely to exert downward pressure on general prices in the short term. From a relatively longer-term perspective, however, they are likely to push up general prices through an improvement in the output gap. In other words, I basically consider that the decline in crude oil prices will bring about positive effects on both economic activity and prices over time, but at the same time, I also consider that attention should be paid to its effects on certain areas of the economy. I mentioned earlier that the projections of global economic growth released by the IMF have been revised downward repeatedly, and I consider that this itself suggests the existence of vulnerable areas in the world economy despite the global recovery trend. In this situation, the decline in crude oil prices is likely to exert adjustment pressure on capital investment by the energy and resources sector, which is said to account for approximately 40 percent of such investment on a global basis. Attention should be paid to the possibility that this in turn will exert downward pressure on orders, production, and exports of Japan’s capital goods, in which the country has a competitive edge. b. Developments in real wages The second key is developments in real wages. Since the turn of fiscal 2014, the year-onyear rate of change in real wages has been negative, due in part to the substantial increase in the rate of change in the CPI including the effects of the consumption tax hike. Meanwhile, there has been a somewhat weak recovery in consumption from the decline following the front-loaded increase prior to the consumption tax hike. I believe that the decline in real wages, in addition to the effects of irregular weather, largely accounted for the weak recovery. Therefore, for private consumption to pick up clearly and maintain an increasing, albeit moderate, trend in fiscal 2015 and beyond, I consider it necessary that nominal wages rise firmly and that wages in real terms – adjusted for inflation – start rising on a year-on-year basis. On this point, let us look at recent developments in Japan’s economy. Corporate profits as a whole have been increasing, with some differences observed in the business performance between exporting firms – which benefit from the yen’s depreciation – and domestic demandoriented firms – against which the yen’s depreciation acts as a headwind. In view of the continued tight employment situation and of developments in prices, it is my consideration that the conditions are being prepared for wages to start rising in the form of increases in base pay and bonus payments. Household income, I believe, will be a great driving force for BIS central bankers’ speeches supporting a virtuous cycle in the household sector from fiscal 2015 if, as a result of wage negotiations in spring 2015, nominal wages improve to an extent that will bring about a rise in real wages; however, attention should be paid to the effects, for example, of the introduction of the macroeconomic slide formula to the pension system in Japan from fiscal 2015. c. Developments in exports The third key is developments in exports. Real exports had been sluggish despite the substantial depreciation of the yen since the introduction of quantitative and qualitative monetary easing (QQE) in April 2013. A range of factors have been pointed to regarding the slow emergence of the J-curve effects; namely, cyclical factors such as the sluggishness in emerging economies and structural factors such as the increase in the relocation of production overseas by Japanese manufacturers. Given these circumstances, unlike in the past, it has become quite difficult for exports to act as the driving force of Japan’s economy even amid the situation of the yen’s depreciation. It must be noted, however, that real exports have started to rise noticeably recently. Moreover, an increasing number of firms has announced plans to expand domestic business, as some manufacturers have been shifting their production back to Japan and making import substitutions. Amid the situation of the yen’s depreciation, developments that will yield a virtuous cycle in the economy are beginning to be observed steadily, and I believe they will continue to gradually strengthen as the yen stabilizes. In determining the outlook for production and exports, it is also necessary to observe such changes in corporate behavior. II. The Bank’s monetary policy A. Expansion of QQE Next, I would like to discuss the Bank’s monetary policy. At the Monetary Policy Meeting held on October 31, 2014, the Bank decided to expand QQE, which it introduced in April 2013. The specific measures of the expansion were as follows. First, the Bank decided to accelerate the pace of increase in the monetary base it provides from “an annual pace of about 60–70 trillion yen” to “an annual pace of about 80 trillion yen.” Second, it decided to raise the pace of increase in the amount outstanding of the Bank’s holdings of Japanese government bonds (JGBs) from “an annual pace of about 50 trillion yen” to “an annual pace of about 80 trillion yen.” At the same time, the Bank decided to extend the average remaining maturity of its JGB purchases from “about seven years” to a flexible range of “about seven to ten years.” And third, it decided to purchase exchangetraded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding would be tripled to annual paces of “about 3 trillion yen” and “about 90 billion yen,” respectively. Around the time of the Bank’s expansion of QQE in October 2014, somewhat weak developments in demand following the consumption tax hike and the substantial decline in crude oil prices had been exerting downward pressure on prices. The Bank considered that, if such downward pressure remained, albeit in the short term, there was a risk that the emergence from the deflationary mindset, which had been progressing steadily, might be delayed. To preempt the manifestation of this risk and to maintain the improving momentum of expectation formation, the Bank decided on the expansion of QQE. B. Enhancement of other fund-provisioning measures Prior to the introduction of QQE, the Bank established – on its balance sheet – the Loan Support Program, with the aim of making the effect of monetary easing permeate the entire economy. The program consists of two measures – namely, the fund-provisioning measure to support strengthening the foundations for economic growth (hereafter the GrowthSupporting Funding Facility) and the fund-provisioning measure to stimulate bank lending BIS central bankers’ speeches (hereafter the Stimulating Bank Lending Facility) – and had been providing support for private financial institutions’ efforts to these ends. In January 2015, the Bank decided to extend the application period of the program by one year. It also decided, with regard to the Growth-Supporting Funding Facility, to increase the maximum amount of funds that it can provide to each financial institution from 1 trillion yen to 2 trillion yen, and also to increase the maximum amount outstanding of its fund-provisioning as a whole from 7 trillion yen to 10 trillion yen. Moreover, the Bank further enhanced the program by introducing a new framework for enabling financial institutions that do not have a current account at the Bank to use the Growth-Supporting Funding Facility and the Stimulating Bank Lending Facility through their central organizations. The Bank also decided, in January 2015, to extend the application period of the fundssupplying operation to support financial institutions in disaster areas affected by the Great East Japan Earthquake by one year. Through these enhancements of the existing measures, the Bank will further promote financial institutions’ lending, as well as stimulate firms’ and households’ demand for credit and continue to support the efforts of financial institutions in disaster areas toward rebuilding. C. Financial Conditions As I have described, the Bank has been implementing large-scale monetary easing through various measures. In this situation, interest rates in financial markets have been hovering at extremely low levels. Yields on 10-year JGBs are currently in the range of 0.3–0.4 percent, although there have been relatively large fluctuations recently. While the U.S. dollar/yen rate has been moving within a narrow range of 115–120 yen, the Nikkei 225 Stock Average has been in the range of 18,000–19,000 yen. Financial conditions have continued to be accommodative. The average contract interest rates on new loans and discounts and the issuance rates for CP and corporate bonds have been at low levels. Firms’ perception of financial institutions’ lending attitudes and financial positions of firms, including those for small firms, have been improving. D. Future Conduct of Monetary Policy 1. The decline in crude oil prices and the conduct of monetary policy Next, I would like to highlight two points regarding the Bank’s future conduct of monetary policy and then conclude my remarks. The first is the relationship between the decline in crude oil prices and the conduct of monetary policy. In the Bank’s interim assessment in January 2015 of the October 2014 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the forecasts for the year-on-year rate of increase in the CPI (all items less fresh food) have been revised downward toward fiscal 2015 from those presented in the October 2014 Outlook Report. From a somewhat longer-term perspective, the decline in crude oil prices – the main factor behind this downward revision – will exert upward pressure on the underlying trend in prices by producing stimulus effects on the economy. In a situation where medium- to long-term inflation expectations among households and firms have been stable according to a number of surveys, as long as the path for the year-on-year rate of increase in the CPI to rise again toward around 2 percent is in sight, the decline in crude oil prices should not pose any particular concern in terms of the conduct of monetary policy. In terms of grasping price developments, it has become difficult to determine the underlying trend of the CPI, due to the large fluctuations in crude oil prices. The basic approach to assessing this trend is to make a comprehensive examination of a range of indicators – particularly the CPI for all items less fresh food. Given the current situation, it is appropriate for the time being to make an assessment by also taking account of the contribution of energy items to the year-on-year rate of increase in the CPI (all items less fresh food). The BIS central bankers’ speeches Bank’s decision to release an estimate of this contribution for the price outlook through fiscal 2016 was based on such thinking. On this point, one view is to examine the year-on-year rate of increase in the CPI for all items less food and energy, or the core-core CPI, in particular. However, when identifying the underlying trend in prices, I personally consider that it also is important to examine the price index that includes food, given that food expenditures in Japan account for a larger proportion of household expenditures than in other countries – such as the United States – and that the rise in the prices of daily necessities has been weighing on consumer sentiment since 2014. Furthermore, I place importance on the CPI for all items less imputed rent, which is used in the calculation of such items as real wages. Imputed rent is an expenditure that is not actually paid in the market. It has long been on a declining trend, and if this trend continues, this will exert strong downward pressure on the CPI for all items, particularly in the phase when the rate of increase in the prices of goods and services accelerates. If this turns out to be the case, various problems may arise from a gap between the rise in prices perceived by households and the rise in the CPI, or in assessing the rate of wage increase. 2. The continuation of QQE The second point is the continuation of QQE. Almost two years have passed since the Bank introduced QQE in April 2013. So far, the Bank has committed to continuing 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 also has committed to examining both upside and downside risks to economic activity and prices, and making adjustments as appropriate. As for the Bank’s outlook for prices, looking at the medians of the Policy Board members’ forecasts, the year-on-year rate of increase in the CPI (all items less fresh food) is projected to remain at 1.0 percent for fiscal 2015 due to the substantial decline in crude oil prices, but to reach 2.2 percent for fiscal 2016. If economic activity and prices develop as projected, the achievement of the price stability target of 2 percent will become more in sight over time. Although it is premature to discuss an exit strategy at this stage, if the year-on-year rate of increase in the CPI accelerates in accordance with the Bank’s forecast I just mentioned, the Bank at some point will need to gradually slow the pace of QQE from the current full-speed operation. From this viewpoint, it will become all the more important for the Bank to carefully grasp and assess prevailing economic developments and the underlying trend in prices, and thereby accurately determine their outlook, in the process of preparing the Outlook Report every April and October, and of conducting the interim assessment thereof every July and January. With respect to the wording “make adjustments as appropriate” used to describe the Bank’s monetary policy stance, my understanding is that these adjustments will only be made in response to, from a longer-term perspective, a heightening of risks to achieving sustainable economic growth with price stability, such as an emergence of economic and financial imbalances, and should not be made in response to changes in the timing for achieving the 2 percent price stability target or in the pace at which this target will be achieved. BIS central bankers’ speeches
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Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at Bruegel, Brussels, 4 March 2015; the European Central Bank, Frankfurt am Main, 6 March 2015, and the Bank of England, London, 10 March 2015.
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Sayuri Shirai: Shifting toward a moderately inflationary economy in Japan – overview of firms’ and households’ inflation expectations Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at Bruegel, Brussels, 4 March 2015; the European Central Bank, Frankfurt am Main, 6 March 2015, and the Bank of England, London, 10 March 2015. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website I. Introduction It is a great honor to have this opportunity to speak to you today about Japan's current monetary policy. With the aim of achieving its 2 percent price stability target, the Bank of Japan (hereafter the Bank) adopted quantitative and qualitative monetary easing (QQE) in April 2013. QQE was expanded further in October 2014. This was because of the potential risk that a decline in the consumer price index (CPI) inflation rate – driven by somewhat weak domestic demand following the consumption tax hike and a substantial decline in crude oil prices – may have exerted downward pressure on inflation expectations, thereby undermining the positive developments in wage negotiations and firms’ price-setting behavior. In my view, the QQE expansion was important to ensure a virtuous cycle from income to spending. Thereafter, crude oil prices dropped further and inflation has continued to decline, but domestic demand has continued its moderate recovery trend. Moreover, the Bank believes that inflation expectations appear to be rising on the whole from a somewhat long-term perspective. Nominal and real incomes are expected to rise, and thus the rate of increase in the CPI is expected to become positive once drops in crude oil prices stall and prices subsequently increase moderately. Low inflation also prevails in Europe. In the euro area, the rate of increase in the Harmonized Index of Consumer Prices (HICP) turned negative in December 2014 mainly as a result of the decline in crude oil prices. Some indicators of inflation expectations have also decreased. The European Central Bank (ECB) has undertaken additional unconventional monetary easing measures in January 2015 similar to those adopted by the Bank. The common features are (1) large-scale purchases of various financial assets (mainly sovereign bonds) as a main pillar and (2) a long-term conditional lending facility, where the amount of lending to financial institutions depends on the increased lending volume by those institutions to the private sector (Chart 1). In this low-inflation environment, one of a central bank's main tasks is avoiding deflation in Europe and conquering deflation in Japan. Bearing this in mind, I will review the Bank’s outlook for economic activity and prices over the past two years and explain my opinions on the upside and downside risks with the latest baseline scenario. In addition, I will discuss developments related to inflation expectations in Japan. II. The bank’s outlook for economic activity and prices and risk assessment A. The bank’s baseline scenario The Bank presents quarterly forecasts on real GDP and core CPI (all items less fresh food), prepared by the nine members of the Policy Board, on a year-on-year basis for the next three years (currently, up to fiscal 2016). Chart 2 shows the median, minimum, and maximum forecasts of the majority of policy board members for the selected four forecast points: (1) April 2013 (the month when QQE was adopted); (2) April 2014 (a year after adoption); (3) October 2014 (the latest month of the publication of the biannual Outlook for Economic Activity and Prices); and (4) January 2015 (the latest forecast point). As the median forecast is often regarded as mostly reflecting the Bank’s baseline scenario, I will proceed with my explanations on the Bank’s baseline scenario based on that median. BIS central bankers’ speeches If one reviews the Bank’s medium-term forecasts on economic activity and prices, it is evident that there were rather large downward revisions over that period (Chart 2). The same is also true of my medium-term relatively cautious forecasts, which have been consistently lower than the median for both real GDP growth and core CPI inflation since the introduction of QQE in April 2013. It is natural for a central bank to revise its forecasts given changes in assumptions with respect to domestic and external conditions. Nevertheless, since the revisions have been large, I feel it necessary to provide a clear explanation for these developments. Thus, I will provide my views in this area in the following sections. B. Revisions of the bank’s outlook for economic activity Downward revisions on growth forecasts for fiscal 2014 In Chart 2, one feature that may attract your attention is the large revisions made on economic growth for fiscal 2014 – from 1.4 percent in the April 2013 forecast point to minus 0.5 percent most recently. Four main reasons may be given here. First, the downward revision took place mainly owing to the greater-than-expected decline in private spending caused by the consumption tax hike in April 2014 as well as the weaker-than-expected subsequent recovery pace. The declines in private consumption (especially durable goods) and residential investment are attributable both to a reaction to the front-loaded increase prior to the tax hike and to a decline in real (disposable) income, mainly associated with the tax hike. The adverse impact of the tax hike turned out to be greater than projected – perhaps because it was difficult to grasp the structural changes in the economic and social structures that occurred after the previous tax hike in 1997. Those changes included the following: (1) an increase in the number of pensioners and a temporary cut in pension benefits in fiscal 2013–15 (owing to dissolution of the special level of pension benefits); and (2) a continued decline and resultant low level of per-capita nominal income that is prevalent even after the wage increase since fiscal 2014 (as a result of the growing number of nonregular workers and the long spell of restrained wage growth for regular workers). In this regard, I have repeatedly emphasized that the Bank should recognize the pace of improvement in the employment and income situation as a downside risk. It is clear that this risk has materialized and played a major role in the downward revision of the Bank’s outlook. In other words, a decline in domestic demand as a result of a real income drop (the Keynesian effect) appears to have exceeded an increase in domestic demand driven by the improved sentiment toward the sustainability of the fiscal balance and the social security system (the non-Keynesian effect). In addition, bad weather conditions adversely affected private consumption in JulyOctober 2014. Thereafter, however, private consumption started to recover gradually as the adverse impact of the tax hike waned. Residential investment also appears to have more or less bottomed out. Second, the sharp depreciation of the yen brought only a limited gain in export volume, thus failing to offset a substantial decline in domestic demand caused by the tax hike. The tepid export performance was due to the following: (1) a shift to overseas production, which was accelerated in the phase of the yen’s sharp appreciation; (2) a loss in price competitiveness in some manufacturing sectors; and (3) weak recovery of global demand. The limited growth in export volume produced few benefits for manufacturing small and medium-sized enterprises (SMEs), which generally operate as suppliers of parts and intermediate goods to larger domestic manufacturing firms; the latter gained profits partly driven by the valuation effect. Since the second half of 2014, meanwhile, the export volume has begun to rise moderately, reflecting a gain in price competitiveness and the relatively strong economic recovery in the United States. Third, while the above two factors were the major reasons for the downward revisions, business fixed investment also did not rise as much as projected. This was partly because the end of support for some widely-used software programs and tightening of gas emission BIS central bankers’ speeches regulations applied to construction machinery produced a front-loaded increase in purchases of personal computers and construction machinery before April 2014; this was followed by a subsequent decline in such purchases. Moreover, some firms postponed their plans to expand business fixed investment owing to the greater-than-expected accumulated inventory (especially consumer durable goods). Currently, however, investment continues to recover, inventory stock has begun to fall, and industrial production has started to rise. Fourth, the potential economic growth rate has trended downward historically, and it still remains below 0.5 percent despite a moderate recent increase (Chart 3). This may be one of the reasons that according to various opinion surveys, many households have not felt signs of economic recovery. That could be contributing to the sluggish pace of domestic demand recovery. The decrease in potential economic growth is considered to be the consequence of demographics, a deceleration in total factor productivity (TFP) growth, and a decline in capital stock (driven by delayed investment). Moreover, the unemployment rate has already dropped to around 3 percent – a level closer to the natural unemployment rate – and along with the decline in the working-age population, the labor shortage is increasingly evident. The labor shortage has favorably contributed to creation of new employment and nominal income growth; however, it has also incurred constraints on economic growth by allowing mainly SMEs and firms in nonmetropolitan areas to lose the opportunity to expand or continue their businesses. For example, owing to a severe shortage of skilled workers and engineers, the construction sector was prevented from adequately expanding the volume of their building construction starts in response to the front-loaded order placement of public investment in April-June 2014. Instead, this sector faced a rapid increase in the unit operating price caused by rising personnel expenses and cost of construction materials. Regarding residential investment, a decline in the real interest rate generated by QQE helped stimulate potential demand for mortgage loans. Conversely, an increase in housing prices caused by rising construction costs partially discouraged residential investment by ordinary households. Nonetheless, let me stress that the economic growth rate for fiscal 2014 could have been even lower without QQE. Corporate profits as well as the employment and income situation might have been less favorable than at the current level. QQE has brought negative real interest rates and promoted the following: (1) the wealth effect, for example through stocks and real estate; (2) the diversification of financing sources for firms; and (3) a correction of the yen’s excessive appreciation (Chart 4). These effects, in turn, have given rise to various positive developments by activating firms’ fixed investment and pricing behavior, financial institutions’ lending and investment behavior, individual investors’ incentives to manage financial assets, and inbound tourism. Therefore, although there were downward revisions to the Bank’s economic outlook, I believe that the effectiveness of QQE should not be questioned. Upward revisions of growth forecasts for fiscal 2015 and 2016 By contrast, the Bank’s forecast on economic growth for fiscal 2015 was adjusted upward significantly from 1.5 percent in the April 2013 forecast point to 2.1 percent in the most recent forecast. The upward revision is natural since it reflects the adjustment process of returning from the bigger-than-expected decline in the previous year. In addition, as for reasons why degree of upward revision was particularly large in the latest January 2015 forecast, I personally view that the following four factors were incorporated: (1) improvement in corporate profits and the resultant greater active business fixed investment (owing to a crude oil price drop and the lagged impact of the yen’s further depreciation since November 2014); (2) gradual recovery overseas (owing to a crude oil price drop) and the resultant positive effects on exports from Japan; (3) an increase in real income and resultant expansion of private consumption (driven by a crude oil price drop and the postponement of the second round of the consumption tax hike); and (4) expected positive effects from the government’s economic measures based on the supplementary budget for fiscal 2014. The most recent BIS central bankers’ speeches forecast on economic growth for fiscal 2016 was also revised upward to 1.6 percent, partly because of a shift of the front-loaded increase in spending from fiscal 2015 to fiscal 2016 as a result of the postponement of the second round of the tax hike. I project that the potential growth rate will rise gradually toward somewhat below 1 percent by the end of fiscal 2016. This will occur mainly through an accumulation of capital stock, an improvement in TFP growth, and a reallocation of the labor force – through corporate sector restructuring and greater focus on higher value-added goods and services. It is also expected that the government will make greater efforts in implementing growth strategies and reforms aimed at promoting greater labor participation by female and elderly persons. C. Revisions of the bank’s outlook for prices Let me now address the Bank’s outlook for prices. The Bank’s forecast on the rate of increase in the core CPI for fiscal 2014 was revised downward from 1.4 percent in the April 2013 forecast point to 0.9 percent in the most recent forecast (Chart 2). The downward revision was due to the following: (1) the greater-than-expected base effect; (2) the delayed improvement in the output gap, which had seen an unexpected deterioration for two consecutive quarters since April-June 2014, although it was at around zero percent (Chart 3); (3) a slower-than-expected increase in inflation expectations; and (4) a decline in crude oil prices since around July 2014. These factors delayed the timing for the rate of inflation to resume the rising trend from fiscal 2014 to the latter half of fiscal 2015. The adjustment for fiscal 2014 also contributed to the forecast on the rate of inflation for fiscal 2015, which was revised downward significantly from 1.9 percent in the April 2013 forecast point to 1 percent in the most recent forecast – primarily because of the decline in crude oil prices. The Bank currently estimates that the contribution of energy items will be in the range of minus 0.7 percent to minus 0.8 percent of the core CPI. It is projected that downward pressure on prices caused by crude oil price drops will diminish gradually toward the middle of fiscal 2015. Subsequently, the rate of inflation is projected to accelerate sharply from around the second half of fiscal 2015 and approach close to around 2 percent by the end of the fiscal year for several reasons. First, the pace of improvement in the output gap will be greater than that envisaged in the April 2013 forecast point due to upward revisions on the economic growth forecast. Second, there will be the lagged impact of the yen’s further depreciation from November 2014. Third, the pace of the increase in inflation expectations will also be greater than initially projected, once it resumes its rising trend. In other words, the forecasts for fiscal 2014 and 2015 reflect the Bank’s view that the underlying price developments will remain intact. First, though the effect from the decline in crude oil prices is considered temporary, its positive support for economic activities will result in an improvement in the output gap, thereby eventually reinforcing longer-term upward pressure on core CPI inflation. Second, while inflation expectations inferred from market data had exhibited a decrease in recent months, as in the United States and Europe, those inflation expectations inferred from various surveys remain roughly constant. Third, spring wage negotiations for fiscal 2015 are currently ongoing. The Japan Trade Union Confederation demanded an over 2 percent increase in base salary, and the Japan Federation of Economic Organizations expressed its willingness to make the greatest efforts to raise wages. These positive developments may be a sign that firms’ and households’ price perceptions and related economic behavior are gradually adjusting to a moderately inflationary environment. It is expected that these forces will generate sufficient upward pressures on prices such that the rate of inflation will accelerate to around 2 percent by the end of fiscal 2015. This is why the Bank maintains the view that this rate is likely to reach about 2 percent around the middle of the projection period, that is, in or around fiscal 2015. The forecast for fiscal 2016 thus remains largely unchanged with the rate of increase in the core CPI exceeding 2 percent. BIS central bankers’ speeches D. Risk factors related to the bank’s baseline scenario Next, let me explain my views on the upside and downside risks that are important as factors that may affect the Bank’s latest outlook. Regarding risks related to the Bank’s outlook on economic activity, I pay particular attention to external factors, including unstable financial and commodity markets and economic developments abroad, which may work both as upside and downside risks. In Europe, there is uncertainty regarding the impact of drops in crude oil prices, debt problems, low inflation, and the geopolitical issues on business fixed investment and employment conditions. In the United States, the economic recovery is solid. The normalization process of the monetary policy by the Federal Reserve is notable, especially with regard to its effect on the domestic economy and markets, as well as global capital flows and economies. The continued economic recovery in the United States with a smooth implementation of the exit policy and a moderate increase in crude oil prices will likely generate upside risks. Regarding the risks associated with domestic factors, I believe that there is a high degree of uncertainty with respect to the extent of the increase in business fixed investment and domestic consumption in response to higher corporate profits and real income growth. First, it may take some time to improve significantly the sentiments of households that are facing difficulties following a sharp drop in real income in fiscal 2014. Second, households may allocate a higher portion of their increased income to savings if they regard it as a temporary windfall gain and do not expect future permanent income growth. Third, households’ and firms’ economic growth expectations may not rise unless the government’s growth strategies make progress. Concerns over the sustainability of the social security system and fiscal balance may undermine households’ and firms’ incentives for spending. In this respect, some local governments, firms, and financial institutions are gradually taking advantage of the accommodative financial environment generated by QQE and the government’s economic policy and structural reforms to energize the local economy and firms’ competitiveness and innovation. Whether remarkable progress will be made remains uncertain – both in terms of upside and downside risks. Turning to my views on risks related to the Bank’s outlook for prices, I pay particular attention to the following three types of risks. First, the crude oil price decline may not only lower the prices directly through a reduction in imported energy prices, it may also lower prices indirectly, through a decrease in overall imported prices caused by global disinflation. Second, though a rise in income (nominal and real) and the resultant improvement in households’ sentiments may make it easier for firms to charge higher sales prices, some firms may lower or contain sales prices to acquire greater market share in the presence of fierce domestic competition. Third, inflation expectations may remain sluggish throughout fiscal 2015 so that the timing for these expectations to resume rising may be delayed. Alternatively, these expectations could become unstable because those of households in particular are heavily affected by the actual price movements of daily necessities and gasoline, as I will indicate later. Finally, in my view, given that QQE was already expanded in October 2014, a temporary reduction in the core CPI inflation is acceptable as long as the underlying price developments and recovery process in domestic demand continue. Nonetheless, the timing of a rate of inflation approaching around 2 percent now entails greater uncertainty, including the possible delay from the Bank’s latest forecast. III. Overview of inflation expectations in Japan A. Underlying price developments Earlier, I mentioned that the Bank regards underlying price developments as having remained unchanged despite a fall in actual inflation rate. Here, I will first explain more clearly what the Bank means by underlying price developments. Generally, underlying price developments are assessed by the output gap and medium- to long-term inflation expectations, and they are typically monitored through the core CPI – assessed after BIS central bankers’ speeches excluding volatile items (that is, fresh food in the case of the Bank). Of course, these relationships are reflected in the trend in income growth and firms’ price-setting behavior. However, the core CPI is not the only indicator monitored. The Bank looks at a wide range of other price indicators, including the 10 percent trimmed mean, the Laspeyres chain index, the ratio of items whose prices are rising to core CPI items (the rising-CPI item ratio), and the breakdown items of the CPI. Producer price index, services producer price index, and commodity prices are also closely monitored. The core CPI, 10 percent trimmed mean, and Laspeyres chain index have shown a decline since the middle of 2014. By contrast, the rising-CPI item ratio has remained unchanged (Chart 5). In practice, whether the underlying price developments remain unchanged could be assessed by observing whether (1) the prices of a wide range of items are increasing, (2) such a rise is persistent, and (3) medium- to long-term inflation expectations have on the whole increased or at least remained stable. Currently, the rising-CPI item ratio indicates that a persistent increase in prices is widely observed for about 60 percent of the items covered by the core CPI. On medium- to long-term inflation expectations, some market-based indicators – such as the break-even inflation (BEI) and inflation swap rates – declined over the past months, but have become constant or begun to rise recently (Chart 6). Moreover, the survey-based indicators of firms, households, and economists have remained more or less stable, as noted earlier (Chart 7). B. Medium- to long-term inflation expectations Major central banks have clear inflation targets and conduct monetary policy so as to achieve around 2 percent in the medium term. Under the so-called flexible inflation-targeting framework, a temporary deviation of actual inflation from the target is accepted. This is permissible as long as there is a natural tendency for actual inflation to converge to around 2 percent. In assessing whether such a tendency prevails, medium- to long-term inflation expectations play an essential role. If these expectations remain stable (or “anchored”) at around 2 percent, actual inflation is likely to converge to around 2 percent – even if actual inflation fluctuates around the target. In this environment, wage negotiations and firms’ pricesetting behavior are more likely to be determined based on expectations of approximately 2 percent inflation. Such an economy could be referred to as having achieved price stability. In the case of Japan, where mild deflation has persisted over a long period, inflation expectations have not been anchored. Moreover, those inflation expectations have been volatile at around 1 percent. Thus, one of the Bank’s challenges is to raise and anchor such expectations toward around 2 percent. A central bank generally makes a judgment on the movements of medium- to long-term inflation expectations using several indicators; this is because the levels of inflation expectations and their directions of movement often differ. This reflects the fact that (1) each indicator entails various, specific biases, and (2) some indicators target different price indexes. With (1), for example, households’ inflation expectations tend to be upward-biased since households always expect that the price level will increase, as will be discussed later. By contrast, large firms’ expectations on sales prices tend to be downward-biased because they tend to make cautious management plans. With (2), for example, the Opinion Survey on the General Public’s Views and Behavior compiled by the Bank asked respondents the price outlook referring to “overall prices of goods and services the respondents purchase.” By contrast, the Bank’s Tankan (Short-Term Economic Survey of Enterprises in Japan) explicitly refers to the CPI when asking firms about their outlook on general prices. Moreover, the BEI and inflation swap rates target the core CPI, but they include both inflation expectations and various premiums. Chart 8 provides basic information about survey based indicators on short-term (one year or less) and medium- to long-term (over one year) inflation expectations. BIS central bankers’ speeches In achieving price stability, what matters most are the inflation expectations of firms and households, as well as their associated economic behavior. I will therefore concentrate on these inflation expectations here. C. Developments in inflation expectations of firms The Bank’s quarterly Tankan asks about 10,000 firms with at least 20 million yen in capital about their outlook regarding sales prices (rate of price changes relative to the current level) and general prices (annual percentage rate changes) for three projection periods: one year, three years, and five years ahead. These questionnaires have been incorporated since the March 2014 survey, and so currently four forecast points are available: March, June, September, and December 2014. Since the amount of data acquired is not yet sufficient, some caution is required in interpreting the results. The respondents are also decomposed into four groups (large manufacturing, large nonmanufacturing, small manufacturing, and small nonmanufacturing). I will now share with you in the following sections my preliminary observations on the survey results. Since the findings that I will describe remain largely unchanged across the forecast points, I will focus on the latest (December 2014) forecast. Inflation expectations for sales prices (one, three, and five years ahead) The outlook on sales prices is chosen from ten options from “around plus 20 percent or higher” to “around minus 20 percent or lower” (categorized in 5 percent increments) and “Don’t know.” The average inflation outlook on sales prices for “all firms, all industries” is 1 percent for one year, 1.7 percent for three years, and 2 percent for five years ahead, and shows a rising trend relative to the current level. It should be noted that these figures refer to the rate of changes relative to the current level, not the annual percentage rate change. Thus, taking the difference between these intertemporal figures gives a 0.7 percent increase for three years relative to one year ahead and a 0.3 percent increase for five years relative to three years ahead. Namely, the scale of the sales price increase tends to fall as the projection period moves from one to five years ahead. Another caution is that the average outlook figures are obtained from the sample pool after excluding the “Don’t know” respondents. So the average outlook figures are based on a limited number of respondents – especially for the outlook over three and five years ahead. • First, large manufacturing firms expect on average that sales prices will remain unchanged from the current level in three years’ time (plus 0.1 percent) and will fall from the current level in five years’ time (minus 0.2 percent). This shows a sharp contrast from the three other groups, all of which expect a rising sales price level from the current level (Chart 9). In large manufacturing, the declining price expectation is evident for five years ahead, especially among processing sectors, such as electrical and transportation machinery. Given that these sectors face fierce competition, large firms in these sectors are more likely to formulate their business plans conservatively or envision their future sales prices without an increase. • Second, regardless of the scale of firms, nonmanufacturing firms tend to expect their future sales prices to be higher than manufacturing ones. Among large nonmanufacturing firms, relatively higher sales prices are expected in the construction & real estate sectors for three years ahead and in the construction & real estate, retailing, and accommodations & eating & drinking services sectors for five years ahead. With small nonmanufacturing firms, relatively higher sales prices are expected in the construction & real estate and accommodations & eating & drinking services sectors for three years ahead and in the construction & real estate, wholesaling & retailing, accommodations & eating & drinking services, and transport & postal activities sectors for five years ahead. Some of these sectors are already facing a labor shortage, higher real estate prices in large cities, or a rise in construction materials. BIS central bankers’ speeches These two observations suggest that sales prices are projected to rise in nonmanufacturing – rather than in manufacturing – and in the labor-intensive sectors. Next, I examine the three largest responses – “around plus 5 percent,” “around 0 percent,” and “Don’t know” – among the aforementioned ten options. The following additional points are observed: • Third, for “all firms, all industries,” the responses for one year ahead tend to concentrate on “around 0 percent” (from the current level); they account for about 60 percent of all responses. The next-largest responses are related to “around plus 5 percent,” which account for about 20 percent. By contrast, the responses for three years ahead are more widely spread among the various options. The largest responses are for “around 0 percent” (accounting for about 30 percent), and the next two largest responses are for “around plus 5 percent” and “Don’t know” (accounting for over 20 percent each). Those three options account for about 80 percent of all responses. Regarding the responses for five years ahead, the largest responses relate to “Don’t know” (accounting for about 35 percent); the proportion of the “around 0 percent” responses drops to about 20 percent and that of the “around plus 5 percent” responses remains at over 20 percent (Chart 10-1). • Fourth, the four-group classification indicates that there are greater differences between large and small firms rather than between manufacturing and nonmanufacturing. For both large and small firms, the “Don’t know” responses grow as the projection period increases from one year to five years ahead. However, the proportion of the “Don’t know” responses is greater among large than among small firms for any projection period. Small firms tend to choose the “around plus 5 percent” option more frequently than large ones (Charts 10–2, 10–3, and 10-4). In light of these responses, it may be said that small manufacturing firms find it easier to form expectations on sales prices than do large ones. This is probably because small manufacturing firms tend to project future sales prices through supplier-transaction relationships with large firms and also because they deal with limited kinds of parts and intermediate goods. Meanwhile, small nonmanufacturing firms form expectations on sales prices by taking into account an expected increase in production costs while considering relevant market prices influenced mainly by large nonmanufacturing firms. This may reflect the fact that small nonmanufacturing firms are relatively more labor intensive than large ones and are already facing a labor shortage. Inflation expectations on general prices (one, three, and five years ahead) Let us now examine the outlook for general prices, as measured by the CPI. The responses are chosen from ten options, ranging from “around plus 6 percent or higher” to “around minus 3 percent or lower” (categorized in 1 percent increments), and “Don’t have clear views” with three sub-categories (on general prices). The average inflation outlook for “all firms, all industries” is 1.4 percent for one year, 1.6 percent for three years, and 1.7 percent for five years ahead, and shows a rising trend as the projection period increases from one to five years ahead (Chart 7). I will now elaborate on three observations on these results. • First, the four-group classification reveals that the differences in the projected inflation level are greater between large and small firms than between manufacturing and nonmanufacturing. Large firms project on average 1.1 percent for one year ahead and 1.2 percent for both three and five years ahead; and small firms on average report about 1.7 percent for one year, 1.8 percent for three years, and 1.9 percent for five years ahead. So while they both basically project a rising trend, small firms have higher levels of inflation expectations (Chart 11). BIS central bankers’ speeches By focusing on the four largest responses – “around plus 2 percent,” “around plus 1 percent,” “around 0 percent,” and “Don’t have clear views” – among the aforementioned options, the following points are observed: • Second, among “all firms, all industries,” the general price outlook for one year ahead is relatively widespread among the options compared with the sales price outlook. The largest “around plus 1 percent” responses account for about 30 percent of total responses, followed by the “around plus 2 percent” and “around 0 percent” responses (accounting for about 20 percent each). The “Don’t have clear views” responses account for approximately 15 percent of total responses. On the outlook for three years ahead, the “Don’t have clear views” response increases to about 30 percent. The next-largest responses are “around plus 1 percent” and “around plus 2 percent” (each accounting for about 20 percent). This pattern becomes more apparent with the outlook for five years ahead. The proportion of the “Don’t have clear views” responses rises to approximately 40 percent; the “around plus 1 percent” and “around plus 2 percent” responses both drop to about 15 percent. From one to five years ahead, the proportion of “Don’t have clear views” responses are greater than that of the “Don’t know” response for sales price outlook (Chart 12–1). • Third, the four-group classification reveals that the “Don’t have clear views” response is greater among large than among small firms. The responses account for over 40 percent on the outlook for three years ahead and over 50 percent on that for five years. As for small firms, the proportion of “around plus 2 percent” responses is greater than that for large firms with the outlooks for one, three and five years ahead (Charts 12–2, 12–3, and 12–4). Summary of observations related to inflation expectations of firms Based on the aforementioned results, I will now summarize the combined observations on sales price- and general price-related inflation expectations of firms. 1. The average outlook for general prices among “all firms, all industries” indicates 1.4 percent for one year, 1.6 percent for three years, and 1.7 percent for five years ahead. However, the outlook among large firms remains largely unchanged over the same projection period. This implies that the rising trend in the outlook appears to largely reflect the outlook among small firms. Large firms also appear to make more conservative, lower projections on sales prices than small firms. 2. For both general and sales prices, the “Don’t have clear views” and “Don’t know” responses are greater among large than small firms. Large firms are likely to face a greater degree of uncertainty in their outlooks for both types of prices – probably because of the direct exposure to fierce global and domestic competition in finalproduct markets. By contrast, small firms tend to expect higher general and sales prices through labor shortage and high input costs because of their labor intensity and relatively low profit margins. 3. Large firms project more conservative, lower sales prices than small firms. This may in turn affect the sales prices of small firms through transaction relationships. As a result, some small firms may find it difficult to pass their rising production costs onto their sales prices, thereby squeezing their margins and profitability. This suggests that small firms will need to make greater efforts to improve margins and shift to higher value-added business models. 4. Because large firms often play a role as price setters, aggregating their sales price outlooks, especially those of processing industries whose products are close to final goods, will likely result in the true outlook for general price inflation, such as CPI inflation. If such large firms maintain their conservative, lower pricing behavior with BIS central bankers’ speeches respect to sales prices, the level of actual inflation in general prices may turn out to be lower than the level suggested by the average of inflation expectations for “all firms, all industries.” 5. Finally, for both general and sales prices, the “Don’t have clear views” and “Don’t know” responses account for 20 percent-40 percent for the projection for three years ahead and 30 percent-50 percent for that for five years. Moreover, greater dispersion among the responses is observed as the projection period increases. In terms of level of general price inflation, even the average of projections by small firms for five years (whose average is highest) is 1.9 percent. In this regard, it may be said that firms’ medium- to long-term inflation expectations are not yet anchored and that the Bank has only passed the halfway point on the path toward achieving the 2 percent price stability target. D. Developments in inflation expectations of households The Bank conducts the Opinion Survey on the General Public’s Views and Behavior with a sample of about 4,000 people (a little over half provide valid responses). The quarterly survey results are currently available on a consistent base since June 2006 up to its latest December 2014 survey. There are two indicators related to inflation expectations: one year (the outlook for price levels one year ahead); and five years (the outlook for the annual average change in price levels over the next five years). In addition, some other relevant price-related indicators that can be calculated using the survey data include the perception diffusion index (DI) of present price levels (the difference between perceived increase and perceived decrease responses compared with one year earlier) and the price rise tolerance DI (the difference between rather favorable and rather unfavorable responses to the price rise). I will explain the features obtained from these indicators and other relevant information derived from the survey (such as income, spending, and employment conditions DIs), starting with the present and short-term developments and proceeding to medium- to longterm inflation expectations. Attitude to the price rise (price rise tolerance) • The perception DI of present price levels appears to be inversely related to the price rise tolerance DI (Chart 13). Namely, whenever households believe that present price levels have increased compared with one year earlier, the price rise tolerance DI tends to drop or the attitude to the price rise becomes negative. The price rise tolerance DI rose from late 2009 to early 2010, when both the actual CPI and the perception DI dropped during the middle of the global financial crisis. This suggests that households accepted the price rise more favorably or found price drop more unfavorably – probably not because of the price hike per se but because of growing concerns about recession reflected in an actual price decline. • Comparing two observation years – 2008 and 2014 – during which a comparable rise occurred in CPI inflation, the price rise tolerance DI was greater in 2014 than in 2008. This may be associated with better employment and income conditions in 2014 than in 2008. Indeed, the present income DI, the one-year-ahead income DI, and the employment conditions DI were all higher in 2014 than in 2008 (Chart 14). Expectations for one-year inflation and relations to income and spending • The indicators for one-year inflation expectations on average remain positive – even in the phase of deflation. This suggests that households always believe that price levels one year ahead will be higher. Conversely, both the present income DI and one-year-ahead income DI remain negative. This suggests that households always consider their present income to have declined compared with one year earlier and that their income one year ahead will decrease compared with the present. This BIS central bankers’ speeches implies that households always expect that their real income one year ahead will decline (Chart 15). • Meanwhile, the present spending DI remains positive, whereas the one-year-ahead spending DI remains negative (Chart 15). Namely, households have increased the present level of spending compared with one year earlier, but plan to reduce the spending level one year from now. Moreover, households tend to regard the rise in living expenses as the main reason for the increase in the current spending level when the present spending DI grows. Taking these features into account, it may be said that households plan to reduce spending one year ahead because they expect their real income to have declined by then. Generally speaking, with a rise in one-year-ahead inflation expectations, households tend to frontload their spending today and reduce their future spending to smooth the intertemporal budgetary constraint. In this regard, an increase in the present spending DI associated with the increase in one-year-ahead inflation expectations could be understood as a sign of defensive action against future price hikes. Present price perception and inflation expectations (one and five years) • Like one-year inflation expectations, the indicators for five-year inflation expectations on average remain positive. This means that households expect that price levels will rise over the next five years – even during a time of deflation (Chart 16). • Among the following – (1) the perception of present inflation (based on the year-onyear percentage price change), (2) one-year inflation expectations, and (3) five-year inflation expectations – the fluctuations for (1) are greatest, followed by (2). Chart 16 reveals that the perception indicator grew sharply in 2008 compared with one- and five-year inflation expectations. This suggests that although households found that present prices had increased sharply in 2008 compared with one year earlier, they believed that that extreme price hike would eventually be contained. By contrast, all three indicators remained stable in 2014, with average values of around 4 percent-5 percent. • The opinion survey began a biannual questionnaire about information sources for households’ price views in September 2013. According to the most recent (September 2014) survey for both present price levels and five-year inflation expectations, “developments in prices of frequently-purchased items such as foodstuffs” was chosen as the most applicable source, followed by “developments in gasoline prices.” Over 50 percent of all respondents regarded those two options as their most relevant information sources (Chart 17). • The indicators for five-year inflation expectations remain stable. At first glance, adopting the 2 percent price stability target and QQE in 2013 appear to have exerted no significant effects on inflation expectations. However, I will return to this issue. E. Summary of households’ inflation expectations and relation to those of firms Let me know sum up my observations on households’ inflation expectations and relate them to the expectations of firms. 1. Households’ five-year inflation expectations on average appear to remain stable at around 4 percent at first glance. However, the survey revealed that the basis for five-year inflation expectations largely depends on the prices of frequentlypurchased items and gasoline – and not much from monetary policy. Thus, stable movements in inflation expectations do not necessarily mean that their medium- to long-term inflation expectations are anchored. BIS central bankers’ speeches 2. One interesting feature is that households rely more heavily on general price-related information and various other sources with respect to five-year inflation expectations compared with perceptions of present price levels. For example, they rely relatively more heavily on “media reports on individual prices of goods and services and prices in general” and “developments in foreign exchange rates” (Chart 17). 3. In addition, the indicators for one- and five-year inflation expectations remain largely unchanged before and after adopting the 2 percent price stability target and QQE. It might appear at first glance that the effects of the monetary policy have been limited. However, the survey responses are known to have reporting biases: outliers with extreme numbers; downward rigidity or the tendency to avoid negative numbers – even when respondents expect deflation; and many responses with integers, especially multiples of five. After taking these biases into account, the modified distribution of one- and five-year inflation expectations has displayed notable changes since 2013. Namely, the skew to the deflationary side has diminished for both inflation expectations. The right tail to the inflationary side for five-year inflation expectations has contracted. As a result, the spike at around 2 percent has become sharper for both inflation expectations, which shows that households’ inflation expectations concentrated at around 2 percent (Chart 18). This may suggest that the change in the Bank’s monetary policy in 2013 has positively affected households’ inflation expectations, leading to a greater concentration of responses to about 2 percent. 1 4. Households’ inflation expectations are higher than those of firms, which suggests the presence of an upward bias. This may be because of two possible reasons. One is that households and firms envisage different prices when responding to the survey questionnaire. Households are asked to respond to “overall prices of goods and services the respondents purchase,” whereas firms are asked to respond to general prices measured by the CPI. The reason households are asked in this manner is that some respondents are unfamiliar with the CPI, which makes it difficult to form an outlook based upon it. 5. The other possible reason for the upward bias is that households tend to perceive and expect higher price levels as a corollary of long-standing sluggish income growth, resulting in an anticipated tightening of household budgets. By contrast, firms tend to form conservative inflation expectations based on the surrounding economic environment and information obtained from transactions with other firms. Given that firms appear to weigh more on macro information and that some of them perceive price developments based not only on input prices but also on sales prices, their inflation expectations as a whole are more likely to be lower than those of households and more closely approximate the rate of actual CPI inflation. The most important finding is that households expect that prices will have risen one year ahead and will increase over the next five years; such an expected price rise is regarded as rather unfavorable because it is associated with an expected decline in their future real income. Partly reflecting such limited tolerance for price rises by households, large firms (manufacturing and nonmanufacturing) may tend to project a relatively conservative, lower increase in both general prices and sales prices than small firms. Households’ poor tolerance for price rises reflects the perception that their present income level has declined compared with one year earlier and also that their income level one year ahead will not increase much. To achieve the 2 percent price stability target with a sustainable increase in private spending, it is necessary for price rises to be widely accepted See Shunsaku Nishiguchi, Jouchi Nakajima, and Kei Imakubo, “Disagreement in Households’ Inflation Expectations and Its Evolution,” Bank of Japan Review Series 2014-E-1, March 2014. BIS central bankers’ speeches by households. This requires an improvement in current employment and income conditions as well as an increase in expectations of future income growth. In this respect, I will closely monitor favorable developments in income (nominal and real) projected for fiscal 2015 and beyond as important steps toward achieving the price stability target. IV. Concluding remarks The Bank adopted the 2 percent price stability target for the following reasons: (1) the need to maintain a sufficient buffer for inflation owing to the upward-bias problems inherent in CPI statistics; (2) the need to leave sufficient room for the conduct of flexible monetary policy by achieving a certain level of inflation in recessionary phases; and (3) the need to set a target of around 2 percent as a global standard in terms of a price stability target to avoid reemergence of excessive appreciation of the yen. In addition, the 2 percent target is essential to realize normal economic conditions, in which positive rates of nominal GDP growth occur on a sustainable basis. However, households tend to regard price level rises as unfavorable. It is not easy to promote their understanding of the Bank’s price stability target – especially since real income dropped sharply in fiscal 2014. Nonetheless, income (nominal and real) will likely rise in fiscal 2015. Therefore, it is essential for the Bank to boost the effectiveness of its communication strategy by explaining more clearly why it aims to achieve the 2 percent target and how this will improve people’s lives in the medium to long term. I will continue making further efforts in this regard. In addition, even though the Bank’s economic growth outlook for 2014 has been revised sharply downward, it is clear that Japan’s economy is currently in a far better shape than it was before the introduction of QQE. A virtuous cycle from income to spending, which is the driving force of the economy, is being maintained in the household and corporate sectors. Thus, it is crucial for the Bank to continue to support the current recovery process. I sincerely hope that all entities will take full advantage of the opportunity afforded by the highly accommodative financial environment generated by QQE to expand their efforts toward enhancing innovation and productivity – in concert with the economic growth strategy and structural reforms implemented by the government. 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 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 address by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Securities Analysts Association of Japan International Seminar, Tokyo, 24 April 2015.
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Hiroshi Nakaso: Asian economy – past, present and future Keynote address by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Securities Analysts Association of Japan International Seminar, Tokyo, 24 April 2015. * * * Accompanying charts can be found at the end of the speech. Introduction It is a great honor for me to speak here at the International Seminar hosted by the Securities Analysts Association of Japan. Today’s seminar is titled “Asset Management in Asia: Opportunities and Future Development.” The participants here today are all engaged in financial markets business, whether directly or indirectly, and your involvement has contributed to the development of financial markets in Japan and other Asian economies. Your continued involvement in financial markets, whether directly or indirectly, has helped build the foundations for the success of the financial markets. As I will elaborate later, we, the Bank of Japan, have also been actively making efforts to develop Asian financial markets, through bilateral and multilateral cooperative initiatives with other Asian economies. Today, under the title “Asian Economy: Past, Present, and Future,” I will first look back at the growth of the Asian economy and its driving forces, and then share my views on the challenges ahead for the sustainable growth of the Asian economy. I. Growth of the Asian economy: Past, present, and future Asian economic growth in historical context Let us turn back the clock and reflect on the history of Asian economic growth. It may come as some surprise to learn that, based on studies by the renowned economic historian, Professor Angus Maddison, the Asian economy accounted for nearly 60 percent of the global GDP before the Industrial Revolution which began in the late 18th century (Chart 1). However, as the Western economies have enjoyed much higher growth since then, the share of the Asian economies has followed a downward path from that high of 60 percent, to as low as just over 10 percent by the early 1950s. The Asian economy did not sink without trace, though. A period of strong economic expansion known as the “Asian Miracle” ensued, characterized by a “flying geese” pattern of development. This began in the 1960s, with high growth in Japan followed by take-off of the “Four Tigers,” Hong Kong, Korea, Singapore, and Taiwan. In the early 1980s, Malaysia and Thailand joined these five to enjoy the high growth path. China gained momentum in the 1980s, and started to record double-digit growth after joining the World Trade Organization in the early 2000s, which made China a driving force of the Asian economy. Of course, during the history of Asian growth over half a century, the road to success was not always smooth. Many of you will recall the 1997 Asian Currency Crisis, which followed a period of high growth in the mid-1990s. Despite the unprecedented impact of the crisis, the regional economy proved its strength and resilience, with its foundations firmly rooted in a strong manufacturing base, as many Asian economies soon regained the prosperous exportled recovery trail. Another more recent illustration of this resilience is the Lehman Shock and the subsequent global financial crisis. After the crisis, the Asian economy continued to follow a relatively high growth path. BIS central bankers’ speeches The resilience and robustness of the Asian economy and its markets was also evident in the aftermath of the so-called taper tantrum in May 2013. The stability of financial markets in emerging economies in general was eroded, but Asian stock and foreign exchange markets remained relatively immune (Chart 2). Returning to the share in global GDP, the Asian economy today has recovered its share to over 30 percent, and is expected to continue contributing to the sustainable growth of the global economy. Mechanism of economic growth in Asia What then makes the Asian economy so strong and resilient? To this end, I want to elaborate on two mechanisms or the dual engines which have driven the Asian economy. The first mechanism is Asia’s position as “the factory of the world,” a position achieved through continued expansion of exports driven by direct investment from abroad. Global trade volumes increased dramatically with trade liberalization and direct investment growth. Firms in advanced economies proactively engaged in strategic global allocation of production sites in order to ensure the most efficient means of production. In this way, these firms could not only cushion the effects of higher wages and saturated demand for goods in advanced economies, but also reap the benefits of growing demand in emerging economies. Significant advances in information technologies and inventory management have also contributed to these movements. It is only natural that Asia became identified as an attractive candidate in this process, given its abundant low-cost and highly-skilled labor force and large potential for future growth. Global firms increasingly moved their production sites to Asia, and traded components and finished goods with their home or third countries, thus making their supply chains more global. Asia, as a hub of such trade networks, enjoyed employment opportunities created by the entry of foreign firms and exports increased significantly. At the same time, adoption of advances in production technology and resource management enhanced competitiveness, along with the accumulation of human resources. The second mechanism that I want to highlight is the autonomous growth in domestic demand spurred by the development of export industries. As export industries grew, a large proportion of the labor force moved from the rural agricultural sector to take up employment in urban factory sites. As income level rose with economic expansion, the number of middleincome households gradually increased, which underpinned the strong growth in consumption. As a result, the ground was laid for an autonomous expansion of domestic demand, which, along with exports, underlined Asian economic growth. As evidenced in the recent increase in direct investment in the non-manufacturing sector, Asia is now recognized not only as “the factory of the world,” but is also gaining prominence as the world’s biggest “consumer base.” Middle-income trap The question here is whether Asia can maintain its position as the world growth center in the future. According to long-term forecasts by international organizations and private-sector economists, Asia is expected to continue to enjoy relatively high growth and thus its share in the global GDP will increase steadily. These forecasts depend largely on the implicit assumption that Asia will maintain its growth momentum without falling into the “middle income trap.” The so-called follower group economies can move from low-income to middle-income status by continuing on the road to high growth, leveraging their abundant resources and importing technology. This catch-upstyle growth will be short-lived though, unless it is underpinned by the gradual sophistication of the industrial structure. History shows that many economies have faced difficulties in advancing beyond the status of a middle-income economy. This is known as the “middleincome trap.” A low-income economy can strengthen export competitiveness in the process of reaching middle-income status by using the abundant inflow of human resources from the BIS central bankers’ speeches rural agricultural sector, which puts downward pressure on wages. However, wages tend to rise after passing what is called “the Lewisian Turning Point” in development economics. This in turn reduces corporate profits and weakens export competitiveness, which together lead to sluggish economic growth. Several Asian economies have taken the world by surprise by achieving the “miracle” of actually escaping the shackles of the middle-income trap (Chart 3). Japan reached the Lewisian Turning Point in the 1960s, but then marked the “Izanagi” boom years from the mid1960s to the early 1970s, growing by more than 10 percent year-on-year. The “Four Tigers” have also continued on a growth path after escaping from the middle-income trap. In these economies, there were many factors at play. On the supply-side, abundant investment in plant and equipment led to higher productivity in manufacturing and other sectors together with higher capital equipment ratios. On the demand-side, the investment in plant and equipment translated into an increase in demand, and higher competitiveness through higher productivity led to a sustained expansion of exports. The population shift from rural agricultural areas to urban areas created a sizable middle-income tier, heralding an increase in consumption. II. Challenges for the Asian economy: Expanding productivity So, how can Asia as a whole continue to enjoy prosperity while ensuring that those Asian economies still in the early stages of growth continue to progress without falling into the middle-income trap? I will focus on three issues that need to be addressed or the “challenges” facing Asian economies. The first challenge is to ensure a continuous increase in productivity. In particular, there are a number of issues to be addressed if we are to strengthen the traditional Asian growth model based on a combination of both exports and domestic demand. Staying competitive in the changing global environment In order to remain competitive and further develop export industries, Asian economies need to keep on adapting to changes in the global competition environment. The global trade volume has been rather depressed of late compared with global economic growth. The concept of “slow trade” is now being actively debated among economists (Chart 4). This “slow trade” phenomenon can be explained in part by the cyclical factor that investment in plant and equipment, which has a greater tendency to induce imports, is lower than in the past. At the same time, a more structural factor can also be identified. The expansion of global supply chains, which has underpinned Asian growth for some time, has reached its maturity stage, thus contributing to the “slow trade” phenomenon. One prominent example of these structural changes can be observed in China, which has been playing a major role as the assembly and export center in global supply chains within Asia. The growth in exports to China from other Asian economies has been depressed as China, by increasingly using domestically produced parts, has become less dependent on imports. Additionally, this year will almost certainly become an epoch-making year for China when outward direct investment exceeds inward direct investment for the first time. Further expansion of production base by Chinese firms to neighboring economies is stimulating the reconstruction of supply chain networks. These developments represent a significant environmental change for Asian firms. In addition, there has been progress toward greater integration within the region in the form of the ASEAN Economic Community (AEC). Such integration will stimulate intraregional trade as barriers to the free movement of goods and services are removed. It will also change the flow of goods and capital, and lead to increased competition. What is required to overcome the challenges posed by such changes in the economic environment? From the experiences of those economies and regions that have already BIS central bankers’ speeches overcome the middle-income trap, it is crucial not to cling to past success, but to concentrate on adapting to the changing environment with an eye to the future direction of changes, and to keep on pushing into new frontiers. The value of investing in areas such as research and development should not be underestimated; the strategic development and advancement of the industrial structure depends upon such investment (Chart 5). If an industrial sector with competitive advantage is developed, this will translate into increased strength in the export business. Nurturing the service sector and urbanization Turning our attention toward the issue of domestic demand, it is clear that the key to offsetting the saturation of demand for manufactured goods is to nurture the service sector and raise its productivity. The service sector is often labor-intensive, and as a consequence, tends to yield lower productivity compared to manufacturing industry. For this reason, the Asian economies should be mindful to maintain a high level of productivity in the overall economy when they shift toward a service economy, by providing high value-added products with the active implementation of innovations such as in information technology. Urbanization will play an important role in this regard. China and other Asian economies have been promoting urbanization as one of their policy targets (Chart 6). Concentration of the population to cities, with a larger middle-income population, will lead to greater demand for high value-added products and services. Increasing investment in infrastructure Increased investment in infrastructure is likewise vital to stimulating both exports and domestic demand. However, there are still some Asian economies where insufficient infrastructure is bottlenecking industrial advancement (Chart 7). For example, a stable supply of electricity is a prerequisite to persuading manufacturing firms to move their production sites. Shipping ports and roads are indispensable in order to expand exports. Supplying sufficient residential infrastructure such as housing, schools, and proper water and sewage systems is crucial to promoting urbanization. According to a report by the Asian Development Bank (ADB), the Asian economy is expected to invest the phenomenal sum of nearly 8 trillion US dollars in the 11 years from 2010, in infrastructure such as power supply and roads. Infrastructure investment is a stimulus not only for domestic demand, but would also attract investment by foreign firms that can provide sophisticated technological expertise, which would in turn contribute to boosting productivity. III. Challenges for the Asian economy: Adapting to changes in demographics The second challenge facing the Asian economy is to embrace changes in demographics. Asia is composed of a diversity of economies, and the patterns in demographics are also diverse (Chart 8). For instance, while India has some time to enjoy the benefits of the demographic bonus, the “Four Tigers,” China and Thailand are already facing an aging population and declining birth rate. It is worth mentioning that China and Thailand will be going from demographic bonus to demographic onus while they are still in the middle-income tier. Finding the appropriate response to these changes in demographics and sustaining growth poses a major challenge to the Asian economy. We could draw lessons from the experience of Japan. One of those lessons is that demographic onus depresses economic growth through both the supply-side and demandside factors. On the supply-side, it is widely recognized that labor constraints put downward pressure on the potential growth rate. There is empirical evidence to support this observation in the case of Japan where, since the 2000s, the labor force has been shrinking, household savings have declined, and the pace of growth in capital accumulation has slowed. BIS central bankers’ speeches On the other hand, the demand-side factors are not so obvious, and they tend to be overlooked. In the case of Japan, the aging population and declining birth rate have, for example, induced higher demand for goods and services targeting the elderly, but not all of this potential demand has been exploited because firms have not necessarily succeeded in identifying and responding to such changes. As to social security systems, severe fiscal conditions in pension and medical insurance systems has been interpreted as heralding potential future increases in payments, which would lead to suppressed consumption. So, with an eye to these potentially serious negative effects of the demographic onus, it would be wise to recognize and assess these effects without delay, and to take action to alleviate them in a forward looking manner. On the supply-side, labor participation of women and the elderly will need to be increased in order to address the decline in the working population. In general, the participation rate of women and the elderly tends to be lower in Asia than in advanced western economies. There is an urgent need to establish a working environment that is receptive to women and elderly workers, so as to make the most of their potential contribution. On the demand-side, firms need to step up efforts to identify and exploit the potential demand of the elderly, adjusting their product lines to cater to targeted needs in areas such as travel, nursing care, and userfriendly electronic appliances. IV. The challenges for the Asian economy: Enhancement of resilience Capital flows and the Asian economy The third challenge is how to make the Asian economy more resilient to global shocks. Asia has successfully maintained its high economic performance so far by attracting and effectively utilizing the capital flowing into the region. The capital inflow first came primarily in the form of direct investment, which helped establish Asia’s position as “the factory of the world.” Later, portfolio investments joined the capital inflows, resulting in more volatility in capital flow in and out of Asia, which then developed into the Asian Currency Crisis of the late 1990s. This experience prompted Asian economies to review their policy frameworks flexibly so as to become more resilient to global shocks. For instance, in terms of foreign exchange policy, the de facto fixed exchange system pegged to the US dollar was replaced by a more flexible system. Foreign reserves were accumulated at a rapid pace. To make financial systems more resilient, Asian economies adopted macroprudential policies well in advance of other regions. On the financial market front, policy initiatives have been introduced to encourage the development of local currency bond markets. These efforts combined have led to a strengthening of Asian markets, as proven by the fact that Asian markets were not as seriously affected by the negative effects of the global financial crisis that followed the Lehman Shock. However, we should also recognize the fact that capital flows to and from Asia will inevitably become more volatile as the Asian financial markets become more integrated into global financial markets with the irreversible progress of globalization. With this in mind, a major challenge facing the Asian economy is to further strengthen its resiliency against global shocks, and I want to share three ways through which this might be achieved. Making use of the region’s abundant savings The first way is to further promote financial intermediation mechanisms which enable effective use of the abundant savings in Asia. Traditionally, Asian economies have relied mainly on the banking sector for financial intermediary services, and this may have been at the expense of development of the capital markets. Against this background, the abundant savings in Asia have not been utilized within the region, but have flowed out to the advanced BIS central bankers’ speeches economies, only to return to Asia as capital flows from advanced economies. In this process of global capital recycling, even small changes in the risk appetite of global investors have caused the rewinding of capital inflows, and that has had a disproportionately large impact on relatively small emerging markets. In order to resolve this issue, it is essential to work simultaneously on strengthening the banking intermediary channel and nurturing alternative financial intermediation channels. In particular, each economy should continue to focus on promoting the development of its local currency bond market, so as to ensure a more diverse range of investment choices into which Asian domestic savings can flow. In this regard, bond markets in Asia have grown significantly since the mid-2000s (Chart 9). This is largely thanks to the invaluable efforts of market participants like the audience today to make the market environment more conducive, including making improvements in soft infrastructure such as enhanced disclosure by Asian firms and standardization of accounting systems. Looking at data by currency, the share of foreign currency-denominated bonds has declined overall. A look at the most recent data, however, paints a somewhat contradictory picture of this trend, with a small increase in foreign currency-denominated bonds as funding costs have declined against the background of unconventional easing policies in advanced economies. Due attention should be paid to the influence that the imminent normalization of the monetary policies in the United States might have on the debt servicing capacity of Asian firms. Regional integration and pickup in cross-border trade The second way to boost resilience to global shocks is to accelerate regional financial integration, which has been lagging behind the integration of trade and other real economic activity. Together, these efforts are expected to encourage more activity in the flow of funds, with a pick-up in cross-border transactions, both inter-regional and intra-regional. Overdependence on capital from outside the region would expose Asia to sudden withdrawal of credit provision and sharp unwinding of capital triggered by shocks not directly related to the region. Expansion of intra-regional cross-border transactions would broaden and deepen the investor base, contributing to higher resilience of Asian markets. The financial markets in Asian economies are in various stages of development. This poses a serious impediment to regional integration, unlike in Europe, which stands as a forerunner case in regional integration. Even so, it is not farfetched to expect a surge of activity in terms of cross-border transactions, once market practices and the relevant laws and regulations are further harmonized. In this connection, one topic which needs to be duly considered alongside the promotion of cross-border trades is payment and settlement systems. Central banks, including the Bank of Japan, are making joint efforts to ensure and enhance smooth cross-border settlements. As part of these efforts, there is ongoing discussion among the ASEAN economies, Japan, China, and Korea to establish cross-border linkage between the securities settlement systems and central banks’ payment systems. This would most likely stimulate an increase in capital transactions within the region, as intra-regional cross-border payments and settlements will become safer and more efficient. Once this initiative is established, for instance, Japanese banks would be able to smoothly and effectively obtain funds in Asian currencies on a Delivery Versus Payment (DVP) basis against Japanese Government Securities (JGSs) collateral (Chart 10). Strengthening the regional safety nets The third way to ensure resilience is to strengthen the regional safety nets. It is especially important to prevent spillover and contagion triggered by a temporary liquidity shortage in terms of the balance of payments or funding by financial institutions. BIS central bankers’ speeches Bilateral swap agreements have already been established among the economies in the region to deal with any liquidity crisis related to balance of payments. Furthermore, the economies of ASEAN, Japan, China, and Korea have agreed on the expansion and strengthening of the Chiang-Mai Initiatives, which help finance short-term US dollar liquidity among participating economies (Chart 11). Preventing liquidity crises among financial institutions is another important task for central banks. The Lehman Shock and the ensuing global financial crisis reminded central banks around the world of the importance of fostering a sound financial system with a resilient funding environment for financial institutions and deep and liquid interbank markets. We have also observed that banks have been increasingly expanding their presence in other economies in the region. This is one of the reasons why Asian central banks are progressively making efforts to enhance environments for the funding of local currencies. The Bank of Japan has already agreed to establish cross-border collateral arrangements with many Asian central banks (Chart 12). These are arrangements in which, for instance, Asian central banks provide local currency liquidity to Japanese financial institutions against yen-denominated assets as collateral, in a situation where the Japanese financial institutions encounter funding difficulties in the Asian currencies. The Bank of Japan has agreed to establish such arrangements as a backstop with central banks in Thailand, Indonesia, and Singapore. In February 2015, the Bank of Japan and Bangko Sentral ng Pilipinas (BSP) agreed to establish a cross-border liquidity arrangement where Philippine pesos are provided against yen cash. In establishing and managing regional safety nets, authorities in the region should recognize and acknowledge the policy issues that each country faces, and be prepared to cooperate in addressing any sudden and serious changes in international financial markets. From this perspective, the Bank of Japan, in cooperation with other central banks in Asia, has been contributing proactively to the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP). Concluding remarks I have talked briefly today about the history of Asian economic growth, and I have highlighted three challenges ahead. These challenges will test whether the Asian economy will be able to realize a sustainable growth path. I believe that Asia has high potential to overcome these challenges, and, we should be able to celebrate the 21st century as the “Asian Century.” Another important question is how Japan can contribute to sustainable growth in the region, as well as enjoying the benefits of this growth. I would like to add a few words on this issue. As Asia becomes more than just “the factory of the world,” but also a globally important market, many changes are being observed in the demand structure in the Asian economy, such as rising demand for goods in local markets and the shift towards a service economy. If Japan is to enjoy the full benefits of the region’s growth, it needs to adapt appropriately to such changes. Japanese firms have nurtured strong product lines and business expertise within a competitive domestic business environment. In order to cultivate local demand, I think it would be very effective to take advantage of such high-quality products and expertise with due consideration to the local cultures and customs of each economy. For Japanese financial institutions, it is essential to focus not only on efforts to support Japanese firms operating in Asian countries, but also to contribute to local economic development by supporting local business firms. These efforts are already underway. Japan has already experienced many of the challenges that other Asian economies will be facing in the near future, such as environmental and energy issues. We could say Japan is “in the vanguard of addressing global issues.” Japan can use this front-runner advantage as a business opportunity in providing skills and expertise in these areas, and through this, can contribute to underpinning sustainable growth in the region. BIS central bankers’ speeches The Bank of Japan, for its part, has been pursuing aggressive monetary easing, or quantitative and qualitative easing (QQE), with the aim of achieving a price stability target of 2 percent. Leading Japan’s economy out of persistent deflation and putting it on a solid recovery path should also contribute to upholding the sustainable economic growth of the Asian economy. I would like to conclude my remarks by adding that the Bank of Japan is determined to play an active role in enhancing the financial infrastructure in Asia, through such means as refining payment and settlement systems and strengthening safety nets. 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 Haruhiko Kuroda, Governor of the Bank of Japan, to the Yomiuri International Economic Society, Tokyo, 15 May 2015.
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Haruhiko Kuroda: Two years under QQE Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, to the Yomiuri International Economic Society, Tokyo, 15 May 2015. * * * Introduction It is a great honor to be invited to this meeting hosted by the Yomiuri International Economic Society today. The last time I addressed this meeting, in April 2013, was immediately after the Bank of Japan’s introduction of Quantitative and Qualitative Monetary Easing (QQE). Two years have passed since then, and the economic and price situation has improved substantially under QQE. Although the year-on-year rate of increase in the consumer price index (CPI) had declined, due mainly to the effects of the substantial decline in crude oil prices since last summer, and recently has been about 0 percent, the underlying trend in inflation has steadily been improving, as I will explain later in more detail. Today, I will review the developments in Japan’s economic activity and prices during the past two years and explain the effects QQE has been exerting. On this basis, I will touch on the outlook and the Bank’s monetary policy, referring to the April 2015 Outlook for Economic Activity and Prices (hereafter the Outlook Report). I. Effects of QQE Transmission mechanism of QQE The Bank, in introducing QQE two years ago, envisioned the following transmission mechanism of QQE as a main channel (Chart 1). Namely, (1) inflation expectations will be raised through a strong and clear commitment to achieving the price stability target of 2 percent and through large-scale monetary easing to underpin the commitment, (2) downward pressure will be put on nominal interest rates across the entire yield curve through massive purchases of Japanese government bonds (JGBs), thereby (3) decreasing real interest rates. The decline in real interest rates will stimulate private demand, which will lead to an upturn in the economy, improving the output gap. Then, the improvement in the output gap, together with a rise in inflation expectations, will increase inflation rates. As people experience actual price increases, their inflation expectations will rise further. Meanwhile, on the financial front, asset prices – such as stock prices and foreign exchange rates – reflect these developments in economic activity and prices or else incorporate future developments. Moreover, due to the decline in JGB yields, coupled with the Bank’s purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs), investors will increase their risk-taking, thereby exerting positive effects on prices of risk assets, and an increase in lending is also expected. These improvements in finance will support economic activity. QQE aims at giving rise to such a virtuous cycle of finance, economic activity, and prices, which in turn raises inflation rates toward 2 percent accompanied by a positive turnaround in the economy. The downward effects on real interest rates Let me assess the outcome of QQE. First, I will review to what extent real interest rates have declined, which is the starting point of the transmission mechanism. Long-term interest rates, which had already been at historical low levels at the time of the introduction of QQE, have declined further with the Bank’s massive purchases of JGBs. Yields on 10-year JGBs have declined by about 0.3 percentage point. Meanwhile, inflation BIS central bankers’ speeches expectations have increased. When asked “to what degree do you think prices will rise,” I believe that you would feel differently now versus two years ago, and that your answer also would be different. The word “deflation” – or defure in Japanese – has not been heard so much except in the context of “overcoming of deflation.” Firms’ price- and wage-setting behavior has been changing and rises in base pay, which had not been seen for more than a decade, have taken place in two consecutive years starting from last year. Given these changes, there is no doubt that inflation expectations have increased. That said, when trying to express such expectations in terms of numeric figures, a single figure cannot be easily found because expectations are what exist in people’s minds. The results of surveys conducted of various economic entities including households, firms, and economists, in addition to figures implied by inflation-indexed bonds that are traded in markets, are wide ranging. With this in mind, medium- to long-term inflation expectations of economists and market participants, for which the results can be obtained in a numerical form, have increased by about 0.5 percentage point. Based on these figures, the degree of decline in real interest rates seems to have been slightly less than 1 percentage point, as calculated by adding the degree of decline in nominal long-term yields mentioned earlier (Chart 2). There are various methods for estimating the degree of decline in real interest rates, such as calculating the degree of downward effects on real interest rates brought about by the Bank’s cumulative JGB purchases thus far; interestingly, regardless of the method employed, the results have been mostly the same. The fact that similar results are obtained from different methods means that it is reasonable to judge that, numerically, real interest rates have declined by less than 1 percentage point; medium- to long-term inflation expectations have increased by about 0.5 percentage point and nominal long-term interest rates have decreased by about 0.3 percentage point. According to research conducted in the United States and Europe, a decline in long-term interest rates has policy effects on economic activity and prices that are approximately a couple of times larger than those of a decline in short-term interest rates. Moreover, our empirical analysis of downward pressure from QQE on nominal interest rates across the entire yield curve showed that, if the same effect were to be gained exclusively through the decline in short-term interest rates, it would be necessary to decrease the rate by about 2 percent. While these analyses are subject to a margin of error due to the situation for each country and to the relevant premises, the policy effects of QQE are such that they are roughly equivalent to those that would arise from making almost ten 0.25 percent cuts in short-term interest rates in one shot under conventional monetary policy. Financial markets responded to QQE relatively swiftly. Stock prices have increased substantially and the appreciation of the yen was corrected in the foreign exchange markets. Lending, including that to small and medium-sized enterprises (SMEs), has been increasing moderately, at a pace of 2.5–3.0 percent on a year-on-year basis recently. In addition to the decline in real interest rates, such developments have made financial conditions even more accommodative. Economic activity and prices under QQE With QQE producing effects, a virtuous cycle from income to spending has been operating in both the corporate and household sectors, and the economy has seen a significant turnaround. In the corporate sector, profits have improved to their highest level historically and fixed investment has been on a moderate increasing trend (Chart 3). Meanwhile, exports, which had been lacking momentum despite the correction of the appreciation of the yen, have finally been picking up clearly, as seen in their increase for three consecutive quarters since the July-September quarter of 2014 (Chart 4). Turning to the household sector, labor market conditions have tightened and the employment situation has improved, as seen in the unemployment rate declining to around 3.5 percent. Consequently, in fiscal 2013 – during the year after the implementation of QQE – the number BIS central bankers’ speeches of employees increased in particular. In fiscal 2014 – the second year after the implementation – wages also turned to an increase. Employee income – that is, nominal wages multiplied by the number of employees – has been rising moderately (Chart 5). Against the background of an improvement in the employment and income situation, private consumption as a whole has been resilient. The effects of the consumption tax hike had been protracted during fiscal 2014, but they have been dissipating recently. Reflecting this turnaround in the economy, the underlying trend in inflation has also steadily increased. As seen in the decline in the unemployment rate, labor and capital have been heavily utilized, and the output gap has already improved to about 0 percent, which is the level of the past long-term average. As mentioned earlier, inflation expectations have also increased. As a result, the year-on-year rate of change in the CPI (all items less fresh food) – about minus 0.5 percent before the introduction of QQE – improved to 1.5 percent last April excluding the direct effects of the consumption tax hike. Thereafter, the rate of increase in the CPI has slowed against the background of somewhat weak developments in demand following the consumption tax hike and the substantial decline in crude oil prices since summer 2014. While the decline in crude oil prices exerts positive effects on Japan’s economy, there is a risk that the mechanism I have explained thus far will not operate if it were to affect firms’ price- and wage-setting behavior through changes in inflation expectations. In order to preempt the manifestation of such risk, the Bank expanded QQE in October 2014 to pursue a stronger monetary easing measure. Looking at developments in inflation expectations thereafter, market-based indicators and various survey results have not declined despite the fall in crude oil prices. Moreover, in the annual labor-management wage negotiations this year, many firms will increase wages, including base pay, which was raised to a larger extent than last year. More firms have been shifting their price-setting behavior toward a strategy of raising sales prices while increasing value-added. Inflation expectations can be judged as rising on the whole from a somewhat longer-term perspective. The financial, economic, and price developments I have outlined are mostly in line with the mechanism anticipated by QQE. The developments are qualitatively described as a decline in real interest rates, a rise in stock prices and depreciation of the yen, improvement in corporate profits, tightening in the labor market, an increase in employee income, and a rise in the CPI. Let me now explain these developments by referring to our quantitative analysis. During the two years since the introduction of QQE – more precisely, up to end-2014, for which quarterly data are available – actual changes in economic activity and prices amounted to improvement of 2 percentage points in the output gap, which represents improvement of about 10 trillion yen, and a 1.0 percentage point improvement in the year-onyear rate of increase in the CPI. Simulating the effects of the less than 1 percentage point decline in real interest rates that I have mentioned by using our macroeconometric model, the results are as follows: the output gap improved by 1–3 percentage points and the yearon-year rate of increase in the CPI rose by 0.6–1.0 percentage point. While these results vary depending on the assumption about how much stock prices and foreign exchange rates are affected by QQE, the results obtained by using the model are generally in line with the actual changes in economic activity and prices. During the past two years, there were both positive and negative effects on economic activity and prices in addition to QQE – such as measures by the government including large-scale public investment, the consumption tax hike, a surge in stock prices, foreign exchange rate movements, and a significant decline in crude oil prices. In reality, however, economic activity and prices as a whole could be assessed – even on a quantitative basis – as being mostly in line with the mechanism anticipated by QQE. Having said this, the year-on-year rate of increase in the CPI has slowed to about 0 percent due to the effects of the decline in energy prices. In order to achieve the price stability target of 2 percent in a stable manner, it is necessary that the CPI inflation rise as inflation BIS central bankers’ speeches expectations increase further. As mentioned earlier, inflation expectations are rising on the whole from a somewhat longer-term perspective, due partly to the effects of the expansion of QQE last October despite the decline in crude oil prices. We will examine whether the trend rise in inflation expectations will continue in a situation where CPI inflation has declined. In the following, I will touch on the outlook for economic activity and prices. II. Outlook for economic activity and prices Outlook for economic activity Looking ahead, Japan’s economy is expected to continue its recovery trend with a virtuous cycle from income to spending maintained in both the household and corporate sectors and with a favorable environment of inexpensive crude oil prices. Exports are expected to increase moderately against the background of the recovery in overseas economies – mainly in advanced economies – and support from the correction of the appreciation of the yen. Turning to domestic demand, with an improvement in corporate profits and monetary accommodation both continuing to provide a boost, business fixed investment is projected to increase steadily, additionally supported by recently emerging developments toward the enhancement of domestic production capacity. Private consumption is projected to accelerate its pace of increase due to a steady improvement in the employment and income situation, given that consumer sentiment has been improving recently and that the effects of the decline in demand following the consumption tax hike in April 2014 have been dissipating. Against this background, with regard to the outlook over the next three years, the economy is projected to continue growing at a pace above its potential from fiscal 2015 through fiscal 2016. Under these circumstances, the output gap is likely to turn positive and thereafter move further into excess demand territory. Expressing the outlook in terms of the median of the Policy Board members’ forecasts of the real GDP growth rate, this was 2.0 percent for fiscal 2015 and 1.5 percent for fiscal 2016 (Chart 6). Subsequently, through fiscal 2017, the economy is projected to maintain its positive growth, although with a slowing in its pace to around a level somewhat below the potential growth rate. The slowdown is due mainly to (1) the effects of a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike planned in April 2017 and (2) cyclical deceleration. In terms of the median of the Policy Board members’ forecasts of the real GDP growth rate, this was 0.2 percent for fiscal 2017. Outlook for prices Next, I will discuss the outlook for prices. The improvement in the output gap and an increase in inflation expectations are likely to continue, and thus the underlying trend in inflation is expected to steadily rise. In addition, downward pressure from the decline in energy prices will gradually dissipate. Therefore, the year-on-year rate of increase in the CPI (all items less fresh food) is likely to be about 0 percent for the time being but accelerate toward 2 percent as the negative contribution of energy prices on a year-on-year basis narrows in the second half of fiscal 2015. Although the timing of the year-on-year rate of increase in the CPI reaching around 2 percent depends on developments in crude oil prices, this is projected to happen around the first half of fiscal 2016, when the negative contribution of energy prices will become almost zero, assuming that crude oil prices will rise moderately from the recent level. Thereafter, the year-on-year rate of increase in the CPI is expected to be around 2 percent on average, although it will be affected by various factors each month. In the April 2015 Outlook Report, the median of the Policy Board members’ forecasts of the year-on-year rate of increase in the CPI (all items less fresh food) was 0.8 percent for fiscal 2015, 2.0 percent for fiscal 2016, and 1.9 percent for fiscal 2017 (Chart 6). Comparing the projections in the Outlook Report with those in the January 2015 interim assessment, the BIS central bankers’ speeches projected rate of increase in the CPI is somewhat lower. The timing of reaching around 2 percent is delayed, albeit slightly, from the former projection of “in or around fiscal 2015.” III. The Bank’s monetary policy As I have explained, QQE has exerted its intended effects. The improvement in economic activity and prices is likely to continue, and the CPI inflation is projected to reach the price stability target of about 2 percent around the first half of fiscal 2016. The Bank will keep its stance of continuing with QQE, aiming to achieve the price stability of 2 percent, as long as it is necessary for maintaining that target in a stable manner. The timing of achieving the 2 percent target has been delayed compared to the previous forecast. Some have raised the question of how the delay should be reconciled with the Bank’s commitment to achieving the price stability target at the earliest possible time, with a time horizon of about two years. Changing people’s deflationary mindset and raising inflation expectations through its commitment to achieving the price stability target of 2 percent at the earliest possible time is by itself an aim of overcoming deflation, and at the same time the starting point of QQE’s effects. As I have explained, the perception of inflation by firms and households started to change markedly. This is because the Bank presented a time frame of achieving the price stability target at the earliest possible time with a time horizon of about two years, and made a clear commitment to doing whatever is necessary to achieve that target. In reality, prices change due to various factors. A slowdown in the inflation rate in Japan since last summer is mainly attributable to the decline in crude oil prices, and it is common to many countries. The rate of decline in crude oil prices since last summer was very large – about 60 percent within about six months. It has been taken for granted among major central banks that the inflation rate would deviate for some time from the price stability target as a result of changes in commodity prices, such as crude oil prices. In fact, the year-on-year rates of change in the headline consumer price index have become zero or even slightly negative in economies such as of the United States, the United Kingdom, and the euro area, and the timing of reverting to 2 percent inflation is projected to be two or three years from now in these economies. In Japan, as I have described, the underlying trend in inflation has improved steadily, and as the effects of the decline in crude oil prices dissipate, the year-onyear rate of increase in the CPI is projected to accelerate toward the price stability target of 2 percent. We believe that this forecast is consistent with the commitment to achieving the price stability target at the earliest possible time, with a time horizon of about two years. That said, if there are changes in the underlying trend in inflation and it is deemed necessary to take action in order to achieve 2 percent inflation, the Bank will make adjustments as appropriate without hesitation. Concluding remarks So far, I have reflected on the progress made in the two years since the introduction of QQE, and with this in mind, I also have discussed the developments in economic activity and prices and the Bank’s monetary policy. Lastly, I will conclude today’s speech by sharing my thoughts. In implementing economic policies, many things can happen, expected or unexpected. Looking back at the two years since the introduction of QQE, there have been expected developments and unexpected events. During the first year – in fiscal 2013 – most of the developments were judged as expected or as better than expected, as the economy experienced a positive turnaround and the inflation rates increased steadily. Exports, however, had been lacking momentum, and this was below my expectations. The effects of firms’ relocation of production overseas, which had taken place amid the excessive appreciation of the yen, were more significant than I had expected. Because of these effects, BIS central bankers’ speeches it is only recently that exports have picked up. During the second year – in fiscal 2014 – private consumption was weaker than expected. This was attributed to the effects of the decline in demand following the consumption tax hike being somewhat prolonged, as well as to other factors, such as the effects of the bad weather last summer. From consumers’ perspective, it was natural that they perceived the consumption tax hike as being part of price increases. Given that the rate of wage increases did not catch up with that of price increases including the tax hike, private consumption weakened. Such effects on private consumption have been anticipated since tax hikes place a burden on consumers, but they have been somewhat larger than our expectations. On top of this, I would note the decline in crude oil prices, which amounted to a 60 percent drop within about six months, as the most unexpected event. As a result, the CPI inflation rate has declined to about 0 percent from 1.5 percent. This decline in the inflation rate created a risk for the mechanism of QQE – namely, the formation of inflation expectations in particular – and this was why the Bank decided to expand QQE. Despite these unexpected events, the mechanism of QQE has been operating as intended. During the past two years, QQE – in tandem with the government’s policy measures – has markedly changed people’s negative mindset, which had taken root under deflation. If the economy continues its turnaround and deflation is to be overcome, Japan will provide a rare example of a regime shift through macroeconomic policy. Despite some unexpected events, I feel encouraged by the fact that the big picture of economic development for these two years is in line with what we envisioned at the outset. The Bank will continue to steadily pursue QQE to achieve the price stability target of 2 percent at the earliest possible time. Thank you. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Keynote speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the Futures Industry Association Japan (FIA Japan) Financial Market Conference 2015, Tokyo, 13 May 2015.
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Takehiro Sato: Toward further development of the Tokyo financial market – issues on repo market reform Keynote speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at the Futures Industry Association Japan (FIA Japan) Financial Market Conference 2015, Tokyo, 13 May 2015. * * * Introduction It is a great honor to have the opportunity today to exchange views on the further development of Japan’s financial markets with distinguished participants from major financial institutions, pension funds, and portfolio managers in Japan, the United States, Europe, and other Asian countries. Today, I would like to talk about the repo market in Japan. The Bank of Japan, collaborating with market participants at home and abroad, is taking active steps to help create a marketwide infrastructure. This is done with the aim of further enhancing the functioning of Japan’s financial markets – which are a focus of the Bank’s monetary policy implementation and a touchstone of policy effectiveness. The repo market plays the extremely important role of supplying liquidity to the primary and secondary markets, as does the Japanese government bond (JGB) futures market. Repos and futures transactions are an integral part of market-making activities and the markets’ price discovery mechanism. In this sense, the futures market works hand in hand with the repo market. In the same vein, the development of the repo market drives further development of the futures market by boosting the liquidity of the JGB market. Hoping for such positive feedback to continue, I would like to talk about the international discussions on repo market reform. I will also touch on issues related to the role of market participants and the Bank in such discussions. As you are well aware, repos are transactions that involve the exchange of cash and securities for a set of period. The repo market is an important place for borrowing and lending of cash and securities in many global financial markets. The amount outstanding of repos in Japan declined temporarily in 2008 due to the collapse of Lehman Brothers, but has regained its size markedly in recent years. It now accounts for almost half of the total transaction amount in the money market (Charts 1 and 2). Currently, market participants are taking initiatives in repo market reform in accordance with international discussions. In my view, these initiatives center on four key ideas: transparency, stability, efficiency, and globalization. I would like to touch on each idea. I. International discussions on repos Drawing on the lessons learned from the recent global financial crisis, discussions on repos have taken place at international forums such as the G20 and the Financial Stability Board (FSB), with the aim of further increasing the transparency and stability of the repo market. The Bank is also taking part in these discussions (Charts 3 and 4). The awareness here is that the financial crisis was worsened by the large increase in repos using illiquid securitized products, particularly in the United States. Excessive leveraging and risk taking in the repo market posed a serious threat to financial stability. This development drew attention to the so-called shadow banking problem. To prevent the repo market from seizing up, the FSB deemed it necessary for regulatory authorities to closely monitor the repo market. It also required further strengthening of risk management by setting haircuts appropriately. In sum, from a prudential policy perspective, there has been an international BIS central bankers’ speeches agreement that increasing transparency and stability of the repo market is an important step in addressing global financial stability risks. A. Reforms to increase transparency (building of a data collection framework) With regard to transparency – the first key idea that I mentioned – the FSB set out its policy recommendation for strengthening repo data collection at both the national and the global level. This was aimed at collecting detailed data on repos such as the type of collateral. By collecting such data, national authorities can monitor financial stability risks such as a buildup of leverage, the degree of maturity mismatch, and the risk concentration among certain market participants. An FSB Data Experts Group is working on the details of this data collection framework, and the Bank is also taking part. A consultation paper containing details such as the data template was released in November 2014, and the framework will be finalized by the end of 2015, after taking account of the results of public consultation. In the coming months, active discussion on the domestic data collection framework will take place in Japan, mirroring developments at the global level. To facilitate the smooth introduction of the framework, it is necessary to pay due attention to the burden on market participants and implications for the market. National authorities see the data collection project as marking significant progress toward increasing transparency of the repo market as well as shadow banking activities. The project should also help to contain financial stability risks. Active participation in it will contribute to global financial stability. Furthermore, the project will enhance Japan’s international competitiveness by ensuring global trust in the nation’s money markets. In cooperation with stakeholders both at home and abroad, the Bank will continue to contribute actively to this project. B. Reforms to increase stability (implementation of appropriate risk management) The second key idea concerns the stability of the repo market. In this regard, “haircuts” are intended to increase the safety of a transaction by reducing the market value of the collateral in proportion to factors such as fluctuations in the collateral price. At the height of the financial crisis, the prices of asset-backed securities (ABSs) plunged. These securities were used as repo collateral, and the level of haircuts for them rose sharply. This led to a further decline in prices and liquidity, destabilizing the entire repo market. With these experiences in mind, the FSB is requesting regulatory authorities to apply two measures to all the repo transactions that are not cleared by a central counterparty (CCP). The first measure is numerical haircut floors (Chart 5). The thinking is that in good times market participants tend to underestimate price volatility risk and set haircuts that are too optimistic. By setting a floor, this measure aims to avoid “procyclicality”: excessive buildup of leverage in good times and rapid deleveraging in stressed market conditions due to a sudden rise in haircuts. Repos using government securities are exempted from the numerical haircut floors. This is because price movements in government securities tend not to be procyclical, and haircuts on government securities are zero or close to zero for most transactions. Unlike in the United States, where a considerable amount of repos uses ABSs, government securities are mainly used in Japan (Charts 6 and 7). For this reason, the implementation of numerical haircut floors would have little impact on the repo market in Japan. The second measure requested by the FSB concerns methodology standards. Regulatory authorities are required to establish qualitative standards for the methodologies that market participants use to calculate haircuts, incorporating stress scenarios. As just mentioned, nearly all the repos in Japan use government securities, for which haircuts are hardly applied. However, even the most creditworthy and liquid assets such as BIS central bankers’ speeches government securities can entail a risk of price fluctuations. Therefore, to ensure repo market stability, it is important to establish a common understanding among market participants on what risk management, including methodology standards, should entail. The FSB will establish a monitoring process to prevent market participants from avoiding numerical haircut floors by booking transactions in different jurisdictions. Depending on the results of this monitoring process, the FSB will consider reviewing the scope of the application, which currently excludes repos using government securities, as well as the level of haircut floors as necessary. The Bank deems it necessary to continue actively participating in the international discussions regarding the framework for numerical haircut floors, while making sure that these do not have unintended consequences for liquidity in the global repo markets. II. Reforms to increase efficiency (shortening of the JGB settlement cycle) In parallel with the international discussions just mentioned, there is an ongoing initiative on efficiency. In Japan, market participants are aiming to further shorten the settlement cycle for outright transactions of JGBs from two business days (T+2) to one business day (T+1) after the trade date. This initiative was taken in response to the significant increase in settlement fails in the JGB market at the height of the Lehman crisis. By compressing the unsettled transaction amount, it intends to reduce settlement risks. In addition, shortening the settlement cycle would bring drastic changes to the repo market, because the initiative is accompanied by the creation of a new market-wide infrastructure. The repo market complements the JGB market, because it accommodates the need to adjust excesses or shortages of cash resulting from outright transactions. Therefore, it is essential to introduce a T+0 settlement cycle for the general collateral (GC) repo market in conjunction with achieving the T+1 settlement cycle for outright JGB transactions. To this end, much greater speed and efficiency are required in processing repo transactions. This leads to the third key idea: increasing efficiency. Japan’s repo market is planning to introduce the subsequent collateral allocation method for GC repo transactions. For this purpose, the market will establish a new collateral management infrastructure with sufficient allocation capacity. Heightened efficiency in the repo market has the potential to bring considerable change to the money market in Japan. More specifically, it could lead to the creation of a significantly expanded T+0 funding market. If all of the overnight GC repos currently settled on T+1 shift to T+0, the market size is roughly expected to reach 20 to 30 trillion yen (Chart 8). On the other hand, the size of the brokered and uncollateralized overnight call market is currently 2 to 3 trillion yen. This suggests that there is a high probability that the size of the T+0 GC repo market will exceed that of the call market and become the largest money market in Japan, offering same-day liquidity. As I mentioned, the size of Japan’s repo market is expanding. From a broader perspective, while unsecured funding has been diminishing globally after the financial crisis, secured funding has been relatively robust. This result seems to reflect structural factors, such as the increase in the awareness of credit risks of interbank transactions following the financial crisis, as well as the introduction of financial regulations that discourage unsecured shortterm funding. On the basis of this broad trend, the establishment of the T+0 repo market has the potential to not only affect the current call market but also bring structural change to the money market, which is vital to the money market operations of the Bank. Currently, banks and money market brokers are major cash borrowers in the call market, while in the GC repo market securities firms are major cash borrowers (Chart 9). The T+0 repos may greatly BIS central bankers’ speeches increase the depth of the T+0 funding market and the diversity of its participants. These changes could help to further vitalize the money market as a whole. With these possibilities in mind, the Bank will work closely with market participants and follow the potential impact of these changes. Specifically, the Bank is greatly interested in the potential impact on the size of call and repo market, the diversity of participants, and the money flow. Changes in these factors might also affect the behavior of the money market rates. III. Reforms toward globalization (shifting to the new gensaki method) Another important initiative is the unification of contract types for repos. Recently, market participants agreed on the uniform adoption of the new gensaki method, a more globally accepted form of a repurchase agreement. They are now working on the transition process, such as amending the master agreement. This leads to the fourth key idea: globalization. In Japan, loan-type repos (called gentan repos) have been widespread in the market. This is because the securities transaction tax – although now abolished – used to be levied on the purchase and sale of securities. Thus, there have been three types of repo contracts in Japan (gentan, new gensaki, and old gensaki), with correspondingly diverse market conventions (Chart 10). This is considered to be one factor that impedes efforts to improve efficiency and automation in the processing of repo transactions. In addition, it is often said that the loan-type repos cause difficulties in communication among domestic participants, and overseas authorities and participants, because the loan-type repos have the same legal characterization as securities lending in major overseas markets. Consequently, the unification of repos to the new gensaki contracts will contribute to the further globalization of Japan’s money market and lead to the vitalization of Japan’s repo market, including transactions with foreign investors who are present here today. Market participants are expected to improve their IT systems, change market conventions, and seek clients’ involvement. The Bank is committed to offering support to achieve these goals. Concluding remarks Today, I have talked about the four key ideas regarding the reform of Japan’s repo market: transparency, stability, efficiency, and globalization. In the creation of a market-wide infrastructure, these four ideas are important for not only the repo market but also the financial markets as a whole. The share of JGB holdings by foreign investors is expected to expand over the medium and longer term, reflecting changes in domestic savings and investment. Developing a safe and attractive repo market for investors both at home and abroad would contribute to boosting liquidity in the JGB market. This would also increase trust in Japan’s financial markets. Reforms in the repo market, which were initiated by the failure of the Lehman Brothers, are expected to reach their final stage in two to three years. In this regard, we are at a critical moment for fulfilling the reforms. The Bank judges that it is extremely important for the repo market, the epicenter of Japan’s money market, to become more transparent, stable, efficient, and easily accessible for foreign investors. The Bank will hold a Repo Market Forum on May 14, and will exchange opinions with major repo market participants on the four key ideas behind the reform. The Bank aims, together with market participants, to contribute further to the development of the repo market and to the Tokyo financial market. Thank you very much for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the ECB Forum on Central Banking, Sintra, Portugal, 23 May 2015.
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Haruhiko Kuroda: Some reflections on unemployment and inflation Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the ECB Forum on Central Banking, Sintra, Portugal, 23 May 2015. * * * The accompanying graph can be found at the end of the speech. It is a great pleasure for me to be able to participate in this conference. More than 40 years ago, in his seminal speech on the subject, James Tobin said, “Unemployment and inflation still preoccupy and perplex economists, statesmen, journalists, house-wives and everyone else.” 1 For the Bank of Japan, employment is not explicitly included in its monetary policy mandate, unlike in the case of the Federal Reserve. Unemployment is still a useful guide for us, however, in pursuing price stability, the explicit mandate of our monetary policy. In addition, it is widely recognized that price stability must be secured because it is an indispensable foundation for the health of the economy, which of course has a direct impact on workers. Therefore, despite some seeming differences in the mandates written in their respective statutes, there is little practical difference between major central banks across jurisdictions, in that both unemployment and inflation are of central concern in formulating their monetary policies. Nevertheless, there are remarkable differences between the United States, the euro area and Japan in their historical observations of unemployment and inflation. Let us take a look at this very simple graph: a scattered diagram showing unemployment and inflation for these three jurisdictions. The horizontal axis is unemployment rate, and the vertical one is inflation rate. There are two approaches regarding how to interpret this graph. One approach is to focus on where each cluster of dots is located. There is a well-known measure of welfare, the Misery Index, which is the simple sum of unemployment rate and inflation rate. If the Misery Index is indeed the most accurate measure of welfare, the further northeast an economy is located, the more miserable the state of that economy is. In this interpretation, Japan’s performance has been consistently outstanding for many years with the lowest unemployment and lowest inflation among the three. 2 However, the Misery Index is an indicator that makes sense only in a high inflation environment, which has not been the case in major economies for the last twenty years. Therefore, the Misery Index would not in fact give us any useful hints in evaluating the monetary policies of major central banks. The other approach is to interpret the clusters as each jurisdiction’s Phillips curve, where the underlying theory is that inflation dynamics can be explained in the context of slackening in the labor market. I know that economists continue debating hotly whether or not a meaningful slope in the Phillips curve is observed in major economies in recent years. 3 As a matter of fact, this simple graph appears to suggest that the Phillips curves for the United States and the euro area have barely sloped, if at all, since the middle of the 1990s. One important aspect is that both flat “curves” are located at around 2 percent inflation. In other words, the inflation rate has been mostly stable around 2 percent, irrespective of noticeable ups and downs in unemployment: inflation has been well anchored at the level intended by the respective central banks. Of course, the recent sizable and persistent deviation from 2 percent for the euro area could be problematic. I understand this is exactly the reason why the European Central Bank joined the QE club recently. James Tobin, “Inflation and Unemployment,” American Economic Review, Vol. 62, 1972. The ranking does not alter even if we use headline inflation instead of core. See, for instance, Robert J. Gordon, “The Phillips Curve is Alive and Well: Inflation and the NAIRU during the Slow Recovery,” NBER Working Paper, No. 19390, 2013. BIS central bankers’ speeches Compared with these two Phillips curves, Japan’s is unique in two points. First, the negative correlation between unemployment and inflation is more apparent in Japan. Second and more importantly, the curve crosses the zero inflation line with a larger part of it remaining in negative territory. This suggests that long-term inflation expectation in Japan has likely been around zero or even slightly negative for nearly two decades since the mid-1990s. This is exactly the problem which the Bank decided to address decisively a little over two years ago through Quantitative and Qualitative Monetary Easing (QQE). Our intention was twofold: first, to stimulate the economy throughout various transmission channels and thereby move the economy and inflation in the northwest direction along our moderately but still meaningfully sloped Phillips curve; and second, to create higher inflation expectations and thereby shift the entire Phillips curve upward, through the drastic shift in our monetary policy. Things are moving in line with our original intention. The latest data point can be interpreted as confirming that underlying inflation in Japan has been improving significantly, although the firmness is currently masked by the temporary negative impact of the sharp decline in oil prices. There have been a number of positive signs in this regard: first, various surveys indicate that inflation expectations have been edging up steadily over the last two years or so. Second, annual spring wage negotiations appear to have started reflecting higher inflation expectations: base pay levels rose last year for the first time since the 1990s, and further accelerated this year. Third, the Bank’s economists recently confirmed, based on a rigorous quantitative analysis, that a “regime-shift” in trend inflation from zero to a meaningful positive level indeed occurred under QQE. 4 All these signs indicate that we are now overcoming the deflation that has long been afflicting our economy. We must maintain our current efforts in order to achieve the 2 percent inflation target at the earliest possible time, which we now expect to be around the first half of fiscal 2016. Another interesting fact illustrated by the graph is that the recent unemployment rate in Japan, about 3.5 percent, is low even by Japanese standards. With everything else being equal, the lower the unemployment rate, the better the economic welfare. However, that may not be the whole story. The fact that we have achieved this very low level of unemployment with only modest economic growth in the last two years indicates how heavily our adverse demography is weighing on the supply side of the economy. Japan’s working-age population started to decline in the middle of the 1990s, and this decline is now gaining pace. This represents a considerable threat to potential growth, which has declined to an anemic 0.5 percent, or possibly even lower. In order to restore a stronger supply side, we need to raise labor participation rates among the female and elderly population as well as labor productivity. As a matter of fact, the third arrow of Abenomics is already working on these issues. Although a central bank cannot directly change the potential growth rate, the Bank of Japan’s unprecedentedly accommodative monetary stimulus is certainly helping the reforms by dispelling the deflationary mindset. In Professor Tobin’s day, the policy problem was primarily related to a trade-off between the social costs of unemployment and those of inflation. The picture is different now. Most major economies are in need of both higher inflation and more jobs. In this sense, there is no tradeoff. The new challenge has more to do with expanding our policy frontier than with choosing between trade-offs. This challenge is further complicated by the structural weakness of the economy, characterized among other things by demography. Professor Tobin stated in his conclusion that, thirty-five years after Keynes, welfare macroeconomics associated with unemployment and inflation was still a relevant and challenging subject. At the same time, he sounded reasonably optimistic about future policy wisdom that would better address these problems. He was half-right. Inflation has not been a serious problem in advanced Sohei Kaihatsu and Jouchi Nakajima, “Has Trend Inflation Shifted?: An Empirical Analysis with a RegimeSwitching Model,” Bank of Japan Working Paper Series, No.15-E-3, 2015. BIS central bankers’ speeches economies for many years now. Nevertheless, growth and job creation are not satisfactory. On top of that, the risk of deflation is a new element that now requires serious consideration, while it was not on the list of concerns in the 1970s. No matter how difficult the problems may seem, however, I believe that the right policies, with strong determination, will ultimately prevail. I hope that we can be even more optimistic after this conference, with a deeper understanding of this subject, and still greater conviction that we are already heading in the right direction. Thank you. 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, Sapporo, 27 May 2015.
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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, Sapporo, 27 May 2015. * * * Accompanying charts can be found at the end of the speech. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in this region. I would like to take this chance to express my sincerest gratitude for your cooperation with the activities of the Bank of Japan, particularly of the Sapporo Branch and the local office in Asahikawa. Today, I would like to have your views on the actual situation of the local economy as well as your candid opinions about the Bank’s policies and activities. Before exchanging views with you, I will briefly explain the recent economic developments at home and abroad, and then touch on some points regarding the conduct of monetary policy. I. The current situation of and outlook for Japan’s economy Japan’s economy has continued to recover moderately in a situation where a virtuous cycle from income to spending has been operating in both the corporate and household sectors. In the following, I would like to elaborate on the background to this assessment and on the outlook for Japan’s economy in terms of the corporate sector – including exports and production – and then in terms of the household sector – such as the employment and income situation and private consumption. A. Corporate sector Exports have been picking up recently owing to the recovery in overseas economies and support from the effects of the depreciation of the yen (Chart 1). In particular, exports to the United States have continued to see a marked increase since capital goods and parts have increased, reflecting the recovery in business fixed investment in the United States, and since motor vehicles and their related goods have picked up. The global economy, which is the key to projecting the outlook for exports, is expected to moderately increase its growth rate as advanced economies continue to see firm recovery and its positive effects gradually spread to emerging economies. According to the April 2015 World Economic Outlook (WEO) released by the International Monetary Fund (IMF) last month, global economic growth is projected to accelerate moderately on the whole: after registering 3.4 percent in 2014, it is projected to be 3.5 percent in 2015 and 3.8 percent in 2016 (Chart 2). Looking specifically at the developments by region, in the United States, which is expected to be the driving force of global growth, the real GDP growth rate for the January-March quarter has decelerated considerably, due in part to effects of adverse weather conditions. Nevertheless, the economy continued its robust recovery trend supported by household spending – as seen in private consumption rebounding from a fall in winter – against the background of the favorable employment and income situation in particular. The U.S. economy is expected to continue to see growth led mainly by private demand, starting from firm household spending. In addition, the European economy, in which the momentum for recovery had been weak, has recently been seeing a clear increase in private consumption, reflecting the effects of the decline in crude oil prices and of a rise in stock prices. It also has been seeing a pick-up in business sentiment and production activity resulting from an BIS central bankers’ speeches improvement in exports and corporate results due to the depreciation of the euro. Going forward, the European economy is expected to continue to see moderate recovery with the permeation of the effects of depreciation of the euro and those of the monetary easing measures by the European Central Bank (ECB). Meanwhile, turning to emerging economies, the growth momentum of the Chinese economy has been sluggish against the backdrop of the deceleration in fixed asset investment and continued inventory adjustments. Nevertheless, it is likely to follow a generally stable growth path as there are likely to be effects of the authorities’ policy measures to support economic activity, although the pace of growth is expected to be somewhat reduced. Other emerging economies and commodityexporting economies have continued to lack momentum on the whole, but are expected to gradually increase their growth rates, mainly as the recovery in advanced economies spreads to them. In sum, the global economy – mainly advanced economies – is expected to continue recovering moderately, and against this backdrop, Japan’s exports are expected to increase moderately. Of course, various uncertainties – including the pace of growth in the U.S. economy, the prospects regarding the European debt problem, including developments in Greece, developments in the emerging and commodity-exporting economies, and geopolitical risks – continue to call for close attention. In a situation where exports have been picking up and, as I will explain later, private consumption has been resilient, production has been picking up. Corporate profits have increased to historical highs and business sentiment has generally stayed at a favorable level (Chart 3). Under these circumstances, with regard to firms’ business plans for fiscal 2015, shown in the March Tankan (Short-Term Economic Survey of Enterprises in Japan), corporate profits as a whole are projected to continue improving and a positive stance on business fixed investment has been maintained for this time of year. In this way, a virtuous cycle in the corporate sector – in which business fixed investment will continue its moderate increasing trend amid a continued improvement in corporate profits – is expected to operate going forward. B. Household sector Next, turning to the household sector, positive developments in the corporate sector have led to a tightening in labor market conditions and to an improvement in the employment and income situation in accordance with that tightening. The unemployment rate has declined to around 3.5 percent, and judging from firms’ view on employment, the labor shortage is growing further (Chart 4). Reflecting this tightening in labor market conditions, nominal wages have increased moderately, albeit with fluctuations. In this way, since nominal wages have been rising and the number of employees has been increasing, employee income has been increasing moderately. An improving trend in private consumption is becoming evident gradually amid steady improvement in the employment and income situation, although some areas had been sluggish. Such firmness in private consumption was also confirmed by the GDP statistics released last week, which showed that private consumption has increased for three consecutive quarters. In addition, a pick-up in consumer sentiment is becoming evident. As for the outlook, the employment and income situation is likely to continue to see steady improvement as many firms will increase wages, including base pay, which will be raised to a larger extent than last year in the annual labor-management wage negotiations in spring 2015; in this situation, private consumption is expected to remain resilient. As I have explained, a virtuous cycle from income to spending is likely to continue operating in both the corporate and household sectors, since domestic demand is likely to be resilient and exports are expected to increase moderately. Against this backdrop, Japan’s economy is likely to continue growing at a pace above its potential from fiscal 2015 through fiscal 2016. Thereafter, through fiscal 2017, the economy is projected to maintain its positive growth, although with a slowing in its pace to around a level somewhat below the potential growth BIS central bankers’ speeches rate. The slowdown is due mainly to (1) the effects of a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike planned in April 2017 and (2) cyclical deceleration. In the Bank’s April 2015 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the Policy Board members’ forecasts of the real GDP growth rate were around 2 percent for fiscal 2015, around 1.5 percent for fiscal 2016, and in the range of 0.0–0.5 percent for fiscal 2017 (Chart 5). II. Conduct of monetary policy and price developments in Japan Next, I would like to touch on the conduct of monetary policy and price developments in Japan. A. Change in policy regime The Bank is pursuing policy measures that aim at converting people’s deflationary mindset, which has been formed firmly amid the prolonged period of deflation, to one that expects moderate inflation. That is, preparing a platform on which people can act on the assumption that prices continue to rise moderately. To begin with, in January 2013, the Bank set the price stability target of 2 percent in terms of the year-on-year rate of change in the CPI; in other words, the introduction of “inflation targeting.” With a view to achieving this price stability target, the Bank has been implementing an aggressive monetary easing measure called quantitative and qualitative monetary easing (QQE) since April 2013, and expanded the measure in October 2014 (Chart 6). By implementing such bold policy measures, the Bank has intended to clearly indicate to the public that the basic thinking behind its monetary policy – that is, the policy regime – has changed, and also to encourage them to change their behavior in view of such change. In other words, this is the Bank’s declaration that “the rules of the game have been changed.” B. Commitment to achieving the price stability target at the earliest possible time Before the introduction of QQE, the Bank had pursued various monetary easing measures that were considered unconventional, such as the introduction of the zero interest rate policy and quantitative easing, and this made the Bank a forerunner in monetary policy history. Although each of the measures on their own could have been a quite powerful policy tool, it turned out that they were not effective enough to overcome deflation. While a variety of analyses attempted to explain why the Bank was not successful in overcoming deflation, a major reason, in my view, was that the Bank’s faith that “deflation can be overcome through monetary policy” was not strong enough, and that its commitment to achieving this aim was insufficient; in other words, the policy regime was not changed considerably. Thus, the mindset of private economic entities such as households, firms, and financial institutions was not converted. Based on this bitter experience, when QQE was introduced in April 2013, the Bank entered a new phase of monetary easing by adopting a large-scale measure and made clear the time frame for achieving the target – namely, 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 Bank showed its commitment to achieving the price stability target at the earliest possible time in a stronger manner than ever, by stating that it was putting forth a specific time horizon of about two years, rather than simply adopting a stance of achieving it at the earliest possible time. As I will discuss later, the Bank currently expects that the CPI inflation rate is likely to reach around 2 percent around the first half of fiscal 2016. This timing is somewhat delayed from the previous projection. However, the underlying trend in inflation itself has been rising steadily with the mechanism of QQE working as envisaged, and at this moment the Bank has BIS central bankers’ speeches no intention of changing its commitment to achieving the price stability target at the earliest possible time. C. Why has the CPI inflation not reached 2 percent yet? Looking at developments in the year-on-year rate of change in the CPI (all items less fresh food), or the core inflation rate in Japan, it had hit a bottom of minus 0.5 percent immediately before the introduction of QQE, and thereafter, excluding the direct effects of the consumption tax hike, followed a steady rising trend until it reached 1.5 percent in April 2014. This means that QQE had pushed up the core inflation rate by 2.0 percentage points in about one year. During this period, the effects of QQE were clearly confirmed on the price front. Nevertheless, the price stability target of 2 percent has not been achieved yet. The core inflation rate peaked in April 2014, and then followed a gradual declining trend. It has recently been about 0 percent (Chart 7). In my view, there are two major factors behind the decline in the inflation rate. 1. Consumption tax hike The first factor is negative effects on demand of the consumption tax hike in April 2014. Although the decline in demand following the front-loaded increase prior to the consumption tax hike had been expected, the degree of the decline had not been projected to be as large as the decline associated with the April 1997 hike, when the consumption tax rate rose from 3 percent to 5 percent. However, the actual negative effects exceeded most of the projections, and were protracted. There are various reasons for this, but here I would like to point out an increase in lowincome households due to the protracted sluggish employment situation as well as an increase in the number of pensioners reflecting the aging of the population as part of the background. That being said, as I have explained, with the steady improvement in the employment and income situation and in corporate profits continuing, a virtuous cycle from income to spending has been operating firmly in both corporate and household sectors. Against this backdrop, the downward pressure on demand exerted by the consumption tax hike has been dissipating. 2. Decline in crude oil prices The other factor behind the recent decline in inflation rates is a rapid and substantial fall in crude oil prices that has occurred since last summer. It should be noted that the effects of falling crude oil prices may be assessed differently depending on the time horizon that you have in mind. To be more specific, the decline in crude oil prices will result in lower costs for various economic activities, and thereby exert wide-ranging positive effects on the real economy. From a longer-term perspective, it will push up prices as the aggregate demand increases. However, from a short-term perspective, until effects of an increase in the aggregate demand are manifested on the price front, the direct effects of falling energy prices exceed those of an increase in demand. Thus, there is temporary downward pressure on prices. The short-term effects of the decline in crude oil prices are expected to dissipate gradually from the second half of fiscal 2015, assuming that crude oil prices will rise moderately from around the recent level, though the timing of this depends on developments in crude oil prices. BIS central bankers’ speeches D. Underlying trend in inflation The year-on-year rate of increase in the CPI is projected to be about 0 percent for the time being, with negative contributions of energy-related items offsetting positive contributions of other items. However, as I have explained, the underlying trend in inflation is likely to rise steadily, and the inflation rate is projected to accelerate toward the target level of 2 percent as the effects of the decline in crude oil prices dissipate. In assessing the underlying trend in inflation, it is necessary to take into account factors such as the following: (1) the output gap that is the difference between the aggregate demand and the supply capacity of the economy as a whole; (2) medium- to long-term inflation expectations; and (3) the extent to which a future increase in prices will be taken into account in wage and price settings. To begin with, let me discuss the first factor, the output gap. Private consumption is expected to remain resilient with the improvement in the income situation against the background of tightening in labor market conditions, together with manifestation of positive effects of the decline in energy prices on real income. Business fixed investment is projected to continue a moderate increasing trend as corporate profits improve. Exports, which have been picking up recently, are expected to increase moderately against the background of the recovery in overseas economies and of underpinning effects of the depreciation of the yen. As such, the improving trend in the output gap will continue with the aggregate demand in the economy as a whole expanding, and upward pressure on prices is expected to increase gradually. Let me turn to the second factor, inflation expectations. Judging from indicators that are observable in the market and analyses of various survey results, medium- to long-term inflation expectations appear to be rising on the whole, despite the recent decline in the inflation rate. Going forward, the observed inflation rate is likely to accelerate. That will bring about a rise in inflation expectations, and such expectations are expected to remain firm. Moreover, as I have mentioned earlier, as a result of the annual labor-management wage negotiations in spring 2015, many firms will increase wages, including base pay, which will be raised to a larger extent than last year. The business model of firms seems to be in a process of transformation from one of the deflationary type – that is, one in which firms adopt a lower price-setting strategy through cutting expenses mainly in labor costs – to one of the innovative type – that is, one in which firms do not resort to lower prices but devote their efforts to developing new products and services that can enhance customer satisfaction. In this situation, some firms have been shifting their price-setting strategy to one of raising sales prices while increasing value-added. In this way, the mechanism of inflation accelerating moderately accompanied by wage increases has continued to operate, and the underlying trend in inflation has steadily improved. In the April 2015 Outlook Report, the Policy Board members’ forecasts of the yearon-year rate of increase in the CPI (all items less fresh food) were 0.8 percent for fiscal 2015, 2.0 percent for fiscal 2016, and 1.9 percent for fiscal 2017 (Chart 5). Although the timing of reaching around 2 percent depends on developments in crude oil prices, it is projected to be around the first half of fiscal 2016, assuming that crude oil prices will rise moderately from the recent level. Thereafter, the year-on-year rate of increase in the CPI is likely to be around 2 percent on average. Concluding remarks In conclusion, let me touch on the economy of Hokkaido Prefecture. The economy has been recovering moderately, although some weakness has been observed in some aspects, such as the public construction sector, which largely affects small firms. Turning to final demand, there are somewhat weak developments in terms of the BIS central bankers’ speeches decline in public investment, but a marked increase in the number of foreign visitors to Japan has been underpinning demand. Moreover, over the period of more than a year since the consumption tax hike, even durable consumer goods and housing investment have started to level off. Meanwhile, as seen in the steady improvement in the employment and income situation, a virtuous cycle from income to spending has been operating in the region in the same way as in Japan as a whole. In Hokkaido Prefecture, there are plenty of topics associated with encouraging tourism. For example, Yoichi city became the setting for Massan, a morning drama serial by Japan Broadcasting Corporation (Nippon Hoso Kyokai, NHK). In addition, the Hokkaido shinkansen will commence its operation by March 2016, and it is scheduled to be extended to Sapporo city. These topics show that Hokkaido Prefecture will receive further attention going forward. Moreover, Sapporo city has announced its intention to bid for the 2026 Winter Olympics, and this will increase the opportunity for Hokkaido Prefecture to display to the world its appeal. Other than tourism, Hokkaido Prefecture has strength in the food industry on the back of its abundant agricultural and fishery resources. I have heard that Hokkaido Prefecture now faces problems such as lower production of raw milk resulting from increasing abandonment of farming as well as slack in unloading in the fishing industry, but I expect that production of higher value-added goods will be promoted through efforts such as Healthy-Do, which is the certification system of functional food that the Hokkaido government is making efforts to popularize. Other initiatives include promoting Hokkaido Prefecture as a back-up base for the metropolitan area and Honshu – the main island of Japan – since Hokkaido Prefecture faces less natural disasters. This initiative has actually led to attracting firms to Hokkaido Prefecture, and I have heard that even some export-related manufacturers, such as those in transportation equipment, in which Hokkaido Prefecture had been facing a disadvantage, have been lured. I believe this will largely contribute to reinforcing Hokkaido Prefecture’s industrial infrastructure. As common issues across the country, the population decline as well as declining birth rate and an aging population have been pointed out, and in this region these issues have progressed faster than in Japan as a whole. Therefore, I expect that, with cooperation among industry, academia, the government, and finance, the region will overcome this problem by promoting vitalization of the local economy ahead of other regions in Japan and developing business models that would apply for Japan as a whole. The Bank’s Sapporo Branch will conduct analyses of the regional economy so as to contribute to such efforts as much as possible. In closing, I wish all the best for the further development of the regional economy. Thank you. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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bank of japan
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Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Mie, 3 June 2015.
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Sayuri Shirai: Japan’s economic and price developments and monetary policy – overview of the two-year period after adopting QQE Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Mie, 3 June 2015. * * * Accompanying charts can be found at the end of the speech. I. Introduction Good morning. I feel honored to have an opportunity to meet with the local business representatives here today. Let me also express my sincere gratitude for your kind cooperation with the activities of the Bank of Japan’s Nagoya Branch. More than two years have passed since adopting quantitative and qualitative monetary easing (QQE) policy in April 2013. So I would like first to review Japan’s economic and price performance over the two years and present my own assessment on the effectiveness of QQE. After that, I will touch on the Bank’s outlook for economic activity and prices for fiscal 2015 through fiscal 2017, as described in the April 2015 Outlook for Economic Activity and Prices (hereafter, the Outlook Report). II. Economic and price performance after adopting QQE Let me now proceed with the actual performance of economic activity during the past two years, followed by that of prices. A. Economic performance in fiscal 2013 and 2014 Let us first look at the performance of real GDP. Chart 1 indicates the amounts as well as the year-on-year rates of change in real GDP for fiscal 2013 and 2014 together with those for fiscal 2012 (a year before the introduction of QQE) as a reference. After having risen by about 5.1 trillion yen in fiscal 2012, the amount of increase in real GDP almost doubled to around 11 trillion in fiscal 2013, but it subsequently dropped by about 5.6 trillion yen in fiscal 2014. The net increase in real GDP over the period of fiscal 2013–14 was around 5.2 trillion yen – roughly the same amount of increase as in fiscal 2012. The year-on-year rate of change in real GDP doubled from about 1 percent in fiscal 2012 to about 2 percent in fiscal 2013, but it then recorded somewhat large negative growth of minus 1 percent in fiscal 2014. Positive growth for two consecutive years without the tax hike effects The consumption tax hike in April 2014 from 5 percent to 8 percent exerted large adverse impacts on Japan’s economy. So, in assessing the effectiveness of QQE, it is important to look at the economic performance by excluding the estimated impacts of the tax hike. Chart 1 shows the estimated amounts and the rates of change in real GDP excluding the tax hike impacts; those impacts are estimated by the Bank to be an increase of around 0.5 percentage point for fiscal 2013 and a decrease of around 1.2 percentage points for fiscal 2014. Please note that the purpose of this estimation is simply to try to examine the effectiveness of monetary easing: judgment about the tax hike is decided purely by the government. For its estimates, the Bank took into account the impacts of the tax increase on household spending (private consumption and housing investment), business fixed investment, and other factors. The impact on business fixed investment was considered because some entities, such as firms eligible for the simplified tax system and tax exemption, appear to have front-loaded an increase in business fixed investment prior to the tax hike. In fiscal 2013, upward pressure on real GDP was propelled by front-loaded increases in private consumption, housing BIS central bankers’ speeches investment, and business fixed investment – as against downward pressure on real GDP created by a decline in inventory investment and a rise in imports. The net impact of the tax hike was positive (an increase of 0.5 percentage point). By contrast, the net impact for fiscal 2014 turned negative (a decline of 1.2 percentage points); this was because all the forces that emerged in fiscal 2013 now worked in the opposite direction and also because additional adverse impacts on private consumption and housing investment appeared as a result of a decline in real (disposable) income. I would note that these estimates are subject to a considerable margin of error because it is difficult to quantify the exact effects of the tax hike. Chart 1 indicates that real GDP, after excluding the effects of the tax hike, increased by 8.1 trillion yen in fiscal 2013 – a decline of 2.7 trillion yen, which represents the net positive impact of the front-loaded increase in expenditure. Yet the rate of real GDP growth maintained a fairly high positive rate of around 1.6 percent. The noticeable change is observed in fiscal 2014, when real GDP growth turned to a positive increase of 0.8 trillion yen rather than a decrease of 5.6 trillion yen. This means that a positive growth rate of around 0.2 percent would have been achieved in fiscal 2014 if there had been no consumption tax hike, which had an estimated net negative impact of around 6.4 trillion yen. My Views regarding the effectiveness of QQE on economic activity Real GDP growth rates during the two years after the introduction of QQE were around 1.6 percent in fiscal 2013 (excluding the effects of the tax hike), which significantly exceeded the potential growth rate (the Bank’s estimate of about 0.5 percent or lower), and around 0.2 percent in fiscal 2014, which was roughly equivalent to the potential growth rate. This positive performance reflects both the fiscal stimulus measures and the impact of monetary easing. Let me briefly summarize the transmission mechanism of QQE on economic growth. The Bank estimates that large-scale asset purchases under QQE succeeded in lowering long-term real interest rates by around 0.7 to 0.9 percentage point – or slightly less than 1 percentage point – cumulatively over the past two years. This decline in real interest rates encouraged private consumption and business fixed investment, and was also associated with a depreciation of the yen and a stock price rise – resulting in favorable corporate profits and an increase in nominal compensation of employees. Given the expected effect of the unusually large-scale monetary easing, some of you may consider that, excluding the impacts of the tax hike, real GDP should have expanded more impressively over the past two years. In this regard, I view that a further expansion of private consumption was constrained to some extent by the following: (1) dissolution of the special level of pension benefits from the second half of fiscal 2013; (2) a cut in real pension benefits and a decline in real wages (both owing to moderate inflation excluding the direct impact of the tax hike); and (3) the severe weather around the summer of 2014. As for business fixed investment, the increase was less than initially expected owing to cautious investment behavior of firms, mainly domestic demand-oriented firms, due in part to sluggish domestic sales. Exports has picked up from the second half of fiscal 2014, mainly to the United States. However, they did not increase as much as initially projected owing in part to a shift of production sites overseas, a decline in international competitiveness in some industries, sluggish recovery in overseas economies, and the J-curve effect. In addition, the effects of expanding domestic demand induced by front-loaded consumption and business fixed investment were somewhat diminished since a sustained rise in inflation expectations was not observed (as described later). These factors are considered to have partly offset the effectiveness of monetary easing and resulted in lower real GDP growth rates for fiscal 2013 and 2014 than those initially forecasted by the Policy Board members (Chart 2-1). Over the period of fiscal 2013–14, the output gap improved by around 1.5 percentage points in fiscal 2013 – from around minus 2.2 percent in fiscal 2012 to minus 0.7 percent (Chart 1). It further improved by 0.5 percentage point to minus 0.2 percent in fiscal 2014. The net 2-percentage-point improvement in the output gap seems remarkable (Chart 3). That said, the scale of improvement in fiscal 2014 was rather limited and largely underperformed BIS central bankers’ speeches the Bank’s initial forecast in April 2013. Although the sluggish improvement in the output gap in fiscal 2014 was mainly due to the greater-than-anticipated impact of the consumption tax hike, the other aforementioned demand-suppressing factors also played a role as “headwinds.” Conversely, it may be concluded that the output gap of nearly 0 percent in fiscal 2014 was actually not so bad given the sharp deterioration of the real GDP growth rate of minus 1 percent. Indeed, my evaluation is that QQE and its expansion supported the economy and prevented actual performance from deteriorating further, and therefore the effectiveness of QQE should not be denied. Here, I should point out that the 2-percentage-point improvement in the output gap was not attributable only to monetary and fiscal policies. It was also affected by a structural factor; for example, of an increasing sense of labor shortage caused by the declining trend in the working-age population, together with the recent retirement of the baby-boomer generation. In addition, a decline in the potential growth rate (caused by sluggish growth in total factor productivity and in capital stock) may have had an effect (Chart 3). In sum, despite the various headwinds, it is evident that QQE pushed up real GDP by lowering real interest rates and contributed to improving the output gap to the 0-percent level from negative territory. Business and household sentiment has been recovering owing to steady improvements in corporate profits and employment, and the economic recovery after the consumption tax hike has now become solid. On economic activity: The outlook report’s “Assessment of the Effects of QQE” Now, let me provide some additional explanation from my perspective about the Bank’s assessment of the effects of QQE, which appeared in the background section of the Outlook Report. 1 In the report, economic outcome was first estimated using a macroeconometric model – based on a real interest rate channel – by exogenously plugging in a decline of minus 0.8 percent to long-term real interest rates (which were close to the estimated actual figure). Subsequently, this estimated value was compared with the actual value. If the actual value exceeds the estimated value, this implies that there are some positive effects other than the real interest rate channel. The result was mixed. Although the estimated value exceeded the actual value in terms of the real GDP growth rate, the actual value exceeded the estimated value in terms of the output gap. This can be interpreted as follows: real GDP did not improve as much as its estimated value owing to the aforementioned headwinds; however, the output gap exceeded its estimated value because of labor shortages as well as a decline in the potential growth rate. Taking into consideration the various headwinds, I believe that real interest rates would have been lower if the sustained rise in inflation expectations had been realized. This would have exerted further upward pressure on the real GDP growth rate, thereby further improving the output gap. B. Price performance in fiscal 2013 and 2014 Next, I will focus on price performance. Let us start with developments in the GDP deflator. The year-on-year rates of change in the GDP deflator increased from minus 0.9 percent in fiscal 2012 to minus 0.3 percent in fiscal 2013. Then, a positive level of 2.5 percent (1.1 percent excluding the direct impact of the consumption tax hike of around 1.4 percent) was reached in fiscal 2014 (Chart 1). Inflation rates turned positive: CPI in fiscal 2013 and GDP deflator in fiscal 2014 In particular, it should be noted that the year-on-year rate of change in the private consumption deflator finally turned positive in fiscal 2013 after having remained consistently negative since fiscal 1998. Also, the rate of change in the business fixed investment deflator See Boxes 2 and 3 in the April 2015 Outlook Report. BIS central bankers’ speeches turned positive in fiscal 2013 after having been on a declining trend since the early 1990s owing to quality adjustment as well as a decreasing trend in the prices of IT-related products. The housing investment deflator likewise rose in fiscal 2013 reflecting front-loaded construction activities, and it is still rising owing to labor shortages as well as the increased cost of construction materials. The year-on-year rate of change in the consumer price index (CPI, all items less fresh food) shifted from minus 0.2 percent in fiscal 2012 to plus 0.8 percent in fiscal 2013 and then to 2.8 percent (around 0.8 percent excluding the direct impact of the consumption tax hike) in fiscal 2014 (Chart 1). GDP deflator-based inflation turned positive one year after the CPI inflation, mainly due to a deterioration in the terms of trade in fiscal 2013. An increase in import prices caused by high crude oil prices and the yen’s depreciation led to an increase in the CPI, but it depressed the GDP deflator because it worked as a subtraction item. Inflation expectations rose by 0.7 percentage point at most Inflation expectations (excluding the direct impact of the consumption tax hike) are assessed based on various indicators. Over the period of fiscal 2013 to 2014, medium- to long-term inflation expectations (usually more than one year) of economists and market participants rose by around 0.3 to 0.7 percentage point; most of that increase was concentrated in fiscal 2013 (Charts 4–1 and 4-2). Meanwhile, an increase in inflation expectations reflected in market-based indicators (such as the inflation swap rates) remained in the range of around 0.0–0.5 percent over the same period. Expectations of households and firms do not seem to have changed much. The faster change in such expectations of economists and market participants may reflect that they tend to make forecasts based on macroeconomic data and are thus more responsive to the Bank’s monetary policy actions. It should be noted that market-based indicators also incorporate the liquidity risk of the relevant market. On prices: the Outlook report’s “Assessment of the Effects of QQE” and my views Overall, I consider that QQE has mitigated deflationary pressure, caused by the excessive appreciation of the yen and fierce discount-based competition in the distribution sector, and has provided an incentive for firms to explore potential demand by urging them to produce innovative goods and services and to set fair prices. The CPI-based inflation was positive for two consecutive years, but the inflation rate was just around 0.8 percent (excluding the direct impact of the consumption tax hike) in fiscal 2014. This rate was about the same as that in fiscal 2013 and much lower than had been initially projected in April 2013 (Chart 2-1). In this regard, I would like to provide my personal views on the “Assessment of the Effects of QQE” on prices described in the aforementioned Outlook Report as an additional explanation. In my view, the actual CPI rise of “plus 1 percentage point” over the past two years exceeded the estimated value from the macroeconometric model because the actual degree of improvement in the output gap was better than the estimated value. Nonetheless, the 2 percent target is yet to be achieved, mainly because of the rapid decline in crude oil prices, but another important factor is the slow pace of the rise in medium- to long-term inflation expectations, which have remained at around plus 0.7 percentage point at most. Regarding developments in medium- to long-term inflation expectations, a number of indicators have deteriorated since the summer of 2014. This deterioration seems to have been affected by the decline in the CPI caused by weakness in domestic demand and the decline in crude oil prices. In October 2014, there were growing concerns that a continuous fall in inflation expectations, partly driven by weak demand, could undermine positive developments in wage negotiations and firms’ price-setting behavior. To prevent those concerns from materializing, the Bank decided to expand QQE. This preemptive, prompt policy action, together with the stability in crude oil prices, helped halt the fall in inflation expectations, and thereafter inflation expectations have become largely constant. Moreover, the recovery in domestic demand became gradually more evident toward the end of fiscal BIS central bankers’ speeches 2014, and the output gap is turning positive. For these reasons, I believe that the underlying trend in prices has been maintained. Having said that, the year-on-year rate of increase in the CPI is currently about 0 percent, and the 2 percent target is still quite distant. The challenge for the Bank over the next few years is whether medium- to long-term inflation expectations will begin to rise steadily. The Outlook Report stipulates that a further rise in inflation expectations is necessary to achieve the 2 percent target in a stable manner. This judgment is consistent with my repeated remarks over recent years. I personally hold the view that inflation expectations of economists and market participants are useful in evaluating the consistency of the Bank’s outlook and its practicality, and they may also gradually affect the inflation expectations of households and firms. However, in ultimately assessing price stability, I consider that greater attention should be paid to households’ price perceptions and their inflation expectations together with firms’ price-setting behavior, as I will now explain. Understanding the movements of households’ and firms’ inflation expectations In terms of achieving the 2 percent price stability target, I believe that important consideration should be placed on households’ inflation expectations and related expenditure behavior. This may appear self-evident because the price stability target – adopted by the Bank and other major central banks – is the CPI, for which prices refer to the consumption basket of households. In other words, central banks attempt to stabilize the cost of households’ living expenses. However, the use of households’ inflation expectations may give rise to an upward-bias problem – an issue that is often pointed out by other central banks. In Japan, households always tend to expect that prices will rise even during a phase of deflation (Chart 5). The upward bias appears to be generated because households’ inflation expectations are heavily affected by price movements – for example, daily necessities and gasoline. Of course, it is also important to consider firms’ inflation expectations because they ultimately set their own sales prices and wages. However, to maintain their profit margins, firms are unable to continue raising sales prices at the expense of suppressing demand for their goods and services. Therefore, I think that the most important determinant of the CPI is likely to be households’ perception of prices and their inflation expectations. In a speech I gave in Europe in March 2015, I discussed households’ and firms’ inflation expectations in detail. And I would now like to share with you some of those findings. 2 Since the amount of data acquired is not yet sufficient with regard to firms’ inflation expectations, some caution is required in interpreting the results. 1. Households’ inflation expectations tend to be higher than those of firms. One of the reasons may be because firms and households envisage different prices when responding to a survey questionnaire. Households are asked to respond about overall prices of goods and services they purchase, whereas firms are asked to respond about general prices measured by the CPI. The reason households are asked in this manner is that some respondents are unfamiliar with the CPI, which makes it difficult to form an outlook based upon it. 2. Another reason may be because households tend to perceive and expect higher price levels as a corollary of long-standing mild deflation and sluggish income growth, resulting in an anticipated tightening of household budgets. By contrast, firms tend to form inflation expectations based on the macroeconomic environment and information obtained from transactions with other firms. As a result, their See Sayuri Shirai, “Shifting toward a Moderately Inflationary Economy in Japan – Overview of Firms’ and Households’ Inflation Expectations,” Speeches at Bruegel (March 4), the European Central Bank (March 6), and the Bank of England (March 10), Bank of Japan, 2015. BIS central bankers’ speeches inflation expectations are likely to be more cautious than those of households and more closely approximate the actual rate of CPI inflation. 3. In addition, households tend to regard a price rise as unfavorable because it is associated with a tightening of household budgets (Chart 6-1). Households’ poor tolerance of price rises is reflected in their continuous perception that their present income level has declined compared with one year earlier and also that their income level one year ahead will not increase much (Chart 6-2). 4. Partly reflecting such limited tolerance for price rises by households, large firms in particular may tend to project a relatively conservative, lower increase in sales prices than small firms. Large firms are likely to face a greater degree of uncertainty in their outlooks regarding their sales prices; thus, the number of “Don’t know” responses tends to increase over a longer projection period – probably because of the direct exposure to fierce global and domestic competition in final-product markets. By contrast, small firms seem to tend to expect higher sales prices through labor shortages and high input costs because of their labor intensity and relatively low profit margins (Chart 7). 5. Given that large firms project more conservative, lower sales prices than small firms, this may in turn affect the sales prices of small firms through transactional relationships. As a result, some small firms may find it difficult to pass their rising production costs on to their sales prices according to their forecasts, thereby squeezing their margins. This suggests that small firms are more likely to find it necessary to improve productivity and shift to higher value-added business models in the near future. Lastly, let me touch on the issue of how monetary policy has affected households’ mediumto long-term inflation expectations. According to a question in the Opinion Survey on the General Public’s Views and Behavior conducted by the Bank about the sources of information used in forming medium- to long-term inflation expectations, responses referring to the Bank’s monetary policy (one of the multiple choices) accounted for only around 10 percent. Therefore, it might appear at first glance that the effects of the Bank’s monetary policy have been limited. After taking upward and other biases into account, however, the adjusted and smoothed distribution of households’ inflation expectations indicates that the spike at around 2 percent became sharper in 2013, which shows that households’ inflation expectations are concentrated at around 2 percent (Chart 8). This may suggest that the change in the Bank’s monetary policy in 2013 has positively affected households’ inflation expectations to some extent, leading to a greater concentration of responses of around 2 percent. To summarize, developments in households’ inflation expectations should be assessed, not only on the basis of the average and/or median of the responses but also on the adjusted and smoothed distribution of those expectations, taking the upward bias into account. Moreover, to achieve the 2 percent price stability target with a sustainable increase in household spending, an improvement in current income conditions as well as an increase in expectations for future income growth is essential. In addition, households’ recognition of the 2 percent target and monetary policy remains low; this points to the need for the Bank to improve its external communication policy toward promoting public understanding of its intentions. Regarding firms’ inflation expectations, I pay close attention to the average value for “all firms, all industries,” particularly the average value of “large nonmanufacturing” firms. This is because the labor productivity of large nonmanufacturing firms is generally lower than that of manufacturing firms, and thus their ability to pass input costs on to their output prices directly affects their profit margins. BIS central bankers’ speeches III. Outlook for economic activity and prices and risk assessment I will now focus on the Bank’s baseline scenario of the outlook for real GDP and the CPI for the next three fiscal years. My personal view regarding such a scenario will also be provided. A. Medium-term outlook for economic activity According to the Bank’s baseline scenario of the outlook for economic activity, Japan’s economy is likely to continue growing at a pace above its potential growth rate from fiscal 2015 through fiscal 2016 (Chart 2-2). As domestic demand is likely to be firm and exports are expected to increase moderately, a virtuous cycle from income to spending is likely to be maintained in the household and corporate sectors. Firms’ and households’ growth expectations are also likely to rise moderately in line with continued accommodative financial conditions. In fiscal 2017, the pace of economic growth is likely to decline to around a level below the potential growth rate – mainly due to the effects of the planned next consumption tax hike and cyclical deceleration – although the positive rate of growth is still likely to be maintained. My outlook for real GDP growth is in the range of around 1.5–2.0 percent for fiscal 2015, around 1.5 percent for fiscal 2016, and slightly above 0 percent for fiscal 2017. My projection for fiscal 2015 is somewhat lower than the median of the Policy Board members’ forecasts, perhaps because of differences in the projected pace of wage increases. Because labor productivity growth in the nonmanufacturing sector has hardly improved over recent years, I project that the pace of increase in wages – and hence that in consumption – is likely to be moderate up through fiscal 2017. B. Medium-term outlook for prices According to the Bank’s baseline scenario of the outlook for prices, the year-on-year rate of increase in the CPI is likely to be about 0 percent for the time being. The rate of increase is projected to accelerate from around the second half of fiscal 2015 and reach about 2 percent around the first half of fiscal 2016 (Chart 2-2). The output gap is projected to expand within positive territory. It is also likely that medium- to long-term inflation expectations will follow an increasing trend and gradually converge to around 2 percent. Regarding my outlook for prices, although the mechanism of price increase is the same with the Bank’s baseline scenario, I project that the rate of increase in the CPI is likely to rise closer to around 2 percent toward the end of fiscal 2016; thereafter, it will remain somewhat lower than 2 percent in fiscal 2017. The average rate of increase for fiscal 2015 is projected to be around 0.5 percent; this is lower than the median of the Policy Board members’ forecasts – perhaps due to the cautious view that the pace of increase in firms’ sales prices will be moderate. According to various corporate surveys (including the Bank’s Tankan – Short-Term Economic Survey of Enterprises in Japan), recent price-setting behavior of some firms has revealed moderation in the rising trend in their sales prices as a result of the decline in their input prices. Given that the rate of increase in the CPI is likely to be about 0 percent for the time being, I believe this tendency will prevail for some time. My outlook for fiscal 2016 is that the average rate of CPI inflation will reach around 1.5 percent and thus be lower than the median. This is because I project that it will take some time before households’ income grows steadily, thereby improving their tolerance of price rises as well as firms’ price-setting ability, and medium- to long-term inflation expectations will gradually converge to around 2 percent. In the baseline scenario, the Bank postponed the timing of reaching around 2 percent inflation by one to two quarters: this was reflected in changing the expression “in or around fiscal 2015” to “around the first half of fiscal 2016.” This postponement is consistent with my own repeated claims in the past. However, I submitted a proposal at the Monetary Policy Meeting against the expression “around the first half of fiscal 2016” being used for the baseline scenario and replacing it instead with the expression “in or around fiscal 2016.” I BIS central bankers’ speeches considered my suggested expression to be more appropriate for two reasons. First, given that the Bank assesses that risks to prices are skewed to the downside, a wider time span to reach around 2 percent seemed appropriate. Second, the Bank reduced the time span significantly – from one year or more to around six months. This is more likely to reduce the flexibility of monetary policy. Here, I would like to make it clear that since the introduction of QQE, I have made all efforts toward achieving the target of around 2 percent at the earliest possible time, without imposing an excessive burden on households and firms. My aforementioned proposal is not in any way contrary to those efforts. It is natural for a central bank to revise its forecasts and delay (or advance) the timing to achieve the price stability target in the face of constantly changing domestic and external conditions. It is important that the Bank endeavors to realize an economy with around 2 percent inflation by taking into account the sustainability perspective, while revising forecasts with updated information and indicating the timing of achieving the target as a reference. This framework embodies the essence of the “flexible inflation targeting” practically adopted by the Bank and other major central banks, which I have been emphasizing since the introduction of QQE. Moreover, I would like to add that my aforementioned forecasts for prices do not rule out the possibility of achieving the target of around 2 percent over the projection period. Thus, my suggested expression was broadly in line with my own forecasts. C. Upside and downside risks to economic activity and prices With regard to upside and downside risks to the Bank’s baseline scenario, the Bank believes that risks are being balanced for economic activity and that risks are skewed to the downside for prices. Regarding my overall risk assessment related to economic activity, the upside and downside risks are likely to remain balanced through fiscal 2016. This is because I take into account upside risks to the European economy and downside risks to emerging economies. By contrast, risks for fiscal 2017 are tilted downward, mainly because of the impact of the next consumption tax hike in April 2017. My assessment of risks to prices is that risks remain tilted to the downside. In particular, if a deviation of the actual inflation rate from the 2 percent target is sustained over a long period, the public and the market may begin to believe that achieving the target will be difficult. This may make it harder for medium- to longterm inflation expectations to rise further and steadily. Lastly, I would like to touch upon monetary policy conduct. Based on my current projection, I believe that the status quo regarding the amount of the Bank’s asset purchases should be maintained for the time being because the underlying trend in inflation is expected to rise steadily in the near future. If downside risks materialize and are likely to significantly weaken the underlying trend in inflation, I would not hesitate to consider some monetary policy actions. At present, however, I view such a possibility to be low. That brings me to the end of my speech. Thank you very much indeed for your kind attention. BIS central bankers’ speeches Chart 1 Japan's Economic Performance in Fiscal 2012-14 Real GDP (yen) FY 2012 FY 2013 FY 2014 Net/average change over FY 2013-14 +5.1 tril. +10.8 tril. -5.6 tril. Net +5.2 tril. +8.1 tril. +0.8 tril. Net +8.9 tril. +2.1% -1.0% Avg. +0.6% +1.6% +0.2% Avg. +0.8% Excluding the effects of the consumption tax hike Real GDP growth rate +1.0% Excluding the effects of the consumption tax hike Real compensation of employees (yen) +2.1 tril. +0.9 tril. -3.2 tril. Net -2.3 tril. (Reference) Nominal compensation of employees (yen) +0.3 tril. +2.4 tril. +4.2 tril. Net +6.6 tril. Output gap (estimated by the Bank） -2.2% -0.7% -0.2% Avg. -0.5% +0.2% pt +1.5% pts +0.5% pt Net +2.0% pts -0.9% -0.3% +1.1% (+2.5%) Avg. +0.4% +0.8% pt +0.6% pt +1.4 % pts (+2.8% pts) Net +2.0% pts -0.2% +0.8% +0.8% (+2.8%) Avg. +0.8% -0.2% pt +1.0% pt 0.0% pt (+2.0% pts) Net +1.0% pt Change (% pts) Rate of change in the GDP deflator Change (% pts) Rate of change in the CPI Change (% pts) Note: The output gap for fiscal 2014 is the average of 1Q-3Q. Figures in parentheses for the GDP deflator and CPI for fiscal 2014 include the direct effects of the consumption tax hike. The CPI refers to all items less fresh food. Sources: Cabinet Office; Ministry of Internal Affairs and Communications; Bank of Japan. BIS central bankers’ speeches Chart 2-1 The Bank's Outlook for Economic Activity and Prices for Fiscal 2013-14 (1) Real GDP Growth Rate 3.5 FY 2013 % 3.5 3.0 3.0 2.5 2.5 2.0 2.0 Actual figure 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 -0.5 -0.5 -1.0 FY 2014 % 13/10 2013/4 14/4 14/10 15/4 -1.0 Actual figure: 1.0% 2013/4 13/10 14/4 14/10 15/4 (2) CPI Inflation Rate 2.5 FY 2013 % 2.5 2.0 2.0 1.5 1.5 1.0 % FY 2014 Actual figure: 0.8% 1.0 Actual figure 0.5 0.0 0.5 2013/4 13/10 14/4 14/10 15/4 0.0 2013/4 13/10 14/4 14/10 15/4 Note: The range and the median of majority forecasts of Policy Board members. Figures for fiscal 2014 exclude the direct effects of the consumption tax hike. Source: Bank of Japan. BIS central bankers’ speeches Chart 2-2 The Bank's Outlook for Economic Activity and Prices for Fiscal 2015-17 (1) Real GDP Growth Rate % 3.5 FY 2015 3.5 % FY 2016 3.5 3.0 3.0 3.0 2.5 2.5 2.5 2.0 2.0 2.0 1.5 1.5 1.5 1.0 1.0 1.0 0.5 0.5 0.5 0.0 0.0 0.0 -0.5 -0.5 -0.5 -1.0 13/10 2013/4 14/4 14/10 15/4 -1.0 13/10 2013/4 14/4 (2) CPI Inflation Rate 2.5 % FY 2015 2.5 % 14/10 15/4 -1.0 FY 2016 2.5 2.0 2.0 2.0 1.5 1.5 1.5 1.0 1.0 1.0 0.5 0.5 0.5 0.0 13/10 2013/4 14/4 14/10 15/4 0.0 13/10 2013/4 14/4 14/10 15/4 0.0 % FY 2017 13/10 2013/4 14/4 % 14/10 15/4 FY 2017 13/10 2013/4 14/4 14/10 15/4 Note: The range and the median of majority forecasts of Policy Board members. Figures for fiscal 2017 exclude the direct effects of the consumption tax hike. Source: Bank of Japan. BIS central bankers’ speeches Chart 3 Potential Growth Rate and Output Gap Estimated by the Bank (1) Output Gap % As of Apr. 2015 As of Apr. 2013 -2 -4 -6 -8 -10 CY 2006 (2) Potential Growth Rate 1.4 y/y % chg. As of Apr. 2015 1.2 As of Apr. 2013 1.0 0.8 0.6 0.4 0.2 0.0 FY2006 Note: The latest estimates are for the second half of fiscal 2014 for the potential growth rate and for October-December 2014 for the output gap. Source: Bank of Japan. BIS central bankers’ speeches Chart 4-1 Medium- to Long-Term Inflation Expectations <1> (Market-Based Indicators and Market Participants' Survey) (1) Break-Even Inflation (BEI) Rate 1.6 (2) Inflation Swap Rate ％ 1.4 1.2 1.0 0.8 0.6 -1 ％ Implied five-year forward rate, five years ahead Five-year rate 0.4 -2 BEI (ten years) -3 0.2 0.0 2013/10 13/10 14/2 14/6 14/10 -4 CY 2007 07 08 09 10 11 12 13 14 15 15/2 (3) Bond Market Participants 1.8 y/y % chg. 1.6 1.4 1.2 1.0 0.8 0.6 0.4 QUICK Bond Monthly Survey, average of two to ten years ahead 0.2 0.0 Mizuho Securities, average of next ten years CY2007 Note: The inflation swap rate is the fixed interest rate of the zero coupon inflation swap. The QUICK Bond Monthly Survey began including the effects of the consumption tax hike from the September 2013 survey. The survey by Mizuho Securities excludes the effects of the consumption tax hike. Sources: Bloomberg; Mizuho Securities; QUICK. BIS central bankers’ speeches Chart 4-2 Medium- to Long-Term Inflation Expectations <2> (Firms, Households, and Economists) (1) Firms (Tankan, All Firms, All Industries) 1.8 (2) Households (Opinion Survey on the General Public's Views and Behavior) y/y % chg. y/y % chg. 1.7 1.6 1.5 1.4 Three years ahead 1.3 1.2 Five years ahead 2014/3 14/6 14/9 14/12 15/3 (3) Economists (Consensus Forecast) 2.0 Five years ahead (average) y/y % chg. Five years ahead (median) CY2006/6 (4) Economists (ESP Forecast) 2.0 y/y % chg. Average of seven to eleven fiscal years ahead 1.5 1.5 1.0 1.0 0.5 0.5 Average of two to six fiscal years ahead Average of six to ten years ahead Average of four to five years ahead 0.0 CY 2006 06 07 0.0 14 15 CY 2009 Note: Survey respondents are asked to exclude the effects of the consumption tax hike for the whole period for the Tankan, from the June 2013 survey for the household survey, and from the October 2013 survey for the ESP forecast. The effects are irrelevant for the Consensus Forecasts. Sources: Consensus Economics Inc., "Consensus Forecasts"; Japan Center for Economic Research (JCER); Bank of Japan. BIS central bankers’ speeches Chart 5 Households' Inflation Expectations and Actual Inflation (1) Households' Inflation Expectations y/y % chg. Five years ahead (average) One year ahead (average) -2 2006/6 (2) Actual Inflation y/y % chg. CPI CPI (excluding the direct effects of the consumption tax hike) -1 -2 -3 2006/2Q 07/2Q 08/2Q 09/2Q 10/2Q 11/2Q 12/2Q 13/2Q 14/2Q Sources: Ministry of Internal Affairs and Communications; Bank of Japan. BIS central bankers’ speeches Chart 6-1 Households' Price Rise Tolerance DI % pts % pts -10 Price rise tolerance DI (left scale) -20 Perception DI of present price levels (right scale) -30 -40 -50 -60 -70 -80 -90 -10 -100 06/6 2006/6 07/6 08/6 09/6 10/6 12/6 11/6 13/6 14/6 Notes: 1. Price rise tolerance DI = ("price rise is rather favorable" and "price decline is rather unfavorable" respondent ratio - "price rise is rather unfavorable" and "price decline is rather favorable" respondent ratio) / (valid respondent ratio - "have remained almost unchanged" respondent ratio). 2. Perception DI of present price levels = ("have gone up significantly" * 1 + "have gone up slightly" * 0.5) - ("have gone down slightly" * 0.5 + "have gone down significantly" * 1). Sources: Ministry of Internal Affairs and Communications; Bank of Japan. Chart 6-2 Households' Income DI -20 % pts -25 -30 -35 -40 -45 -50 Income DI (present) -55 Income DI (one year ahead) -60 06/6 2006/6 07/6 08/6 09/6 10/6 11/6 12/6 13/6 14/6 Notes: 1. Income DI="will increase (has increased)"-"will decrease (has decreased)" 2. Income DI (present) refers to present income compared with a year ago, and income DI (one year ahead) refers to income of one year ahead compared with present income. Source: Bank of Japan. BIS central bankers’ speeches -20 Chart 7 Firms' Outlook for Sales Prices: Medium to Long Term (Average) Large manufacturing firms 2.0 % chg. from the current level Large nonmanufacturing firms 4.0 % chg. from the current level 3.5 1.5 3.0 2.5 1.0 2.0 0.5 1.5 1.0 0.0 0.5 -0.5 0.0 2014/3 14/3 14/6 14/9 14/12 2014/3 14/3 15/3 % chg. from the current level 14/9 14/12 15/3 Small nonmanufacturing firms Small manufacturing firms 4.0 14/6 4.0 % chg. from the current level 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 Note: The Tankan explicitly asks respondents to disregard the effects of the consumption tax hike. Figures for March 2015 are 1.0 those based on sample firms after the March 2015 revision. Source: Bank of Japan. 0.5 0.5 2014/3月 0.0 0.0 2014/3 14/3 14/6 14/9 14/12 15/3 Three years ahead 2014/3 14/3 14/6 14/9 14/12 15/3 Five years ahead Note: The Tankan explicitly asks respondents to disregard the effects of the consumption tax hike. Figures for March 2015 are those based on sample firms after the March 2015 revision. Source: Bank of Japan. BIS central bankers’ speeches Chart 8 Distribution of Households' Inflation Expectations (After Adjusting for Reporting Biases) (1) Distribution of Expectations in 2012 (2) Distribution of Expectations in 2013 Density, % Density, % Five-year expectations Five-year expectations One-year expectations One-year expectations Average Average 0 Source: Bank of Japan. -10 -5 Inflation expectations, % -10 -5 Inflation expectations, % Source: Bank of Japan. BIS central bankers’ speeches
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Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2015 BOJ-IMES Conference, hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 4 June 2015.
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Haruhiko Kuroda: Monetary policy – its effects and implementation Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2015 BOJIMES Conference, hosted by the Institute for Monetary and Economic Studies, Bank of Japan, Tokyo, 4 June 2015. * I. * * Introduction Good morning, ladies and gentlemen. It is my great honor to say a few words at the beginning of the 22nd BOJ-IMES Conference. On behalf of my colleagues at the Bank of Japan and myself, I would like to express my sincere welcome to all of you. At last year’s conference titled “Monetary Policy in a Post-Financial Crisis Era,” we had active discussions on fundamental issues of monetary policy during the period of slow economic growth following the global financial crisis. Since then, there has been further progress in research on the effects of unconventional monetary policy in academic and central bank circles. Besides, growing attention has been paid to renewed debate over the slow recovery after the financial crisis, as represented by the thesis of secular stagnation. Against the backdrop of these factors, we have selected “Monetary Policy: Its Effects and Implementation” as the theme of this year’s conference. The aim is not only to keep monetary policy at the center of the discussion, but also to put greater emphasis on implications for policy conduct in practice. I hope that, in light of the progress in monetary policy research and the recent developments in the global economy, we will have frank and lively discussions on the monetary policy challenges that we central bankers currently face. To kick things off, I would like to raise some issues relevant to these challenges. II. Global economic conditions and current issues concerning the conduct of monetary policy Over the past year, the global economy as a whole has been recovering moderately. However, we have observed considerable differences in developments of economic activity and prices among countries and regions. In reflection of these differences, diverging directions of monetary policy among the United States, Europe, and Japan have become increasingly apparent. This certainly was a major feature of monetary policy in the global context for the past year. Meanwhile, headline inflation rates dropped globally, due primarily to a plunge in crude oil prices. With these significant developments in mind, I would like to raise three current issues concerning the conduct of monetary policy. The first issue concerns the effects of unconventional monetary policy and its transmission channels. In terms of monetary policy implementation, the European Central Bank launched the expanded asset purchase programme in January, and many of the major central banks have now adopted quantitative easing (QE). On the research front, academic and central bank circles have accumulated studies on unconventional policy that have been conducted vigorously to date. These studies have demonstrated that unconventional measures, such as QE and forward guidance, have been generating monetary easing effects, primarily through influencing long-term interest rates and asset prices, as well as inflation expectations. I believe that it will be meaningful if we can further promote a common understanding on unconventional policy by sharing the various insights obtained from both implementation and academic research of monetary policy. The second issue pertains to inflation expectations and the decline in crude oil prices. The plunge in crude oil prices since 2014 has posed a new challenge for the conduct of monetary policy. In October 2014, the Bank of Japan decided to expand quantitative and qualitative monetary easing (QQE). This policy decision aimed at maintaining the improving momentum of expectation formation and at pre-empting manifestation of a risk that the decline in the BIS central bankers’ speeches inflation rate, even though caused by the oil price decline, could delay conversion of the deflationary mindset, which had been progressing steadily under QQE. The background to the policy decision is that, unlike the United States and other countries where medium- to long-term inflation expectations have been well anchored, Japan is in the midst of drastically changing the deflationary mindset; namely, re-anchoring inflation expectations to the price stability target of 2 percent. Inflation expectations are obviously one of the most important variables for the conduct of monetary policy. Therefore, it is a major policy concern for central bankers to gain a better understanding of how to measure inflation expectations, how such expectations actually affect firms’ price- and wage-setting behavior, as well as households’ consumption decisions, and how to evaluate the degree to which inflation expectations are anchored. I hope that further progress will be made in research in this field. The third issue is how to deal with the international spillovers induced by the diverging directions of monetary policy among advanced economies. In emerging economies, monetary authorities have paid more attention to developments in foreign exchange rates and international capital flows that are influenced by major central banks’ policy actions and announcements of their future directions of policies. In addressing these international spillovers, how to use monetary policy, macro-prudential policy, and capital flow management policy in combination has come to be a crucial issue, particularly for countries that have financial system vulnerability. III. Policy issues concerning slow post-financial crisis recoveries Thus far, I have explained the three issues central banks now face in the conduct of monetary policy. Next, I would like to raise some policy issues from a longer-term perspective. In the wake of the global financial crisis, economic recoveries around the world have been modest relative to past recoveries despite the implementation of unconventional monetary policy. For the past year or so, academic and central bank circles have actively discussed how to interpret this fact. Such discussions have been initiated by Lawrence Summers’ revisit to the “secular stagnation thesis” advocated originally by Alvin Hansen in the late 1930s. Various views have been raised regarding the causes of slow post-financial crisis recoveries; for example, the persistent weakness on the demand side of the economy and the low productivity on the supply side. There have been wide-ranging interpretations and views on secular stagnation. In light of the discussions over slow post-financial crisis recoveries, I would like to raise three policy issues. The first issue is to what extent central banks should consider the impact on the supply side of the economy in conducting monetary policy. As a backdrop of the slow recoveries following the global financial crisis, it has been pointed out that the interaction between demand and supply has gained importance. That is, the weakness in demand impairs the supply side mainly by discouraging workers from participating in the labor market and dampening firms’ investment in capital stock and in research and development. Furthermore, a decline in expectations about future economic growth may cause insufficiency of demand. That said, the conventional view takes the supply side, such as the potential growth rate and the natural rate of unemployment, as a given in the conduct of monetary policy. How would the mechanism of slow recoveries affect such a conventional view? The second issue is with regard to what monetary policy tools are desirable under a low natural rate of interest. If the natural rate remains at a relatively low level over the medium to long term, compared with in the past, as suggested by the secular stagnation thesis, then the nominal interest rate is likely to stay around zero. Furthermore, even after the normalization of interest rates, the nominal rate might fall back to zero or to a very low level. In that case, would unconventional monetary policy continue to be important even “beyond the exit”? Moreover, would it eventually be regarded as conventional in an economy under the “new normal”? BIS central bankers’ speeches The third issue concerns the optimal policy mix for an economy undergoing medium- to longterm stagnation with a low natural rate of interest. What would be the best policy mix among monetary policy, fiscal policy, and structural reform in such a situation? Are there any constraints to the implementation of the best policy mix, such as mounting government debts or constraints under a common currency area? What alternative mix of policies could be considered as a second best choice? IV. Concluding remarks Every word and deed of central banks around the globe has been drawing more attention as the diverging directions of monetary policy among advanced economies become apparent. The issues I have raised so far are all complex, and there are no quick, definitive solutions for them. Nevertheless, I strongly believe that, at this one-and-a-half day conference, we will address the issues we currently face and find our way forward through lively discussions. I trust that many of you are familiar with the story of Peter Pan, in which it says, “the moment you doubt whether you can fly, you cease forever to be able to do it.” Yes, what we need is a positive attitude and conviction. Indeed, each time central banks have been confronted with a wide range of problems, they have overcome the problems by conceiving new solutions. I am sure that we all can share a conviction backed by our collective experience and wisdom. I would like to close my remarks now as we ready ourselves for discussion. Thank you for your attention. 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, Kofu, Yamanashi Prefecture, 10 June 2015.
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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, Kofu, Yamanashi Prefecture, 10 June 2015. * * * 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 the political, economic, and financial arena of Yamanashi 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 Kofu 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 Yamanashi 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. I. Recent economic and financial developments in Japan and abroad A. Developments in the world economy The world economy has been sluggish, despite the decline in energy prices (Chart 1). In the January–March quarter of 2015 in particular, it exhibited signs of a slowdown, as the growth rate of the U.S. economy turned negative due to the effects of the severe winter weather and the labor disputes at West Coast ports, and as the growth rate of the Chinese economy remained at around 7 percent. These developments in the world economy affected Japan’s economy to some degree as well. The decline in energy prices since 2014 was initially expected to have positive effects on the world economy, but negative effects seem to have preceded them – such as the decline in income in commodity-exporting countries and the decrease in investment in resource development – due to the rapid pace of the energy price declines. As for the outlook, the world economy is expected to see a moderate increase in its growth rate, with the recent improvement in soft data reflected in hard data, as positive effects of the decline in energy prices – such as an increase in real income in the energy-consuming countries – permeate gradually. As for the U.S. economy, a substantial deceleration in growth in the January–March quarter has been observed three times in the past five years. The deceleration occurred for different reasons each time, but there seems to be a seasonal pattern of some kind. Besides the severe winter weather and the labor disputes at West Coast ports, the appreciation of the dollar also casts a shadow on manufacturers’ sentiment, thereby affecting indicators of business fixed investment. The effects of the decline in energy prices on investment in resource development are also evident (Chart 2). In contrast, reflecting the improvement in the employment situation and the decline in gasoline prices, consumer sentiment has generally stayed at a high level. It is a matter of concern that, despite the favorable sentiment, private consumption remains lackluster and growth in the April–June quarter of 2015 has been sluggish so far. However, the economy is expected to gradually return to a recovery path led by private consumption on the back of a moderate increase in wages as the employment situation continues to improve – following more or less the same pattern of the past five years. The inflation rate has been stable due to the decline in energy prices, but the slack in the labor market seems to be diminishing to a certain degree, reflecting the BIS central bankers’ speeches decline in the unemployment rate, although there are such problems as the increases in the number of long-term unemployed workers and part-time workers. In this situation, the Federal Reserve (Fed) has been communicating to the public a path toward raising the policy interest rate, but is taking a flexible and cautious stance that the exact timing will depend on future economic indicators. In Europe, manufacturers’ sentiment has been picking up in reflection of the decline in energy prices and the depreciation of the euro, and consumer sentiment has also started to recover (Chart 3). With the improvement in soft data, the pick-up in hard data has become evident, as seen, for example, in positive GDP growth for eight consecutive quarters. The inflation rate, which temporarily had been negative, has recovered to around 0 percent. That being said, given that the effects of the debt problem remain, the risk of prolongation of low inflation leading to a postponement of investment and consumption has receded but seems to still exist, and I have been monitoring these developments closely. Meanwhile, unconventional monetary policy measures introduced by the European Central Bank (ECB) initially had significant effects on the foreign exchange and bond markets; however, these markets have recently shown large fluctuations. Many points are being made regarding the sustainability of such large-scale asset purchases, and I will pay attention to any progress made regarding this matter. With regard to the Chinese economy, the GDP growth rate for the January–March quarter of 2015 decelerated to 7.0 percent. Looking at recent developments in electricity consumption and railway freight turnover, my impression is that actual economic growth could be slower than suggested by the GDP figures, although we should not make a decisive judgment as these developments may reflect the effects of the shift toward a service economy and the progress in structural reforms that are promoted by the Chinese government (Chart 4). Moreover, manufacturers’ sentiment has been dampened further. Movements toward inventory adjustments in Japan – in materials and related goods such as iron and steel – seem to be partly affected by the slowdown in the Chinese economy. As for the outlook of the Chinese economy, the growth rate is likely to remain downwardbiased, owing to a sharp change in the demographic situation and the resultant fall in the potential growth rate. However, given the typical pattern observed over the past few years – in which, once the economy is projected to deviate downward from the growth target, the government implements small-scale economic packages, thereby achieving the pick-up in the economy – the same developments generally seem to be taking place this year as well. Meanwhile, attention should be paid to the point that downward pressure on inflation has been increasing, as evidenced by the year-on-year rate of change in the GDP deflator for the January–March quarter of 2015 turning negative for the first time since 2009. B. Developments in global financial markets Taking into account the developments in the world economy that I have illustrated, let me turn to developments in global financial markets for the time being. The first key point is how a hike in the policy rate in the United States affects global financial markets. In light of the recent U.S. economic indicators, the timing of a hike in the target federal funds rate that market participants expect is either moving forward or backward. On the other hand, the Fed is working to let the markets factor in a rate hike in the near future while cautiously avoiding providing decisive information. Judging from pricing in the federal funds futures market, this intention by the Fed has generally permeated the markets, and the difference in views between Federal Open Market Committee (FOMC) participants and the markets – which was seen some time ago – is starting to be resolved (Chart 5). Of course, if market participants begin to identify the specific timing of a rate hike, global financial markets might show a different reaction from the past. This concern seems to have materialized in the market reaction when Fed Chair Janet Yellen mentioned the valuation in the stock and bond markets in early May 2015. Meanwhile, as a result of a number of financial regulations, major market makers’ risk-taking activities have been restricted, inducing concern regarding a decline in BIS central bankers’ speeches liquidity even in the U.S. Treasury markets. Given these circumstances, I would like to monitor carefully whether, when the timing of a rate hike becomes clearer in the future, a change in the international flow of funds will not cause any significant repricing or unexpected knock-on effects in various asset markets. The second key point in terms of developments in global financial markets is the effects of large-scale asset purchases by the ECB (Chart 6). When these purchases were first implemented, it was considered that the effects of the purchases had already been factored in. However, even after the implementation, long-term interest rates in European countries fell markedly; for example, 10-year German bund yields declined to around 0 percent temporarily. At the same time, the euro depreciated further. Since late April, however – probably because of a reaction to the sharp drop in interest rates – long-term interest rates in Germany have risen above the level seen before the implementation of the ECB’s asset purchases, and thus have exhibited rather volatile movements. This increase in volatility appears to be related to a decline in market liquidity, resulting from the scale of the ECB’s purchases being massive relative to the size of sovereign bond markets. Also, in Japan, a rise in volatility in long-term interest rates was observed both after the introduction of quantitative and qualitative monetary easing (QQE) in April 2013 and following the expansion of QQE at end-October 2014. Specifically, contrary to the initial intention, yields on 10-year Japanese government bonds (JGBs) temporarily jumped up somewhat significantly immediately after the implementation of QQE. In contrast, they declined further after the expansion of QQE and have recently returned to around the level seen before such expansion. These fluctuations in long-term interest rates appear to be attributable not only to monetary policy but also to external factors, and therefore should be assessed carefully. That being said, if the effects of monetary policy are produced by the declines in nominal or real interest rates, due attention should be paid to the possibility that liquidity premiums in the JGB markets – brought about by the Bank’s massive JGB purchases – might in part be weakening the effects of monetary policy. There is also a possibility that the fluctuations in long-term interest rates reflect the move to factor in improvement in the outlook for economic activity and prices. The third key point is also related to European factors – namely, developments in political and economic conditions in Greece. As the Greek government faces severe financing needs, negotiations regarding financial assistance to the country continue. At this point, possible effects on peripheral European countries are limited. However, I would like to monitor future developments whether or not any unexpected knock-on effects emerge in global financial markets. C. Developments in Japan’s economy Looking at developments in Japan’s economy for the January–March quarter of 2015, not only business fixed investment but also exports and production maintained their moderate improving trend. Private consumption and imports were resilient and final demand remained firm. For the April–June quarter, the economy is expected to continue recovering moderately because, for example, it seems that private consumption has been resilient since March, although production is projected to be more or less unchanged, mainly due to inventory adjustments in some industries (Chart 7). Expectations for somewhat higher growth in the world economy will also serve as a tailwind for Japan’s economy. The virtuous cycle from income to consumption and investment will likely operate, with its certainty gradually increasing, on the back of the firm employment situation and favorable corporate results. However, we should probably be mindful of the risk that the increase in households’ real purchasing power and the improvement in corporate profits, both brought about by lower crude oil prices, will not lead to an expansion of spending by as much as expected, and consequently pressure for excess savings – or for an increase in current account surplus – will not be alleviated easily. BIS central bankers’ speeches With regard to the employment and income situation, which forms the basis for the virtuous cycle that I just mentioned, wages continue to rise moderately in a situation where labor market conditions have become increasingly tight, even after the year-on-year growth in total cash earnings was revised downward due to the replacement of samples in the Monthly Labour Survey (Chart 8). Wages are expected to continue increasing moderately, reflecting a base pay increase that is likely to take place for a second consecutive year. Thus, private consumption is expected to reach a moderately higher level as the effects of a decline in real income due to the consumption tax hike in April 2014 dissipate gradually. From a somewhat longer-term perspective, I focus on the pace of increase in firms’ productivity, which is the basis for a sustainable rise in wages, as well as on the impact of the aging population. In order for consumption to maintain its uptrend in the medium term, it would be necessary to have a sustainable recovery in real wages of about 60 million workers that could offset developments in real income of about 40 million pensioners. The pace of recovery in private consumption will likely remain very moderate from a somewhat longerterm perspective, even considering that wages will gradually see a higher rate of increase in accordance with a rise in productivity brought about by an increase in business fixed investment, and that confidence in the sustainability of the social security system will increase because of the implementation of related reforms. Regarding private business fixed investment, such investment on a GDP basis has been slow to increase so far despite a pick-up in monthly indicators, such as shipments and the aggregate supply of capital goods, and the firmness in investment plans suggested by the results of the Tankan (Short-Term Economic Survey of Enterprises in Japan). However, fixed investment overseas has been marking consecutive double-digit increases recently, suggesting that firms’ appetite for fixed investment on a consolidated basis has been robust for some time (Chart 9). What matters is not whether firms will increase fixed investment further, but whether they will make investments in Japan. In this regard, domestic fixed investment so far has been made by nonmanufacturers in particular, but some manufacturers are finally beginning to increase production capacity in Japan, reflecting the yen’s depreciation the past two years, although automobile firms’ shifting of production facilities to overseas, which has been made in a full-fledged manner since around 2014, remains in some part. From a somewhat longer-term perspective, whether a change in firms’ production network strategies will become widespread, in turn leading to increasingly building up production capacity in Japan rather than overseas, depends on their medium- to long-term projections for exchange rates. Specifically, if firms judge the yen’s depreciation the past two years to be a sustainable trend, they would proceed with increasing their production capacity in Japan. On the other hand, firms that have concern regarding a possible resurgent appreciation of the yen would not easily change their production network strategies even with the recent depreciation of the yen. In this regard, the Annual Survey of Corporate Behavior, conducted by the Cabinet Office, provided a favorable factor: the yen-U.S. dollar rate for the next year forecasted by firms was 119.5 yen/dollar, marking a weaker yen forecast for the third consecutive year (Chart 10). However, it should be noted that, when firms decide their fixed investment, long-term projections for the next five to ten years are important. Therefore, it is uncertain whether a trend of increasing production capacity in Japan will become widespread in the future. D. Developments in prices Let me now turn to developments in prices. The year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food has been about 0 percent recently, reflecting the decline in energy prices. It is likely to be at this level for the time being, due to the remaining effects of the decline in energy prices (Chart 11). This suggests that consumer prices also lack momentum at present. However, a decline in general prices due to the decrease in energy prices exerts upward pressure on real income, and therefore I consider BIS central bankers’ speeches this to be a favorable factor for Japan’s economy. What matters is not the fluctuations in monthly figures of the year-on-year rates of change in the CPI, but the underlying trend in inflation, which reflects the overall economic conditions. In my view, the underlying trend in inflation is firmly maintained. In a situation where the inflation rate rose mainly due to the depreciation of the yen and the increase in energy prices in the past two years, various soft data suggested a negative reaction by households to a rise in the inflation rate in light of sluggish growth in real wages. In fact, private consumption, which was also affected by the consumption tax hike, had been sluggish (Chart 12). This should prove that people consider it desirable to see the inflation rate rising in balance with wages and income as economic conditions improve, rather than seeing the inflation rate simply rising. I believe that the price stability target intrinsically aims for such desirable developments. A matter of concern is whether the deceleration in the rate of increase in the CPI or the decline in the CPI on a year-on-year basis, which have been observed recently, will not affect people’s medium- to long-term inflation expectations in a backward-looking manner. In this regard, judging from firms’ price-setting behavior, consumers’ spending activity, and the recent developments in wage negotiations, people’s perception of inflation has been changing steadily despite the decline in energy prices. Moreover, a wide range of estimates – such as those of expected inflation derived from nominal interest rates 1 and those of trend inflation using a regime-switching model 2 – suggest that medium- to long-term inflation expectations in Japan appear to be rising since the introduction of QQE from a somewhat longer-term perspective (Chart 13). However, under the deflation that lasted for over 15 years, medium- to long-term inflation expectations appear to consistently remain lower than those in the United States. The challenge is to re-anchor these expectations at around 2 percent, comparable to the level in the United States. What I consider important as factors that determine people’s medium- to long-term inflation expectations are not just the past developments in the inflation rate that I mentioned earlier, but also developments in the overall economy and in asset prices, as well as forward-looking expectation formation based on, for example, wage revisions. Taking this point into account, I hold the optimistic view that it is less likely that people’s medium- to long-term inflation expectations will be negatively affected by a decline in the inflation rate due to the fall in energy prices. I would note that the recent results of academic research on the methods for measuring inflation rates offer valuable suggestions for the old but also new issue of how to define consumer prices. For example, the SRI-Hitotsubashi Unit Value Price Index, which has been developed by Professor Naohito Abe of Hitotsubashi University, incorporates prices of new goods that firms frequently introduce into markets in calculating price indexes 3 According to the research by Professor Abe, 46–47 percent of goods do not exist in the same week of the previous year at the average retailers, indicating that replacement rates of goods are very high in reality (Chart 14). The same research also finds that some new goods are virtually unchanged from the previous ones, suggesting a possibility that firms replace goods frequently as a means of adjusting prices in effect. In calculating a change in prices of goods See Kei Imakubo and Jouchi Nakajima, “Estimating Inflation Risk Premia from Nominal and Real Yield Curves Using a Shadow-Rate Model,” Bank of Japan Working Paper Series No. 15-E-1, April 2015. See Sohei Kaihatsu and Jouchi Nakajima, “Has Trend Inflation Shifted? An Empirical Analysis with a RegimeSwitching Model,” Bank of Japan Working Paper Series No. 15-E-3, May 2015. For details, see Naohito Abe, “Saikin no Kakaku Shisuu no Doukou to Shin Shohin no Eikyo ni tsuite (Recent Developments in Price Indexes and Effects of New Goods),” Newsletter No. 3, the Research Center for Economic and Social Risks (RCESR), Institute of Economic Research, Hitotsubashi University, March 2015 (available in Japanese), and Naohito Abe et al., “Effects of New Goods and Product Turnover on Price Indexes,” RCESR Discussion Paper Series No. DP15–2, March 2015. BIS central bankers’ speeches over a particular period, general consumer price indexes only cover the goods for which price information is available at the beginning and the end of the period; on the other hand, the SRI-Hitotsubashi Unit Value Price Index quantifies the importance of the introduction of new goods that I have just mentioned. The research concludes that, mainly due to the effects of such introduction on prices, the year-on-year rate of increase in the SRI-Hitotsubashi Unit Value Price Index for supermarkets has recently been at about 1 to 1.5 percent, which shows a higher rate of inflation than in CPI statistics released by the Ministry of Internal Affairs and Communications (MIC) and in a price index that only covers continuing goods (Chart 15). These research results do not allow simple comparison with the CPI statistics released by the MIC, in part because the coverage of the SRI-Hitotsubashi Unit Value Price Index is limited to goods with point-of-sale (POS) data. However, I take the view that they provide useful insights to firms’ price-setting behavior through the introduction of new goods and its effects on developments in prices, and to a divergence between the inflation rate perceived by households and that measured by price statistics. II. Future conduct of monetary policy A. The price stability target and conduct of monetary policy In what follows, I explain issues regarding monetary policy. About two years ago, 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 latest figure for the year-on-year rate of increase in the CPI is about 0 percent due to the decline in energy prices, and the baseline scenario outlined in the April 2015 Outlook for Economic Activity and Prices shows that the timing of reaching the price stability target has been delayed to around the first half of fiscal 2016 (Chart 16). However, the Bank’s Policy Board has judged that no policy actions are necessary at this point based on the view – as I mentioned earlier – that the underlying trend in inflation is firmly maintained under the virtuous cycle of the economy. With regard to the timing of reaching the price stability target, I believe that the phrase “at the earliest possible time” represents the essence and that “a time horizon of about two years” is only a non-binding target, as the commitment to achieving a specific price level within a specific time frame, in my opinion, does not fit the conduct of monetary policy adopted by other major countries in the first place. That is, in my understanding, the price stability target is a rolling target with a time horizon of about two years, and this is broadly in line with the idea of inflation targeting adopted by major countries. From this viewpoint, the delay in the timing of reaching the price stability target would not be the essential problem. As I touched on earlier, firms and households generally have a negative reaction to mere inflation, mainly due to concern over a rise in costs and to the negative effects on real wages, both stemming from a rise in import prices. On the other hand, in continuing with QQE, I consider it necessary to take into account that this policy is a kind of shock therapy that influences formation of people’s inflation expectations through the lowering of real interest rates and risk premiums brought about by massive asset purchases, as well as through a strong commitment. The Bank has provided forward guidance – namely, that it will continue with QQE, as long as it is necessary for achieving the price stability target in a stable manner – and of course, the necessity of continuing QQE will be judged in line with this guidance. I therefore do not think that the current policy framework should be reviewed in an automatic fashion simply because two years have passed since the introduction. In my understanding, the price stability target is a flexible concept with a certain range for upward and downward deviations of the actual inflation rate from the target under the framework of forecast targeting. It is also my understanding that achieving the price stability target in a stable manner does not refer to a state in which the year-on-year rate of increase in the CPI simply marks 2 percent, but rather one in which people’s medium- to long-term inflation expectations are re-anchored at around BIS central bankers’ speeches 2 percent – in other words, a situation in which households and firms are projected to shift their consumption and investment behavior to one that assumes around 2 percent inflation. The status of achieving the price stability target and the necessity of continuing QQE will be judged by the Bank’s Policy Board at each Monetary Policy Meeting. In doing so, I would like to take into account (1) the effects of QQE after its expansion, (2) the sustainability of the Bank’s massive JGB purchases, and (3) a wide range of QQE’s side effects, all of which I will elaborate on shortly. B. Effects of QQE after its expansion The first point that needs to be examined in continuing with QQE is its policy effects (Chart 17). After the expansion of QQE at end-October 2014, the 10-year JGB yields temporarily dropped below 0.2 percent, but these recently have recovered to around the level seen prior to the expansion. Meanwhile, the market’s outlook for economic activity and prices has actually been revised downward, and therefore there is a lack of persuasive evidence of a further rise in inflation expectations. One of the assumed transmission mechanisms of QQE is to put downward pressure on nominal interest rates across the entire yield curve through massive purchases of JGBs. I understood the expansion of QQE at end-October 2014 as an action that would strengthen such a mechanism. In reality, however, it appears to me that the degree of difficulty in implementing QQE is rising, as the effect of lowering nominal interest rates has been diminishing gradually, due mainly to a rise in liquidity premiums, despite a large-scale expansion of the Bank’s JGB purchases. Let me give you some background as to why it has become difficult for long-term interest rates to decline. First, interest rate levels are already low, and it is becoming difficult to see a linear relationship between the amount of JGB purchases and interest rates. Second, there tends to be less demand for JGBs from final investors under extremely low interest rates. Third, dealers’ risk tolerance is declining, as there is an increase in volatility due to the decline in market liquidity and to the effects of overseas interest rates. I will explain these three factors in more detail. With regard to the first one, the key is whether real interest rates will decline further – in other words, whether people’s medium- to longterm inflation expectations will rise further only with the Bank’s “strong and clear commitment” – in a situation where it is becoming difficult for nominal interest rates to decline. Of course, it may be theoretically possible to further push down nominal interest rates if the Bank continues its purchases of JGBs even with negative interest rates. However, in that case, the Bank would become the only buyer of JGBs, which would likely give rise to a concern over the Bank’s purchases being perceived as financing the fiscal deficit, as well as to a further decline in market functioning. Regarding the second factor, whether or not demand from final investors will decrease depends in part on their future stance on JGB purchases. For example, a reduction in life insurance companies’ promised return for some insurance products that will start from July 2015 might affect investors’ future behavior (Chart 18). As for the third factor, dealers’ risk tolerance will likely change depending on market conditions. Taking such factors into consideration, I will pay close attention not only to the effects of the progress in the Bank’s asset purchases on interest rate formation, but also to changes in investors’ and dealers’ behavior, and closely monitor how policy effects will emerge in the future. C. Sustainability of the Bank’s massive asset purchases The second point that needs to be examined in continuing with QQE is the sustainability of the Bank’s massive JGB purchases (Chart 19). The Bank currently commits to purchasing JGBs with medium- to long-term maturities so that their amount outstanding will increase at an annual pace of about 80 trillion yen. On a gross basis, the Bank purchases JGBs at an BIS central bankers’ speeches annual pace of about 110 to 120 trillion yen, which is equivalent to about 90 percent of the total amount of JGBs’ market issuance. If final investors were to reduce their holdings of JGBs by redeeming the bonds each time they come to maturity and not reinvesting the amount redeemed in JGBs, the Bank’s massive JGB purchases would be sustainable. However, in reality, there is a certain level of demand for JGBs, mainly for those used as collateral. For example, the amount of JGB holdings by major banks, which had been reduced at the time QQE was introduced, has been stable recently, and the same applies to the amount held by regional financial institutions. In a situation where there appears to be a certain level of demand by final investors to reinvest the amount redeemed at maturity, the sustainability of the Bank’s JGB purchases may become an issue if the Bank continues its massive purchases at the current pace while final investors reduce their holdings of JGBs to the least possible extent. This limit is dependent on the interest rate level and other factors at each point in time, and thus is difficult to project at this point. Nevertheless, in continuing with QQE, it is important to give consideration to its feasibility in terms of the Bank’s market operations. D. Examination of side effects The third point that needs to be examined in continuing with QQE is the side effects of the Bank’s massive asset purchases. It is true that policy effects and side effects are two sides of the same coin, and positive effects cannot be expected from policies that have no side effects. Having said that, in continuing with the unprecedented policy, it is essential to compare its positive effects and side effects and examine whether the latter do not outweigh the marginal effects from continuing the policy. With regard to how the increase in the share of the Bank’s holdings in the JGB market affects market functioning, I am somewhat concerned about the results of the Bond Market Survey conducted by the Bank in February 2015, as recovery in market functioning is considered to be the key to a smooth exit from QQE from a somewhat longer-term perspective (Chart 20). I also continue to pay careful attention to the effects of the continued extremely low interest rates on financial institutions’ business, and to the stability of the broadly defined settlement system. E. Importance of efforts toward fiscal consolidation The Bank’s massive purchases of JGBs are carried out only in the context of the conduct of monetary policy and not in any way to finance the fiscal deficit. In order for this explanation to be persuasive, the government’s efforts toward fiscal consolidation are important. It also should be noted that the massive JGB purchases, if continued over a long period, could lead to extremely low interest rates being built into the fiscal plan, thereby affecting fiscal discipline – although the continuation of such purchases aims at fulfilling the purpose of monetary policy. Once market participants have concern about fiscal discipline, controlling long-term interest rates will become difficult, even for the Bank. My assessment is that QQE has generally been exerting its intended effects so far, but in order for QQE to gain success – such as a smooth process of finding an exit from QQE from a somewhat longer-term perspective – the government’s initiatives toward fiscal consolidation are important. The government looks to formulate a new fiscal consolidation plan by summer 2015 to maintain its goal of generating a surplus in the primary balance for fiscal 2020. The Bank strongly expects that the government will steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of the country’s fiscal management. Concluding remarks: Economic activity in Yamanashi Prefecture My concluding remarks will touch on the economy of Yamanashi Prefecture. A feature of the industrial structure of Yamanashi Prefecture is that its share of manufacturing – industries relating to machinery in particular – is larger than that in the country overall. The prefecture’s economy has recently been recovering moderately, led by BIS central bankers’ speeches manufacturing firms that are attracting external demand, both directly and indirectly (Chart 21). Nevertheless, from a somewhat longer-term perspective, there have been moves by manufacturing industries in the prefecture to concentrate their production sites in Japan or shift a part of their production overseas, for the purpose of enhancing cost competitiveness, mainly in response to the yen’s appreciation since the Lehman shock and to intensification of competition stemming from growth of Asian firms. Such moves have led to structural issues in the prefecture, such as a declining population as well as an aging population and declining birth rate. In addressing these issues, the key should be to make full use of the advantages of Yamanashi Prefecture. The first advantage is that the prefecture is close to Tokyo and yet blessed with a bounteous nature, including Mt. Fuji and hot springs. Recently, in particular, the number of foreign visitors to the prefecture has been increasing substantially, partly owing to the yen’s depreciation. It also should be noted that the prefecture is a highly attractive place to move to, for those who live in the Tokyo metropolitan area. I have heard that initiatives to take advantage of such an environment are spreading, such as improving tourism infrastructure and expanding a supporting system to invite those who wish to move to the area. Moreover, events such as the Tokyo 2020 Summer Olympic and Paralympic Games and the launch of the Linear Chuo Shinkansen line will act as a tailwind for Yamanashi Prefecture. The second advantage is the advanced technologies that firms in Yamanashi Prefecture have developed so far. I hope that technological innovation will advance as a result of further brushing up these technologies, applying them to new areas, and working to integrate them with other firms’ technologies. This, together with cooperative efforts among industry, government, academia, and financial institutions, is expected to lead to future achievements. I would like to conclude this speech by expressing my strong hope that the region will enjoy further growth in the future through the initiatives I have mentioned, while making use of its potential. 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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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, for the Panel Discussion at the Bank for International Settlements Annual General Meeting, Basel, 28 June 2015.
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Haruhiko Kuroda: How unconventional monetary policy stimulates demand – theory and practice Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, for the Panel Discussion at the Bank for International Settlements Annual General Meeting, Basel, 28 June 2015. * * * It is a great honor to be able to participate in this panel discussion today. The Bank of Japan introduced its Quantitative and Qualitative Monetary Easing (QQE) in April 2013. One tentative conclusion that can be drawn from the experience of a little over two years is that central banks can overcome the zero lower bound, as long as the policy maker commits decisively to fulfilling its mandate with well-designed unconventional policy measures. To give you some idea of the outcomes since the beginning of the QQE, the unemployment rate has fallen 0.8 percentage point, and CPI inflation has risen about 1 percentage point. Other major central banks have also been successful in stimulating demand through their own unconventional policies. It has become a common understanding among the central bank community that unconventional monetary policy, despite some lingering skepticism from the academic front, has actually proven to be effective. This is best characterized by a famous quote from the former Fed Chair, Ben Bernanke: “The problem with QE is it works in practice but it doesn’t work in theory.” In that case, the question remaining about unconventional monetary policy is not whether it works, but why it works. The rest of my remarks will focus primarily on this issue from both theoretical and practical perspectives. First, let me start with term premiums. Whether central banks’ large-scale asset purchases succeed in reducing term premiums hinges upon whether the preferred habitat hypothesis holds. 1 Some influential academics deny this effect, claiming that “open-market operations should be largely ineffective to the extent that they fail to change expectations regarding future policy.” 2 This argument is presumably what was in Mr. Bernanke’s mind when he said that QE didn’t work in theory. Among central bankers, however, it is becoming increasingly accepted that term premiums can actually be reduced by large-scale purchases of long-term bonds through changes to their demand-supply conditions. 3 Experience has further convinced us that the fall in longterm interest rates in turn affects the price of other financial assets such as equities and private credits through portfolio rebalancing, as predicted by James Tobin’s General Equilibrium theory. 4 Economists have recently started to embed this preferred habitat mechanism in their macro-economic models so as to explicitly incorporate this transmission channel of QE. 5 Franco Modigliani and Richard Sutch, “Innovations in Interest Rate Policy,” American Economic Review, Vol. 56, pp. 178–197, 1966. Gauti Eggertsson and Michael Woodford, “The Zero Bound on Interest Rates and Optimal Monetary Policy,” Brookings Papers on Economic Activity, No. 1, pp. 139–235, 2003. There are a number of empirical studies that attempt to decompose long-term government yields into the expected path of short-term interest rate and premium components. For Japanese government bonds, see Kei Imakubo and Jouchi Nakajima, “Estimating Inflation Risk Premia from Nominal and Real Yield Curves Using a Shadow-Rate Model,” Bank of Japan Working Paper, No. 15-E-1, 2015. James Tobin, “A General Equilibrium Approach to Monetary Theory,” Journal of Money, Credit and Banking, Vol. 1, pp. 15–29, 1969. Han Chen, Vasco Cúrdia, and Andrea Ferrero, “The Macroeconomic Effects of Large-Scale Asset Purchase Programmes,” The Economic Journal, Vol. 122, pp. F289-F315, 2012. BIS central bankers’ speeches Second, forward guidance, which is another element of unconventional monetary policy, is generally supported both in theory and in practice. In theory, forward guidance could pin down the future expected path of policy rates by clarifying the central bank’s policy reaction function and thereby reducing the volatility of financial markets. In fact, forward guidance, together with a strong commitment to policy objectives, has been used effectively in various policy settings across jurisdictions. Third, let me discuss the “quantitative” aspect of quantitative easing. Does the size of the central bank’s balance sheet matter in itself and, if so, why? Some theoretical economists argue that QE is effective from the viewpoint of monetary financing of the government budget. However, this is the opposite case of Ben Bernanke’s quote: it works well in theory but cannot be applied in practice. Monetary finance is widely understood to run the risk of eroding the credibility of the central bank and thereby potentially increasing risk premiums rather than reducing them. Furthermore, recent experience in the United States and the United Kingdom has demonstrated that an unconventional monetary policy works even in the midst of substantial fiscal consolidation. In the case of Japan, the joint statement of January 2013 clearly stated that the Bank of Japan would pursue a 2 percent inflation target while the government committed to ensuring long-term sustainability of the public debt. Thus, from the beginning there was no intention at all that QQE would work through facilitating fiscal expansion. While monetary finance is not on our agenda, the size of central bank balance sheets is, in my view, important for a different reason. Since inflation is widely perceived to be ultimately a monetary phenomenon, the creation of a massive quantity of money would be a strong signal of a central bank’s commitment to fighting deflation. It is in this context that an unprecedented expansion of the monetary base plays an essential role in our QQE. Fourth and lastly, I will discuss what I believe is a very critical transmission channel of unconventional monetary policy: the expectation channel. This overlaps with the signaling effect associated with the “quantity” that I just mentioned.6 One possible problem is that the theoretical foundations seem not to be well established. Standard theories simply assume that rational expectations automatically hold, while they tend to be silent on exactly what it would take to change the way firms and households formulate their expectations. I am quite confident, however, that a strong commitment to policy objectives, clear and consistent communication, and decisive action to fulfill the commitment would collectively be powerful enough to have a significant impact on inflation expectations, and therefore on the behavior of private entities. This expectation channel is crucial for Japan in particular, where the deflationary mindset, so firmly embedded for such a long period, needs to be dispelled completely. Before I conclude, I would like to quote the words of Walter Heller, economic adviser under Presidents Kennedy and Johnson: “An economist is a man who, when he finds something works in practice, wonders if it works in theory.” If this adage is true, I suppose we can look forward to a much deeper theoretical understanding of the secrets of unconventional monetary policies in the coming years. At the same time, practitioners in central banks cannot afford to be complacent. Speaking of the Bank of Japan, for example, inflation is still well below our target, although this is partly due to the temporary influence of low oil prices. While our projection is that inflation will be in the neighborhood of 2 percent most likely around the April-September period of 2016, the risks to that scenario cannot be ignored, particularly when the global economy is full of uncertainty, including over geopolitical factors. That being said, our commitment to achieving the 2 percent inflation target will never be compromised. With our unwavering determination, I am confident we can achieve that goal. Thank you. See, for instance, Haruhiko Kuroda, “What We Know and What We Do Not Know about Inflation Expectations,” (Speech at the Economic Club of Minnesota), April 19, 2015. 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, Kumamoto, 27 July 2015.
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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, Kumamoto, 27 July 2015. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Kumamoto 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 Kumamoto Branch. The Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013 with the aim of overcoming deflation that has lasted for about 15 years. Thereafter, QQE has been exerting its intended effects, and Japan’s economic activity and prices have improved markedly. The underlying trend in inflation, as I will explain later, has continued to be of improvement, although the year-on-year rate of increase in the consumer price index (CPI) has declined, due in particular to the effects of the substantial decline in crude oil prices since last summer, and recently has been about 0 percent. Today, before exchanging views with you, I would like to explain the Bank’s view on the current situation of and outlook for economic activity at home and abroad. I will then touch on the mechanism and effects of QQE and move on to Japan’s price developments and the Bank’s monetary policy. I. Current situation of and outlook for economic activity at home and abroad To start with, let me talk about economic developments at home and abroad. Japan’s economy has continued to recover moderately, and a virtuous cycle from income to spending is becoming more evident in both the corporate and household sectors. That is, in the corporate sector, profits marked a record high, and an increase in fixed investment is becoming clear. In the household sector, wages have been growing, as seen in the raise in base pay for two consecutive years, and private consumption has been resilient. In contrast, exports – which had been increasing since last autumn – have recently shown some weakness in their momentum. However, this is due to a temporary slowdown in overseas economies. Exports are expected to increase moderately, albeit with some fluctuations, against the background of the recovery in overseas economies and supported by past developments in foreign exchange rates. Overseas economies and Japan’s exports First, I would like to touch on overseas economies. Overseas economies – mainly advanced economies – have been recovering, albeit with a lackluster performance still seen in part of emerging economies. Overseas economies weakened rather substantially in the JanuaryMarch quarter of 2015, particularly in the United States and China, but they are expected to continue recovering moderately, mainly in the advanced economies, and the positive effects of this are likely to gradually spread to the emerging economies. This view is shared among international organizations such as the International Monetary Fund (IMF). According to the World Economic Outlook (WEO) Update published in July by the IMF, global economic growth in 2015 has been revised downward to 3.3 percent, due to its weakening in the January-March quarter, but is projected to accelerate moderately and register 3.8 percent in 2016 (Chart 1). BIS central bankers’ speeches Looking closely at the developments in overseas economies by region, the U.S. economy has continued to recover solidly, assisted by household spending, although adjustments have been seen in the industrial production sector, mainly on the back of the decline in crude oil prices and the appreciation of the U.S. dollar. In the January-March quarter of 2015, the economy exhibited slightly negative growth due to transitory factors such as the effects of the severe winter weather and the strikes at West Coast ports (Chart 2). Nevertheless, the growth momentum of the economy has recently recovered from the temporary stall in winter against the backdrop of the continued favorable employment and income situation. From spring, private consumption clearly has rebounded, as seen mainly in improvements in retail and automobile sales. Going forward, there will be sectors that are affected by the decline in crude oil prices and the appreciation of the U.S. dollar, but the U.S. economy is likely to continue to see growth led mainly by private demand, with robust household spending assisted by the favorable employment and income situation. Regarding monetary policy, the next step toward normalization will come into sight; namely, raising the target range for the federal funds rate. This seems to suggest that the U.S. economy has recovered to a considerable level. However, it is necessary to monitor with due attention whether markets, especially those in emerging economies, will be affected unexpectedly through a reversal of the global flow of funds as the federal funds rate – which has been at the zero lower bound after the global financial crisis – will be raised. Next, I will move on to the European economy. The euro area economy has continued to see moderate recovery, as can be observed in positive growth in the real GDP for eight consecutive quarters (Chart 3). The European economy has recently been seeing a clear increase in private consumption given the improvement in labor market conditions, as well as reflecting the effects of the decline in crude oil prices and of a rise in stock prices. It also has been seeing a recovery trend in business sentiment and industrial production resulting from an improvement in exports and corporate profits due to the depreciation of the euro. As for prices, the year-on-year rate of change in the Harmonized Index of Consumer Prices (HICP) for all items, which had once been negative, has recently recovered to a slight positive, and concerns about deflation have been alleviating. Going forward, the European economy is expected to continue to see moderate recovery as depreciation of the euro and the monetary easing measures by the European Central Bank (ECB) are taking effect. Currently, the largest uncertainty over Europe is the sovereign debt problem in Greece. At the Euro Summit this month, leaders agreed in principle that they were ready to start negotiations on a European Stability Mechanism (ESM) program on the condition that various requirements would be met by Greek authorities. The scenario in which Greece will exit from the eurozone was avoided, and global financial markets have reacted positively. That said, Greece is still confronted with large problems; namely, reorganizing its economy and financial system, as well as fiscal consolidation. In particular, I believe that it is essential for the reconstruction of the Greek economy to restore its financial intermediary function through swift recapitalization and liquidity assistance to financial institutions. The Bank strongly expects that there will be steady progress toward resolution of the sovereign debt problem in Greece with support by the institutions and European countries. Now, turning to emerging economies, the growth momentum of the Chinese economy has been slowing against the backdrop of the deceleration in fixed asset investment – under excess production capacity – and of continued adjustments in the real estate market (Chart 4). In this situation, the Chinese authorities have been taking both fiscal and monetary measures toward underpinning the economy in a more proactive manner since spring. Going forward, due attention needs to be paid to the possibility that excess production capacity and adjustments in the real estate market will be prolonged, but the economy is likely to follow a generally stable growth path, although the pace of growth is expected to be somewhat reduced. That said, even if the Chinese economy maintained its growth rate, the main contribution would likely be public investment, so the degree of effects on Asian economies’ and Japan’s exports continues to warrant due attention. BIS central bankers’ speeches In sum, overseas economies as a whole temporarily slowed their pace of growth due to the slowdown in the U.S. and Chinese economies, but are expected to continue to recover moderately, mainly in advanced economies. There are various uncertainties concerning overseas economies, such as effects of normalization of monetary policy in the United States on the global financial markets, the sovereign debt problem in Greece, and developments of emerging economies including China, and close attention will continue to be paid to these issues. In light of the developments in overseas economies, Japan’s exports and production had been increasing but are slightly lacking momentum recently (Chart 5). The lack of momentum in exports is temporary due to the effects of the slowdown in overseas economies for the January-March quarter appearing with a time lag; as for production, it is due to inventory adjustments of compact cars (with engine sizes of 660cc or less) as well as of iron and steel, in addition to the slowing in exports. Looking ahead, as overseas economies are expected to maintain their moderate recovery, mainly in advanced economies, and as it seems that inventory adjustments will be completed sooner or later with an improvement in domestic demand, exports and production are expected to increase moderately, albeit with some fluctuations. Corporate sector: high profits and positive investment stance Turning to Japan’s economy, in the corporate sector, profits increased to a record high owing in part to the decline in crude oil prices and to effects of the correction of the appreciation of the yen (Chart 6). They are expected to continue on their solid increasing trend as sales grow accompanied by an increase in domestic and external demand. With corporate profits increasing to their highest level, firms’ positive investment stance is maintained. Real business fixed investment in the GDP statistics for the January-March quarter has increased markedly. According to the June Tankan (Short-Term Economic Survey of Enterprises in Japan), firms seem to have increased their fixed investment this fiscal year, as they did last fiscal year. The plans of large manufacturing firms in particular marked a high level at this time of the year, the highest since fiscal 2004, reflecting in part an increase in domestic investment as it appears that the situation of a weaker yen will be prolonged. The continued positive investment stance appears to suggest that firms consider the current weakness in exports and production as temporary. Business fixed investment is projected to keep rising moderately as the improvement in corporate profits and monetary easing effects continue to exert upward pressure, and as firms will continue increasing their domestic investment. Household sector: continued improvement in the employment and income situation and resilient private consumption Next, I will turn to the household sector. Positive developments in the corporate sector have led to a tightening in labor market conditions and to an improvement in the employment and income situation in accordance with that tightening. The unemployment rate was 3.3 percent, a low level last seen in 1997 (Chart 7). Judging from firms’ view on employment, the labor shortage is growing further. Tight labor market conditions have been creating upward pressure on wages. Nominal wages have increased moderately, albeit with fluctuations, due partly to the fact that many firms increased wages, including base pay, which was raised to a larger extent than last year in the annual labor-management wage negotiations this spring. Consequently, since the number of employees has been increasing and nominal wages per employee have risen, overall employee income has been increasing moderately (Chart 8). Private consumption for fiscal 2014 was relatively weak. This is due to the effects of the consumption tax hike having been larger than expected and of the bad weather during the summer, both creating a strong headwind to private consumption. However, this wind grew calm this fiscal year, and a tailwind has started to blow. Nominal wages have continued to increase, as they did last year, and the increase has been seen in small and medium-sized BIS central bankers’ speeches enterprises (SMEs) as well. Moreover, reflecting in part the past decline in crude oil prices, real wages are projected to increase in a sustainable manner. Consumer sentiment, which fell considerably towards last year-end, has evidently been picking up. In this situation, private consumption has become more resilient, and with steady improvement in the employment and income situation continuing going forward, supported in part by the wealth effects resulting from the rise in stock prices, private consumption is expected to maintain its resilience. Interim assessment of the outlook for economic activity and prices Regarding Japan’s economy, with a virtuous cycle from income to spending in both the corporate and household sectors expected to continue operating, domestic private demand is likely to be firm, and exports are expected to increase moderately, albeit with some fluctuations. The Bank released its interim assessment in July of the April 2015 Outlook for Economic Activity and Prices (the Outlook Report). In fiscal 2015, the growth rate is likely to deviate somewhat downward compared to the projection made in April, due to the recent weakness in exports and production, but the economy is projected to continue growing at a pace above its potential – estimated to be around 0.5 percent or lower – in both fiscal 2015 and 2016. In fiscal 2017, the economy is projected to maintain its positive growth, although with a slowing in the pace to around a level somewhat below the potential growth rate due mainly to the effects of the consumption tax hike planned in April 2017. According to the Bank’s interim assessment, the median of the Policy Board members’ forecasts of the real GDP growth rate was 1.7 percent for fiscal 2015, 1.5 percent for fiscal 2016, and 0.2 percent for fiscal 2017 (Chart 9). II. Japan’s price developments and monetary policy I will next talk about the price situation in Japan and the Bank’s monetary policy. Transmission mechanism of QQE First, let me review the transmission mechanism of QQE that the Bank is currently pursuing. Under QQE, the decline in real interest rates, adjusted by the inflation rate, is envisioned as a main transmission channel (Chart 10). Namely, (1) inflation expectations will be raised through a strong and clear commitment to achieving the price stability target of 2 percent and through large-scale monetary easing to underpin the commitment, (2) downward pressure will be put on nominal interest rates across the entire yield curve through massive purchases of Japanese government bonds (JGBs), and thereby (3) real interest rates will decline, and this will be the starting point of QQE’s effects. The decline in real interest rates will stimulate private demand, which will lead to an upturn in the economy, improving the output gap. The improvement in the output gap will increase inflation rates. As people experience actual inflation, their inflation expectations will rise further. Effects of QQE QQE has been producing its intended effects through the policy transmission mechanism I have just described. Nominal long-term interest rates have declined with the Bank’s massive purchases of JGBs. Yields on 10-year JGBs have declined by about 0.3 percentage point. While there are wide-ranging indicators for medium- to long-term inflation expectations such as various surveys and figures implied by inflation-indexed bonds that are traded in markets, inflation expectations seem to have increased by about 0.5 percentage point compared to the period before QQE. The degree of decline in real interest rates seems to have been slightly less than 1 percentage point, as calculated by adding the degree of the decline in nominal long-term yields and that of the increase in inflation expectations. The changes in financial markets, economic activity, and prices after the introduction of QQE are broadly consistent with the roughly 1 percentage point decline in real interest rates. BIS central bankers’ speeches Financial markets responded to the introduction of QQE relatively swiftly. Stock prices have increased substantially and the excessive appreciation of the yen before the introduction has been corrected. The pace of increase in lending has been moderately accelerating and recently reached around 2.5 percent on a year-on-year basis. In addition to the decline in real interest rates, such developments have made financial conditions even more accommodative. With such accommodative financial conditions, a virtuous cycle from income to spending has been operating in both the corporate and household sectors, and Japan’s economy has seen a significant turnaround. I am aware that some firms have had difficulties in passing increased costs, including wages, on to sales prices smoothly; thus, some may not share the sentiment that the economic condition has improved. However, the positive feedback between higher profits/wages and higher inflation – where higher corporate profits feed through into higher wages, leading to higher sales prices, which in turn results in even higher profits/wages – is now in place. This is the opposite of the negative feedback that was observed in the deflationary period. To this end, the temperature of the economy is gradually rising. Outlook for prices and the bank’s monetary policy going forward Reflecting this turnaround in the economy, the underlying trend in inflation has also steadily improved. The year-on-year rate of change in the CPI (all items less fresh food), which was about minus 0.5 percent before the introduction of QQE, improved to 1.5 percent last April excluding the direct effects of the consumption tax hike (Chart 11). Thereafter, the rate of increase in the CPI has slowed, recently to about 0 percent, against the background of the substantial decline in crude oil prices since summer 2014 and somewhat weak demand following the consumption tax hike. Looking forward, due to the effects of the decline in energy prices, the year-on-year rate of increase in the CPI is likely to be about 0 percent during this summer. But thereafter it is projected to increase at an accelerated pace and reach around 2 percent – the price stability target – around the first half of fiscal 2016. Some may wonder how the rate of increase in the CPI can really reach 2 percent around the first half of fiscal 2016, given that the current level is about 0 percent. In response to this question, it may help you understand if we decompose the changes in consumer prices into two parts: the contribution of energy prices and the underlying trend in inflation. First, I will describe the contribution of energy prices. Crude oil prices were over 100 dollars per barrel up until mid-2014 but then declined substantially, temporarily falling to about 40 dollars per barrel, which accounts for the decline in prices of more than 60 percent. The decline in crude oil prices will lead to pushing down various energy prices, including gasoline and electricity charges, with some time lag. The negative contribution to the CPI will be largest this summer, pushing down the year-on-year rate of increase in the CPI by about 1 percentage point. In other words, if crude oil prices had not declined, the year-on-year rate of increase in the CPI this summer would be higher by about 1 percentage point than what is observed. Furthermore, unless crude oil prices continue to decline, the negative contribution to the year-on-year rate of increase in the CPI will eventually dissipate. Although it is difficult to precisely forecast future crude oil prices, if we assume that they will rise very moderately from the current level – and there are many who predict such a rise, as prices in the futures markets suggest – the negative contribution is expected to dissipate gradually from the second half of fiscal 2015 and be around 0 percentage point in the first half of fiscal 2016. In other words, as the negative contribution of energy prices dissipates, this alone will push up the year-on-year rate of increase in the CPI for the first half of next fiscal year by about 1 percentage point, compared with that for this summer. In addition to these changes, the underlying trend in inflation is expected to improve further. The underlying trend in inflation is determined by the output gap of the economy as a whole and by inflation expectations. First, when it comes to the output gap, this was about minus 2 percent just before the introduction of QQE, but with the tightening in labor market BIS central bankers’ speeches conditions and heightening utilization of production capacity, it has improved to around 0 percent, which is the past long-term average. Going forward, as the economy continues to grow at a pace above its potential, the output gap is expected to improve further into positive territory. Next, as I described earlier, inflation expectations appear to be rising on the whole. In particular, the recent changes in firms’ wage- and price-setting behavior are drawing specific attention. As for wage setting, many firms have increased their base pay for two consecutive years. Moreover, their price-setting has also been shifting from a low-price strategy to raising sales prices while increasing value-added. Under deflation, firms could not raise sales prices against weak demand, and thus focused on lowering costs as much as possible – including personnel expenses – in order to secure profits. However, as economic activity continues to improve, an increasing number of firms seem to be able to pass increased costs, including the rise in input prices and personnel expenses, on to sales prices. In particular, since the turn of the fiscal year in April, upward price revisions have been more widespread, which is something that has not been observed in recent years. At the meeting of general managers of the Bank’s branches held recently, many reported in this context. These changes also can be observed in hard data (Chart 12). The index calculated as the number of items for which prices rose minus that of items for which prices declined – among 524 items that CPI (all items less fresh food) consists of – has recently risen further, and the most recent index for May 2015 is the highest since 2003. Furthermore, the University of Tokyo Daily Price Index and SRI-Hitotsubashi Consumer Purchase Indices, which promptly report prices of daily use items and food, turned clearly positive on a year-on-year basis in April this year, and have continued to rise to the present. Compared with last year, when prices of many items rose in April with the consumption tax hike, quickly followed by the decline in prices due to weak sales, price movements this year present a clear contrast. As I have explained, QQE has been exerting its intended effects and a mechanism has been operating in which the year-on-year rate of increase in prices rises moderately, accompanied by an improvement in corporate profits and increases in employment and wages. The yearon-year rate of increase in the CPI is likely to be about 0 percent for the time being, but as the underlying trend in inflation steadily rises and as the effects of the decline in crude oil prices dissipate, it is projected to accelerate toward 2 percent – the price stability target. The timing of reaching around 2 percent, as I described earlier, is projected to be around the first half of fiscal 2016, assuming that crude oil prices will rise moderately from the recent level (Chart 9). The Bank will continue with QQE, aiming to achieve the price stability of 2 percent, as long as it is necessary for maintaining that target in a stable manner. The Bank will continue to examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate. Strengthening growth potential of Japan’s economy So far, I have described the developments in economic activity and prices, as well as the Bank’s monetary policy. Let me now touch on the challenges Japan’s economy faces; namely, strengthening its growth potential. Japan’s potential growth rate has been on a declining trend since the 1990s (Chart 13). Raising the growth potential is an important challenge for Japan’s economy, and the government is currently undertaking various structural reforms. Under the initiatives by the government, it is very encouraging that various regulatory and institutional reforms have steadily been implemented. That said, I would like to note two points. First, the current situation where the economic condition has been improving presents a good opportunity to push ahead with structural reforms. As the economy improves, the need for structural reforms and challenges to overcome is now clearer. For instance, many can easily understand that, in order to strengthen Japan’s economic growth, it is important to BIS central bankers’ speeches shore up the labor participation of women and the elderly in view of the declining birthrate and aging population. However, this has not been recognized as a critical challenge under a high unemployment rate. As the economy improved and the labor market became tight, firms and people have started to recognize the supply constraint of the labor force, and measures have been taken to enhance the labor participation of women and the elderly. Also, in the context of regulatory reforms, with firms and households becoming more proactive in economic activity, it will become clear which regulatory and institutional aspects have hampered economic activity. Actual needs will become a powerful driving force in promoting regulatory reforms. Second, I will describe the impact of structural reforms on the economy. Structural reforms, in principle, are needed to raise the long-term growth of the economy and its sustainability. In some countries, and in Europe in particular, it is often discussed whether, in the short run, structural reforms entail pain and thus impede economic activity. However, there are various types of structural reforms that raise growth expectations and thereby enhance consumption and investment in the short run, resulting in stimulated demand. For example, regulatory reforms, which broaden the frontier of corporate activities and free up firms to conduct activities in which they have wanted to engage or ignite their animal spirits, will produce expectations that the productivity and profits of firms will be raised in the future. Such a rise in growth expectations would stimulate investment even in the short run. If people are more confident in the sustainability of social welfare, households will be able to spend money without worry. In order to achieve sustainable growth for Japan’s economy, it is necessary to overcome deflation as well as to raise the potential growth through strenuous efforts both of the public and private sectors. The Bank will contribute to strengthening the growth potential of Japan’s economy by dispelling the deflationary mindset that persisted among people. Such change will encourage firms and households to be more proactive with their economic activities. With this in mind, the Bank will steadily pursue QQE and achieve the price stability target of 2 percent at the earliest possible time. Conclusion In concluding, let me touch on the economy of Kumamoto Prefecture. The economy has generally continued to see moderate recovery. A virtuous cycle from income to spending has been operating in both the corporate and household sectors, as in Japan’s economy as a whole. In the corporate sector, manufacturers in particular, including of electronic parts and devices and production machinery – both of which are the driving force of the region – have kept production at a high level while incorporating domestic and external demand, and in this situation, business fixed investment has been on an increasing trend. Even in the Kumamoto Branch’s June Tankan, business fixed investment plans for fiscal 2015 registered a double-digit increase, particularly in manufacturers. In the household sector, the pick-up in private consumption after the consumption tax hike is still sluggish compared to that in metropolitan areas. Nevertheless, labor market conditions have tightened, as observed in the active job openings-to-applicants ratio for May marking 1.11 times – the highest level since these statistics started to be kept. Against the background of the tight labor market conditions, there has been a spread of initiatives among firms in the prefecture to increase wages, including raising base pay, with the aim of mooring human resources. In line with the improvement in the employment and income situation, the recovery trend in private consumption is expected to gradually become evident. About 40 years ago, when I worked at the Bank’s Fukuoka Branch, I remember that Kumamoto Prefecture had a plan of technopolis construction, putting efforts into accumulating advanced technology. The prefecture continued to vigorously invite firms thereafter, and through the accumulation of firms related to electronic parts and devices, as well as machinery, those firms currently contribute largely to the industry in the region. BIS central bankers’ speeches Kumamoto Prefecture is endowed with tourist attractions such as Kumamoto Castle, Mount Aso, and Amakusa. The Manda Coal Mine and Misumi West Port have been approved for inscriptions on UNESCO’s World Heritage List as “Sites of Japan’s Meiji Industrial Revolution.” An increase in international charter flights and the establishment of regular flights to and from Kumamoto Airport, as well as an increase in the number of cruise ships visiting Yatsushiro Port, are being planned. Other than reinforcing the tourism industry, Kumamoto Prefecture is intensifying its efforts to vitalize the region with cooperation among industry, the government, academia, and local financial institutions. An issue worth considering in strengthening regional growth is to fully and effectively utilize the tangible and intangible resources each region possesses. Kumamoto Prefecture enjoys various advantages including (1) industrial clusters such as of electronic parts and devices, as well as machinery, (2) tourist attractions composed of abundant nature and landscapes, as well as of history and culture, (3) a competitive agricultural, forestry, and fishing industry, and (4) geographical proximity to other Asian economies that are growing considerably. The fact that Kumamoto Prefecture is making various efforts utilizing these advantages is quite propitious. The Bank hopes, centering on its Kumamoto Branch, to contribute as much as possible to the initiatives in the prefecture to vitalize the region. In closing, I wish all the best for the further development of the economy of Kumamoto Prefecture. 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 Haruhiko Kuroda, Governor of the Bank of Japan, at the Japan Society, New York City, 26 August 2015.
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Haruhiko Kuroda: Moving forward – Japan’s economy under Quantitative and Qualitative Monetary Easing Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Japan Society, New York City, 26 August 2015. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website. Introduction It is a great honor to be invited to speak at the Japan Society today. More than two years have passed since the Bank of Japan introduced Quantitative and Qualitative Monetary Easing (QQE) to achieve the price stability target of 2 percent. Let me briefly look back at these two years. In the first year, Japan’s economy improved impressively, registering both rising growth and inflation. Real GDP growth in fiscal 2013 exceeded 2 percent and annual CPI inflation (consumer price index, all items less fresh food) increased from minus 0.5 percent just before the introduction of QQE to 1.5 percent in April 2014 (Chart 1). In contrast, in fiscal 2014, the second year after the introduction of QQE, Japan’s economic performance was a little disappointing. One reason is that the negative impact of the consumption tax hike in April 2014 was larger than expected. The tax hike brought about swings in demand and a decrease in real income, both of which resulted in sluggish private consumption, in particular of durable goods such as automobiles. On the inflation front, crude oil prices declined substantially from the beginning of autumn. Although the oil price decline should have a favorable impact on economic activity in the longer term, in the short term it has a downward impact on inflation through the decline in energy prices such as gasoline and electricity prices. As a result, annual CPI inflation rapidly declined toward the end of last year and has been about 0 percent this year so far. Against this background, it is not surprising that some wonder whether the Bank’s price stability target of 2 percent can really be achieved. Has the trend toward overcoming deflation come to an end? This is far from the case. What I would most like to stress here is that the two factors – the consumption tax hike and the substantial decline in oil prices – only temporally have a downward impact on inflation. The growth and inflation figures were strongly affected by these factors and were indeed disappointing, but if we take a closer look at the underlying trends, we find that significant changes that were not observed during the deflationary period are taking place. Let me highlight two of these changes. The first is that Japanese firms are seeing record profits and their investment stance has become increasingly positive. The other change is that wages have clearly risen for the first time in two decades, reflecting that the tight labor market has brought about “full employment” – that is, a situation in which, from a statistical perspective, there is no unemployment other than that due to the frictional mismatch between job openings and job applicants. What I would like to focus on today are the remarkable changes that have been taking place in Japan’s economy during the past two years under QQE. I would also like to review the transmission mechanism of QQE and how QQE has brought about those changes. I believe that at the end of my speech you will share our outlook for Japan’s economy. BIS central bankers’ speeches I. Changes in Japan’s economy Record profits and firms’ positive investment stance I would like to start by touching on the improvement in the corporate sector. As I mentioned, Japanese firms have been making record profits. In fact, their profits have considerably exceeded those around 1990 at the peak of the bubble economy (Chart 2). Let me briefly review what has happened in Japan’s economy over the past several years. Japan’s economy was hit much harder than the U.S. economy by the global financial crisis triggered by the failure of Lehman Brothers in 2008, even though the United States had been the epicenter of the crisis caused by subprime mortgages. In fiscal 2008, industrial production in Japan fell by more than 10 percent and real GDP contracted by about 4 percent. There were a number of reasons why Japan’s economy was hit particularly hard. One notable factor is that, since Japanese products and technologies play an essential part in global supply chains, the decline in global final demand affected Japanese firms especially severely. Subsequently, in 2011, Japan was hit by the Great East Japan Earthquake, which caused widespread damage to people and facilities. The situation was further exacerbated by the sharp appreciation of the yen. In sum, Japan’s economy was confronted with a series of adverse shock during these years. In the face of this adversity, firms made progress in improving their efficiency and profitability through a wide range of efforts such as reorganizing production and shifting operations overseas. Having survived the hardship of the recent past, Japanese firms improved their profitability considerably. Under Abenomics, the excessive appreciation of the yen has been corrected. This correction has not only improved Japanese firms’ export profitability, but also raised the yen value of the profits generated through foreign subsidiaries and other overseas-related business. The latter effect is larger than in the past because of the expansion of firms’ overseas operations in recent years. In addition, the decline in oil prices since last autumn has been pushing up profits in a wide range of sectors in Japan’s economy, which is almost completely dependent on imports for crude oil supply. Meanwhile, despite of the correction of the yen’s excessive appreciation, the recovery in exports – compared to past recovery phases – remained sluggish due to the expansion of Japanese firms’ overseas production. However, since the July-September 2014 quarter, exports have clearly been picking up, rising for three quarters in a row before registering a small decline in the latest quarter. Looking ahead, corporate profits are expected to remain high. According to the Bank of Japan’s June Tankan (Short-Term Economic Survey of Enterprises in Japan), firms have revised their fiscal 2014 profits upward and the outlook for fiscal 2015 remains strong. Given this favorable profit situation, firms are more confident about their business outlook and the recovery in business fixed investment is becoming more pronounced. A particularly significant change is that, after prioritizing overseas investment in the past few years, firms are turning to domestic investment in response to the correction of the yen’s excessive appreciation. There has been some concern over the weakness in exports and production in recent months, but we see this as temporary, mainly reflecting the sluggishness of the U.S. economy in the January-March quarter and the recent slowdown in Asian economies. Indeed, in the recent Tankan, business sentiment has remained favorable, and firms expect corporate profits to remain high and plan to increase business fixed investment further in fiscal 2015. Moreover, leading indicators such as machinery orders and construction starts also point at an increase in business fixed investment. At the same time, due attention needs to be paid to risks such as the situation in emerging and commodity-exporting economies and recent developments in global financial markets. BIS central bankers’ speeches Full employment and the positive feedback between wage increases and inflation Another significant change is that, with the economy virtually at full employment, wages have increased for the first time in two decades. There now is a positive feedback mechanism operating between wage increases and moderate inflation. I would like to elaborate on this point since it is the key to overcoming deflation. Japan’s economy was mired in deflation – a persistent decline in prices – for more than 15 years, starting in the mid-1990s. A key feature of deflation is that it tends to become entrenched in a self-fulfilling manner once the economy falls into it. Under deflation, people engage in economic activities based on the expectation that prices will continue to decline in the future or that, at least, prices will not increase. The decline in prices of goods and services in turn results in a decline in firms’ sales and profits, leading to stagnant wages. Households become cautious in their consumption, since they do not expect their wages to increase. As a result, the economy falls into a vicious cycle of sluggish demand and a decline in prices of goods and services. John Maynard Keynes argued that during a recession downward rigidity in nominal wages would cause unemployment to increase. However, in Japan, downward rigidity in nominal wages, which was widely considered rock-solid, started to disappear in the mid-1990s and the economy fell into an equilibrium with declining wages and prices (Chart 3). Under deflation, there were various changes in economic and social practices that had been built on the assumption that prices would rise. For instance, in Japan, workers and management engage in wage negotiations every year called shunto or the spring offensive, which take place collectively across industries in early spring. Until the mid-1990s, base pay increases, that is, across-the-board wage increases reflecting inflation, were common as part of the shunto. In the late 1990s, such base pay increases disappeared. Another longstanding tradition in Japan was that prices of a wide range of goods and services were raised at the beginning of each fiscal year in April. This practice also disappeared. In order to escape from this deflationary equilibrium, it was necessary to dispel the deflationary mindset – that is, the entrenched view that prices will not rise – and achieve a state in which firms and households act based on the assumption that prices will continue to rise moderately in the future. In the economics jargon, inflation expectations needed to be raised. In plain English, this means that we have to change firms’ and households’ views on prices, which form the basis for their economic activities. In this context, there have been very encouraging changes since the introduction of QQE. The practices that disappeared in the deflationary period have come back. First, in the shunto last year, base pay was increased for the first time in two decades. And in the shunto this year, base pay was raised for the second year in a row and at many firms the increases were larger than last year. In addition, base pay increases have become widespread across industries and firms of different size. The practice of hiking prices at the beginning of the fiscal year also seems to have returned this year. Let me provide you with some evidence. First, looking at the items that make up the CPI (all items less fresh food), the share of items whose prices rose minus the share of items whose prices fell has risen markedly since the beginning of this fiscal year and has reached the highest level since the early 2000s (Chart 4). Second, daily and weekly indices of the prices of food and daily necessities – namely, the University of Tokyo Daily Price Index and the SRI-Hitotsubashi Consumer Purchase Price Index – since April this year also point at clear price increases on a year-on-year basis. Moreover, the rate of increase shown by these indicators has continued to go up. Many firms attempted to raise their prices at the beginning of the last fiscal year as well, but this coincided with the consumption tax hike, which was followed by a decline in demand. Firms were therefore forced to quickly take price rises back. The price changes this year present a clear contrast with those last year. For example, in April this year, the price of ketchup was raised for the first time in 25 years – I should note that this price hike was not due to purchases by the Bank of Japan. BIS central bankers’ speeches The simultaneous comeback of these practices – base pay increases in the shunto and price hikes at the start of the fiscal year – is by no means a coincidence. Workers have demanded increases in base pay, since they expect the rising trend in prices to continue and want to avoid a decline in real wages. On the other hand, firms’ management has agreed to such demands, since they expect that the wage increases can be absorbed by raising sales prices. The government’s initiative at the joint meeting of representatives from the government, labor unions, and firms’ management may have facilitated these developments, but it is clear that a positive feedback loop between wage increases and moderate inflation is now firmly in place. Finally, I would like to mention the tight labor market conditions behind these wage increases. Japan’s unemployment rate, which was above 4 percent before the introduction of QQE, has declined to a range of 3.0–3.5 percent (Chart 5). The decline in the unemployment rate has been accompanied by increases in both the labor force participation rate and the number of employees. Based on the relationship between job openings and job applicants in the past, the current unemployment rate of 3.0–3.5 percent can be regarded as corresponding to “full employment,” that is, the remaining unemployment is solely due to the mismatch between job openings and job applicants and there is no excess labor. In the United States, against the background of higher-than-normal long-term unemployment, there has been intense debate on the degree of slack in the labor market. In contrast, in Japan, all relevant indicators strongly suggest that labor market conditions are very tight. For example, the broadly-defined unemployment rate, which counts so-called marginally attached workers as unemployed and corresponds to U-6 in the United States, has declined to about 6 percent, which is low compared to past levels. II. Transmission mechanism of QQE As I just explained, remarkable changes have been taking place in Japan’s economy in the last two years. Of course, these changes cannot entirely be attributed to the effects of QQE implemented by the Bank of Japan. However, it can be judged that QQE has been producing its intended effects through the transmission mechanism envisioned at the time of its introduction. Let me review the transmission mechanism of QQE. Japan’s monetary policy has been constrained for a long time by the zero lower bound on short-term nominal interest rates. In this situation, QQE aims to achieve further easing effects by reducing long-term real interest rates. Specifically, the mechanism is as follows. The Bank raises inflation expectations through a strong and clear commitment to achieving the price stability target of 2 percent and large-scale monetary easing to underpin the commitment (Chart 6). At the same time, the Bank exerts downward pressure on nominal interest rates across the entire yield curve through massive purchases of Japanese government bonds (JGBs). As a result, long-term real interest rates decline. With private demand being stimulated, the output gap improves, and actual inflation rates rise accordingly. Once people actually experience increases in inflation, their inflation expectations rise, further reinforcing this process. The changes we have witnessed since the introduction of QQE are broadly consistent with this transmission mechanism. Nominal long-term interest rates have declined, with yields of 10-year JGBs down by about 0.3 percentage point. Medium- to long-term inflation expectations seem to have increased by about 0.5 percentage point. The combined effects of these two factors – the decline in nominal long-term yields and the increase in inflation expectations – have brought about a decline in real interest rates by slightly less than 1 percentage point. Studies for the United States and Europe suggest that the effects of a downward shift of the entire yield curve – i.e., including long-term interest rates – on economic activity and prices are several times larger than those of a decline in short-term rates under conventional monetary policy. Along similar lines, empirical research by our staff suggests that the effects of QQE are roughly equivalent to those arising from lowering the short-term policy rate by 2 percentage points. Given how powerful monetary easing under BIS central bankers’ speeches QQE has been, it is no wonder that Japan’s economy has been experiencing the drastic changes I mentioned. The former Fed Chairman, Ben Bernanke, is quoted to have said, “The problem with QE is it works in practice but it doesn’t work in theory.” The effectiveness of QE likely differs across economies, depending on economic conditions and financial structures, and academics have not reached a consensus on how effective QE is. However, in the case of Japan, we believe that it is possible to explain how QQE works in theory, and QQE has been working as envisaged. Based on this belief, the Bank will continue to steadily pursue QQE to achieve the price stability target of 2 percent at the earliest possible time. It will examine both upside and downside risks to economic activity and prices, and make adjustments without hesitation if necessary. Conclusion With the prospect of overcoming deflation in sight, efforts to raise the growth potential of Japan’s economy should gather steam. The government is currently implementing various regulatory and institutional reforms as part of its growth strategy. I am aware that many have found previous proposals to raise Japan’s growth potential disappointing. In hindsight, it is clear that there has been a lack of sufficient incentive and impetus to make change happen. Firms had few incentives to grow and simply removing obstacles to growth had little effect. Partly because of this, the political will to remove such obstacles was also weak. But this time is different. Since Japanese firms now believe that deflation is over, there will be strong incentive for change. Under deflation, sticking to the status quo was a reasonable business strategy. This is no longer the case and, aware of the drastic changes that have occurred in the domestic business environment, a growing number of Japanese firms are now taking action. This should be a major driving force for removing regulatory and institutional obstacles. For instance, low labor participation by women has long been an issue for Japan’s economy; however, faced with a tight labor market, firms have recently made efforts to promote labor participation by women. At the same time, the government has also tried to do so by incorporating institutional reforms in the growth strategy. As a result, labor participation by women has finally increased. The key to raising the growth potential is “action” and there is no better time than now to move forward. The Bank of Japan will contribute to raising the growth potential of Japan’s economy by achieving the price stability target of 2 percent at the earliest possible time through QQE and dispelling the deflationary mindset that has taken hold of Japan. 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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Article by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, contributed to the Joint IMF-Bank Indonesia Conference "Future of Asia's Finance: Financing for Development 2015", 2 September 2015.
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Hiroshi Nakaso: Development finance in the economy facing double trilemmas Article by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, contributed to the Joint IMF-Bank Indonesia Conference “Future of Asia’s Finance: Financing for Development 2015”, 2 September 2015. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website. Introduction It is a great honor for me to contribute to the Joint IMF-Bank Indonesia Conference. Under the title “Future of Asia’s Finance: Financing for Development 2015”, I will first look back at Japan’s post-war experience of financing for the development of specific industries, and will then explain lending behavior of Japanese banks including their involvement in project finance for emerging Asian countries in the last two decades. Based on these two examples regarding Japan’s financial intermediation function, I will finally share my views on policies for the stability of development finance in emerging economies facing double trilemmas, i.e., Mundell’s and Schoenmaker’s trilemmas. Evaluation of the priority production system in Japan after World War II: Importance of price stability A period of strong economic expansion known as the “Asian Miracle” ensued in the aftermath of World War II, characterized by a “flying geese” pattern of development. This began in the 1960s with high growth in Japan, followed by economic take-off in other Asian countries. To begin with, I would like to look at the situation during the period of post-war reconstruction in Japan. The situation immediately after the end of World War II in Japan was characterized by a combination of severe problems such as ruined infrastructure, a sluggish recovery in goods production, and high inflation. For example, as shown in Figure 1, the level of industrial production dropped significantly to about 30% of the peak level before the war (1934–36). The stagnation of production at that time was caused not so much by a lack of production facilities as by a shortage of raw materials such as coal and steel. The coal production level in domestic mines dropped below 40% of the peak level before the war (1934–36) due to the lack of digging materials made of steel. In turn, the steel production industry remained stagnant due to the coal shortage. In order to overcome this situation, the Japanese government at that time applied the “priority production system”, in which resources such as materials, funds and labor were mobilized intensively and with priority being given to key industries such as coal and steel in order to reconstruct Japan’s post-war economy. This policy was applied from 1947 to 1949. The priority production system is considered to have had a stimulating effect on Japan’s economy. However, most funding for the priority production system was central bank money provided through the “price-support subsidy system” and the Reconstruction Finance Bank. In the price-support subsidy system, the government provided subsidies to suppliers of important materials such as steel for the differentials between sales prices and production costs in order to enhance production, and these subsidies were financed through borrowing from the Bank of Japan. The Reconstruction Finance Bank was a government-sponsored bank established in 1947 to lend to the aforementioned key industries such as coal, and most of its funding also depended on financing by the central bank. Both the price-support subsidy system and the Reconstruction Finance Bank supported the priority production system and contributed to the reconstruction of Japan’s economy, but BIS central bankers’ speeches their dependence on central bank money became a factor causing high inflation (Figure 1). Inflation heightened the opportunity cost of holding deposits, with deposit avoidance behavior being observed among a large proportion of households. The decrease in deposits then caused a decline in private financial institutions’ lending to firms in comparison with GDE (Figure 2). In sum, the inflation tolerant aspect of the priority production system weakened the financial intermediation function and impeded fund flows from household savings to corporate investments, thereby having a negative impact on the economy. The net effect of the priority production system on economic reconstruction was lessened due to high inflation. Japan’s experience of post-war reconstruction suggests that price stability is a necessary condition for a stable financial intermediation function, and that policy-makers should pay attention to price stability in order to fully realize the effect of mobilizing resources for financing development. Role shared by public finance and private finance in the context of infrastructure investment After overcoming the period of post-war confusion, Japan entered a period of rapid growth (during the 1960s). In its initial stage, funding by the World Bank supported Japan’s engagement in big infrastructure projects such as construction of the Shinkansen, the bullet train line, the Tomei (Tokyo and Nagoya) Motor Expressway, and several power plants. This kind of social capital then improved the productivity of the Japanese economy, leading to a virtuous economic cycle. Development finance during the period of rapid growth was also served by the so-called “guidance policy finance” of the Fiscal Investment and Loan Program (FILP). Postal savings funds deposited with the Ministry of Finance’s Trust Fund Bureau were on-lent to the FILP, and the Development Bank of Japan, which acquired the assets of the Reconstruction Finance Bank in 1952, allocated funds for industrial development to meet national and regional development goals, as one of the major recipients of FILP funding. Since the 1970s, social infrastructure investments have been financed through the issuance of Japanese government bonds. Many empirical analyses suggest that the productivity effect of social capital is significant and contributes to a rise in potential growth of the Japanese economy. While the government-led system worked well in Japan in the latter half of the 20th century, an important issue to be tackled emerged as outstanding government debt continued to rise significantly and fiscal conditions became severe: how to introduce private funds and the necessary know-how to social infrastructure development. In order to tackle this problem, the PFI (private finance initiatives) Law was promulgated in 1999, and an action plan for the drastic reform initiatives of PFI/PPP (public private partnerships) was launched in 2013. By making use of PFI/PPP, safer, convenient, and resilient social infrastructure will be developed efficiently. Loans to emerging countries by Japanese banks Asian countries face issues similar to Japan’s, i.e., how to increase PPP from the economic efficiency perspective in addition to effective utilization of financing from foreign countries. As there is huge demand for infrastructure funding in Asian countries, Japanese banks have recently been actively increasing their project financing and syndicated loans, which have contributed to promoting infrastructure projects in these countries. However, we should also be mindful of the historical record of fluctuation in the amount of lending to Asian countries by Japanese banks. When the Asian financial crisis broke out in the late 1990s, Japanese banks drastically reduced their lending to Asian countries (Figure 3). The background factors include a decline in both their lending capacity and demand for funding in the Asian region. BIS central bankers’ speeches Limits on the funding capacity of Japanese banks and the deterioration of their equity capital was the most significant factor at that time, considering that the scale of the reduction in loans by Japanese banks was much bigger than that among U.S. and European banks. For Japanese banks, the burden of disposing of domestic non-performing loans that had mounted up after the bursting of the asset bubbles resulted in erosion of their equity capital. The Japanese financial crisis in the late 1990s led to a decline in their creditworthiness and hence the loss of their funding capacity in foreign currencies. Since the mid-2000s, Japanese banks have returned their balance sheets to soundness and started to increase their loans to Asian countries (Figure 3). In contrast to U.S. and European banks, among which lending to Asian countries was disrupted after the Lehman crisis due to their deteriorating balance sheets, Japanese banks have been constantly engaged in project finance and have increased their share of syndicated loans. Financing for development and stability of the global financial system As I have discussed so far, the financial system of emerging countries has been affected by the lending behavior of advanced countries’ banks, and this trend will continue. Therefore, as a prerequisite to the stability of development finance in emerging countries, stability must be maintained in the financial intermediation function of advanced countries’ banks and domestic banks. As the financial globalization process evolves, it is important for us to pay attention to two kinds of trilemmas in order to stabilize the financial system and facilitate development finance in emerging countries (Figure 4). As Japan’s post-war experience, which I explained in the first part of this article, suggests, price stability is important for fully realizing the effects of financing for development. However, in emerging countries, monetary tightening against the backdrop of inflationary pressure due to overheating of the economy often induces carry trades and accompanies a rapid increase in capital inflows from advanced countries. This boosts the economy further and/or leads to a surge in asset prices and financial imbalances. In such conditions, it is difficult for policy-makers facing Mundell’s Trilemma to achieve price stability by choosing the combination of national monetary policy and capital mobility. Therefore, it is important to use macroprudential policy tools in order to mitigate the effect of capital flows on the real economy and the financial system, and this then contributes to the stability of development finance. When conducting macroprudential policy, global (or regional) financial coordination is important beyond the national-level financial policy framework. In a country faced with Schoenmaker’s Trilemma, it is impossible to simultaneously achieve national financial policy, capital mobility and financial stability including the stability of development finance 1 Therefore, a global (or regional) macroprudential perspective is indispensable for maintaining financial stability while allowing for capital mobility. The Chiang Mai Initiative – a multilateral currency swap arrangement among Asian countries – and cross-border usage of collateral assets, which are eligible instruments for central banks, are notable examples of regional financial coordination to complement macroprudential policy of each country. In addition to global financial coordination, when considering macroprudential policy, global financial regulation is also a key factor. If the financial intermediation function of internationally active banks subject to macroprudential regulation is stable, then financing for development is also expected to be stable in emerging countries. During the Asian financial crisis, U.S. and European banks filled lending gaps that Japanese banks had left as a result of their withdrawal from the cross-border lending arena, whereas during the recent global financial crisis, these roles were reversed. This kind of substitution Dirk Schoenmaker (2011), “The Financial Trilemma,” Economic Letters, 111, 57–59. BIS central bankers’ speeches by internationally active banks may have somewhat mitigated the shortfall in financing for development in emerging countries. However, it’s not beyond the realms of possibility that all internationally active banks might cut lending simultaneously in the next crisis. It is desirable that as many internationally active banks as possible constantly maintain their lending without severe disruptions. To this end, global regulations are expected to play a crucial role from a longer-term perspective. Finally, in relation to global regulation, let me share my views on an ongoing issue. Last December, the BCBS (the Basel Committee on Banking Supervision) published a consultation document entitled “Revisions to the standardised approach for credit risk”. In this document, it is proposed that the risk weight for corporate exposures, project finance, and equities be heightened. Not a few market participants have sent comment letters to the BCBS, pointing out that a significant increase in risk weight leads to a decrease in banks’ capital ratios, and the potential impact on financing for development can be huge. While I understand that the revisions proposed by the BCBS were made to reflect the experience of the last global financial crisis, a thorough cost-benefit analysis including an examination of the impact on financing for development is necessary. Conclusion As the Japanese case shows, the productivity effect of social capital is significant, and stable development finance supported by price stability contributes to an improvement in potential economic growth. In order for emerging countries to stabilize development finance, not only price stability but also effective utilization of financing from advanced countries’ banks is indispensable. Facing the double trilemmas, an adequate combination of monetary policy and macroprudential policy is needed to achieve price stability and stabilize capital flows including those banks’ loans, which will contribute to higher potential growth among emerging economies. BIS central bankers’ speeches 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, Aomori, 3 September 2015.
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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, Aomori, 3 September 2015. * * * I. Economic activity and prices A. Recent developments at home and abroad I would like to start my speech with a look at developments in economic activity and prices. Japan’s economy has continued to recover moderately. The first preliminary estimate of the real GDP growth rate registered negative growth for the first time in three quarters, at minus 1.6 percent on an annualized quarter-on-quarter basis for the April-June quarter of 2015. Industrial production also dropped in that quarter on a quarter-on-quarter basis for the first time in three quarters, mainly due to the effects of the slowdown in overseas economies toward around spring 2015, as well as to inventory adjustments of small cars with engine sizes of 660cc or less. However, it has been picking up, albeit with some fluctuations. With regard to the outlook, industrial production is expected to increase moderately – albeit with some fluctuations – reflecting the developments in demand both at home and abroad on which I will elaborate shortly. In this situation, the economy is expected to continue recovering moderately. Looking at domestic demand, private consumption has been resilient, with the employment and income situation improving steadily. The number of new passenger-car registrations excluding small cars with engine sizes of 660cc or less has moved upward in the April-June quarter of 2015, but declined in the July-August period relative to that quarter. Sales of household electrical appliances in real terms have trended moderately upward, supported by increased sales of smartphone products and a rise in sales to foreign visitors to Japan. However, sales of household electrical appliances have shown somewhat weak movements, due in part to lackluster sales of air conditioners as a result of irregular weather in the early summer. Sales at department stores have remained firm, due in part to the wealth effects as a result of the rise in stock prices and to improvement in consumer sentiment, but fell in the April-June quarter, affected mainly by irregular weather. Meanwhile, as for service-related consumption, outlays for travel have been firm on the domestic side, although those in overseas travel have fallen, and sales in the food service industry have remained steady. As for the employment and income situation, labor market conditions have continued to improve steadily, and employee income has risen moderately. The unemployment rate has been at a low level of 3.3 percent or slightly higher, and has continued on a moderate improving trend, with the fluctuations smoothed out. The improving trend in the active job openings-to-applicants ratio has become evident recently, as seen in the fact that it recorded 1.21 in July, a high level since that in February 1992. Scheduled cash earnings on a year-onyear basis as a whole – including those of part-time employees – have increased moderately, since the rate of increase in scheduled cash earnings of full-time employees has accelerated at a moderate pace, mainly due to the effects of the rise in base pay. As for the outlook, employee income is expected to continue increasing moderately, in line with the recovery in economic activity and business performance. With the employment and income situation continuing to improve steadily as described, private consumption is expected to remain resilient. Business fixed investment has been on a moderate increasing trend as corporate profits have improved. The aggregate supply of capital goods (excluding transport equipment) – a coincident indicator of machinery investment – has been trending moderately upward, albeit BIS central bankers’ speeches with fluctuations. Looking at leading indicators, machinery orders (private sector, excluding orders for ships and those from electric power companies) have increased at a moderate pace, notably in manufacturing. Moreover, construction starts (floor area, private, nondwelling use) have started to pick up, albeit with fluctuations, since the turn of the year. In these circumstances, business fixed investment plans are projected to grow further for fiscal 2015 from the previous fiscal year. Taking these factors into account, business fixed investment is projected to continue increasing moderately as corporate profits follow their improving trend. Let me turn to overseas demand. 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, the U.S. economy has continued to recover, assisted by household spending, although adjustments have been seen in the industrial production sector, mainly on the back of the decline in crude oil prices and the appreciation of the U.S. dollar. The European economy has been on a moderate recovery trend. The Chinese economy has maintained its stable growth as a trend but there has been downward pressure from an overhang in supply capacity in the manufacturing sector and adjustments in the real estate market. Apart from China, emerging and commodity-exporting economies as a whole have shown sluggish growth, due in part to the effects of the slowdown in the Chinese economy. In this situation, Japan’s exports have been picking up, albeit with some fluctuations. Real exports had increased for three quarters in a row starting with the July-September quarter of 2014, and fell in the April-June quarter of 2015. They have shown sluggishness recently due to the effects of the slowdown in overseas economies toward around spring 2015. As for the outlook, exports are expected to increase moderately, albeit with some fluctuations, as overseas economies, mainly advanced economies, are expected to continue recovering moderately – although there are issues that require attention, such as the outcome of the European debt problem, including the situation in Greece, and developments in emerging and commodity-exporting economies. Turning to price developments, the year-on-year rate of increase in the consumer price index (CPI, all items less fresh food) is about 0 percent. With regard to the outlook, it is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices. B. Outlook for economic activity and prices So far, I have illustrated recent developments in economic activity and prices. Let me now turn to the Bank of Japan’s interim assessment of the April 2015 Outlook for Economic Activity and Prices (hereafter the Outlook Report), which was made in July 2015. In this assessment, the Bank revised the forecasts for economic activity and prices through fiscal 2017. In the Bank’s interim assessment, the median of the Policy Board members’ forecasts for the real GDP growth rate was revised somewhat downward to 1.7 percent for fiscal 2015, mainly due to the sluggishness in exports, but was more or less unchanged at 1.5 percent and 0.2 percent for fiscal 2016 and 2017, respectively, from the forecasts presented in April. In other words, Japan’s economy is likely to continue growing at a pace above its potential through fiscal 2016 and maintain its positive growth in fiscal 2017, although with a slowing in its pace, due mainly to the effects of the consumption tax hike planned in April 2017. With regard to the year-on-year rate of increase in the CPI (all items less fresh food), the median of the Policy Board members’ forecasts was more or less unchanged at 0.7 percent for fiscal 2015, 1.9 percent for fiscal 2016, and 1.8 percent for fiscal 2017, from the April forecasts. The year-on-year rate of increase in the CPI (all items less fresh food) is likely to be about 0 percent for the time being, but the rate will likely accelerate gradually, on the assumption that Dubai crude oil prices will rise moderately from 60 U.S. dollars per barrel. BIS central bankers’ speeches II. Keys to assessing the outlook for economic activity and prices I believe that Japan’s economic and price conditions have already regained stability consistent with the economy’s growth potential, mainly due to the effects of almost two and a half years of quantitative and qualitative monetary easing (QQE). I expect that such stable conditions will continue through fiscal 2017 – the projection period covered in the Bank’s April 2015 Outlook Report and its interim assessment in July. However, I hold a more cautious view on the outlook for Japan’s economic activity and prices compared with the aforementioned forecasts in the Policy Board members’ baseline scenario regarding that activity and prices in the July interim assessment. Let me share some of my considerations regarding the outlook with you. A. Output gap, potential economic growth rate, and outlook for the growth rate According to the estimates the Bank presented in the April 2015 Outlook Report, the potential growth rate of Japan’s economy, which represents – from the supply side – the pace of growth that is consistent with the economy’s growth potential, has been around 0.5 percent or lower, and thus remains at a low level. The Bank also estimates Japan’s output gap, which represents the degree of utilization of labor and production capacity, at 0.1 percent for the January-March quarter of 2015. The output gap has maintained a neutral level of around 0 percent since the end of 2013. I would like to note that the output gap in Japan is also at a favorable level compared with those in other major countries, according to the estimates made by the Organisation for Economic Co-operation and Development (OECD). While these estimates are subject to a considerable margin of error, they generally 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). The active job openings-to-applicants ratio and other indicators also suggest that supply and demand conditions in the labor market are tightening further, rather than being neutral. However, in a situation where the economy enters a phase in which the negative output gap almost closes, it is considered that it becomes more difficult for the economy to grow at a pace well above its potential compared with the early stage of economic recovery when the output gap is wide. I also consider the possibility that supplyside constraints such as labor shortages will have the effect of constraining economic activity. Based on these developments, as I will describe in more detail later, my assessment is that the economy will continue to grow at a moderate pace as a trend through fiscal 2017, which is roughly equivalent to its growth potential, and that – although lower than the Policy Board members’ baseline scenario in the July interim assessment – stable economic activity and prices will be maintained. This is because the cumulative effects of QQE will continue to exert a positive impact on the economy, while on the demand side of the economy, there is downward pressure on exports, business fixed investment, and private consumption. B. Overseas economies and Japan’s exports The latest forecasts for global economic growth for 2015 released by international organizations such as the International Monetary Fund (IMF) were revised downward from those made at the end of last year. This was mainly due to weaker-than-expected growth in the United States and China, which are Japan’s major trading partners. The U.S. economy has been picking up on the whole, after being sluggish in the JanuaryMarch quarter of 2015, reflecting effects such as of the severe winter weather and the labor disputes at West Coast ports. However, the sluggishness remains, particularly in private consumption. The average growth rate in the first half of 2015 fell below the past trend, and it is still uncertain whether the pace will recover in the second half. If the growth in labor productivity continues to follow a downtrend, this would increase anticipation of a downward deviation in the growth trend, and an optimistic view on the economic outlook consequently would seem unlikely to spread on the basis of support from a favorable employment situation BIS central bankers’ speeches alone. Meanwhile, the growth in the Chinese economy has also continued to trend downward, and considering the deterioration in the employment situation and the decline in the inflation rate, it cannot necessarily be said that the economy is currently in a stable condition that is neutral to the output gap. The rate of economic growth appears to be slowing faster than the rate of decline in potential growth. As for Asian economies with vulnerabilities arising from the high-level accumulation of private-sector debt, their downtrend may become more evident amid the spreading effects of the weaker-than-expected economic growth in the United States and China. In this environment, Japan’s real exports for the April-June quarter of 2015 turned negative on a quarter-on-quarter basis for the first time in three quarters, registering minus 3.6 percent, and I consider that this has become one of the factors behind the weaker-thanexpected real GDP growth rate for the April-June quarter – that is, the temporary lull in the economy. Real exports are expected to increase on a quarter-on-quarter basis in the JulySeptember quarter, albeit moderately. Thereafter, however, they are likely to continue to lack momentum for some time and overall economic growth is expected to be quite modest as a result of the adverse effects on production and employment in manufacturing. C. Growth expectations and business fixed investment Business fixed investment has continued to be on an increasing trend on the back of improvement for the situation in corporate profits and of higher capacity utilization rates. However, firms’ cautious investment stance still has not changed considerably, particularly in terms of business fixed investment in Japan. This seems contrary to firms’ active stance toward hiring new employees, due in part to strong concern over future labor shortages. In this situation, for firms to become more active in their fixed investment, it is essential to bring about a clear rise in medium- to long-term growth expectations – underpinned as well by the government's growth strategy and measures to respond to the population decline. Meanwhile, focusing on the capital stock cycle of business fixed investment, I consider that fixed investment is likely to increase in fiscal 2015, and thereafter the pace of increase is likely to generally peak out toward fiscal 2017, on the assumption that the current growth expectations will be maintained. D. Expectations of price rises and private consumption Private consumption has continued to lack momentum, despite the favorable environment evidenced by such factors as improvement in the employment and income situation and accommodative financial conditions. One factor behind this may be consumers’ expectations of price rises for the time being. Since April 2015 in particular, a rise in prices of daily necessities such as food has been widely observed. In my view, comments by respondents in the recent Economy Watchers Survey and the sluggishness in the consumer confidence index in the Consumer Confidence Survey are evidence that this rise has negatively affected consumer sentiment. Let me consider this situation together with the effects of monetary easing. While real interest rates continued to decline due to the policy effects of QQE at the time of its introduction, there was no significant change in the outlook for real income. Therefore, a monetary easing effect emerged temporarily – that is, the bringing forward of future consumption. However, in the current phase, the decline in real interest rates has come to a halt, and a view seems to be spreading among consumers that the rate of increase in wages will not easily catch up with that in prices. Therefore, if expectations spread of a rise in prices of daily necessities in the near future, the outlook for real income for the time being may deteriorate, thereby further constraining consumption activity. This trend may be observed more clearly among elderly households, including those of pensioners, and low-income households. BIS central bankers’ speeches E. Price developments and the outlook Turning to price developments, retail price statistics released by the private sector show a clear uptrend, particularly in prices of food. However, no significant changes have yet been observed in CPI statistics released by the Ministry of Internal Affairs and Communications, which cover a wider range of goods and services. In terms of the CPI for all items less food and energy – which tend to fluctuate largely – or the core-core CPI, the year-on-year rate of increase may have started to accelerate somewhat. However, it still cannot be judged that there has been a clear change in the underlying trend; this is partly because, in 2014, the rate of increase in prices had slowed after the consumption tax hike, and the rate of increase in that index reflected this effect. Comparing the recent situation with that from 2013 through the beginning of 2014 – when the year-on-year rate of increase in the CPI accelerated markedly – there is a large difference in the pace of improvement in the output gap and of the rise in prices of electronic appliances, which has been relatively stable recently even amid the depreciation of the yen. Under these circumstances, the effects of the depreciation of the yen so far on price rises seem to have weakened on the whole compared with those observed last year. Supermarkets have recently been passing on increases in costs by food manufacturers to sales prices and refraining from holding discount sales that are intended for sales promotion, as food sales do not decline even when prices are increased. However, this can be regarded as an overvaluation by retail stores that the relatively high level of the year-on-year rate of increase in sales since April 2015 – which actually is due to the base effect of the decline in demand after the consumption tax hike in 2014 – is an indication of the firmness in sales. Furthermore, one reason behind the fact that sales of food are less likely to decline despite the rise in sales prices may be that the necessity for food is high and the price elasticity of its consumption is considered to be relatively low. It is necessary to take into consideration the possibility that the rise in prices of daily necessities such as food will intensify consumers’ defensive attitude toward spending and, as a result, restrain price increases. Under these circumstances, I expressed dissent from the description presented in the April 2015 Outlook Report regarding the year-on-year rate of increase in the CPI (all items less fresh food) that the timing of reaching around 2 percent is projected to be around the first half of fiscal 2016. Even now, I still hold the view that the year-on-year rate of increase in the CPI (all items less fresh food) will be about 0 percent for the time being, and thereafter accelerate very moderately, and consider that the rate of increase is unlikely to reach 2 percent even in fiscal 2017. III. Conduct of monetary policy In April 2013, the Bank introduced 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. Furthermore, in October 2014, the Bank decided to expand QQE. Specifically, the Bank decided to (1) accelerate the annual pace of increase in the monetary base from about 60–70 trillion yen to about 80 trillion yen, (2) increase its Japanese government bond (JGB) purchases so that the amount outstanding of its holdings would be increased from an annual pace of about 50 trillion yen to about 80 trillion yen, and (3) triple the annual paces of increase in the amounts outstanding of its holdings of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). Despite supporting the introduction of QQE, I cast a dissenting vote on the decision to expand it in October 2014. Moreover, since April 2015 – that is, two years after the introduction of QQE – I have continued to submit a proposal to change the guidelines for money market operations and asset purchases, including a reduction in the pace of asset purchases. Next, I would like to explain in detail my policy stance and the idea behind it from the viewpoint of positive effects and side effects of QQE. BIS central bankers’ speeches A. My view on QQE The Bank introduced QQE in April 2013 and decided on the following guidelines for money market operations and asset purchases: accelerate the annual pace of increase in the monetary base to about 60–70 trillion yen and purchase JGBs so that the amount outstanding of the Bank’s holdings would be increased to an annual pace of about 50 trillion yen. I supported these guidelines employed at the time of introduction, judging that the scale was one in which the associated positive effects would just about outweigh the side effects when confined to a certain time period. In the meantime, however, I have considered that the associated side effects would outweigh the positive effects over time. Therefore, I have continued to submit a proposal – that is, 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 – since the introduction of QQE in April 2013 through the Monetary Policy Meeting (MPM) held in March 2015. This was because, while I personally considered it difficult to achieve the price stability target of 2 percent in a short period of time, I was concerned that, if the Bank carried out QQE with the rigid purpose of achieving the 2 percent price stability target, the policy decided at the time of introduction would be protracted or would strengthen and the side effects would increase in a cumulative manner. Based on this view, in deciding the expansion of QQE in October 2014, I judged that the timing of the associated side effects outweighing the positive effects would be moved forward due to increases such as in the amount outstanding of the Bank’s JGB holdings from an annual pace of about 50 trillion yen to about 80 trillion yen. I therefore cast a dissenting vote on the measure and insisted that it was appropriate for the Bank to continue with the guidelines employed at the time of the introduction of QQE. Since then, I have continued to cast a dissenting vote on the current guidelines. On this basis, I submitted another proposal at the MPM held on April 7 and 8, 2015 – that is, to (1) reduce the annual paces of increase in the monetary base and in the amount outstanding of the Bank’s JGB holdings from the current ones of about 80 trillion yen to about 45 trillion yen, which are levels below the initial pace employed at the time of the introduction of QQE; (2) change back the average remaining maturity of the Bank’s JGB purchases from the current one of about 7–10 years to the initial one of about seven years; and (3) reduce the annual paces of increase in the amounts outstanding of the Bank’s holdings of ETFs and J-REITs from the current ones of about 3 trillion yen and about 90 billion yen, respectively, to the initial ones of about 1 trillion yen and about 30 billion yen. Since then, I have continued to submit the same proposal through the most recent MPM held on August 6 and 7. This proposal was formulated based on the judgment that the associated side effects would outweigh the positive effects even under the guidelines employed at the time of the introduction of QQE, in terms of such aspects as the pace of the Bank’s JGB purchases. This judgment was formed on careful examination of whether the side effects of QQE are outweighing the positive effects now that two years have passed since the time of the introduction, a milestone that had been borne in mind over that period. I also considered that, if the Bank changed the current guidelines so that the annual pace of increase in the amount outstanding of the Bank’s JGB holdings would be about 45 trillion yen – a level below the initial pace employed at the time of the introduction of QQE – excessive pressure on the JGB market would be eased considerably, as the Bank’s JGB purchases on an annual basis would be reduced to a level equivalent to below about half the amount of JGBs planned to be issued in scheduled auctions from April 2015 to March 2016 (calendar base). The proposal I just mentioned is intended only to reduce the pace of the Bank’s asset purchases, and not in any way reduce the amount outstanding of its asset holdings. Even if the paces of increase in the monetary base and of the Bank’s JGB purchases were to be reduced, accommodative financial conditions would be strengthened in a cumulative manner as the amount outstanding of its asset holdings increases. I personally consider it appropriate, first of all, to proceed with phased reductions, aiming to stabilize the amounts outstanding of the monetary base and of the Bank’s JGB holdings at certain levels. However, BIS central bankers’ speeches this does not mean that the Bank will end QQE. It will take considerable time before the end of QQE – that is, when excess reserves are depleted and the amount outstanding of the Bank’s JGB holdings is normalized. I consider my proposal as a first step toward somewhat lowering the weight of QQE in the overall policy package and shifting to a flexible policy conduct using a combination of a range of policy tools, including virtually zero interest rates and the fund-supplying measure to stimulate bank lending (the Stimulating Bank Lending Facility). B. Positive effects of QQE I would now like to explain the idea behind my proposal in more detail from the viewpoint of positive effects and side effects of QQE. Firstly, as was stated in “Quantitative and Qualitative Monetary Easing: Assessment of Its Effects in the Two years since Its Introduction,” released by the Bank in May 2015, QQE has been effective in increasing domestic private demand through a decline in long-term real interest rates, thereby continuing to exert positive effects on Japan’s economy as a whole. In addition, I think that the cumulative effects of the policy have already firmly taken hold in the economy. I consider that this is evident judging from the degree of narrowing of the following three gaps. First, when the economy faces a shortage of demand, it is considered an important role of monetary policy to close the negative output gap by stimulating the economy from the demand side. As I explained earlier, according to the Bank’s estimate, the negative output gap in Japan seems to have almost closed at around the end of 2013, and thereafter the output gap has been at a neutral level. Second, Japan’s economy had long been in an undesirable situation because the observed inflation rate had been sluggish whereas the medium- to long-term expected rates of inflation, on which basis firms and households carry out their economic activities, had generally been positive. Since the introduction of QQE, the gap between the medium- to long-term expected rates of inflation and the observed inflation rate has narrowed. Third, reflecting the narrowing of the output gap and the rise in the inflation rate, some estimates indicate that the level of the policy interest rate derived from the Taylor rule has risen from negative territory to around 0 percent, and that the gap between the actual short-term interest rates – which are virtually at around 0 percent – and the derived policy interest rate has almost closed. This suggests the possibility that QQE is overcoming the negative effects of the zero lower bound of interest rates. However, I consider that the additional effects of QQE have been diminishing since around the middle of 2014, given that the decline in long-term real interest rates, which is considered to be the main source of policy effects, has come to a halt. With regard to nominal interest rates, the declining trend in yields on 10-year JGBs observed through 2014 seems to be coming to a halt. While these developments are affected in part by developments in overseas interest rates, I think that they also stem from a domestic factor of the significant decline in term premiums on JGBs in recent years already having approached its limit. Meanwhile, there have not been major changes in medium- to long-term inflation expectations so far, judging from various surveys and market indicators; these expectations have been relatively stable at a level that remains far from that deemed to be consistent with the price stability target of 2 percent. Given that the global disinflationary trend is likely to persist, I think that it is difficult to encourage medium- to long-term inflation expectations to continue rising solely by presenting the Bank’s policy stance of exerting influence on expectations. C. Side effects of QQE The side effects of QQE are not necessarily evident at present because they are mostly potential effects. However, due attention needs to be paid to the risk that, once the side effects materialize at some point in the future, it will become difficult to handle them appropriately, and it may become too late to take action. Given this feature of the side effects, I personally pay particular attention to a range of problems arising from excessive BIS central bankers’ speeches impairment of functioning of the JGB market caused by the Bank’s large-scale purchases and holdings of JGBs. In other words, these problems are potential risks that could lead to instability in the financial system – such as impairment of functioning of the JGB market, including decreased liquidity or impairment of the price-discovery function. For example, if liquidity in the JGB market were to decline substantially, the market would become less resilient against negative shocks and thereby become unstable more easily, such that volatility in the market would increase. In particular, since JGB prices affect the price formation of many financial products and assets, risks already may have accumulated in such a way that drastic fluctuations in JGB prices could lead to revisions to prices of a wide range of financial products and assets, thereby exerting severe effects on the financial system and economic activity. In addition, attention should be given to (1) the possibility of a higher risk that the Bank’s large-scale JGB purchases will be perceived as central bank financing of fiscal deficits and (2) a risk that the mechanism of maintaining fiscal discipline through interest rates will be impaired, reflecting overly heightened expectations that the stability in the JGB market will be ensured. Furthermore, considering that there is a limit to the amount of JGBs and that the Bank cannot purchase from the market all JGBs issued, a problem regarding the sustainability of the policy of purchasing JGBs may materialize sooner or later. It is very difficult to predict when a limit to the Bank’s JGB purchases will arise, but if the purchases were to be hindered suddenly, this could impair the credibility of monetary policy and rapidly increase uncertainty regarding the future monetary policy conduct, thereby leading to a sudden heightening of instability in financial markets. In addition to these problems related to the JGB market, I am concerned about another side effect of QQE; namely, the risk that the Bank’s profits might be reduced in the course of normalizing monetary policy in the future, which could impair its capital or increase the public burden. For example, if the Bank reduced the amount outstanding of its JGB holdings in line with the pace of redemption, its interest income on JGBs would decrease, while its payment of interest on financial institutions’ accumulated excess reserves would increase. As a result, the environment for the Bank’s profits might deteriorate, thereby impairing its capital. It is necessary to bear in mind that, if such a situation were to occur, this could (1) generate uncertainty about the Bank’s financial soundness and impair the stability in the value of the currency and (2) ultimately cause unexpected increases in the public burden as a result of a possible decrease in the Bank’s payment to the government and capital injection into the Bank. I think that such side effects of QQE have not diminished but rather have been increasing with the continuation of QQE. In addition, even if the Bank starts to normalize QQE, it will take considerable time for this to be completed; given this, it is important to fully take into account the side effects of QQE that may emerge over a considerable period of time and conduct monetary policy in a more forward-looking manner than when conducting the conventional interest rate policy. Relative to other economic measures, the side effects of monetary policy are difficult to grasp until they actually materialize. Therefore, I believe that the Bank should thoroughly explain the side effects of QQE widely to the public and show that it conducts policy paying full attention to these effects. I believe that this will enhance the credibility of the Bank’s policy, and thereby boost the policy effects. D. Examination and comparison of positive effects and side effects of QQE So far, I have described in detail the positive effects and side effects of QQE. My understanding is that, while the positive effects are largely determined by the amount outstanding of the Bank’s JGB holdings – that is, the stock of its JGB purchases – the side effects, such as the decline in JGB market liquidity, are considerably affected not only by the stock of the Bank’s JGB purchases but also by the pace of such purchases – that is, the flow of these purchases. It is already the case that long-term real interest rates have become less likely to decline despite the increase in the amount outstanding of the Bank’s JGB holdings, and therefore additional effects of QQE clearly have been diminishing. Given this situation, I BIS central bankers’ speeches consider that a reduction in the pace of Bank’s JGB purchases will reduce the side effects of QQE without significantly constraining the positive effects, thereby enabling the balance between the positive effects and the side effects to improve marginally. As I mentioned earlier, my policy proposal is not to reduce the stock of the Bank’s JGB purchases but to reduce the flow of such purchases. In my view, the cumulative effects of QQE have already firmly taken hold in the economy, and such effects will not diminish significantly unless the Bank reduces the amount outstanding of its JGB holdings. If normalization of QQE – such as the measure to reduce the pace of the Bank’s JGB purchases – is postponed in fear of a negative market reaction, this could further increase the potential risk of financial markets becoming unstable, which consequently could ruin the positive results of QQE gained so far. The success of QQE will be judged at the time when its normalization is completed smoothly, and this should be kept in mind. E. Progress toward achieving the price stability target As explained so far, I have been proposing at MPMs a change to the guidelines for money market operations and asset purchases, including a reduction in the pace of asset purchases. I also have been submitting a proposal 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 Bank’s 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 consider that firms’ and households’ medium- to long-term inflation expectations are mainly determined by supply-side factors – or, the economy’s growth potential – such as the potential growth rate and the labor productivity growth rate, rather than by factors such as the following: the level of the Bank’s price stability target; the supply and demand balances in goods and services, as well as in the labor market; and developments in the observed inflation rate. From this point of view, I think that the price stability target of 2 percent is well above the level that is consistent with the current growth potential of Japan’s economy. Therefore, in my view, it is difficult at this point to achieve the 2 percent target in a stable manner through monetary policy alone, unless structural changes that would increase the underlying trend in inflation make further progress. In this situation, if excessive monetary easing is to continue in order to push prices higher in the short term than levels justified by the economy’s growth potential, this could in turn impair the stability in economic activity and prices. Moreover, 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. 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 also 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 important to address structural issues such as population decline and massive government debt, both of which can hinder expansion of domestic demand in the medium to long term. Efforts toward achieving fiscal consolidation are also important not only in terms of ensuring the stability in financial markets and thereby creating an environment in which the effects of QQE will be maximized, but also in terms of enabling smooth normalization of QQE in the future. As mentioned earlier, my assessment is that QQE has exerted a considerable effect in light of the role originally expected of monetary policy. In this current situation, the future role that monetary policy should play in the overall economic policy is to shift the focus, while maintaining favorable financial conditions, toward consistently providing indirect support for efforts by the government and firms so that the productivity growth rate and the potential growth rate will increase to levels consistent with the 2 percent inflation rate. To this end, it is BIS central bankers’ speeches important to conduct monetary policy with the aim of achieving prolonged economic recovery, albeit moderate, at a pace consistent with the economy’s growth potential – that is, the potential growth rate – by reducing the side effects of monetary easing that could lead to financial market turmoil, thereby working to lessen future risks and uncertainty. My proposal to change the guidelines for money market operations and asset purchases, which I have been submitting at MPMs, is based on such a viewpoint. I believe this proposal is a quicker way of achieving the 2 percent price stability target. In the future conduct of monetary policy, I consider it necessary for the Bank to conduct its policy flexibly, giving greater consideration to its policy framework of “two perspectives.” Specifically, 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 is reasonable judging from the growth potential of Japan’s economy at each point in time. In relation to this, the inflation rate that the Bank should aim at achieving through monetary policy over roughly the next two years is expected to climb gradually, as the potential growth rate and the sustainable inflation level rise due to efforts by entities such as the government and firms. Such an inflation rate could possibly reach around 2 percent in the medium to long term, but I consider it important to conduct monetary policy based on a reasonable level consistent with the economy’s growth potential at each point in time. The second perspective places importance on thoroughly examining, over 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 doing so, it is important to not focus too much on short-term developments in economic activity and prices, but instead to pay close attention to medium- to long-term risks that could lead to instability in the financial system, and thereby aim to achieve economic and price stability in the long run. This contributes to the sound development of the national economy, thereby maintaining and enhancing the credibility of the Bank’s policy into the future. 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, Kyoto, 30 July 2015.
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Koji Ishida: Japan’s economy, price developments and monetary policy Speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kyoto, 30 July 2015. * * * I. Developments in economic activity and prices A. Overseas economies Overseas economies – mainly advanced economies – have been recovering, albeit with a lackluster performance still seen in part. Aggregate real GDP growth rate for major economies, weighted by value of exports from Japan, decelerated to around 2.5 percent in the January-March quarter of 2015 due to the slowdown in the U.S. and Chinese economies. Although low crude oil prices since summer 2014 had been expected to push up consumption, the growth rate has been decelerating on a quarterly basis recently – resulting in somewhat sluggish economic conditions. The projection of global economic growth in the World Economic Outlook (WEO) Update released in July by the International Monetary Fund (IMF) has been revised somewhat downward for 2015 relative to the April 2015 WEO, but the projection that the growth rate will accelerate toward 2016 is unchanged. Although overseas economies might continue to lack momentum for the time being, the Bank expects that they will continue to recover moderately, as advanced economies will continue to recover firmly and as the positive effects gradually spread to emerging economies. Looking at movements by major region, the U.S. economy has been recovering, following its exit from the slowdown observed last winter, which was affected mainly by the severe weather. According to U.S. employment statistics for June 2015, the unemployment rate has been decreasing and the number of employees has been increasing firmly. In addition, consumer confidence has been improving. As for the outlook, although attention should be paid to the effects of low crude oil prices and the appreciation of the U.S. dollar, the economy is likely to continue to see growth led mainly by private demand, with robust household spending assisted by the favorable employment and income situation. Economic activity in the euro area seems to have continued to recover moderately, although there was still tension in financial markets regarding the debt problem in Greece. Private consumption has been increasing, supported in part by the improvement in the labor market, and business sentiment as well as production activity have been recovering moderately. As for the outlook, the euro area economy is likely to maintain its moderate recovery as the effects of the depreciation of the euro and monetary easing will permeate the economy, but close attention should continue to be paid to such risk factors as the debt problem in Europe, including developments in political and economic conditions in Greece. As for the Chinese economy, the year-on-year growth rate of real GDP for the April-June quarter was 7.0 percent, generally maintaining its stable growth. However, its growth momentum remains sluggish against the backdrop of the deceleration in fixed asset investment, particularly that in real estate, and continued inventory adjustments in manufacturing. Stock prices have been volatile as well. As for the outlook, the economy is likely to follow a generally stable growth path, albeit at a somewhat reduced pace, due to policy measures carried out by the authorities to support economic activity from both the fiscal and monetary sides. However, the nominal GDP growth rate has been declining, and the acceleration of the disinflationary trend as well as the excess debt problem continue to require attention. Emerging economies have been somewhat weak. Asian economies continue to be underpinned by the positive effects of the recovery in advanced economies and monetary BIS central bankers’ speeches easing, but recently weakness has been seen in exports and production of IT-related goods due to downward pressure from the slowdown in the Chinese economy. Economic activity in Russia and Brazil – that is, the countries facing structural problems and political unrest – continues to be severe. As for the outlook, emerging economies as a whole are likely to gradually increase their growth rates, but the pace is highly uncertain as several economies are facing various structural problems. B. Japan’s economy and price developments 1. Current situation Now I will discuss developments in economic activity and prices in Japan. Japan’s economy has continued to recover moderately. In the corporate sector, the diffusion index (DI) for business conditions (the proportion of firms responding that business conditions were “favorable” minus the proportion of those responding that they were “unfavorable”) in the June 2015 Tankan (Short-Term Economic Survey of Enterprises in Japan), which was released at the beginning of July, has improved for large firms in both manufacturing and nonmanufacturing – recovering to a level close to that seen prior to the consumption tax hike in 2014. The DI for small firms has been unchanged for all industries, but it continues to be at a relatively high level. As for business fixed investment, firms have maintained their positive investment stance, as suggested by, for example, the upward revision of their fixed investment plans for fiscal 2015 in the June Tankan, with corporate profits increasing to a historical high. In the household sector, despite the effects of irregular weather, private consumption has been resilient, reflecting steady improvement in the employment and income situation, as seen in, for example, the continued improvement in the active job openings-to-applicants ratio. In addition, housing investment has started to pick up. Given these developments, a virtuous cycle from income to spending is expected to continue operating steadily in both the corporate and household sectors. With regard to prices, the year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food had slowed toward the end of fiscal 2014, due in part to the effects of low crude oil prices. Excluding the direct effects of the consumption tax hike, the rate has been about 0 percent recently. 2. Outlook Japan’s economy is expected to continue recovering moderately. On the price front, the year-on-year rate of increase in the CPI is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices. Nevertheless, as the underlying trend in prices steadily rises and the effects of the decline in crude oil prices dissipate, the rate is likely to accelerate toward 2 percent – the price stability target. Risks to the outlook are those that primarily stem from overseas factors. Specifically, these include developments in emerging and commodity-exporting economies, the prospects regarding the debt problem and the momentum of economic activity and prices in Europe, and the pace of recovery in the U.S. economy. The Bank compiles and releases the Policy Board members’ forecasts for economic activity and prices on a quarterly basis. Looking at the medians of the members’ forecasts released in July 2015, the real GDP growth rate is projected to be 1.7 percent for fiscal 2015, 1.5 percent for fiscal 2016, and 0.2 percent for fiscal 2017. The year-on-year rate of increase in the CPI (all items less fresh food), excluding the direct effects of the consumption tax hikes, is projected to be 0.7 percent for fiscal 2015, 1.9 percent for fiscal 2016, and 1.8 percent for fiscal 2017. The Bank projects that the timing of the rate reaching around 2 percent will be around the first half of fiscal 2016, assuming that crude oil prices will rise moderately from the recent level. BIS central bankers’ speeches 3. Keys to assessing the outlook Next, I will discuss the three keys to assessing economic activity and prices for the time being. These are developments in various components of the economy. a. Exports and production The first is developments in exports and production. Real exports had increased for three quarters in a row since the July-September quarter of 2014, but registered negative growth of 3.6 percent in the April-June quarter of 2015, mainly because the slowdown in overseas economies during the first half of the year weighed down on them with some time lag. Industrial production has shown sluggishness recently, partly due to domestic inventory adjustments of small cars with engine sizes of 660cc or less and an accompanying weakness in automobile-related industries – namely, materials – in addition to the slowing in exports. While the sluggishness in exports and production is likely to exert downward pressure on the real GDP growth rate for the April-June quarter of 2015, which will be released in August, what matters is whether both exports and production will emerge from the pause and trend moderately upward again from summer. At the moment, it seems likely that both will increase moderately, albeit with some fluctuations, due to the rebound in the U.S. economy and the progress in inventory adjustments at home. However, exports could come under downward pressure due to concern over a slowdown in the Chinese economy and a subsequent spreading of its effects to emerging economies, as well as a global decline in business fixed investment related to energy brought about by low crude oil prices. Production is also subject to some uncertainty regarding the pace of progress in inventory adjustments in materials industries. In any event, I would like to closely monitor the pace of improvement in exports and production while paying attention to underlying downside risks. b. Private consumption and real income The second key is developments in private consumption and real income, which have a significant impact on prices. Some recent indicators with respect to private consumption have been relatively weak, due partly to adverse weather conditions. Nevertheless, private consumption is likely to remain resilient for the time being, as it is expected to be underpinned by an improvement in the income situation; namely, a rise in base pay this spring and an increase in summer bonus payments. That being said, in a situation where price rises are expected to take hold from the second half of fiscal 2015 onward, improvement in real wages should become an important key to ensuring continued resilience in private consumption. Looking back on developments in fiscal 2014, the year-on-year rate of change in real wages has remained substantially negative as improvement in wages has not been able to keep up with the substantial price increases, which reflected the effects of the consumption tax hike. This seems to have led to consumers’ defensive attitude toward spending, bringing about sluggishness in private consumption and weakness in the supply side’s price-setting stance, which until then was starting to show confidence. Since the turn of fiscal 2015, the year-on-year rate of increase in the CPI (all items less fresh food) has been about 0 percent, but the Nikkei-UTokyo Daily Price Index – which is mainly comprised of daily necessities and food products – has been trending upward, and there has been no sign so far that the trend in price rises will stall as it did last year. This indicates firms’ aggressive stance of setting higher prices on the sales front, evidencing the resilience in private consumption. Having said that, although the year-on-year rate of change in real wages – which greatly affects the sustainability of consumption – had recently been rising rapidly, it has just reached close to 0 percent. Thus, I would like to pay attention to the future pace of improvement in real wages. In assessing developments in private consumption, consumption by pensioners warrants attention. With the aging of the population, the number of pensioners has reached close to BIS central bankers’ speeches 40 million, and the effects their behavior exert on overall private consumption have become significant. From a relatively longer-term perspective, a cut in real pension benefits, owing in part to the introduction of the macroeconomic slide formula, might exert downward pressure on pensioners’ consumption. Thus, I believe that even greater attention should be given to future developments. c. Business fixed investment The third key is developments in business fixed investment. For part of 2014, growth in business fixed investment was sluggish relative to that in corporate profits and firms’ fixed investment plans, partly due to the effects of the decline in demand following the front-loaded increase prior to the consumption tax hike and heightened uncertainty regarding developments in foreign exchange rates and crude oil prices. However, the rate of change in business fixed investment on a real GDP basis turned noticeably positive for the JanuaryMarch quarter of 2015. Thereafter, the June 2015 Tankan showed that firm’s fixed investment plans have been relatively strong, particularly of large manufacturing firms, and machinery orders – a leading indicator of machinery investment – have increased as well, indicating a clear improvement in firms’ investment stance. As for the outlook, business fixed investment is likely to continue increasing moderately on the back of an improvement in corporate profits, accommodative financial conditions, and an increase in domestic investment by manufacturing firms in view of developments in foreign exchange rates. However, I presume that there is a risk that the recent deceleration in overseas economies and the accompanying sluggishness in exports and production will weaken business sentiment, which is starting to become aggressive. I believe that the pace of increase in business fixed investment for the time being will be determined by the extent to which firms will be able to gain confidence and certainty regarding the outlook for developments in demand both at home and abroad amid continued moderate recovery in Japan’s economy. II. The Bank’s monetary policy A. The current conduct of monetary policy Thus far, I have outlined developments in economic activity both at home and abroad and price developments in Japan. Next, I would like to discuss the Bank’s monetary policy. I will start by briefly explaining the Bank’s current conduct of monetary policy. 1. Quantitative and qualitative monetary easing (QQE) QQE, which the Bank continues to pursue, has entered the third year since its introduction in April 2013. At the end of October 2014, the Bank decided to expand QQE to preempt the manifestation of a risk that the emergence from the deflationary mindset might be delayed, due mainly to a substantial decline in crude oil prices. The specific measures of the expansion were as follows. First, the Bank decided to accelerate the pace of increase in the monetary base it provides from an annual pace of about 60–70 trillion yen to an annual pace of about 80 trillion yen. Second, it decided to raise the pace of increase in the amount outstanding of the Bank’s holdings of Japanese government bonds (JGBs) from an annual pace of about 50 trillion yen to an annual pace of about 80 trillion yen. At the same time, the Bank decided to extend the average remaining maturity of its JGB purchases from about seven years to a flexible range of about seven to ten years. And third, it decided to triple annual purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding would increase by about 3 trillion yen and about 90 billion yen, respectively. 2. The Loan Support Program and other measures Prior to the introduction of QQE, the Bank established – on its balance sheet – the Loan Support Program, with the aim of making the effect of monetary easing permeate the entire BIS central bankers’ speeches economy. Through this program, it has been providing support for private financial institutions’ efforts to strengthen the foundations for economic growth and to increase their lending. Meanwhile, the Bank has also been conducting the funds-supplying operation to support financial institutions in disaster areas affected by the Great East Japan Earthquake. Since the establishment in 2010 of the measure that later constituted the Loan Support Program, the Bank has been enhancing the program by, for example, increasing the maximum amount outstanding of its fund provisioning and extending the application period of the program. As a result, the amount outstanding of loan disbursement under the program has reached about 29 trillion yen as of mid-July 2015. Through these efforts, the Bank will further promote financial institutions’ lending, as well as stimulate firms’ and households’ demand for credit and continue to support the efforts of financial institutions in disaster areas toward rebuilding. B. Assessment of the underlying trend in prices I will now move on to discussing price developments – a crucial factor in making the Bank’s policy decisions – with a particular focus on how to assess the underlying trend in prices in an environment where fluctuations in energy prices observed since 2014 have been exerting a substantial influence on overall prices. When assessing the underlying trend in prices, I consider it appropriate to also examine for the time being the CPI (all items less energy), given that price fluctuations of energy items since 2014 have been exerting a significant effect on the year-on-year rate of increase in the CPI for all items. There is a view that it is necessary to pay attention to a similar index, the year-on-year rate of increase in the CPI (all items less food and energy). However, in Japan, food expenditures account for a quarter of total household expenditures, which is quite high among advanced economies. Therefore, I personally consider it inappropriate to examine the price index that excludes food, considering the extent to which food expenditures affect households. In assessing the underlying trend in prices, I also consider it necessary to take note of the characteristics of the components of the CPI basket in Japan. For example, prices of public services and rent in Japan are sticky by nature, and less susceptible to developments in economic activity compared to those in the United States. In addition, imputed rent does not represent households’ actual expenditures and the existence of bias in its index has been pointed out due, for example, to the fact that the index does not incorporate deterioration in housing quality. Given the limitations of respective price indexes in accurately grasping prices, I believe it is necessary to make a comprehensive assessment of price developments in the policy conduct, keeping in mind how the CPI is affected by factors such as the characteristics of its components, items on which households actually spend, and people’s perceptions of inflation. C. Transmission effects of monetary policy and financial system stability Before closing my remarks, I would like to briefly touch on the subject of the transmission effects of monetary policy and the financial system stability. The Bank has been implementing QQE with the aim of achieving the price stability target of 2 percent. Under QQE, naturally, the Bank has been able to bring about various transmission effects on corporate financing conditions, financial markets, and a variety of asset markets. Financial institutions have been advancing so-called portfolio rebalancing. While decreasing the amount of their holdings of Japanese government securities (JGSs), they have been increasing various risk assets including foreign currency assets. With QQE’s strong monetary easing effects, long-term interest rates have stably remained at extremely low levels. While this has brought down yields on financial institutions’ interest-earning assets, firms’ funding costs have declined substantially. Moreover, through an improvement in economic activity BIS central bankers’ speeches and corporate profits, stock prices have been rising and real estate transactions have become active. All of these developments are effects that have emerged with the mechanisms that were intended with QQE’s introduction and basically can be regarded positively. To achieve sustainable economic growth with price stability, any large imbalances or overheating on the financial front should be clearly identified. In this regard, I believe that there have been no signs of financial imbalances or overheating to date. Nevertheless, to ensure financial system stability under QQE, it is necessary to thoroughly examine, from a longer-term perspective and without holding a predetermined view, whether risks are accumulating in the financial system due to excessive strength in financial activity and overheating in economic activity. 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 Panel Discussion "Monetary Policy and Central Banking: A Global Outlook", at the Bruegel Annual Meeting, Brussels, 8 September 2015.
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Sayuri Shirai: Unconventional monetary policies of the Bank of Japan and European Central Bank Remarks by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the Panel Discussion “Monetary Policy and Central Banking: A Global Outlook”, at the Bruegel Annual Meeting, Brussels, 8 September 2015. * * * Accompanying charts can be found at the end of the speech. I. Introduction Thank you very much for inviting me as a panelist to the discussion on monetary policy at the Bruegel Annual Meeting. Recently, the directions of monetary policy among advanced economies have become increasingly divergent. Whereas the U.S. Federal Reserve has begun considering normalization of its policy interest rates, the Bank of Japan (BOJ) and European Central Bank (ECB) continue their large-scale asset purchase programs. As one of the policy makers at the BOJ, I have closely monitored developments in the global economy and the monetary policies of major central banks. I would therefore like to talk today about the features of monetary easing of the two central banks (BOJ and ECB) as well as about developments regarding inflation expectations in Japan and the euro area. Let me stress that the views expressed here are entirely my own and do not necessarily represent those of the BOJ. II. Unconventional monetary policies – common features of the BOJ and ECB The monetary-easing instruments adopted by the two central banks have several features in common. They are (1) large-scale asset purchases centered on government bonds, (2) forward guidance used to indicate a future monetary-easing stance, and (3) a conditional long-term lending facility (Chart 1 and Reference Chart). Regarding the first instrument, the large-scale asset-purchase program is referred to as a “balance sheet policy.” This enables a central bank to expand the size of its balance sheet to a predetermined level and to maintain that size over a relatively long period. One of the expected results here is a portfolio rebalancing effect. This policy aims at promoting holders of government bonds to shift away from those bonds and invest in riskier assets, such as loans and corporate bonds, stocks, foreign securities, and real estate, thereby affecting a wide range of markets and energizing economic activity. Since April 2013, the BOJ has adopted an aggressive balance sheet policy by setting a target on the annual pace of the monetary base increase under quantitative and qualitative monetary easing (QQE). The BOJ has been increasing the monetary base at an annual pace of about 80 trillion yen. It has also been purchasing Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace also of about 80 trillion yen. With a view to encouraging a decline in interest rates across the entire yield curve, JGBs with all maturities, including 40-year bonds, are eligible for the BOJ’s purchase and the average remaining maturity of government bonds to be purchased is currently targeted in the range of seven to ten years. In addition to government bonds, the BOJ makes such purchases as exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). This balance sheet policy has contributed to an expansion of corporate profits and employment together with a stock price hike and depreciation of the yen, which have helped improve the output gap by about 2 percentage points. The ECB (as well as European national central banks) has purchased euro-denominated bonds issued by euro-area governments, agencies, and European institutions since March 2015 in an effort to restore the size of its balance sheet to that of March 2012 – or about BIS central bankers’ speeches 3 trillion euros. In conjunction with covered bonds and asset-backed securities (ABS) purchased since October 2014, the monthly pace of the combined asset purchase is set at about 60 billion euros. Except for very long-dated assets, the remaining maturity of eligible public sector assets to be purchased must be within two to 30 years. In principle, the assets need to be investment grade (above BBB–). This policy may be regarded as a reaction to growing concerns over the potentially weakened effectiveness of monetary easing as a result of the shrinking balance sheet amid a decline in some inflation expectation indicators. Although the interest rate applied to a central bank’s asset purchases is generally determined through supply and demand forces in the relevant market, the ECB applies the deposit facility rate of minus 0.2 percent as a floor rate. With regard to the second common monetary-easing instrument, forward guidance has been adopted by the two central banks with the objective of indicating a future direction for the ongoing monetary easing. This is expected to produce a signaling effect. The most commonly observed form is to signal the intention to maintain a significantly low policy interest rate over a long period. This instrument is supposed to exert downward pressure on the short- to medium-term yield curve to achieve additional monetary easing. Moreover, forward guidance could also be used to signal a central bank’s future stance over an ongoing asset purchase program, and thereby exert downward pressure mainly on the long-term yield curve (albeit dependent on the remaining maturity spectrum of purchased assets). Unlike the Federal Reserve, the BOJ has had no forward guidance related to a policy interest rate since the BOJ switched its main operating target for money market operations from the uncollateralized overnight call rate to a monetary base when it introduced QQE in 2013. The BOJ thus applies forward guidance to indicate its future stance over the continuation of QQE as a package (monetary base targeting together with the size and type of assets to be purchased). Forward guidance is expressed mainly according to the following outcomebased statement: 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. That statement is followed by a qualifying clause, which declares that both the upside and downside risks to economic activity and prices will be examined and that adjustments to QQE will be made as appropriate. The BOJ’s forward guidance therefore signals a condition that determines continuation of QQE provided no major risks materialize. Given that the short- to medium-term yield curve was lowered substantially under the previous comprehensive monetary easing (October 2010 to March 2013), the intention with the forward guidance related to QQE is to exert downward pressure on the longer-term yield curve. 1 At the same time, this form of forward guidance is expected to raise inflation expectations – considering that maintaining a price stability target of 2 percent in a stable manner is equivalent to anchoring inflation expectations at around 2 percent. With the ECB, forward guidance was first applied to policy interest rates in July 2013. It was achieved in terms of the following statement: “The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time.” In September 2014, when the ECB cut policy rates by 10 basis points – to 0.05 percent for the main refinancing operations (MRO), 0.3 percent for the marginal lending facility, and minus 0.2 percent for the deposit facility – ECB President Mario Draghi reported that further downward adjustments would no longer be possible. Thus, the ECB’s present forward guidance refers to the duration of maintaining the ongoing low policy interest rates. The ECB also adopted forward guidance in March 2015 to signal its future stance over combined monthly asset purchases of about 60 billion euros with the following remark: “Intended to be carried out until the end of September 2016 and will, in any case, be conducted until we see The BOJ also purchases short-term treasury bills and maintains a 0.1-percent interest rate on excess reserves (IOER). Those moves have helped promote market expectations that very short-term market interest rates would remain substantially low for a long period. BIS central bankers’ speeches a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2 percent over the medium term.” The third common monetary-easing instrument is a conditional long-term lending facility. The BOJ provides low-cost funding (fixed at 0.1 percent) to financial institutions up to an amount that is twice the net increase in their lending – with a maximum of four years under the Stimulating Bank Lending Facility. This measure is planned to continue until June 2016. Similarly, the ECB launched Targeted Longer-Term Refinancing Operations (TLTROs) in September 2014. Since March 2015, TLTROs have provided low-cost funding (at interest rate on MRO) to financial institutions up to an amount three times as much as the net increase in lending to non-financial firms and households (excluding loans to households for house purchases). Currently, the maximum is three years; TLTROs are scheduled to continue until June 2016. Both Japan and the euro area are characterized by a system of bank-based financial intermediations; thus, the ultimate goal with these instruments is to promote bank lending to the private sector. At the same time, they could also help expand the central bank’s balance sheet. III. Unconventional monetary policies – differences between the BOJ and ECB I would now like to examine differences in monetary-easing policies (Chart 2). A. Background to the ECB’s adoption of a negative deposit facility rate The ECB adopted its first negative deposit rate of minus 0.1 percent in June 2014, followed by minus 0.2 percent the following September. I believe that three main factors contributed to the ECB’s decision to maintain the negative interest rate up to the present. First, there are many nonresident holders of government bonds in the euro area: their holdings account for over 50 percent of outstanding bonds issued. The types of nonresident investors are also diverse, ranging from short-term-oriented hedge funds to long-term-oriented institutional investors and foreign central banks. Some of those investors are therefore likely to sell government bonds to the ECB in search of capital gains without being overly affected by the negative interest rate or with the need to rebalance their portfolios, giving higher weight to corporate bonds and stocks in the euro area. Second, as long as potentially large demand exists for credit among firms and households, financial institutions in the euro area could be encouraged to extend credit to the private sector in an attempt to avoid a negative deposit rate, or they may be able to charge a higher lending rate without restraining credit demand. Consequently, financial institutions may achieve profits that will more than offset the negative interest rate by promoting credit creation. Third, given the presence of segmentation in the cross-border interbank markets in the euro area after the global financial crisis, the negative interest rate policy is unlikely to harm the behavior of liquidity-abundant financial institutions. B. The BOJ’s decision to hold a positive interest rate on excess reserves (IOER) By contrast, the BOJ has maintained a 0.1-percent IOER since 2008. I would like to explain the broad background behind this decision. That is, it is important to note that QQE was adopted in an environment that provided little room for further cuts in short- to medium-term interest rates. To generate a large-scale monetary-easing effect, therefore, the BOJ decided to adopt a strategy of exerting downward pressure on real long-term interest rates; it did so through a decline in nominal long-term interest rates and an increase in inflation expectations. This strategy is more accommodative than a policy of seeking further marginal cuts in shorter-term interest rates. That said, I will give three reasons for the decision to keep a positive IOER. First, it reflects the view that further cuts in the IOER could give rise to a more challenging environment for the BOJ in terms of smoothly fulfilling the targeted amount of asset purchases. Unlike in the euro area, there are substantial numbers of resident holders of JGBs: the amount of their holdings accounts for over 90 percent of outstanding bonds issued. Many of those investors BIS central bankers’ speeches are long-term-oriented financial institutions. With such a market structure, a positive IOER may have the effect of inducing those holders to sell government bonds to the BOJ. Second, a negative IOER may incur the risk of undermining the intermediary function of financial institutions by lowering profitability in the banking system. Banks may be unable to pass the increased cost (caused by the negative interest rate) on their retail depositors by lowering the deposit interest rate (which, at around 0 percent, is already low). Alternatively, financial institutions may attempt to raise their lending rates in an effort to maintain profits; however, that may discourage credit demand and thus undermine lending activities. Some European central banks charge a negative interest rate on both the deposit facility rate and on the main lending (refinancing) policy rate. Some of those financial institutions apparently apply a negative interest rate on the deposits of large clients and interbank markets as well as charging a higher lending rate for some corporate clients; they do this while maintaining a positive interest rate on retail deposits. This practice is unlikely to occur in Japan given that the loan-to-deposit rate remains around 70 percent and competition for lending is fierce. Banks may ultimately absorb the increased cost by squeezing their profit margins, thereby somewhat stifling the incentive to take credit risks by increasing lending activities. Third, it is important to support the function of interbank markets to a certain degree by allowing arbitrage in interest rate transactions between banks holding current account balances at the BOJ and those without access to such accounts. Such transactions also enable market interest rates to function relatively effectively as reference interest rates, which are conducive to various other related financial transactions and monetary policy judgments. 2 More importantly, the ECB faced a decline in some inflation expectation indicators and the accumulated disinflation risk in the second half of 2014, when a negative deposit facility rate was in place. This suggests that a positive impact of raising inflation expectations that the BOJ emphasizes could not really be expected at any significant level from a negative interest rate policy. Thus, although the feasibility of lowering the IOER should not be denied, such a policy needs to be better understood and properly discussed in light of differences in the financial market structures of each country and region. C. Differences in importance of credit easing between the BOJ and ECB Another difference between the ECB and BOJ is that the ECB’s monetary easing generally entails an element of credit easing. Recently, the lending rate charged on the private sector has dropped and credit growth has turned positive in the euro area. Nonetheless, small and medium-sized enterprises (SMEs) in some peripheral countries still face restrictive lending criteria, higher funding costs, and limited access to the credit volume. For these reasons, TLTROs aim to promote financial institutions’ lending activities by reducing their funding costs, thereby indirectly lowering the lending rates charged on the private sector. In addition, the ABS purchase program was initiated to activate the market through purchases of securities and promote the securitization market for bank loans, including those for SMEs. The ECB thus continues to place the priority on credit easing as the banking system has not yet fully recovered its financial intermediary function arising from the global financial and European debt crises. By contrast, Japan experienced a decline in the functions of the CP and corporate bond markets immediately after the global financial crisis. That caused the BOJ to purchase those assets as a credit-easing policy in 2009. However, Japan did not face a banking crisis, and In a speech I delivered in Italy in January 2013, I touched on the pros and cons of a cut in the IOER and suggested the positive impact of such a cut on correcting the yen’s excessive appreciation. However, after QQE, those arguments no longer apply. See Shirai, Sayuri, “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 (January 11–12), Bank of Japan, 2013. BIS central bankers’ speeches the balance sheet of the banking sector generally remains sound. Even before QQE, SMEs had therefore enjoyed an accommodative monetary environment, such as with low funding costs and availability of credit volumes. Credit easing has now become a less important element of monetary easing. IV. Inflation expectations in Japan and the euro area Let me now proceed with inflation expectations – a key to achieving the price stability target – starting with those of economists and market-based indicators before turning to those of households and firms. A. Japan’s agenda – restoring inflation expectations to around 2 percent According to economists whose long time-series data are available, their inflation expectations stood at around 2 percent before Japan entered the era of long-standing mild deflation (Chart 3). Medium- to long-term inflation expectations (i.e., five years ahead) remained around 2 percent in the first half of the 1990s. The year-on-year rate of change in the consumer price index (CPI) and short-term inflation expectations (i.e., one year ahead) were also around 2 percent until the early 1990s. From around 1992, after the collapse of the asset bubble, however, the rate of change in the CPI began to drop, turning negative from around 1999. The first half of this period coincided with a declining trend in real GDP growth rates. Since these rates were mostly lower than potential GDP growth rates, which had been on a declining trend, the output gap deteriorated significantly, generating downward pressure on actual prices (Chart 4). Short-term inflation expectations dropped in line with actual price performance: they turned negative around 1999 and subsequently fluctuated at about 0 percent before QQE. 3 One interesting feature of medium- to long-term inflation expectations is that they were unstable from the second half of the 1990s to 2012, with year-on-year movements ranging from around 0.5 percent to 2 percent. It was evident that those inflation expectations were insufficient to raise the rate of change in the CPI and short-term inflation expectations. Inflation expectations thus did not fully play anchoring role. The BOJ’s expression of price stability may be attributable to the instability in medium- to long-term inflation expectations. In 2006, the BOJ introduced the concept of the understanding of medium- to long-term price stability and described price stability as, in terms of the year-on-year rate of change in the CPI, approximately between 0 and 2 percent with the median of 1 percent. The BOJ’s description was clarified somewhat in 2009 to a positive range of 2 percent or lower, with a midpoint of around 1 percent, thereby eliminating the possibility of a 0-percent price change. In 2012, the BOJ introduced the price stability goal in the medium to long term, describing it as a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI, while setting the goal at 1 percent for the time being. Despite these statements, it was not wholly clear whether the BOJ was ultimately pursing a 2-percent level or a lower one. Against this background, the BOJ adopted the 2 percent target and QQE in 2013 to restore medium- to long-term inflation expectations back to around 2 percent – the level that had been achieved over 20 years earlier. Since the introduction of QQE, medium- to long-term inflation expectations of economists and the inflation swap rate (implied five-year forward rate, five years ahead) have risen moderately and remain around 1 percent today. Nevertheless, the 2 percent target remains distant (Chart 3). From Japan’s experience, it is essential first to make a continuous improvement in the output gap and thereby steadily raise the rate of change in the CPI. In this regard, the output gap It must be noted that the year-on-year rate of change in the CPI, as well as short-term inflation expectations, rose substantially, owing to consumption tax hikes in 1997 and 2014, and the surge in commodity prices in early 2008. BIS central bankers’ speeches estimated by the BOJ turned positively to 0.1 percent in the January–March quarter of 2015. After a temporary deterioration projected for the April–June quarter, the output gap is expected to gradually improve in positive territory from the July–September quarter this year and increase its upward pressure on prices. The change in the core CPI (all items less fresh food) is currently about 0 percent. However, the CPI excluding food and energy is about 0.6 percent, which exceeds the core CPI. The proportion of items whose prices have risen among all core CPI-composing items has increased to around 65 percent (Chart 5). Moreover, some price hikes have accompanied increased sales. For those reasons, it is fair to say that there has been no deterioration in the underlying trend in prices. The BOJ projects that the rate of change in the core CPI will begin to rise from the second half of fiscal 2015. Once the rising trend of the core CPI becomes stable, inflation expectations are projected to rise gradually toward around 2 percent. B. Euro area’s inflation expectations: broadly consistent with the price stability target By contrast, in the euro area, the medium- to long-term inflation expectations of economists have been more or less stable at around 2 percent since the initial phase of adopting the euro (Chart 6). This is evident in two ways: one is that the rate of inflation had already moved to around 2 percent a few years prior to the euro adoption; the other is that the ECB initially defined price stability as inflation rates below 2 percent over the medium term. Medium- to long-term inflation expectations appear to have stabilized more firmly after the ECB further clarified its definition in 2003 as inflation rates below, but close to, 2 percent over the medium term. This situation changed somewhat after 2012, when the rate of change in the Harmonized Index of Consumer Prices (HICP) began to decrease continuously. The decline occurred across a wide range of goods and services in the face of a re-deterioration in the output gap and a price drop in various commodities (Charts 7 and 8). Nevertheless, the HICP excluding food and energy remains at around 1 percent. Following the decrease in HICP, short-term inflation expectations declined significantly, whereas medium- to long-term inflation expectations decreased moderately; they currently stand at around 1.8 percent. The inflation swap rate (implied five-year forward rate, five years ahead) strengthened a declining trend from mid-2014 and reached around 1.5 percent by early 2015, which triggered concerns over the risk of disinflation. Thereafter, the inflation swap rate has increased moderately and recovered to around slightly below 2 percent, owing to the impact of the ECB’s asset purchase program (including an announcement effect) and the greater-than-expected performance of economic activity and prices. But most recently, the gap from the target has somewhat widened, partly owing to the recent re-drop in crude oil prices (Chart 6). A recent decline in the inflation swap rate is also observed in Japan. This might be a reflection of a decrease in inflation risk premium associated with declining oil prices rather than declining inflation expectations. C. Gap between households’ price perception and price performance in Japan: different feature from the euro area I would now like to turn to households’ price expectations and spending patterns. Owing to the lack of comparable data, I will use short-term data (about one year ahead). From the BOJ’s Opinion Survey on the General Public’s Views and Behavior, the following data are available from June 2006: (1) the perception diffusion index (DI) of present price levels (the present price perception DI); (2) the one-year-ahead price DI; and (3) the one-year-ahead spending DI. From the European Commission’s Business and Consumer Surveys, I will use the following data from 1999: (1) the price trend DI over the previous twelve months; (2) the price trend DI over the next twelve months; and (3) the spending expectation DI for major purchases (such as furniture and electrical or electronic devices) over the next twelve months. BIS central bankers’ speeches As a commonly observed feature, households in Japan and the euro area tend to perceive that the present price level represents an increase – except for a short period immediately after the global financial crisis – and they tend to expect higher price levels about one year ahead (Charts 9 and 10). Moreover, those households commonly tend to expect to spend less in the near future. From these features, it may be said that households plan to reduce their spending about one year ahead because they expect a tighter budget as a result of expected higher prices. A different feature is evident with regard to the relationship between actual price performance and households’ present price perception (as well as their one-year-ahead price expectation). In the euro area, households’ present price perception and price expectation DIs are roughly in line with actual price performance. By contrast, Japanese households’ present price perception (except for a short period immediately after the global financial crisis) and price expectation DIs remained positive even when mild deflation prevailed from 2009 to mid-2013. More recently, despite the rate of change in the core CPI having dropped to around 0 percent, the rising trend in the present price perception DI has been firm and the relatively high level of price expectation DI has been sustained. Thus, Japanese households’ price perceptions and expectations constantly differ from the movements of official price statistics. On this front, it is known that Japanese households’ price perceptions and expectations are heavily affected by the price movements of daily necessities and gasoline, resulting in an upward bias. This could be interpreted as a sign of a strong defensive action against the anticipated tighter budget. If so, households may perceive a rate of actual inflation of much higher than 2 percent in the process of approaching the 2 percent target, and regard such price rises as unacceptable. Thus, it is important for the BOJ to promote public understanding that its objective is to achieve a moderate price rise and a sustainable increase in household spending. Additionally, households’ tolerance for price rises needs to improve in accordance with a sustainable income rise. D. Euro area firms’ price expectations becoming comparable with those of Japan With respect to firms’ price expectations, the sales price expectation DI for three months ahead is available from the BOJ’s Tankan (Short-Term Economic Survey of Enterprises in Japan) and the European Commission’s surveys (Chart 11). One interesting finding is that in Japan, firms’ sales price expectation DI has fluctuated in negative territory since the first half of the 1990s, when the rates of change in the CPI remained positive. Among those firms, the DI of manufacturing firms remains negative today even though there has been improvement after the global financial crisis. By contrast, the euro area’s sales price expectation DI mostly moved in positive territory before the global financial crisis, which suggests that European manufacturing firms found it relatively easy to raise sales prices. However, especially after 2012, when the European debt crisis deepened, the sales price DI became sluggish and has since remained around 0 percent. This implies that European manufacturing firms now find it more challenging to raise their sales prices and are in a similar position to Japanese firms. An exception is Germany, where the sales price expectation DI has remained in positive territory despite a drop in the present sales price DI. This may indicate that German firms continue to provide more differentiated, higher value-added products than other firms in the euro area. With regard to the sales price expectation DI of non-manufacturing firms, the DI in Japan turned moderately positive after QQE, and it remains positive although low. The sales price expectation DI in the euro area has become stagnant – albeit with large fluctuations – following the European debt crisis. In three non-manufacturing sectors, the current DIs in services and retail trade are moderately positive, albeit at low levels, like those of Japanese firms. The DI of construction has mostly been in significantly large negative territory since the global financial crisis. In the case of Germany, the sales price expectation DI of services has shown a remarkable recovery and already exceeds the pre-crisis level. Nonetheless, the DI of retail trade has recently been at a low level, although moderately positive, which suggests BIS central bankers’ speeches that consumption activities have not yet fully recovered. The DI in construction has been sluggish and was often negative even before the global financial crisis; the current level is low. E. Conclusions In the euro area, short-term price expectations of households and firms dropped after the financial crises and are currently stagnant; the medium- to long-term inflation expectations of economists and market-based indicators are somewhat below, but roughly in line with, the price stability target. This may suggest that the sluggish households’ and firms’ price expectations are temporary and that those expectations will eventually begin to rise as economic conditions improve. In Japan, the medium- to long-term inflation expectations of economists and market-based indicators remain around 1 percent. This is partly because the price rising trend – except for the oil price – seems to have been settling. This may imply that firms’ short-term sales price expectations, although still low, may begin to rise as the recovery process improves. Moreover, households’ price expectations tend to be substantially high owing to the upward bias, and they deviate substantially from actual price performance. However, such an upward bias may be corrected in the future once households’ tolerance for price rises gradually improves together with a sustainable income rise and more widespread understanding of the 2 percent target. That said, it is important for the BOJ to maintain an accommodative monetary environment to support economic recovery and make greater efforts to increase public awareness of that target and the BOJ’s intention. 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
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Osaka, 28 September 2015.
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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, 28 September 2015. * * * Introduction It is my great pleasure to have the opportunity today to exchange views with a distinguished gathering of business leaders in Kansai. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the Bank of Japan’s branches in Osaka, Kobe, and Kyoto. Looking at the recent economic developments, the slowdown in emerging economies, particularly China, has led to the sluggishness in Japan’s exports and production. Financial markets globally were volatile against the background of the decline in Chinese stock prices. Meanwhile, on the price front, the year-on-year rate of increase in the consumer price index (CPI, all items less fresh food) is about 0 percent, due mainly to the effects of the substantial decline in crude oil prices from 2014. Thus, somewhat stagnant developments have been noticeable since summer, but as I will explain, the fundamentals of Japan’s economy are sound and the underlying trend in inflation has been improving steadily. Quantitative and qualitative monetary easing (QQE), which the Bank introduced in April 2013, has been exerting its intended effects toward overcoming deflation. Today, before exchanging views with you, I would like to explain the Bank’s view on the current situation of and outlook for economic activity and prices, as well as its monetary policy. I. Economic activity in Japan and abroad Current situation of and outlook for Japan’s economy Let me start by discussing the current situation of and outlook for Japan’s economic activity. Japan’s economy has continued to recover moderately with a virtuous cycle from income to spending operating in both the corporate and household sectors, although exports and production are affected by the slowdown in emerging economies. That is, in the corporate sector, profits have marked a record high and firms’ fixed investment stance has been positive. In the household sector, wages have been growing – as seen in the rise in base pay for two consecutive years in a situation where the unemployment rate has declined to the level that can be regarded as almost corresponding to “full employment” – and private consumption has been resilient. The real GDP growth rate for the April-June quarter of 2015 was minus 0.3 percent on a quarter-on-quarter basis, registering a negative figure for the first time in three quarters (Chart 1). This is due to weak exports affected mainly by the recent slowdown in emerging economies and to somewhat sluggish private consumption reflective of bad weather. Exports are likely to remain more or less flat for the time being, due to the effects of the slowdown in emerging economies. After that, however, they are likely to increase moderately as emerging economies move out of their deceleration phase. On this basis, Japan’s economy is expected to continue recovering moderately, as the virtuous cycle from income to spending will continue to operate in both the corporate and household sectors. Now, I would like to touch on two points of note when observing Japan’s economic activity. BIS central bankers’ speeches Robust domestic private demand First, domestic private demand has continued to be robust. In the corporate sector, Japanese firms have been improving their profitability considerably in the face of various adversities that have occurred since the global financial crisis. In addition, with the correction of the excessive appreciation of the yen and with the decline in crude oil prices since summer 2014, Japanese firms have been making record profits, exceeding the peak registered before the global financial crisis (Chart 2). Looking ahead, corporate profits are expected to remain at their high levels. Under this favorable earnings environment, firms’ fixed investment stance is positive. Leading indicators such as machinery orders and construction starts also suggest an increase in business fixed investment. Firms’ positive fixed investment stance could be confirmed by various survey results. According to the June Tankan (Short-Term Economic Survey of Enterprises in Japan), the business fixed investment plans of large manufacturing firms for fiscal 2015 marked their highest level for this time of the year since fiscal 2004, reflecting in part an increase in domestic investment as it appears that the yen is likely to remain weak, and those of small firms marked roughly the same level as the average since fiscal 2000, suggesting robustness. What is worth noting is that, as the excessive appreciation of the yen is corrected, Japanese firms – which had been prioritizing foreign investment – seem to be increasing their domestic investment. This is a big change. On the back of a marked improving trend in corporate profits and the effects of monetary easing, business fixed investment is projected to continue increasing moderately. Turning to the household sector, labor market conditions are tight as firms have maintained their positive stance in hiring. The unemployment rate, which was above 4 percent before the introduction of QQE, has declined and recently registered 3.3 percent, a low level last seen in 1997, accompanying increases in both the labor force participation rate and the number of employees (Chart 3). Given that there is always a mismatch to some extent between job openings and job applicants in the labor market, the unemployment rate cannot go down to 0 percent. Estimating based on the past relation between job openings and job applicants in Japan, the recent unemployment rate of 3.0–3.5 percent could be regarded as almost corresponding to “full employment.” As labor market conditions are tight, nominal wages have been increasing moderately, albeit with some fluctuations. In the annual labormanagement wage negotiations this spring, many firms increased wages, including base pay, which was raised to a larger extent than last year (Chart 4). This development has even spread to small firms. Since the number of employees has been increasing and nominal wages per employee have risen, overall employee income has been increasing moderately. In terms of household spending, private consumption is somewhat sluggish recently, reflecting bad weather in the April-June quarter. Nevertheless, as the employment and income situation has continued with its steady improvement and consumer sentiment is on an improving trend, private consumption seems to have remained resilient on the whole. Looking ahead, with no consumption tax hikes this fiscal year – unlike last fiscal year – and crude oil prices declining on an annual basis, wage increases are expected to exceed price increases and thereby real wages are expected to rise. In this situation, private consumption is expected to be more resilient. Housing investment, the other component of household spending, having declined following the front-loaded increase prior to the consumption tax hike, has picked up evidently since the turn of the year against the backdrop of steady improvement in the employment and income situation. The pick-up is likely to continue going forward. Exports and overseas economies Second, I would like to touch on exports and overseas economies. Exports had increased for three quarters in a row since the July-September quarter of 2014, but have recently been more or less flat, due mainly to the effects of the slowdown in emerging economies (Chart 5). BIS central bankers’ speeches They are expected to remain more or less flat for the time being, but after that, they are likely to increase moderately, supported by the correction of the appreciation of the yen to date as emerging economies move out of their deceleration phase. Looking closely at the developments in overseas economies by region, the U.S. economy has continued to recover, underpinned by household spending. In the January-March quarter of 2015, economic growth decelerated significantly due to transitory factors such as the effects of the severe winter weather and the strikes at West Coast ports, but a clear rebound was observed in the April-June quarter, with high growth. Against the backdrop of the continued favorable employment and income situation, the growth momentum seems to be solid. The Federal Reserve’s tightening coming into sight also suggests improvement of the U.S. economy. The European economy saw continued growth of nine consecutive quarters and has continued to recover moderately. As the financial assistance to Greece is being implemented, global financial markets’ view on the situation has become positive. Going forward, as the effects of the depreciation of the euro and monetary easing permeate, the European economy will likely continue to recover moderately. While the advanced economies are growing steadily, the emerging economies are slowing. First, as for China, the recent substantial decline in stock prices has had a significant impact on global financial markets. This could be regarded as a correction of the excessive level in stock prices that had more than doubled during about the half-year prior to the decline. Nevertheless, the real economy has also seen somewhat of a slowdown recently. With the increase in income levels, the Chinese economy is experiencing a phase of a shift in its economic structure from one centered on manufacturers to one centered on the services sector, leading to a change from high growth to medium growth. The recent slowdown is considered to be the adjustments of excess investment in manufacturers in this phase. The fact that investment in regional economies has been weak as political, economic, and social structural reform is carried out seems to be another reason for the slowdown. Under this situation, the Chinese authorities have been providing a series of economic stimulus measures both on the fiscal and monetary fronts. With relatively large room for conducting policy measures both on the fiscal and monetary fronts, the Chinese economy is likely to follow a generally stable growth path, albeit at a somewhat reduced pace. Emerging economies other than China are also showing sluggishness, reflecting the spillover effects of adjustments in China and global weakness in IT-related demand. This sluggishness is likely to continue for some time, but as the positive effects of the growth in advanced economies spread, economic growth in those emerging economies is expected to gradually accelerate, with domestic demand picking up, supported by economic stimulus measures. As a main scenario, overseas economies, particularly advanced economies, are expected to continue to grow moderately, and emerging economies are likely to move out of the deceleration phase. On that basis, although Japan’s exports are expected to remain more or less flat for the time being, they are likely to increase moderately thereafter. Needless to say, due attention needs to be paid to risk factors including developments in the emerging economies and in the global financial markets. II. Japan’s price developments I will next talk about Japan’s price developments. The year-on-year rate of increase in the CPI (all items less fresh food) increased from minus 0.5 percent just before the introduction of QQE to 1.5 percent in April 2014, excluding the direct effects of the consumption tax hike. However, as somewhat weak developments in private consumption continued after the consumption tax hike and crude oil prices declined substantially from summer last year, annual CPI inflation declined and has been about 0 percent since the turn of the year (Chart 6). The absence of an acceleration in headline CPI inflation can be attributed to the negative contribution of energy prices. Because of this negative effect, the year-on-year rate of BIS central bankers’ speeches increase in the CPI has been pushed down by about 1 percentage point in recent months. Needless to say, unless crude oil prices continue to decline, the negative contribution of energy prices to the year-on-year rate of increase in the CPI eventually will dissipate. Simple arithmetic shows that the negative contribution of energy prices falling off alone will push up the year-on-year rate of increase in the CPI by about 1 percentage point compared with the current level. In addition, although the effects of the decline in energy prices have made it hard to discern, the underlying trend in inflation has steadily improved. For example, the year-on-year rate of change in the CPI for all items less fresh food and energy has been positive for 23 consecutive months since October 2013, and has increased to 1.1 percent according to the latest figure in August. Behind such steady improvement in the underlying trend in inflation is that firms’ and households’ views on prices have changed. The changes in firms’ and households’ views on prices have been revealed in their wageand price-setting behavior. To begin with, in the spring wage negotiations between workers and management last year, base pay was increased for the first time in two decades. In this year’s negotiations, base pay was raised for the second year in a row, and at many firms the increases were larger than last year (Chart 4). Base pay increases were achieved at more firms than last year and became widespread across industries and firms of different size. As for price setting, an increasing number of firms seem to be able to pass increased costs, including the rise in input prices and personnel expenses, on to sales prices. In addition, it seems that households have started to accept such sales price increases on the back of an increase or prospects for an increase in their wages. There is a variety of evidence that firms’ price-hiking behavior has become widespread and sustained since the start of this fiscal year. For example, looking at the items that make up the CPI (all items less fresh food), the share of items for which prices rose minus the share of items for which prices fell has risen markedly since the beginning of this fiscal year and recently has reached the highest level since 2000 (Chart 7). In addition, price indices compiled by the University of Tokyo and Hitotsubashi University by aggregating the prices of food and daily necessities also show clear price increases since April this year on a year-on-year basis, and the increases seem to be accelerating. Many firms attempted to raise their sales prices at the beginning of last fiscal year, but this coincided with the consumption tax hike, which was followed by a decline in demand. Firms therefore were forced to quickly take price rises back. The price changes this year present a clear contrast with those last year. The simultaneous occurrence of base pay increases and price hikes should be regarded as evidence that a positive feedback loop between the increases in employment and wages and the moderate rise in inflation is now in place. Given these developments, although annual CPI inflation is likely to be about 0 percent for the time being, with the underlying trend in inflation steadily rising and the negative contribution of the crude oil price decline dissipating, annual CPI inflation will accelerate toward the price stability target of 2 percent. The timing of reaching around 2 percent is projected to be around the first half of fiscal 2016, but it should be noted that the timing could be either earlier or later than the projection, depending on developments in crude oil prices. III. Monetary policy going forward The Bank has been pursuing QQE, aiming to achieve a state in which the 2 percent inflation rate is maintained in a stable manner. The observed inflation rate could move, reflecting various temporary factors; thus, in order to achieve 2 percent in a stable manner, the underlying trend in inflation is important. As I described earlier, the trend has been improving steadily. However, the positive feedback loop between the increases in employment and wages and the rise in inflation should gain further momentum in order to achieve the price stability target of 2 percent. BIS central bankers’ speeches 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. The Bank maintains its policy stance that, when there are changes in trend inflation due to manifestation of risk factors, it will make adjustments without hesitation if judged as necessary to achieve the price stability target at the earliest possible time. Concluding remarks Lastly, I would like to touch on the point that I believe is most important to ensuring that a virtuous cycle of the Japanese economy will continue to work. Now firms are enjoying record profits and the labor market is in a full-employment condition. In light of the mechanism of the economy, this naturally would lead to decent economic growth and to moderate increases in wages and prices, a view that I also share. At the same time, it is also true that the pace of increase in fixed investment and wages is lackluster in light of record profits. This is perhaps because deflation has been protracted in Japan and it takes time to change the deflationary mindset of firms and households. With this in mind, the Bank will continue to strongly commit itself to overcoming deflation and to achieving the price stability target of 2 percent. As I have explained on several occasions, in a situation where the 2 percent target is achieved in a stable manner, the current low interest rate environment would not last and the labor shortage would be more acute. Those who act early to move forward to secure opportunities in the future by utilizing profits currently at hand will be rewarded, and I am sure some of you have already started to act. The mechanism of the economy will surely prevail, and the Bank will definitely and decisively play its role. I will conclude my remarks by making this promise. Thank you. 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, held by the Naigai Josei Chosa Kai (Research Institute of Japan), Tokyo, 6 November 2015.
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Haruhiko Kuroda: Challenges to achieving the price stability target of 2 percent Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting, held by the Naigai Josei Chosa Kai (Research Institute of Japan), Tokyo, 6 November 2015. * * * Introduction It is my great honor to have the opportunity to address you today at the Naigai Josei Chosa Kai. At the Monetary Policy Meeting held on October 30, the Bank of Japan produced the Outlook for Economic Activity and Prices (Outlook Report) and published its projections for Japan’s economic activity and prices through fiscal 2017. Looking at the recent economic developments, Japan’s exports and production have been sluggish, reflecting the slowdown in emerging economies, particularly China. On the price front, the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) has declined and reverted to about 0 percent, due mainly to the effects of the substantial decline in crude oil prices. However, as I will explain, the fundamentals of Japan’s economy are sound and the environment surrounding firms and households has significantly improved compared to some years ago. Moreover, the underlying trend in inflation has been improving steadily. Quantitative and qualitative monetary easing (QQE), which the Bank introduced in April 2013, has been exerting its intended effects toward overcoming deflation. The Bank will continue to steadily pursue QQE and solidly maintain accommodative financial conditions. In this circumstance, firms and households are expected to be more proactive in economic activity, Japan’s economy is likely to continue growing at a pace above its potential, and the price stability target of 2 percent certainly would be achieved. Today, I would like to explain the Bank’s view on the outlook for economic activity and prices, as well as on its monetary policy while touching on the Outlook Report. I would first like to elaborate on the Bank’s baseline scenario regarding the outlook for economic activity and prices, which is considered most probable, and then touch on risks to the baseline scenario. I. Current situation of Japan’s economic activity and its outlook Corporate profits at high levels and firms’ positive investment stance Let me start by discussing the current situation of Japan’s economic activity and its outlook. As many of you must be aware, the slowdown in emerging economies, particularly China, has become marked recently, and this has affected Japan’s exports and production. In the April-June quarter of 2015, private consumption was somewhat weak, reflecting in part bad weather. Against this backdrop, the projected real economic growth rate for fiscal 2015 was revised downward to 1.2 percent in the Outlook Report compared with the projection of 1.7 percent in the July 2015 interim assessment (Chart 1). Nevertheless, corporate profits have been seeing record highs, and improvements in the employment and income situation have continued. A virtuous cycle from income to spending has been operating steadily in both the corporate and household sectors, and it is judged that Japan’s economy has continued to recover moderately. A situation in which corporate profits continue increasing despite the flattening of exports and industrial production was not commonly observed in Japan’s past economic recoveries. Let me point out two reasons why this time is different. The first is firmness in domestic demand. BIS central bankers’ speeches In the past economic recoveries, the general course of events was an increase in exports leading to rises in corporate profits and business fixed investment in the manufacturing sector; this time, the nonmanufacturing sector has shown a strong recovery on the back of resilience in domestic demand. This can be observed in a clear improvement in the diffusion index for business conditions and corporate profits of the nonmanufacturing sector compared to the manufacturing sector, as shown in the Tankan (Short-Term Economic Survey of Enterprises in Japan) (Chart 2). As the current economic recovery has been driven by domestic demand, even though Japan’s exports have become more or less flat due to the slowdown in overseas economies, the tolerance of Japan’s economy for this slowdown seems to be relatively high compared to the recoveries in the past. Second, the decline in commodity prices, mainly crude oil prices, affected in part by the slowdown in emerging economies, has pushed up profits through an improvement in the terms of trade. Put differently, a sort of automatic adjustment has been working in which the negative impact from a decline in quantity has been offset by positive effects in terms of prices. In addition, the rise in repatriated income from overseas business through dividends and interest, which has accelerated partly as a result of the depreciation of the yen, has contributed to the recent improvement in corporate profits. Under this favorable situation in corporate profits, firms’ fixed investment stance has become positive. According to business plans for fiscal 2015 released in the September Tankan, the year-on-year rate of growth of fixed investment plans for all enterprises and industries was revised upward from the June Tankan, from 3.4 percent to 6.4 percent. Turning to overseas economies, as shown in the October 2015 World Economic Outlook (WEO) published by the IMF, global growth for this year is projected to decline compared to 2014, but to accelerate toward 2016 (Chart 3). Advanced economies have continued to see a firm recovery trend, mainly in the United States. Emerging economies are likely to continue their slowdown for the time being. Since the Chinese authorities, having relatively large room for monetary and fiscal policy, have proactively been carrying out economic stimulus measures, the Chinese economy is expected to follow a generally stable growth path, albeit at a somewhat reduced pace. Emerging economies other than China are also likely to move out of their deceleration phase on the back of the robust growth in advanced economies. Based on these projections of overseas economies, the favorable developments seen in Japan’s corporate sector are likely to continue. Improvement in the employment and income situation, and resilient private consumption I would next like to explain developments in the household sector. Needless to say, the employment and income situation is a key factor in deciding household spending. On this point, the tightening trend in labor market conditions has continued. Namely, the active job openings-to-applicants ratio is currently 1.24 times, a high level last seen in 1992, and the unemployment rate has declined to 3.4 percent, a low level last seen in 1997 (Chart 4). What is worth noting is that the labor market has continued to tighten despite the flattening of exports and production. In fact, as seen in the diffusion index for employment conditions released in the September Tankan, a perception of labor shortage has heightened further among firms, and the labor market can be regarded as being in a situation of “full employment.” As corporate profits have increased to their highest level historically and tightening in labor market conditions has continued, there has been upward pressure on wages. Based on the Monthly Labour Survey, scheduled cash earnings have increased, reflecting in part a rise in base pay, which was seen for two consecutive years (Chart 5). According to various survey results, summer bonuses this year were raised in many sectors and firms. As a result, the employment and income situation has been improving steadily, and consumer sentiment, which deteriorated after the consumption tax hike in 2014, has been on an improving trend on the whole (Chart 6). Private consumption for the April-June quarter was somewhat weak BIS central bankers’ speeches due to lackluster sales of small cars and the effects of bad weather, but results of various sales statistics suggest that private consumption has turned to an increase since around July in many categories, and can be judged as being resilient on the whole. With a virtuous cycle from income to spending in both the corporate and household sectors, Japan’s economy through fiscal 2016 is likely to continue growing at a pace above its potential, which is currently estimated to be around 0.5 percent or lower. Thereafter, through fiscal 2017, the economy is projected to maintain its positive growth, although with a slowing in its pace to around a level somewhat below the potential growth rate. The slowdown is due mainly to (1) the effects of a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike planned in April 2017 and (2) cyclical deceleration. II. Price developments and the path toward achieving the price stability target of 2 percent Current state of and outlook for prices Let me turn to price developments. The year-on-year rate of change in the CPI for all items less fresh food, which was minus 0.5 percent just before the introduction of QQE, increased to as high as 1.5 percent in April 2014, excluding the effects of the consumption tax hike. However, as somewhat weak developments in private consumption continued after the consumption tax hike and crude oil prices declined substantially from the summer of 2014, annual CPI inflation declined and has been about 0 percent in recent months (Chart 7). Nevertheless, the underlying trend in inflation has steadily improved, excluding the effects of the decline in energy prices. For example, the year-on-year rate of change in the CPI for all items less fresh food and energy has been positive for 24 consecutive months since October 2013, increasing to 1.2 percent this September. This was the first time since the late 1990s, when Japan’s economy fell into deflation, that a continued price increase was seen. Meanwhile, the rate of increase in the daily or weekly price indices, such as for food and daily necessities, has followed an accelerating trend since this April. Firms’ price-hiking has become widespread and sustained, as seen in the fact that the share of items in the CPI for which prices have risen has been outweighing that for which prices have declined by an increasing margin (Chart 8). Monthly data for the CPI are susceptible to various factors, such as developments in import prices that reflect changes in energy prices and fluctuations in foreign exchange rates. On the other hand, the underlying trend in inflation is determined mainly by the output gap and medium- to long-term inflation expectations. From this perspective, significant changes that have not been seen in recent years are taking place. I will elaborate on these two aspects as follows. Developments in the output gap The output gap indicates the supply and demand balance of Japan’s economy as a whole; that is, the extent to which capital and labor are utilized. Although capacity utilization has continued its increasing trend as the economy continues to recover moderately, the effects of the flattening of exports, reflecting the slowdown in emerging economies, have been observed recently (Chart 9). Meanwhile, labor market conditions have continued to tighten. This is partly because, reflecting firmness in domestic demand, the current economic recovery has been largely attributable to the nonmanufacturing sector, which is more laborintensive than the manufacturing sector. Therefore, the output gap has steadily followed its improving trend, mainly on the labor side (Chart 10). Looking ahead, with the economy expected to continue growing at a pace above its potential, capital and labor utilization is likely to rise further and thereby the output gap is expected to continue improving further. Thus, upward pressure on prices stemming from the output gap is likely to increase steadily. BIS central bankers’ speeches Developments in medium- to long-term inflation expectations Let me move on to inflation expectations. Medium- to long-term inflation expectations appear to have been rising on the whole from a somewhat long-term perspective. Inflation expectations can be assessed from various market indicators and survey results. Although there are some indicators or results showing that inflation expectations have been somewhat weak, they have been flat on the whole recently, despite the significant decline in crude oil prices (Chart 11). In addition, it is important to analyze firms’ and households’ views on prices upon which they engage in economic activities. Since the turn of the fiscal year, firms’ price-hiking behavior has been increasingly conspicuous. At the same time, households have come to accept price increases as well, against the backdrop of actual and prospective increases in their income. The increases reflect rises in wages, including base pay, which took place at many firms. This makes a striking contrast with the episode that occurred last April, when many firms attempted to raise their sales prices, only to back off rather quickly as demands faltered, perhaps because this move coincided with the consumption tax hike. As firms’ and households’ views on prices have changed clearly, especially since the turn of the fiscal year, a positive feedback between the increase in wages and the moderate rise in inflation is now firmly in place on the back of record profits. Relationship between wage increases and inflation I would like to elaborate on the relationship between wage increases and inflation of goods and services. Our experience shows that wage increases have been moving almost in parallel with inflation of goods and services (Chart 12). It often is said that, if wages do not match up with inflation, real income will decrease, thereby exerting negative effects on consumption. However, such developments, if they occur at all, will not last for long, at least in the economy as a whole. This is because, if they were to occur, consumption will decrease, making it difficult for firms to keep raising prices. In turn, if wages increase, firms will be urged to raise their sales prices in order to secure their profit margins, leading to higher inflation. Thus, there are only two scenarios in reality: either both wages and prices increase or neither wages nor prices increase. Wage increases and price rises are two sides of the coin, so to speak. QQE, which the Bank has been pursuing, is not intended to engineer increases merely in prices by any means. But rather, it is designed, in accordance with the mechanism of the economy, to realize a moderate inflation being accompanied with wage increases. Looking ahead, as the Bank pursues QQE and the observed inflation rate rises, medium- to long-term inflation expectations are also likely to follow an increasing trend and gradually converge to around 2 percent – the price stability target. Accordingly, firms’ wage- and pricesetting behavior is expected to be more proactive, and inflation rates are likely to gradually rise accompanied by wage increases. The year-on-year rate of change in the CPI for all items less fresh food is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices and, as the underlying trend in inflation steadily rises and the effects of the decline in crude oil prices dissipate, the rate of increase is expected to accelerate toward 2 percent – the price stability target. Although the timing of reaching around 2 percent depends on developments in crude oil prices, it is projected to be around the second half of fiscal 2016, assuming that crude oil prices will rise moderately from the recent level. As shown in the October 2015 Outlook Report, the projected rates of increase in the CPI for fiscal 2015, 2016, and 2017 are 0.1 percent, 1.4 percent, and, excluding the direct effects of the scheduled consumption tax hike, 1.8 percent, respectively (Chart 1). Compared to the projections in the July 2015 interim assessment, the projected rates of increase in the CPI for fiscal 2015 and 2016 are lower due mainly to the effects of the decline in crude oil prices, but the projection for fiscal 2017 is more or less unchanged. BIS central bankers’ speeches III. Risk factors regarding the outlook for economic activity and prices I have so far explained the baseline scenario regarding the outlook for economic activity and prices. However, there are various uncertainties surrounding the economy, and I would like to touch on the risk factors that can affect the outlook for economic activity and prices. The most important risk factor with regard to the outlook for economic activity is the slowdown in emerging economies, particularly in China. The Chinese economy is currently in the transition process from investment-driven high growth to consumption-driven stable growth. The industrial structure is also shifting from one centered on manufacturing to one on nonmanufacturing. It is in this context that economic activity in manufacturing has been sluggish recently, whereas that in nonmanufacturing maintains its robustness (Chart 13). With regard to short-term developments, the pace of increase in spending by local governments, whose deceleration was one of the sources of sluggishness in the Chinese economy in the first half of this year, has accelerated recently, due partly to instructions by the central government and the measures taken to facilitate the financing of local governments (Chart 14). It therefore is expected that the growth rate in China will accelerate toward next year. That said, we have to bear in mind the risk that the structural problems, such as excess capacity in steel, automobiles, and other industries, will be protracted in the transition process toward stable economic growth. There is also an uncertainty about the impact of fiscal stimulus, depending on its composition, on boosting the economy. Even if the growth rate in China picks up, its impact on other economies in East Asia should be carefully assessed (Chart 15). In China, the relative weight of nonmanufacturing has been on the rise, and even within the manufacturing sector, domestic production of manufactured parts and products with high value-added, which were mostly imported previously, has been increasing. Against this background, the effects of the economic growth in China stimulating exports of other countries in East Asia via a trade channel have been getting smaller. Taking this into account, there remains uncertainty about the impact of the positive spillover from the recovery of the Chinese economy on other economies in East Asia. As I described earlier, the slowdown in emerging economies already has been exerting downward pressure on Japan’s exports and production, which already is incorporated in the baseline scenario. If the slowdown in emerging economies is within the range of our assumption, notwithstanding its negative impact, Japan’s economy is expected to continue to grow, reflecting the steady increase in domestic demand and the positive impact of the decline in energy prices on real income. However, if the slowdown in emerging economies becomes much deeper than expected or prolonged, the negative impact on Japan’s economy accordingly will be larger. What matters most is the impact on the business confidence of Japanese firms. If firms start to downsize their fixed investment plans or wage increases against the backdrop of increasing concerns over the developments in emerging economies, this will have a negative impact on the steady increase in domestic demand. Although this is currently one of the risk factors rather than a probable scenario, we are mindful of it. When it comes to the impact on prices, the focal point is the developments in wage increases toward next fiscal year. As I described earlier, the rates of increase in wages and in prices move almost in parallel in the long run, and the underlying trend in inflation already has shown a clear improving trend. In order to maintain the real wages and income of households, it is important for the underlying trend in inflation to be reflected in wage increases, notwithstanding the recent seeming decline in the rate of change in inflation. In the baseline scenario, wage increases that are consistent with the trend inflation are expected. We are mindful of a downside risk, however, of firms becoming more cautious with regard to wage increases against the backdrop of uncertainties regarding developments in overseas economies, particularly emerging economies. There is also a downside risk that, in BIS central bankers’ speeches the case of insufficient wage increases, consumers will become more resistant to price increases on goods and services, pushing down the pace of inflation. IV. Challenges toward overcoming deflation Japan’s economy has been improving steadily toward achieving the price stability target of 2 percent, but it is only halfway through and due attention needs to be paid to risk factors including developments in emerging economies. In my concluding remarks, I would like to touch on the challenges toward overcoming deflation and achieving the price stability target of 2 percent, particularly those of firms’ behavior and monetary policy. As I described earlier, firms are now enjoying record profits and the labor market can be considered to be in a situation of full employment. In light of the mechanism of the economy, under such favorable circumstances, firms are expected to increase business fixed investment for their future growth, and to raise wages to secure the labor force needed for the further expansion of business and production. Indeed, they continue to show a positive stance toward fixed investment, and wages have been rising moderately, including base pay increases. At the same time, however, the data to date give us an impression that the pace of increase in fixed investment and wages is not at a high enough level in light of record profits. The fact that firms are still restrained from spending amid a high level of profits is also evidenced from the ample cash they hoard, which has accumulated to an even higher level (Chart 16). One of the reasons behind such restrained behavior of firms – exemplified by record profits mostly being used just to build up already ample cash rather than being used for fixed investment and wages – is that the deflationary mindset of firms still has not necessarily been removed. From a different perspective, firms tend to see the current high level of profits as windfall profits, being only transitorily helped by the current benign circumstances, and thus they restrain from taking advantage of them. Given that Japan’s economy has been mired in deflation for a long period of time, it is never easy to get out of such a situation and dramatically change firms’ persistent mindset. But the direction is clear. Firms should be strongly encouraged to devise a new strategy that fits with the post-deflation era based on the prospect of Japan’s economy overcoming deflation. In light of this prospect, firms’ forward-looking actions, which were not sufficiently rewarded in the deflationary period, look quite promising. Firms should recognize that, without such actions, it will be difficult to generate profits in the future and to increase firms’ value. Not all firms need to change at the same time. The more firms start to act in view of such a prospect, the more vibrant the economy will become. Some forward-looking firms have started to act already, and they will be rewarded in the end if such actions become widespread. The Bank of Japan will definitely and decisively play its role to make this happen. For these past two and half years, the Bank has strongly committed to achieving the price stability target of 2 percent and has been pursuing QQE. Japan’s economy has been improving steadily toward achieving the target. The Bank will continue the unprecedented large-scale monetary easing to achieve the target. As I explained, the Bank currently is of the view that the price stability target of 2 percent can be achieved through continuation of the current policy. At the same time, the Bank will continue to carefully assess economic activity and prices, recognizing downside risks to them, including the effects of the slowdown in emerging economies. The Bank will make the most appropriate policy decisions by scrutinizing the current situation of economic activity and prices and their outlook, various risk factors, and developments in financial and capital markets at every Monetary Policy Meeting. Let me reiterate that the Bank will make adjustments without hesitation if judged as necessary to achieve the price stability target of 2 percent 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 BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Yutaka Harada, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Tochigi, 11 November 2015.
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Yutaka Harada: Economic activity and prices in Japan and monetary policy Speech by Mr Yutaka Harada, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Tochigi, 11 November 2015. * * * Introduction This will be my first speech to deliver as a Policy Board member of the Bank of Japan. Before starting, I would like to extend my sincere condolences for the lives lost and to the people who have suffered from the heavy rains that devastated areas including Tochigi Prefecture in September. Thank you for giving me this opportunity to exchange views with people representing Tochigi, who have taken time to be here despite their busy schedules. It is indeed a great honor to be here today. Please allow me to express my gratitude for your great cooperation with the activities of the Bank’s Research and Statistics Department on the economy of Tochigi, and also with those of the Bank’s other departments. Around two and a half years have passed since the Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013. Today, I would like to offer my assessment of QQE and then discuss the Bank’s outlook for economic activity and prices through fiscal 2017 indicated in its report, the Outlook for Economic Activity and Prices (hereafter the Outlook Report), which was released at the end of October this year. Following my speech, I look forward to hearing your views on the actual situation for Tochigi’s economy, and to your candid opinions. I. Major shift in monetary policy The current QQE was adopted following a major shift from the previous monetary policy regime. In January 2013, the Bank 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, in March that year, Mr. Haruhiko Kuroda was appointed as Governor of the Bank, and in April, the Bank introduced QQE in order to achieve the price stability target at the earliest possible time, with a time horizon of about two years. QQE consists of a strong commitment to achieving 2 percent inflation in terms of the yearon-year rate of change in the CPI and bold monetary easing measures to underpin such a commitment. At the Monetary Policy Meeting held on April 3 and 4, 2013, the Bank decided on the following specific measures. First, it decided to change the main operating target for money market operations from the interest rate – namely, the uncollateralized overnight call rate – to the monetary base, and to conduct money market operations so that the monetary base would increase at an annual pace of about 60–70 trillion yen, doubling in two years, from 138 trillion yen at the end of 2012 to 270 trillion yen at the end of 2014. Second, in terms of the qualitative aspect, with a view to encouraging a further decline in interest rates across the yield curve, the Bank decided to purchase Japanese government bonds (JGBs), so that the amount outstanding of its holdings would increase at an annual pace of about 50 trillion yen, similarly doubling in two years, from 89 trillion yen at the end of 2012 to 190 trillion yen at the end of 2014. In addition, the Bank decided to extend the average remaining maturity of its JGB purchases from slightly less than three years to about seven years. Third, with a view to lowering the 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 would increase at an annual pace of 1 trillion yen and 30 billion yen, respectively. And fourth, the Bank committed to continuing with QQE, aiming BIS central bankers’ speeches to achieve the price stability target of 2 percent, as long as it was necessary for maintaining that target in a stable manner. Furthermore, the Bank decided to expand QQE in October 2014 to prevent a risk that conversion of the deflationary mindset would be delayed because, after the consumption tax hike in April that year, it became clear that the negative effects of the hike on economic activity and prices would persist, and also because of the drop in crude oil prices – a factor that would be desirable in the longer term but exert downward pressure on prices in the short term. Specifically, the Bank decided to accelerate the annual pace of increase in the monetary base from 60–70 trillion yen to 80 trillion yen, and to increase purchases of JGBs so that the amount outstanding of its holdings would be increased from an annual pace of 50 trillion yen to 80 trillion yen. The average remaining maturity of the Bank’s JGB purchases would be extended from about seven years to a range of seven to ten years. In addition, the Bank decided to accelerate the annual paces of increase in the amounts outstanding of its holdings of ETFs and J-REITs from 1 trillion yen and 30 billion yen, respectively, to 3 trillion yen and 90 billion yen. Next, I will explain what has occurred as a result of these monetary easing measures, as well as the problems with them. II. Consequences of the monetary policy shift Trends in production, consumption, and investment First, I will talk about trends in production, consumption, and investment over the period of around two and a half years since the introduction of QQE. Chart 1 shows that, excluding the negative effects of the consumption tax hike in April 2014, investment, in terms of domestic shipments and imports of capital goods, has been expanding as a trend, although it has shown weakness very recently. On the other hand, production and consumption have been stagnant. Even excluding such factors as the effects of the front-loaded increase in demand prior to the consumption tax hike and the subsequent decline, it is difficult to say that production and consumption have been recovering steadily. The effects of the consumption tax hike have been particularly large on consumption. The Synthetic Consumption Index – which is a combination of supply-side and demand-side statistics and shows similar movements to consumption on a GDP basis – has not yet surpassed the peak before the front-loaded increase in demand. However, it is natural that a consumption tax hike leads to a decrease in consumption because the hike reduces households’ real income. What is important is whether real consumption is increasing as a trend despite this phenomenon. The Bank’s baseline scenario is that consumption has been resilient, but I think that there have been some worrisome developments in consumption very recently, as in production. Steady growth in employment In contrast, employment has grown steadily since the shift to QQE. As shown in Chart 2, the numbers of both part-time and full-time employees have continued rising. The unemployment rate has been declining steadily. The active job openings-to-applicants ratio, as shown in Chart 3, was 1.24 times in September 2015, marking its highest since January 1992. Improvement in employment is spreading across Japan, although we have heard voices of concern that the economic recovery has only been observed in major cities. As shown in Chart 3, the active job openings-to-applicants ratio has risen in all regions, although it had temporarily declined following the consumption tax hike. It rose to 0.99 times in September 2015 in Hokkaido, where the ratio has been the lowest in Japan. BIS central bankers’ speeches Increase in wages It has been said that wages have not increased despite the rise in employment. However, as shown in Chart 4, employee income – that is, wages multiplied by the number of employees – has increased. Real employment income has also increased, when excluding the effects of the April 2014 tax hike. Since April 2015 – when the effects of the tax hike dissipated – the uptrend in employee income has become clearer. Here, I would like to note that, according to the Monthly Labour Survey, employment income fell sharply in June and did not rebound much in July. However, the results seem odd given that all surveys concerning the outcome of summer bonus payments in 2015 indicated a year-on-year increase. 1 I personally think that there was a sample bias in the Monthly Labour Survey. One reason wages are not rising is that the commonly used data on wages are the monthly average of wages for all employees. During the early stage of an economic recovery, firms try to meet increases in labor demand by hiring non-regular employees. This is because they are not sure whether such demand will grow continuously. As a result, during this stage of economic recovery, the number of employees increases for those with low hourly wages and short monthly working hours. Statistically, this appears as a decline in the monthly average wages for all employees. If economic recovery continues, firms will start to hire regular employees, but it takes time before they do so. Chart 5 shows nominal hourly wages for full-time and part-time employees. As wages for fulltime employees include bonuses, their wage level fluctuates widely even after making seasonal adjustments, and therefore it is difficult to find a clear trend. However, the wage level for part-time employees has been rising in a stable manner. Wages for both full-time and part-time employees are likely to increase in a sustainable manner as the economic recovery continues, enabling us to confirm an uptrend in wages. As for the rate of increase in wages between April 2013 – when QQE was introduced – and September 2015 – the latest month for which the data are available – the rate for part-time employees was 3.8 percent, which is higher than the rate for full-time employees of 1.2 percent. Sluggish growth in exports There has been criticism that exports have not grown even after the introduction of QQE. On the other hand, those who have opposed monetary easing have argued that this policy would create a serious problem by causing exports to surge, which would reignite trade frictions. However, the economy is improving and exports have not grown much, as shown in Chart 6, and I believe this is a rather desirable situation on balance. I will refer to the outlook for exports later. There is a strong perception that exports have been the main driving force of Japan’s economic recovery. However, past experience shows that exports have not necessarily acted as such during economic recovery phases. 2 Chart 6 shows the real export index, the real import index, and the difference between the two; that is, the real trade balance. Here, only the upward/downward movement of the real trade balance, and not the absolute level, is meaningful. Japan’s economy has experienced five recovery phases since 1990, from the troughs of October 1993, January 1999, January 2002, March 2009, and November 2012. However, exports and the trade balance increased simultaneously only in two phases, in According to the Monthly Labour Survey, summer bonus payments in 2015 (special cash earnings for the June-August period) were minus 3.3 percent on a year-on-year basis. Surveys conducted by the Japan Business Federation (Keidanren), Nikkei Inc., the Institute of Labour Administration, and the Ministry of Health, Labour and Welfare indicated increases of 2.8 percent, 2.1 percent, 3.0 percent, and 4.0 percent, respectively. This is when “export-driven” growth is defined as the growth in net exports, which in turn contributes directly to GDP growth. BIS central bankers’ speeches 2002 and 2009. Moreover, in the 2002 phase, the trade balance started to increase after more than three years had passed since the trough. In the 2009 phase, the trade balance increased at first but decreased thereafter. These findings indicate that the monetary easing policy can achieve economic recovery without causing such problems as trade frictions. Decline in crude oil prices has been weighing on price increases We cannot rule out the risk of a pause in economic recovery, and yet, as I have explained, the economy thus far has continued to recover, albeit at a moderate pace. In particular, employment has been improving continuously. Even so, some people may criticize the Bank for not being able to achieve the price stability target of a year-on-year rate of increase in the CPI of 2 percent. As shown in Chart 7, prices do not appear to be rising, as the year-on-year rate of change in the CPI (all items less fresh food) was negative for September, registering minus 0.1 percent 3. However, this was caused by a decline in energy prices due to the fall in crude oil prices worldwide, and prices in terms of the CPI for all items less fresh food and energy show a steady increase. As energy prices will not continue falling forever, I am confident that the CPI for all items, including energy, will start to rise as the effects of the fall in energy prices dissipate over time. Monetary policy and price movements Chart 8 shows the correlation between the monetary policy and price movements since 2012. This chart indicates the actual inflation rates in terms of the CPI and inflation expectations; namely, the breakeven inflation (BEI) rates, which are calculated from the price of inflation-indexed JGBs. 4 Both the BEI rates and the CPI started to rise after the introduction of QQE in April 2013 that followed the inauguration of the second Abe Cabinet in December 2012. However, after entering fiscal 2014, increases in the CPI excluding the effects of the consumption tax hike, the CPI for all items less fresh food, the CPI for all items less fresh food and energy, and also the BEI rates became stagnant. To resolve this situation, the Bank expanded QQE in October 2014, and the BEI rate and the CPI for all items less fresh food and energy started rising again. In light of this result, the introduction and expansion of QQE have been effective in pushing up the inflation rate, as recent price developments show. Here, I would like to note that the consumption tax hike has a negative impact on economic activity, and that this works to push down the inflation rate. The hike reduces consumer demand by exerting downward pressure on households’ real income, which then lowers the inflation rate. I feel that, in many cases, this is a point that is forgotten in discussions on prices. The reasons why the bank had not implemented monetary easing Japan’s economy has been recovering and moving toward overcoming deflation as a result of QQE. Until this bold measure was taken under Governor Kuroda’s leadership, there had been criticism that the Bank had not been implementing sufficient monetary easing. The following arguments have been pointed out as reasons behind the Bank’s hesitation at that time. The Bank was not able to implement monetary easing given that interest rates were at While the Bank has adopted the CPI for all items including fresh food as its price target, to determine the underlying trend in prices, it makes forecasts for the CPI for all items less fresh food, for which prices fluctuate significantly. The Bank makes an assessment of inflation expectations by taking into account indicators based on surveys conducted of firms, households, and economists, in addition to those calculated from market data, e.g., the BEI based on transaction prices of inflation-indexed JGBs shown in Chart 8. BIS central bankers’ speeches zero. Even if quantitative easing were to be implemented, this would only increase the outstanding balance of private banks’ current accounts held at the Bank and would not stimulate lending. Under zero interest rates, quantitative easing would not affect the yen’s exchange rates against other currencies. Should the yen depreciate, there would be a serious problem of invoking competition among countries to devalue their currencies. In reality, the Bank has managed to implement effective monetary easing both in terms of quantity and quality. Bank lending has been increasing, and, as I discussed earlier, the yen has depreciated without causing competition among countries with regard to devaluing their currencies. 5,6 Another argument that has been pointed out is concern about the risk that monetary easing would lead to higher interest rates in the long term and cause some banks that are holding a large amount of JGBs to be saddled with massive unrealized capital losses on their JGB holdings. A rise in interest rates is naturally a positive factor for banks’ business conditions in the long term, but it is likely to temporarily increase their losses before getting to that stage. However, I believe that, even if there was indeed such a risk, the Bank should not have put off monetary easing. This is because, if deflation is allowed to continue, banks will have no option but to increase their holdings of JGBs in the absence of borrowers. Loans account for a large portion of banks’ assets. An interest rate rise of 1 percentage point would reduce the total value of bonds held by the entire banking sector by 7.5 trillion yen, compared with the total assets outstanding of nearly 1,200 trillion yen. 7 If deflation is overcome and interest rates rise as a result of economic recovery, the business conditions of banks’ borrowers will improve, enhancing the soundness of loan assets. In other words, the business conditions of banks will improve when interest rates rise as a result of economic recovery. In a newspaper opinion page, Professor Paul Krugman of Princeton University, a Nobel economic sciences laureate, cited “the Fed’s strange, destructive turn away from expansionary policy in 1932” in the midst of the Great Depression, arguing that “a key factor [behind the decision] was the complaints of commercial banks that low interest rates on government securities were squeezing their profits.” 8 Given that the monetary tightening led to a further deepening of the depression and deterioration of banks’ business conditions, the tightening clearly was a misjudged action that focused on narrow and fleeting interests. III. Transmission mechanism of QQE for economic recovery Thus far, I have shown that QQE has helped Japan’s economy recover, albeit at a moderate pace. Now, I would like to discuss the mechanism through which this has been achieved. QQE has been effective in reducing real interest rates by lowering long-term interest rates and raising inflation expectations. The Bank has committed to increasing the monetary base in order to raise inflation expectations, and the increase in the monetary base has had In the current phase of economic recovery, bank lending has been increasing, but there were many cases in the past where the economy recovered as a result of monetary easing without an increase in bank lending. For details, see Yutaka Harada, “Nihon wo Sukutta Rifure-ha Keizaigaku (Reflationalist Economics that Saved Japan),” Nikkei Publishing Inc., November 2014, pp.49–50 (available only in Japanese). For details on foreign exchange rates mentioned in the arguments, see Ai Nakagawa and Yutaka Harada, “Kinyu Kanwa Seisaku, Tsuka Sensou, Koueki Joken (Monetary Easing Policy, Competitive Devaluation, and Terms of Trade),” The Keizai Seminar, December 2015-January 2016, Nippon Hyoron Sha Co. Ltd. (forthcoming; available only in Japanese). Bank of Japan, Financial System Report, October 2015, charts III-1–29 and IV-2–2. Paul Krugman, “Rate Rage in 1932,” The New York Times, September 22, 2015. BIS central bankers’ speeches portfolio rebalancing effects in the broad sense of the term; namely, the effects of boosting stock prices and weakening the yen. 9 Chart 9 shows the BEI rates, which are calculated from the price of inflation-indexed JGBs, and real interest rates. From the chart, we can see that inflation expectations in terms of the BEI rate started to rise following the introduction of QQE. This will reduce real interest rates, leading to a rise in asset prices, a decrease in the yen’s exchange rate, and an expansion in employment and production through an increase in business fixed investment and consumption of durable goods, and consequently economic recovery. IV. My views on criticisms against QQE As I have explained, QQE has somehow managed to support economic recovery. There is a theoretical basis for this, but even so, criticism against this policy has not subsided. Let me first introduce a general criticism. Many people do not feel that the economy is recovering. Indeed, only about 10 percent of respondents answered that economic conditions have improved in the Bank’s survey. Chart 10 shows the trend in responses to the question: “How do you think economic conditions have changed compared with one year ago?” Here, 10 percent is by no means low. Even at its peak before the Lehman shock, the ratio was only at around 20 percent. Considering the effects of the consumption tax hike in fiscal 2014, it will take time before people begin to feel more strongly that economic conditions are improving. Criticisms against monetary policy are as follows. Exports have not grown even after the introduction of QQE. It is true that exports had been sluggish at the time of the introduction. However, this was due to the shift of Japanese firms’ production sites to overseas that was brought about by the fact that no measures were taken to deal with the appreciation of the yen after the Lehman shock. Even though the yen has depreciated, it takes time to shift production sites back to Japan. If a monetary easing policy like the one that is now in place had been adopted immediately following the Lehman shock, I think that this situation could have been avoided. Meanwhile, revenue from inbound tourism, which is part of service exports, has grown by a considerable degree. Such revenue, which was 1.2 trillion yen in 2012, rose to 1.5 trillion yen in 2013 and nearly 2.0 trillion yen in 2014, and already has exceeded 2.0 trillion yen in the January-August period of 2015. It takes time to shift production sites back to Japan, but tourism is apparently an industry that can respond quickly. However, it is necessary to make additional investment, such as in hotels, in order to continue attracting international tourists, as the lack of hotels has become conspicuous. Since the beginning of 2015, exports have been declining again, but this has been caused by a temporary pause in the U.S. economic recovery and the slowdown in growth in emerging economies, including China. Another criticism concerning monetary policy is that QQE will weaken fiscal discipline by making it easier for the government to issue JGBs. Needless to say, the objective of monetary policy is to dispel the deflationary mindset and achieve the price stability target of 2 percent, thereby improving and stabilizing economic activity. Monetary Affairs Department, “Quantitative and Qualitative Monetary Easing: Assessment of Its Effects in the Two Years since Its Introduction,” Bank of Japan Review Series, 2015-E-3, May 2015; Kikuo Iwata and Yutaka Harada, “Kinyu Seisaku to Seisan: Yoso Infureritsu no Keiro (Monetary Policy and Production: A Channel of Expected Inflation Rate),” Waseda Institute of Political Economy Working Paper, No.1202, March 2013 (available only in Japanese). BIS central bankers’ speeches If fiscal discipline weakens due to monetary policy, the same is true in the case of a tax hike. If the government squanders revenues because it is easy to issue JGBs, I believe that it will also squander additional revenues gained from a tax hike. The government and the parliament are responsible for maintaining fiscal discipline, and monetary policy should be independent. Another line of criticism is that QQE is a failure because prices are not rising. QQE would be criticized as a serious failure if prices rose without employment growth. In my opinion, growing employment means that this policy has been very successful. Prices will rise in due course in line with the narrowing of the output gap and a decline in the unemployment rate, both of which follow expansion in employment; thus, there is no cause for concern. The last example pertains to future concerns: a serious problem will come up sooner or later even though the current situation may be favorable. For example, people making such a criticism argue that QQE eventually will lead to hyperinflation despite the lack of an increase in prices so far, a surge in interest rates, or a loss of confidence in the currency due to impairment of the Bank’s balance sheet. I think that these arguments are merely pointing to what could occur in the future, whereas the present situation has proved to be favorable. V. The October 2015 outlook report I have basically talked about the past thus far, but would now like to discuss the outlook for Japan’s economy in and after fiscal 2015, based on the recently released October 2015 Outlook Report. The Bank’s baseline scenario of the outlook for economic activity – that is, the median of the Policy Board members’ forecasts of the real GDP growth rate – as in Chart 11, was 1.2 percent for fiscal 2015, 1.4 percent for fiscal 2016, and 0.3 percent for fiscal 2017. The forecast of the real GDP growth rate for fiscal 2017 is low because consumption obviously is likely to be restrained as the result of another consumption tax hike scheduled to take place in April 2017. To respond to this situation, I believe that various approaches are expected to be taken under the government’s strategic framework of Abenomics as well as the promotion of dynamic engagement of all Japanese citizens. The Bank’s baseline scenario of the outlook for prices – that is, the median of the Policy Board members’ forecasts of the year-on-year rate of increase in the CPI (all items less fresh food) – was 0.1 percent for fiscal 2015, 1.4 percent for fiscal 2016, and 3.1 percent for fiscal 2017 on a basis including the effects of the scheduled consumption tax hike, and 1.8 percent on a basis excluding such effects. The forecast for fiscal 2017 is lower than that for fiscal 2016 because the negative impact of the scheduled consumption tax hike on the economy will exert downward pressure on prices as well. I have explained the Bank’s baseline scenario so far. My outlook for economic activity and prices is only slightly weaker, and I do not feel it is necessary to explain it in detail. Risk of economic deceleration In terms of economic activity and prices, there are indeed many risks that deviate from projections. Here, I will discuss solely the Chinese economy, over which uncertainty has been spreading since this summer. There is a criticism that data on the Chinese economy released by the Chinese statistics office are unreliable. I admit that these data may be questionable. But I do not think that the economic activity indicated by these data has diverged widely upward from the actual situation. How can we confirm whether the recent economic activity in China indicated by the official statistics – for example, production – diverges widely from the actual situation? On this point, rather than looking at statistics with a high degree of processing, such as those for BIS central bankers’ speeches production and GDP, I think we should examine economic data with a relatively low degree of processing – for example, real exports and imports, as well as the Purchasing Managers’ Index (PMI) for manufacturing activity that consists of an indicator compiled by the Chinese government and one by a private-sector organization called Markit – or data for economies that are closely connected with production in China, such as production in Taiwan and South Korea. All of these data showed movements corresponding to the official statistics on Chinese production. Recently, however, the figures estimated by the regression between these data and the official statistics have shown higher growth rates than the official statistics. Among them, I have shown only the results calculated using data on Taiwan and South Korea in Chart 12. The results indicate that the official statistics on Chinese production have not been overly assessed upward. Japan’s exports to China may face stagnation due to the economic slowdown in China, and this eventually may lead to deceleration in Japan’s economy. In fact, Japan’s exports to China have already been decreasing. However, I do not think that they will see a significant further decrease. Meanwhile, the possibility cannot be ruled out that, if such a decrease in exports becomes large, this will lead to a decline in production, and further to a deterioration in employment. Concluding remarks As I mentioned, QQE has been exerting its intended effects. Despite the negative impact of the April 2014 consumption tax hike, employment has continued to recover. The active job openings-to-applicants ratio has risen in all regions, although it had been said that Abenomics would not benefit local economies. It also has been said that wages have not increased despite the rise in employment, but hourly wages have been rising. Employee income – that is, wages multiplied by the number of employees – also has increased in real terms. Corporate profits have been increasing as well, and thus so has income. If these developments lead to positive movements in spending, such as consumption and investment, production will recover. Unfortunately, however, recoveries in consumption and investment remain weak despite the continued rise in income. Prices have not risen as much as initially had been expected, but I think that QQE would be criticized as a serious failure if prices rose without employment growth. Prices eventually will start rising as the output gap in the overall economy tightens. We will be able to confirm by the end of fiscal 2015 that the year-on-year rate of increase in the CPI is accelerating toward 2 percent. However, there are still risks of economic deceleration in Japan, caused by factors such as (1) a further slowdown in emerging economies, particularly China; (2) the possibility of an unexpected shock stemming from an interest rate hike in the United States; and (3) a resurgence of the European sovereign debt crisis. If the virtuous cycle of income to spending ceases to operate, with employment deteriorating, consequently undermining the mechanism through which prices trend upward, I think that the Bank should implement additional monetary easing without any hesitation. Particular attention also should be paid to the fact that indicators of employment are lagging those of economic activity. Thank you for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Remarks by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the panel discussion at the 2015 Asia Economic Policy Conference, organized by the Federal Reserve Bank of San Francisco, San Francisco, 20 November 2015.
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Sayuri Shirai: Monetary policies in a diversifying global economy – Japan, the United States, and the Asia-Pacific region Remarks by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at the panel discussion at the 2015 Asia Economic Policy Conference, organized by the Federal Reserve Bank of San Francisco, San Francisco, 20 November 2015. * * * Accompanying charts can be found at the end of the speech and on the Bank of Japan’s website. I. Introduction Thank you very much for inviting me as a panelist to the discussion on monetary policy at the 2015 Asia Economic Policy Conference organized by the Federal Reserve Bank of San Francisco. My presentation today will highlight two topics. First, as one of the policymakers at the Bank of Japan (BOJ), I would like to talk about Japan’s price developments and monetary policy by making a comparison with the case of the United States. I will then focus on the Asia-Pacific region by summarizing the recent features of price developments and its challenges related to monetary policy, covering nine countries (Australia, China, Indonesia, Malaysia, New Zealand, the Philippines, Singapore, South Korea, and Thailand). Let me stress that the views expressed here are entirely my own and do not necessarily represent those of the BOJ. II. Japan’s price developments and monetary policy: comparison with the United States As you may know, the BOJ adopted a 2 percent price stability target in January 2013, followed by the implementation of quantitative and qualitative monetary easing (QQE) the following April. Partly reflecting the impact of QQE, the year-on-year rate of change in the headline consumer price index (CPI) turned positive in June 2013. It then achieved 1.6 percent in December 2013 and March 2014 – the highest rate of inflation since the introduction of QQE after excluding the direct impact of the consumption tax hike. From the end of 2014, however, the rate of change in the CPI began to decelerate and since July 2015 has been sitting at around 0 percent, mainly due to drops in crude oil prices and other commodity prices. The sluggish performance of headline price indices is also commonly observed in many other countries. Here, I would like to highlight the features of Japan’s price developments in comparison with those of the United States. A. Headline and core price index deviations from 2 percent inflation As the first feature, the year-on-year rate of change in the price index excluding energy has been higher than that in the headline price index both in Japan and the United States. In the case of Japan, not only has the rate of change in the headline CPI been recently hovering around 0 percent, but also that of the core CPI (defined as all items less fresh food). However, the CPI (excluding fresh food and energy) has risen to 1.2 percent (Chart 1). Similarly, in the United States, the rate of change in the headline personal consumption expenditures (PCE) deflator has recently been more or less flat, at around 0 percent year-onyear, but that in the core PCE deflator (defined as all items less food and energy) has been around 1.3 percent. The rates of change in the CPI and PCE deflator have been substantially below the 2 percent target (or the longer-run goal) in the two countries. However, looking ahead, the rates of change in the price indices will likely accelerate as the effect of the crude oil price drop wanes in the near future – provided that crude oil prices will at least remain unchanged or begin to rise moderately. Against this backdrop, it is taking longer than initially projected for the BOJ and the Federal Reserve to achieve 2 percent inflation. In particular, for the Federal Reserve, such a BIS central bankers’ speeches prolonged underperformance of prices has not been experienced in recent years, given that inflation in the decade prior to the sharp drop in oil prices in October 2014 averaged around 2 percent, even including the period of the global financial crisis. One encouraging development in the United States is that economists’ and market-based long-term inflation expectations currently remain stable, at near 2 percent, which indicates that the recent sluggish price performance is projected to be temporary and will eventually converge to about 2 percent. Meanwhile, Japan’s corresponding long-term inflation expectations rose rapidly in 2013, but have since generally remained more or less flat at a little over 1 percent and distant from the 2 percent target (Chart 2). This suggests a need to generate a further increase in inflation expectations in Japan with a view to achieving a steady inflation rate of around 2 percent. B. Labor market approaching full employment with sluggish wage growth Regarding the second feature, both Japan and the United States continue to enjoy a sustained recovery in employment. As a result, the rate of unemployment has reached around 3.0–3.5 percent in Japan and 5 percent in the United States – approaching the structural rate of unemployment (longer-run normal rate of unemployment for the United States). Considering the favorable pace of job creation, however, the rate of wage growth appears to be limited in both countries. Let me elaborate on this point. In Japan, the number of job applicants exhibits a declining trend due to a decline in the working age population. A growing number of firms report a persistent labor shortage, and thus economic opportunities appear to be constrained at some firms in labor-intensive industries. Firms enjoy historically high profits, but so far those profits have not generated sufficiently high wage growth. The mediocre wage growth reflects a shift effect – or a rising share of part-time (mostly voluntary part-time) workers in total employment – caused mainly by the increased labor market participation of older adults and housewives, as well as by firms’ high demand for flexible low-cost part-time workers. The rate of change in per worker wages turned positive from fiscal 2014 onward, but presently remains roughly at around 0.5 percent (or slightly below 1 percent on an hourly basis). To achieve the 2 percent price stability target, it is clear that wages must further increase. To do so, firms must review their business strategies fostered during the persistently stagnant wage environment, and improve labor productivity. Meanwhile, in the United States, there are still some discouraged workers and involuntary part-time workers. Partially because of this slack and moderate labor productivity growth, the hourly rate of wage growth remains at 2–2.5 percent, which is about half of the level prior to the global financial crisis. Moreover, the output gap, a broader concept of the economic slack, reports a demand shortage of about negative 1.5 percent in 2015 in both countries, according to International Monetary Fund (IMF) estimates. The slack is larger than the one based on the unemployment rate, suggesting extra room for further improvement in the labor force participation rate and the capital stock utilization rate. That said, it is becoming increasingly difficult across countries to estimate the output gap partly due to the declining trend in potential GDP after the global financial crisis – leading to widely dispersed output gap estimates. For example, the BOJ’s estimate on the output gap for the recent April-June period is negative 0.7 percent and is smaller than that of the Cabinet Office of negative 1.6 percent. This implies that the output gap estimates must be interpreted with wide margins. In any case, the trends indicate that both Japan and the United States have been achieving steady improvement in the employment and output gap, and thus their downward pressures on prices have weakened. Large swings in commodity prices and foreign exchange rates, however, have blurred the positive price effects driven by the domestic demand-supply balance. BIS central bankers’ speeches C. Households’ upward bias in inflation expectations and its relation to income As the third feature, short- and long-term inflation expectations (median) have been fluctuating at around 2–3 percent in Japan and the United States (Chart 3). From the BOJ’s Opinion Survey on the General Public’s Views and Behavior and Michigan University’s Surveys of Consumers, short-term inflation expectations – one year ahead in Japan and over the next year in the United States – have remained stable, at a similar level of around 3 percent over the past two years. Long-term inflation expectations – five years ahead in Japan and over the next five to ten years in the United States – have been stable for a longer period, at about 2 percent in Japan and around 3 percent in the United States. Furthermore, it is not widely known that households in Japan kept positive inflation expectations even when mild deflation prevailed from 2009 to mid-2013. Similarly, Japanese households’ present perceived inflation (defined as present perceived price changes relative to one year ago) has never turned into the negative territory over the same mild deflationary period (Chart 4). Another commonly observed trend that should be highlighted is that households’ inflation expectations tend to be higher than the actual price developments captured in official price statistics in both countries – suggesting the presence of an upward bias in inflation expectations. This may reflect that households’ responses in the survey are often affected by the recent price movements of everyday goods and services, such as food, daily necessities, and gasoline. However, there is a difference in the scale of upward bias; it appears to be generally greater in Japan than in the United States. Let me assume that a gap between the average rate of long-term inflation expectations and the average rate of change in the headline price index roughly reflects an upward bias. The scale of the bias over about the decade before the sharp drop in oil prices in October 2014, averaged at around 2 percent in Japan and around 1 percent in the United States. This implies that the seemingly stable long-term inflation expectations of around 2 percent held by Japan’s households may simply be a result of the upward bias, rather than representing their true inflation expectations. Under the presence of such a bias, households in Japan may perceive that a rate of actual inflation is much higher than 2 percent in the process of approaching the 2 percent price stability target, and regard such a price rise as unacceptable. One factor contributing to Japan’s larger upward bias may be a difference in future income prospects. To see this, a comparison can be made between the two countries by focusing on the diffusion index (DI) for expected income (one year ahead in Japan and over the next year in the United States) – calculated by subtracting the percentage share of households responding that prices will “decrease” from that of “increase.” Japan’s expected income DI always remains negative and currently records about negative 30 percent. This suggests that Japan’s households always expect a decline in future income, leading to anticipated tighter budgets as a sign of a strong defensive action, and resulting in a larger upward bias in their inflation expectations. If so, it will be important for the BOJ to promote public understanding that its objective is to achieve a moderate price rise associated with a wage hike and a sustainable increase in household spending, to improve households’ tolerance to price rises. In sharp contrast, the corresponding expected income DI in the United States always remains positive and has recently risen to around 40 percent (Chart 5). Moreover, in the United States, the year-on-year rate of change in (household) expected income over the next year (median) has started to improve since around 2013 and since early 2015 has risen to around 1.5 percent – after having dropped from around 2.5 percent before the global financial crisis to a low of around 0.5 percent in 2009–2012 (Chart 6). Let me also illustrate that the upward bias appears to be different across income groups in the United States, by comparing expected income growth over the next year and corresponding expected inflation by high- and low-income groups. Specifically, expected income growth for lowincome (bottom third of the income distribution) households tends to be lower than that of high-income (top third of the income distribution) ones, while inflation expectations of low- BIS central bankers’ speeches income households tend to exceed those of high-income ones (Chart 7). This suggests that in the United States there is a similar positive correlation between lower income prospects and higher expected prices as in Japan. Next, we look at income prospects in real terms. We can do so by paying attention to expected price DI (one year ahead in Japan and over the next year in the United States) and corresponding expected income DI. Expected price DI has always been positive in both countries with each currently recording around 50 percent in Japan and over 80 percent in the United States. Moreover, the expected price DI continues to exceed expected income DI in both countries (Chart 5). The comparison between Japan and the United States suggests that a large number of households in Japan project a decline in real income, as many households expect lower incomes and more expect higher prices. In the United States, households are less likely to perceive tighter budgets than in Japan because households expect a rise in nominal income, although many households probably project lower real income. In fact, the probability expectations on real income gains over the next five years – available from the U.S. survey – have risen from 2013 onward and have now fully recovered to the level before the global financial crisis of around 40 percent, having dropped temporarily to a low of around 30 percent after the crisis (Chart 8). These data support the view that U.S. households’ recent income conditions are relatively favorable both in nominal and real terms. D. Japan’s mild deflationary experience and monetary policy Based on the aforementioned observations, I will now summarize my views on Japan’s mild deflationary experience and the effectiveness of QQE. Japan’s deflationary experience could be characterized with the following two features. First, the expression the “prevalence of deflation-oriented mindsets” seems to have been very applicable to the state of the corporate sector. It refers to firms’ deflationary expectations and associated cautious price-setting behavior. As for the household sector, on the contrary, they tended to form high inflation expectations reflecting long-standing stagnant income growth and anticipated tighter budgets. As a result, whenever the households’ present perceived inflation rose, their tolerance to price rises dropped, fostering a negative correlation between them (Chart 9). Based on this perception, firms appear to have found it difficult to raise sales prices, contributing to a wide spread of discount-based marketing strategies. Since the introduction of QQE, firms’ price-setting behavior has been gradually changing – some firms have raised their sales prices by providing innovative goods and services that stimulate potential demand, and maintaining sales volumes. Nevertheless, many households continue to perceive that current prices are much higher than the official price statistics and expect a rise in prices. This could be one reason why many firms still generally maintain cautious price-setting behavior. Indeed, this seems to be reflected in the recent developments in firms’ sales price expectation DI for three months ahead in the BOJ Tankan (Short-Term Economic Survey of Enterprises in Japan), which has shown significant improvement from the low level in 2013 but currently hovers around 0 percent (Chart 10). In addition, the average inflation outlook on sales prices for one year ahead (relative to the current level) dropped moderately to somewhat below 1 percent year-on-year. In detail, looking at the percentage share of the number of respondents, 60 percent of firms answered “around 0 percent,” reaching about 80 percent if those that answered “will decline” and “don’t know” are included. Looking ahead, favorable corporate profits and an increase in wage growth, if sustained, may improve households’ tolerance to price rises, thereby helping to correct households’ upward bias. Once that happens, firms may be gradually more willing to change their cautious price-setting behavior. Against this backdrop, I feel that a policy to raise average inflation is relatively more challenging than to lower inflation. On this front, a lesson can be learned from the U.S. experiences of an anti-inflationary policy through bold monetary tightening adopted by then BIS central bankers’ speeches Federal Reserve Chairman Paul Volcker in the late 1970s to the early 1980s. At that time, until around 1983 economic recession caused a continuous decline in households’ expected income DI over the next year. At the same time, however, both actual inflation and inflation expectations dropped sharply, and thus real income and its outlook improved instead and partially contributed to an improvement in consumption. For example, during that period, the aforementioned U.S. survey responses showed that there was an increase in the share of households that considered low prices as a good reason to purchase durable goods and automobiles. In other words, while a tight monetary policy to reduce inflation in a sustainable manner could be accompanied by a serious challenge of potentially increasing unemployment, it may obtain more support from the public compared with the opposite inflationary policy – as it could bring about improvement in real income as long as a decline in inflation moves ahead of a decline in income growth. Turning to Japan, wage growth per worker in real terms turned positive in July this year, but still remains at around 0.5 percent. To achieve around 2 percent inflation, a further improvement in real wage growth is necessary. Regarding the second feature of Japan’s deflationary experience, a lack of healthy risktaking practices should be mentioned. Households have accumulated their assets largely in the form of deposits. Assessing in real terms, they have benefitted from relatively high interest rates and an increase in value of outstanding deposits, owing to the zero lower bound on nominal interest rates and mild deflation. Setting aside whether households actually perceived this to be true, their risk-averse behavior has turned out to be rational. In the corporate sector, on the other hand, the expected returns on investment were so low that actions to improve profitability and to efficiently utilize their assets were limited. Meanwhile, financial institutions concentrated their assets on government bonds and their supply of risk money necessary to support startup firms and business was limited. Since the introduction of QQE, this situation has been gradually changing together with the government’s economic policies. Households and financial institutions increasingly express interest in riskier assets and diversification of risks. Banks are more eager to extend credits with innovative financial services. The number of initial public offerings has increased and firms are more active in business investment, mergers and acquisitions, and organizational rationalization both domestically and globally. It is important that the BOJ continue to support these positive developments by maintaining an accommodative monetary environment. III. Price developments and monetary policy in the asia-pacific region Next, I would like to focus on the Asia-Pacific region, covering nine countries. Among these nine, six (Australia, Indonesia, New Zealand, the Philippines, South Korea, and Thailand) have officially adopted an inflation-targeting framework (Chart 11). Regarding the monetary policy frameworks of the region, I had an opportunity to speak in Singapore in July 2014. 1 Since then, economic and financial conditions have changed dramatically globally as well as in the region. Thus, today I will briefly review recent developments. A. Growing divergence in monetary policy in the Asia-Pacific region Since the East Asian economic crisis in the 1990s, central banks in the region have placed a greater emphasis on price stability than on exchange rate stability. Specifically, six central banks took the lead on this by adopting an inflation-targeting framework with a clear numerical inflation target. Under the framework, the realized inflation and inflation expectations of these six countries gradually showed a downward trend in line with their targets. The inflation-targeting framework in the region is more flexible than that in other See Sayuri Shirai, “Recent Monetary Policy Trends in Advanced Economies and the Asia-Pacific Region,” Keynote Address delivered at the National Asset-Liability Management Conference held in Singapore (July 2014). BIS central bankers’ speeches inflation-targeting countries with the following features: (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. Inflation developments showed a tendency to converge, albeit with temporary deviations, to the long-term inflation expectation level, which has remained stable within target ranges (Chart 12). One difference observed between inflation-targeting countries and other countries until the first half of 2014 was that the policy interest rates were more frequently adjusted to actual price developments in the former. I would like to highlight two new developments that have occurred since the second half of 2014. First, inflation in all six inflation-targeting countries has now deviated from the inflation target range (Chart 12). Among them, only in Indonesia has inflation been above the upper bound of the target range again since late 2014. This is due to a cut in the fuel subsidy in 2014 and a sharp depreciation of the rupiah. In contrast, inflation in the remaining five countries has been below the lower bound of the target range, mainly due to declining crude oil prices. Looking ahead, depending on future global economic and financial conditions, it may take some time for these six countries to achieve their respective inflation targets. That said, as their long-term inflation expectations have remained more or less within the target range, inflation is projected to reach the target levels in the future. Second, since the adoption of their inflation-targeting frameworks, these countries have regarded short-term policy interest rates as their major operational tool for monetary policy and these policy rates tended to be frequently adjusted to price developments. Meanwhile, in China and Malaysia, the two non-inflation-targeting countries, such rates remained largely flat because they also used other tools including reserve requirements. Since the second half of 2014, however, this differentiation no longer seems valid. Namely, China has been lowering policy interest rates more flexibly in response to a declining trend in the inflation rate since November 2014 – to contain an increase in real interest rates. Together with a cut in the reserve requirement, moreover, China has dealt with a shortage in market liquidity caused by a drop in foreign reserves by expanding the volume and frequency of fundssupplying operations (including term facilities). As a result, the annual growth rate of M2 has exceeded the annual target of 12 percent. Meanwhile, inflation in both Indonesia, an inflationtargeting country, and Malaysia, a non-inflation-targeting country, has risen significantly, mainly owing to a large depreciation of their currencies. 2 However, because their policy rates were barely adjusted perhaps in an attempt to avoid capital outflows, their inflation rates have been approaching their policy rates, leading to a recent decline in their real interest rates to nearly 0 percent. The region has been subject to various domestic and external shocks ranging from commodity price drops, a reversal of capital inflows centered on securities investment, a depreciation of currencies, a decline in trade with China, and unstable global financial markets. Depending on the type and extent of those shocks received, price developments in each country are diverse and are not necessarily consistent with the business cycle. This makes the direction of their monetary policy stances diverse. While it is likely that these shocks will eventually fade away, until then the region’s monetary policy conduct will remain divergent – regardless of whether a country has an inflation-targeting framework. B. Future possible direction of monetary policy conduct and challenges To conclude, let me summarize the implications for monetary policy conduct in the AsiaPacific region based on recent developments. In Malaysia, the inflation rate has also been affected by the introduction of the 6 percent Goods and Services Tax in April 2015. BIS central bankers’ speeches • In the region, a growing number of countries are conducting more flexible exchange rate arrangements. This is confirmed by the fact exchange rates have become more volatile than before. One example is China, which has gradually enhanced the flexibility of exchange rate movements. As a result, the IMF concluded in the recent Article IV consultation report that the renminbi is no longer undervalued. The report also recommended that China adopt a flexible exchange rate regime over the next two to three years. • Nonetheless, a sharp depreciation of the exchange rate, while contributing to improving international price competitiveness, may generate a further depreciation expectation and thereby accelerate capital outflows. This may amplify the risk of overshooting the exchange rate far beyond the equilibrium (depreciated) level, thus leading to the risk of a surge in domestic interest rates and economic recession. For this reason, the region could utilize the accumulated foreign reserves to mitigate abrupt exchange rate volatility. Depending on the type of shocks, the scale of changes in foreign exchange rates, and the size of foreign reserves, policy responses vary widely across the region. • In the case of drawing down foreign reserves, a country may need to deal with possible slower growth in the monetary base. To offset the resultant shortage in liquidity supply to the market, a central bank may find it necessary to expand fundssupplying operations to a greater extent than before. To enable smooth operations, monetary policy conduct must be more centered toward a policy interest rate adjustment – together with measures to foster collateral asset markets, to develop yield curves with long maturities and sufficient liquidity, and to promote the monetary policy transmission mechanism based on the policy interest rate. • In this sense, this may be an opportunity for a country that once relied on liquidity supply through foreign reserve accumulation as a monetary easing tool to shift toward a more market-based monetary policy tool. Such a practice may promote convergence of monetary policies to ones that are more consistent with the flexible inflation-targeting framework within the region, regardless of whether a country has an inflation-targeting framework. This concludes my presentation. Thank you very much for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches 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, 30 November 2015.
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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, 30 November 2015. * * * Introduction It is my great pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in the Chubu region. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the Bank of Japan’s Nagoya Branch. Looking at recent economic developments, the slowdown in emerging economies, particularly China, has affected Japan’s exports and production. Nevertheless, as I will explain, the fundamentals of Japan’s economy are sound and the environment surrounding Japan’s firms and households has improved significantly compared to a few years ago. The underlying trend in inflation has also been improving steadily. Quantitative and qualitative monetary easing (QQE), which the Bank introduced in April 2013, has been exerting its intended effects toward overcoming deflation. Today, I would like to explain the Bank’s view on the outlook for economic activity and prices, as well as on its monetary policy, and then touch on remaining challenges for Japan’s economy to overcoming deflation. I. Developments in Japan’s economic activity and prices To begin with, let me talk about developments in Japan’s economic activity and prices. Economic activity The slowdown in emerging economies, particularly China, has recently become more pronounced, and this has affected Japan’s exports and production. Mainly reflecting the slowdown in overseas economies, the projected real economic growth rate for fiscal 2015 was revised downward in the Outlook for Economic Activity and Prices (Outlook Report) released at the end of last month to 1.2 percent from the 1.7 percent projected in July 2015 (Chart 1). However, Japan’s economic fundamentals are sound and the economy has continued to recover moderately. Real GDP growth in the July-September quarter of 2015 was slightly negative for the second consecutive quarter, due mainly to inventory adjustments, but final demand as a whole has been increasing. Regarding the corporate sector, firms’ investment stance has continued to be positive reflecting the favorable earnings environment. Corporate profits as a whole have reached record highs, and fixed investment plans have also been robust. According to the September Tankan (Short-Term Economic Survey of Enterprises in Japan), the year-on-year rate of growth of planned fixed investment for all enterprises and industries was 6.4 percent, up from the June Tankan. In the household sector, the employment and income situation has been improving steadily; as a result, private consumption has been resilient. Turning to labor market conditions, the active job openings-to-applicants ratio is currently 1.24, a level last seen in 1992, and the unemployment rate has declined to 3.1 percent, a level last seen in 1995. Thus, labor market conditions have continued to tighten and Japan is in a situation close to “full employment.” As seen in the diffusion index for employment conditions released in the September Tankan, firms’ perception that they are facing a shortage of labor has intensified, and labor market BIS central bankers’ speeches conditions seem to continue to be tight despite the flattening of exports and production (Chart 2). With corporate profits having risen to historically high levels and the tightening in labor market conditions continuing, there has been upward pressure on wages. Scheduled cash earnings have been increasing on a year-on-year basis for three consecutive quarters since the turn of the year, reflecting in part increases in base pay, which has gone up for two years in a row. Moreover, various surveys suggest that summer bonuses this year were raised again following the substantial increase last year (Chart 3). On the back of the steady improvements in the employment and income situation, private consumption in the JulySeptember quarter increased on a quarter-on-quarter basis. Taking, in addition, more recent anecdotal evidence into account, the Bank judges that private consumption has been resilient. With a virtuous cycle from income to spending in both the corporate and household sectors in place, Japan is likely to continue to see real GDP growth through fiscal 2016 of about 1.0–1.5 percent. This rate exceeds Japan’s potential growth rate, which is currently estimated to be around 0.5 percent or lower. Prices Let me turn to prices. The year-on-year rate of change in the consumer price index (CPI, all items less fresh food), which was minus 0.5 percent just before the introduction of QQE, increased to as high as 1.5 percent in April 2014, excluding the effects of the consumption tax hike. However, reflecting the substantial decline in crude oil prices since the summer of 2014, annual CPI inflation declined and has been about 0 percent in recent months (Chart 4). Nevertheless, once the effect of the decline in energy prices is excluded, the underlying trend in inflation has steadily improved. For example, the year-on-year rate of change in the CPI for all items less fresh food and energy had been negative before the introduction of QQE, but turned positive in October 2013. Since then, it has been positive for 25 consecutive months, and increased to 1.2 percent this October. This is the first time since the late 1990s, when Japan’s economy fell into deflation, that sustained price increases have been seen. Meanwhile, the rate of increase in the daily and weekly price indices gathered by the University of Tokyo and Hitotsubashi University based on the prices of items such as food and daily necessities has continued to show an accelerating trend since this April. Price hikes by firms have become widespread and sustained, as seen in the fact that the share of items in the CPI for which prices have risen has been outweighing that for which prices have declined by an increasing margin (Chart 5). Meanwhile, some economists argue that the recent price rises are just a temporary phenomenon brought about by the rise in import prices prompted mainly by the past depreciation of the yen and that therefore it is difficult to judge whether the underlying trend in inflation has been improving. It is certainly the case that the rise in import prices prompted by the depreciation of the yen has contributed to the rise in consumer prices. However, as I mentioned earlier, attempts by firms to raise prices can be seen across a wide range of items and are not confined to items affected by import prices. In addition, neither the recent extent of inflation nor its persistence can be explained as the result of the depreciation of the yen. Instead, it makes more sense to interpret the extent and persistence of recent inflation as a result of improvements in the employment and income situation as well as changes in firms’ and households’ perceptions of price developments. Looking ahead, the year-on-year rate of change in the CPI (all items less fresh food) is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices. However, with the underlying trend in inflation steadily rising and the effects of the decline in crude oil prices dissipating, the rate of increase is expected to accelerate toward 2 percent – the price stability target. Although the timing of when inflation of around 2 percent is reached BIS central bankers’ speeches depends on developments in crude oil prices, the Bank projects this to be around the second half of fiscal 2016, assuming that crude oil prices will rise moderately from recent levels. II. Developments in emerging economies and their effects on Japan’s economy One of the risks to this outlook is the slowdown in emerging economies, particularly China, and its repercussions. Looking around the global economy, a clear contrast can be observed, with the economic situation in advanced economies improving, while emerging and commodity-exporting economies have been decelerating. In China, economic activity in manufacturing has continued to be sluggish, but that in nonmanufacturing has remained robust (Chart 6). Spending by local governments was one of the reasons for the sluggishness of the Chinese economy in the first half of this year. However, the pace of spending increases has accelerated recently, partly as a result of instructions by the central government and measures to facilitate the financing of local governments (Chart 7). With these initiatives taking effect, China’s economic growth is expected to accelerate from the end of 2015 to early 2016. That being said, China continues to suffer from structural problems such as excess capacity and there are uncertainties surrounding the outlook. Even if the Chinese economy were to recover, uncertainty remains to what extent this recovery would push up other economies in East Asia. Looking at emerging economies as a whole, although there have recently been signs of a pick-up in, for example, the production of IT-related goods in East Asia, commodity prices remain low, so that commodity-exporting economies continue to face difficult circumstances and developments differ across individual economies. A continued increase in corporate profits, despite lackluster developments in exports and production reflecting the effects of the slowdown in emerging economies, are not something one would normally have observed in Japanese economic recoveries in the past. This suggests that Japan’s economic fundamentals have become more resilient to external shocks and the economy is becoming more stable. Reasons for this resilience likely include favorable changes in the external environment – such as the decline in crude oil prices and the correction of the excessive appreciation of the yen – as well as the firmness of the nonmanufacturing sector, which has been a key feature of the recent economic recovery. In other words, the fact that a virtuous cycle from income to spending is operating steadily has led to the current resilience of Japan’s economy (Chart 8). Based on these observations, let us consider the repercussions for Japan if emerging economies were to slow down further. The risk that a contraction in exports and production will undermine corporate profits and hence investment does not seem to be that great. Corporate profits are extremely high and some decline in exports and production could be easily absorbed. On the other hand, what does warrant attention is the possibility that increased uncertainty regarding emerging economies undermines business confidence in Japan, which might lead firms to scale down investment and wage increases. Although business confidence has been improving, it would be premature to say that it is sufficiently strong. I will further elaborate on this point later. III. Looking ahead to the post-deflation era In sum, while Japan’s economy has continued to recover moderately and the underlying trend in inflation has steadily improved, due attention should be paid to risk factors such as developments in emerging economies. With regard to monetary policy, QQE has been exerting its intended effects, and 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. The Bank will make the most appropriate policy decisions by scrutinizing the current situation of economic activity and prices and their outlook, various risk factors, and developments in financial and capital markets at every Monetary Policy Meeting. Let me BIS central bankers’ speeches reiterate that the Bank will make adjustments without hesitation if judged as necessary to achieve the price stability target of 2 percent at the earliest possible time. Lastly, I would like to touch on overcoming deflation and corporate strategy. In my recent speeches in Osaka and Tokyo, I said that the data to date give the impression that the pace of increase in fixed investment and wages was still relatively slow when considering that firms have been making record profits. To avoid any misunderstanding, I would like to note that increases in fixed investment and wages are necessary not only for Japan’s economy as a whole, but would also benefit themselves. That is, given that Japan’s economy is on the road to overcoming deflation and entering a new phase in which the economy will grow in a sustainable manner under price stability with 2 percent inflation, now is the time for firms to wipe out the deflationary mindset and make investment in human and physical capital. Taking actions now is a prerequisite for firms to be among the winners in the future. In this context, the one key message that the Bank wants to get across is that deflation will be overcome and the price stability target of 2 percent will definitely be achieved. And this will happen at the earliest possible time. The Bank considers it desirable to achieve a situation in which both prices and wages rise in a balanced manner. However, this does not mean that the Bank will adjust its policies aimed at achieving moderate inflation simply in response to the pace of increase in wages. From both a theoretical and an empirical perspective, prices generally move in parallel with wages (Chart 9). If the Bank were to move slowly toward achieving the price stability target, wage adjustments would also be slow. At the end of the day, this issue comes down to a chicken and egg situation. In order to overcome deflation – in other words, break the deadlock – somebody has to show an unwavering resolve and change the situation. This means that, when it comes to price developments being at stake, the Bank must be the first-mover. The Bank has been pursuing QQE based on the stance that it will do whatever it can to achieve the price stability target. As a result, conditions in financial markets – as exemplified by stock prices and foreign exchange rates – as well as corporate profitability and labor market conditions – particularly the unemployment rate – have improved significantly, so that the underlying trend in inflation has changed markedly. Looking at the CPI for October 2015, the year-on-year rate of change in the CPI for all items less fresh food and energy was 2.0 percentage points higher and that for all items less food and energy was 1.5 percentage points higher than in March 2013, that is, immediately before the introduction of QQE. As evidenced by these figures, the Bank has the capability as well as the strong will to achieve price stability at 2 percent inflation at the earliest possible time. The Bank of Japan’s price stability target of 2 percent provides a benchmark which firms can refer to when adjusting wages and individual prices. Once 2 percent inflation prevails, firms that continue to base their investment, hiring, and price-setting decisions on a deflationary mindset will be at a disadvantage and fall behind their competitors. In our view, the environment for wage increases – such as a tight labor market and high corporate profits – is certainly already well established. However, it is of course up to firms’ management and labor whether to raise wages in line with the 2 percent inflation benchmark in anticipation of price increases of 2 percent as we move on. In fact, I see that an increasing number of firms are already moving in new directions. And I am aware that this region, which produced Japan’s first domestically-manufactured automobile, is home to many forward-looking entrepreneurs. Coincidentally, the Mitsubishi Regional Jet (MRJ) – Japan’s first domestically-produced passenger jet – recently made its successful maiden flight. At this juncture, we are witnessing the start of a new legend in this region. I am hoping that the wind of change blowing from the Chubu region will give flight to Japan’s economy and lift it to a new, post-deflationary stage. 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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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Paris EUROPLACE Financial Forum, Tokyo, 7 December 2015.
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Haruhiko Kuroda: The current situation in Japan’s financial system and macroprudential policy Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Paris EUROPLACE Financial Forum, Tokyo, 7 December 2015. * * * Introduction It is a great honor to have this opportunity to speak before the Paris Europlace Financial Forum today. Before I begin, I would like to offer my deepest condolences to the victims of the recent terrorist attacks in Paris. Since the global financial crisis, the “macroprudential” perspective has become widely recognized. Underlying the macroprudential framework is the view that, to ensure financial stability, it is necessary to devise institutional designs and policy measures to prevent systemic risk from materializing, based on analyses and assessments of risks in the financial system as a whole, taking into account the interconnectedness of the real economy, financial markets, and financial institutions’ behavior. Today, I will start by providing an assessment of the current situation in Japan’s financial system from a macroprudential perspective. I will then share with you my views on some of the issues regarding macroprudential policy. Assessment of the Current Situation in Japan’s Financial System Let me begin with an overview of the current situation in Japan’s financial system. The Bank of Japan has been pursuing quantitative and qualitative monetary easing (QQE) since April 2013, and the policy has been steadily exerting its intended effects toward achieving the price stability target of 2 percent. It goes without saying that the financial system serves as an important transmission channel through which QQE produces its effects. Indeed, the following positive financial effects have been observed in the past two and a half years: (1) stability of long-term interest rates at low levels and declines in credit risk premiums; (2) progress in portfolio rebalancing among financial institutions and institutional investors; and (3) a positive spillover to asset prices. Looking ahead, further enhancement of the financial intermediation function continues to be expected as financial institutions have secured robust capital bases. As such, the effects of QQE are gradually becoming evident on the financial front as well. From a macroprudential perspective, however, the more financial activity increases, the more important it becomes to be vigilant as to whether such effects of QQE would lead to financial excesses or imbalances. Under the current framework for the conduct of monetary policy, the Bank examines financial imbalances - from a longer-term perspective as a risk that will significantly affect economic activity and prices. As part of the examination process, the Bank releases semiannually its Financial System Report. In this report, it makes a forward-looking assessment of the stability of the financial system from various angles including analyses of the balance between financial institutions’ risks and financial bases, macro stress testing, and the monitoring of risk indicators that suggest signs of financial imbalances - and presents tasks and challenges toward achieving financial stability. Taking the latest findings into account, significant financial imbalances are not observed at present. That said, the Bank will continue to examine developments without presumption. BIS central bankers’ speeches Macroprudential Policy I will now turn to macroprudential policy. In recent years, this area has seen various international discussions conducted and measures implemented worldwide. First, “structural measures” for enhancing the resilience of the financial system, including implementation of the Basel III requirements and responses to the “Too Big to Fail” problem, have been proceeding steadily. Second, many countries have been making use of macroprudential measures aimed at containing excessive financial cycles and the accumulation of imbalances. These are sometimes referred to as “time-varying macroprudential policy,” thereby distinguishing them from structural measures. In what follows, I will touch upon some of the issues regarding macroprudential policy. First, let me discuss the selection and application of “time-varying” macroprudential tools. Many of the measures that have been adopted recently in various countries are ones with which to lean against financial cycles, by utilizing regulatory ratios such as the countercyclical capital buffer (CCB) and the loan-to-value (LTV) ratio. The introduction of the CCB regime is scheduled for 2016 in countries worldwide, including Japan. Among countries that already have proceeded with the activation of these measures, some have noted that the measures have been exerting their intended effects on such sectors as the housing market, where overheating has been observed. At the same time, some point to the considerable uncertainty surrounding the measures’ effects and to difficulties that accompany their application, including the following. First, there is a lag after activation before the measures begin producing effects. Second, leakages of policy effects to unregulated sectors, such as shadow banking institutions, as well as to overseas, may well occur. And third, measures intended for specific sectors, such as housing, give rise to the issue of conflict with other governmental measures. In fact, the inability to employ these macroprudential tools in a timely fashion entails the risk of accelerating financial cycles. “Hard” measures, which involve the adjustment of regulatory ratios in a countercyclical manner, are relatively new. Given this, the ultimate challenge, including responses to the various others I have just mentioned, is how to carry out these measures in an accountable manner. One point I want to stress in relation to this is that, in dealing with financial imbalances, what is important and effective is supervisory guidance by central banks and financial authorities namely, their “soft” approach, by which they issue advance warnings while providing guidance and advice to financial institutions based on assessments of financial system stability. Supervisory guidance for financial institutions is primarily regarded as a microprudential measure. By carrying them out from a macroprudential perspective in an industry-wide and collective manner, however, the soft approach is capable of producing effects as a form of macroprudential policy. Moreover, compared with hard approaches like the CCB, this approach allows for more forward-looking and flexible responses. Based on such understanding, the Bank’s disclosure of the challenges and risks involved in ensuring financial stability, through the publication of the Financial System Report, and its responses to these issues, through on-site examinations and off-site monitoring, are considered part of macroprudential policy. Second, let me shift my focus to international financial regulations as a form of “structural” macroprudential policy. Reform of international financial regulation is entering its final stages. Basel III and responses to the issue of “Too Big to Fail,” such as TLAC (Total Loss-Absorbing Capacity), are measures designed to substantially strengthen the resilience of the global financial system. Furthermore, it is important to acknowledge the fact that financial authorities and the financial industry worldwide have developed a common understanding on international regulation, overcoming differences in their views. This indicates a major step forward, in that we have created a foundation for international cooperation to tackle many issues and crises that could arise in the future. BIS central bankers’ speeches Having said this, I would like to mention several points with regard to the finalization and gradual implementation of the Basel III regulatory reforms. The first point is the importance of a comprehensive calibration of the framework in its finalization. Several of the remaining issues involve quite a number of calibrations based on the accumulation of very technical and expert considerations, such as the measurement of risk-weighted assets. The outcome of these considerations would have a significant impact on the determination of required macro capital and the risk-taking behavior of financial institutions. I would like to emphasize that the calibration should be finalized in such a way that the amount of risk-weighted assets and required capital as a whole would be maintained at an appropriate level, while taking a holistic approach in examining effects on the institutions. The second point is the necessity of a review of the effects and impacts of these regulatory reforms after their implementation. Reforms of international financial regulations to date have been drastic enough that it is no exaggeration to refer to them as a “fundamental re-design.” Looking at individual countries, large-scale financial and structural reforms are underway, as typified by the Volcker rule in the U.S. The extent of the effects and impacts of these regulatory reforms on international financial intermediation and flow of funds in the financial sector as a whole remains unknown, and therefore requires close monitoring. From a long-term perspective, in order for the financial system to ensure stability and in turn contribute to sustainable economic growth, financial institutions need to be sufficiently profitable through active and innovative financial intermediation. In this regard, it is important to remove any regulatory excess, inconsistency among regulations, and uncertainty regarding the regulatory environment. Concluding Remarks That brings me toward the end of my speech. Topics for discussion regarding macroprudential policy go beyond those I have raised today. One such topic regards the effective institutional arrangements for macroprudential policy. Needless to say, there is no such thing as a universally optimal set of arrangements, as financial and economic structures as well as legal frameworks differ from country to country. Moreover, the desirable form of arrangements would vary depending on the kind of macroprudential measures each country intends to utilize. Looking at the recent developments in countries with multiple regulatory and supervisory authorities, there has been quite a number of movements to establish new bodies or councils in charge of macroprudential policy. In Japan, the Financial Services Agency (FSA) - which is legally authorized to conduct industry-wide supervision and inspections - and the Bank - which contributes to financial system stability, such as through the “lender of last resort” function are making joint efforts in carrying out macroprudential policy, fulfilling their respective functions. Furthermore, in June 2014, the two entities together established a task force with the aim of holding regular joint meetings, and they have been fostering further coordination. The Bank is determined to continue with its efforts to contribute to ensuring the stability of the financial system, making use of these arrangements. Thank you. 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, Okayama, 2 December 2015.
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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, Okayama, 2 December 2015. * * * Accompanying charts can be found at the end of the speech and on the Bank of Japan’s website. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Okayama Prefecture. I would like to take this chance to express my sincerest gratitude for your cooperation with the activities of the Bank of Japan’s Okayama Branch. Today, I would like to have your views on the actual situation of the local economy as well as your candid opinions about the Bank’s policies and activities. Before exchanging views with you, I will briefly explain the recent economic developments at home and abroad, and then touch on some points regarding monetary policy. I. The current situation of Japan’s economy and its outlook Looking at Japan’s economy, exports and production are affected by the slowdown in emerging economies, particularly China. However, with firms having seen record profits, a virtuous cycle from income to spending in both the corporate and household sectors is in place, and Japan’s economy has continued to recover moderately. In the following, I would like to elaborate on this issue. A. Developments in exports and overseas economies Japan’s exports have been more or less flat recently (Chart 1). Breaking these down by region, exports to advanced economies such as the United States and Europe have maintained their moderate increasing trend, but those to emerging economies have shown weaker developments, particularly to East Asia. The background to this is that the decelerated situation for the Chinese economy is continuing with downward pressure from excess capacity and inventory adjustments in the manufacturing sector, and that the effects of the Chinese economy have been spreading to other emerging and commodity-exporting economies through trade. In this situation, Japan’s production also has been more or less flat. As for the outlook for overseas economies, it is likely that the effects of the slowdown in emerging economies will remain for the time being, but that moderate growth, mainly in advanced economies, will continue, and this will positively affect emerging economies. The Chinese economy is expected to generally follow a stable growth path with a variety of economic stimulus measures being implemented. As shown in the October 2015 World Economic Outlook (WEO) published by the International Monetary Fund (IMF), global growth for this year is projected to decline somewhat to 3.1 percent, but for 2016, it is projected to moderately accelerate on the whole and register 3.6 percent (Chart 2). In this situation, Japan’s exports and production are expected to remain more or less flat for the time being, but after that they are likely to increase moderately. Nevertheless, taking account of the decline in growth expectations for and excess capacity in emerging and commodity-exporting economies, risks for the time being seem to continue to skew to the downside, and this warrants close attention. BIS central bankers’ speeches B. Developments in domestic private demand Despite the lackluster developments in exports and production I have outlined, corporate profits are at record high levels (Chart 3). The improvement in corporate profits is partly due to a fall in commodity prices – particularly crude oil prices – and to the rise in repatriated income from overseas business through dividends and interest, which has accelerated partly as a result of the correction of excessive appreciation of the yen. In addition, what can be pointed out as a characteristic of the recent economic recovery is the fact that the recovery of the nonmanufacturing sector has been marked on the back of the resilience in domestic demand. In the past economic recoveries, the general course of events was an increase in exports leading to a rise in production and rises in corporate profits and business fixed investment in the manufacturing sector; this time, however, different developments are being seen. According to the September Tankan (Short-Term Economic Survey of Enterprises in Japan), the diffusion index for business conditions in the nonmanufacturing sector improved to a level exceeding that seen during the economic recovery period in the mid-2000s, while some cautiousness has been observed in the manufacturing sector. An improvement in corporate profits is producing a virtuous cycle that is spreading to domestic private demand through the corporate and household sectors. First, the corporate sector is maintaining its positive fixed investment stance. This can be confirmed by the high year-on-year rate of growth in fixed investment plans for all enterprises and industries for fiscal 2015; namely, 6.4 percent, as shown in the September Tankan. Turning to the household sector, the employment and income situation has been improving steadily. Labor market conditions have continued to tighten and the active job openings-toapplicants ratio is at a high level last seen in 1992. The unemployment rate for October has declined to 3.1 percent, a low level last seen in 1995. Under this circumstance, upward pressure is being exerted on wages. Scheduled cash earnings in the Monthly Labour Survey have been positive on a year-on-year basis for three consecutive quarters since the turn of the year, with base pay being raised for two years in a row (Chart 4). Private consumption has been resilient, as evidenced by a clear increase on a quarter-on-quarter basis for the July-September quarter against the background of steady improvement in the employment and income situation. That said, a virtuous cycle in both the corporate and household sectors has been maintained in Japan’s economy. The real GDP growth rate for the July-September quarter was slightly negative for a second consecutive quarter, but this is mainly due to the progress in inventory adjustments, and final demand as a whole has been increasing. Turing to the outlook, Japan’s economy through fiscal 2016 is likely to continue growing at a pace above its potential, which is estimated to be around 0.5 percent or lower recently. As shown in the Outlook for Economic Activity and Prices (hereafter the Outlook Report) released at the end of October, the outlook in terms of the median of the Policy Board members’ forecasts of the real GDP growth rate was 1.2 percent for fiscal 2015 and 1.4 percent for fiscal 2016. II. Monetary policy and price developments in Japan As I have explained, Japan’s economy is likely to continue growing at a pace above its potential. In this situation, how are prices expected to develop? Next, I would like to talk about price developments in Japan after touching on the Bank’s monetary policy. A. Change in policy regime The Bank is implementing quantitative and qualitative monetary easing (QQE) that aims at converting people’s deflationary mindset, which has been formed firmly amid the prolonged period of deflation, to one that moderate inflation is to be expected. That is, it is preparing a BIS central bankers’ speeches foundation on which people can act on the assumption that prices will continue to rise moderately. QQE consists of two pillars. The first is a clear commitment under which the Bank 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. The second pillar is the Bank’s thorough communication of its measures and implementation of them to achieve the price stability target. These measures are to massively increase the “quantity” of the monetary base through the Bank’s large-scale asset purchases – mainly the purchase of Japanese government bonds (JGBs) – and to change the “quality” of its asset purchases, mainly through the purchase of long-term government bonds that entail relatively large risks (Chart 5). By pursuing QQE, the Bank aims at decreasing expected real interest rates through exerting downward pressure on nominal interest rates across a wide range of maturities and raising peoples’ inflation expectations toward 2 percent (Chart 6). The decline in expected real interest rates will lead to a rise in prices of risky assets such as equities and hence to an increase in private consumption through the wealth effect. In addition, with the excessive appreciation of the yen being corrected, real exports have increased, albeit moderately, and exporting companies’ earnings have improved, due partly to an improvement in profitability. In this situation, the number of foreign visitors to Japan has also increased noticeably. Moreover, households and firms, which have devoted their efforts to increase their savings, are expected to expand housing investment or business fixed investment in view of the decline in expected real interest rates and the improvement in their income and financial conditions. As illustrated above, QQE aims at raising the observed inflation rate toward 2 percent by increasing aggregate demand through several transmission channels in which its effects start with the decline in expected real interest rates brought about by the drastic change in the policy regime. B. Developments in the underlying trend in inflation In the Bank’s current outlook for prices, the timing in which the year-on-year rate of change in the CPI (all items less fresh food) reaches around 2 percent is projected to be around the second half of fiscal 2016. Comparing the current projection to the previous one, the timing is likely to be delayed. That said, the delay is mainly due to the effects of the decline in crude oil prices, and the underlying trend in inflation itself can be judged to be improving steadily as the transmission mechanism of policy effects has worked as expected. Here, I would like to discuss developments in the underlying trend in inflation from the following three perspectives: (1) those in consumer prices; (2) those in the output gap, which is a gap between aggregate demand and supply capacity of the economy as a whole; and (3) those in medium- to long-term inflation expectations. 1. Developments in consumer prices To begin with, let me talk about developments in consumer prices. The year-on-year rate of change in the CPI for all items less fresh food has been about 0 percent recently. However, in the case where crude oil prices decline by about 50 percent in a short period, as they did for some months starting from last summer, the CPI excluding fresh food and energy (hereafter, the CPI excluding energy) becomes a more important indicator in assessing the underlying trend in inflation. To verify this point, I would like to break down the year-on-year rate of change in the CPI for all items less fresh food (hereafter, the CPI including energy) into two components: the contribution of energy items and the contribution of the CPI excluding energy (Chart 7). BIS central bankers’ speeches Until the introduction of QQE, the year-on-year rate of change in the CPI including energy had mostly been hovering within slightly negative territory, with a positive contribution of energy items being offset by a negative contribution of the CPI excluding energy. This means that, if price developments had been assessed on the basis of the CPI excluding energy instead of the CPI including energy, they should have been judged as being deeper in deflation. By contrast, after the introduction of QQE, the negative contribution of the CPI excluding energy started to lessen. Its contribution turned positive in early autumn 2013 and moved further into positive territory until around April 2014 when the consumption tax rate was raised. During the same period, with the positive contribution of energy items, the year-onyear rate of change in the CPI including energy – excluding the direct effects of the consumption tax hike – also continued to rise and reached 1.5 percent in April 2014. In other words, annual CPI inflation had continued to rise steadily toward 2 percent from the introduction of QQE until around April 2014 when the consumption tax rate was raised. Thereafter, until early 2015, partly due to the effects of the consumption tax hike, the positive contribution of the CPI excluding energy – and also excluding the direct effects of the consumption tax hike – shrank. Moreover, since around the summer of 2014, a substantial decline in crude oil prices has become a factor that decreases the year-on-year rate of increase in the CPI. In light of these developments, the Bank decided at the end of October 2014 to expand QQE in order to preempt manifestation of a risk that conversion of the deflationary mindset might be delayed and to maintain the improving momentum of expectation formation. Looking at the developments after the expansion of QQE, the positive contribution in the CPI excluding energy stopped decreasing in early 2015 and then resumed an uptrend. The positive contribution has been about 1 percentage point recently, thus marking the largest size since the introduction of QQE. During the same period, the year-on-year rate of change in the CPI including energy has declined, which can be attributed mainly to an increase in the negative contribution of energy items. Given these developments, it can be judged that the underlying trend in inflation, which was on the verge of returning to deflation due to the consumption tax hike, has come back since the turn of 2015 on a rising path toward 2 percent thanks to the effects of the expansion of QQE. 2. Output gap Next, I would like to talk about developments in the output gap, which can be defined as a gap between the aggregate demand and supply capacity of Japan’s economy. In short, the output gap is likely to improve steadily against the backdrop of an expansion of demand such as business fixed investment and private consumption. With regard to business fixed investment, as I have explained, surveys including the Tankan suggest that firms’ fixed investment plans for fiscal 2015 have been at high levels. Although firms’ actual fixed investment has been somewhat weaker than planned so far, possibly in view of high uncertainty over prospects regarding the slowdown in emerging economies, for example, it is expected to take place firmly sometime soon. With regard to private consumption, the employment and income situation is the key. On this point, labor market conditions have continued to tighten, as I have mentioned, and a rise in wages has started to spread across industries and by size of firms. Looking ahead, reflecting historical high corporate profits and the tight labor market, wages are expected to gradually rise further, which will underpin resilience in private consumption. Therefore, increases in business fixed investment and private consumption are likely to lead to an improvement in the output gap and thereby push up prices moderately. Such a virtuous cycle is likely to become more evident going forward. BIS central bankers’ speeches On this point, looking at the recent developments in fixed investment and wages in relation to corporate profits, it is true that these give the impression that the paces of increase in fixed investment and wages were still relatively slow when considering that firms have been making record profits (Chart 8). However, this situation has started to change as the output gap has continued to improve moderately and is expected to turn to excess demand. 3. Medium- to long-term inflation expectations Lastly, I would like to talk about inflation expectations. Looking from a somewhat longer-term perspective at results of various surveys such as those conducted of firms and households, these expectations started to increase around the introduction of QQE (Chart 9). Although there are some indicators that show relatively weak developments recently, firms’ pricesetting behavior clearly has changed, particularly since the start of this fiscal year. Firms’ price-hiking behavior has become widespread and sustained. Looking ahead, as the observed inflation rate rises toward 2 percent, which itself will push up inflation expectations, medium- to long-term inflation expectations are also likely to rise toward 2 percent. As I have explained, an examination of all three developments – namely, those in the CPI, the output gap, and inflation expectations – confirms that the underlying trend in inflation has been improving steadily toward achieving the price stability target of 2 percent. On this basis, the year-on-year rate of increase in the CPI including energy is projected to reach around 2 percent around the second half of fiscal 2016, taking into account such developments as those in crude oil futures prices. Of course, in reality, there are various uncertainties in the global economy. The most significant risk at this moment is that a further slowdown in the emerging economies, particularly China, and commodity-exporting economies will exert negative effects on Japan’s economy, which will exert downward pressure to the underlying trend in inflation. As for the future monetary policy management, if the manifestation of such risk leads to a deterioration of the underlying trend in inflation, the Bank will make adjustments without hesitation. Concluding remarks In conclusion, let me touch on the economy of Okayama Prefecture. The prefecture is privileged not only for being a transport node that connects the Chugoku and Shikoku regions, but also for experiencing natural disasters less frequently than others; industries taking advantage of this geography have been underpinning the economy of the prefecture through the ages. Specifically, many factories of iron and steel products, motor vehicles, and chemical products are located in Okayama Prefecture, and Mizushima Coastal Industrial Area in particular, and about 30 percent of gross product in the prefecture is by manufacturers. Nonmanufacturers saw consecutive construction starts of large distribution centers covering the whole of the Chugoku and Shikoku regions making use of the highway network, and the floor area of warehouses has increased by slightly less than 20 percent in the last ten years. Initiatives to start up new businesses have been observed in sectors with growth potential; for example, in Maniwa City, which is located in the north of the prefecture, a biomass power station – using timber from forest thinning for fuel – co-funded by local businesses has started to operate in April this year. Moreover, Okayama Prefecture is endowed with tourist attractions such as Korakuen, the Kurashiki Bikan historical quarter, and the Shizutani School. I have heard that these are attracting many visitors within Japan and from abroad. Last month, the first Okayama marathon was held in Okayama City and many people from all over Japan have participated in it. In May next year, the Summit Education Minister’s Meeting will be held in Kurashiki City. Through these opportunities, I hope the fascination with Okayama Prefecture will further expand within Japan and to abroad. BIS central bankers’ speeches I believe people in Okayama Prefecture have already been tackling new challenges while fully exploiting the inherited merits of geographical conditions and rich tourism resources. I would like to encourage the staff at the Okayama Branch to contribute to these developments in this region through their analysis of the regional economy and dissemination of information. In closing, I wish you all the best for the further development of the regional economy. Thank you. 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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, Shimane, 25 November 2015.
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Sayuri Shirai: Japan’s economic and price developments and monetary policy – underlying inflation trend and inflation expectations Speech by Ms Sayuri Shirai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shimane, 25 November 2015. * * * Accompanying charts can be found at the end of the speech. I. Introduction Good morning. I feel honored to have an opportunity to meet with the local government officials and business representatives here today. Let me also express my sincere gratitude for your kind cooperation with the activities of the Bank of Japan’s Matsue Branch. Today, I would like to talk about the Bank’s baseline scenario of the outlook for economic activity and prices through fiscal 2017 as well as risks to the scenario, as described in the October 2015 Outlook for Economic Activity and Prices (hereafter the Outlook Report). Accordingly, I also will present and explain my views. II. Japan’s medium-term outlook for economic activity and risk assessment Let me begin with Japan’s economic activity. A. Outlook for economic activity In the Bank’s baseline scenario of the outlook for economic activity, the projected growth rate for fiscal 2015 was revised considerably downward while the projections for fiscal 2016 and 2017 were more or less unchanged, compared with those in the July 2015 interim assessment. Nevertheless, domestic demand is likely to increase and exports are expected to continue increasing moderately on the back of the recovery in overseas economies. A virtuous cycle among production, income, and spending is likely to be maintained in the corporate and household sectors. Firms’ and households’ growth expectations and potential economic growth are also likely to rise moderately in line with continued accommodative financial conditions. In fiscal 2017, the rate of economic growth is likely to decelerate significantly – mainly due to the effects of the planned consumption tax hike and cyclical deceleration in business fixed investment – but is still likely to remain positive (Chart 1). My outlook for economic activity is somewhat lower than the median of the Policy Board members’ forecasts: around 1 percent for fiscal 2015; a little less than around 1.5 percent for fiscal 2016; and slightly above 0 percent for fiscal 2017, owing to a significant decline in the growth rate, due, for example, to the planned consumption tax hike. Let me explain in some detail. For fiscal 2015, my projection is lower than that in the July 2015 interim assessment, reflecting the negative economic growth recorded in the April-June quarter (relative to the previous quarter), mediocre performance thereafter, and the prospect that such performance is likely to continue for the time being. Several factors comprise the background to this outlook. First, I adopted a more conservative projection of real exports, not only because external demand was temporarily weak, but also because more consideration was being given to the possibility that structural changes had been hampering rapid export recovery. The latter point is consistent with the fact that industrial production and exports by Japanese firms have remained sluggish while those by their BIS central bankers’ speeches overseas subsidiaries have expanded rapidly since 2009.1 In particular, a shift to overseas production, mainly in the transportation machinery and electrical machinery sectors, left the Japanese economy with the general-purpose, production & business oriented machinery, and information & communication equipment sectors, etc. as the main engine for generating domestic production and export growth. The export performance of these leading sectors has been stagnant, mainly due to a deceleration in economic growth in Asia. Although real exports improved very recently, partly due to the release of new smartphones, they are likely to be more or less constant for the time being in light of the economic slowdown in emerging economies. Second, I revised downward my projection of real private consumption for fiscal 2015. Quarteron-quarter growth rates for real consumption and real retail sales have turned positive in the July-September quarter. However, this downward revision was attributable to (1) very moderate real wage growth after turning positive in July this year and (2) stagnant developments in the consumer confidence index and its components over the next six months – including consumer perception indices on income growth and willingness to buy durable goods. Nevertheless, looking ahead, a moderate recovery trend in consumption is likely to be maintained as nominal wages will continue on a moderate rising trend, amid the tightening labor market conditions. Third, I revised downward my projection of business fixed investment for fiscal 2015 as well, owing to negative growth recorded in the April-June quarter (relative to the previous quarter). In contrast to positive business fixed investment plans for fiscal 2015 reported by the Bank’s Tankan (Short-Term Economic Survey of Enterprises in Japan), actual machinery orders and capital goods shipment have remained disappointing; some firms may postpone their fixed investment plans because of higher unexpected costs caused by labor shortages and rising prices of construction materials. One positive development, meanwhile, is a sustained recovery in residential investment. The recent problems related to the apartment construction wrongdoings in Yokohama and other related problems may dampen such investment temporarily. However, I continue to project a steady recovery in residential investment under the low interest rate environment, since a front-loaded increase in demand prior to the planned consumption tax hike will gradually materialize. For fiscal 2016, I am projecting relatively high economic growth owing to a front-loaded increase in private consumption and residential investment prior to the planned consumption tax hike, amid the favorable employment situation. However, I made a moderate downward revision compared with the July 2015 interim assessment, mainly due to lower-than-expected real export growth. My outlook is more cautious than the median of the Policy Board members’ forecasts, probably because I allocate a greater weight to a potential loss of economic opportunities arising from labor shortages, resulting in a more moderate pace of economic growth. In Japan, firms with good business conditions tend to feel labor shortages and to be increasingly constrained from expanding business activities, while firms with bad business conditions tend to operate their businesses by managing existing employment. This may be one reason why the pace of replacing nonviable less active firms with viable active firms is slow, thereby hampering economic growth. B. Upside and downside risk assessment with regard to economic activity In the October 2015 Outlook Report, the Bank pointed out the following as risks to its baseline scenario for economic activity: (1) developments in overseas economies; (2) the effects of the planned consumption tax hike in April 2017; (3) firms’ and households’ medium- to longterm growth expectations; and (4) fiscal sustainability in the medium to long term. On the whole, it assessed that risks are skewed to the downside. See Ministry of Economy, Trade and Industry, “Global Shipment Index.” BIS central bankers’ speeches In my risk assessment related to economic activity, the upside and downside risks are likely to remain balanced through fiscal 2015 and 2016. By contrast, risks for fiscal 2017 are tilted to the downside. Particularly, I find the following risks related to overseas economies important: • In the Chinese economy, while the labor force population ratio declines, private consumption and Internet sales are firm, due in part to a continuing rise in wages. But the year-on-year rate of increase in retail sales for the first ten months of 2015 remains moderately below the annual target of 13 percent. The tertiary sector, i.e., services industries, is growing and already accounts for over 50 percent of the total value added of the economy. Whether the services industries could become an engine for domestic and global economic growth in the foreseeable future is yet to be seen and may incur downside risk, given that an increasing number of private-sector firms face uncertainty with respect to financing conditions amid the more cautious lending behavior of the banking sector. • Other Asian economies are expected to see stronger growth, led mainly by domestic demand, since the pace of trade growth through the global value chain has decelerated. However, the downside risk is that such developments in domestic demand could be contained by large-scale portfolio capital outflows and the amplified volatility in the foreign exchange and capital markets, perhaps as a result of the normalization of the U.S. monetary policy. • The U.S. economy may achieve greater-than-expected growth if business fixed investment and residential investment expand firmly in tandem with greater growth in labor productivity and wages. This is plausible given that the deleveraging process has made progress in the corporate and household sectors. • In the euro area, the fragmentation in interbank markets has improved and some cross-border capital flows have increased, partly owing to the accommodative monetary easing performed by the European Central Bank, thereby leading to an increase in lending to firms and households. In addition, the intra-regional competitiveness gap has shrunk as the wage growth rate per worker in Germany has been maintained at a high level, at around 3 percent, while wages in peripheral countries have been contained and adjusted. The upside risk is that these favorable developments may enable the euro area to generate stronger-than-expected economic recovery. In addition, for fiscal 2017, the downside risk is greater because there is considerable uncertainty at present related to subsequent declines in demand and in real income after the planned consumption tax hike. It is not clear how much these negative impacts could be offset by a “quantitative” expansion of public- and private-sector fixed investment associated with the Tokyo 2020 Olympic Games, amid the tightened labor market conditions. III. Japan’s medium-term outlook for prices and risk assessment Next, I will turn to the price outlook and risk assessment. A. Outlook for prices In the Bank’s baseline scenario of the outlook for prices, the year-on-year rate of change in the core consumer price index (CPI, all items less fresh food and excluding the direct effects of the consumption tax hikes) is likely to be at around 0 percent for the time being, lower than that in the July 2015 interim assessment. After that, the rate of increase in the core CPI is projected to accelerate toward 2 percent as the underlying trend in inflation steadily rises and the effects of the decline in crude oil prices dissipate. Although the timing of reaching around 2 percent depends on developments in crude oil prices, this is projected to happen around the second half of fiscal 2016, assuming that crude oil prices will rise moderately from the recent BIS central bankers’ speeches level. Thereafter, Japan’s economy is expected to gradually shift to a growth path that sustains such inflation in a stable manner (Chart 1). Regarding my outlook for prices, let me first present an overall picture. Although the mechanism of the price rises I assume is the same as that in the Bank’s baseline scenario, my projections remain more cautious than the median of the Policy Board members’ forecasts. The outlook throughout fiscal 2017 was revised somewhat downward. Currently, my projection is that the rate of increase in the core CPI is likely to rise closer to around 2 percent “from the end of fiscal 2016 to early fiscal 2017” – a delay of about a quarter from my previous projection of “toward the end of fiscal 2016.” Let me explain my outlook in some detail. My projection for prices for fiscal 2015 is that the core CPI will be at around 0 percent. The slight downward revision from the July 2015 interim assessment is attributable to the decline in crude oil prices. Also, the delay in the pace of the output gap improvement was taken into account as the actual output gap deteriorated in the April-June quarter. My projection for fiscal 2016 that the core CPI inflation will rise to a little over 1 percent is rather cautious compared to that presented previously. This reflects (1) the remaining effects of the drop in energy prices, (2) a delay of about a quarter in terms of the timing for the output gap to turn positive, and (3) a delay in the timing for inflation expectations to begin rising owing to a slower pace of increase in prices. Thereafter, the rate of increase in the core CPI will accelerate and reach around 1.7–1.8 percent, or rise closer to around 2 percent from the January-March quarter of 2017 (the peak of the front-loaded increase in domestic demand) to the April-June quarter (the period most likely to see an opportunistic price increase with the planned consumption tax hike). My outlook for fiscal 2017 as a whole is that the average rate of core CPI inflation will decline somewhat and reach around a little over 1.5 percent – slightly below my July assessment – mainly due to the effects of the decline in demand following the frontloaded increase and a decline in real income. On the timing with respect to achieving sustained inflation of around 2 percent in a stable manner, it might be necessary to assess this over a little longer time span. This is because there is high uncertainty regarding the effects of the planned consumption tax hike and the “quantitative” expansion of public- and private-sector fixed investment associated with the Tokyo 2020 Olympic Games. Moreover, it is likely to take some time for inflation expectations to rise. B. Upside and downside risk assessment with regard to prices With regard to risks to the Bank’s baseline scenario for prices, the Bank highlighted the following four factors: (1) developments in firms’ and households’ medium- to long-term inflation expectations; (2) developments in the output gap; (3) responsiveness of inflation to the output gap; and (4) developments in import prices. It assessed that risks are skewed to the downside. My risk assessment related to prices, on the other hand, is that risks for fiscal 2015 are balanced but those for fiscal 2016 and 2017 are tilted to the downside. In particular, there is a great deal of uncertainty related to crude oil prices and foreign exchange rate developments, which could generate both upside and downside risks to the price outlook. On the other hand, there is a downside risk that a steady increase in inflation expectations, a key factor in raising inflation in a stable manner, may not take place as fast as projected. On the whole, therefore, the risks are judged to be tilted to the downside. C. Expression on the timing with respect to achieving around 2 percent inflation In the baseline scenario described in the October 2015 Outlook Report, the Bank postponed the timing of reaching around 2 percent inflation by two quarters, from “around the first half of fiscal 2016” as described in the April Outlook Report to “around the second half of fiscal 2016.” On this front, I opposed the expression “around the first half of fiscal 2016” and proposed to change it to “in or around fiscal 2016” at the Monetary Policy Meeting (MPM) held BIS central bankers’ speeches on April 30. Meanwhile, at the MPM held on October 30, I supported the Bank’s revised expression. Let me explain why. Due to the fact that the median of the Policy Board members’ forecasts was revised downward sharply this time, it is apparently unfeasible to achieve around 2 percent inflation around the first half of fiscal 2016. Therefore, it is reasonable for the Bank to change the expression. However, given that it assessed that risks to prices are skewed to the downside, it may be appropriate for the Bank to use an expression that allows for a wider time span to reach around 2 percent, such as “from around the second half of fiscal 2016 to around the first half of fiscal 2017” – instead of “around the second half of fiscal 2016.” On the other hand, the timing expressed as “around the second half of fiscal 2016” practically corresponds to the latter half of the intended period in my proposal in April. Also, more importantly, the expression is very similar to my present projection and could be regarded as more or less in line with it by interpreting “around 2 percent” flexibly. Based on these two reasons, I supported the Bank’s revised expression. IV. Conduct of monetary policy Despite the downward revision of the Bank’s outlook for economic activity and prices from the July 2015 interim assessment, I view that it is important for the Bank to maintain the accommodative monetary environment by continuing the current guideline for money market operations. Before I elaborate on my line of thinking, by making referrals in contrast to trends observed last October when the expansion of quantitative and qualitative monetary easing (QQE) was implemented, let me emphasize that the price stability target of 2 percent does not just pursue a price hike; the target should be achieved with sustained wage growth and expansion of private consumption. On this front, it is important to assess whether Japan’s economy continues to face a virtuous cycle among production, income, and spending operating in both the corporate and household sectors. Let me highlight five viewpoints that are essential to making such an assessment. First, firms’ business conditions and current profits are more favorable than those in the previous year. For example, the Bank’s September 2015 Tankan indicates that the diffusion index (DI) for actual business conditions for all industries – calculated by subtracting the percentage share of firms responding that business conditions are “unfavorable” from the share of those indicating that business conditions are “favorable” – improved moderately from 7 percent in June to 8 percent in September, in contrast to a decline from 7 percent to 4 percent over the same period last year. In particular, the business conditions DI of large nonmanufacturing enterprises improved further from 23 percent in June to 25 percent in September – exceeding the levels of the previous year (dropping from 19 percent to 13 percent over the same period). Projected current profits are favorable as well. The September Tankan shows that the year-on-year rate of change in projected current profits of all industries for fiscal 2015 recorded 3.3 percent (4.0 percent in manufacturing and 2.7 percent in nonmanufacturing). The profitability outlook shows a complete change from that for fiscal 2014 reported in September last year, when the rate of change in projected profits was minus 4.0 percent (minus 2.6 percent in manufacturing and minus 5.1 percent in nonmanufacturing). Furthermore, let me plot the relationship between the year-on-year rate of growth in projected current profits and sales for all industries for fiscal 2015 as of September 2015 (Chart 2). This shows that a relatively large number of sectors are positioned in the first quadrant (positive territory for both growth in current profits and sales). Generally, growth in current profits is much greater than that in sales – reflecting an improvement in the terms of trade (caused by a plunge in commodity prices such as for crude oil) as well as profits from revaluation of dividends from overseas and higher yen-based export prices, both driven by the yen’s depreciation. Noticeable developments are that the rates of growth in current profits and sales in (1) food; (2) accommodations, eating & drinking services; and (3) services for individuals are greater than those for fiscal 2014 reported in September 2014. The food sector, which is BIS central bankers’ speeches included in manufacturing, projects export sales growth of 5 percent and domestic sales growth of 3 percent – suggesting that domestic private consumption is quite solid as well. The aforementioned data indicate that domestic demand is recovering from the adverse effects of the consumption tax hike in April 2014. Second, a risk of returning to deflation is considered low given that prices of a wide range of consumption items, excluding energy, have been rising. While the Bank assesses the underlying trend in inflation based on various indicators, typical indicators are mainly the core CPI and trimmed mean. Both exclude temporarily volatile items in order to grasp the trend behavior of prices. They often are utilized to project future prices owing to their relatively high predictive power. The difference is that the core CPI always excludes the same items that tend to show high volatility from the consumption basket weight. In contrast, the trimmed mean looks at the price changes every month for each item of the CPI and eliminates a certain fraction (e.g., 10 percent) of the most extreme observations at both ends of the largest and smallest changes. Thus, items eliminated each month could vary month to month. The Bank uses the CPI for all items less fresh food, or the “core CPI,” in determining its medium-term outlook for prices in the Outlook Report. Energy prices are included in the core CPI because they did not have a statistically significant impact on CPI movements in the long term. However, as a sharp fall in energy prices since the latter half of the previous year has amplified the volatility in the core CPI, it has become more important to assess the underlying trend in inflation in a comprehensive manner, not only with the core CPI but also with multiple indicators. As one such indicator, the Bank has begun to release the “CPI for all items less fresh food and energy” on a monthly basis. While the rate of change in the core CPI has been at around 0 percent recently, that in the CPI for all items less fresh food and energy has risen to 1.2 percent lately (Chart 3). Moreover, the trimmed mean is increasingly becoming important since the indicator automatically removes highly volatile items every month – given that fluctuations in commodity prices and foreign exchange rates have amplified. The “10 percent trimmed mean” has been rising moderately and is currently at 0.6 percent, and this contrasts sharply with the declining trend observed about the same period last year. Third, firms’ pricing behavior with respect to sales prices has shown positive developments. To see this, let me plot the relationship between the actual sales price DI and the rate of growth in projected domestic sales for fiscal 2015, according to the September Tankan (Chart 4). The sales price DI is calculated by subtracting the percentage share of firms responding that their sales prices are “falling” from the share of those indicating that the prices are “rising.” Chart 4 indicates that a few sectors are positioned in the first quadrant (positive territory for both the actual sales price DI and projected domestic sales). Developments in sectors such as (1) food and (2) accommodations, eating & drinking services are worthy of note. The sales price DI in these sectors used to be negative to a relatively large degree or showed greater responses with “fall” than those with “rise” before QQE was launched. This indicates a significant turnaround in firms’ pricing behavior toward an environment where they find it easier to raise their sales prices than before. The current rise in a wide range of CPI items reflects three factors: (a) an import price rise driven by the yen’s depreciation; (b) an increase in domestic demand; and (c) a pass-through of a wage rise. While it is difficult to disentangle these factors, the impact of (a) above, the import price rise, seems large and it eventually will fade away unless a further depreciation of the yen takes place. Meanwhile, firms have provided high value-added goods and services, and higher sales prices have accompanied a sales increase in some items, as seen in the food and accommodations, eating & drinking services sectors. Looking ahead, nominal wages are likely to rise and the output gap is likely to improve in positive territory, which will help enhance the sustainability of a price rise. Fourth, developments in inflation expectations should be monitored closely, although some indicators have declined recently. Inflation expectations are a collective term referring to those of households, firms, and economists, as well as market-based indicators. Attention should be BIS central bankers’ speeches paid to a recent decline in inflation expectations of firms and economists, as well as in marketbased indicators. At the same time, however, a decline in inflation expectations has been a global phenomenon since summer 2015. Therefore, it is important to understand whether such a decline reflects a downward revision of commodity price projections and a temporary deceleration in global economic growth, or alternatively a deterioration of the outlook for the domestic supply-demand balance. On this front, domestic private consumption has been resilient. The corporate sector has maintained its positive business fixed investment plans according to various recent surveys, and thus fixed investment is likely to expand in the near future. These domestic demand conditions support the view that domestic supply-demand balance is not bad at all. Inflation expectations, therefore, are likely to show a sustainable rise once the rate of change in the CPI begins to rise following an improvement in the output gap. Fifth, as a related issue, households’ inflation expectations tend to be higher than those of firms. Households tend to perceive that prices are always rising and they always keep positive inflation expectations even under a mild deflationary phase or a very slight inflationary phase (Chart 5). This suggests the presence of an upward bias in inflation expectations. On this point, I have delivered several speeches abroad in the past and have suggested that the scale of upward bias appears to be generally greater in Japan than in Europe and the United States.2 Given the past long-standing stagnant wages, households appear to have formed an expectation over time that future wages will always decline. This has led households to anticipate tighter budgets, and such strong defensive action has resulted in a larger upward bias in their inflation expectations. In this environment, it is important for households to form a perception that wages will increase steadily and that such an increase will continue; indeed, wages are currently improving moderately. In addition, at present, a further monetary policy action is unnecessary given that current sluggish movements of the core CPI caused by a decline in energy prices are temporary, and that a decline in production costs and the resultant improvement in corporate profits might enhance the opportunity for firms to raise wages more readily. Based on these five viewpoints, it is time to closely monitor whether prices will exhibit a rising trend under the current accommodative monetary easing environment. If such a path toward price rises does not materialize at all, the Bank – depending on the causes – may consider some adjustments with regard to the monetary policy. This brings me to the end of my speech. Thank you very much indeed for your kind attention. For recent speeches, see Sayuri Shirai, “Monetary Policies in a Diversifying Global Economy: Japan, the United States, and the Asia-Pacific Region,” Remarks at the Panel Discussion Organized by the Federal Reserve Bank of San Francisco, Bank of Japan, 2015, and Sayuri Shirai, “Unconventional Monetary Policies of the Bank of Japan and European Central Bank,” Remarks at the Panel Discussion at the Bruegel Annual Meeting, Bank of Japan, 2015. 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, Nara, 7 December 2015.
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Takehiro Sato: Recent economic and financial developments and monetary policy in Japan Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Nara, 7 December 2015. * * * The charts can be found at the Bank of Japan’s website http://www.boj.or.jp/en/whatsnew/index.htm/. Introduction Thank you for giving me this opportunity to exchange views with people representing the political, economic, and financial communities of Nara 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 Osaka Branch. In today’s speech, I will begin by focusing on recent economic and financial developments in Japan and abroad, as well as the Bank’s monetary policy. I will then touch briefly on the economy of Nara 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. I. Recent economic and financial developments in Japan and abroad A. Overseas economies Overseas economies – mainly advanced economies – have continued to grow at a moderate pace, despite the slowdown in emerging economies. In a situation where commodity and energy prices remain sluggish, the growth rates of emerging and commodity-exporting economies have not risen, and advanced economies have been affected partly by the decrease in investment related to resource development. This presumably means that the decline in commodity and energy prices, which at first was expected to have favorable effects on the world economy as a whole, is not only due to the supply factor but also has been influenced to a certain degree by the demand factor; namely, a decline in demand from China and other emerging economies. Regarding the supply factor, the textbook view that supply is automatically adjusted through the price mechanism appears to not necessarily fit with reality, as resource developers continue to operate at prices below the breakeven point in order to recover the sunk cost, for example. Considering this situation, it is difficult in the short term to envision a scenario of commodity and energy prices recovering remarkably and to expect a situation where the growth rate of commodity-exporting economies would increase. Therefore, even if emerging economies gradually move out of their deceleration phase due to favorable effects of the growth in advanced economies, the pace of increase in the growth rate of the world economy as a whole may continue to accelerate only moderately. Recently, the International Monetary Fund (IMF) has also been fairly consistently revising downward its forecast of global growth in its World Economic Outlook (Chart 1). Although the Chinese economy has been slowing somewhat, mainly in the manufacturing sector, its services sector has been firm (Chart 2). Under the authorities’ strong commitment to supporting growth, the economy is expected to broadly follow a stable growth path, albeit with the growth rate continuing to slow somewhat, as the authorities proactively carry out policy measures to support economic activity from both the fiscal and financial sides (Chart 3). However, there are signs of deflationary pressure from asset price adjustments, as shown in the GDP deflator turning negative again in the GDP statistics for the July-September quarter, and this warrants attention. The key to realizing stable growth will be whether the economy can shift from being investment- and export-driven to being domestic demand-driven, accompanied by structural reforms. BIS central bankers’ speeches I see downside risks to the outlook that I have just described, and note the following three points. First, the growth of the world economy is disproportionately led and driven by that of the United States. The expansionary phase of the U.S. economy already has lasted for around seven years since the global financial crisis, representing the fourth longest period of expansion in the postwar era, and from the perspective of the economic cycle, it can be said that the expansionary phase is maturing. Of course, under pressure from balance sheet adjustments, the pace of recovery after the global financial crisis has been moderate compared with that in past recovery phases, so making a simplistic comparison in terms of the duration of expansion may be problematic. However, if wage growth – which so far has been lagging – gains momentum while the slack in the labor market diminishes gradually, it seems it will be necessary to keep in mind the risk that the economy may enter an adjustment phase due to the narrowing of the margin for firms. Under these circumstances, the Federal Reserve intends to normalize the monetary policy at a moderate pace. I would like to watch how the normalization of interest rates plays out in relation to the duration of the expansionary phase. Second, in Europe, there remain various adjustment pressures; in addition, the refugee problem is emerging as a serious challenge. For example, an agreement of sorts was reached among relevant countries on the Greek debt problem around the middle of the year. This is supposed to inject capital into banks at an early date in order to maintain financial system stability, but drastic measures to reduce sovereign debt have yet to be drafted. In this situation, there is a fair possibility that the debt problem will attract attention once again. Moreover, the influx of refugees will likely increase the fiscal burden on European countries for the moment. Third, in emerging and commodity-exporting economies, the pace of recovery may slow on the whole, albeit with differences across countries and regions, if the slump in commodity and energy prices is prolonged, or if the outflow of funds from those economies escalates in the global financial markets due to an interest rate hike in the United States. In particular, I have concern about the impact that may hit the fiscal position of oil-producing countries and the possibility of geopolitical risks growing if the slump in crude oil prices is prolonged. B. Global financial markets The global financial markets grew risk-averse toward summer 2015 because of such factors as concerns over the slowdown in the Chinese economy. Although such concerns remain, there has been an improvement in the market’s risk appetite due to last month’s employment statistics, which showed the steadiness of the U.S. economy, and to the proactive stance of the European Central Bank (ECB) on additional monetary easing. Although there are heightened expectations among market participants that the interest rate hike will be implemented in the United States at the Federal Open Market Committee (FOMC) meeting this December, there has been no sign so far of the risk aversion trend flaring up again, as the Federal Reserve has carefully engaged in communication with market participants. While there remain concerns over a further outflow of funds from some emerging markets that may be triggered by the interest rate hike, I expect that the first such hike since the global financial crisis will be welcomed as an event symbolic of the U.S. economic recovery, and also will lead to dispelling the uncertainties that have hung over the global financial markets for a long time. Looking forward, the first point that we should keep in mind under these circumstances is the impact of a decline in market liquidity. The exchange rate reform of the Chinese yuan was presumably the direct trigger of the global turmoil that occurred this summer, and issues regarding the Chinese currency and monetary authorities’ communication have been pointed out on various occasions. However, at a more fundamental level, I have the sense that the global financial markets were affected to a certain degree by the fact that market liquidity declined because risk taking by major market makers was constrained by the full-fledged enforcement of the so-called Volcker rule since July, and consequently the presence of technical players – that is, players engaging in algorithmic trading and high frequency trading (HFT) – grew amid the thin summertime trading volume. I feel it is necessary to carefully BIS central bankers’ speeches monitor whether or not something trivial could lead to market instability not only in summer but also at other times, such as the end of the year or quarter, when liquidity tends to decline due to various constraints imposed by regulation (Chart 4). Second, there is a possibility that the U.S. dollar funding cost will hover at a high level due to structural factors. The cost of converting yen into U.S. dollars in the swap market has been increasing and the basis swap spread has widened, as expectations for the interest rate hike in the United States have mounted, in addition to the usual end-of-year strengthening of demand for U.S. dollar funds (Chart 5). While I assume that Japanese banks already have been making efforts to enhance their stable foreign-currency funding base while expanding their overseas business, I feel that it is necessary to carefully monitor this situation. The Bank, in cooperation with the Federal Reserve, has a backstop in place in the form of the U.S. dollar funds-supplying operations, but I would like to reemphasize the importance of financial institutions’ efforts to secure their own stable funding base. The third point is the impact of additional monetary easing by the ECB on the global financial markets. In Europe, the presence of negative interest rates already has become prevalent in some countries in relation to the currency policy, even before the deposit rate reduction by the ECB to a negative rate. The ECB’s recent deposit rate reduction is expected to escalate this situation. The yield curve in Germany, used as a benchmark, had temporarily turned negative with respect to bonds with maturities of six or seven years. I am keeping a close watch on how such an interest rate formation, coupled with the interest rate hike in the United States, will affect the flow of funds in the global financial markets, and whether or not the flattening of the yield curve will undermine the sustainability of government bond purchasing by the ECB from the perspective of the sustainability of the Bank’s purchases of Japanese government bonds (JGBs), which I will describe later. C. Japan’s economy Looking at developments in Japan’s economy, indicators had been relatively weak for the AprilJune quarter through the July-September quarter, particularly on the industrial production side, and real GDP had declined for two consecutive quarters (Chart 6). Given this situation, there are views, mainly among overseas media, that Japan’s economy has technically entered a recessionary phase due to the slowdown in emerging and commodity-exporting economies, particularly China. That being said, on the back of an increase in receipts of income from overseas business reflecting the yen’s depreciation, as well as an improvement in the terms of trade due to the declines in energy and commodity prices, firms have seen record profits, which consequently is reflected in gross national income (GNI) and gross domestic income (GDI) having been on clear increasing trends compared to GDP. The mechanism of aggregate income formation has been relatively robust and business sentiment at a high level (Chart 7). Thus, it seems that the economy has been resilient recently to exogenous shocks to a certain extent, such as the slowdown in overseas economies. In fact, despite relatively weak indicators of exports and industrial production, domestic demand has maintained its resilience, mainly in private consumption, and a virtuous cycle from income to spending has continued to operate on the whole. Final demand also remained firm in the July-September quarter. This is contrary to what the economy experienced from 2007 until the global financial crisis occurred in 2008, when Japan’s economy actually entered a recessionary phase triggered by the slowdown in overseas economies as the terms of trade deteriorated because of the surge in energy and commodity prices. Let me add a few things about exports and industrial production. Real exports have been picking up slightly recently, albeit with a rising concern over the slowdown in the Chinese economy (Chart 8). This is suggested by the divergence between the volume of exports in trade statistics and figures for real exports, which might be attributable to a rise in exports of goods with relatively high value-added – such as electronic parts and devices – observed after the July-September quarter, reflecting the product life-cycle of mobile phones. Moreover, strength in imports is also a reflection of firmness in domestic demand. Meanwhile, although BIS central bankers’ speeches the July-September quarter represented the second consecutive quarter of decrease in industrial production, it is expected to pick up in the October-December quarter, mainly due to the increase in production of automobiles. We are currently in a puzzling situation where exports have been more or less flat while industrial production has posted a relatively clear decrease and business sentiment has generally stayed at a high level. However, such firm business sentiment is evidence that a “mirage of demand,” which commonly occurs during an economic recession, is not taking place, and weakness in industrial production might be only due to the base year of statistics on production being set at 2010, which has not been revised for a while, thus making it difficult to fully reflect the increase in the weight of goods with high value-added brought about by the recent changes in the production structure. That being said, it is unclear whether the virtuous cycle from income to spending is strongly at work. For example, although firms’ fixed investment plans have been at high levels, coincident and leading indicators such as shipments of capital goods and machinery orders suggest that actual business fixed investment has been sluggish, and real business fixed investment on a GDP basis can be assessed as having been more or less unchanged, or even fallen marginally (Chart 9). In addition, firms still seem to have a negative stance toward increasing spending that could lead to an expansion in fixed costs, as seen in the fact that base pay has increased for two consecutive years but the pace has remained only moderate (Chart 10). One of the reasons behind firms maintaining such a cautious stance toward spending would be that the deflationary mindset has not been dispelled in a broad sense. In addition to this, even though corporate profits had registered a record high recently, this was not due to an increase in sales volume, but rather to an increase in foreign exchange gains of income from overseas business reflecting the yen’s depreciation, as well as to a decrease in input costs stemming from the decline in commodity prices. Therefore, firms do not consider the improvement in their profits to be indicative of a permanent increase in income, and remain cautious about expanding their fixed costs. In other words, their growth expectations for profits may not have risen that much. In an effort to assist firms from the financial side, the Bank has been taking the initiative to create accommodative financial conditions through, for example, the fund-provisioning measure to support strengthening the foundations for economic growth. In raising growth expectations, however, there are many issues beyond the scope of monetary policy, and I consider it important for the government to make strenuous efforts to change firms’ and households’ expectations by steadily implementing the growth strategy. In relation to firms’ stance toward spending, I also would like to touch on the annual labormanagement wage negotiations in spring 2016. A sustainable rise in workers’ base pay is one of the key points for achieving steady recovery in household consumption expenditure and raising people’s medium- to long-term inflation expectations, which appear to remain lower than those in the U.S. and European economies. Thus, I am paying attention to whether or not base pay will see a rise for a third consecutive year in the annual labor-management wage negotiations in spring 2016. Although the Japanese Trade Union Confederation (Rengo) has presented a basic stance toward the next spring wage negotiations – namely, demanding a base pay increase of about 2 percent – it is uncertain how rises in the underlying trend in inflation and the outlook for prices will be reflected in base pay. I therefore expect the government to take initiatives such as deregulating the labor market so that firms can find it easier to decide on a base pay increase. D. Prices Let me now turn to developments in prices. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food has been about 0 percent recently due to the decline in energy prices (Chart 11). The year-on-year rate of increase in the CPI for all items less fresh food and energy, on the other hand, has been about 1 percent recently, and the ratio of increasing and decreasing items in the CPI and the year-on-year rate of change in the trimmed mean have been increasing moderately. In addition, people’s medium- to long-term BIS central bankers’ speeches inflation expectations appear to be rising on the whole, albeit with some weakness, partly due to changes in the behavioral patterns of firms and households since the introduction of quantitative and qualitative monetary easing (QQE). Given these factors, the Bank is of the view that the underlying trend in inflation has been rising steadily. I am aware that there are various views on how to assess the underlying trend in inflation. In a situation where price indicators have been affected significantly recently by the short-term fluctuations in energy prices, it does sound reasonable to look at the CPI excluding energy prices. Nonetheless, as I will describe later, I believe that it is necessary to closely examine a wide range of price indicators, including wages, as the recent rise in the CPI for all items less fresh food and energy might only be attributable to households’ acceptance of price rises, mainly in daily necessities, brought about by the decline in energy prices. With these factors in mind, I would like to discuss recent developments in the CPI for all items less fresh food and energy. There is a view that its recent rise can be inferred from the yen’s depreciation observed since the expansion of QQE at end-October 2014, and that such a rise will peak out after the turn of fiscal 2016 as no further depreciation is expected. I would say, however, that it seems unreasonable to explain the recent developments in the CPI for all items less fresh food and energy in a consistent manner by the yen’s depreciation alone, as prices of food products and durable goods – leading to the recent rise in the CPI for all items less fresh food and energy – have resumed a clear uptrend recently under the yen’s depreciation trend that has generally lasted since around the introduction of QQE in April 2013. I consider that the recent rise is actually attributable to the fact that households have more readily accepted price rises on the back of moderate improvement in the employment and income situation as well as the decline in energy prices, and firms accordingly have taken a somewhat aggressive stance of setting higher prices. Yet, it is uncertain whether or not households will continue to accept price rises if the effects of the decline in energy prices dissipate. Moreover, if no further depreciation of the yen is expected, it is likely that prices of food products and durable goods will stop rising. In view of these possibilities, the key to whether or not the year-on-year rate of increase in the CPI for all items less fresh food and energy will remain stable at around 1 percent will likely lie in whether rises in services prices – which have been lagging recently – would start to be observed following the wage negotiations for fiscal 2016. There are uncertainties over future developments in the wage negotiations, as I mentioned earlier, and also downside risks as to whether price rises in daily necessities and durable goods will lead to a rise in services prices. In my opinion, however, it is possible to generally maintain the annual growth pace of around 1 percent throughout the projection period, excluding the effects of the decline in energy prices. As a member of the Policy Board – which has the responsibility to ensure price stability – I made all efforts to present the most probable scenario in the October 2015 Outlook for Economic Activity and Prices (Outlook Report). In my view, whether or not the underlying trend in inflation will jump to 2 percent depends on whether people’s medium- to long-term inflation expectations will jump to around 2 percent, and this suggests that people’s expectations are unlikely to become so bullish within the projection period as wages have not yet risen to that level. II. Future conduct of monetary policy A. QQE It has been two years and eight months since the introduction of QQE. My evaluation of the policy is that, as evidenced by economic and market developments during this period, the intended purpose of promoting the conversion of the deflationary mindset is gradually being achieved, although we are still only halfway toward accomplishing this goal. Meanwhile, in the October 2015 Outlook Report, it was projected that the timing of reaching the price stability target would be delayed to around the second half of fiscal 2016 (Chart 12). I am aware that, consequently, there are various views on the Bank’s commitment to achieving the price stability BIS central bankers’ speeches target of 2 percent in a stable manner at the earliest possible time, with a time horizon of about two years. Given this situation, I find it necessary to go over what I had explained about the Bank’s commitment, and would also like to share my thinking again. I consider this commitment to be a rolling target. It is not intended to achieve a specific price level within a specific time frame but rather to achieve the price stability target at the earliest possible time with a time horizon of about two years. I also regard the price stability target itself as a flexible concept with a certain range for upward and downward deviations of the actual inflation rate from the target. I believe such commitment is as reasonable as the framework of the inflation target adopted by central banks in other major countries. In fact, developments in prices depend, for example, on those in crude oil prices in the short term, and inflation expectations that affect the underlying trend in inflation are susceptible to monetary policy as well as other factors that cannot necessarily be controlled directly through the conduct of monetary policy, such as the outcome of wage negotiations and growth expectations. As I have stated before, prices reflect the state of the economy and are not a variable that can be directly operated by a central bank. Therefore, the policy conduct aiming at a specific inflation rate within a specific time frame seems unreasonable in the first place, and if a central bank persists in achieving such an aim, there may be a risk that its credibility will be undermined. Let me reiterate the significance of achieving the price stability target of 2 percent. The price stability target is set based on the CPI for all items, and as reference figures to capture its underlying trend, the Bank has used the CPI for all items less fresh food in presenting the Policy Board members’ projections. However, unlike the cases in Europe and the United States, the CPI entails statistical problems in that stickiness of fees for public services is high and that private rent and imputed rent structurally exert downward pressure on it. Thus, the CPI, which is included in official statistics compiled by the government, seems to have deviated recently from being in line with people’s perception of inflation that reflects a price rise in daily necessities, as shown, for example, in the University of Tokyo Daily Price Index and the SRIHitotsubashi Consumer Purchase Price Index. In particular, the year-on-year rate of increase in the SRI-Hitotsubashi Unit Value Price Index – which factors in firms’ strategy to maintain sales prices by making frequent changes in their products – has been around 2 percent recently, representing somewhat more of an acceleration than that in the CPI for the same items covered by this index (Chart 13). If the Bank conducts its monetary policy by focusing only on the CPI in official statistics, in a situation where people’s perception of inflation level exceeds its growth rate, there is a possibility that people would come to feel an excessive rise in prices, and that could cause many distortions in their sentiment and actual spending behavior (Chart 14). What matters is that the inflation rate rises in balance with wages as the level of economic activity increases. With these factors in mind, I would like to reemphasize that achieving 2 percent in terms of the year-on-year rate of increase in the CPI for all items is not the ultimate goal of the price stability target, but rather that its achievement should be assessed flexibly from various aspects while examining a wide range of price indicators. B. Continuation of QQE Meanwhile, it seems that market participants still hold expectations for a further expansion of QQE. I believe this might be attributable not only to interpretation of the price stability target, as I explained earlier, but also to the thinking regarding the effects of QQE; namely, that easing and tightening effects would depend on the flow – that is, the amount – of financial assets to be purchased by the Bank. Theoretically speaking, however, the effects of QQE have the nature of strengthening cumulatively with the progress in the Bank’s asset purchases. This means that, even if the Bank maintains the same amount of asset purchases, monetary easing effects will strengthen as long as it continues with the purchases. Therefore, I hold the view that the Bank’s decision at each monetary policy meeting to continue with the current QQE in and of itself is very critical in terms of monetary easing effects. BIS central bankers’ speeches The Bank has committed to purchasing JGBs so that its net holdings will increase at an annual pace of about 80 trillion yen. Nonetheless, considering that the amount of redemption of its JGB holdings will increase, the amount of purchases on a gross basis is likely to rise even under the current policy commitment. For this reason, the Bank’s presence in the JGB market could increase further, although this also will depend on the government’s JGB issuance plan. Given this situation, for the Bank’s explanation – namely, that massive purchases of JGBs are carried out only in the context of the conduct of monetary policy and not in any way to finance the fiscal deficit – to remain fully persuasive, I also would like to reiterate that the government’s commitment toward fiscal consolidation is important. As I mentioned earlier, monetary easing effects appear cumulatively in theory, but in terms of positive effects and side effects, it is likely that the easing effects have been diminishing marginally, since the pace of decline in nominal interest rates has been minimal despite the progress in the Bank’s purchases, as evidenced by a limited decline in longer-term interest rates since the expansion of QQE at end-October 2014. There is no doubt that policy effects are always accompanied by side effects, and I believe that a basic approach is to decide on the continuation of monetary policy after comparing and examining its positive effects and side effects. I initially did not expect that QQE, which is a kind of shock therapy that influences formation of people’s inflation expectations through massive asset purchases, would be continued for a very long time, and am concerned about a possibility that continuation of the policy will cause the positive effects to decline marginally while the side effects increase marginally. C. Sustainability of the bank’s market operations As the Bank continues with its JGB purchases at the current pace, the amount outstanding of JGBs in the markets will decrease by the difference between the amounts of the government’s net issuance and the Bank’s net purchases. Since the amount outstanding in the markets is limited, the Bank will not be able to continue with the purchases at the current pace indefinitely. In reality, financial institutions have reasons to hold a certain amount of JGBs, such as for use as collateral, so they would stop selling their holdings to the Bank before the amount outstanding in the markets hits the bottom. At this point, it is difficult to project when this critical point is likely to happen, because financial institutions’ incentive to sell their JGB holdings is expected to depend on the interest rate level and the shape of yield curves at each point in time. If QQE continues to exert its intended effects and market participants’ medium- to long-term inflation expectations rise, the yield curve will steepen and financial institutions will have greater incentive to sell their JGB holdings. On the other hand, in a case where the conversion of the deflationary mindset does not make progress and market participants’ medium- to longterm inflation expectations do not rise, the yield curve would flatten and financial institutions would have a stronger preference for JGB holdings. Therefore, the Bank’s massive JGB purchases involve difficulties, in that there is a possibility that they become easier if the probability of realizing the policy objectives rises, whereas the Bank’s market operations might become problematic if realizing these objectives is considered to be difficult. Thus, when judging the necessity of continuing QQE, I would like to take into account the sustainability of the Bank’s market operations. Concluding remarks: economic activity in nara prefecture My concluding remarks will touch on the economy of Nara Prefecture. Compared with the national average, the industrial structure of Nara Prefecture is characterized by the large weights of not only local industries – such as plastics, rubber, and textiles – but also of electrical machinery and general machinery. The prefecture is also well known for its production of such items as cha sen (a tea ceremony tool), sumi ink, ink brushes, leather products, and somen noodles, as well as goldfish farming. Although the economy of BIS central bankers’ speeches Nara Prefecture has shown weakness recently in terms of production, a moderate recovery is underway. Production has been declining mainly because of decreases in electrical machinery and general machinery. Meanwhile, in the household sector, the active job openings-toapplicants ratio is rising moderately and employee income has been above the previous year’s levels. Private consumption has been recovering on the whole, as retail sales have remained robust, despite the continued weakness of passenger-car sales (Chart 15). From a longer-term perspective, the transfer of production sites from Nara Prefecture to other locations, including foreign countries, has been proceeding amid intense international competition. In addition to such dwindling sources of employment, there also has been the critical challenge of responding to the aging of society coupled with the low birthrate and shrinking population, which reflects Nara Prefecture’s history of development as a commuter town for neighboring large cities such as Osaka and Kyoto. However, I hear that Nara Prefecture already has been conducting broad-ranging activities through cooperation between the public and private sectors in order to deal with this challenge. For example, as an initiative to become more than just a commuter town, the prefecture is inviting businesses from the outside and promoting the development of local industries by creating an industrial cluster area at a convenient location close to an expressway. Over a period of eight years, the prefecture succeeded in inviting 205 projects for factories and other facilities. In addition, in the southern and eastern parts of the prefecture, where large tracts of abandoned farmland exist, agriculture promotion measures are being implemented to encourage a shift to the so-called sixth industry, including such activities as opening a privately run auberge (restaurant equipped with boarding facilities) using local food materials. In April next year, NARA Agriculture and Food International College will be opened. Furthermore, Nara Prefecture has an abundance of tourism resources, including several World Heritage sites, and the number of visitors has been rising, partly as a result of an increase in foreign visitors in recent years. Until now, there has been a scarcity of inns and hotels in the prefecture, so the rising number of visitors has failed to increase overnight stays, meaning that its tourism resources have not necessarily been utilized sufficiently. However, I hear that there is an ongoing project, in order to resolve the shortage of hotel rooms, to build a large hotel at a site in Nara City that is owned by the prefectural government. I am hoping that Nara Prefecture will further revitalize its economy by continuing with steady efforts to do so through cooperation between the public and private sectors. BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Kisaragi-kai meeting, Tokyo, 3 February 2016.
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Haruhiko Kuroda: Introduction of “Quantitative and Qualitative Monetary Easing with a Negative Interest Rate” Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Kisaragi-kai meeting, Tokyo, 3 February 2016. * * * Introduction It is my great pleasure to have the opportunity today to speak at the Kisaragi-kai meeting. At the Monetary Policy Meeting held on January 29, the Bank of Japan decided to introduce “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” in order to achieve the price stability target of 2 percent at the earliest possible time. Today, I will first explain the Bank’s recognition of and prospects for economic activity and prices in Japan, and then elaborate on the background to the policy decision made this time around. I. Economic activity in Japan First, I would like to talk about economic activity in Japan. Japan’s economy has continued to recover moderately on the back of firm domestic private demand, although exports and production have been affected by the slowdown in emerging economies. In the corporate sector, profits clearly have continued to improve, registering a record high, with support from an improvement in the real economy as well as the low crude oil prices and the low yen rate (Chart 1). Against this background, business fixed investment has been on a moderate increasing trend. According to the business fixed investment plans in the December 2015 Short-Term Economic Survey of Enterprises in Japan (Tankan), firms have maintained their positive fixed investment stance. In the household sector, labor market conditions have continued to tighten. The active job openings-to-applicants ratio and the diffusion index for employment conditions in the December Tankan have improved to almost the same levels as around the first half of 1992 (Chart 2). Moreover, the unemployment rate has been declining and is in the range of 3.0–3.5 percent for the first time in 18 years, since 1997. It can be judged that the labor market is in a situation of “full employment,” where remaining unemployment is due solely to mismatches between job openings and job applicants. Reflecting the tightening of labor market conditions, employee income has been increasing moderately. Under such steady improvement in the employment and income situation, private consumption has been resilient. Looking ahead, domestic demand is likely to follow an uptrend, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors. Exports are expected to increase moderately on the back of emerging economies moving out of their deceleration phase. As in the January 2016 Outlook for Economic Activity and Prices (Outlook Report) released by the Bank last week, the real GDP growth rate is projected to be 1.1 percent for fiscal 2015 and 1.5 percent for fiscal 2016, and thus is estimated to continue to exceed the potential growth rate (Chart 3). Against this backdrop, Japan’s economy is likely to shift from the phase of recovery to expansion; namely, the output gap is expected to turn positive (excess demand). In fiscal 2017, the real GDP growth rate is projected to maintain positive growth of 0.3 percent, although with a slowing in its pace to around a level somewhat below the potential growth rate, reflecting the effects of a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike as well as the cyclical developments in the economy. II. Price developments in Japan Let me now turn to price developments in Japan. BIS central bankers’ speeches The year-on-year rate of change in the consumer price index (CPI, all items less fresh food), which had been minus 0.5 percent just before the introduction of QQE, increased to as high as 1.5 percent in April 2014, excluding the effects of the consumption tax hike (Chart 4). However, as a result of a substantial fall in crude oil prices since summer 2014, it has declined gradually and currently is around 0 percent. Nonetheless, the Bank is of the view that the underlying trend in inflation has been improving steadily. Next, I would like to elaborate on the background to our view on prices. To begin with, I would like to touch on the relationship between the price stability target of 2 percent and the underlying trend in inflation. The Bank has set the target at 2 percent in terms of the year-on-year rate of change in the all-item CPI. It is common in major economies to define the price stability target as the all-item inflation rate. This is because the all-item CPI comprehensively covers goods and services that households consume. However, when assessing price developments at each point in time, there is a need to exclude the effects stemming from the factors that fluctuate temporarily and evaluate the underlying trend in inflation appropriately. Since such factors will dissipate eventually, we cannot make appropriate policy decisions if we look only at superficial price developments, which are affected by temporary factors. We usually refer to the CPI (all items less fresh food) to explain price developments because prices for fresh food fluctuate remarkably in Japan. Given this, in a case where crude oil prices fluctuate largely, it is natural to think that the CPI should be looked at on a basis excluding energy. On this basis, I would like to examine the underlying trend in inflation in Japan. The Bank is of the view that the underlying trend in inflation has been improving steadily, and this is based on two factors. First, the year-on-year rate of change in the CPI excluding fresh food and energy – both of which are with large fluctuations – had been negative until the introduction of QQE, but turned positive in October 2013. Since then, it has remained positive for 27 consecutive months and increased to 1.3 percent recently (Chart 4). Second, both the output gap and medium- to long-term inflation expectations, which determine the underlying trend in inflation, have been improving. Let me now briefly reflect on the output gap and medium- to long-term inflation expectations. First off, the output gap – an indicator for the supply and demand balance – fluctuates, reflecting the utilization of labor and capital. As I mentioned earlier, the labor market is in a situation of “full employment,” and the output gap has steadily followed an improving trend driven mainly by labor market developments, with the tightening trend in labor market conditions having continued (Chart 5). With the economy continuing to grow at a pace above its potential, the tightening of the labor market conditions is likely to strengthen and capacity utilization rates are expected to increase as exports and production pick up. Against this background, the output gap is likely to turn positive, or in other words, become a situation of excess demand. Secondly, we have medium- to long-term inflation expectations. According to various survey results and the beak-even inflation rate using inflation-indexed bonds, there is concern that medium- to long-term inflation expectations have been somewhat weak recently, mainly reflecting the decline in crude oil prices. On the other hand, the share of price-increasing items minus the share of price-decreasing items in the CPI, as well as daily and weekly indices of the prices of food and daily necessities, have been on a remarkable expanding trend since last spring up to the present (Chart 6). In the annual labor-management wage negotiations, 2015 represented the second consecutive year of base pay increasing, and movements toward wage increases have continued to be seen in various sectors this year. What these indicators and developments suggest is that firms’ price- and wage-setting stance has clearly changed and that households seem to be increasingly accepting price rises. Against this backdrop, price hikes by firms have been widespread and sustained. Inflation expectations therefore appear to be rising on the whole from a somewhat longerterm perspective and it can be assessed that conversion of the deflationary mindset has been progressing steadily thus far. BIS central bankers’ speeches I have just explained the recent developments and outlook for the underlying trend in inflation. I would now like to give an overview of the Bank’s projections for the CPI (all items less fresh food) in the January 2016 Outlook Report (Chart 3). In brief, the forecasts of the CPI (all items less fresh food) are obtained by adding the underlying trend in inflation to the contribution of energy items to the CPI. The January Outlook Report assumes that Dubai crude oil prices will rise moderately from the recent 35 U.S. dollars per barrel to the range of 45–50 dollars per barrel toward the end of fiscal 2017, which marks the end of the projection period. The contribution of energy items to the year-on-year rate of change in the CPI (all items less fresh food) is estimated to be slightly more than minus 1 percentage point and is at its highest level recently. However, under the aforementioned assumption of crude oil prices, the contribution is projected to decrease gradually. Meanwhile, since the underlying trend in inflation is likely to rise steadily, this is likely to be seen clearly in the CPI (all items less fresh food) as the contribution of energy items to the CPI lessens. Taking these factors into account, the year-on-year rate of change in the CPI (all items less fresh food) is projected to reach around 2 percent – the price stability target – around the first half of fiscal 2017. III. Risk factors regarding the outlook for economic activity and prices Thus far, I have explained the outlook for economic activity and prices that the Bank considers most probable. The baseline scenario assumes that Japan’s economy is likely to be on a moderate expanding trend and the year-on-year rate of change in the CPI is likely to accelerate toward 2 percent. However, there are various risks associated with this outlook. In the following, I would like to touch on two important factors to this end. Changes in firms’ behavior The first factor is changes in firms’ behavior. As I mentioned earlier, corporate profits are at historical high levels and the labor market is in a situation of “full employment.” In theory, under an economic mechanism, this situation will lead to economic growth and an increase in wages and prices. In fact, as I have noted, Japan’s economy has continued to recover moderately, and the underlying trend in inflation has been improving steadily in a situation where wages have increased moderately. Nevertheless, it is true that, given the high level of corporate profits and the degree of tightening of labor market conditions, the spread of this favorable condition to the expenditure side, such as in terms of wages and business fixed investment, is somewhat weak at an aggregate level. Of course, many firms are proactively investing in physical and human capital. The Bank judges that firms’ and households’ deflationary mindsets have steadily been converting under QQE. However, the degree of conversion differs largely by industry and firm; thus, seeing Japan’s economy as a whole, it cannot be said that firms’ incentives to spend have fully taken hold. Moreover, it is inevitable that a conversion of firms’ deflationary mindset, which had taken root under the protracted deflation, will take time. At this stage, attention is warranted to a significant risk that, in the case where business sentiment deteriorates, reflecting uncertainties over overseas economies, firms might revert to acting based on a deflationary mindset. Slowdown in emerging and commodity-exporting economies Next, I would like to touch on the slowdown in emerging and commodity-exporting economies, which has been drawing attention recently as the most significant risk factor. The baseline scenario for the global economy assumes that advanced economies will continue to grow firmly and that emerging economies, with the spread of such growth’s effects, will move out of their deceleration phase. A similar projection is presented in the World Economic Outlook (WEO) Update released in January by the International Monetary BIS central bankers’ speeches Fund (IMF) (Chart 7). Recently, however, uncertainties over the outlook for emerging and commodity-exporting economies, mainly China, have heightened in the financial markets. In this situation, international commodity prices, such as crude oil prices, have been declining substantially (Chart 8). The decline in commodity prices exerts positive effects on commodity-importing economies, mainly advanced economies. In Japan, this decline is one of the factors that encourage favorable corporate profits and it also has been supporting households’ real income. In contrast, the possibility that the decline might exert considerable downward effects on commodity-exporting economies – mainly Brazil, Russia, and oilproducing countries in the Middle East – warrants attention. What kinds of risks would these be for Japan’s economic activity and prices? A further slowdown in emerging and commodity-exporting economies could possibly lead to a decrease in exports. But what warrants more attention is its effect brought through sentiment. Specifically, if business sentiment were to deteriorate, reflecting uncertainties over the outlook for emerging and commodity-exporting economies or reflecting volatile developments in the financial markets, there is a risk that firms’ fixed investment stance and price- and wage-setting stance will become cautious. If such risk materializes, the virtuous cycle of economic recovery from income to spending would be impaired and the underlying trend in inflation would also be affected. As I have explained, although business sentiment has been on an improving trend, it still is not bullish enough, and thus warrants extra attention. IV. Monetary policy management Rationale for a negative interest rate policy and its effects Taking account of the environment surrounding Japan’s economy, such as the decline in crude oil prices and the developments in emerging and commodity-exporting economies, as well as the volatility in global financial markets reflecting these developments, there is an increasing risk that an improvement in business sentiment and conversion of peoples’ deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected. In order to preempt the manifestation of this risk and to maintain momentum toward achieving the price stability target of 2 percent, the Bank decided to introduce “QQE with a Negative Interest Rate” at its Monetary Policy Meeting on January 29, 2016 (Chart 9). I will explain the objectives and rationale for the newly introduced policy as follows. The Bank introduced QQE in April 2013, about three years ago. The main transmission mechanism of QQE is envisaged as pushing down real interest rates by lowering nominal rates across the entire yield curve by large-scale purchases of Japanese government bonds (JGBs) and by raising inflation expectations through a strong and clear commitment toward achieving the price stability target of 2 percent. QQE has been exerting its intended effects. Yields on 10-year JGBs have been lowered to a record low level, and inflation expectations have been rising on the whole from a somewhat longer-term perspective. The decline in real interest rates has been stimulating private demand, and, as I explained earlier, has brought record profits of firms and a full-employment labor market condition. “QQE with a Negative Interest Rate” introduced this time is a new policy framework in which a “negative interest rate” is added to the existing options of “quantity” and “quality.” So what does a “negative interest rate” mean in practice? If an interest rate is negative, you can receive interest when you borrow money and you have to pay interest when you lend money. In normal financial transactions, such a thing would never happen. When a central bank wants to lower interest rates through its monetary policy, it normally will increase the amount of money provided to the markets. As a result, a greater number of people want to lend or invest extra money. With the supply of money exceeding the demand for money, the interest rate, which is a charge for money lent, will decline. If a central bank continues to provide more money to the markets, to what extent will the interest rate be lowered? The lower limit, BIS central bankers’ speeches or floor, should be at the level where one cannot make more profits even if one can lend more money; i.e., at zero percent. This is called the “zero lower bound” of a nominal interest rate. Since central banks in major advanced economies started their unconventional monetary policies after the global financial crisis, they have been providing money to the markets in various ways, and the last constraint to be conquered was the “zero lower bound” of a nominal interest rate. However, in some European countries, as various policy options have been tried to address slowdown in economic activity and lower inflation, a negative interest rate was introduced, starting with the central bank in Sweden, followed by those in Denmark, Switzerland, and the European Central Bank (ECB). How have these central banks overcome the “zero lower bound”? The starting point of the mechanism is a framework where an interest rate applied to deposits financial institutions hold at the central bank is set in negative territory. As financial institutions incur losses on cash they hold at the central bank, they will try to invest it in the markets even at a negative interest rate if they can reduce losses in comparison with holding it at the central bank. As those raising funds can make profits by simply borrowing money, there will be demand for funds in the markets. As the needs of both investors and those needing funds match in this way, short-term money market transactions will be made at a negative interest rate. This is how a negative interest rate is achieved in practice. A negative interest rate in the money markets means that the short end of the yield curve will be lowered to below zero percent. The objective of monetary easing is to push down the entire yield curve; therefore, a negative interest rate will be a very powerful “weapon” for monetary easing. In combination with the continuation of large-scale purchases of JGBs, a negative interest rate will exert downward pressure on interest rates across the entire yield curve more powerfully. It will lower real interest rates, and thus have favorable effects on the economic activity of firms and households. So why did the Bank of Japan adopt a negative interest rate at this timing? QQE has been exerting its intended effects. If judged necessary, there is ample room to further expand the size of asset purchases. We do not share the view that the Bank’s asset purchases are now approaching their limit. That said, after nearly three years have passed since the launch of QQE, it is true that it took time more than initially envisioned to achieve the price stability target of 2 percent, due mainly to a substantial decline in crude oil prices. Against this background, we decided to further enhance and strengthen QQE by taking account of the experiences in European countries with a negative interest rate. However, it should be noted that financial conditions significantly differ between Japan and Europe. In Japan, the relative size of the current account balance at the central bank is far larger than that in Europe. Moreover, it will continue to increase at an annual pace of around 80 trillion yen under QQE. If a negative interest rate is applied to the entire balance of the current account, financial institutions will have to bear excessive burdens. In that case, there is a risk that a negative interest rate will actually have an adverse impact on the functions of financial intermediation. With this in mind, a “multiple-tier system,” where a negative interest rate is applied only to a marginal increase in the current account balance, has been adopted. The multiple-tier system is designed so that a negative interest rate can have its full impact on market rates while minimizing its side effects. This is a unique policy framework of a negative interest rate that fits well into the Japanese system. Scope for further monetary easing in terms of three dimensions Under the newly introduced framework of “QQE with a Negative Interest Rate,” the Bank will pursue monetary easing by making full use of possible measures in terms of three dimensions: quantity, quality, and a negative interest rate (Chart 10). Going forward, if judged necessary, it is possible to further cut the interest rate from the current level of minus 0.1 percent. In Europe, the ECB has set the deposit rate at minus BIS central bankers’ speeches 0.3 percent, Swiss National Bank at minus 0.75 percent, and Riksbank (the central bank in Sweden) at minus 1.1 percent. As shown by these examples, there is sufficient room for further monetary easing in the “negative interest rate” dimension. If deemed necessary, the Bank will cut the interest rate further into negative territory. With regard to the purchases of JGBs, which are conducted so that the Bank’s holding will increase at an annual pace of about 80 trillion yen, about two thirds of the total outstanding JGBs are left in the market. Therefore, we believe that there is sufficient room for further expansion in the size of purchase. In this context, let me remind you that, at the Monetary Policy Meeting last December, the Bank decided various measures, including the expansion of eligible collateral that it will accept from banks, the extension of the average remaining maturity of its JGB purchases, and the increase in the maximum amount of each issue of Japan real estate investment trust (J-REIT) to be purchased. Possible technical obstacles for further monetary easing in terms of “quantity” and “quality” dimensions already have been removed. You might think that the introduction of a negative interest rate would make it difficult for the Bank to carry out its asset purchase operations. At first sight, such concern sounds reasonable, because when financial institutions sell their assets such as JGBs to the Bank, they end up holding the current account balance as proceeds, on which a negative interest rate will be applied. In that case, however, the costs of holding the current balance with a negative interest rate will be compensated by higher sales prices, or lower yields, of the assets sold to the Bank. Therefore, a negative interest rate policy will not necessarily make the Bank’s purchases difficult. Of course, the Bank will implement JGB purchases by paying due attention to how a negative interest rate affects the dynamics of JGB markets. Monetary policy going forward The Bank will continue with “QQE with a Negative Interest Rate,” aiming to achieve the price stability target of 2 percent, as long as necessary for maintaining that target in a stable manner. It will examine risks to economic activity and prices, and take additional easing measures in terms of three dimensions – quantity, quality, and a negative interest rate – if it is judged necessary for achieving the price stability target. It is no exaggeration that “QQE with a Negative Interest Rate” is the most powerful monetary policy framework in the history of modern central banking. Sometimes it is argued that the Bank of Japan is running out of ammunition for further monetary easing. Frankly speaking, I feel uncomfortable with such an argument. If we judge that existing measures in the toolkit are not enough to achieve the goal, what we have to do is to devise new tools, rather than give up the goal. Indeed, the constraint of “zero lower bound” of a nominal interest rate, which was believed to be impossible to conquer, has been almost overcome by the wisdom and practices of central banks, including those of the Bank of Japan. I am convinced that there is no limit to measures for monetary easing. The Bank will continue to devote itself to innovation in monetary policy measures. The commitment by the Bank to achieve the price stability target of 2 percent is firm and unshaken. Given that the central bank is firmly committed to the price stability target and is taking necessary measures as appropriate, the goal will surely be achieved. Let me conclude my speech by reiterating what I have repeatedly stated since I took the governorship of the Bank of Japan: The Bank of Japan will do whatever we can to achieve the price stability target of 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
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Japan Society in New York, New York City, 12 February 2016.
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Hiroshi Nakaso: Monetary policy and structural reforms Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Japan Society in New York, New York City, 12 February 2016. * * * Accompanying slides can be found at the end of the speech. Introduction It is a great honor to have this opportunity to give a presentation at the Japan Society. Looking back at my central banking career, which has been devoted to dealing with the economic and financial problems that have unfolded since the burst of Japan’s asset bubble more than two decades ago, I have become more and more determined to overcome deflation. At the same time, I am aware, more than ever, of the importance of raising Japan’s growth potential, and this is the topic that I would like to talk about today. Raising the growth potential is an issue that, I believe, is of relevance not only for Japan but also for other industrialized nations, since Japan’s experience of decelerating trend growth is a potential precursor of things to come elsewhere. In fact, Japan’s experience provides a good case study of the issues that need to be tackled. In the following presentation, I would like to talk about how to address the challenge of low trend growth, paying particular attention to the relationship between demand stimulus and supply-side reforms. I will then try to assess how much progress Japan has made so far. Slower trend growth Let me start with a brief overview of Japan’s growth prospects. Japan has continued to struggle with slower trend growth. The Bank of Japan estimates that Japan’s potential growth rate has fallen to as low as 1/2 percent or even slightly lower. Given such a low potential growth rate, even a small negative shock or simply statistical noise can tip Japan’s measured GDP growth rate into negative territory. Trend growth can be decomposed into growth in labor input and growth in labor productivity, and as is well known, both factors are responsible for the decline in Japan’s slowing growth trend (Slide 1). Will this trend continue? If so, what can be done? To give you a sense of the challenge, let me show you some calculations how the 2 percent growth which the Japanese government is aiming at can be achieved. The table shows two alternative scenarios based on different assumptions regarding labor participation (Slide 2). The first is the status quo scenario, where things remain unchanged. The other is the optimistic scenario, which is based on two assumptions: First, it is assumed that the female labor participation rate in Japan rises to the level observed in Sweden. Second, it is assumed that all healthy elderly will continue working irrespective of the retirement age. For instance, reflecting Japan’s rising life expectancy, 60 percent of 80 to 84 year olds in Japan say that they are healthy enough to go about their daily lives. We assume that all of these elderly continue to work. Setting aside how realistic they are, these assumptions mean that the labor force can be expected to increase by about 1/2 percent per year. However, as shown in the slide, to achieve 2 percent GDP growth, labor productivity still needs to rise by about 1 1/2 percent per year. That being said, in the status quo scenario, labor input shrinks by almost one percent per year, so that labor productivity would have to grow by a hefty 3 percent to achieve the 2 percent GDP growth target. The productivity growth of 1 1/2 percent required in the optimistic scenario would still be high both from a historical and international perspective, but it may not be unachievable. Economic theory suggests that the key drivers of growth are productivity catch-up and growth at the technological frontier. There is no doubt that a number of Japanese manufacturers are at the BIS central bankers’ speeches global technology frontier, but there remains ample room for catch-up in many industries, particularly in the non-manufacturing sector. For example, it is often said that Japanese firms, especially in the non-manufacturing sector, lag behind their foreign counterparts in the use of information technology, primarily due to underinvestment in this area and a shortage of related expertise. 1 As a result, Japan’s productivity level is about 35 percent below that of the United States, which is often assumed to represent the world technology frontier (Slide 3). During their course of economic development, countries tend to enjoy rapid growth during the period of technological catch-up. Japan had largely gone through this phase by the 1980s, so productivity growth decelerated thereafter, as seen in Slide 1. That being said, as seen in the right panel of Slide 3, in the period between 2000 and 2014 Japan still enjoyed one of the highest productivity growth rates among the G7 countries, probably because there still remained some room for catch-up. In any case, this back-of-the-envelope calculation underscores the importance of labor productivity in raising the growth potential. Particularly in an economy like Japan’s, with its demographic constraints, policies should have a clear focus on raising productivity growth. Secular stagnation hypothesis What does this slower trend growth mean for central bankers? First, slower trend growth, other things being equal, implies a smaller output gap (Slide 4). This is simple arithmetic: changes in the output gap equal changes in real GDP minus changes in potential output. At the height of the 1997–98 financial crisis in Japan, it was thought that Japan might fall into a deflationary spiral like that experienced by the United States during the Great Depression in the 1930s. However, in the wake of the 1997–98 crisis, even at its worst, Japan’s CPI deflation rate did not substantially exceed one percent. 2 With the benefit of hindsight, the output gap was smaller than we had envisaged due to a decline in the potential growth rate. In fact, although I am afraid I may confuse you, the story actually is a bit more complicated than I have just described. I will later argue that slower trend growth may worsen the output gap, as other things may not be equal. The second corollary of slower trend growth for central bankers is that it implies a lower equilibrium real interest rate or natural rate of interest (Slide 5). The equilibrium real interest rate is the real interest rate that would prevail at full employment and inflation at the targeted level, and thus provides a reference point for the policy interest rate. Economic theory suggests that slower trend growth leads to a lower equilibrium real interest rate. Presented with a lower equilibrium interest rate, a central bank, unless it faces the zero lower bound, needs to cut its policy rate if it wants to maintain monetary stimulus at the prevailing level. Recently, the decline in the equilibrium interest rate has been a hotly debated topic not only in Japan but also in other industrial economies including here in the United States. The debate was, as you probably know, initiated by Larry Summers, who put forward the secular stagnation hypothesis. 3 The focus of the discussion among scholars, policy makers, and market commentators is (a) whether the lower equilibrium interest rate is a permanent phenomenon; K. Fukao, T. Miyagawa, H. K. Pyo, and K. H. Rhee (2012), “Estimates of Total Factor Productivity, the Contribution of ICT, and Resource Reallocation Effects in Japan and Korea,” in M. Mas and R. Stehrer (eds.), Industrial Productivity in Europe: Growth and Crisis, Edward Elgar Publishing. As I have argued previously, Japan fell into a deflationary equilibrium with mild but persistent deflation due to a combination of a decline in inflation expectations and in the natural rate of interest. See H. Nakaso (2014), “The Conquest of Japanese Deflation: Interim Report,” Remarks at the Athens Symposium “Banking Union, Monetary Policy and Economic Growth.” L. H. Summers (2014), “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound,” Business Economics, Vol. 49(2), pp. 65–73. BIS central bankers’ speeches (b) what its causes are – slower trend growth undoubtedly is one important factor, but there may be other explanations such as a change in saving-investment preferences; and (c) how to cope with the lower equilibrium interest rate, given that nominal policy interest rates have already hit the zero lower bound in many advanced economies. 4 Policy implications Due to time constraints, I will not cover all of these questions today. Instead, let me focus on possible policy measures under these circumstances. Linked to the second issue – the causes of a lower equilibrium interest rate – there is an ongoing debate regarding whether demand stimulus or supply-side reforms are more relevant to counter the possible secular stagnation. 5 On the one hand, those who attribute the lower natural rate of interest to excess saving advocate more demand stimulus through monetary and/or fiscal policy. On the other hand, those who argue that potential growth has declined because of a deterioration in supply-side factors tend to stress the importance of structural reforms including deregulation and educational reforms. My answer to what kind of policies are needed is that both monetary and fiscal policies and structural reforms are indispensable, which is in the spirit of the joint statement of the Bank of Japan and the Japanese government issued in January 2013. There are three reasons underpinning my answer. First, from a practitioner’s point of view, we cannot wait for the day when the academic debate is settled. If both demand stimulus and supply-side reforms are potentially important, why not try both? We need to dispense all the medicine that might work for the patient. Second, if supply-side reforms incur short-term pain, at least part of that pain needs to be alleviated through demand measures. For instance, if labor market reforms temporarily raise the unemployment rate, it is quite sensible to stimulate demand to smooth the transition through those reforms. Third, I think that from a theoretical perspective, the distinction between demand- and supplyside measures is quite blurred. For example, supply-side reforms raise potential growth and reduce uncertainty about the future, so that firms and households spend more today in anticipation of higher profits and incomes in the future, thus raising current demand. On the other hand, demand stimulus such as monetary easing raises potential output through an increase in the capital stock as well as labor input, thus affecting the supply side as well. 6 This difficulty in separating demand- and supply-side aspects also applies when examining the causes of the decline in the equilibrium interest rate. For example, both the demand- and supply-side camps argue that demography – lower or negative population growth and population aging – play a role in lowering the natural rate of interest. From a supply-side perspective, a decline in the growth rate of the working-age population lowers the growth potential of the economy and thus the natural rate of interest. On the other hand, from a demand-side perspective, the aging of the population reduces the population share of younger My fellow central bankers have recently addressed these issues. See, for instance, A. Haldane (2015), “How Low Can You Go?,” Speech given at the Portadown Chamber of Commerce, and S. Fischer (2016), “Monetary Policy, Financial Stability, and the Zero Lower Bound,” Speech at the Annual Meeting of the American Economic Association. See L. Rachel and T. D. Smith (2015), “Secular Drivers of the Global Real Interest Rate,” Bank of England Staff Working Paper, No. 571; O. Blanchard, E. Cerutti, and L. H. Summers (2015), “Inflation and Activity – Two Explorations and their Monetary Policy Implications,” IMF Working Paper, WP/15/230; R. J. Gordon (2015), “Secular Stagnation: A Supply-Side View,” American Economic Review, Vol. 105(5), pp. 54–59. This point has been highlighted by Fed economists such as D. Reifschneider, W. Wascher, and D. Wilcox (2015), “Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy,” IMF Economic Review, Vol. 63, pp. 71–109. BIS central bankers’ speeches generations, and since younger generations tend to borrow more heavily than older generations, a drop in their share results in a decline in the natural rate of interest through a decline in loan demand. 7 I sometimes feel that this difficulty to distinguish between supply- and demand-side factors goes beyond the issue at hand and may shake up conventional ways of thinking in other fields of economics such as the clear distinction between growth and business cycle models. Broadly speaking, business cycle models, which deal with how the output gap is determined, assume that trend growth is exogenously given. On the other hand, growth models, which examine the evolution of this trend growth, omit the output gap. This division of labor between standard models makes it difficult for economists to consider the interactions between the output gap and trend growth. 8 In any event, all these considerations lead to the conclusion that demand stimulus and supplyside reforms are complements rather than substitutes. It is for this reason that I believe that monetary policy to overcome deflation and supply-side reforms to raise the growth potential must be pursued in tandem to bring Japan’s economy back on track towards sustained growth. I am a firm believer that, at this critical juncture, the Bank of Japan needs to provide support to the economy by pursuing its inflation targeting policy. Monetary policy needs to remain lax and in fact is lax. This is illustrated in Slide 5, which shows that, under quantitative and qualitative monetary easing, the Bank of Japan is keeping the real interest rate well below the natural rate of interest. However, I also agree with former Chairman Bernanke that monetary policy is not a panacea. 9 In light of recent developments in growth theory and other fields, I do believe that institutions or systems matter. What is needed is an institutional framework that fosters innovation to push the technology frontier and raise productivity. Although I said that catching-up is still important for Japan, in the end the ultimate engine of growth is innovation. And by “institutional framework” here I mean not only economic institutions but also other aspects of society, such as the legal system, education, and so on. 10 Against this background, I strongly hope and believe that the Japanese government will play its role in providing such a framework by continuing with structural reforms. Progress so far The question that naturally arises is how much progress Japan has made in addressing the challenges facing its economy. My short answer is that there is some progress but not enough. In fact, there is one area in which good progress has been made: raising the labor participation rates of young women and the elderly, which have increased to exceed the corresponding rates in the United States (Slide 6). However, based mainly on the following three observations, I think that overall the glass remains half empty. All three observations – concerning potential growth, growth expectations, and wage growth – suggest that productivity growth is still not sufficiently high. See, for example, the overlapping generations model of G. B. Eggertsson and N. R. Mehrotra (2014), “A Model of Secular Stagnation,” NBER Working Paper No. 20574. A similar argument is made by J. Faust and E. M. Leeper (2015), “The Myth of Normal: The Bumpy Story of Inflation and Monetary Policy,” in Inflation Dynamics and Monetary Policy, 2015 Jackson Hole Symposium: Federal Reserve Bank of Kansas City Economic Conference Proceedings. See, e.g., B. S. Bernanke (2012), “U.S. Monetary Policy and International Implications,” Speech at a High-Level Seminar sponsored by the Bank of Japan and the International Monetary Fund. D. Acemoglu and J. A. Robinson (2012), Why Nations Fail: The Origins of Power, Prosperity and Poverty, Crown Business; E. Moretti (2012), The New Geography of Jobs, Houghton Mifflin Harcourt; R. E. Litan (2011), Rules for Growth: Promoting Innovation and Growth Through Legal Reform, Ewing Marion Kauffman Foundation. BIS central bankers’ speeches First, potential growth has not sufficiently increased. As seen in Slide 5, the Bank of Japan estimates that potential growth remains around or slightly below 1/2 percent. It is well known that real-time estimates of the potential growth rate are fraught with great uncertainty and it is often only after a considerable time lag that we can recognize changes in potential growth. For example, assuming that Japan continues to follow a steady growth path, it is well possible that we may find in hindsight that Japan’s growth potential has actually already increased a bit, although I doubt that it has reached a level of 2 percent. Second, Japanese firms have continued to hoard huge savings. It is true that Japanese firms, backed by record profits, have recently started to increase fixed investment, which, according to our December Tankan Survey, will increase by about 8 1/2 percent this fiscal year. However, if we look at the saving-investment balance of the corporate sector, in April-September last year, saving continues to exceed investment by more than 15 trillion yen or about 6 1/2 percent of GDP, as shown in the left-hand panel of Slide 7. In contrast, until the early 1990s corporate investment used to exceed corporate saving. There may be a variety of reasons why Japanese firms keep saving. For instance, given the volatility of financial markets observed in recent times, firms may prefer to retain liquidity against the backdrop of perceived higher uncertainty in the economy. They may also try to pile up cash as a precaution due to lingering memories of financial crises in the past. However, it seems to me that the main reason behind the large saving surplus is the fact that firms’ growth expectations have not sufficiently improved, as shown in the right-hand panel of Slide 7. The subdued growth expectations, in turn, will restrain productivity growth in the future as a result of insufficient capital deepening. Third, nominal wages have not risen fast enough. Recently, nominal wages have been increasing by about 1/2 percent on a year-on-year basis. This is a big change from the situation a couple of years ago, when nominal wages were declining at a rate of about 1 1/2 percent. However, wage increases are still failing to keep up with inflation and remain well below the Bank’s 2 percent inflation target. The sluggish increase in nominal wages is thought to reflect low productivity growth and the strong deflationary mindset, since, in the long run, nominal wage growth should equal productivity growth plus inflation. Again, these developments support the view that sustained improvements in productivity are necessary to maintain the economic growth momentum. In this regard, the current spring wage negotiations, or “Shunto” in Japanese, are critically important. It is too early to tell the outcome at this stage and the picture is mixed. Since faster wage increases are indispensable for steady consumption growth and higher inflation, we are now carefully monitoring how the negotiations unfold. Recent monetary policy Structural reforms have been steadily moving forward, but it will take time until such reforms boost the potential growth rate. In a country where the natural rate of interest has declined, the central bank has to implement monetary policy based on the lower rate. As I explained earlier, monetary easing means achieving a real interest rate that is lower than the natural rate of interest. In pursuing monetary policy in Japan, the challenges resulting from the decline in the natural interest rate had been compounded by the increasing difficulties in lowering real interest rates. These difficulties reflected the fact that nominal interest rates at the shorter end of the yield curve had already been subject to significant downward pressure and were facing the zero lower bound, while inflation expectations had faded. In order to tackle this suboptimal situation, the Bank of Japan judged it necessary to lower the real interest rate by shoring up inflation expectations and at the same time seeking room for a further decline in nominal interest rates. Quantitative and qualitative monetary easing (QQE), which the Bank of Japan launched in April 2013, provided a major breakthrough in these two dimensions. The main transmission mechanism that QQE envisages is twofold. The first is to convert people’s deflationary mindset and raise their inflation expectations though a strong BIS central bankers’ speeches commitment toward achieving the price stability target of 2 percent. The second is to encourage nominal interest rates to decline further across the entire yield curve through largescale purchases of Japanese government bonds (JGBs). Together, these two mechanisms have the effect of pushing real interest rates down further. QQE has produced its intended effects. The decline in real interest rates has stimulated private sector demand and has brought about record profits at firms and full employment in the labor market. Moreover, the underlying trend in inflation has been steadily improving. The annual rate of change in the CPI excluding fresh food and energy – items subject to large price fluctuations – has remained positive for 27 consecutive months and recently climbed to 1.3 percent. Looking ahead, the baseline scenario assumes that Japan’s economy is likely to be on a moderate expanding trend and the annual rate of change in the CPI is expected to revert to an uptrend toward the price stability target of 2 percent. The Bank of Japan recently took further actions to strengthen monetary easing by adding a negative interest rate dimension to QQE. The decision was taken against the backdrop of volatile global financial markets reflecting the further slide in crude oil prices and growing uncertainty over the outlook for emerging and commodity-exporting economies. We judged that there was an increasing risk that the improvement in business confidence could be undermined and the conversion of people’s deflationary mindset be delayed. Consequently, we were worried that this would negatively affect the underlying trend in inflation. In order to preempt the manifestation of this risk and maintain the momentum toward achieving the price stability target, we judged that it was necessary to further strengthen monetary easing at this juncture. In introducing “QQE with a Negative Interest Rate,” we focused on two points. First, the introduction of a negative interest rate is an additional element that leaves the basic framework of QQE intact. That is, the Bank will continue to push down the entire yield curve through largescale purchases of JGBs under QQE. In addition, it aims to create even more powerful easing effects by lowering the short end of the yield curve through the introduction of the negative interest rate policy (Slide 8). Thus, quantitative easing and the negative interest rate are not inconsistent but instead complement each other. In designing the policy, we benefitted a great deal from the wisdom and experiences of those central banks in Europe that have adopted a negative interest rate policy. Simply transplanting the policy, however, was out of the question, since Japan’s idiosyncratic circumstances need to be taken into account. Specifically, in Japan, reserves at the central bank are far larger than in Europe and under QQE will continue to increase at an annual pace of around 80 trillion yen. To address the concern that a negative interest rate might impose an excessive burden on financial institutions and have an adverse effect on the functioning of financial intermediation, we adopted a multiple-tier system so that a negative interest rate is applied only to the marginal increase in excess reserves (Slide 9). This is a unique feature of our policy framework. The second important aspect of “QQE with a Negative Interest Rate” is that it aims to provide scope for further monetary easing in terms of the “interest rate” dimension, in addition to the “quantity” and “quality” dimensions. If judged necessary, we are ready to take further actions in terms of “quantity” and “quality,” and we do not share the view that the Bank’s asset purchases are approaching their limit. To further supplement these tools, the new policy adds an “interest rate” option to these two existing options, so that the Bank can now pursue additional monetary easing measures in terms of three dimensions: “quantity,” “quality,” and “a negative interest rate.” The new policy framework will provide significant reinforcement to complete our mission to overcome deflation. Our monetary policy initiatives will also contribute to shoring up the potential growth rate. The Bank aims at providing accommodative financial conditions and dispelling people’s persistent deflationary mindset by pursuing “QQE with a Negative Interest Rate.” We believe it will contribute to creating a business environment that encourages firms to pursue more proactive investment strategies and make greater efforts to improve productivity. If all economic entities BIS central bankers’ speeches fully take advantage of this extremely favorable environment, this should help to improve the potential growth rate. I fully expect this will happen. Concluding remarks Japan needs to raise the trend growth of the economy. This is necessary not only for the sake of the current generation but also to ensure that future generations can enjoy a decent life with a sense of hope and security. To that end, we need to utilize both demand- and supply-side measures to the greatest possible extent. Now that the Bank of Japan has taken monetary easing one step further at the end of last month, I think that the original third arrow of Abenomics, the growth strategy, must also fly faster. The challenges ahead are formidable, but it is time now to deliver results, no matter how difficult the challenges are. I hope that by doing so Japan sets an example for other countries similarly facing a decline in trend growth. I will stop here. Thank you very much. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Statement by Mr Haruhiko Kuroda, Governor of the Bank of Japan, before the Committee on Financial Affairs, House of Councillors, Tokyo, 18 February 2016.
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Haruhiko Kuroda: The Bank’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 Councillors, Tokyo, 18 February 2016. * * * Introduction The Bank of Japan submits to the Diet its Semiannual Report on Currency and Monetary Control in June and December. I am pleased to have this opportunity today to talk about 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 continued to recover moderately, with a virtuous cycle from income to spending operating in both the household and corporate sectors, although exports and production have been affected by the slowdown in emerging economies. Looking ahead, Japan’s economy is likely to be on a moderate expanding trend as domestic demand is likely to follow an uptrend and as exports are expected to increase moderately on the back of emerging economies moving out of their deceleration phase. On the price front, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is about 0 percent. The year-on-year rate of change in the CPI for all items less fresh food and energy has remained positive for 27 consecutive months and increased to 1.3 percent recently; this suggests that the underlying trend in inflation has been improving steadily. The year-on-year rate of change in the CPI for all items less fresh food is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices, and, as the underlying trend in inflation steadily rises – on the back of an improvement in the output gap and of an increase in medium- to long-term inflation expectations – accelerate toward the price stability target of 2 percent. Assuming that crude oil prices will rise moderately from the recent level, the timing of the year-on-year rate of change in the CPI reaching around 2 percent is projected to be around the first half of fiscal 2017. II. Conduct of monetary policy As explained, the baseline scenario assumes that Japan’s economy is likely to be on a moderate expanding trend and the year-on-year rate of change in the CPI is likely to accelerate toward 2 percent. However, from the turn of the year, global financial markets have been volatile against the backdrop of the further decline in crude oil prices and uncertainty such as over future developments in emerging and commodity-exporting economies, particularly the Chinese economy. For these reasons, there is an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected. In order to preempt the manifestation of this risk and to maintain momentum toward achieving the price stability target of 2 percent, the Bank introduced “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” in January 2016. The Bank will lower the short end of the yield curve by slashing its deposit rate on current accounts into negative territory and will exert further downward pressure on interest rates across the entire yield curve, in combination with continued large-scale purchases of Japanese government bonds (JGBs). The JGB yield curve has declined after the introduction of “QQE with a Negative Interest Rate,” BIS central bankers’ speeches and policy effects have been seen. Going forward, these effects are likely to steadily spread to both the real economy and the price front. The Bank will continue with “QQE with a Negative Interest Rate,” 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 risks to economic activity and prices, and take additional easing measures in terms of three dimensions – quantity, quality, and interest rate – if it is judged necessary for achieving the price stability target. In global financial markets, risk aversion of investors has been spreading excessively around the globe recently. The Bank will carefully monitor how the developments in global financial markets influence Japan’s economy and prices. Thank you. 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, Kagoshima, 25 February 2016.
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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, Kagoshima, 25 February 2016. * * I. Economic activity and prices in Japan A. Current situation * I would like to start my speech with a look at developments in economic activity and prices in Japan. Japan's economy has continued to recover moderately. Overseas economies – mainly advanced economies – have continued to grow at a moderate pace, despite the slowdown in emerging economies. In this situation, exports have been picking up, although sluggishness remains in some areas, and industrial production has been more or less flat. On the domestic demand side, business fixed investment has been on a moderate increasing trend as corporate profits have continued to improve markedly, and private consumption has been resilient against the background of steady improvement in the employment and income situation. The first preliminary estimate of the real GDP growth rate for the OctoberDecember quarter of 2015 was minus 1.4 percent on an annualized quarter-on-quarter basis. Meanwhile, as for prices, the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) is about 0 percent. B. Outlook Against the background of such developments, the Bank of Japan revised the forecasts for both economic activity and prices for the period from fiscal 2015 through fiscal 2017 in its January 2016 Outlook for Economic Activity and Prices (hereafter the Outlook Report). Comparing the median of the Policy Board members' forecasts in the January 2016 Outlook Report with that in the October 2015 report, the projection for the real GDP growth rate was more or less unchanged. In other words, Japan's economy is likely to continue growing at a pace above its potential through fiscal 2016, and thereafter, through fiscal 2017, is likely to maintain its positive growth, although with a slowing in its pace, due mainly to the effects of the consumption tax hike planned in April 2017. The projection for the year-on-year rate of change in the CPI (all items less fresh food) for fiscal 2016 was revised downward somewhat largely, due to the assumption of lower crude oil prices. Specifically, the projection was revised downward from 1.4 percent in the October 2015 Outlook Report to 0.8 percent in the January 2016 report. For fiscal 2017, however, the projection was more or less unchanged at 1.8 percent. In other words, the year-on-year rate of change in the CPI (all items less fresh food) is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices, but the rate will likely accelerate gradually, on the assumption that crude oil prices will rise moderately. II. Considerations regarding the outlook A. Policy board members' baseline scenario and my outlook I believe that Japan's economy has already regained stability that is consistent with its growth potential, mainly due to the effects of quantitative and qualitative monetary easing (QQE). This can be seen by how the output gap – which represents the degree of utilization of production capacity and labor – recovered to a more or less neutral level at around the BIS central bankers’ speeches end of 2013 from being significantly negative at the time of the introduction of QQE, and has remained at almost the same level thereafter. Moreover, I think that the underlying trend in inflation has also already regained stability that is consistent with the growth potential of Japan's economy. According to my baseline scenario for the outlook, such stable economic and price conditions will continue through fiscal 2017 – the projection period covered in the January 2016 Outlook Report. However, my view on the outlook for Japan's economic activity and prices, when expressed in figures, is more cautious compared with the median of the Policy Board members' forecasts in the January 2016 Outlook Report. I hold a relatively cautious view based on the following two reasons. First, the potential growth rate of Japan's economy, which represents – from the supply side – the pace of growth that is consistent with the economy's growth potential, is currently estimated to be around 0.5 percent or lower, and thus has stayed at a low level. Given this situation, I believe that its pace of improvement is likely to remain moderate. Second, I do not think that there is a strong driving force from the demand side – including in terms of the additional effects of monetary easing – that will even temporarily bring about economic growth at a pace much higher than its potential and clearly improve the output gap. Let me share some of my considerations regarding the outlook with you. B. Corporate profits and business fixed investment Corporate profits have been at high levels, and it has been expected that making active use of corporate funds to increase business fixed investment and wages in Japan would make the virtuous cycle from income to spending operate more effectively. However, I personally consider that fixed investment and wages have not increased to the extent initially expected. While this situation is largely due to the fact that the recent improvement in corporate profits has been supported by temporary factors, I believe that it also is attributable to firms' assessment that the domestic market has not yet improved sufficiently. For example, while the recent improvement in current profits of large manufacturing firms has been brought about largely by factors that cannot necessarily be considered sustainable, such as the depreciation of the yen and low crude oil prices, the contribution of the increase in domestic sales volume to such profits is limited. Moreover, the potential growth rate has stayed at a low level, and its pace of improvement is likely to remain moderate. Under these circumstances, firms would make active use of their profits in overseas markets – where expectations are high for increases in sales and profits – while in the domestic market, they would maintain their cautious stance toward spending. Based on these developments, for firms to increase fixed investment relative to cash flow, I think that a rise in their growth expectations for the domestic market is indispensable. However, with strong headwinds such as the population decline with a low birth rate and aging, I personally consider that it would still take considerable time to raise the growth potential of Japan's economy through various measures and thereby raise firms' medium- to long-term growth expectations for the domestic market. C. Real income and private consumption In my view, private consumption has continued to lack momentum on the whole, although it has somehow maintained its resilience supported by the favorable environment, such as the improving employment and income situation and accommodative financial conditions. I think that some of the factors behind this sluggishness in consumption have been that, in addition to such temporary factors as bad weather, consumers have been more acutely sensing inflation while their expectations for wage increases have stayed low. Indeed, since around spring 2015 in particular, prices of a wide range of food and daily necessities have been raised while the rate of increase in wages has remained moderate, and this may have negatively affected consumer sentiment to a considerable degree. BIS central bankers’ speeches Let us look at this situation from the perspective of monetary easing effects. While real interest rates continued to decline due to the policy effects of QQE at the time of its introduction, there was no significant change in the outlook for real income. Therefore, a monetary easing effect emerged – that is, the bringing forward of future consumption. Currently, however, the pace of the decline in real interest rates has been slowing on the whole, and in this situation, consumers seem to be increasingly expecting that the rate of increase in wages will not immediately catch up with that in prices. Therefore, the outlook for real income may have deteriorated, thereby leading to conservative consumption activity. In relation to this, according to the Bank's December 2015 Opinion Survey on the General Public's Views and Behavior – although the results of the survey are subject to a considerable margin of error due to the limited number of respondents – while the proportion of respondents who described the price rise as "rather unfavorable" was 82.4 percent (82.5 percent in the September survey), the proportion of those who described the price decline as "rather favorable" jumped to 52.4 percent from 23.8 percent in the September survey. I think that these results suggest the possibility that there are concerns among consumers about a decline in real income due to price rises. Going forward, if the positive effects of the decline in energy prices on real income run their course, consumption activity might become even more conservative. This trend may be observed more clearly among elderly households, including those of pensioners, and low-income households, taking into account, for example, the recent improvement in their sentiment reflecting the decline in energy prices. D. Overseas economies and Japan's exports Exports have shown signs of picking up. Real exports for the October-December quarter of 2015 have increased for the second consecutive quarter, mainly in those of motor vehicles and IT-related goods, registering an increase of 2.8 percent on a quarter-on-quarter basis. However, I personally consider that, from the January-March quarter of 2016 onward, the pace of growth in exports is likely to slow due to a dissipation of the effects of the introduction of new cars to the market and to weaker-than-expected demand related to new models of smartphones. Accordingly, there is a possibility that the pace of increase in industrial production will decline markedly in and after the April-June quarter. Regarding the environment surrounding exports, the outlook for overseas economies is not optimistic. In the United States, firmness in private consumption has been maintained supported by the favorable income situation and financial conditions, but production activity in the manufacturing sector has been stagnant accompanied by inventory adjustments, reflecting weak exports bound for emerging economies and sluggish demand of energyrelated firms for capital goods. Although we cannot make a simplistic comparison with the past, the current phase of economic recovery in the United States has already lasted for a period longer than the average of past recoveries, and this is a matter of some concern in view of the sustainability of the current recovery. Excess production capacity and excess debt in emerging economies including China should not be overlooked as downside risks to the global economy as a whole. Since the global financial crisis, corporate debt has increased significantly in countries such as China, Turkey, and Brazil. A breakdown shows that (1) debt related to commodities and energy reflecting excessive expectations for growth in demand for these goods accounts for a considerable share, and (2) not a few countries carry a large share of foreign currency-denominated debt. It cannot be denied that the slowdown in emerging economies could gradually heighten pressure to reduce debt, thereby starting a downward spiral in the economies in a mutually reinforcing manner. Furthermore, I am paying due attention to the risk that the change in the global flow of funds – triggered by the fall in commodity prices as well as the change in financial and economic conditions in the United States – might rapidly heighten pressure to reduce debt, through the depreciation of currencies and the rise in the long-term interest rates in emerging economies. BIS central bankers’ speeches If growth in overseas economies decelerates due to the materialization of the aforementioned risks and exports clearly turn to a decreasing trend, this might push down production activity in Japan and negatively affect business fixed investment, as well as private consumption through deterioration in employment conditions. Furthermore, I am paying attention to the possibility that volatile movements observed in global financial markets since the beginning of 2016 will cause the economic activity of firms and households to become cautious. I therefore consider the outlook for overseas economies and financial conditions as major downside risks to Japan's economy. E. Price developments and the outlook The underlying trend in consumer prices, in terms of the year-on-year rate of change in the CPI for all items less food and energy and that for all items less fresh food and energy, showed some signs of peaking out in the October-December quarter of 2015, after having risen markedly in the first half of the fiscal year. Meanwhile, the year-on-year rate of increase in the trimmed mean – an indicator intended to capture the trends of price movements by mechanically excluding items with large price fluctuations – has been relatively stable at around 0.5 percent recently, a level somewhat higher than before. As for the outlook, I think that there is not much room for these indicators, which are intended to capture the underlying trend in prices, to see a further rise in their year-on-year rates of increase, given that (1) the effects of the depreciation of the yen on a year-on-year basis have almost run their course; (2) materials prices and the producer price index (PPI), both of which represent upstream prices, have been on a clear declining trend; (3) upward pressure on prices stemming from the output gap is not, in my opinion, likely to increase noticeably; and (4) the rise in medium- to long-term inflation expectations seems to have paused. Furthermore, my impression is that plans to raise sales prices of food and daily necessities – which many firms announced at around the beginning of 2015 – are not so common this year. Therefore, I believe that there is a risk that the year-on-year rates of increase in these indicators around the April-June quarter of 2016 will come in somewhat lower than expected. In considering the outlook for prices, it also is important to focus on the relationship between prices and wages. Although wages as a whole have risen moderately, I think that wage growth has been weaker than expected despite the extremely tight labor market conditions. The background to this is that, as is the case with business fixed investment, firms remain cautious about raising scheduled cash earnings of their employees as this will lead to an increase in fixed costs, in a situation where their growth expectations for Japan's economy have not risen clearly. I think that this stance by firms is also constraining a rise in households' medium- to long-term expectations for income growth, or in other words, a rise in growth expectations for permanent income. Moreover, it is possible that sluggishness in the outlook for the rate of increase in real income would constrain private consumption, thereby exerting downward pressure on prices. Taking these factors into consideration, I personally believe that the underlying trend in inflation is likely to maintain a relatively stable level without declining substantially for the time being, albeit growing at a reduced pace. On this basis, I expressed dissent from the description presented in the January 2016 Outlook Report regarding the year-on-year rate of change in the CPI (all items less fresh food) that the timing of reaching around 2 percent is projected to be around the first half of fiscal 2017. Even at this point, I still hold the view that the year-on-year rate of change in the CPI (all items less fresh food) will be about 0 percent for the time being, and thereafter accelerate very moderately, and consider that the rate of change is unlikely to reach around 2 percent even through fiscal 2017 – the projection period covered in the January 2016 Outlook Report. BIS central bankers’ speeches III. Conduct of monetary policy A. My proposals at times of QQE decisions 1. The Bank's decisions leading to QQE with a Negative Interest Rate The Bank decided to introduce 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 October 2014, the Bank expanded QQE. The specific measures of the expansion included (1) acceleration in the annual pace of increase in the monetary base from about 60–70 trillion yen to about 80 trillion yen, and (2) an increase in the Bank's Japanese government bond (JGB) purchases so that the amount outstanding of its holdings would be increased from an annual pace of about 50 trillion yen to about 80 trillion yen. And, in December 2015, the Bank adopted the following as supplementary measures for QQE for such purposes as facilitating its smooth implementation: (1) extension of the average remaining maturity of JGB purchases; (2) establishment of a new program for purchases of exchange-traded funds (ETFs); and (3) an increase in the maximum amount of each issue of Japan real estate investment trust (J-REIT) to be purchased. The Bank took another step forward in January 2016 by introducing QQE with a Negative Interest Rate, under which it would apply a negative interest rate of minus 0.1 percent to some of the outstanding balance of current accounts that financial institutions hold at the Bank. 2. My proposals at times of QQE decisions I supported the decision to introduce QQE in April 2013, judging that its scale was one in which the associated positive effects would just about outweigh the side effects when confined to a certain time period. At that point, however, I considered that the side effects would outweigh the positive effects over time. I therefore continued to submit a proposal – that is, 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 – since the introduction of QQE through the Monetary Policy Meeting (MPM) held in March 2015. This was because, while I personally considered it difficult to achieve the price stability target of 2 percent in a short period of time, I was concerned that, if the Bank carried out QQE with the rigid purpose of achieving the 2 percent price stability target, the policy decided at the time of introduction would be more protracted or strengthened than expected and the side effects would increase in a cumulative manner. On the decision to expand QQE in October 2014, I cast a dissenting vote based on the judgment that the timing of the associated side effects outweighing the positive effects would be moved forward. Since then, I have continued to cast a dissenting vote on the guidelines. Moreover, I submitted a proposal in April 2015 that included a reduction in the annual paces of increase in the monetary base and in the amount outstanding of the Bank's JGB holdings from the current ones of about 80 trillion yen to about 45 trillion yen, which would be levels below the initial paces employed at the time of the introduction of QQE. Thereafter, I have continued to submit the same proposal through the most recent MPM held in January 2016, which was formulated based on the judgment that the associated side effects were outweighing the positive effects even under the guidelines employed at the time of the introduction of QQE, in terms of such aspects as the pace of the Bank's JGB purchases. This judgment was formed on careful examination of whether the side effects of QQE were outweighing the positive effects given that two years had passed since the introduction. Meanwhile, in December 2015, as they were inconsistent with my proposal mentioned earlier, I cast a dissenting vote on adoption of the following supplementary measures for QQE: (1) extension of the average remaining maturity of JGB purchases; (2) establishment BIS central bankers’ speeches of a new program for purchases of ETFs; and (3) an increase in the maximum amount of each issue of J-REIT to be purchased. In addition, in January 2016, I cast a dissenting vote on the introduction of QQE with a Negative Interest Rate, mainly because it would have adverse effects on the smooth conduct of the Bank's JGB purchases and therefore would only be an appropriate policy measure in a crisis situation. 3. Thinking behind my proposal My proposal, which I have continued to submit at MPMs since April 2015, has not been intended to reduce the stock of the Bank's asset holdings, but to reduce the pace of increase in such holdings. I have considered the following as consequences of the Bank's change in the current guidelines of the annual pace of increase in the amount outstanding of its JGB holdings to about 45 trillion yen, a level below the initial pace employed at the time of the introduction of QQE: the excessive pressure on the JGB market would be eased considerably, and the Bank's JGB purchases, for the time being, would be more sustainable and stable as the risk that the Bank faces a limit to its JGB purchases at an early stage subsides. Meanwhile, even if the paces of increase in the monetary base and in the amount outstanding of the Bank's JGB holdings were to be reduced, accommodative financial conditions would be strengthened in a cumulative manner as the amount outstanding of its asset holdings increases. Given that it will take considerable time before the end of QQE – that is, when excess reserves are depleted and the amount outstanding of the Bank's JGB holdings is normalized – the Bank must be careful when deciding on policies. Next, I would like to elaborate on the thinking behind my proposal, focusing on policy effects and side effects. B. Policy effects and side effects 1. Policy effects through long-term real interest rates I think QQE is effective in increasing domestic private demand, mainly through a decline in long-term real interest rates, bringing forward future real private consumption. In this regard, by way of pushing down long-term real interest rates, the cumulative policy effects already have firmly taken hold in Japan's economy, as especially evident by the following developments: (1) the output gap in Japan recovered to a more or less neutral level at around the end of 2013 and has generally stayed at this level; and (2) the gap has narrowed between the actual inflation rate and the medium- to long-term expected rates of inflation, on which basis firms and households carry out their economic activities. However, I consider that the additional effects of QQE have been diminishing. This is because long-term real interest rates, which showed a marked decline for about a year after the introduction of QQE, have generally seen a slowdown in their pace of decline since around the middle of 2014, although the levels of these rates were reduced somewhat very recently due to the introduction of QQE with a Negative Interest Rate. Medium- to long-term inflation expectations in various surveys and market indicators have been at a level that remains far from the price stability target of 2 percent, and some recent results showed a downward trend. Under these circumstances, I believe it remains difficult to encourage a rise in medium- to long-term inflation expectations solely through the Bank's policy measures. Long-term real interest rates have become less likely to decline despite the continued increase in the amount outstanding of the Bank's JGB holdings, and therefore the additional effects of QQE have been diminishing. Given this situation, I consider that a reduction in the pace of the Bank's JGB purchases will only marginally decrease the additional effects of QQE, while it can restrain the increase in its side effects, thereby enabling the balance between the positive effects and the side effects to improve. BIS central bankers’ speeches 2. Attention required to potential side effects of QQE The side effects of QQE have not yet materialized fully because they are mostly potential effects. However, due attention needs to be paid because, once they do materialize, it will become difficult to handle them appropriately and promptly. Given this, I am personally paying particular attention to the side effects of QQE arising from the Bank's large-scale purchases and holdings of JGBs, which impair the proper functioning of the JGB market. Specifically, these particular side effects include risks such as the following: (1) the proper functioning of the JGB market – in terms of liquidity and the price-discovery function – will be impaired and financial institutions' profits will deteriorate, both of which could lead to instability in the financial system; (2) interest rates will rise in the course of normalizing monetary policy; and (3) drastic fluctuations in JGB prices will cause revisions to prices of a wide range of financial products and assets, thereby exerting severe effects on the financial system and economic activity. With the Bank's large-scale JGB purchases, I consider that attention should also be given to (1) the further heightening of the possibility that the Bank's large-scale JGB purchases will be perceived as central bank financing of fiscal deficits; and (2) the impairment of the mechanism to maintain fiscal discipline through interest rates, reflecting overly heightened expectations that the stability in the JGB market will be ensured. 3. Sustainability of JGB purchases and stability of interest rates From the perspective of the side effects regarding the Bank's JGB purchases, I would also like to discuss the sustainability of such purchases and stability of interest rates. Under QQE, the share of the Bank's holdings in the JGB market has continued to increase. As of September 30, 2015, the Bank held about 30 percent of the total outstanding amount of JGBs issued. Meanwhile, financial institutions in Japan need to hold a certain amount of JGBs for such purposes as collateral for transactions, a safe asset portfolio in assetliability management (ALM), and compliance with financial regulations. Therefore, it is not possible for the Bank to hold all of the JGBs issued. Looking at the share of central banks' holdings in the respective government bond markets, in 2016, the Bank of Japan's share of holdings will exceed that of the Bank of England at its peak level and proceed into unprecedented territory for a major central bank. In addition, purchasing government bonds in Japan is potentially more difficult than in other countries given that, while the share of overseas investors – who tend to hold JGBs for short-term trading purposes – is small, a large share is held by life insurance companies and pension funds – which tend to hold JGBs to maturity. So far, the Bank has conducted outright purchases of JGBs smoothly and a technical problem has not materialized. Nevertheless, if financial institutions in Japan become more risk averse due to concerns over overseas financial markets, for example, and increasingly prefer to hold JGBs, this may tighten supply and demand conditions of JGBs and in turn abruptly make it difficult for the Bank to continue with its JGB purchases. I personally believe that such potential risks have increased steadily with the progress in the Bank's large-scale JGB purchases. I do not think that the economy and financial markets will be negatively affected to a large degree if long-term nominal interest rates rise as improvement in economic and price conditions brings about an increase in medium- to long-term inflation expectations and an upward revision to the outlook for the economic growth rate. However, if long-term nominal interest rates rise due to a rise in term premiums on JGBs – which are determined by factors other than inflation expectations and the outlook for short-term interest rates – caused, for example, by concerns over the sustainability of the Bank's JGB purchases, the subsequent impact on the economy and financial markets could be serious. Therefore, it is important to prevent a significant rise in term premiums. Based on the thinking that, under the Bank's policy of purchasing JGBs, term premiums are determined not only by the current amount outstanding of the Bank's JGB holdings but also BIS central bankers’ speeches by the projection for the amount outstanding, if market participants suddenly become concerned about a limit to the Bank's JGB purchases, they may revise their forecasts that the time frames for such purchases and for maintaining the amount outstanding of the Bank's JGB holdings will be shorter than expected, or that the peak level of the amount outstanding of its JGB holdings will be lower than expected, thereby leading to a significant rise in term premiums. In relation to this, I view the mindset that it is acceptable for the Bank to continue with its JGB purchases until a limit comes into sight as inappropriate. Considering that financial institutions need to hold a certain amount of JGBs for such purposes as collateral, as mentioned earlier, there will be a phase in which they will not sell their JGB holdings actively even amid declining interest rates. In this situation, as the responsiveness of interest rates to the level of JGB demand will decline substantially, there is a possibility that interest rates will tend to show large fluctuations, thereby exerting severe effects on financial markets and the economy. When reaching such a phase, it also is likely that the Bank will face difficulties, including in terms of reducing the amount outstanding of its JGB holdings while maintaining financial market stability, and the normalization of QQE will not be an easy process. Furthermore, there is a possibility that fiscal risks will heighten as interest rates fluctuate largely depending on the government's debt issuing policy and its outlook. 4. Financial soundness of the Bank As another potential side effect that will heighten steadily from maintaining QQE for a protracted period, I am paying attention to the effect on the Bank's profits and balance sheet when it raises interest rates applied to excess reserve balances of financial institutions' current accounts at the Bank in the course of normalizing QQE. Under QQE, the Bank has conducted large-scale JGB purchases and its annual interest income on JGBs has exceeded 1 trillion yen. Meanwhile, the Bank has financed such purchases at low cost through financial institutions' current accounts at the Bank – to most of which is currently applied a positive interest rate of 0.1 percent – and issuance of banknotes, which entails little cost. Therefore, with the continuation of QQE, the Bank's profits have continued to improve amid the increase in net interest income, which is the difference between interest income on JGBs and interest payments on excess reserve balances of financial institutions' current accounts at the Bank. This net interest income can be regarded as seigniorage under QQE. Most of the Bank's profits are paid to the government and this constitutes government revenue; therefore, seigniorage has the effect of indirectly reducing the tax burden on the private sector. However, it should be noted that, in the course of normalizing QQE in the future, due to the Bank's current accounting rules under which securities are valued at amortized cost, its interest income on JGBs will increase only moderately despite rises in long-term interest rates. On the other hand, depending on when and how interest rates applied to excess reserve balances of financial institutions' current accounts at the Bank are raised, payment of such interest could increase substantially and a negative spread could occur. This could lead to a deterioration in the Bank's profits and impairment of its capital, and at the same time cause a possible decrease or delay in the Bank's payment to the government, which in turn could decrease government revenue. What is notable here is that the more protracted the period of maintaining QQE and the higher the level of excess reserves at the Bank, the larger the magnitude of such effects. In the long run, it can be expected that, on the back of a rise in long-term interest rates, the negative spread will be resolved with a gradual increase in the Bank's interest income on JGBs, and the environment for its profits will improve, making it possible for the Bank to restore its capital. As a result, the effects of QQE on the Bank's profits, and ultimately on government revenue, may be considered neutral from a long-term perspective. Nevertheless, the path toward realization of this projection is highly uncertain, as it depends BIS central bankers’ speeches on the actual measures of monetary policy and developments in market interest rates, and also requires considerable time. I have focused so far on the possibility of a deterioration in the Bank's profits and impairment of its capital deriving from the difference between interest income on JGBs and interest payments on excess reserve balances of financial institutions' current accounts at the Bank. However, attention also needs to be paid to the fact that a similar issue could arise; for example, in case of a fall in the prices of ETFs and J-REITs – of which the Bank's holdings have increased under QQE. It also is important to note that a decrease in the Bank's payment to the government, by way of causing a decrease in government revenue, could be the trigger for the public to clearly acknowledge the costs of QQE, which had been hard to discern without such a decrease. In other words, it will be widely shared among the public that the Bank, through its pursuit of QQE, is deeply involved in income distribution. Although the deterioration in the Bank's profits and impairment of its capital that I mentioned earlier may not directly hinder its business operations, the possibility cannot be denied that these could negatively affect the stability in the value of currency in some way. In addition, the Bank has communicated its stance that it will implement the policy measures necessary to achieve price stability while giving consideration to its financial soundness. However, given the Bank's accounting rules under which the capital adequacy ratio is maintained at around 10 percent, within the range of about two percentage points above or below that level, speculation in financial markets could be raised that the Bank might, as economic and price conditions improve, place priority on maintaining financial soundness over price stability and maintain interest rates on excess reserve balances of financial institutions' current accounts at the Bank at relatively low levels. 5. Side effects of QQE with a Negative Interest Rate QQE with a Negative Interest Rate may have additional negative effects on financial institutions' profits, mainly through a narrowing of interest rate margins on loans and a reduction in yields on financial assets, and this potentially could undermine financial system stability. It also should be noted that financial institutions – to compensate for deterioration in their profits –could pass on costs to their depositors and borrowers by, for example, not only lowering deposit rates but also increasing lending rates and transaction fees. This conversely could lead to monetary tightening effects. In addition to such side effects, my concern is the possibility of impairing the sustainability and stability of the Bank's JGB purchases, which are the core of QQE. Many financial institutions – regional banks in particular – are said to have a strong tendency to hold JGBs with the aim of obtaining stable income gains rather than having temporary capital gains. For these financial institutions, if the levels of interest rates applied to excess reserve balances of their current accounts at the Bank become lower relative to yields on their current JGB holdings, or if yields on reinvested JGBs decline, this could reduce their incentive for selling JGBs to the Bank. Financial institutions also could become less encouraged to increase funds in their current accounts at the Bank to which a negative interest rate is applied, in view of difficulty in satisfying their stockholders and of reputation risks. Taking these possible effects into account, if an introduction of a negative interest rate leads market participants to become aware that the Bank could face a limit on its JGB purchases sooner than expected, there is a risk of financial market instability, such as a rise in term premiums, which in turn could negatively affect the economy. In this regard, some may argue that, in the euro area, the negative interest rate policy and the asset purchase program are being pursued simultaneously at present, and thus the Bank can do so as well. However, the example in the euro area is not necessarily applicable to Japan, as there are great differences in the situations between the two, such as the following. First, the scale and the implementation period of asset purchases in the euro area significantly fall below those in Japan. Second, in the euro area, a large share of government BIS central bankers’ speeches bonds are purchased from financial institutions that are not eligible for the deposit facility, and their incentive for selling such bonds is not directly affected by the level of the deposit facility rate. Therefore, with regard to the negative interest rate policy, I considered that the following two conditions should be met for its introduction. First, that it would be necessary to ensure that the sustainability and stability of the Bank's JGB purchases is enhanced through a reduction in the pace of such purchases. Second, on this basis, that the policy would only be appropriate in a crisis situation, such as when financial and economic conditions deteriorate markedly. Based on the judgment that the two conditions were not being met, I expressed dissent from introduction of QQE with a Negative Interest Rate at the MPM held in January 2016. In addition, I considered that the Bank should have refrained from implementing the measure and saved it for the future, as any additional monetary easing – not limited to the introduction of a negative interest rate – was not necessary, given that economic and price conditions in Japan were stable and that volatile movements in financial markets had not been critical. C. Future conduct of monetary policy 1. Policy change and market stability As explained so far, I have been proposing at MPMs a change to the guidelines for money market operations and asset purchases, including a reduction in the annual pace of increase in the amount outstanding of the Bank's JGB holdings. In light of my proposal, how such a reduction, if actually implemented, will affect financial markets in particular has been drawing wide interest. My understanding is that the additional effects of the Bank's JGB purchases have already been diminishing, and that there is a limit to such purchases. I therefore consider that the risk of impairing financial market stability will be smaller if the Bank proceeds with a reduction in the pace of its JGB purchases at an early stage in an orderly manner while closely communicating with the markets, rather than further proceeding with its JGB purchases and then implementing the reduction once such purchases come close to the limit. It also is possible to reduce the risk of impairing financial market stability by providing a thorough explanation, or forward guidance, to the markets that the reduction in the pace of the Bank's JGB purchases (1) will not in the near future lead to a rise in interest rates applied to excess reserve balances of financial institutions' current accounts at the Bank or a reduction in the amount outstanding of the Bank's JGB holdings, which could weaken the accumulated effects of its JGB purchases, and (2) will instead enhance the sustainability and stability of the Bank's JGB purchases for the time being. Based on this understanding, with regard to the Bank's future monetary policy stance, I have been proposing at MPMs that it should continue with asset purchases and a virtually zero interest rate policy as long as each of these policy measures is deemed appropriate, in addition to the proposal to change the guidelines for money market operations and asset purchases. 2. Examination of a wide range of policy measures It should be noted that, although I have been proposing a reduction in the pace of the Bank's asset purchases, I am not ruling out the possibility of implementing additional policy tools in the case of future marked deterioration in financial and economic conditions. My understanding is that, even if the Bank starts to normalize its asset purchases, it is highly likely that it would take considerable time for this to be completed; given this, it is necessary to fully take into account the side effects of such purchases that may emerge over a considerable period of time and also try to conduct monetary policy in a much more forward-looking manner than when conducting the interest rate policy. I therefore think that BIS central bankers’ speeches it is inappropriate to expand the amount of assets to be purchased, to address short-term changes in financial and economic conditions. At the same time, I consider it desirable that monetary policy be conducted flexibly and comprehensively with an appropriate combination of various measures. If stability in economic activity and prices, or in financial conditions, were to be undermined significantly, thereby causing a serious situation in which economic, price, and financial conditions could deteriorate in an accelerated manner without a monetary policy response, I personally think it necessary to examine possible additional measures other than expansion in the amount of assets to be purchased – such as those to fully ensure financial system stability by temporarily providing ample funds in yen and foreign currencies regardless of the target for the annual increase in the monetary base. 3. My view regarding the price stability target In addition to the proposal to change the guidelines for money market operations and asset purchases, I have been submitting a proposal 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. I consider it appropriate to implement these two proposals together. Next, I would like to explain my view regarding the price stability target that lies behind such consideration. The Bank's 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 important to have a positive change in economic structure that is in line with the 2 percent price stability target. In the process of the change in economic structure, firms' and households' medium- to long-term inflation expectations – on which basis they carry out their economic activities – will become stable at around 2 percent, and this will support the actual inflation rate continuing to be stable at around 2 percent. In this regard, I consider that firms' and households' medium- to long-term inflation expectations are mainly determined by supply-side factors – or, the economy's growth potential – such as the potential growth rate and the productivity growth rate, rather than by factors such as the following: the level of the Bank's price stability target; the supply and demand balances in goods and services, as well as in the labor market; and developments in the actual inflation rate. In light of this view, I think that the price stability target of 2 percent is well above the level that is consistent with the growth potential of Japan's economy. Therefore, it is difficult at this point to achieve the 2 percent price stability target in a stable manner through monetary policy alone, unless further progress is made in economic structural changes that would increase the underlying trend in inflation. In this situation, my concern is that, if the Bank, through monetary policy, tries to push prices higher in the short term than levels justified by the economy's growth potential, this could in turn impair the stability in economic activity and prices. Let me note that the joint statement by the government and the Bank released in January 2013 indicated that "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." In my interpretation, the statement was based on the recognition that a prerequisite for the Bank to set the 2 percent price stability target is a rise in the growth potential of Japan's economy to the level that is in line with price stability at 2 percent inflation through efforts such as by the government and firms. 4. New role of monetary policy in the future In order to raise the growth potential of Japan's economy, it is necessary for firms to make technological innovations, as well as active fixed investment, so that such innovations lead to increased productivity. Moreover, to encourage firms to make active fixed investment in BIS central bankers’ speeches Japan and increase the potential growth rate through accumulation of capital stock, it is necessary that the government take various measures to increase firms' medium- to longterm expectations for the growth rate of domestic demand. As mentioned earlier, my assessment is that QQE has exerted a considerable effect. In this current situation, I personally consider that the new role that monetary policy should play in the overall economic policy has shifted to consistently providing, while maintaining favorable financial conditions, indirect support for positive efforts by the government and firms so that the economy's growth potential – which is represented mainly by the potential growth rate and the productivity growth rate – will increase to the level consistent with the 2 percent inflation rate. To this end, it is important to conduct monetary policy with the aim of achieving prolonged economic recovery, albeit moderate, at a pace consistent with the economy's growth potential – that is, the potential growth rate -– by reducing the side effects of monetary easing that could lead to financial market turmoil, thereby making the utmost efforts to lessen future uncertainty. My proposal to change the guidelines for money market operations and asset purchases, which I have been submitting at MPMs, is based on such a viewpoint. I believe that this proposal is in fact a quicker way of achieving the 2 percent price stability target. BIS central bankers’ speeches
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Opening remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the BIS FXWG-MPG meeting, Tokyo, 26 February 2016.
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Hiroshi Nakaso: Developing a global code of conduct for the foreign exchange market Opening remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the BIS FXWG-MPG meeting, Tokyo, 26 February 2016. * I. * * Introduction It is a great pleasure to welcome the BIS FXWG (Foreign Exchange Working Group) and MPG (Market Participants Group) joint meeting on developing a single global code of conduct for the foreign exchange market.1 In March last year, the eight foreign exchange committees in the major financial centers gathered here in Tokyo and adopted the “Global Preamble,”2 sharing their commitment to developing and promoting clear, robust, and implementable best-practice guidance in the foreign exchange market. Building on the Global Preamble, in May last year, the BIS governors agreed to set up a working group to facilitate the establishment of a single global code of conduct for the foreign exchange market. Since its inception, 16 central banks and more than 30 private-sector professionals from around the world have been participating actively in this project. Without a doubt, this project is a cornerstone for the ongoing global initiatives to address the misconduct issues in the broad financial market. Thanks to the hard work of each member and the excellent leadership of the Chair, Guy Debelle, significant progress has been made with the first public update, which is envisaged in May 2016. As a member of the FXWG, the Bank of Japan is honored to host this joint meeting with the MPG today. In my remarks, first I would like to share my views on why we need the global code and how it matters to the central banks, and then express my support on key concepts of the code that have been shared among our colleagues here. II. Why we need the global code Let me begin with my thoughts on how the global code can contribute to the sound functioning of the foreign exchange market. It has been broadly agreed that the single global code of conduct for the foreign exchange market aims to promote a robust, fair, liquid, open, and transparent market. Achieving this goal is crucial to the sound functioning and development of the foreign exchange market. Why is a well-functioning foreign exchange market highly important from a central bank’s perspective? We closely monitor the financial market developments when conducting our policy in pursuit of price and financial stability. Financial markets carry crucial information regarding market participants’ views on economic and financial conditions, and also play a vital role for transmission of our policy. Financial markets must be functioning effectively to play such important roles. A well-functioning market needs to be supported by sufficient market liquidity. Therefore, I strongly believe that the central banks should continue to be committed to enhancing market “Foreign Exchange Working Group” (FXWG), which consists of 16 central banks, was established under the auspices of the BIS Markets Committee to facilitate the establishment of a single global code of conduct for the foreign exchange market and to promote greater adherence to the code. To support the FXWG, a “Market Participants Group” (MPG) was established, drawing on more than 30 private-sector professionals in the foreign exchange market. The relevant press release is available at http://www.bis.org/press/p150724.htm. Available at http://www.fxcomtky.com/announce/pdf_file/global_preamble.pdf. BIS central bankers’ speeches liquidity as part of our efforts to develop the code. According to the widely accepted definition of the BIS, “A liquid market is a market where participants can rapidly execute large-volume transactions with a small impact on prices.”3 I believe that a robust, fair, open, and transparent market, where diverse types of participants with diverse business models can confidently transact will indeed support market liquidity, which in turn enhances the functioning of the foreign exchange market. III. Key concepts of the global code Next, I would like to touch upon a few key concepts of the global code that have been shared among our colleagues here. I would like to express my strong support for these concepts, as they are crucial to improve market functioning. A. Principle-based code The first key concept is that the global code will become most effective when it is principlebased, taking into account the diversity of market participants. The foreign exchange market is a large cross-border market uniquely featured with diverse participants. Indeed, we cannot find any other market where such a wide variety of financial and nonfinancial corporations transact on a daily basis. Over-the-counter (OTC) transactions prevail, and the electronic trading venues are also diverse, ranging from brokers to single- and multiple-dealer platforms. Regulatory settings covering foreign exchange transactions are also diverse in a range of jurisdictions. A principle-based approach, rather than a prescriptive rule-based approach, is well suited to address such a diversity of participants and a complexity in market structures across the globe. Regarding the approach, Guy Debelle raised an important point in his speech last November, and let me repeat it here: History has shown that “the more prescriptive it becomes the easier it is to get around [because] rules are easier to arbitrage than principles.”4 I fully support his views. B. Collaboration between the public sector and the private sector The second key concept of the global code is that continuous collaboration between the public sector and the private sector is indispensable. The foreign exchange market has evolved through close collaboration between the public and private sectors. For example, the foreign exchange committees in the major financial centers typically comprise both central bankers and private-sector participants. Work on the global code has also achieved progress through a public sector-private sector partnership. The MPG, which consists of both sell-side and buy-side institutions, has been providing valuable insight based on its members’ expertise in market practices and innovation. It would be desirable that innovations led by the private sector continue to evolve under the appropriate code of conduct, thereby improving market functioning. The public sector should endeavor to align the private sector’s incentives appropriately to support further market innovation and sound functioning of the foreign exchange market. Bank for International Settlements (1999), “Market Liquidity: Research Findings and Selected Policy Implications,” CGFS Publications No 11. See Guy Debelle, “The Global Code of Conduct for the Foreign Exchange Market,” speech at the FX Week Europe conference in London on November 25, 2015. Available at http://www.rba.gov.au/speeches/2015/spag-2015–11–25.html. BIS central bankers’ speeches C. User-friendliness The third key concept is that the global code should be succinct, clear, and easy to use. The code becomes valuable only when market participants make good use of and adhere to it in their day-to-day business at the practical level. In addition, bearing in mind the existence of diverse participants and diverse business models, I would like to emphasize the importance of clearly addressing what market participants can do under the code. This is to prevent over-cautious behavior of market participants which could be detrimental to fostering well-functioning markets. As an initiative to enhance market functioning through clearer dialogue among market participants, the Tokyo Foreign Exchange Market Committee developed the “Tokyo Blue Book” in April last year.5 The book provides guidance with succinct, clear statements and practical examples to help promote understanding of the code among Tokyo market participants. IV. Concluding remarks I firmly believe that the successful development of a single global code and greater adherence to it will reinforce the functioning of the foreign exchange market and facilitate vibrant, sound development of the market. The Bank of Japan has been, and will continue to fully support and be committed to the work of the global code. I am confident that this Tokyo meeting will provide us with a valuable opportunity to achieve further progress in our work. Thank you very much for your kind attention. Available at http://www.fxcomtky.com/coc/code_of_conduct_e2015.pdf. 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, Okinawa, 3 March 2016.
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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, Okinawa, 3 March 2016. * * * Accompanying charts can be found at the end of the speech. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Okinawa 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 Naha Branch. At the Monetary Policy Meeting held at the end of January 2016, the Bank decided to introduce “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate.” Today, before exchanging views with you, I would first like to explain the Bank’s view on the recent developments in and outlook for economic activity and prices. I will then move on to its recent conduct of monetary policy while elaborating on “QQE with a Negative Interest Rate” that the Bank has decided to introduce. I. Recent developments in and outlook for economic activity and prices at home and abroad Current situation of Japan’s economic activity and the bank’s projection in the January 2016 outlook report To start with, let me talk about economic developments in Japan. Although global financial markets have been volatile since the turn of the year, I believe there is no need to be too pessimistic as the fundamentals of Japan’s economy have been firm. With regard to Japan’s recent economic activity, domestic demand has followed an uptrend, with a virtuous cycle from income to spending being maintained in both the household and corporate sectors. In the corporate sector, profits clearly have continued to improve, reaching a record high, with support from an improvement in the real economy as well as the low crude oil prices and the correction of the yen’s appreciation (Chart 1). Against this background, business fixed investment has been on a moderate increasing trend. In the household sector, labor market conditions have continued to tighten. The active job openings-to-applicants ratio and the diffusion index for employment conditions in the December 2015 Short-Term Economic Survey of Enterprises in Japan (Tankan) have improved to almost the same levels as around the first half of 1992. Moreover, the unemployment rate has been declining and in the range of 3.0–3.5 percent for the first time since 1997. The labor market is in a situation close to “full employment,” where unemployment is due solely to mismatches between job openings and job applicants (Chart 2). Reflecting the tightening of labor market conditions, employee income has been increasing moderately. Under such steady improvement in the employment and income situation, private consumption has been resilient. Looking ahead, domestic demand is likely to follow an uptrend, with a virtuous cycle from income to spending being maintained in both the household and corporate sectors. Exports are expected to increase moderately on the back of emerging economies moving out of their deceleration phase. Against this backdrop, Japan’s economy is likely to be on a moderate expanding trend. As in the January 2016 Outlook for Economic Activity and Prices (Outlook Report), it is estimated that the economy will continue growing at a pace above its potential through fiscal 2016. In fiscal 2017, it is projected to maintain positive growth, although with a BIS central bankers’ speeches slowing in its pace to around a level somewhat below the potential growth rate, reflecting the effects of a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike, as well as the cyclical developments in the economy. The medians of the Policy Board members’ forecasts for the real GDP growth rates are also indicated in the January Outlook Report, and those for fiscal 2015, 2016, and 2017 are 1.1 percent, 1.5 percent, and 0.3 percent, respectively (Chart 3). Price developments in Japan and the outlook Let me now turn to price developments in Japan. Ａsignificant change in price developments has been observed after the introduction of QQE. The year-on-year rate of change in the consumer price index (CPI, all items less fresh food), which had been minus 0.5 percent before the introduction of QQE, improved to as high as 1.5 percent in April 2014, excluding the effects of the consumption tax hike (Chart 4). Thereafter, the year-on-year rate of change in the CPI has declined, marking about 0 percent recently, but this was largely attributable to a substantial fall in crude oil prices since summer 2014. As for the underlying trend in inflation, the year-on-year rate of change in the CPI excluding fresh food and energy – both of which are with large fluctuations – had been negative before the introduction of QQE, but turned positive in October 2013. Since then, it has remained positive for 28 consecutive months and increased to 1.1 percent recently. The share of price-increasing items minus the share of price-decreasing items in the CPI has been increasing clearly, suggesting that price rises have been observed in a wide range of goods and services (Chart 5). In brief, the forecasts of the CPI (all items less fresh food) are obtained by adding the underlying trend in inflation to the contribution of energy items to the CPI. The January Outlook Report assumes that Dubai crude oil prices will rise moderately from the recent 35 U.S. dollars per barrel to the range of 45–50 dollars per barrel toward the end of fiscal 2017, which marks the end of the projection period. The contribution of energy items to the year-on-year rate of change in the CPI (all items less fresh food) is estimated to be slightly more than minus 1 percentage point and is at its highest level recently. However, under the aforementioned assumption of crude oil prices, the contribution is projected to decrease. Meanwhile, since the underlying trend in inflation is likely to rise steadily, this is likely to be seen clearly in the year-on-year rate of change in the CPI. Therefore, the underlying trend in inflation has been improving steadily and the baseline scenario would be as follows: the year-on-year rate of change in the CPI is likely to accelerate toward the price stability target of 2 percent as the economy is likely to be on a moderate expanding trend. Taking these factors into account, the year-on-year rate of change in the CPI (all items less fresh food) is projected to reach around 2 percent – the price stability target – around the first half of fiscal 2017. Global financial markets and overseas economies On the other hand, global financial markets have been nervous since the turn of the year; the yen has appreciated as investors sought a safe haven due to elevated risk aversion against the backdrop of declining global stock prices resulting from the further decline in crude oil prices and looming uncertainty such as over future developments in the Chinese economy. Next, I would like to explain the current situation of and outlook for overseas economies that are creating turmoil in global financial markets. To give an overview of the recent developments, overseas economies – mainly advanced economies – have continued to grow at a moderate pace on the whole, despite the slowdown in emerging economies. By region, the U.S. economy has continued to steadily recover, reflecting the firmness in household spending. Some market participants are holding a cautious view toward developments in the U.S. economy, but no new concerns are being observed, and therefore I suppose their view is too pessimistic. The European economy also has continued to recover moderately (Chart 6). BIS central bankers’ speeches It is true that the Chinese economy, which has been attracting the world’s attention, has continued to be in a state of deceleration due to downward pressure from an overhang of production capacities and inventory adjustments in the manufacturing sector (Chart 7). Other emerging economies and commodity-exporting economies as a whole also remain in a situation of deceleration, as the effects of the slowdown in the Chinese economy have spread to them and as the decline in commodity prices has been protracted. Some economies in Asia, however, have seen a pick-up in IT-related demand. Looking ahead, the Chinese economy is likely to broadly follow a stable growth path, albeit at a somewhat slower pace mainly in the manufacturing sector, as authorities proactively carry out policy measures to support economic activity. Other emerging economies and commodity-exporting economies as a whole are expected to gradually increase their growth rates, due mainly to the effects of the recovery in advanced economies and of economic stimulus measures, although some commodity-exporting economies are likely to remain in a situation of deceleration for the time being. II. The bank’s Monetary Policy Management Basic mechanism of monetary easing However, after the turn of the year, the global financial markets have continued to be volatile, as I have mentioned earlier. At the Monetary Policy Meeting held at the end of January 2016, many Policy Board members pointed out that there is an increasing risk that such volatility in global financial markets might delay an improvement in business confidence of Japanese firms and conversion of the deflationary mindset, and might also negatively affect the underlying trend in inflation. To preempt the manifestation of this risk and to maintain momentum toward achieving the price stability target of 2 percent, the Bank decided to introduce “QQE with a Negative Interest Rate.” Now, I would like to focus on the Bank’s monetary policy management. To begin with, let me review the basic transmission mechanism of monetary easing that the Bank had pursued, and then talk about the newly introduced “QQE with a Negative Interest Rate.” Generally speaking, the main transmission channel of monetary easing would be as follows: it will cut the real interest rate – that is, interest rate adjusted by inflation expectations – and stimulate economic activities such as business fixed investment and housing investment. Inflation expectations are taken into account because, if prices are expected to rise, corporate profits and wages also are likely to increase, and thus the real interest rate, which means the real cost of borrowing, will become lower than the nominal interest rate. When deciding to what extent the real interest rate should be lowered, policymakers can focus on the natural rate of interest as a reference level. Every country has its own natural rate of interest, which is neutral to economic activity in that it will neither accelerate nor decelerate the economy. The effects of monetary easing will be produced by reducing the real interest rate to a lower level compared to the natural rate of interest. In general, the natural rate of interest will be determined largely by the potential growth rate, which represents the economy’s growth potential. In Japan, the potential growth rate was in the range of 3–4 percent during the 1980s but declined significantly after the turn of the 1990s. Recently, it is estimated to be around 0.5 percent or lower. Bearing these factors in mind, monetary policy since the 1990s can be summarized as follows. With the aim of taking measures to bring about recovery following the economic recession after the burst of the bubble, the Bank gradually cut the policy interest rates. As a result, short-term interest rates reached approximately 0 percent at the end of the 1990s. However, at the same time, the potential growth rate became low, and accordingly the natural rate of interest declined. Even though the Bank had lowered the nominal short-term interest rate to 0 percent, it was unable to reduce the real interest rate to a level significantly BIS central bankers’ speeches below the natural rate of interest due to the widely spread deflationary sentiment among the public. In order to make a breakthrough in this situation, the Bank introduced QQE in April 2013. This policy measure aimed at lowering the real interest rate by two means (Chart 8). The first is to raise inflation expectations through the Bank’s strong commitment to achieving the price stability target of 2 percent at the earliest possible time. The second is to make use of the room for lowering the nominal interest rate. Although short-term interest rates already had declined to as low as 0 percent, long-term interest rates still had room to fall. Therefore, the Bank decided to massively purchase Japanese government bonds (JGBs), thereby putting downward pressure across the entire yield curve; i.e., not only short-term interest rates but also long-term interest rates including 10-year JGBs, as well as super-long-term interest rates of JGBs with maturities of 20 years or longer. By referring to some specific data, let me briefly explain how the intended effects have been spreading so far. Yields on 10-year JGBs already had been lowered to a record low level before the Bank decided to introduce “QQE with a Negative Interest Rate,” and thus the entire yield curve has been pushed down to an extremely low level (Chart 9). At the same time, inflation expectations have been rising on the whole from a somewhat longer-term perspective. According to various survey-based indicators, inflation expectations generally have been raised by about 0.5 percentage point under QQE (Chart 10). The decline in the nominal interest rate and the rise in inflation expectations suggest that the real interest rate has been largely pushed down. In fact, after the introduction of QQE, the real interest rate has remained in negative territory. Thus, as I have mentioned, the real interest rate, having declined to the record low level, stimulated domestic demand, resulting in a moderate recovery in Japan’s economy and an improvement in the underlying trend in inflation. Zero lower bound of interest rates and framework for “QQE with a negative interest rate” The newly introduced “QQE with a Negative Interest Rate” maintains and reinforces the basic mechanism of QQE, which has produced its intended effects. For a long period of time, a common understanding has made us believe that the nominal interest rate cannot fall below the zero lower bound. However, at present, some central banks in Europe, including the European Central Bank (ECB), are in fact implementing negative interest rate policies. The following two points were considered to be reasons why the nominal interest rate cannot turn negative. First, financial institutions’ profits would be squeezed if a negative interest rate were applied to their current accounts at the central bank. If a negative interest rate were to massively squeeze financial institutions’ profits – which I would view as an extreme case – functioning of financial intermediation could be hampered and, as a result, the intended effects of monetary easing would wane. Second, a larger negative interest rate would incentivize financial institutions to withdraw more cash from their current accounts at the central bank in an attempt to avoid a negative interest rate being applied. Since financial institutions, by holding a large amount of cash, have to suffer various costs including that of delivery and storage, as well as run new risks such as theft, it is unlikely that they will largely replace their current account balances with cash holdings as soon as the interest rate on current accounts becomes negative. This implies, however, that there could be a certain limit to the depth of the negative interest rate. In other words, if these two concerns were dispelled, negative short-term interest rates could be formed by applying a negative interest rate to current accounts at the central bank, thereby pushing down the short end of the yield curve. The Bank came up with a solution to the challenges regarding a negative interest rate. This is “QQE with a Negative Interest Rate,” through which the outstanding balance of each financial institution’s current account at the Bank will be divided into three tiers and a negative interest rate will only be applied to a certain tier. The three-tier system has been adopted partly in consideration of the impact on financial institutions’ profits as well BIS central bankers’ speeches (Chart 11). The outstanding balance of current accounts is divided into three tiers, and a positive interest rate of 0.1 percent will continue to be applied to a vast majority of an existing balance. Practically, as the “first floor” of the three-tier system, the “Basic Balance” is defined as the average outstanding balance of current accounts in January through December 2015. In the “Basic Balance,” the 0.1 percent positive interest rate continues to be applied to about 210 trillion yen; in other words, the amount outstanding exceeding the required reserves, to which a zero interest rate had been applied under the old scheme. Next, a zero interest rate will be applied to the “second floor.” For the most part, the second floor is intended to keep the amount to which a negative interest rate is applied from building up over time. Therefore, the balance of the “second floor” will be adjusted at an appropriate timing in the future. Some lending programs by the Bank, such as the Loan Support Program and the funds-supplying operation to support financial institutions in disaster areas, will be implemented at a zero lending rate from now on. A zero interest rate will be applied to the amounts outstanding of these facilities so that a negative margin incurred between lending rates and the interest rate applied to the corresponding balance of current accounts at the Bank would not disincentivize financial institutions from using the facilities. In a similar vein, the interest rates applied to the required reserves will continue to be zero. A negative interest rate of minus 0.1 percent will be applied only to a portion of current account balances exceeding the amounts outstanding of the “first” and “second” floors. This is the “third floor” of the three-tier system and is called the “Policy-Rate Balance” as a negative interest rate is applied in the course of monetary policy. Admittedly, it is true that an interest rate of minus 0.1 percent is applied to current account balances at the Bank, but in practice, as I just explained, a negative interest rate is applied only to the “Policy-Rate Balance.” At the start of the negative interest rate policy, the balance amounts to about 10 trillion yen, consisting of a small portion of the total current accounts outstanding of about 260 trillion yen. Therefore, an adverse impact on financial institutions’ profits will be largely mitigated while the negative interest rate policy will powerfully produce its intended effects of pushing down the short end of the yield curve. This is because prices of any new financial transactions such as JGB transactions are determined based on a “marginal” cost, as economic jargon puts it. Consequently, a negative interest rate of minus 0.1 percent applied to a marginal increase in the current account balances at the Bank will define the short end of the yield curve. Besides the costs incurred by holding current account deposits at the Bank, the downward shift of the entire yield curve itself admittedly can have a negative impact on financial institutions’ profits. It should be noted that this is always the case with monetary easing in general and there is nothing special with a negative interest policy in this regard: the gist is that it is a mere reflection of monetary easing effects. Looking ahead, as the negative interest rate policy will exert its intended effects, private demand such as business fixed investment and housing investment is expected to increase. In that sense, the negative interest rate policy will accelerate the process of overcoming deflation. This could be a quicker way to get out of the low interest rate quagmire as well as bring about favorable business conditions for financial institutions. Financial institutions may want to properly consider this point, and we do hope that they will proactively explore potential borrowing needs, thereby creating new business opportunities. Spillover effects of “QQE with a negative interest rate” In addition to the transmission mechanism for QQE, which intends to push down long-term interest rates through massive purchases of JGBs, “QQE with a Negative Interest Rate” aims to lower the short end of the yield curve by applying a negative interest rate of minus 0.1 percent to a certain tier of current accounts at the Bank, thereby exerting further downward pressure on interest rates across the entire yield curve. “QQE with a Negative Interest Rate” already has brought tangible effects. The JGB yield curve has been declining BIS central bankers’ speeches further; yields on shorter-than-around 10-year JGBs have been negative (Chart 9). Reflecting the declines in JGB yields, financial institutions’ benchmark lending rate and housing loan interest rates also have been declining clearly. Looking ahead, I am confident that the effects of the declines in these interest rates will steadily spread to the real economy and prices. Some may have concern that financial institutions’ retail deposit interest rates also might turn negative. Admittedly, each financial institution makes its own decision on interest rates for their depositors. In the meantime, I would like to emphasize that negative retail deposit interest rates are hardly seen even in some European countries, where a negative interest rate policy has already been adopted with much lower rates compared to Japan – minus 0.75 percent in Switzerland, for example. Given those European experiences, I am sure that there are no grounds for retail deposit interest rates turning negative in Japan (Chart 12). Under a negative interest rate policy, there is no doubt that a wide range of interest rates will decline. However, this does not mean that deposit interest rates will turn negative owing to the monetary policy. Rather, this policy will bring about positive effects on borrowers through a declining cost of borrowing. In the wake of “QQE with a Negative Interest Rate,” housing loan interest rates, for example, have declined more significantly than deposit interest rates, which already had been extremely low. The decline in housing loan interest rates will spur housing investment and lead to economic expansion. The unquestionable fact is that, not just a negative interest rate policy, but any kind of monetary easing reduces interest rates. The changes in interest rates could have different effects across individual entities in the short term; however, looking at the economy as a whole, a decline in interest rates brought about by monetary easing would likely stimulate domestic demand and expand the economy. The bank’s determined commitment toward overcoming deflation and sustainable economic growth Japan has been mired in deflation for more than 15 years. For Japan to achieve sustainable economic growth in the future, the utmost priority is to overcome deflation at the earliest possible time. In order to indicate its unwavering will to attain this target, the Bank decided to introduce “QQE with a Negative Interest Rate.” Japan’s economy has steadily progressed toward overcoming deflation for the past three years after the introduction of QQE, but we are only halfway to achieving the price stability target. Meanwhile, the Bank has devised the framework of monetary policy in various ways so as to adjust to economic and financial developments. Related to this point, I will touch on the supplementary measures decided at the Monetary Policy Meeting in December 2015 to facilitate smooth implementation of QQE. Specifically, we took the measures of (1) expanding eligible collateral for the Bank’s provision of credit and (2) extending the average remaining maturity of JGB purchases. As for the expansion of eligible collateral, as the Bank continues its massive purchases of JGBs, the amount of eligible collateral of private financial institutions has been on the decrease. Expanding the range of eligible collateral will contribute to smooth asset purchases in the future. As for the extension of the average remaining maturity of JGB purchases, it aims at more flexible and smooth asset purchases while assuring liquidity in the JGB markets. As is indicated by these measures, not only “a negative interest rate” but additional monetary easing in terms of “quantity” and “quality” dimensions will naturally remain a policy option. I am convinced that this new policy framework will be a drastic measure to fulfill the Bank’s responsibility to overcome deflation. Raising growth potential of Japan’s economy and monetary policy In order to achieve sustainable economic growth, Japan’s economy inevitably should tackle the challenges to raising medium-term growth potential, on top of overcoming deflation. As I have noted, the potential growth rate in Japan is estimated to have declined to around 0.5 percent or lower. Taking a shrinking population as a given, an overall increase in labor productivity will be a key to raising the potential growth rate. In this sense, looking ahead, a BIS central bankers’ speeches structural reform needs to be promoted not only in an economic context but also in a social context, and should focus on developing a productivity-enhancing mechanism and environment. I strongly expect the government to continue committing to such a structural reform without loosening the reins. The Bank also can contribute to raising the growth potential because powerful monetary easing will dispel people’s deflationary mindset and provide a favorable environment for firms to make investment proactively and take actions to improve productivity. Furthermore, while the Bank has been purchasing exchange-traded funds (ETFs) at an annual pace of about 3 trillion yen under QQE, it additionally has established a new program for purchasing ETFs at an annual pace of about 300 billion yen, composed of stocks issued by firms proactively investing in physical and human capital. This program will be enacted next month. We already have received various encouraging opinions and comments from market participants in the run-up to the start-up of the new program on which we place our hope for enhancing growth potential. With such encouragement, we are working diligently on setting eligible criteria and the operational framework for purchases. As I have noted so far, I believe that monetary policy to overcome deflation and the structural reform to raise the potential growth rate must be pursued in tandem to bring Japan’s economy back on track toward sustained growth. Now that the Bank of Japan has taken monetary easing one step further by introducing “QQE with a Negative Interest Rate,” I expect the original third arrow of Abenomics, the growth strategy, to fly higher and faster. Moreover, I hope that households and firms will take bold steps towards economic prosperity, making full use of the current financial environment, which is more accommodative than ever. Conclusion In concluding, let me touch on the economy of Okinawa Prefecture. The economy has continued to expand on the whole. This is attributable to a high level of public investment and to an increase in tourism demand mainly supported by the weaker yen, an increase in the volume of international flights, and the easing of visa requirements. The buoyant construction and tourism sectors have been leading the expansion of corporate activity, which has steadily improved the employment and income situation. In terms of private consumption recently, more consumers are inclined to purchase high-end products. These developments point to a virtuous cycle from income to spending being in operation. This is evidenced in the Naha Branch’s September and December Tankan last year, in which business sentiment registered a new record high for two consecutive quarters. Let me focus on buoyant tourism demand. Led by a significant increase in tourists from China and other foreign regions, the number of tourists to Okinawa Prefecture in 2015 increased by 0.7 million from a year earlier and registered a new record high, marking 7.76 million in total. Even after the turn of the year, its increasing trend has continued, and the effects of the slowdown in the Chinese economy have not been observed thus far. As tourism demand increases, hotel occupancy rates and spending per tourist have been rising. I have heard that, due to an increase in tourists from overseas, many domestic tourists even had to give up visiting the prefecture during the high season last year. This uptrend in tourism demand is likely to continue on the back of the overseas travel boom seen in neighboring economies and an expansion of the runways at the Naha Airport. Okinawa Prefecture has been assigned as the National Strategic Special Zone for international tourism, leading to an increase in domestic fixed investment, such as construction of hotels. Increasing demand for duty free goods and souvenirs is reflected in favorable corporate profits in the retail and wholesale sectors. With regard to the outlook for the tourism industry, the major industry in Okinawa Prefecture, the prefecture aims at achieving 1 trillion yen in tourism revenue and 10 million tourist arrivals. With the aim of attaining these targets, it plans to develop the world’s highest quality BIS central bankers’ speeches resort area in an attempt to attract high-end inbound tourists. To realize this goal, it is vital to make the best use of its nature-rich environment as well as historical and cultural properties that have been inherited from the Ryukyu Kingdom dating back to the 15th century, while further upgrading the tourism industry. In terms of efforts to make use of its geographical characteristics, on the logistics front, the setting up of the Okinawa international logistics hub that aims to enable high-speed transportation to major Asian cities has been progressing steadily. The decision has been made to build a new international convention facility, with an expectation that this will encourage demand for MICE (i.e., meeting, incentive, convention, and exhibition/event) and promote business matching. The creation and improvement of infrastructures are likely to largely contribute to further development of Okinawa Prefecture in line with economic growth in neighboring economies. There is an old phrase in Okinawa Prefecture: bankoku shinryo (i.e., bridge between nations). I heard that the origin of this phrase goes back to the 15th century, when the Ryukyu Kingdom – which was in close proximity to Japan, China, Korea, and Southeast Asian regions – prospered as a transit trade country. Bankoku shinryo expresses that the Ryukyu Kingdom will serve as a bridge that connects the entire world through its trading vessels, making use of geographical advantages. This phrase fits today’s Okinawa Prefecture even better, since it provides bridges between countries all over the world in terms of not only a gateway of international logistics but also a tourism site. The Bank, centering on its Naha Branch, hopes to contribute as much as possible to further development that takes full advantage of the economic features of the prefecture. In closing, I wish all the best for the further development of the economy of Okinawa Prefecture. 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 Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the Yomiuri International Economic Society, Tokyo, 7 March 2016.
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Haruhiko Kuroda: Answers to Frequently Asked Questions on “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the Yomiuri International Economic Society, Tokyo, 7 March 2016. * * * Accompanying charts can be found at the end of the speech. Introduction It is a great honor to be invited to this meeting hosted by the Yomiuri International Economic Society today. At the end of January, the Bank of Japan decided to introduce “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate,” which added the new dimension of “a negative interest rate” to the existing policy of QQE. Specifically, the Bank applies a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank. This measure enables the Bank to now pursue additional monetary easing by providing the new option of “a negative interest rate” in addition to the “quantitative” and “qualitative” measures used so far. Some market participants had voiced doubts that a further expansion of QQE would be possible, arguing that QQE had reached its limit, but I think such views have been completely dispelled. “QQE with a Negative Interest Rate” will have an impact on financial institutions, financial markets, and, more broadly, people’s lives in general. Moreover, as the term itself, “negative interest rate,” sounds somewhat shocking, the measure has been the focus of attention in the newspapers and on TV day after day. Given the wide impact – on financial markets, the management of financial institutions, and people’s everyday lives – it will have, the measure has given rise to a variety of questions and concerns. Today, I would like to explain the Bank’s thinking with regard to this policy and respond to frequently asked questions. I. Benefits for households and firms Are there benefits for households and firms? To start with, I would like to explain the benefits of “QQE with a Negative Interest Rate” for households and firms. The media has been reporting that while interest rates on housing loans have declined, deposit interest rates have also declined, asking whether the net impact of the policy for households is negative or positive. The answer is very clear. Individuals and firms as a whole will definitely benefit from this policy (Chart 1). Deposit interest rates are declining, but the extent of the decline is minimal, since rates already were close to 0 percent. For example, interest rates on deposits in ordinary accounts (the Japanese equivalent to checking accounts for retail customers) at mega-banks decreased from twohundredths of a percent to a thousandth of a percent. In other words, the interest earned on depositing 1 million yen for a year declines by 190 yen – from 200 yen to 10 yen. On the other hand, the extent of the decline in lending rates is much larger. Lending rates for 10-year fixed-rate housing loans provided by mega-banks have declined by 0.25 percentage point, and the Tokyo Inter-Bank Offered Rate (TIBOR), a benchmark rate for lending to firms, has also fallen, with the 3-month TIBOR, for example, declining by slightly less than 0.1 percentage point. While it is true that the interest earned from depositing 1 million yen will be only 10 yen, we need to consider since when and why deposit interest rates have become so low. The first BIS central bankers’ speeches time interest rates on deposits in ordinary accounts fell to units of hundredths of a percent was in 1999, when Japan was falling into deflation. Under deflation, prices decline across the board and nominal interest rates fall accordingly. This situation persisted in Japan for a prolonged period. In order to increase deposit interest rates, we have to revitalize the economy and overcome deflation. Another concern is that the Bank’s negative interest rate policy will have a negative impact on financial institutions’ business, making them more reluctant to lend or leading them to demand higher lending rates. It is certainly the case that in the prolonged environment of extremely low interest rates, financial institutions’ net interest income from their core business of taking deposits and making loans has been on a declining trend. Under these circumstances there is a strong concern that the introduction of a negative interest rate will make the situation even worse. From a theoretical perspective, financial institutions may not tolerate the costs imposed by a negative interest rate and instead pass on these costs through an increase in lending rates. In Europe, where negative interest rate policies were adopted before Japan, it has been debated whether such policies are having a negative effect on financial institutions’ business and the stability of financial system, and whether such negative effects might put a limit on negative interest rate policies. However, the situation in Japan is quite different from that in Europe. First, Japan’s financial institutions have a sufficient capital buffer and remain very sound, since they were not severely affected by the subprime mortgage problems in the United States and the global financial crisis. Second, even though their net interest income has fallen, the profits of financial institutions in Japan have remained high due mainly to lower credit costs reflecting Japan’s economic recovery. In fact, in fiscal 2014, major and regional banks’ net income reached about 3.3 trillion yen – close to a record high. Therefore, it is entirely inconceivable that in Japan the functioning of financial intermediation will weaken due to strains by negative interest rates on financial institutions’ business. In fact, given the fierce competition in Japan’s lending market, banks are unlikely to increase lending rates to offset the rise in costs through the negative interest rate policy. Instead, financial institutions should consider why they cannot make sufficient profit from their core business – taking deposits and making loans. The reason is deflation. Under deflation, the difference between deposit rates and short-term money market rates (deposit spreads) as well as the gap between long- and short-term interest rates have been shrinking. This means that the only way to drastically improve financial institutions’ profit is to revitalize the economy and overcome deflation. “QQE with a Negative Interest Rate” aims at overcoming deflation completely and achieving the price stability target of 2 percent. Let me explain how the policy seeks to achieve this. II. Background to the introduction of “QQE with a Negative Interest Rate” Why was the policy implemented? To begin, I would like to touch on the background to the introduction of the negative interest rate policy. Since the turn of the year, global financial markets have been volatile against the backdrop of the further decline in crude oil prices and uncertainty such as over future developments in emerging and commodity-exporting economies, particularly the Chinese economy (Chart 2). Crude oil prices have dropped to around 30 U.S. dollars. The drop is positive for Japan, which is an importer of crude oil, but has a negative impact on commodity-exporting economies including Russia, Brazil, and countries in the Middle East, creating uncertainty for the global economy. Furthermore, Chinese stock prices have declined considerably, resuming the slide that started last summer. However, although the Chinese economy has embarked on a process of deceleration, it has not deteriorated suddenly. The reasons for the slowdown in the Chinese economy appear to be the adjustment of excess investment by manufacturers and restraint in public investment by municipal governments under the tightening of discipline. As BIS central bankers’ speeches a result, fixed asset investment decelerated but has now leveled off as municipal governments have resumed with public construction orders from the second half of 2015. In contrast, private consumption and automobile sales have remained firm, reflecting progress in the transformation of China’s economic structure from one centered on manufacturing to one centered on nonmanufacturing. Instead of signaling a sudden deterioration in China’s fundamentals, the decline in stock prices can be seen as the correction of a bubble as well as a reaction to movements in the exchange rate of the yuan. The yuan is being sold on speculation of a devaluation, resulting in a decline in China’s foreign currency reserves. This has led to instability in markets. Consequently, stock prices have declined globally and markets have become more pessimistic, with investors switching to a risk-off mode. In the foreign exchange markets, demand for the yen, which is regarded as a safe haven currency, has increased, leading to an appreciation of the yen. Although markets have become more volatile, Japan’s economic fundamentals remain sound (Chart 3). Japan’s economy has improved significantly from three years ago. Corporate profits are at historically high levels and the unemployment rate is 3.2 percent, which essentially represents full employment. The year-on-year rate of change in the consumer price index excluding fresh food and energy has increased from minus 0.8 percent in March 2013 to above 1 percent most recently. Japan’s economy is likely to grow moderately and inflation is likely to increase toward 2 percent. This baseline scenario remains unaffected by the recent volatility. Nevertheless, in light of their record profits, firms’ investment in physical and human capital has remained rather subdued. Under these circumstances, the volatility in global markets entails the risk that it may lead to a deterioration in firms’ sentiment and a setback in the conversion of people’s deflationary mindset, which had been underway. In fact, price perceptions by firms have recently deteriorated. Thus, the reason why the Bank introduced “QQE with a Negative Interest Rate” is that it judged it necessary in order to preempt the manifestation of these risks and to maintain the momentum toward achieving the price stability target of 2 percent. III. Effects of “QQE with a Negative Interest Rate” What effects will the negative interest rate policy have? Next, I would like to explain the effects the policy will have. The key aim of this policy is to drive down real interest rates, which is the main transmission channel of QQE. The fact that over the past three years Japan’s economy has significantly improved and we are no longer in deflationary situation is proof that a fall in real interest rates has a positive impact on the economy and inflation. Let me explain the transmission mechanisms of QQE in more detail. First, QQE raises inflation expectations through the Bank’s strong and clear commitment to achieving the price stability target of 2 percent at the earliest possible time and through large-scale monetary easing to underpin the commitment. Second, QQE puts strong downward pressure on nominal interest rates across the entire yield curve through massive purchases of Japanese government bonds (JGBs). These two channels result in a decline in real interest rates. The decline in real interest rates boosts business fixed investment and housing investment through a decline in interest rates on business and housing loans. In financial markets, QQE underpins stock prices and helps to weaken the yen, which in turn pushes up corporate profits, thereby improving employment and wages. The boost in economic activity improves the output gap – that is, the balance of aggregate supply and demand – which together with rising inflation expectations, lifts prices. Developments since the introduction of QQE exactly conform to the anticipated transmission mechanisms. “QQE with a Negative Interest Rate” represent a framework in which these transmission channels are further enhanced. The negative interest rate lowers short-term interest rates, BIS central bankers’ speeches while the massive purchases of long-term JGBs lower long-term yields. These two elements together exert strong downward pressure on interest rates across the entire yield curve. The important aspect here is that the effect on the yield curve is stronger when the two elements are implemented in tandem than when carried out independently. The introduction of the negative interest rate on current accounts that financial institutions hold at the Bank reduces their incentive to sell JGBs in exchange for current accounts at the Bank. The reason is that JGBs with a positive interest rate become more valuable for financial institutions that attach great importance to interest income. As a result, purchases of long-term JGBs by the Bank will have stronger effects. Under normal circumstances, when short-term yields are lowered, long-term interest rates do not decline to the same extent. However, with the Bank’s introduction of the negative interest rate, a large part of the yield curve has declined by about 0.2 percentage points, which is close to the decline in short-term yields, or more (Chart 4). This means that the extent of the decline in interest rates brought about by the negative interest rate policy is quite substantial. Going forward, the Bank will assess how the effects of the decline in interest rates permeate and spread through the real economy. Doubt over firms’ willingness to invest even with a decline in interest rates Some argue that a decline in real interest rates will not produce the intended effects if firms are unwilling to borrow and invest. This is possible in the short term, while people are pessimistic. Over a longer period of time, however, the decline in real interest rates will surely boost economic activity and inflation through the impact on financial institutions’ behavior and financial markets. In fact, bank lending, which had been declining, has increased over the past three years at an annual rate of about 2 percent (Chart 5). Stock prices have risen as well, and the excessive appreciation of the yen has been corrected. Against the backdrop of such improvement in capital markets, economic growth and the underlying trend in inflation have increased. A decline in real interest rates will have no effect only when the expected growth rate, or natural rate of interest, is at such a low level that the central bank cannot produce a real interest rate that is lower than that. While this extreme case cannot be ruled out as a theoretical possibility, I am convinced it does not apply to Japan. Let me point out a couple of reasons. First, in the past three years, the decline in real interest rates has, as I just mentioned, produced actual effects. And second, looking at Japan’s economy and Japanese firms, I do not think the situation is as dire as that, given Japan’s economic strengths such as its technological prowess and the skill-level of the labor force. It is implausible that the natural interest rate is so low that monetary policy would be ineffective. Does volatility in global financial markets render monetary policy ineffective? The volatility recently observed in global financial markets certainly makes it more difficult to clearly see the effects of the negative interest rate policy. Immediately after the introduction of the negative interest rate policy, stock prices rose, with the Nikkei index adding 800 points in two days, while the yen fell to 121 yen against the U.S. dollar. Since then, however, the global decline in stock prices and the appreciation of the yen have continued, triggered by pessimistic views on the U.S. economy and concern about the stability of the financial system in Europe. These developments have led to newspaper headlines claiming that the effects of the negative interest rate policy have been cancelled out. This is not an accurate assessment. Since the introduction of “QQE with a Negative Interest Rate,” interest rates across the board have clearly declined. This is exactly what we intended. The decline in yen interest rates and the fact that further monetary easing is possible – all else being equal – have a positive impact on asset prices. In other words, the policy works in the direction of raising stock prices and lowering the value of the yen. At the moment, these effects are being outweighed by the excessive risk aversion among investors around the globe. However, given that the fundamentals of Japan’s economy and Japanese BIS central bankers’ speeches firms remain strong and that the negative interest rate policy will have powerful effect, financial markets will turn positive as investor confidence returns. IV. Adverse effects on financial institutions’ earnings and financial markets Next, I would like to discuss possible costs associated with the negative interest rate policy. Any policy comes with costs. In other words, there is no such thing as a free lunch. In deciding on policy action, it is essential to weigh its expected costs against the need for such policy action and to try to reduce costs wherever possible. How to mitigate the adverse effect on financial institutions’ earnings Regarding the negative interest rate policy, the potential adverse effects on financial institutions’ earnings and their functioning as financial intermediaries are of utmost importance. For example, financial institutions might pass on the costs resulting from the negative interest rate policy to borrowers by raising lending rates for firms and homeowners. In order to avoid such unintended consequences, the Bank has adopted a multi-tier system in which current accounts held by financial institutions at the Bank are divided into three separate tiers. Multi-tier systems have been in place for some time in European countries. Under the multi-tier system in Japan, a zero interest rate and a positive interest rate apply to financial institutions’ current account balances at the Bank of Japan up to certain thresholds (Chart 6). Let me explain how the Bank’s three-tier system works. First, the same interest rate as before – a positive rate of 0.1 percent – is applied to financial institutions’ current account balances already held at the time of the introduction of the negative interest rate policy. Specifically, such balances are calculated as the average amount outstanding on financial institutions’ current account during 2015 – which are referred to as financial institutions’ “Basic Balances” – minus required reserves. The total of “Basic Balances” minus required reserves for all financial institutions that have a current account at the Bank is about 210 trillion yen or about 80 percent of the aggregate amount outstanding of financial institutions’ current accounts. Second, a zero interest rate continues to be applied to the required reserves held by financial institutions subject to the Reserve Requirement System; a zero interest rate is also applied to the amount of current account balances that corresponds to the outstanding amount of borrowing from the Bank of Japan through the special facilities (the Stimulating Bank Lending Facility, the Growth-Supporting Funding Facility, and the Funds-Supplying Operation to Support Financial Institutions in Disaster Areas affected by the Great East Japan Earthquake). The sum of these items is called financial institutions’ “Macro Add-on Balance.” The sum of such “Macro Add-on Balances” of all financial institutions at the start of the negative interest rate policy amounted to about 40 trillion yen. And third, financial institutions’ remaining current account balance is called the “Policy-Rate Balance,” to which the negative interest rate is applied. At the start of the negative interest rate policy, the aggregate amount of “Policy-Rate Balances” for all financial institutions that have a current account at the Bank was about 10 trillion yen on a net basis. Since the Bank will continue to purchase JGBs at an annual rate of about 80 trillion yen and the proceeds of such purchases will be paid into financial institutions’ current account at the Bank, financial institutions’ current account balances will increase. Therefore, if the thresholds remain unchanged, the balances to which the negative interest rate is applied will increase over time. In light of this, the Bank will raise the amount of current account balances to which a zero interest rate is applied (“Macro Add-on Balances”) at certain intervals – for example, once every three months – in an incremental manner in order to keep the amount of current account balances to which a negative interest rate is applied (“Policy-Rate Balances”) more or less unchanged. By doing so, the amount of current account balances on which financial institutions incur negative interest will be kept to the minimum necessary to achieve the objectives of the negative interest rate policy. BIS central bankers’ speeches Given that a negative interest rate applies to only part of financial institutions’ current account balances, you may wonder whether the negative interest rate policy will fully exert its intended effects. We believe it will. Let me give you an example. If one bank sells JGBs to another, the proceeds will be transferred into the selling banks’ current account with the Bank of Japan. This transaction will lead to an increase in the selling banks’ current account balance, raising the amount on which the negative interest rate is imposed. This means that prices in financial markets – such as interest rates, stock prices, and exchange rates – will be determined under the premise that a negative interest rate is applied to a marginal increase in financial institutions’ current account balances. As the proverb says, seeing is believing. All you have to do is look at changes in the yield curve. Interest rates have indeed clearly dropped across all maturities since the introduction of the negative interest rate policy (Chart 4). Japan’s three-tier system is designed to minimize the direct impact on financial institutions’ earnings while maximizing the positive effects of the negative interest rate policy. The system works as intended. Despite the carefully calibrated design of the multi-tier system, the decline in market interest rates will inevitably have adverse effects on financial institutions’ profits. For example, it is virtually impossible for banks to cut interest rates on their customers’ deposits into negative territory, because they want to maintain their long-term relationships with customers. In addition, if a negative interest rate is imposed on customers’ deposit, this would prompt their customers to withdraw cash from bank accounts and hoard cash in vaults. In fact, financial institutions’ retail deposit interest rates have never turned negative even in European countries where the central bank has cut its deposit rate to as low as minus 1 percent. On the other hand, banks’ interest income will decrease reflecting the decline in JGB yields. Moreover, lending rates on housing and corporate loans will decline to some extent. As a result, banks’ earnings will be negatively affected. However, it should be noted that monetary easing has been pursued with a view to exerting positive effects on the economic activities of firms and households – both of which are financial institutions’ customers. These positive effects on the economy and the negative impact on financial institutions’ profits are two sides of the same coin. As mentioned before, the decline in the yield curve itself is the starting point of the transmission of policy effects. Reducing the impact of this is not something that can be achieved by changing the design of the policy. It is more productive to consider why this adverse interest rate environment, which is responsible for the decline in financial institutions’ profits from their core business – taking deposits and making loans – has been so protracted. As I mentioned earlier, the improvements in Japan’s economic activity and prices have had a positive impact on financial institutions’ business, for example through the reduction in credit costs. Moreover, bank lending has been increasing, albeit moderately. However, as financial institutions’ profit margin has not improved, financial institutions’ profits remain under strong downward pressure. The fundamental cause is the protracted deflation in Japan. In an environment of deflation and low interest rates in which short-term interest rates are close to zero, profits from deposit spreads disappear, while those from maturity transformation shrink because of the narrower differential between long- and short-term interest rates due to the flattening of the yield curve. In addition, since Japanese firms have restrained fixed investment and have instead hoarded cash and deposits, banks’ loan-to-deposit ratios have substantially declined. Further, reflecting severe competition among banks, lending margins continue to narrow. In order for Japan’s economy to escape from this trap, the economy needs to overcome deflation completely. If deflation was to return to Japan and the low interest-rate environment to continue, this would cause more serious problems for banks’ profitability. Once deflation is overcome completely, firms will become more proactive in making investments, which will lead to an increase in loan demand. Under these circumstances, as short-term interest rates become positive, banks will be able to profit again from deposit spreads. As the yield curve BIS central bankers’ speeches become steeper, interest-rate margins will improve due to a larger interest-rate differential between long- and short-term rates. Therefore, overcoming deflation is essential not only for the recovery of Japan’s economy but also for the full-fledged recovery of financial institutions’ profitability through an improvement in their profit margins. How to mitigate any adverse effects on financial markets Another important point that we had to take into consideration when introducing negative interest rates is the potential adverse effect on the functioning of financial markets. Another purpose of the three-tier system therefore is to ensure that transactions continue to take place in the short-term money market. Under the three-tier system, some financial institutions will hold current account balances to which the negative interest rate is applied, while other financial institutions will have unused allowances in tiers to which a zero or positive interest rate is applied. I mentioned earlier that the aggregate amount of policy-rate balances to which the negative interest rate is applied was initially about 10 trillion yen on a net basis for all financial institutions that hold a current account at the Bank. In fact, looking at the January 2016 reserve maintenance period, if we sum up the amounts outstanding of policy-rate balances of financial institutions that have a positive policy-rate balance, the sum was about 20 trillion yen. However, given that some financial institutions have unused allowances in tiers to which a zero or positive interest rate is applied, these financial institutions can raise funds from financial institutions that have a positive policy-rate balance at a rate that is still negative but higher (i.e., less negative) than minus 0.1 percent. These transactions will be profitable for both sides. If these arbitrage transactions take place in full, the net amount of negative-rate balances will be about 10 trillion yen. In other words, this suggests that there are incentives for financial institutions to engage in transactions in the interbank money market. In Switzerland, money-market transactions are taking place at negative rates. In these cases, private banks, which have large negative-rate balances, are lenders, and major banks, which have unused zero interest rate tier allowances, are borrowers. Going forward, we expect that these arbitrage transactions in the money market will gradually increase in Japan as well. Looking at developments in the money market since February 16, when the negative interest rate started to be applied, although there were no transactions with a negative uncollateralized overnight call rate on that day, there have been uncollateralized overnight call transactions with a negative interest rate since February 17, and the weighted average rate has been negative. Meanwhile, the volume of transactions in call markets decreased from the previous reserve maintenance period. Nevertheless, I believe that as financial institutions proceed with updating their computer systems and operations, and as markets become more accustomed to negative interest rates, transactions in call markets will increase. In fact, as mentioned, in Switzerland and Denmark, which adopted negative interest rates earlier, transactions between financial institutions with negative rate balances – which have become lenders – and those with unused zero or positive interest rate tier allowances – which have become borrowers – have taken place at negative interest rates. The volume of money market transactions in the two countries is quite substantial. The Bank will continue to carefully monitor developments in the money market, including how financial institutions adjust their computer systems and operations to cope with negative interest rate transactions. Concluding remarks We cannot deny that “QQE with a Negative Interest Rate” has an adverse effect on financial institutions’ earnings. That said, let me reiterate that the aim of the policy is to benefit households and firms and ultimately to fully overcome deflation. The policy seeks to further reduce real interest rates and strengthen the effects of QQE, which has proven to be effective over the past three years. By making full use of “QQE with a Negative Interest Rate,” the Bank will achieve the price stability target of 2 percent at the earliest possible time. BIS central bankers’ speeches Deflation will not return to Japan. Price stability with 2 percent inflation will definitely be achieved. Thank you. 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, Fukuoka, 18 February 2016.
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Koji Ishida: Japan’s economy, price developments and monetary policy Speech by Mr Koji Ishida, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Fukuoka, 18 February 2016. * I. * * Developments in economic activity and prices At the Monetary Policy Meeting held on January 28 and 29, 2016, the Bank of Japan produced the Outlook for Economic Activity and Prices (Outlook Report) and published its projections for Japan’s economic activity and prices through fiscal 2017. I would like to explain the Bank’s view on economic activity and prices by presenting the main content of the Outlook Report. A. Overseas economies Overseas economies – mainly advanced economies – have continued to grow at a moderate pace, despite the slowdown in emerging economies. Production and trade in the manufacturing sector had been weak on a global basis in the first half of 2015, but have generally picked up somewhat, albeit with some weakness still seen in emerging economies. In the outlook, the pace of growth in overseas economies is expected to accelerate moderately as the positive effects of the recovery in advanced economies gradually spread to emerging economies. A similar projection is presented in the World Economic Outlook (WEO) Update released in January by the International Monetary Fund (IMF). However, given the decline in expected growth in emerging and commodity-exporting economies and the protracted low commodity prices, the capital stock that accumulated amid the higher expected growth rates and higher commodity prices in the past is likely to continue to be excessive. Thus, firms’ restrained stance toward fixed investment expenditure is likely to be seen globally for some time. Reflecting such circumstances, business sentiment within major economies’ manufacturing sectors has generally deteriorated. Looking at developments by major region, the U.S. economy has continued to steadily recover, reflecting the firmness in household spending. As for the outlook, the economy is expected to continue its firm recovery centered on the private sector, underpinned by accommodative financial conditions. The European economy is projected to continue to see moderate recovery, mainly on the back of improvement in the employment and income situation, as well as accommodative financial conditions. The Chinese economy has continued to be in a state of deceleration due to downward pressure from an overhang of production capacities and inventory adjustments in the manufacturing sector. However, the economy is likely to broadly follow a stable growth path – albeit at a somewhat slower pace, mainly in the manufacturing sector – as authorities proactively carry out policy measures to support economic activity. Overall, emerging economies other than the Chinese economy and commodity-exporting economies also remain in a situation of deceleration, as the effects of the slowdown in the Chinese economy have spread to them and as the decline in commodity prices has been protracted. These economies as a whole are expected to gradually see a rise in their growth rates, due mainly to the effects of the recovery in advanced economies and of economic stimulus measures. BIS central bankers’ speeches B. Japan’s economy and price developments 1. Current situation Now I would like to discuss developments in economic activity and prices in Japan. Japan’s economy has continued to recover moderately, although exports and production have been affected by the slowdown in emerging economies. On the domestic demand side, business fixed investment has been on a moderate increasing trend as corporate profits have continued to improve markedly. According to the December 2015 Tankan (Short-Term Economic Survey of Enterprises in Japan), firms have generally continued to plan to increase fixed investment firmly despite the slowdown in emerging economies. Against the background of steady improvement in the employment and income situation, private consumption has been resilient and housing investment has been picking up. Industrial production has continued to be more or less flat against the background of the prolonged inventory adjustments of small cars with engine sizes of 660cc or less and some capital goods. Exports have been picking up, reflecting the developments in overseas economies that I mentioned earlier, although sluggishness remains in some areas. With regard to prices, the year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food has been about 0 percent due to a substantial fall in energy prices, reflecting the decline in crude oil prices. 2. Outlook Japan’s economy is likely to be on a moderate expanding trend. The improvement in corporate profits is expected to continue as the favorable external environment, owing to the low crude oil prices and the low yen rate, is likely to continue to support the income-generating mechanism, and as overseas economies are expected to see a moderate rise in their growth rates. Employee income is also projected to continue to increase moderately on the back of an improvement in corporate profits and the tightening of labor market conditions. Domestic demand is likely to follow an uptrend against the backdrop of income generated by this virtuous mechanism and of the monetary easing effects. Thus, Japan’s economy is likely to continue growing at a pace above its potential through fiscal 2016. In fiscal 2017, although demand related to hosting the Olympic Games will underpin the economy, the growth rate is expected to slow to around a level somewhat below the potential, mainly because of a fall in household spending due to the consumption tax hike. Looking at the medians of the Policy Board members’ forecasts in the January 2016 Outlook Report, the real GDP growth rate is projected to be 1.1 percent for fiscal 2015, 1.5 percent for fiscal 2016, and 0.3 percent for fiscal 2017. Looking at the outlook in detail by major component, business fixed investment is projected to continue to see a moderate increase on the back of a marked improvement in corporate profits and accommodative financial conditions. Private consumption is projected to generally remain resilient, reflecting the developments in real disposable income. Housing investment is expected to continue picking up, underpinned by the continued steady improvement in the employment and income situation and the low levels of housing loan rates. Industrial production is likely to start picking up as the inventory adjustments progress, and thereafter is likely to follow a moderate increasing trend, supported by an increase in final demand at home and abroad. Exports, which have been picking up, are expected to head toward a moderate increase for the time being since automobile-related exports are likely to continue increasing on the back of firm sales developments in the United States, Europe, and China. However, in the longer run, exports are expected to tend to mark a fall rather than a clear increase, given the decline in expected growth in emerging and commodity-exporting economies, protracted low commodity prices, and the resulting excess in production capacity related to materials and energy. On the price front, the year-on-year rate of increase in the CPI (all items less fresh food) is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices. Nevertheless, as the underlying trend in prices steadily rises and the effects of the decline in BIS central bankers’ speeches crude oil prices dissipate, the rate is likely to accelerate toward 2 percent – the price stability target. Looking at the medians of the Policy Board members’ forecasts in the January 2016 Outlook Report, 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 projected to be 0.1 percent for fiscal 2015, 0.8 percent for fiscal 2016, and 1.8 percent for fiscal 2017. Upside and downside risks to the Bank’s baseline scenario regarding economic activity are developments in overseas economies, (2) the effects of the consumption tax hike, (3) firms’ and households’ medium- to long-term growth expectations, and (4) fiscal sustainability in the medium to long term. The risks to the Bank’s baseline scenario regarding prices are developments in firms’ and households’ medium- to long-term inflation expectations, developments in the output gap, (3) responsiveness of inflation to the output gap, and developments in import prices. II. The bank’s monetary policy Next, I would like to talk about the Bank’s monetary policy. The Bank decided to introduce “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” at the Monetary Policy Meeting held on January 28 and 29, 2016. This policy framework is designed to enable the Bank to further pursue monetary easing by making full use of possible measures in terms of three dimensions – quantity, quality, and an interest rate – in which a negative interest rate is added to the existing options of QQE conducted to date. Specifically, on the interest rate side, the Bank will partially apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank. This will exert further downward pressure on interest rates across the entire yield curve, in combination with the continuation of large-scale purchases of Japanese government bonds (JGBs) conducted in terms of quantity and quality. Under the new scheme introduced in January, the Bank adopted a multiple-tier system in which it applies a negative interest rate of minus 0.1 percent to a marginal increase in current accounts that financial institutions hold at the Bank, while continuing to apply a positive interest rate of 0.1 percent to the average outstanding current account balance that each financial institution held during the past year. The Bank devised the scheme by taking into account the following unique circumstances of Japan: an extremely large outstanding balance of current accounts at the Bank and the necessity for the Bank to proceed smoothly with large-scale purchases of assets even under the negative interest rate scheme. As described in the January 2016 Outlook Report, Japan’s economy has continued to recover moderately and the underlying trend in prices has been rising steadily. Recently, however, global financial markets have been volatile against the backdrop of the further decline in crude oil prices and uncertainty such as over future developments in emerging and commodityexporting economies, particularly the Chinese economy. In this situation, the Bank judged that there was an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in prices might be negatively affected. To preempt the manifestation of this risk and to maintain momentum toward achieving the price stability target of 2 percent, the Bank decided to introduce “QQE with a Negative Interest Rate.” I have explained the outline of the Bank’s assessment presented in the January 2016 Outlook Report and the new monetary policy scheme introduced in January. Next, I would like to touch upon several features of economic and price developments. BIS central bankers’ speeches III. Several features of economic and price developments As I mentioned earlier, global stock markets and foreign exchange markets have been in turmoil recently, especially since the turn of the year, and such volatile movements have started to negatively affect financial markets in Japan. Investors have become increasingly risk averse due to several factors that have been reinforcing each other: (1) the shift toward monetary tightening in the United States, (2) the economic slowdown in China as well as the turmoil in Chinese stocks and the yuan rate, (3) a sharp decline in crude oil prices, and (4) the sluggishness in emerging and commodity-exporting economies. I believe that the recent volatile movements in global financial markets are less likely to induce instability in the global financial system, unlike in the past. Nevertheless, attention should be paid to the possibility that, if volatile movements are protracted, this may affect confidence among individuals and firms and ultimately economic activity. A continuation of monetary tightening in the United States would indicate that economic conditions there are deemed to be favorable. If the momentum of economic activity is judged as weak, the rate rise will be postponed. As for China, there is room for adequate fiscal and monetary measures. I do not expect that these developments will intensify negative impacts on emerging and commodity-exporting economies or on Japan’s economy. In contrast, the substantial decline in crude oil prices has been exerting an extremely large impact on recent developments in the global economy and financial conditions worldwide, regardless of whether such decline was the cause or the consequence of these developments. A. Decline in crude oil prices The decline in crude oil prices has had a negative influence on a wide range of corporate activities. For example, firms have substantially reduced their fixed investment related to crude oil production, which accounts for a large share of global business fixed investment. Firms that provide oil-related facilities and services have been particularly affected. Furthermore, oilproducing countries, which had been in excess of funds, are now in shortage of funds, and this has caused a reversal in the flow of funds, creating considerable stress not only on the economic activity of these countries but also on global stock markets and foreign exchange markets. As I have described, the substantial decline in crude oil prices has had large negative impacts; however, when viewed in the somewhat longer term, these will be net positive effects on the global economy, because income will be transferred from economies with a low propensity to consume to those with a high propensity to consume, and from capital-intensive industries to more labor-intensive industries. I consider that the overall positive effects on Japan – for which the self-sufficiency rate of crude oil is extremely low – are particularly large, although the magnitude of the effects, both positive and negative, differs by firm and industry. Hikes in crude oil prices have often caused global economic recessions. However, there have never been recessions stemming from a decline in these prices. The immediate negative effects of the decline in these prices – such as those on financial markets – have been more pronounced than the positive effects, which will take time to become apparent, but it is my view that we do not need to be overly concerned about the present situation. B. Prices A substantial decline in crude oil prices leads to a fall in energy prices, and consequently pushes down the level of overall prices. Some say that developments in individual prices do not affect the level of overall prices, because such developments cause prices of other items to move inversely to these individual prices. For example, even if energy prices decline, real income will increase accordingly, and thus prices other than energy prices will rise through an increase in spending. While this may be true in the long run, such an outcome is unlikely to occur within about two years, the time horizon that central banks typically consider as appropriate in conducting monetary policy. As noted in the January 2016 Outlook Report, the BIS central bankers’ speeches projected timing of the year-on-year rate of increase in the CPI (all items less fresh food) reaching the price stability target of 2 percent has been delayed as the overall inflation rate will be pushed down due to the substantial decline in crude oil prices. Nevertheless, a decline in crude oil prices by nature is a considerable positive factor for Japan’s economy, and its effects on overall prices eventually will dissipate. Thus, I consider that the delay itself is acceptable. Also, in terms of monetary policy, I believe that it is appropriate to exclude the effects of energy prices as temporary factors and grasp the underlying trend in prices. The year-on-year rate of increase in the CPI (all items less fresh food) for December 2015 was 0.1 percent but that for all items less fresh food and energy – which indicates the underlying trend in prices – was 1.3 percent. The Bank projects that, in a situation where Japan’s economy is likely to continue growing at a pace above its potential, the year-on-year rate of increase in the CPI (all items less fresh food) will likely rise closer to 2 percent through fiscal 2017 when the negative contribution of energy items dissipates. Inflation expectations are referred to as a factor that largely affects the price outlook, but it is difficult to actually assess them. It can be said that the inflation expectations of both firms and consumers have been rising from a somewhat longer-term perspective – as suggested by the recent price-setting behavior of firms and the subsequent purchasing behavior of consumers, or by rises in base salaries for two consecutive years. In addition, I consider that two indicators – the inflation swap rates and break-even inflation (BEI) rates for JGBs, both of which are frequently used to assess inflation expectations and are compiled based on financial market data – have not sufficiently reflected the actual inflation expectations in Japan, unlike in the cases of the United States or Europe, given the size and liquidity of Japanese financial markets. Therefore, these indicators should be regarded only as a reference. Let me note here that prices are normally determined when consumers accept the prices set by firms. Since spring 2015, manufacturers have been raising the wholesale prices of their standard products, due mainly to the rise in costs, and this has led to a rise in sales prices. In addition, prices of general services have been rising due to labor shortages. These factors have been pushing up the underlying trend in prices. It is the second year of such price increases, which raises difficult issues including the following: (1) whether manufacturers can raise the prices of their standard products again; (2) whether manufacturers will implement a de facto price increase by developing new products with value added or those similar to the previous ones; (3) whether manufacturers will raise the prices of goods for which they have postponed increases so far; (4) whether the cost that has been absorbed by the distribution sector will be passed on to sales prices; and (5) whether the services sector can continue to pass the rise in labor costs on to final prices. That being said, many firms are experiencing less room for further cost reductions. In these circumstances, they need to increase sales in order to maintain or raise the level of profits in the face of upward pressure on labor costs. In the current situation of it being difficult to expect an increase in sales volumes as the aging population and declining birthrate have progressed, the only solution is to raise the unit prices of goods and services. As firms start to increase prices, the focus is on whether consumers will accept such increases. In this regard, I consider that the key to a continued steady rise in the underlying trend in prices is whether consumers will be optimistic about future developments in income and wages. C. Wages Recently, labor market conditions have been extremely tight, and an increasing number of firms are experiencing labor shortages. In textbook theory, wages are determined by the supply-demand balance in the labor market, but statistics show that the pace of increase in wages as a whole has remained only moderate. This is because regular employees’ wages, which account for a major part of total employee income, have been rising only moderately, BIS central bankers’ speeches although the hourly pay of non-regular employees has been rising markedly, reflecting tight labor market conditions. One major cause behind this situation is the framework for regular employees in Japan, although it is gradually changing. It is unique to Japan because of the country’s systems and practices. Let me elaborate on this point. In Japan, where it is difficult to discharge regular employees, excesses and shortages of regular employees are balanced by the number of new graduates to be hired. New graduates go through in-house training so that they become well suited to their individual firms. The salaries and other benefits available to regular employees throughout their careers are significant as long as they are regular employees. These factors lower their labor mobility to move from one firm to another. If regular employees do not change jobs despite some dissatisfaction with their salary levels, employers will have less incentive to raise the levels of salaries to secure suitably qualified employees. Thus, employers take the initiative in setting regular employees’ wages. Even if corporate profits are increasing, employers tend to be reluctant to increase wages, particularly base salaries, given the uncertainty regarding the outlook for profits. They also may be reluctant to allocate profits obtained through overseas operations to an increase in wages in Japan. As has been evident so far, regular employees’ wages do not rise smoothly because each firm negotiates wages with its own union amid the low mobility of regular employees. Although it has been pointed out that an increase in labor productivity is necessary for wages to rise, it is difficult to expect proper operation of the mechanism in which productivity in the economy as a whole increases. This is because, with low labor mobility, wages do not work as the intermediary function to smoothly correct the differences in productivity among firms. In order to increase productivity and the economic growth rate in Japan, a change in the employment framework is necessary so that labor is transferred smoothly – through an increase in wages – from firms with low productivity and profits to those with high productivity and profits. This will take time, but if the economy continues to grow at a pace exceeding its potential, firms may face more acute labor shortages and an immediate issue of securing suitably qualified employees. In addition, the decline in energy prices will underpin corporate profits, including those of small firms. Reflecting such a situation, the wage level can be expected to rise gradually among many firms. The Bank, for its part, will maintain the accommodative financial conditions through the conduct of monetary policy so that the virtuous cycle from corporate profits to wages, and in turn to consumption, operates properly. Given that the effects of tighter labor market conditions are not spreading to wages smoothly, some may voice various opinions about the government’s recent action to encourage wage increases, but I understand that such action is necessary. BIS central bankers’ speeches
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Forum on Payment and Settlement Systems, Tokyo, 17 March 2016.
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Haruhiko Kuroda: Innovations in payments and FinTech – the central bank’s perspective Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Forum on Payment and Settlement Systems, Tokyo, 17 March 2016. * * * Introduction It is a great pleasure to welcome you all today to our Forum on Payment and Settlement Systems. I. Innovations in payments and FinTech Recent years have seen a number of developments in financial services, including in the area of payments. Innovations that combine finance and new technology, called “FinTech,” have become a particular focus of attention. It is clear that there are both supply-side and demand-side factors behind such developments. On the supply side, the advance in technological innovations related to information and communications is progressing. The processing power of computers continues to grow rapidly, and computers can analyze huge amounts of data – that is, “big data” – in a relatively short period of time. There has also been a rapid spread of forms of infrastructure such as the internet and mobile terminals, which are easily accessible to a wide range of people. In other countries – particularly in emerging or developing nations where existing financial services provided by banks have not penetrated sufficiently – new services such as mobile payments are generating large expectations in terms of “financial inclusion” – or the promotion of access to financial services. On the demand side, globalization of the economy continues to progress, and more and more transactions are being made across borders as well as time zones. New forms of economic activities have arisen both here and abroad – such as “e-commerce” and the “sharing economy” – while lifestyles have diversified. Reflecting such developments, the needs for financial services are growing increasingly diverse and complex. For example, there is an emerging need for payment methods that are compatible with internet shopping on weekends or at midnight as well as low-value cross-border remittances. There is also a growing need to use forms of information associated with payments by utilizing loyalty cards. As I just pointed out, we can judge that there are factors on both the supply and demand sides which are affecting developments in FinTech. If we consider that the financial business has strong characteristics as an “information industry,” then it is not surprising that developments in information technology have a large influence, especially in finance. For example, credit, investment, and risk management are based on the accumulation of a great deal of information and analysis in which new technology has a large role to play. In these financial services, particularly in payments, the transmission of information has significant importance. Thus, it is natural that recent developments in information technology are generating a number of innovations and services in the area of payments. II. Benefiting from the merits of innovation Innovations in financial services have the potential to improve efficiency and enhance access to financial services. They also bring a wide range of benefits to the economy as a whole. BIS central bankers’ speeches This happens in several ways. First, expansion of the frontier for financial services enlarges the possibilities for new economic activities. For example, if people who lack access to financial services become able to use mobile payments, potential customer base for many businesses will expand and new businesses targeting these people might arise more easily. Moreover, if payment methods are fast, inexpensive, and have ubiquity, this will expand the frontier of businesses that use them – for example, businesses that provide e-commerce, music, or software by precisely taking into account customer needs. Second, new technologies arising from financial innovations will possibly be applied to other means. For example, distributed ledgers – a technology underpinning digital currencies – are receiving considerable attention as a way to secure the accuracy of ledgers through verification by their users, without relying on trusted third parties (that is, central operators such as government and central banks). And distributed ledgers are now under consideration for application to the recording of transfers of financial assets such as stocks as well as to the management of registry books for land and houses. To sum up, innovations in finance including payments that are backed by innovations in information technology have the potential to boost economic welfare and revitalize economic activities through interaction with a range of businesses. Now, I would like to emphasize three points that I consider important in maximizing the benefits of these innovations and leading to further development of the economy. The first point is public’s great sensitivity to innovations in information technology and financial requirements. At present, information technology is developing rapidly and new types of businesses are emerging one after the other. Accordingly, those involved in providing financial services – including financial institutions – are increasingly expected to pay close attention to changes in public’s requirements and development of technologies that can be applied, and to be sufficiently aggressive and flexible about using the new technology to provide concrete financial services. The second point is the importance of communication with many entities across business categories. To expand financial services by capturing diversifying needs and adapting new technologies, it is useful to form new networks composed of entities such as financial institutions and high-tech and venture companies that enjoy advantages in information technology and data usage. It is also important to ensure communication, cooperation, and sound competition among these entities. The third point is acquiring public’s trust regarding financial infrastructure. Financial services using the internet and mobile terminal are spreading, but new types of threats to the financial infrastructure – such as hacking and cyber attacks – are gaining prominence. If concerns spread that countermeasures against these threats are insufficient, this might lead to doubts about the innovative financial services themselves. Therefore, providers of new financial services should prepare sufficiently against new risks and threats. In this regard, it will be important to draw on technologies that help to enhance security such as encryption techniques and biometric authentication. III. The central bank and Innovations in payments Lastly, I would like to talk about the Bank of Japan’s involvement in payment and settlement systems and our perspective on innovations in payments. The Bank issues banknotes, which are the most familiar type of payment instrument. We also operate the Bank of Japan Financial Network System, or BOJ-NET, which enables the settlement of large-value funds and Japanese government bonds among financial institutions. Considering the fact that all funds are ultimately settled using central bank money – that is, cash or the central bank’s current account deposits – the settlement infrastructure provided by the Bank serves as the essential infrastructure of the Japanese economy. BIS central bankers’ speeches It is also crucial for the central bank to maintain stability and improve the efficiency of the payment and settlement systems, including those provided by the private sector. In this regard, the Bank – through oversight of private-sector payment and settlement systems – monitors, communicates and, when necessary, encourages these systems to achieve stability and improve their functionality. Concurrently, the Bank has been enhancing its BOJ-NET. In Oct 2015, the new BOJ-NET was fully launched. It is a highly flexible system that uses the latest information technology and offers enhanced accessibility, and thus it provides a powerful base for the development of innovations in payment and settlements and the provision of new financial services. Furthermore, in February 2016, the BOJ-NET extended its operating hours to 9 p.m. (Japan Standard Time) to achieve an overlap with almost all Asian markets during the day and with European markets until about noon. In addition, by taking part in a number of forums that discuss issues related to payment and settlement systems – including the Committee on Payments and Market Infrastructures of the Bank for International Settlements – the Bank actively participates in international discussions on innovations in payments and payment and settlement systems. From the standpoint of a central bank, the Bank is monitoring closely and with great interest the developments in innovations in payments and payment and settlement systems, from a range of perspectives. These include the safety of payments, the efficiency of payment services and the convenience to users, stability of the financial system, and the influence on finance intermediation and the economy. To make the innovations in payments that are taking place due to innovations in information technology truly useful for the users of financial services and the economy, it is important to develop a network and win-win relationships with a wide range of entities beyond the traditional financial industry. The Bank, as the nation’s central bank, is firmly committed to being a catalyst in fostering such developments. Moreover, I am pleased to announce that the Bank will soon establish a “FinTech Center” in its Payment and Settlement Systems Department. We aim to reinforce our efforts in which the new wave of FinTech will contribute to enhancing financial services and achieving sustainable growth of Japan’s economy. I would like to close my remarks now by wishing that today’s Forum on Payment and Settlement Systems will generate new knowledge and perspectives, and that the stimulating discussions here will lead to further development of the financial markets and the vitalization of economic activities. 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 the IVA (The Royal Swedish Academy of Engineering Sciences) - JSPS (The Japan Society for the Promotion of Science) Seminar, Stockholm, 21 March 2016.
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Hiroshi Nakaso: Challenges toward financial stability and the policy frontier – unconventional monetary policy, macroprudence, and financial institutions’ low profitability Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the IVA (The Royal Swedish Academy of Engineering Sciences) – JSPS (The Japan Society for the Promotion of Science) Seminar, Stockholm, 21 March 2016. * * * Accompanying charts can be found at the end of the speech. Introduction Good evening, ladies and gentlemen. It is a great honor and pleasure for me to be able to speak to you at this esteemed institution today. Before I get into the substance of this speech, let me first thank the person who made this event possible: Mr. Robert Stenram. Mr. Stenram was the Tokyo representative of Swedbank in the 1990s, during the acute financial crisis in Japan. While he was posted in Tokyo, he was instrumental in liaising very closely with the Japanese banking industry. I benefitted from his deep insights and thoughtful advice based on his experiences as a professional banker. It was indeed the most turbulent of times, but we also became friends, and I have long enjoyed his friendship since then. I deeply regret that he no longer is with us, and wish to pay my tribute to the great work he has accomplished in linking Sweden and Japan in the world of finance. Robert, I will not forget how much we owe to you. May his soul, now joined by his beloved wife Siv, rest in peace. Over the years, both Sweden and Japan have confronted a few very difficult issues in terms of monetary policy and financial stability. In the late 1980s, we saw financial bubbles develop and burst. From 2008 to 2009, we tackled the most recent global financial crisis together, and today the two countries are fighting deflationary headwinds. As you know, the Riksbank and the Bank of Japan have adopted negative interest rate policies so as to achieve their respective price stability targets. In order to discharge our responsibilities for maintaining price and financial stability, central banks must be prepared to meet new challenges as they appear. Reflecting on my experiences, I have been on the front lines as a central banker during Japan’s financial crisis in the 1990s and 2000s, and during our Bank’s long battle with deflation for nearly two decades. Not once during all those years could I forget the importance of financial stability. With this background, I will describe today the importance of financial stability and the policy implications of newly emerging challenges from three perspectives: unconventional monetary policy, macroprudence, and low profitability of financial institutions. Financial crisis and growth inflection To begin with, let me go back to the 1990s and explain my experiences during the bursting of the bubble economy in Japan. As I touched on at the beginning, both Sweden and Japan experienced financial bubbles. Nevertheless, the subsequent paths of the two countries were quite different (Chart 1). In Sweden after the crisis in the early 1990s, capital was quickly injected into the banking system and the stability of the financial system was restored. In addition, the Swedish krona was floated, and the Riksbank was able to ease monetary policy. With the tailwind of the depreciating krona contributing, the Swedish economy began to recover as early as 1993. Furthermore, following Sweden’s accession to the European Union in 1995, factors such as the growth of the IT industry benefitting from the increases in inbound investment contributed BIS central bankers’ speeches to productivity growth. In fact, Sweden’s potential growth actually increased after the bursting of the bubble. In contrast, Japan only managed to inject capital into financial institutions on a meaningful scale after the “Dark November” in 1997, when it experienced a series of failures of large financial institutions.1 That was nearly eight years after the bubble had burst. During those years, financial institutions’ behavior, such as evergreening their loans to practically failed businesses by extending additional loans, resulted in a further buildup of impaired assets, which made it all the more difficult to cleanse financial institutions’ balance sheets of problem loans, and which distorted the allocation of resources. The layering of these multiple factors pushed the Japanese economy into deflation, and concurrently, productivity growth declined.2 Furthermore, this period overlapped with rapid changes in demography, resulting from a declining working-age population against the backdrop of a low birth rate and aging. The confluence of the two currents – financial sector problems and demographic changes – significantly pulled down Japan’s potential growth rate (Chart 2). That in turn exacerbated over-leveraging in the corporate sector and discouraged corporate investment. From a macroeconomic perspective, lower investment depressed productivity growth, which again negatively impacted potential growth. There was a vicious cycle: over-leveraging in the corporate sector led to the decline in the potential growth rate, which in turn exacerbated the difficulty of resolving non-performing loans in the banking sector and over-leveraging in the corporate sector. Admitting one can be wise only after the event, in retrospect, the forbearance policy at an early stage after the bursting of the asset bubble and the underestimation of the systemic nature of what was going on in the financial sector allowed the problem in the banking sector to develop into a full-blown financial crisis.3 This is the shorthand account of the extended stagnation and deflation following the bursting of the bubble: the so-called “lost two decades” in Japan. From this painful episode, we have learned two things. One is that financial stability is the foundation of sustained growth of the economy, and another is that changes in potential growth amplify the financial cycle and consequently impact financial stability. The widespread recognition in the international policy fora of the need to take account of the macroprudential perspective may be a consequence of the recent global financial crisis, but Japan’s predicament that preceded it seems to amply underscore the importance of such a perspective. To me, this was a formative experience as a central banker. I have attached importance to macroprudence ever since. Stability consequences of QQE with a negative interest rate Next on my agenda today is the implementation of monetary policy by the Bank of Japan and its relationship with macroprudential policy. After the bursting of the bubble, the lowering of potential growth brought about a large decline in the natural rate of interest, which is the guidepost for monetary policy formulation (Chart 3). As you know, monetary easing is used to bring down real interest rates below the natural rate of interest. Mindful of the prevailing views then that there was a zero lower bound for nominal interest rates, quantitative and qualitative monetary easing (QQE) introduced by the Bank of Japan in April 2013 was a breakthrough in the following sense: the Bank made a strong commitment to achieve the price stability target of 2 percent at the earliest possible time, which encouraged expected During this month, as many as four financial institutions, including internationally active ones, failed in succession: Sanyo Securities, Hokkaido Takushoku Bank, Yamaichi Securities, and Tokuyo City Bank. Caballero, Ricardo J., Takeo Hoshi, and Anil K. Kashyap. 2008. “Zombie Lending and Depressed Restructuring in Japan.” American Economic Review, 98(5): 1943–77. Nakaso, Hiroshi. “The financial crisis in Japan during the 1990s: how the Bank of Japan responded and the lessons learnt,” BIS Papers No 6, October 2001. BIS central bankers’ speeches inflation to rise. Concurrently, the Bank, recognizing that there was only limited room for short-term interest rates to decline, exerted downward pressure on nominal interest rates across the entire yield curve by purchasing a large amount of long-term government bonds, so that together with higher inflation expectations, real interest rates would be brought down. The QQE with a negative interest rate framework that was introduced by the Bank of Japan this January aims at reinforcing the existing QQE and supports the activities of firms and households, thereby ensuring the earliest attainment of the 2 percent inflation target. The policy will work through the same channels, by bringing down real interest rates. As I just noted, the conventional wisdom was that there was a zero lower bound for nominal interest rates, but the demonstration by a few European central banks, including the Riksbank, that such limitation could be overcome to some degree led the Bank of Japan to adopt the new policy framework. In fact, after the introduction of the negative policy rate, the financial environment has further relaxed, with the yield curve shifting significantly lower and financial institutions lowering their lending rates (Chart 4). In addition, rebalancing of the portfolios of financial institutions is also starting to take place, with increased interest in investing in foreign currency denominated bonds, although this trend is somewhat masked by the effects of recent market turmoil. Against the backdrop of these positive developments in financial intermediation, from the macroprudential perspective, their effects on financial stability must be carefully monitored. I believe that we need to be mindful of two angles. One is the “overheating” risk, where the extremely relaxed financial environment could destabilize the financial system through excessive risk taking. The other is the “contraction” risk, where low revenue streams resulting from low interest rates could erode the risk appetite and/or undermine the soundness of financial institutions. For the time being, we believe that there is generally no need to be overly concerned as regards the overheating risk. There is evidence of increasing real estate transactions, with prices of apartments in the Tokyo area topping their previous peak during the bubble years, but leverage in the real estate sector is still not excessive. Our general view is that the financial sector has a robust capital base relative to risks taken and its resilience in the face of stress is sufficient, and thus it could undertake positive risk taking and portfolio rebalancing under QQE with a negative interest rate framework. At the same time, we believe that the contraction risk at present is also small. The extended period of monetary easing has tended to pressure the interest rate margins of financial institutions, negatively impacting their revenue streams (Chart 5). This is not something that is unique to a setting of unconventional monetary policy, but in an economic environment where such exceptional policy needs to be adopted, there tends to be less room for deposit rates to fall – in other words, the interest rate margins are tighter than ever – and additional easing of policy could result in a non-linear compression of margins.4 Having said that, Japanese financial institutions have been able to remain sound because the reduction in margins thus far has been more than offset by revenue improvements against the backdrop of improving economic conditions under monetary easing, such as increases in lending volume, lower credit costs, and higher investment incomes. The policy framework of QQE with a negative interest rate maintains monetary easing in terms of quantity and quality and boosts it strongly with a negative policy rate. As such, it will strongly influence the financial system. Accordingly, the Bank of Japan must thoroughly monitor and analyze the state of the financial system from a macroprudential perspective. To this end, the Bank of Japan is publishing its Financial System Report twice a year. In this report, it assesses the stability of Japan’s financial system from various angles, including the Borio, Claudio, Leonardo Gambacorta, and Boris Hofmann. 2015. “The Influence of Monetary Policy on Bank Profitability.” BIS Working Papers No.514. BIS central bankers’ speeches balance between the amount of risks borne by financial institutions and their financial bases, macro stress testing, and macro risk indicators (i.e., the “heat map”). I believe that independent examination of developments from a financial perspective will enhance the credibility of QQE with a negative interest rate. Macroprudential policy and monetary policy Even if the risks are contained at this juncture, what should we do if, in the future, the overheating risk becomes more apparent? There are two contrasting views on the relationship between monetary and macroprudential policies: the separation principle and leaning against the wind. The former says to render unto monetary policy things that concern price stability, and render unto macroprudential policy things that concern financial stability. On the other hand, the latter holds that, if the amplification of financial imbalances is expected to threaten price stability in the long run, the central bank should resort to monetary policy in order to dampen the financial cycle, notwithstanding a temporary deviation of inflation from the target. Let me offer you my views, which are influenced by the experiences of the Japanese bubble. Up until the 1980s, the Bank of Japan was requiring banks to comply with guidance that set their loan growth at levels individually assigned by the Bank. This arrangement, called “window guidance” was then regarded as a tool for monetary policy, but under the current taxonomy, it would be regarded as a time-varying macroprudential policy tool, akin to regulation of loan-to-value (LTV) or debt-to-income (DTI). There were two schools of thought regarding the effectiveness of the tool: the “independent tool theory,” which held that window guidance was effective by itself, and the “complementary tool theory,” which held that window guidance had to be used alongside the mainstream monetary policy of official discount rate adjustments to be effective. The subject was actively discussed in academia, and those supporting the independent tool theory argued that a tightening of window guidance could dampen the financial cycle, even if the official discount rate was held steady.5 The Bank of Japan, in the meantime, basically adopted the complementary tool theory and explained window guidance as a tool to support general policy instruments, such as changes to the official discount rate, rather than an independent policy instrument. Notwithstanding such an official position, in the last half of the 1980s, as the call for international policy coordination necessitated the maintenance of a low interest rate environment with a view to expanding domestic demand, the Bank of Japan attempted to respond to signs of financial excesses through the tightening of window guidance. As a result, the growth of bank lending slowed gradually, but large corporates were still able to raise funds from outside the banking sector through the issuance of bonds (Chart 6). The period coincided with the gradual relaxation of underwriting guidelines for corporate bonds, and the buoyant stock market, which was partly a reflection of monetary easing, that reduced the costs of equity financing, such as convertible bonds and bonds with embedded warrants. The resulting increases in capital market financing sustained the relaxed financial environment, and corporate balance sheets kept on expanding. The Bank of Japan could not effectively deal with the signs of overheating. Another notable feature of the Japanese bubble in the late 1980s was that potential growth and the natural rate of interest were both fairly high at the time (Charts 2 and 3). The degree of monetary easing at one particular level of the policy rate depends on whether the natural rate of interest is high or low. When the natural rate of interest and expected growth were high, there were likely to be strong incentives for both financial institutions and corporates to circumvent the restriction imposed by window guidance. Fukumoto, Tomoyuki, Masato Higashi, Yasunari Inamura, and Takeshi Kimura. “Effectiveness of Window Guidance and Financial Environment,” Bank of Japan Review Series, 10-E-4, August 2010. BIS central bankers’ speeches In light of the Japanese experiences, while I fully subscribe to the view that narrowly confined imbalances should be countered by macroprudential policy as the first line of defense, the effectiveness of such policy by itself is very uncertain, considering the changes in financial market structure due to deregulation and the level of the natural rate of interest. Accordingly, I cannot fully uphold the separation principle, which reflects the view that time-varying macroprudential policy measures are by themselves effective. I believe we should leave open the possibility of responding to widening financial imbalances with fiscal policy, including tax policy, and monetary policy. Such thinking is reflected in how the Bank of Japan conducts monetary policy, where the Bank examines economic and monetary conditions in a two-pillar approach: the deliberation of the most likely outcomes for the first pillar, and the deliberation of other risk factors relevant for the conduct of monetary policy, financial imbalances in particular, for the second pillar. Low profitability of financial institutions Let me now turn to the other risk: the contraction risk. What should we do if this risk becomes apparent? More specifically, what should we make of the low profitability of financial institutions from a macroprudential perspective? This question seems to be attracting more and more attention in Europe as well. In order to properly think about this issue, it is important to distinguish between low profitability due to acute problems and that due to chronic issues. When profits of financial institutions severely decline because of acute stresses, it is necessary to have sufficient capital in order to maintain financial stability. Looking at current developments, the international banking system has significantly raised the capital ratio, reflecting the strengthening of the capital rules following the recent financial crisis. Such capital strength is also important for the effective transmission of monetary policy. Given that monetary easing pressures interest margins at financial institutions in the short run, weakly capitalized institutions will not be able to increase lending, undercutting the positive effects of easing. As I noted earlier, the fact that Japanese financial institutions were able to increase lending as the Bank of Japan implemented unconventional monetary policies and margins were compressed demonstrates how well capitalized the institutions are. In short, even if the economy suffers an acute stress and profits of financial institutions are negatively impacted, as the cushion provided by sufficient capital prevents the instability of the financial system, stimulus from monetary easing should provide the shot in the arm that would turn around the economy and thence the profits of financial institutions. Such an outcome, however, is not assured when the financial system is confronted with more chronic stresses, even if current levels of capital are adequate. This is because the persistence of an environment in which financial institutions cannot get sufficient net returns on capital would eventually erode the capital of financial institutions. One example of such chronic stress is foot-dragging by financial institutions in their recognition of non-performing loans and its flip side: the over-leveraging of corporates. Another is the inflection of the potential growth rate, which would lower firms’ expectations for growth and depress investment. In fact, in many developed economies, excess savings are observed in the corporate sector (Chart 7). With the stagnation of investment comes the decline in productivity growth, which would again negatively impact the potential growth rate. As the process unfolds, financial institutions would face downward pressure on their lending rates. Financial institutions facing the resulting compression of interest rate margins would then pursue volume to increase their revenue flows. Such increases in competitive pressure would further depress lending rates and revenues as well. Excessive competition by financial institutions in lending would thus make it easier for low-productivity firms to survive, hindering the efficient allocation of resources in the economy and the so-called “creative destruction,” and consequently would prevent the lifting of the potential growth rate. If the low levels of profits at financial institutions and the depressed potential growth rate are tied together by excessive lending competition by financial institutions, the risk that profits become “too low to BIS central bankers’ speeches recover” could gradually increase, unless financial institutions succeed in changing their business models. The quest for innovations in financial intermediation Joseph Alois Schumpeter, in his seminal The Theory of Economic Development, stresses the important role played by the “banker,” as well as that of the “entrepreneur”6 The banker profits from her ability to identify those entrepreneurs who develop truly innovative undertakings that are high-quality startups, and from generating information that leads to improved corporate performance. Schumpeter expects that such profit motives of the banker backed up by her exceptional ability to pick winners would bring about a more efficient reallocation of risks in the macroeconomy and lead to an endogenous rise in the economic growth rate.7 This role of the banker – promoting the creative destruction through financial intermediation – has not changed since the time of Schumpeter. However, as economies mature, the nature of investment that supports innovations by entrepreneurs changes gradually from investments in tangible assets to those in intangible assets, such as research and development, information technology, and human and organizational capital. Accordingly, investment in intangible assets is now identified as an important element of new sources of growth in the developed economies.8 If I may point out the findings of one recent research study, investments in intangible assets are more sensitive to the availability of internal funds (or cashflow) compared with investments in tangible assets.9 If financial markets were perfect markets, the sources of funds – that is, internal financing or external financing including bank financing – would be completely substitutable, and corporate investment would not be affected by the availability of internal funds. Nevertheless, the fact that investments in intangibles are more sensitive to the availability of internal funds suggests that firms could be facing financial constraints due to information asymmetries. One could say that such asymmetries result from the difficulty of assessing the collateral value of intangible assets compared with tangible assets. Consequently, there are opportunities for the banker to profit from overcoming information asymmetries. In Japan, the ratio of investments in intangible assets to nominal GDP is lower than that in the United States and other major peers (Chart 8). If financial institutions are able to tease out the corporate demand for investments in intangible assets, that not only would enhance the productivity of the whole economy but also would contribute to solving the structural problem of low profitability of financial institutions. The future path of the Japanese economy would be influenced by the behavior of financial institutions whether financial institutions would continue their war of attrition under their existing business models or would expand their business frontiers by unearthing new financing needs. Just as in human beings, for whom chronic syndromes demand fundamental changes in lifestyles, financial institutions must be prepared to fundamentally change their business models in order to extricate themselves from a structural lack of profitability. Schumpeter, Joseph Alois. 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.) Laeven, Luc & Levine, Ross & Michalopoulos, Stelios. 2015. “Financial innovation and endogenous growth,” Journal of Financial Intermediation, Elsevier, vol. 24(1), pages 1–24. OECD. 2011. “New Sources of Growth: Intangible Assets.” Morikawa, Masayuki. 2015. “Financial Constraints on Intangible Investments: Evidence from Japanese Firms,” in Ahmed Bounfour and Tsutomu Miyagawa eds. Intangibles, Market Failure and Innovation Performance, Springer, Ch.6, pp.139–155. BIS central bankers’ speeches The Bank of Japan has implemented a few measures that would encourage financial institutions to implement their essential reforms. One is to adjust the way in which the Bank injects liquidity into the financial system – for example, the fund-provisioning measure to support strengthening the foundations for economic growth, and purchases of ETFs composed of stocks issued by firms that are proactively investing in physical and human capital. These measures are expected to play catalytic roles in enhancing the financial intermediation functions of financial institutions and capital markets, which would foster productivity increases and ultimately lead to improvements in the potential rate of growth. Another set of measures is designed to enhance the function of financial institutions to efficiently allocate resources. The Bank of Japan is actively providing financial institutions with information and know-how through seminars, etc., so that they can enhance the value of their financial intermediation through, for example, support for startup businesses, business matching, rejuvenating businesses, and utilizing information technology. These undertakings by the Bank of Japan are somewhat different from those found in the conventional macroprudential toolkit, but I believe that they perform important functions in promoting financial stability. Unconventional policy and beyond Before concluding my remarks today, I would like to emphasize that, if changes in the potential growth rate would influence the effectiveness of monetary and macroprudential policies, and ultimately affect price and financial stability, that would naturally affect central banks’ thinking on policy formulation. As a matter of fact, in the area of monetary policy, the effectiveness of policy had been constrained in Japan by the concurrent decline in expected inflation under persistent deflation and in the potential growth rate. In this regard, the current pursuit by the Bank of Japan of the 2 percent inflation target through QQE with a negative interest rate will contribute to lifting potential growth through purging the deflationary mindset and encouraging capital formation. At the same time, in the area of macroprudential policy, the current focus on strengthening regulation does not solve the structural problem of low profitability at financial institutions. With regard to this problem, in the global policy fora, the jury is still out, so to speak, as regards how to expand the policy frontier. Central banks perhaps need to be a little more flexible in the designing of macroprudential policies to serve this end. Of course, structural problems cannot solely be solved by central bank actions. Economic policies of the government and undertakings by firms and financial institutions aimed at encouraging innovation are also essential. The Bank of Japan is working with these actors in order to tackle the new challenges in terms of financial stability. 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 Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hyogo, 23 March 2016.
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Yukitoshi Funo: Economic activity and prices in Japan, and monetary policy Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Hyogo, 23 March 2016. * * * I. Recent economic and price developments A. Overseas developments I would like to begin my first speech delivered as a Policy Board member of the Bank of Japan by talking about developments in global financial markets and overseas economies. In global financial markets, risk aversion has increased from the end of 2015, against the backdrop of the declines in crude oil prices and Chinese stock prices. In this situation, overseas economies have been decelerating somewhat, mainly in emerging economies, although they have continued to grow at a moderate pace. As for the outlook, however, the pace of growth in overseas economies is expected to accelerate moderately as the positive effects of the recovery in advanced economies gradually spread to emerging economies. According to the World Economic Outlook (WEO) Update released in January 2016 by the International Monetary Fund (IMF), the projection of global economic growth has been revised somewhat downward from the October 2015 WEO, but the longer-term projection that the growth rate will accelerate moderately from the current estimate of 3.1 percent in 2015 to 3.4 percent in 2016, and 3.6 percent in 2017, is unchanged. Looking at movements by major region, the U.S. economy has been on a recovery trend, assisted by household spending. Amid the steady increase in employment on the whole, private consumption has been increasing steadily, although the pace has been slowing somewhat. Housing investment has followed a moderate uptrend. As for the outlook, the manufacturing sector is likely to remain lackluster for the time being, due mainly to the slowdown in emerging economies, but the economy is expected to continue its recovery centered on the private sector, supported by the firmness in household spending, under accommodative financial conditions. The euro area economy has continued to recover moderately. Although exports have shown some weakness, mainly due to the effects of the slowdown in emerging economies, private consumption has been on an increasing trend, supported mainly by the improvement in the labor market. As for the outlook, the economy will likely continue to see a moderate recovery, mainly on the back of the improved employment and income situation under accommodative financial conditions. The Chinese economy has maintained its stable growth on the whole. However, the pace of growth has decelerated somewhat, mainly in exports and production, reflecting (1) persisting excess production capacity and inventory adjustment pressure in the manufacturing sector; and (2) some weakness in external demand, due mainly to a pause in growth in demand for IT-related goods. In this situation, authorities have proactively carried out policy measures to support economic activity, mainly in fiscal spending. As for the outlook, the economy is likely to broadly follow a stable growth path, due in part to authorities’ measures to support economic activity. Emerging economies have been slowing, mainly in terms of exports and production. Although effects of the economic stimulus measures have been observed, exports and production in Asia have shown some weakness due to excess production capacity and inventory adjustments as well as a pause in growth in demand for IT-related goods in BIS central bankers’ speeches emerging economies, including China. In addition, low commodity prices have been exerting downward pressure on commodity-exporting economies such as Brazil and Russia. As for the outlook, emerging economies are likely to gradually move out of their deceleration phase, mainly on the back of the effects of the recovery in advanced economies and the fiscal and monetary policy measures to stimulate the economy, although differences across countries and regions are likely to remain for the time being. However, the pace of the pick-up will likely remain moderate on the whole. One of the risks to the outlook for overseas economies is that it is difficult to deduce the pace of growth in the global economy, given that the uncertainties surrounding emerging and commodity-exporting economies – particularly China – remain high and that there are negative effects of the declines in commodity prices. In addition, risk factors to the overseas economic outlook are wide ranging, as exemplified by (1) developments in the U.S. economy and the influences of its monetary policy response to them on the global financial markets, (2) prospects regarding the European debt problem and developments in economic activity and prices in Europe, and (3) geopolitical risks such as those in the Middle East. Therefore, I consider it necessary to closely monitor various risk factors from a broad perspective. B. Japan’s economy and prices 1. Economic activity I will now discuss the economic situation in Japan given the overseas developments I have just outlined. Japan’s economy has continued to recover moderately as a trend, although exports and production have shown sluggishness, due mainly to the slowdown in emerging economies. The real GDP growth rate for the July-September quarter of 2015 increased by an annualized quarter-on-quarter growth rate of 1.4 percent, which exceeds the potential growth, due mainly to an increase in domestic private demand. That for the OctoberDecember quarter registered minus 1.1 percent on an annualized quarter-on-quarter basis, due partly to the effects of irregularly warm weather. As for the outlook, although the sluggishness in exports and production will probably remain for some time, domestic demand is likely to follow an uptrend, with a virtuous cycle from income to spending being maintained in both the household and corporate sectors, and exports are expected to increase moderately on the back of emerging economies moving out of their deceleration phase. Thus, Japan’s economy is likely to be on a moderate expanding trend. Specifically, the economy is expected to continue growing at a pace above its potential through fiscal 2016. Thereafter, through fiscal 2017, it is projected to maintain its positive growth, although with a slowing in its pace to around a level somewhat below the potential growth rate, due mainly to the effects of a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike planned in April 2017. According to the Bank’s January 2016 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the medians of the Policy Board members’ forecasts for the economic growth rate – 1.1 percent for fiscal 2015, 1.5 percent for fiscal 2016, and 0.3 percent for fiscal 2017 – were more or less unchanged from the forecasts presented in October 2015. 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 has generally been about 0 percent, with the decline in energy prices and the increase in non-energy prices broadly offsetting each other. The rate of change for all items less fresh food and energy – one of the indicators that capture the underlying trend in the CPI – has remained positive for 28 months and has been at a level above 1 percent recently. In addition, looking at annual price changes in all CPI BIS central bankers’ speeches items less fresh food, the share of price-increasing items minus the share of price-decreasing items has shown a marked increase since spring 2015, albeit with some fluctuations. With regard to the outlook, the year-on-year rate of change in the CPI for all items less fresh food is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices, and, as the underlying trend in inflation steadily rises, accelerate toward 2 percent. Meanwhile, assuming that crude oil prices will rise moderately from the recent level, it is likely that the negative contribution of energy prices to the year-on-year rate of change in the CPI will decrease gradually. Based on this assumption, the timing of the yearon-year rate of change in the CPI reaching around 2 percent – the price stability target – is projected to be around the first half of fiscal 2017. Specifically, the medians of the Policy Board members’ forecasts of the year-on-year rate of increase in the CPI for all items less fresh food presented in the January 2016 Outlook Report were 0.1 percent for fiscal 2015, 0.8 percent for fiscal 2016, and, on a basis excluding the direct effects of the scheduled consumption tax hike, 1.8 percent for fiscal 2017. Comparing these with the forecasts presented in October 2015, that for fiscal 2016 is lower and that for fiscal 2017 is more or less unchanged. The downward revision of the forecast for the CPI is due to the assumption of lower crude oil prices. 1 II. Keys to assessing the outlook for economic activity and prices In what follows, I will discuss the keys to assessing the outlook for economic activity and prices in Japan, including several points that I think deserve particular attention in terms of realizing the outlook that I mentioned earlier. A. Employment and income situation First, I will talk about developments in the employment and income situation. Supply-demand conditions in the labor market have continued to improve steadily, and employee income has increased moderately. According to the Labour Force Survey, the number of employees has been increasing, and the labor force participation of women and the elderly has been rising. Against this backdrop, the active job openings-to-applicants ratio has risen steadily and a perception of labor shortage suggested by the diffusion index for employment conditions (the proportion of firms responding that employment was “excessive” minus the proportion of those responding that employment was “insufficient”) in the December 2015 Tankan (ShortTerm Economic Survey of Enterprises in Japan) has heightened. The unemployment rate has declined moderately, albeit with some fluctuations, and recently has been in the range of 3.0–3.5 percent. The supply-demand conditions in the labor market are expected to continue improving steadily. On the wage side, hourly cash earnings of part-time employees, which are responsive to labor market conditions, have shown an especially clear improvement of late, supported in part by a recent increase in minimum wages. With regard to the outlook, as the tightening of labor market conditions and the heightening of inflation expectations will become more evident, these will tend to exert upward pressure on wages. In light of these prospects for employment and wages, the rate of increase in employee income is expected to moderately accelerate. Nevertheless, given that the unemployment rate has declined to the range of 3.0–3.5 percent in a situation where corporate profits have Individual Policy Board members made their forecasts assuming that Dubai crude oil prices would rise moderately from the recent 35 U.S. dollars per barrel to the range of 45–50 dollars per barrel toward the end of the projection period. Under this assumption, the contribution of energy prices to the year-on-year rate of change in the CPI (all items less fresh food) was estimated to be around minus 0.9 percentage point for fiscal 2015, and approximately in the range of minus 0.7 to minus 0.8 percentage point for fiscal 2016. More specifically, the contribution was expected to start to lessen in the second half of fiscal 2016 and reach around 0 percentage point during the first half of fiscal 2017. BIS central bankers’ speeches been at high levels, it should be noted that the pace of improvement in wages to date has been somewhat slow and the labor share has remained on a downtrend. B. Exports I will now discuss developments in exports. The pick-up in exports has paused recently. Specifically, exports of capital goods have continued to be relatively weak, due mainly to the slowdown in emerging economies, including China; with regard to IT-related exports, those of smartphone-related goods have been slowing. However, automobile-related exports have been increasing as a trend, mainly those to the United States and Europe, due partly to shifting of overseas production sites back to Japan. With regard to the outlook, Japan’s exports are expected to tend to mark a fall for the time being, given the decline in expected growth in emerging and commodity-exporting economies, protracted low commodity prices, and the resulting excess in production capacity related to material and energy. I therefore consider that this warrants careful attention. Automobile-related exports, particularly those for advanced economies, are likely to continue to firmly increase. On the other hand, the pick-up in exports of capital goods and IT-related goods are projected to be sluggish, due to the effects of the slowdown in emerging economies, and remain at a pause. I will continue to closely monitor developments in the global economy. C. Business fixed investment Let me now explain developments in business fixed investment, which has been on a moderate increasing trend as corporate profits have been at high levels. According to the December 2015 Tankan, firms have generally continued to plan to increase fixed investment firmly for fiscal 2015 despite the slowdown in emerging economies. As for the outlook, business fixed investment is projected to continue to increase moderately on the back of (1) the high level of corporate profits, (2) stimulative financial conditions such as low interest rates and accommodative lending attitudes, and (3) manufacturers’ positive stance on domestic investment. Machinery orders – a leading indicator of machinery investment –have been increasing moderately. In light of high corporate profits, firms are judged so far as having maintained their restrained fixed investment stance due to sluggish growth expectations. However, their stance is projected to gradually become more positive in response to a moderate rise in growth expectations and a sustained improvement in profitability. Nevertheless, I think that it is necessary to pay close attention to the effects of the recent risk aversion in global financial markets on firms’ sentiment, and in turn on their fixed investment stance. D. Prices Next, I will discuss the output gap and inflation expectations, which are the main factors that determine inflation rates. First, the output gap is expected to head toward improvement, reflecting a rise in the manufacturing sector’s capacity utilization supported by a pick-up in exports and production, and a further improvement in labor market conditions. In fiscal 2016, the output gap is projected to expand within positive territory, reflecting a higher utilization of production inputs accompanying the economic expansion and higher growth due to a frontloaded increase in demand prior to the consumption tax hike planned in April 2017. Second, medium- to long-term inflation expectations still appear to be rising on the whole from a somewhat longer-term perspective, judging from firms’ price-setting and households’ spending behavior, although market indicators and various surveys have been somewhat weak recently. Firms’ price- and wage-setting stance clearly has changed, and consumers seem to be accepting firms’ movements to increase prices, mainly reflecting an improvement in the employment and income situation. In the annual labor-management wage negotiations, movements toward wage increases have been broadening since 2014, reflecting corporate performance and supply-demand conditions in the labor market. Looking BIS central bankers’ speeches ahead, as the observed inflation rate rises, medium- to long-term inflation expectations are also likely to follow an increasing trend and gradually converge to 2 percent – the price stability target. Nevertheless, I believe that it is still necessary to pay close attention to how factors such as the decline in crude oil prices will affect firms’ and consumers’ outlook for prices. III. Conduct of monetary policy Let me now turn to the Bank’s monetary policy. The Bank decided to introduce Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate at the Monetary Policy Meeting (MPM) held in January 2016. Let me look back on how the Bank came to introduce it. About three years ago, at the MPM held in April 2013, the Bank made a commitment to achieving the price stability target of 2 percent at the earliest possible time, and decided to introduce QQE as a necessary measure to underpin this commitment. The main transmission mechanism of QQE is stimulating firms’ investment and households’ consumption through lowering nominal interest rates across the entire yield curve by making large-scale purchases of Japanese government bonds (JGBs) and showing the Bank’s clear commitment toward achieving the price stability target of 2 percent by continuing with massive asset purchases. Thereafter, the Bank decided to expand QQE at the MPM held at the end of October 2014. In January 2016, it introduced QQE with a Negative Interest Rate, which is designed to enable the Bank to make full use of possible monetary easing measures in terms of the three dimensions of quantity, quality, and the interest rate, in which a negative interest rate is added to the existing options of QQE conducted to date. After the turn of 2016, there had been uncertainty over future developments in emerging and commodity-exporting economies, and financial markets had been volatile. Reflecting such developments, there was an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed, and that the underlying trend in inflation – which had been rising steadily – might be negatively affected. Based on such recognition, the Bank decided to introduce QQE with a Negative Interest Rate to preempt the manifestation of this risk and to maintain momentum toward achieving the price stability target of 2 percent. For the good of Japan’s economy, it is necessary to dispel people’s deflationary mindset that has taken hold amid deflation that has lasted for a long period. Therefore, at present, I consider that it is most important to steadily pursue monetary easing to achieve the price stability target of 2 percent while paying attention to various effects that monetary easing may bring. We are only halfway to achieving the 2 percent price stability target. Given this, I think that it is vital that the Bank continue to steadily pursue QQE with a Negative Interest Rate to achieve the price stability target. The Bank aims to achieve the target of 2 percent at the earliest possible time. In order to do so in a sustainable and stable manner, I think that it is necessary that the target be achieved while the economy as a whole maintains the virtuous cycle in a balanced manner, such as with prices rising along with wage increases. The Bank will continue to steadily pursue monetary easing, making full use of all possible measures in terms of the three dimensions of quantity, quality, and the interest rate to achieve the price stability target of 2 percent. IV. Challenges for Japan’s economy I would now like to express my thoughts regarding the current situation of Japan’s economy from a longer-term perspective. In my view, the economy, which has experienced deflation for a long period of time, faces the challenge of strengthening its growth potential. Japan’s potential growth rate as estimated by the Bank has declined to around 0.5 percent or lower, BIS central bankers’ speeches and this reflects factors including decreases in (1) the growth rate of capital stock due to postponement of business fixed investment, (2) labor input due to the aging of the population and the decrease in the number of hours worked, and (3) productivity growth due to sluggish innovation. In order to enhance the potential growth rate of the economy, I believe that it is important to steadily proceed with measures that will cause increases in these factors. Let me elaborate on each of them. First, firms’ fixed investment is made based on their future prospects and strict selection of such investment based on the quality criteria and on value added. They recently have been exhibiting moves such as the shifting of production sites back to Japan and expanding investment in research and development. In order to manage risks and maintain sustainable growth, many Japanese firms that face global risks seem to be in the process of adopting a strategy that allocates fixed investment in several areas in a balanced manner and establishing their own competitive supply chains. I believe that, in this process, firms are reaffirming the advantage of having bases in Japan. That is, it has become a widely acknowledged view that there are things that Japanese firms can achieve only in Japan. I expect that investment behavior that takes such a view into account will become more active. Second, as for labor input, labor market conditions remain tight. Both manufacturers and nonmanufacturers have been voicing concern recently that they cannot provide sufficient goods or services due to labor shortages. This situation reflects the structural issues surrounding Japan’s labor market – for example, labor shortages, the rigid labor market, and the insufficient job training framework. It is therefore necessary to make efforts to resolve these issues. That being said, the labor force participation rate both of women raising small children and of the elderly is rising, and this is an encouraging development as a first step to resolving these issues. Third, in order to increase productivity, I consider it important that not only manufacturers but nonmanufacturers – the services sector, for example – make innovations to increase productivity. Indeed, let me note that there is severe price competition among commoditized goods and services that firms provide, and thus firms need to take initiatives to develop capital goods, materials, or parts with high technology, or unique high value-added goods or services with high brand value. In addition, considering that foreign firms are often pointed out as having higher productivity than Japanese firms, it seems that there is room for enhancing Japanese firms’ productivity, and that making efforts to attract foreign firms’ inward investment in Japan will contribute to enhancing productivity. Firms’ initiatives are essential to addressing these issues facing Japan’s economy. They should not be overly pessimistic about the structural changes to the economy, such as the decrease in population. Rather, they should take these structural changes into account and take active steps toward enhancing the growth potential of the economy. The Bank, for its part, has established the Loan Support Program, through which it provides long-term funds at low interest rates so that firms and households can fully utilize accommodative financial conditions. Moreover, the Bank decided on measures to support firms’ investment in physical and human capital at the MPM held in December 2015. There has been progress in converting firms’ and households’ deflationary mindset since the introduction of QQE, and many firms have become proactive in making investment in physical and human capital. I consider it desirable that these developments spread further. In closing, let me underline that enhancing the growth potential of the economy is essential for the virtuous cycle in the economy to continue operating. I strongly hope that, in addition to the promotion of a growth strategy by the government, various measures and frameworks introduced by the Bank will be utilized effectively, and that this will contribute to further progress in the efforts to strengthen the growth potential of Japan’s economy. Thank you for your attention. BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at Columbia University, New York City, 13 April 2016.
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Haruhiko Kuroda: The battle against deflation – the evolution of monetary policy and Japan’s experience Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at Columbia University, New York City, 13 April 2016. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website. Introduction It is a great privilege to be invited to speak at Columbia Business School today. I was told that the Center on Japanese Economy and Business (CJEB), which is kindly hosting this conference, is celebrating its 30th anniversary this year. The CJEB has long played a pivotal role in promoting a better understanding of the Japanese economy and U.S.-Japan economic relations. I would like to express my sincere appreciation to Professor Hugh Patrick, the founder and long-time director of the CJEB and a leading expert on Japan’s economy, and all those related to the CJEB. As you all know, Japan has long been mired in deflation. Deflation was once perceived to be a phenomenon unique to Japan. Looking back to the late 1990s and 2000s, while Japan was suffering from deflation, other economies were performing quite well. With Alan Greenspan, sometimes called the “maestro,” at the helm of the Federal Reserve, the United States enjoyed a prolonged period of stable prices and high economic growth, and overcame several economic shocks such as the collapse of IT Bubble in the early 2000s. At the time, there was talk of the so-called New Economy in which business cycles had allegedly disappeared due to IT innovation and economic globalization, resulting in strong and lasting economic growth under low and stable inflation. In Europe, regional economic integration made substantial progress with introduction of a common currency, the euro, in 1999, and the economy grew in a stable manner. Meanwhile, emerging economies including China and commodity-exporting countries continued to enjoy rapid growth. Only Japan seemed to be left behind in this tide of global growth. But then the global financial crisis struck in 2008. Major advanced economies suffered a sharp deceleration in economic activity, but thanks to prompt and bold policy actions taken by the authorities including central banks, the global economy was able to avoid another Great Depression. However, even though eight years have passed since the start of the crisis, the global economy has yet to regain its full strength. Many countries – particularly advanced economies – continue to be plagued by low economic growth and low inflation, and there is concern that they might fall into Japanese-style deflation. Fortunately, the end of deflation in Japan is in sight as a result of the bold monetary policy measures called “quantitative and qualitative monetary easing,” or QQE for short, we launched three years ago. Today, I will discuss how Japan, as the “front runner” of deflation, has fought against deflation and is overcoming it. While doing so, I will also explain the theoretical background to the evolution of what is called unconventional monetary policy. I. What is deflation? The harm of moderate yet persistent deflation What is deflation? For those living in the United States, which has enjoyed moderate inflation for an extended period of time, this might not be immediately obvious, so let me start with this point. Deflation refers to a situation where prices decline persistently. If prices of individual goods and services fall thanks to innovation and improved productivity, this is of course a good thing. A good example is the gradual price decline in PCs and smartphones. However, the BIS central bankers’ speeches deflation I am talking about refers to a situation in which the prices of a broad range of goods and services decline, and consequently, prices as a whole drop. In most countries, including the United States, general prices are measured in terms of consumer price indices, which are the weighted averages of baskets of goods and services purchased by consumers. Put very simply, deflation can be understood as a continuous decline in consumer prices. What happens to the economy if prices as a whole decline continuously (Chart 1)? Looking at the overall economy, suppliers of goods and services will see a decrease in sales and profits, and firms with declining profits typically start to lay off employees or restrain their wages. Employees that have been laid off or whose wages have declined experience a fall in their income and restrain their spending due to uncertainty about their future. Such restraint in spending leads to a further decline in the sale of goods and services, resulting in harsher competition among firms. Firms therefore lower prices in order to compete, leading to a further decline in their sales and profits. This simple outline shows that once deflation starts, it perpetuates itself, so that the economy falls into a bad “equilibrium, in which economic activity is shrinking.” Japan has been struggling with deflation for a decade and a half, triggered by the collapse of the asset bubble of the late 1980s/early 1990s and the destabilization of the financial system reflecting this collapse. A key characteristic of Japan’s deflation is that it has been moderate but persistent. During the Great Depression in the United States, which is often cited as a typical example of deflation, prices plunged by nearly 30 percent in total. Moreover, they fell precipitously, dropping at an annual rate of almost 10 percent in 1931 and 1932. However, deflation persisted only for four years. In contrast, Japan’s consumer prices only fell by 4.1 percent in total in the 15 years from fiscal 1998 to fiscal 2012, which is equivalent to an annual average rate of only 0.3 percent. Thus, while deflation was much milder, it lasted for a decade and a half. Such prolonged deflation gave rise to the entrenched belief that prices and wages will not rise in the future. If we use disease as an analogy, the substantial deflation of the 1930s can be regarded as an “acute disease,” while Japan’s deflation since the late 1990s is a “chronic disease.” Chronic diseases tend to cause relatively little pain to patients, but for that reason they can be “silent killers” that quietly ruin the entire body. Let me explain why moderate yet persistent deflation is harmful to the entire economy. The biggest problem is that, under deflation, the value of cash gradually increases with the passage of time, discouraging firms and households from spending. The nominal value of cash remains unchanged and interest rates on deposits at banks are very unlikely to be negative. (I will come back to this point later when I talk about negative interest rate policy.) At the same time, prices of goods and services gradually decline, so that for consumers it is better to wait now and buy later when prices are lower. For firms, instead of exploring new business opportunities and investing in facilities or research and development, an easier way to shore up corporate value is to cut costs such as wages, increase cash flow, and accumulate cash in bank deposits. In Japan, all these phenomena have been widely observed since the 1990s. Let us take a look at sectoral saving-investment balances under deflation. Normally, the corporate sector has a financial deficit, that is, it is a net borrower. Firms conduct their business and produce added value in the economy by raising funds from banks and capital markets. However, in the late 1990s, the corporate sector started to register a financial surplus, or become a net saver. To make up for the shortage in aggregate demand brought about by the changes in the corporate sector, the government raised funds by issuing large amounts of Japanese government bonds (JGBs) and increased fiscal spending such as public works. Meanwhile, in the banking sector, deposits increased substantially while lending decreased as a result of the financial surplus in the corporate sector. The banking sector, in turn, invested these surplus funds in JGBs. Thus, under Japan’s deflationary environment, a peculiar flow of funds established itself, in which the corporate sector has a BIS central bankers’ speeches financial surplus, the government sector has a financial deficit, and the banking sector expands its investment in JGBs (Chart 2). Another problem of moderate yet persistent deflation is that, as the belief becomes entrenched that prices will not rise but continue to steadily decline, real interest rates remain high, hampering the effectiveness of monetary policy. Let me elaborate a bit on this point. In terms of both lending and deposit interest rates, what matters for economic activity is not the nominal interest rate, but the real interest rate, or the interest rate adjusted by the outlook for inflation. For instance, if the nominal interest rate is 3 percent per annum and prices are expected to rise by 2 percent, the real interest rate is 1 percent. On the other hand, if the nominal interest rate is again 3 percent, but prices are expected to fall by 1 percent, the real interest rate is 4 percent. Obviously, financial conditions are more accommodative in the former than the latter case. If people start to think that prices will steadily decline – in the economics jargon, “inflation expectations” fall into negative territory – real interest rates will remain high compared to nominal interest rates. These considerations illustrate how moderate yet persistent deflation is like a harmful chronic disease. It not only stymies the dynamism of the economy but also weakens the effectiveness of monetary policy. II. The evolution of monetary policy: What is “Unconventional Monetary Policy”? Given the insidious effects of such deflation, you may be wondering how the Bank of Japan responded. Naturally, the Bank did not merely stand by. Although the Bank’s monetary policy measures were often criticized – especially abroad – as being “too little, too late,” the Bank did in fact adopt a variety of unconventional monetary policy measures from the late 1990s onward (Chart 3). To start with, in 1999, the Bank adopted a “zero interest rate policy,” in which the overnight money market rate was guided close to 0 percent. In 2001, the Bank switched its main operating target from the overnight money market rate to current account balances held by financial institutions at the Bank of Japan, which are equivalent to what in the United States are usually called “reserve balances.” Under the policy, which lasted from 2001 to 2006, the Bank provided large amounts of liquidity, so that reserve balances eventually reached several multiples of required reserves. To the best of my knowledge, this was the world’s first quantitative easing. At the same time, the Bank committed itself to continuing with the policy until the annual rate of change in the consumer price index (CPI) would register “stably a zero percent or an increase.” This means that the Bank also pioneered what in recent years has come to be called “forward guidance.” After the global financial crisis in 2008, Japan’s economy decelerated significantly as a result of the global recession, even though the direct impact of the global financial crisis on Japan’s financial system was relatively small. CPI inflation, which had been positive since 2006, fell back into negative territory. Against this backdrop, the Bank introduced another policy initiative in 2010 which we called “comprehensive monetary easing.” Under this policy, the Bank purchased large amounts of JGBs, focusing in particular on those with maturities of up to three years, pushing down interest rates on such JGBs to close to 0 percent. In addition, to reduce risk premiums, the Bank also – though to a lesser extent – purchased privatesector debt such as corporate bonds and commercial paper (CP), as well as equity financial products such as exchange-traded funds (ETFs) and real estate investment trusts (REITs). Moreover, in order to encourage lending by financial institutions, the Bank introduced special long-term lending facilities with a low interest rate, which are similar to the Funding for Lending Scheme by the Bank of England (BOE) and the targeted longer-term refinancing operations (TLTROs) by the European Central Bank (ECB). This means that the unconventional monetary policy measures taken by the Bank of Japan can stand comparison with those taken by other central banks at least in terms of their breadth and variety. BIS central bankers’ speeches The series of unconventional monetary policy measures implemented by the Bank prevented Japan’s economy from falling into a 1930s-style deflationary spiral of sharply falling prices and economic contraction. However, none of these monetary policy measures were sufficiently strong to overcome deflation. Why was this the case? To understand the reasons, we should start with the mechanisms through which monetary easing affects the economy. A key concept in this context is the so-called “natural rate of interest,” which is the real interest rate at which the economy neither accelerates nor decelerates. Monetary easing aims to push real interest rates in financial markets below the natural rate of interest through a lowering of the policy rate and/or increase in the supply of funds in order to stimulate economic activities such as business fixed investment and housing investment. This is the main channel through which monetary easing seeks to boost economic activity. Although the determinants of the natural rate of interest are the subject of considerable debate, it is widely thought that the potential growth rate of the economy plays a major role. The conceptual framework I just outlined allows you to easily see that Japan’s monetary policy under deflation faced two major challenges. The first was that real interest rates remained high. Nominal short-term interest rates – the policy tool of traditional monetary policy – already were close to 0 percent after the introduction of the zero interest rate policy in 1999. This means that short-term interest rates already faced the so-called “zero lower bound” in the sense that nominal interest rates cannot be lowered below 0 percent. At the same time, with the economy stuck in a deflationary equilibrium, inflation expectations remained low. As a result, real interest rates – that is, nominal interest rates minus inflation expectations – remained high. The second major challenge that made it more difficult to overcome deflation is the decline in the natural rate of interest reflecting a deceleration in Japan’s growth potential. With the benefit of hindsight, we know that deflation has coincided with a decline in the productive population as a result of rapid population aging, reducing Japan’s growth potential. Another factor contributing to the deceleration in growth potential was sluggish capital accumulation reflecting the prolonged deflation. Specifically, while Japan’s potential growth rate in the early 1990s was around 3–4 percent, it subsequently followed a declining trend and recently has been under 1 percent (Chart 4). Given that, as mentioned, the potential growth rate likely is a key determinant of the natural rate of interest, it is likely that the latter also followed a declining trend. As a result, Japan was trapped in a situation in which the zero lower bound on nominal interest rates and the decline in inflation expectations made it difficult to reduce real interest rates just at a time when lower real interest rates were warranted due to the decline in the natural rate of interest. This situation can be easily grasped by comparing Japan’s estimated potential growth rate and real interest rates as approximated by the yields on 10-year JGBs minus actual inflation (Chart 5). Given these challenges, Japan was unable to find an appropriate cure for the chronic disease of prolonged deflation. This is how a deflationary equilibrium took hold. I hope that, based on this outline, you can clearly see the challenges that Japan’s policy authorities have been facing in order to overcome deflation. The first challenge has been to raise the potential growth rate and thereby increase the natural rate of interest. The second challenge has been to simultaneously devise monetary policy measures to substantially lower real interest rates. It has been widely argued that monetary policy is no longer effective and that economic policy should center on strategies to promote growth. However, as I hope my explanation so far has made clear, tackling deflation is not a choice between monetary policy or a growth strategy: both are necessary. In this context, the government’s initiative to enhance Japan’s economic growth as well as growth-oriented efforts by the private sector are of vital importance. At the same time, the Bank of Japan has to accomplish its mission as the central bank. BIS central bankers’ speeches III. The 2 percent price stability target and the introduction of QQE In the course of Japan’s prolonged battle against deflation, it became increasingly clear that more powerful monetary easing was needed. Against this background, the newly elected Abe administration in December 2012 launched “Abenomics,” consisting of “three arrows,” namely, bold monetary policy, flexible fiscal policy, and a growth strategy to promote private investment. In January 2013, the Bank of Japan then introduced a price stability target of 2 percent CPI inflation, which was reiterated in the joint statement of the government and the Bank of Japan. This followed the Federal Reserve’s announcement of a similar longer-run inflation goal a year earlier in January 2012. I was installed as the governor of the Bank of Japan just after the introduction of the price stability target, in March 2013. The following month, in April, we introduced a new policy initiative, QQE. We designed QQE to overcome the limitations of previous policies. QQE consists of two major elements (Chart 6). First, QQE seeks to raise inflation expectations and hence drastically change the deflationary mindset that has taken hold among the public through the Bank’s strong commitment to achieving the price stability target of 2 percent at the earliest possible time. Second, through massive JGB purchases by the Bank, QQE exerts downward pressure not only on short-term nominal interest rates but on the entire yield curve. By combining these two elements, QQE allows the Bank to significantly lower not only short-term but also long-term real interest rates. As for the massive JGB purchases, the Bank is purchasing JGBs with maturities of up to 40 years, the longest maturity in Japan, exploiting to the greatest extent possible any remaining room for further declines in nominal interest rates. When QQE was initially introduced, the Bank’s operational guideline was to purchase JGBs so that the Bank’s holdings of JGBs would increase at an annual pace of about 50 trillion yen. The pace was accelerated in October 2014 to about 80 trillion yen a year and this guideline continues to this day. Given that Japan’s nominal GDP is about 500 trillion yen, JGB purchases of about 80 trillion yen correspond to about 16 percent of Japan’s GDP. As a result of such purchases, the ratio of the Bank’s balance sheet to nominal GDP has risen from 35 percent at the end of March 2013 to 77 percent at the end of December last year and will continue expanding. The equivalent ratio in the case of the Federal Reserve, after three rounds of large-scale asset purchases (LSAPs), is 25 percent as of end-December last year. This comparison should give you a good sense of how massive monetary easing in Japan is. Turning to the qualitative aspect of the Bank’s JGB purchases, the average remaining maturity of JGBs purchased by the Bank was extended from slightly less than three years to about seven years when QQE was introduced. The Bank later extended the targeted average remaining maturity further and the target range now is about seven to twelve years. Moreover, the Bank is continuing with the purchase of ETFs and REITs, which started under “comprehensive monetary easing” in 2010, but expanded the scale of such purchases as well. IV. Effects of QQE: Japan’s economy is overcoming deflation QQE, which differs drastically from previous measures, has been exerting its intended effects. I would now like to show how Japan’s economy has changed since the introduction of QQE by referring to major financial and economic indicators. Let me start with financial indicators. Nominal long-term interest rates as measured by the yields on 10-year JGBs declined by 0.4 percentage points from 0.7 percent before the introduction of QQE in 2013 to 0.3 percent around the end of 2015. Next, turning to inflation expectations, while it should be noted that measures of inflation expectations tend to vary considerably and therefore should be treated with a degree of caution, a widely watched survey of economists indicates that medium- to long-term inflation expectations have risen by about 0.4 percentage points in the same period. Using these figures to calculate real longterm interest rates suggests that these have declined by 0.8 percentage points. Research by BIS central bankers’ speeches the Bank’s staff indicates that the effects of QQE on the entire yield curve are equivalent to a reduction in the short-term policy rate of about 2 percent. Under these accommodative financial conditions, the amount outstanding of bank lending, including lending to small firms, has continued to increase at a moderate pace of 2.0–3.0 percent on a year-on-year basis. The stimulative effects of the substantial decline in real interest rates on the economy have become increasingly apparent (Chart 7). Japanese firms’ profits have been increasing, reaching record levels. This is not only the case for large firms, but also for small firms. Against this background, business fixed investment has been increasing moderately. Turning to the labor market, the unemployment rate has declined to a range of 3.0–3.5 percent, which can be regarded as full employment. Moreover, in the 2014 Shunto – the annual wage negotiations between workers and management in spring – an increase in base pay was seen for the first time in two decades, and an increase for the third year in a row will follow this year. Moreover, there are signs that wages of non-regular employees including part-time employees are also being raised as a result of labor shortages. Reflecting the improvement in the employment and income situation, private consumption has been resilient, albeit with some fluctuations due to factors such as the weather. Japan’s economy has continued its moderate recovery with a virtuous cycle from income to spending being maintained in both the corporate and household sectors. On the back of the improvement of the real economy, the underlying trend in inflation has been steadily improving (Chart 8). The output gap, which shows the utilization of production factors such as labor and capital, has been improving and recently returned to the average of the past of 0 percent. As I noted earlier, compared to the time before the introduction of QQE, inflation expectations have increased on the whole. The year-on-year rate of change in the CPI recently has been around 0 percent, largely reflecting the substantial decline in crude oil prices since summer 2014. However, the year-on-year rate of change in the all-item CPI excluding energy and fresh food shows a completely different picture. Before the introduction of QQE in April 2013, the rate of change was slightly negative, registering about minus 0.5 percent. Following the introduction of QQE, it turned positive in October 2013 and since then has remained positive for 29 consecutive months. It recently increased to a level above 1 percent. This is the first time that Japan has registered such sustained inflation since it fell into deflation. Thus, although Japan’s economy still has some way to go until the price stability target of 2 percent is achieved, there is no doubt that there has been a clear change in the inflation trend under the Bank’s QQE. V. Objectives of the negative interest rate policy Against the background just described, the Bank of Japan introduced “QQE with a Negative Interest Rate” in January 2016. As indicated, QQE has been exerting its intended effects. However, since the turn of the year, global financial markets have been unstable against the backdrop of the further decline in crude oil prices and uncertainty over future developments in emerging and commodityexporting economies, particularly the Chinese economy. Moreover, although Japanese firms’ behavior has become increasingly proactive based on the prospects of a post-deflationary economy, they have nevertheless remained somewhat cautious despite their high levels of profits, probably reflecting that the prolonged period of deflation is still fresh in their memories. Therefore, the risk that market volatility could lead to a deterioration in firms’ sentiment and bring about a setback in the conversion of people’s deflationary mindset, which had been underway, should not be underestimated. It was in order to preempt the manifestation of such risk and to maintain the momentum toward achieving the price stability target that the Bank decided on further monetary easing through “QQE with a Negative Interest Rate.” Let us return to the mechanism of monetary easing considered earlier (Chart 3). Through “QQE with a Negative Interest Rate,” the Bank’s aim is to lower the short end of the yield BIS central bankers’ speeches curve by applying a negative interest rate of minus 0.1 percent to part of financial institutions’ current account balances at the Bank of Japan. In combination with large-scale purchases of JGBs, the Bank can exert even stronger downward pressure on interest rates across the entire yield curve, resulting in lower real interest rates. Some argue that the negative interest rate policy has shifted the Bank’s policy focus from the quantitative to the interest rate aspect. This is not the case. Rather, “QQE with a Negative Interest Rate” further boosts the effects of existing policy measures by directly pushing down the short-end of the yield curve. In this sense, it can be called “enhanced QQE.” As I mentioned earlier, in the debate on monetary policy, the zero lower bound on nominal interest rates has traditionally been regarded as insurmountable. Since a negative interest rate implies that the borrower receives interest while the lender has to pay interest, it is something that under normal circumstances is highly unlikely. However, the experience of some central banks in Europe in recent years has shown that it is possible to have negative interest rates between institutional players in financial markets by applying a negative interest rate on financial institutions’ current accounts held at the central bank. The policy framework adopted by the Bank of Japan follows the example of the frameworks adopted by European central banks but includes some modifications reflecting the specifics of Japan’s financial system. In designing a policy framework to overcome the zero lower bound, a key challenge is that a negative interest rate potentially has adverse effects on the profitability of the banking sector. The reason is that private banks will end up holding assets, including current accounts at the Bank of Japan, that have a negative yield. Given that income from yield spreads – such as the difference between yields on loans and deposits – represents financial institutions’ main source of earnings, the negative interest rate policy potentially reduces their profitability. Yet, the banking sector plays a key role in the transmission of monetary policy in that it acts as an intermediary between those that have surplus funds and those that have a deficit of funds; therefore, if the negative interest rate policy were to excessively reduce financial institutions’ earnings and undermine the stability of the financial sector, it would make them more reluctant to lend or lead them to demand higher lending rates, which would potentially weaken their functioning as financial intermediaries and thus impair the effects of monetary easing. That being said, there is no danger of this happening in Japan. One reason is that Japan’s financial institutions have a sufficient capital buffer, since they were barely affected by the global financial crisis. In addition, credit costs have declined significantly, since amid the continued economic recovery the number of bankruptcies has declined to a very low level. In fact, not only major banks but also regional banks have registered profits close to record levels despite the low interest rate environment. Moreover, the Bank of Japan carefully calibrated the framework in order to ensure that the negative interest rate policy does not excessively reduce financial institutions’ profits and hence undermine the transmission of monetary policy. Specifically, it adopted a three-tier system in which current accounts held by financial institutions at the Bank are divided into tiers with different interest rates, namely, plus 0.1 percent, 0 percent, and minus 0.1. Moreover, the Bank caps the amount to which the negative interest rate is applied by adjusting the tier to which an interest rate of 0 percent is applied (Chart 9). This is a practical application of the basic principle taught in introductory economics (Econ 101) that prices are determined by marginal costs, not average costs. Put differently, what matters in the formation of interest rates is the cost of a one unit increase in a financial institution’s current account balance. Roughly speaking, the total of financial institutions’ current account balances at the Bank is somewhat less than 300 trillion yen, and the tier to which the negative interest rate is applied is about 10 to 30 trillion yen – that is, no more than one tenth of the present entire balance. The Bank continues to apply an interest rate of 0.1 percent to a portion of current account balances roughly corresponding the average balances financial BIS central bankers’ speeches institutions held in 2015, which amount to about 200 trillion yen. Under this framework, the direct impact on financial institutions’ profits of the negative interest rate is minimized, while the policy still produces its intended effects on interest rates in financial markets. In fact, the impact of the policy is already clearly visible in developments in JGB yields. Interest rates across the entire yield curve have declined further, with rates up to a maturity of about 10-years having become negative (Chart 10). Benchmark rates for business lending as well as interest rates on housing loans have also declined. Moreover, recently CP with a negative yield has been issued. Going forward, the effects of the negative interest rate policy are likely to steadily spread to the real economy and inflation. In sum, “QQE with a Negative Interest Rate” is a very powerful framework enabling the Bank to pursue monetary easing by combining a negative interest rate with quantitative and qualitative easing. The Bank will continue with “QQE with a Negative Interest Rate,” 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 risks to economic activity and prices, and will not hesitate to take additional easing measures in terms of three dimensions – quantity, quality, and the interest rate – if it is judged necessary for achieving the price stability target. It is probably no exaggeration to say that “QQE with a Negative Interest Rate” represents the most powerful monetary easing in modern central banking history. The Bank of Japan will achieve the price stability target of 2 percent for sure by making full use of “QQE with a Negative Interest Rate.” Conclusion Central banks around the world currently are facing an unprecedented challenge: to firmly anchor inflation expectations amid strong downward pressure on prices while almost having exhausted the traditional monetary policy tool of lowering short-term interest rates. In the United States, thanks to the Federal Reserve’s decisive and timely conduct of monetary policy, the economy has been recovering steadily and inflation expectations have remained anchored; yet, with wage growth and inflation not as strong as the tightening of labor market conditions might suggest, the process of normalizing interest rates is attracting close attention globally. Meanwhile, in Europe, the ECB in March this year decided to take additional easing measures in order to deal with increasing risks to the price stability target, pointing to the importance of avoiding second-round effects of low inflation rates on inflation expectations. Under these circumstances, Japan’s experience of fighting prolonged deflation should provide a valuable case study for the central banks of other advanced economies in finding appropriate monetary policy responses. Throughout their long history, central banks around the world have overcome various difficulties by learning from each other’s experience and coming up with innovative solutions. I am convinced that, through their wisdom and will, central banks will continue to fulfill their mission of ensuring price stability in this changing and challenging world. Thank you very much for your attention. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chosa Kai (Research Institute of Japan), Tokyo, 13 May 2016.
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Haruhiko Kuroda: Outlook for Japan’s economy and challenges to achieving the price stability target of 2 percent Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting held by the Naigai Josei Chosa Kai (Research Institute of Japan), Tokyo, 13 May 2016. * * * Introduction It is my great honor to have the opportunity to address you today at the Naigai Josei Chosa Kai. I would like to express my sincere condolences to the victims of the Kumamoto Earthquake and offer my heartfelt sympathies to those who are suffering. The Bank of Japan continues to provide its central banking services seamlessly following the earthquake – including the supply of cash and business operations at teller windows in its Kumamoto Branch as well as the operation of the Bank of Japan Financial Network System (BOJ-NET) used for funds settlement among banks – and is making efforts to maintain the financial infrastructure. With the support and cooperation of relevant parties, most of the branches of the financial institutions in the disaster area have been able to resume their operations, and the financial and settlement systems there are functioning in an organized manner. At the Monetary Policy Meeting (MPM) held in April 2016, the Bank decided to introduce a funds-supplying operation for financial institutions in disaster areas affected by the Kumamoto Earthquake at a total loan amount set at 300 billion yen, with a view to supporting them in their efforts toward meeting demand for funds for restoration and rebuilding. This operation will surely contribute to backing the restoration and rebuilding. The Bank introduced “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” at the January 2016 MPM. Since the turn of the year, global financial markets have been volatile against the backdrop of the further decline in crude oil prices and uncertainty such as over future developments in emerging and commodity-exporting economies, particularly the Chinese economy. Meanwhile, there was an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected. In order to preempt the manifestation of this risk and to maintain momentum toward achieving the price stability target of 2 percent, the Bank judged it necessary to implement an extremely powerful policy scheme. In fact, following the introduction of “QQE with a Negative Interest Rate,” the policy effects on interest rates already have been seen; namely, a substantial decline in the Japanese government bond (JGB) yields and resulting declines in benchmark rates for business lending and in interest rates on housing loans. Going forward, these effects are likely to steadily spread to both the real economy and the price front. However, uncertainty over emerging economies has been strong and volatile developments in financial markets, including the stock market and yen exchange rates, have continued to be seen. Today, I would like to first explain the Bank’s view on Japan’s economic activity and prices under this situation and then elaborate on how it is going to implement the new policy framework of “QQE with a Negative Interest Rate.” I. Current situation of Japan’s economic activity and its outlook Developments in the corporate sector Let me start by discussing the current situation of Japan’s economic activity and its outlook. At the MPM held in April, the Bank released the Outlook for Economic Activity and Prices (Outlook Report) and published its projections for Japan’s economic activity and prices through fiscal 2018. I would like to give you the overview of this Outlook Report. BIS central bankers’ speeches Developments in the corporate sector to date show that the pick-up in exports has paused recently due to the slowdown in overseas economies. As for business sentiment, manufacturers have become cautious mainly in the sectors that are closely linked to emerging economies, and the pace of improvement in corporate profits of manufacturers seems to have decelerated. On the other hand, nonmanufacturers’ profits have followed a clear rising trend, partly because the decline in crude oil prices has led to an improvement in the terms of trade; thus, current profits in the corporate sector as a whole have remained at high levels. Firms maintain their positive stance toward fixed investment on the back of the high corporate profits. According to business fixed investment plans shown in the March 2016 Tankan (Short-Term Economic Survey of Enterprises in Japan), investment made both by large and small firms in fiscal 2015 is likely to have increased on a year-on-year basis by about 10 percent and about 4 percent, respectively. Moreover, the plans for fiscal 2016 are relatively favorable (Chart 1). With regard to the outlook for overseas economies, advanced economies are likely to continue to see a firm recovery trend, mainly in the United States. Meanwhile, emerging economies are expected to remain in a state of deceleration for the time being, but move out of their deceleration phase with positive effects of firm growth in advanced economies spreading. The Chinese economy is likely to broadly follow a stable growth path, albeit at a somewhat reduced pace, as authorities – having relatively large room for monetary and fiscal policy – have proactively been carrying out economic stimulus measures. Against this background, Japan’s exports are projected to head toward a moderate increase, although sluggishness is likely to remain for the time being. In the meantime, business fixed investment is projected to continue to see a moderate uptrend, mainly due to continued high levels of corporate profits along with the further decline in real interest rates under “QQE with a Negative Interest Rate,” an increase in growth expectations, and a rise in demand related to the 2020 Tokyo Olympic and Paralympic Games. Improvement in the employment and income situation, and wide-spread wage increases I would next like to explain developments in the household sector. Favorable corporate profits have steadily exerted positive effects on the employment and income situation. The tightening trend of labor market conditions is becoming clearer: the active job openings-toapplicants ratio has been 1.30 times recently, marking the highest level seen since 1991, and the unemployment rate has declined to 3.2 percent, which is the lowest level seen since 1997 (Chart 2). A perception of labor shortage suggested by the employment conditions DI in the March Tankan has heightened further, which can be regarded as full employment. The major feature of recent economic activity is that labor market conditions continue to tighten despite the sluggishness observed in exports and production. In this situation, upward pressure has continued to be exerted on wages (Chart 3). In this spring’s labor-management wage negotiations, or so-called shunto, it is almost certain that base pay will be raised for a third consecutive year. Although the rise in large firms is likely to be somewhat less than that of last year, wage increases seem to be spreading to small firms and non-regular employees, including part-time employees. This can be explained by the fact that, at small firms, mobility of employment is relatively high and wages are susceptible to the effects of labor market conditions. In addition, firms continue to be willing to return their profits to their employees in the form of bonuses. Thus, the high corporate profits have continued to positively affect employee income. Against the background of steady improvement in the employment and income situation, private consumption has been resilient, although relatively weak developments have been seen in some indicators, due in part to a deterioration in consumer sentiment, reflecting volatile developments in financial markets. Private consumption is likely to increase moderately as the employment and income situation continues improving. BIS central bankers’ speeches Outlook for economic activity presented in the April Outlook Report Turning to the outlook for Japan’s economic activity based on the developments explained so far, although sluggishness is expected to remain in exports and production for the time being, domestic demand is likely to follow an uptrend, and exports are expected to increase moderately on the back of emerging economies moving out of their deceleration phase. Thus, Japan’s economy is likely to be on a moderate expanding trend. Taking into account the fluctuations due to a front-loaded increase and subsequent decline in demand prior to and after the consumption tax hike planned in April 2017, the expected growth rates during the projection period are in the range of 1.0–1.5 percent for fiscal 2016, slightly positive for fiscal 2017, and about 1 percent for fiscal 2018 (Chart 4). Comparing the current projections through fiscal 2017 with those in the January 2016 Outlook Report, GDP growth is somewhat lower, influenced mainly by weaker exports that reflect the slowdown in overseas economies. II. Current situation of prices and their outlook Next, I will touch on price developments. The year-on-year rate of change in the consumer price index (CPI, all items less fresh food), which had been minus 0.5 percent just before the introduction of QQE, increased to as high as 1.5 percent in April 2014, excluding the effects of the consumption tax hike. However, as private consumption continued to be relatively weak after the consumption tax hike and as a result of a substantial fall in crude oil prices since summer 2014, the year-on-year rate of change has declined and currently is around 0 percent (Chart 5). Nevertheless, excluding the effect of the decline in energy prices, the underlying trend in inflation has improved steadily. For example, the year-on-year rate of change in the CPI for all items excluding fresh food and energy has remained positive for 30 consecutive months since October 2013, and was 1.1 percent in March 2016. This is the first time since the late 1990s, when Japan’s economy fell into deflation, that sustained price increases have been seen. Monthly data for the CPI are susceptible to various factors, such as developments in import prices that reflect changes in energy prices and fluctuations in foreign exchange rates. Therefore, an assessment that takes account of the underlying trend in inflation and economic developments behind such trend is necessary in the Bank’s monetary policy management. To this end, the output gap, which is one of the factors that determine the underlying trend in inflation, is more or less unchanged, as the tightening of labor market conditions has continued while an improvement in manufacturers’ capacity utilization rates has been delayed against the background of the sluggishness in exports and production. Going forward, the output gap is expected to move into positive territory and gradually increase further from the second half of fiscal 2016, albeit with fluctuations due to the frontloaded increase in demand prior to the consumption tax hike, with an increase in capacity utilization rates as exports and production are likely to pick up. Thus, upward pressure on wages and prices due to the tightening of supply-demand conditions is likely to steadily increase. Medium- to long-term inflation expectations, which represent another determinant of the underlying trend in inflation, have weakened recently, although they appear to be rising on the whole from a somewhat longer-term perspective. Market indicators – such as break-even inflation (BEI) rates calculated using yields of inflation-indexed JGBs – as well as results of various surveys conducted of households, firms, market participants, and economists imply that inflation expectations have been declining since end-2015. In Japan, where, unlike the United States and Europe, inflation expectations are not anchored firmly at 2 percent, these indicators tend to be largely affected by the observed inflation rate, financial market sentiment, and developments in crude oil prices. When assessing developments in inflation expectations, it is necessary to grasp firms’ actual wage- and price-setting behavior as well. On this point, firms have maintained their willingness to increase prices since last year in spite of low all-item CPI inflation due to the decline in energy prices. Consumers seem to be BIS central bankers’ speeches accepting the price increases, benefitting from an improvement in the employment and income situation. Taking anecdotal evidence into account, firms seem to be maintaining their willingness to increase prices in a situation where a base-pay rise for a third consecutive year is likely to be confirmed. The mechanism in which inflation rises moderately accompanied by wage increases has been operating steadily. Looking ahead, as the Bank pursues “QQE with a Negative Interest Rate” and the observed inflation rate rises, medium- to long-term inflation expectations are also likely to follow an increasing trend and gradually converge to around 2 percent – the price stability target. Against this backdrop, firms’ wage- and price-setting stance is likely to shift further toward raising wages and prices, and with an acceleration in wage increases, inflation rates are expected to rise gradually. Specifically, the year-on-year rate of change in the CPI (all items less fresh food) is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices, and, as the underlying trend in inflation steadily rises, accelerate toward 2 percent. Meanwhile, assuming that crude oil prices will rise moderately from the recent level, it is likely that the contribution of energy items to the year-on-year rate of change in the CPI will decrease gradually from the current level of slightly more than minus 1 percentage point, but remain negative until the beginning of fiscal 2017. Based on this assumption, the timing of the yearon-year rate of change in the CPI reaching around 2 percent – the price stability target – is projected to be during fiscal 2017. Thereafter, the year-on-year rate of change in the CPI is likely to be around 2 percent on average. As shown in the April 2016 Outlook Report, the projected rate of increase in the CPI for fiscal 2016 is 0.5 percent, and excluding the direct effects of the scheduled consumption tax hike, those for fiscal 2017 and 2018 are 1.7 percent and 1.9 percent, respectively (Chart 4). Comparing these projections with those in the January 2016 Outlook Report, the projected rate of increase in the CPI for fiscal 2016 is lower, mainly reflecting downward revisions in projections for real GDP growth and wage developments, but that for fiscal 2017 is more or less unchanged. III. Risk factors regarding the outlook for economic activity and prices Risks to economic activity: uncertainties surrounding overseas economies Thus far, I have explained the baseline scenario of the outlook for economic activity and prices that the Bank considers most probable. From now on, I will explain risk factors that could affect the baseline scenario. The most important risk factor regarding the outlook for economic activity would be developments in overseas economies. The outlook for emerging economies, particularly China, and commodity-exporting economies, including countries in the Middle East, Brazil, and Russia, remains uncertain. The Chinese economy is likely to follow a generally stable growth path, underpinned by proactive economic stimulus measures by the authorities, but if adjustments in excess production capacity are prolonged, that may delay the recovery of the emerging economies, particularly those in Asia, mainly through the trade channel (Chart 6). Meanwhile, although anxiety over crude oil prices marking a bottom has waned recently, uncertainty over both the demand and supply sides remains heightened (Chart 7). In addition, attention continues to be warranted on developments in the U.S. economy and the impact on global financial markets of expectations over the pace of future rate hikes by the Federal Reserve in reflection of the developments in the economy. Europe faces uncertainty regarding such factors as the outcome of the debt problem in Greece and other countries as well as the possibility of the United Kingdom leaving the European Union – so-called Brexit. If these risks were to materialize, there is a possibility that firms’ positive stance toward investing in physical and human capital might be restrained through the effects of business confidence, and this point continues to warrant attention. BIS central bankers’ speeches Risks to prices One of the risk factors specific to prices is developments in medium- to long-term inflation expectations. The baseline scenario of the April 2016 Outlook Report assumes that, amid rises in observed inflation accompanied by wage increases, people’s inflation expectations will rise further and gradually converge to around 2 percent – the price stability target. However, the pace of any future increase in wages and inflation expectations is uncertain during a prolonged period of low energy prices and no visible rises in annual all-item CPI inflation. In this regard, the following factors indicate that progress is being made in terms of dispelling the deflationary mindset – that is, the entrenched view that wages will not rise: (1) the certainty that a base pay increase will be achieved for a third consecutive year in this year’s shunto and (2) the spread of wage increases to small firms. This progress is an encouraging change toward overcoming deflation. At the same time, this year’s base pay increase is viewed as being somewhat less than last year’s rise, mainly at large firms; therefore, the pace of wage increases is not felt at present as accelerating. Factors such as the slowdown in overseas economies and volatile developments in global financial markets since the turn of this year seem to have made firms hesitate to take one step forward. Based on the fact that corporate profits remain at historical high levels and that labor shortages have been heightened under a “full-employment” condition, while the labor share remains below the long-term trend, wage increases may well be projected to accelerate. It is strongly expected that firms will proactively invest in human capital based on the prospects of a post-deflationary economy. As I explained earlier, the Bank is of the view that the mechanism in which inflation rises moderately accompanied by wage increases has been operating steadily. As wage increases have been spreading to small firms, firms as a whole seem to have maintained their willingness to increase prices even after the turn of this fiscal year. Depending on consumers’ attitude toward price increases, firms’ price-setting stance could be positively or negatively affected. The Bank will carefully assess the developments in CPI after April without preconception. IV. The Bank’s monetary policy management Lastly, I will explain the Bank’s monetary policy. The Bank introduced “QQE with a Negative Interest Rate” at the end of January. Since then, yields on JGBs declined significantly, with rates up to a maturity of over 10 years having turned negative. Benchmark rates for business lending and interest rates on housing loans also declined clearly. Specifically, lending rates on 10-year fixed-rate housing loans have fallen to a level below 1 percent. In the March Tankan, financial institutions’ lending attitudes as perceived by firms have improved further following the introduction of the negative interest rate policy, and firms’ perception of borrowing costs is that these have declined notably to a degree that has not been seen for years (Chart 8). Issuance rates on CP and corporate bonds also have declined. A number of CPs have been issued with around zero interest rates, or even with negative rates in some cases, while long-term corporate bonds – with a maturity of ten years or longer in particular – are being issued with ultra-low rates recently (Chart 9). As such, the policy effects already have materialized in the form of declines in interest rates. These effects are expected to steadily spread to the real economy and inflation. Firms find themselves in an environment in which interest rates have never been lower. The financial conditions suggest that they face a once-in-a-lifetime chance for investment. Bearing this fact in mind, I acknowledge that firms’ investment decisions critically should depend on the prospects for profitability of each project, which could be formed based on the outlook for medium- to long-term macroeconomic developments – in other words, growth expectations. In this context, unarguably, expanding the business frontier through, for example, regulatory reform is being called for to enhance said expectations. That said, it is by far the least convincing argument that the potential growth rate and growth prospects are BIS central bankers’ speeches too low for the economy to be stimulated by the current real interest rates, which are substantially negative. Looking at some specific data, Financial Statements Statistics of Corporations by Industry, Quarterly points to firms’ profitability in terms of return on assets (ROA) at somewhere around 4 percent while average interest payments amount to only about 1 percent (Chart 10). Firms’ ROA exceeds their funding cost by a larger margin than ever before. Among other points of evidence, we can reaffirm our progress made in the past three years. That is, negative real interest rates in fact have spurred the economy and raised prices significantly. As a result, we have come to a situation where the economy is no longer deflationary. Even in normal cases, it takes some time to see the penetration of monetary policy effects. In circumstances such as those in evidence today, where global financial markets remain volatile, partly due to uncertainties regarding the outlook for emerging and commodityexporting economies, it could be even more difficult for positive changes to emerge. Against this backdrop, at the April MPM, the Bank judged that it would be appropriate at present to examine the extent of the penetration of policy effects. To be clear, I am not saying that the Bank will stand pat until the policy effects can be confirmed. Rather, I would like to offer reassurance regarding the strength of monetary policy. Namely, we will take monetary policy measures in a timely, forward-looking manner. Risks to the outlook are tilted to the downside owing to (1) uncertainty over the global economy, particularly emerging economies, (2) volatile developments in financial markets, and (3) the repercussions on business sentiment. The Bank will continue to carefully examine these risks to economic activity and prices at each MPM, and take additional easing measures without hesitation in terms of three dimensions – quantity, quality, and the interest rate – if it is judged necessary for achieving the price stability target. “QQE with a Negative Interest Rate” is an extremely powerful policy scheme and there is no doubt that ample space for additional easing in each of these three dimensions is available to the Bank. It will carefully consider how to make the best use of the policy scheme in order to achieve the price stability target of 2 percent, and will act decisively as we move on. 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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Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Conference on Retail Payments, Tokyo, 12 May 2016.
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Hiroshi Nakaso: Central bank policy on financial market infrastructure Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Conference on Retail Payments, Tokyo, 12 May 2016. * * * Introduction It is a great pleasure to welcome you all today to this Conference on Retail Payments. Today, I would like to say a few words on the Bank of Japan’s views on policies related to financial market infrastructures (FMIs), including payment and settlement systems, in light of innovations in information technology that have brought about various innovations in payments. For every central bank, payment and settlement are its primary functions. Many central banks, including the Bank, were established to stabilize payment and settlement systems as a single issuer of the currency. Compared to such history of central banks’ deep involvement with payments and settlements, history of monetary policy for macro-management of aggregate demand is fairly new. After the recent global financial crisis, various initiatives have been introduced at international forums over FMIs including payment and settlement systems. Moreover, in line with development of information technology and various financial innovations, which are often referred to as “FinTech”, the frontier of the policies related to FMIs is rapidly expanding, and has become a major policy field that could be called “financial market infrastructure policy (FMI policy)” for central banks around the world. In order to ensure the stability and enhance the efficiency of FMIs as a whole, it is important not only to ensure stability of individual players including financial institutions, but also to understand complicated interactions and market dynamics among these players as well as the impacts of technological innovations, and to fully mobilize available policy toolkits of the central bank. For central banks, FMI policy is deemed as “the oldest and the newest” policy field, which is also intellectually challenging. I. Origin and evolution of central bank policy on FMIs The role of money in the economy “Money”, like “language”, is undoubtedly one of the greatest of human inventions. Language has enabled human beings to share knowledge among others and wisdom across generations and has played a critical role in developing civilizations. Similarly, money has enabled human beings to exchange goods and services “across space” and “over time”, and has served as a foundation for the development of an economic society. The transmission mechanism of monetary policy, too, is ultimately dependent on the fact that money has enabled us to exchange expenditures over time. The exchanges via money is build upon a “chain of trust” among human beings The reason why I can purchase goods with money is because the recipient believes that it can be used for its own payments and will be accepted by unknown others. As such, the fact that human beings were able to create a chain of trust among many others, including among those with no personal acquaintance, was the key to the development of an economic society. This shows how important “trust” is for the payment system and the economy. BIS central bankers’ speeches Central banks and payments infrastructure To put it in another way, one break in the chain of trust could have a catastrophic impact on the payment system and the overall economy. Indeed, many central banks, including the Bank, were founded with the aim of restoring and maintaining confidence in payment systems when people’s trust in them were about to be lost or damaged, which also shows that payments and settlements are inherently the primary function of central banks. The central banks’ other core functions – such as the lender of last resort and monetary policy – are also ultimately based on the ability of central banks to provide, without constraints, central bank money, which provides “finality” to payments and settlements in a sense that receivers of central bank money do not have to worry about payment unwinding or its credit risks any more. Such power also gives central banks the ability to influence real interest rates, which are regarded as the “rate of exchange” on expenditures exchanged over time, as a foundation of monetary policy. Most central banks around the world, including the Bank, support economic activities by issuing banknotes and operating large-value payment and settlement systems, which constitute basic infrastructures of the economy. Following the emergence of money in the form of banknotes and coins, various types of payment instruments, including checks, bank transfers, credit cards, debit cards, and e-money, have emerged to meet people’s evolving needs. At the same time, the role of central bank payment and settlement infrastructure is playing a more important role in light of economic developments and innovations in information technology, since the central bank is the only entity to be able to settle more diverse and complex transactions with finality. Payment infrastructures intrinsically have the characteristics of a “network”. The value of participating in a network increases as more participants use it. At the same time, a single payment failure could spill over across the network, potentially leading to systemic crisis. Moreover, participation in the network by a high risk profile member could increase the risk for all others. Given such characteristics, central banks, including the Bank, determine the range of participants to be granted access to its payment infrastructures, ensure the soundness of those participants through on-site examinations and off-site monitoring, and, where necessary, serve as the lender of last resort to avoid negative spill-overs and systemic crisis. Another important contribution to the economy by central banks is to enhance the safety and efficiency of the payment and settlement systems they operate. The Bank has made continuous efforts also in this regard. Indeed, a number of improvements have been made to the BOJ-NET over time, including the adoption of delivery-versus-payment (DVP) and realtime gross settlement (RTGS). Liquidity-saving features have also been introduced with the aim of enhancing efficiency while avoiding payment delays. Furthermore, in October 2015, the new BOJ-NET was fully launched, with its operating hours extended to 9 p.m. in February 2016. II. Frontiers of FMI policy The financial crisis and FMI policy – the importance of interactions and market dynamics The global financial crisis, triggered by the Lehman Crisis in 2008, put payment and settlement systems under the spotlight of international debates, and frontiers of FMI policy have been expanding. The FMIs as a whole could be regarded as an “eco-system”, since they have similar interconnectedness, complexities and interactions as biological ecosystem. Policymakers including central banks are increasingly asked to grasp those complicated interactions and market dynamics among various players as well as the impacts of technological innovation, and to maintain not only the soundness of individual players but BIS central bankers’ speeches also the stability of whole FMIs as an eco-system, with making full use of all the available policy tools. At the Pittsburgh Summit in 2009, G-20 leaders agreed that all standardized over-the-counter derivatives contracts should be centrally cleared at central counterparties (CCPs). This agreement was one example of the expanding frontier in that the policymakers took a step forward to consider the “structure” of post-trade processing of financial transactions, in addition to the risks in individual transactions or counterparties. Stepping into unexplored policy areas raises a number of intellectually challenging issues. For example, central clearing might accompany the accumulation of risks in CCPs and make CCPs “too-big-to-fail.” There are also issues of “trade-off”, in a sense that a CCP’s call for its participants to provide additional capital or liquidity in times of market-wide stress could weaken the capital and liquidity positions of those participants. Similarly, terminating membership of a financially troubled participant would make the recovery of the participant difficult, while maintaining its membership could increase risks for other participants and the CCP itself. Moreover, a CCP’s efforts to enhance its stability by collecting an extra layer of margin could undermine the incentives of participants to make use of CCPs, possibly increasing aggregate risks in the overall market. Adding on to such complex challenges is the perspective of globalization. Also on this front, there emerge many issues, such as what should be the appropriate framework for international oversight of CCPs operating across borders, how liquidity shortages at crossborder CCPs dealing with multiple currencies should be addressed, and how central banks should contribute to the resolution of those issues. Various international forums also recognize the importance of good understanding of complex interactions and market dynamics by central banks and policymakers in enhancing stability and efficiency of FMIs as an eco-system. In 2012, the Committee on Payment and Settlement Systems (CPSS) – which is now the Committee on Payments and Market Infrastructures (CPMI) – of the Bank for International Settlements and the Technical Committee of the International Organization of Securities Commissions (IOSCO) published the “Principles for Financial Market Infrastructures (PFMIs).” Since then, effective framework has been developed for central banks and other authorities to ensure, through their oversight and international peer reviews, that FMIs including payment and settlement systems meet the PFMIs. The Bank is actively engaged in this initiative as an overseer of FMIs in Japan. Innovations in information technology and FMI policy Continuous efforts are being made to develop, enhance and sophisticate FMI policy. In recent years, in accordance with innovation in information technology and rapid popularization of internet, mobile phones and other digital outlets, wide-ranging financial innovations, which are often referred to as “FinTech”, have been taking place. In such an environment, central banks and other policymakers need to grasp the impacts of those technological innovations on financial architecture and FMIs, and to make full use of the benefits of those innovations while effectively addressing any new risks. The safety and efficiency of FMIs including payment and settlement systems have always been closely linked to the information technology of the time. For example, many of the operational practices and security features of traditional financial instruments, such as banknotes, paper securities and ledgers, have been to a large extent based on paper-based and printing-related technologies. For example, the security of banknotes is reliant on paperbased anti-counterfeit features such as watermarks and holograms, and bill and check clearing houses were established to facilitate and reduce the burden of their physical delivery. Given that the financial service industry has strong characteristics as an “information industry,” it is not surprising that innovations in information technology have a particularly large impact on financial services and infrastructures. FMIs including payment and BIS central bankers’ speeches settlement systems have been all the more characterized as “information infrastructures” for recent developments in information technology. With “FinTech” developments, which combine finance and information technology, financial services are expanding their frontiers, while new players are venturing into the financial services market. Such dynamics are also evidenced by the rich variety of participants attending today’s conference. Innovations in financial services and FinTech have significant potential to bring wide-ranging benefits to the overall economy by expanding also the frontier of economic activities, including e-commerce, sharing economies, big data processing, smart contracts and IoT (internet of things). At the same time, FinTech may also have the potential of drastically reshaping the forms of financial services and financial architecture. Traditional financial infrastructure is built around “centralized ledgers,” where banks have managed ledgers of deposits and other financial products. On the other hand, “blockchain” and “distributed ledger” – technologies underpinning digital currencies such as “Bitcoin” – are considered as enabling to keep ledgers in a de-centralized manner without relying on a trusted third parties to manage ledgers. Owing to such characteristics, blockchain and distributed ledger have attracted considerable attention, since international forums are focusing on their potential to be applied to wide-ranging businesses and practices. The application of those technologies would also change the structure of the financial infrastructure that has been built around centralized ledgers managed by trusted third parties. Thus, central banks will and have to follow these issues closely and with great interest. FinTech has also the potential to unbundle and reconstruct various financial services. For example, there may be payment-related services having substantial synergies with services provided by non-financial businesses such as e-commerce and big data processing. As a result of exploitation of “economies of scale” under technological innovations, new players may become the providers of new services that incorporate financial solutions. Moreover, it could be considered that such changes in financial architecture may change the risk profiles of financial systems and infrastructures. Commercial banks have long been the main provider of payment services. Commercial banks, based on their deposit-taking as the core of their services, have kept on providing both financial intermediations such as lending through maturity transformation and payments services. Various financial infrastructures were built around such structure of commercial banking. For example, access to the current account at central banks, including the Bank, have been provided primarily to commercial banks and other depository institutions. The risk of “bank-runs,” which stems from maturity transformation by commercial banks, has been considered as the main trigger of systemic crisis. Reflecting the above, central banks have traditionally been assumed to provide its “lender of last resort” function mainly to commercial banks and other depository institutions. Since more and more non-financial institutions are providing payment services under “FinTech” developments and there seem to be structural changes in the supply-side of financial services, however, risk profiles might also change from those originally assumed. For example, it is hard to assume the risk of bank-runs in “crowd-funding”, which directly matches demand and supply of funds through the internet, and in remittance services that are fully covered by deposits. Deputy Governor Ben Broadbent of the Bank of England pointed out in his speech in March the possible shift towards a risk profile that traditional debates on “narrow banking” or “free banking” suggested due to the application of technological innovation to finance. 1 On the other hand, with the expansion of access points Ben Broadbent, “Central banks and digital currencies” (speech made at London School of Economics on March 2, 2016). BIS central bankers’ speeches to financial services through the popularization of internet, mobile phones and other digital outlets, there are risks that would require higher attention, such as cyber attacks and hacking against vulnerabilities on information security. III. Bank of Japan’s FMI policy Taking into account the above-mentioned technological innovation, the Bank has been actively enhancing the stability and the efficiency of Japan’s FMIs by utilizing various policy tools. They include providing banknotes and BOJ-NET as basic infrastructures to the economy, conducting on-site examination and off-site monitoring of financial institutions, oversight against FMIs including payment and settlement systems, and playing a “catalyst” role to facilitate communication among wide-ranging players involved in FMIs. Under globalization of the economy and technological innovations, more and more transactions and payments are being made across borders and time zones, and more diverse players are now providing payment-related services. One of the challenges for private-sector entities to provide payment services related to global cash management and e-commerce is how to deal with unsettled exposures that arise from time-zone differences and payment operations at night hours and on weekends. Central bank money is the solution that would ultimately erase these unsettled exposures through settlement with finality, but providing central bank infrastructure also involves costs. In taking both possible benefits and costs in account, the Bank will continue to consider the most appropriate way to provide its central bank accounts and BOJ-NET from both “time” (i.e. operation hours of the BOJ-NET) and “space” (i.e. eligibility criteria of the Bank’s accounts), so as to contribute to the overall economy. Besides, banknotes are payment instruments that all the people can use 24/7, and under the innovation in information technology, there emerges an issue about whether central banks themselves should provide, in the future, digitalized payment tools that would substitute paper-based banknotes. Indeed, some central banks have recently mentioned the possibility of central banks’ issuing digital currencies, and there are arguments that central banks’ digital currencies would be similar to the provision of central bank accounts not only to financial institutions but also to the general public. 2 The Bank does not have a specific plan to issue digital currencies at this stage, but will deepen its research and analytical activities so as to understand the impact of technological innovations, FinTech and distributed ledger on financial architectures and FMIs while keeping all options open, including the possibility of the Bank’s utilizing such advanced technologies in its own operations in future. Moreover, taking into account the importance of the people’s “trust” towards financial services and FMIs, the fact that the Japanese financial system has maintained its stability during the recent global financial crisis could be a great advantage in developing innovative financial services in Japan. On the other hand, as access to financial services expands through internet and mobile devices, new types of threats to financial systems and infrastructures, such as hacking and cyber-attacks, are gaining prominence. In order to maintain people’s trust towards financial infrastructures and innovative financial services, relevant entities are strongly encouraged to take effective countermeasures against these new risks also by utilizing new technologies such as digitalized encryption and biometrics authentication. Furthermore, it is important to establish business continuity plans (BCPs) for FMIs with sufficiently conservative stress scenarios such as natural disasters and acts of terrorism. The Bank will work to deal with these important tail risks on FMIs. At the recent As documents mentioning the possibility of central banks’ issuing digital currencies, see, for example, Andrew Haldane, “How long can you go?” (speech given at the Portadown Chamber of Commerce on September 18, 2015 http://www.bankofengland.co.uk/publications/Pages/speeches/2015/840.aspx) and the document published by the People’s Bank of China on January 20, http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3008070/index.html. BIS central bankers’ speeches earthquake in Kumamoto, the Bank’s Kumamoto Branch, other area branches and Tokyo Head Office took immediate and coordinated actions to firmly maintain the functions of financial infrastructures in the region through various efforts such as ensuring smooth supply of banknotes and funds settlement. The Bank will make use of those experiences so as to strengthen overall BCP strategy. In addition, in order to ensure the stability and enhance the efficiency of FMIs as a whole, including those operated by the private sector, it is important to cooperate with the private sector and encourage their efforts. Through the oversight of private-sector payment and settlement systems, the Bank will conduct monitoring and dialogues with these infrastructures, and when necessary, will strongly urge them to take actions to ensure the stability and enhance the functionality of these infrastructures. Furthermore, while more players with wider backgrounds have entered in the market of providing payment-related services, it has become important to facilitate interactive dialogue among wide-ranging entities beyond traditional financial industry, in order to make the expansion of the financial service frontiers under the technological innovations fruitful for the customers and the overall economy, and to enhance the stability and efficiency of FMIs. The Bank, as the nation’s central bank, is firmly committed to being a “catalyst” in fostering such developments, and the establishment of the Bank’s “FinTech Center” on April 1 is a part of such commitment. The Bank is ready to mobilize all the policy tools available while paying attention to interactions among various players involved in FMIs, market dynamics and impacts of technological innovations, and make maximum efforts as a central bank to enhance the stability and the efficiency of Japan’s financial infrastructure. I would like to close my remarks by wishing that today’s Conference on Retail Payments will generate fruitful discussions. 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 the Economic Conference to commemorate the 150th Anniversary of Diplomatic Relations between Italy and Japan "The Economics of Italy and Japan: Historical Development and Future Policies for Stability and Growth", co-hosted by Keio University and Bocconi University, Tokyo, 23 May 2016.
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Hiroshi Nakaso: Japan’s economy and the Bank of Japan – yesterday, today, and tomorrow Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Economic Conference to commemorate the 150th Anniversary of Diplomatic Relations between Italy and Japan “The Economics of Italy and Japan: Historical Development and Future Policies for Stability and Growth”, co-hosted by Keio University and Bocconi University, Tokyo, 23 May 2016. * * * Accompanying charts can be found at the end of the speech. Introduction It is a great honor to have the opportunity to speak to you today at this conference commemorating the 150th anniversary of the establishment of diplomatic ties between Italy and Japan. Moreover, I am grateful for the wide-ranging close relationship that has developed between the Bank of Italy and the Bank of Japan at all layers and am very happy to be able to speak with Senior Deputy Governor Rossi in this session. Personally, when I was a young boy, the legend of Romulus and Remus about the founding of Rome left a lasting impression on me, and ever since, I have been one of the many Japanese who are fascinated by Italy’s history, art, fashion, food, and football. The subtitle of today’s speech – “Yesterday, Today, and Tomorrow” – is chosen based on the title of the movie starring Sophia Loren and Marcello Mastroianni, which won the 1965 Academy Award for Best Foreign Language Film. Well, let me start with my speech today. As is well known, following the collapse of the bubble economy in the early 1990s, Japan’s economy suffered a prolonged period of low growth and deflation – what has come to be called the “Lost Decades.” The causes of the Lost Decades have been the subject of active debate among policy makers and economists alike, but until relatively recently, the associated issues were regarded as specific to Japan. However, since the 2008 global financial crisis, the United States and Europe also have faced the threat of low growth and deflation, giving rise to talk about a “Japanization” and renewed interest in Japan’s experience. In fact, when I glance at the economies of the euro area including Italy, I have to say I often have a sense of deja vu. Therefore, in my speech today, I would like to look back at Japan’s experience since the collapse of the asset bubble and the Bank of Japan’s policy responses to maintain the stability of the financial system as well as monetary policy. I will then go on to discuss the policy challenges for Japan as well as the implications of Japan’s experience for Europe today. I. Developments in Japan’s economy during the lost decades As is well known, Japan’s economy has been mired in stagnation since the 1990s. On the other hand, what is less well known, especially abroad, is that the challenges that Japan’s economy has faced during this prolonged stagnation have differed over time. Put simply, until the early 2000s, the main challenge consisted of dealing with the instability of the financial system and deleveraging in the banking sector brought about by the collapse of the asset bubble, and of resolving the so-called “three excesses” in the corporate sector, consisting of excess debt, excess capacity, and excess employment. However, these problems were essentially resolved by the early 2000s and a more serious challenge since the second half of the 2000s has been the decline in Japan’s growth potential and inflation expectations. The decline in both since the 1990s has been brought to the fore by the large decline in aggregate demand as a result of the global financial crisis. These two major challenges appeared in succession and it is mainly for this reason that Japan’s economic stagnation has been so prolonged. BIS central bankers’ speeches The collapse of the asset bubble, financial system instability, deleveraging, and the “three excesses” In the 1990s, Japan’s banking sector was riddled with a mountain of nonperforming loans resulting from the collapse of the 1980s bubble in real estate and stock prices. At the same time, Japan’s corporate sector was suffering from the “three excesses” just mentioned – excess debt, capacity, and employment – owing to the expansion of businesses driven by overly optimistic growth expectations. In 1997 through 1998, these problems led to the successive failure of major financial institutions, significantly impairing the functioning of financial intermediation and causing a sudden credit crunch (Chart 1). The economy contracted severely and the year-on-year rate of change in the consumer price index (CPI) fell into negative territory, marking the beginning of Japan’s prolonged, though moderate, deflation (Chart 2). The Bank of Japan responded to this financial crisis in Japan during the 1990s by acting extensively as lender of last resort. 1 Moreover, since the safety net was underdeveloped at that time, the Bank of Japan, in order to carry out its mission of ensuring the stability of the financial system, played the role that essentially should have been the responsibility of the government, had there been a robust financial safety net; specifically, in addition to supplying liquidity, the Bank took various extraordinary measures such as injecting capital to an ailing bank and setting up a bridge bank on its own. However, as a result, the Bank had the painful experience of recording credit losses reaching 200 billion yen. The crisis became obvious to everyone, and legislative steps to set up a safety net were finally taken. It was only in 1998, almost a decade after the collapse of the bubble, that a comprehensive framework for the temporary nationalization and the injection of capital using public funds was put in place. Under this framework, the resolution of failed banks progressed. Whereas the increase in the number of failed financial institutions in the late 1990s occurred under circumstances in which the underdeveloped safety net made it difficult to get the crisis under control, the spike from 2000 onward is proof of a systematic resolution of failed banks under the new framework (Chart 3). During this period, deleveraging in the banking sector and the resolution of the three excesses in the corporate sector continued. For example, the amount outstanding of bank lending, which stood at more than 500 trillion yen in the second half of the 1990s, fell below 400 trillion yen in the mid-2000s – a drop of more than 20 percent (Chart 1). The decline in bank lending through this deleveraging process finally came to an end in 2006, when bank lending rebounded. Moreover, in the same year, CPI inflation returned into positive territory, so that deflation temporarily receded (Chart 2). Fortunately, Japan had been able to avoid a 1930s-style deflationary spiral with a rapidly deteriorating economy and falling prices. Thus, by the mid-2000s, Japan’s economy had overcome the negative legacy of the asset bubble and appeared to have laid the foundations for renewed sustained growth. The decline in the growth potential and inflation expectations In fact, Japan’s economy did return to a growth trajectory, benefitting from the tailwind of a favorable global economy spurred on by rapid growth in China. However, triggered by the outbreak of the global financial crisis in autumn 2008, circumstances changed at a stroke. In contrast with Europe and the United States, the exposure of Japan’s financial sector to subprime mortgage-related financial products was limited and the financial system generally remained stable; however, the real economy, as a result of the significant slowdown of the global economy, could no longer rely on exports, the traditional engine of economic recoveries in Japan. Against this background, the decline in the potential growth rate came to the fore as For details on Japan’s experience during the financial crisis, see Hiroshi Nakaso, “The financial crisis in Japan during the 1990s: how the Bank of Japan responded and the lessons learnt,” BIS Papers No. 6, October 2001. BIS central bankers’ speeches a major economic challenge (Chart 4). 2 The decline in the potential growth rate reflects a slowdown in productivity growth since the collapse of the bubble economy, a decline in the labor force since the late 1990s due to demographic trends, and deceleration in the pace of capital accumulation. Meanwhile, on the price front, CPI inflation fell back into negative territory, and inflation expectations started to slide (Chart 2). With only little room to lower interest rates, it did not take much time for Japan to face the zero lower bound on interest rates again and real interest rates remained elevated. At the same time, in line with the falling potential growth rate since the 1990s, the natural rate of interest – that is, the interest rate at which the economy neither accelerates nor decelerates – had declined substantially (Chart 4). As a result, Japan’s economy fell into a situation in which it was difficult for the Bank of Japan to provide sufficiently accommodative financial conditions through an extension of policies that had been employed before. These economic difficulties were compounded by the Great East Japan Earthquake in 2011. II. Evolution of monetary policy during the lost decades Next, I would like to look back at monetary policies taken by the Bank of Japan from the start of the Lost Decades until recently. As the first central bank facing the aftermath of the collapse of a bubble and deflation, the Bank developed a range of new policy measures. These consist mainly of two measures that correspond to the challenges that the Bank faced at different points in time. The first measure was quantitative easing, QE for short, which concentrated on the provision of ample liquidity, while the second was quantitative and qualitative monetary easing, or QQE, which focused on raising inflation expectations (Chart 5). QE, which was implemented from 2001 to 2006, proved effective in that it maintained the stability of the financial system through the provision of ample liquidity and prevented Japan’s economy from falling into a deflationary spiral. However, it was not powerful enough to reverse the declining trend in inflation expectations and overcome deflation. As mentioned earlier, Japan’s natural rate of interest had been falling due to the decline in the potential growth rate; at the same time, real interest rates remained high due to the zero lower bound on nominal short-term interest rates and the decline in inflation expectations. As a result, QE did not provide sufficiently accommodative financial conditions. Under these circumstances, a vicious cycle of a decline in prices, a fall in sales and profits, restraint in wages, stagnation in consumption, and a further decline in prices took hold. This indicates that once the economy becomes stuck in a deflationary equilibrium, it is difficult to escape from it. From a theoretical perspective, the policy prescriptions are obvious. What is needed is to remove, once and for all, the deflationary mindset and raise inflation expectations – that is, to lower real interest rates – through decisive monetary easing, and to raise the potential growth rate – that is, to raise the natural rate of interest – through a growth strategy and deregulation. This, in fact, is exactly what the three arrows of Abenomics are aimed at. One can often hear discussions as to whether monetary easing or structural reforms are more important, but I do not see this is a particularly constructive question. Both are essential for overcoming deflation and achieving sustainable growth. It is not a question of either monetary easing or structural reforms – they are complementary to each other. With regard to the first arrow, monetary policy, the Bank of Japan introduced the price stability target in January 2013 with the aim of achieving 2 percent inflation in terms of the year-onyear rate of change in the CPI. This was followed, in April 2013, by the introduction of QQE to achieve the price stability target of 2 percent at the earliest possible time. The challenge for I gave my detailed views on the implications of the decline in the potential growth rate in my speech on “Monetary Policy and Structural Reforms” at the Japan Society in New York in February 2016. BIS central bankers’ speeches monetary policy is how to raise inflation expectations given the limited room for lowering shortterm interest rates. For this reason, QQE consists of two elements. The first is the Bank’s strong and clear commitment to the target. Specifically, the Bank has made clear its stance that it seeks to achieve the price stability target at the earliest possible time, with a time horizon of about two years, and has committed itself to pursuing QQE as long as it is necessary for achieving the price stability target in a sustainable manner. The second element is the exertion of downward pressure on nominal interest rates across the entire yield curve through massive purchases of Japanese government bonds (JGBs). That is, the Bank seeks to exploit to the greatest possible extent any remaining room for further declines in nominal interest rates. The combination of the two elements will lower real interest rates and thereby stimulate private demand. If people as a result see prices going up, this will raise their confidence in the Bank’s commitment, which will further reinforce this process. In January 2016, the Bank further enhanced QQE by adding the new dimension of a negative interest rate. “QQE with a Negative Interest Rate” aims to exert stronger downward pressure on the entire yield curve by lowering the short end of the yield curve through a negative interest rate applied to a certain tier of current accounts at the Bank while continuing with massive purchases of JGBs. In designing the negative interest rate policy scheme, we were inspired by the experience of central banks in Europe, including the ECB. III. The effects of QQE and QQE with a negative interest rate About three years have passed since the introduction of QQE, and the Bank judges that QQE has been exerting its intended effects. Let me start by considering the effects on interest rates. Since the introduction of QQE, yields on 10-year JGBs have cumulatively fallen by about 70 basis points (Chart 6). Against this background, bank lending rates have continued to decline, so that the average interest rate on the stock of total bank lending has fallen to a level around 1 percent. The amount outstanding of bank lending, including to small firms, has continued to rise, with the annual pace of increase recently exceeding 2 percent (Chart 1). It appears that, at present, with real interest rates substantially below the natural rate of interest, financial conditions for the real economy are highly accommodative (Chart 4). Given such accommodative financial conditions, the real economy has evidently improved. In the household sector, the employment and income situation has steadily improved. Labor market conditions have continued to tighten as seen in the fact that the unemployment rate has declined to the range of 3.0–3.5 percent, which we think corresponds to full employment (Chart 7). Reflecting the tight labor market conditions, base pay increases – that is, acrossthe-board wage increases mainly reflecting inflation and decided in the annual labormanagement wage negotiations – returned in 2014 for the first time in two decades. Base pay increases have continued this year, marking the third consecutive year of such increases. In the corporate sector, profits have increased to record levels, partly helped by the correction of the excessive appreciation of the yen and the decline in energy prices. Against this background, firms have maintained their positive stance with regard to fixed investment. As for prices, the year-on-year rate of change in the all-item CPI excluding fresh food is about 0 percent, reflecting the decline in energy prices, but the underlying trend in inflation has steadily improved. CPI inflation for all items excluding fresh food and energy, which had been in the range of about minus 0.5 to minus 1.0 percent before the introduction of QQE in April 2013, has been positive for 30 consecutive months since the latter half of 2013 and in recent months has been about 1 percent (Chart 8). This is the first time since the second half of the 1990s, when Japan’s economy fell into deflation, that such sustained inflation has been observed. Moreover, looking at price changes across all items, the share of price-increasing items minus the share of price-decreasing items has been rising clearly since the introduction of QQE, and is currently near its peak. This indicates that firms have maintained their BIS central bankers’ speeches willingness to increase prices, and a virtuous cycle between a moderate rise in inflation and wage growth has remained in place. Meanwhile, I admit there has been a fair amount of criticism in Japan of the negative interest rate policy adopted by the Bank in January 2016. The situation seems not dissimilar to the one in Europe. Such criticism can be divided into two broad strands. The first is that the negative interest rate policy may have an adverse impact on economic activity and prices by squeezing banks’ profits, which could hamper the functioning of financial intermediation. However, in the case of Japan, the concern that the negative interest rate policy will undermine financial intermediation is unfounded, at least at this moment. First, as I explained, the process of deleveraging in Japan was completed by the mid-2000s, and financial institutions now have a strong capital base, partly helped by the fact that the impact of the global financial crisis on them was limited. Second, despite the current low interest rate environment, the profits of both major banks and regional banks are close to record levels, mainly reflecting the significant decline in credit costs due to the steady economic recovery. And third, when the Bank introduced the negative interest rate policy, it designed the policy so as not to excessively squeeze banks’ profits. Specifically, the Bank designed the policy framework such that a negative interest rate is applied only on the margin by dividing the current account balances that financial institutions hold at the Bank into three tiers. As the Bank continues to purchase JGBs, the current account balances will increase accordingly; however, since the tier will be adjusted at the same time, the balances subject to a negative interest rate will remain relatively small, between around 10 and 30 trillion yen. Needless to say, the Bank will closely monitor the effects on financial institutions’ earnings, and will examine and evaluate those effects in the Financial System Report. The importance of banks’ functioning as financial intermediaries in the transmission of monetary policy cannot be overemphasized. 3 That is exactly why, since the outbreak of the financial crisis in the 1990s, the Bank of Japan has consistently acted as the guardian of financial intermediation. I assure you this shall not change in the future. The second criticism is that the general public will not really feel the benefits of the negative interest rate policy. While the public understand that their deposits will not diminish as a result of the negative interest rate policy, we are aware that, for example, households that do not have a mortgage will not necessarily feel any specific benefits. Particularly those who rely on their savings, such as pensioners and the elderly, may think that the negative interest rate policy has an adverse effect, since their interest income further decreases. The Bank’s negative interest rate policy can be understood as an extension of QQE in that its transmission channel is to maintain real interest rates well below the natural rate of interest, but I cannot deny that some aspects of this policy may be counterintuitive to the public. Therefore, we need to carefully listen to criticisms. At the same time, we need to clearly explain that the effects of monetary policy should not be assessed only in terms of households’ and firms’ direct profits and losses in transactions with banks, but in terms of the macroeconomic effects such as the benefits from an increase in employment and a rise in wages. In other words, it is essential to explain more persuasively that these policy measures are necessary for the economy to revert to a sustainable growth path. This seems to be a challenge the Bank of Japan and the ECB have in common. At any rate, I will keep a watchful eye on how the negative interest rate policy, through the further decline in interest rates following its introduction, will work through the economy. I explained the importance of the functioning of financial intermediation in my speech “Challenges toward Financial Stability and the Policy Frontier: Unconventional Monetary Policy, Macroprudence, and Financial Institutions’ Low Profitability” made at the IVA-JSPS seminar in Stockholm in March 2016. BIS central bankers’ speeches IV. Central banks’ lender of last resort function: lessons from the global financial crisis So far, I have outlined the challenges facing Japan’s economy in the past and present and how the Bank of Japan has responded. Now, looking into the future, I would like to touch upon two issues which I believe are important from the perspective of central banks. First, we need to work on the development of an international financial safety net and discuss, from a global perspective, central banks’ lender of last resort function. Domestically in Japan, our financial safety net has been strengthened based on the lessons learned during Japan’s financial crisis in the 1990s and the role of the Bank of Japan’s lender of last resort function has become quite clear. The global financial crisis has raised new challenges for central banks’ role as lender of last resort, especially in the case of a temporary liquidity crisis of a systemically important financial institution operating in multiple jurisdictions and currencies. Issues include how central banks should share information and how responsibilities should be allocated in such circumstances. Moreover, it is also possible that different countries and jurisdictions treat banks and non-bank differently under their individual safety nets. The Bank of Japan actually has experience in some aspects of such cross-border challenges, since Yamaichi Securities, which failed in 1997 and to which the Bank provided liquidity, had overseas bank subsidiaries. In addition, partly as a result of lessons learned during the global financial crisis, the use of central counterparties (CCPs) to centrally clear transactions is being promoted to reduce settlement risks. This raises additional issues, such as how liquidity shortages at cross-border CCPs dealing with multiple currencies should be addressed, and how central banks should contribute to resolving such issues. 4 Central banks are responsible for the stability of their respective domestic financial systems. However, in order to fulfill their responsibilities, they need to ever more closely monitor and engage with the global financial system. There is also a growing importance of further strengthening cooperation among central banks. I believe the Bank of Japan, based on its wealth of experience, should take a leading role in the discussions in this area. V. Strengthening Japan’s growth potential The second issue is the need to redouble efforts to raise the growth rate. In order to return Japan’s economy to a sustainable growth path, it is also important to strengthen the dynamism of the corporate sector and raise the economy’s growth potential. In this respect, the government’s growth strategy plays a major role. If the growth strategy bears fruit, the natural rate of interest will rise in line with the potential growth rate. The shape of the yield curve will gradually return to normality as upward pressure is exerted on the longer end. A key characteristic of the government’s growth strategy is that it will take a while before its effects become visible. Nonetheless, we are starting to see some tangible results. Let me give you one example: raising the labor participation of women (Chart 9). As in Italy, the female labor force participation rate in Japan has historically been low and raising it is a long-term challenge. Specifically, a major issue is that women in their prime of life have to interrupt their career for child rearing. Against this background, one of the pillars of the Abe administration’s aim to achieve the “Dynamic Engagement of All Citizens” is to boost support for child rearing. In fact, the labor participation rate of women has already started to increase through measures such as the expansion of childcare facilities. If such tangible results were to spread, this would build further public support for the growth strategy and help to drive it forward. I provided a detailed explanation of central bank policies with regard to financial market infrastructure and the associated challenge, including the relationship between central banks and CCPs, in my remarks on “Central Bank Policy on Financial Market Infrastructure” delivered at the Conference on Retail Payments in May 2016. BIS central bankers’ speeches Of course, the problems Japan needs to address span a wide range of areas. As mentioned, the decline in Japan’s potential growth rate is due partly to the deceleration in productivity growth. To give you one example, it appears that there is substantial room for productivity improvements in IT-related sectors. Both in IT-producing and IT-using sectors, productivity growth is lower than in the United States (Chart 10). In this context, a survey on firms in the United States and Japan provides instructive results: compared to firms in the United States, fewer firms in Japan attach importance to IT investment or have a chief information officer (CIO). These results suggest that strengthening Japan’s growth potential is not something that can be achieved through the government’s growth strategy alone; what is also needed are greater efforts on the part of the private sector to strengthen competitiveness. VI. Lessons for Europe Finally, I would like to make a few comparisons between Japan’s Lost Decades and Europe since the global financial crisis. What is worth noting is that in Europe the policy response has been quick and decisive. In addition to innovative policy measures such as the coordinated provision of dollar funds by the major central banks through swap arrangements, financial system instability was warded off through the provision of ample liquidity, preventing the financial crisis from turning into a global panic. Moreover, on the institutional front, the Single Supervisory Mechanism (SSM) for the supervision of banks became operational. Further, I expect that efforts to deal with remaining issues such as the full operation of the Single Resolution Mechanism (SRM) charged with the resolution of failed financial institutions and the expeditious recapitalization of undercapitalized banks will make good progress. Meanwhile, on the monetary policy front, the ECB has stressed from an early stage the risks associated with a potential decline in inflation expectations. In fact, the ECB has responded very proactively, being the first among major central banks to introduce a negative interest rate policy and combining it with asset purchases. There is also perceived to be a need to redouble efforts to drive ahead with structural reforms to raise the potential growth rate. However, this too is clearly recognized, as indicated in President Draghi’s observation that low interest rates are not the consequence of monetary policy but a symptom of low growth and low inflation. I am convinced that the risk of a Japanization of the euro economy is small, given that European policy makers are aware of the issues and are responding appropriately. Conclusion In my speech today I tried to look back at Japan’s Lost Decades and consider potential lessons for the current economic situation in Italy and Europe. Naturally, there are many other aspects in which Japan and Italy can learn from each other, not only with regard to finance and the economy. Looking at the OECD’s Better Life Index, which measures happiness across countries based on various indicators such as education and the living environment, both Japan and Italy rank in the middle of OECD countries; interestingly, however, individual indicators suggest that whereas Japan ranks favorably in terms of labor market conditions and education, Italy ranks highly in terms of work-life balance and health (Chart 11). It is said that Japan became widely known in Europe when the Venetian-born merchant Marco Polo in his 13th century travel diary introduced Japan as “Zipangu, the Land of Gold.” Since then, as countries with a long history and long traditions, Italy and Japan have continued to learn from each other. Let me close this speech by saying that although our two countries are currently facing a number of similar problems, I am convinced that by overcoming these problems through cooperation, our bonds will continue to grow over the next 150 years and bring a golden future for our two countries, even without the Zipangu’s gold. 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 Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kushiro, 2 June 2016.
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Takehiro Sato: Recent economic and financial developments and monetary policy in Japan Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Kushiro, 2 June 2016. * * * 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 the political, economic, and financial communities of eastern Hokkaido, including Kushiro. I would like to take this opportunity to express my sincere gratitude for your cooperation with the activities of the Bank of Japan’s Kushiro Branch and Obihiro Office. In today’s speech, I will begin by focusing on recent economic and financial developments in Japan and abroad, as well as the Bank’s monetary policy. I will then touch briefly on the economy of eastern 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. I. Recent economic and financial developments in Japan and abroad A. Global financial markets and overseas economies Global financial markets -- which had been unstable since the turn of the year, affected by an interest rate hike by the Federal Reserve in December 2015 -- have been gradually regaining stability following the Group-of-Twenty (G-20) Finance Ministers and Central Bank Governors Meeting in Shanghai (Shanghai G-20) in late February. Recently, crude oil prices have rebounded despite adverse factors such as the stalled negotiation among oil-producing countries over production cuts, while currencies and stock markets of emerging and commodity-exporting economies have generally been recovering. This situation may be described as a lull in the negative spiral of the strong dollar -- and the consequent strengthening of Chinese yuan -- and the weak crude oil prices, which had increased the uncertainty of the future prospects of the world economy. The communiqué issued at the Shanghai G-20 indicated a consensus among the authorities of various countries on the need to deal with the economic slowdown not only by implementing monetary policy measures but also by taking every possible policy measure. As expectations have also spread that the pace of U.S. interest rate hikes will be moderate, a sense of relief appears to have gradually grown in the markets. Even so, causes for concern remain. The problem -- posed by the financial market turmoil caused by the Global Financial Crisis and the European sovereign debt crisis as well as its spillover effects on the real economy -- was an acute disease, so to speak, so it was clear what solutions should be prescribed. Meanwhile, the problem that has emerged recently can be described as a chronic disease, given that dollar-denominated debts built up by emerging economies, including China, and commodity-exporting economies during the period of monetary easing in the United States are coming to the fore again as a debt overhang issue since the start of a liftoff by the Federal Reserve. It will probably take a long time before this problem can be cured. Looking back at developments in the world economy during the recent period, the annualized growth rate of the U.S. economy, which is the driving force of the world economy, was a low 0.8 percent in the January-March quarter because of the sluggishness in industrial production accompanying the appreciation in the U.S. dollar and the decline in commodity prices and because of unfavorable weather conditions in the winter. According to the nowcast by regional BIS central bankers’ speeches Federal Reserve Banks and other forecasts, the growth rate appears likely to be somewhat higher in the April-June quarter. However, the U.S. employment statistics for April, the latest month for which the data is available, showed a slight slowdown in employment after a period of firm growth. With the economic recovery phase about to enter its eighth year, the economic cycle is presumed to be gradually reaching maturity. Therefore, at the beginning of the year, there were even voices of concern over a possible economic downturn. Although such fears have proved unfounded, there is the risk that productivity growth will be sluggish as business fixed investment continues to lack momentum amid the prolonged slowdown in emerging and commodity-exporting economies. Under these circumstances, I am paying attention to the risk that a squeeze on firms’ profit margins may affect employment, income, and consumption if wages increase too rapidly relative to the productivity growth because of tight labor market conditions. Meanwhile, the Chinese economy is generally regaining stability despite a slight slowdown mainly in exports and production, as the effects of the economic stimulus measures taken by the authorities are apparently starting to appear. The exchange rate of the Chinese yuan, which became a source of the instability in the global financial markets since last year, has recently stayed stable and the stock market is also in a state of calm. The somewhat moderate decline in the yuan’s effective exchange rate following the recent pause in the rise in the U.S. dollar is apparently easing concerns over the future prospects of exports and production. In addition, a sense of relief is apparently growing in the markets because the Shanghai G-20 has alleviated concerns that the kind of abrupt change in the exchange rate system that was made in the summer of 2015 may occur again. Still, as the problem of excess production capacity in the manufacturing sector lurks in the background, the low growth in fixed asset investment and inventory adjustments are expected to continue for a while. As for prices, the disinflationary trend is likely to continue for a while, as the supply-demand conditions remain easy, mainly with respect to goods. As for overseas economies, as I have explained until now, the slowdown in emerging economies, including China, and commodity-exporting economies is coming to a halt. However, as the recovery of the U.S. economy, which is the driving force, lacks strong momentum, the world economy is expected to remain in a state of slight deceleration for the time being. While the negative spiral of the strong dollar -- and the strong Chinese yuan -- and the weak crude oil prices is in a lull in the global financial markets, market liquidity has apparently been reduced due to various financial regulations. In addition, the influence of algorithmic trading and high-frequency trading (HFT) is apparently growing, so the possibility cannot be ruled out that the markets will become unstable again because of the effects of the U.S. economic developments and ensuing monetary policy conduct. Therefore, I continue to pay attention to the possibility that these factors will affect such aspects as market confidence. B. Japan’s economy Japan’s economy grew by 1.7 percent in the January-March quarter this year on an annualized quarter-on-quarter basis, after posting negative growth of 1.1 percent in the OctoberDecember quarter last year; however, if the leap-year factor is excluded, the latest growth was close to zero. Recently, private consumption has continued to be lackluster after weatherrelated factors that affected consumption in the winter have dissipated. In addition, production activity, which has recently been more or less flat or weaker due to the effects of the slowdown in emerging economies, including China, and commodity-exporting economies and of an accident at a steel plant, is showing some weakness, mainly in the transportation equipment sector, whose supply chains have been disrupted by the damage caused mainly in Kumamoto Prefecture by the earthquake. Production activity in the affected region has already partially shifted to the recovery production phase thanks to the strength of Japanese manufacturing industries’ business continuity planning. In addition, restoration and reconstruction projects are expected to be implemented under the recent supplementary budget, and reconstruction BIS central bankers’ speeches demand is expected to emerge. Therefore, there will be no need to change the medium-term scenario. However, diffusion indexes (DIs) of the Economy Watchers Survey, which is a leading indicator of the short-term economic trend, declined to the lowest level since immediately after the consumption tax hike in 2014 on a seasonally-adjusted basis because of the impact of the earthquake in Kumamoto, among other factors. Regarding the medium-term scenario, while Japan’s potential growth rate continues to slump in the range of 0.0-0.5 percent due in part to the sluggishness of capital stock accumulation, the world economy lacks momentum as I mentioned earlier. I therefore am somewhat cautious about the outlook compared with the Bank’s baseline scenario in the April 2016 Outlook for Economic Activity and Prices (Outlook Report). In fact, real GDP growth has recently been fluctuating almost evenly between positive and negative growth. As the economic growth rate continues to be low, the potential economic growth rate is less likely to rise. Compared with the low growth rate of real GDP, aggregate income formation as measured by real gross national income (GNI) and real gross domestic income (GDI) has so far remained relatively firm. Moreover, because of the robustness of the aggregate income formation, it has been presumed that Japan’s economy is resilient to such shocks as the slowdown in overseas economies. However, income receipts from abroad converted into yen terms are expected to be eroded by the yen’s appreciation since the beginning of the year, and the decline in commodity prices that has until recently contributed to the improvement in the terms of trade is generally coming to a halt. As the strong yen contributes to the improvement in the terms of trade, it offsets the effects of the halt in the decline in commodity prices. All the same, it may become difficult to emphasize the relative firmness of aggregate income formation compared with expenditure-based GDP. Meanwhile, as is indicated by the consumption activity index, which is compiled by the Bank’s Research and Statistics Department based on sales- and supply-side statistics, the actual trend of private consumption may have stayed stable compared with private consumption in terms of preliminary GDP data, which reflects demand-side statistics such as the Family Income and Expenditure Survey. When demand-side statistics show weaker results than the actual trend due to sample factors or for other reasons, the level of private consumption in terms of revised GDP data is likely to be revised upward compared with the preliminary data. Therefore, the perception of the recent consumption trend may also be changed when revised GDP data are announced in one and a half years. However, as the relatively firm aggregate income formation may lack momentum somewhat due to the reason that I already mentioned, a scenario in which a virtuous economic cycle from income to spending will pick up steam does not seem to be so persuasive. While firms are earning record profits, they have until now been cautious about raising base salary or making domestic business fixed investments because of the view that such bumper profits are a temporary windfall brought by the weak yen and the improvement in the terms of trade. This cautious trend may grow depending on the results of the recent developments in the global financial markets. After all, as Japan’s economy, with its potential growth rate of nearly 0 percent, is so fragile as to be liable to post negative growth even because of trivial external factors such as weather conditions, I expect that its growth is highly likely to remain sluggish in the future while being susceptible to developments in the global financial markets and overseas economies. Even so, nonmanufacturing industries, which maintain relative firmness in terms of employment and business fixed investment, will serve as a buffer against the weakness of manufacturing industries, so I expect that recession can be avoided. C. Prices Regarding consumer prices, my outlook presented in the April 2016 Outlook Report continues to be lower than the median of the Policy Board members’ forecasts. This is because, due to the various domestic and overseas downside factors that I mentioned earlier, it is difficult at BIS central bankers’ speeches the moment to expect that the potential growth rate will clearly rise from the current level of nearly 0 percent, leading to an inflation that is consistent with income growth. Although the inflation rate will not reach the price stability target of 2 percent during the projection period according to my forecast, I believe that it is unnecessary to achieve the price stability target of 2 percent at all costs. People are not hoping for inflation that is not accompanied by income growth. We have learned from our experiences that if inflation rises ahead of income, consumer sentiment dampens due to a decline in real income, producing negative effects on consumption. Although the year-on-year growth rate in the SRI-Hitotsubashi Unit Value Price Index, which I cited in my previous speech, has recently slowed down steeply, it stayed at around 2 percent throughout last year. In short, this index, which is closer to people’s perception of inflation because it reflects the effects of changes in the volume of products and minor product modifications, indicated a higher growth rate than consumer price statistics compiled by the Ministry of Internal Affairs and Communications. In order to achieve the price stability target of 2 percent at the earliest possible time, with a time horizon of about two years, the Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013. Because more than three years have passed since the introduction of QQE, I believe it is high time that we reviewed the significance of this commitment. In this regard, I have been having uneasy feelings about the approach of aiming to achieve a specific inflation rate within a specific time frame, given the time lag required for monetary policy effects to be produced and the uncertainty over the effects. I have some doubts as to why Japan alone should set a specific time frame amid the disinflationary trend around the world, including emerging economies, and whether the target can be achieved through monetary policy alone. For my part, I have not changed my position that the Bank should achieve the price stability target of 2 percent as a medium- to long-term goal. I consider this as a rolling target, which means that we should constantly aim to achieve it at the earliest possible time with a time horizon of about two years. Based on this idea, I submitted a proposal to revise the description in the April 2016 Outlook Report at the Monetary Policy Meeting (MPM) in April. The recent environment surrounding consumer prices contains various unfavorable factors, such as (1) an expected delay in the improvement in the output gap due to the slow recovery in the real economy, (2) an expected lack of momentum in the pace of year-on-year wage growth following the labor-management negotiations this spring, and (3) the possibility that the yen’s appreciation since the beginning of the year will affect the underlying inflation trend that has been led by rising prices of food products and durable consumer goods. As is indicated by the SRI-Hitotsubashi Unit Value Price Index, which I mentioned earlier, the year-on-year growth in the goods price index based on the point-of-sale (POS) data collected through chain stores appears to have slowed. The price index based on the POS data covers only around 20 percent of the consumer price index (CPI) in terms of its weight, so the trend in the POS data-based index may not necessarily affect overall prices immediately. Service prices, which have a substantial weight in the CPI, may have a pent-up potential for a rise following the recent increase in hourly wages for non-regular employees. Unlike changes in food and clothing prices, changes in prices of individual services, which are provided by many small firms, are seldom featured in media reports, making it difficult to keep track of them. Therefore, looking at consumer price statistics is the only way to examine the trend of overall service prices. As for the outlook, while the year-on-year growth rate of prices of food products and durable consumer goods are expected to peak out as indicated by the POS data, the key will be the extent to which prices of individual services, with their pent-up potential for a rise, can offset that. However, house rent and imputed rent, which have a large weight in service prices, are strongly correlated with wages, and given the results of the labor-management wage negotiations this spring, it may be difficult to expect much of a rise in rents. House rent and imputed rent are not adjusted for quality associated with the passage of time, so the presence of a downward bias in consumer price statistics has been pointed out. With respect to public service prices, which also have a large weight, there are various factors that constrain price BIS central bankers’ speeches increases. One such factor is the norm applied to prices by those who are reluctant to tolerate a hike in fees for public services. In consideration of all these factors, it is highly uncertain whether or not an increase in service prices will offset an expected drop in the year-on-year growth rate of goods prices, resulting in a higher growth or a similar rate of growth in overall prices. Although people’s inflation expectations over the medium to long term are relatively stable, their expectations over the short term have been affected in a backward-looking manner by the recent price trend that reflects energy price movements. This is clearly apparent in firms’ inflation expectations indicated in the Tankan (Short-Term Economic Survey of Enterprises in Japan). Furthermore, comments made by the respondents in the Economy Watchers Survey suggest the possibility that people’s sentiment has become cautious due to the introduction of the negative interest rate policy. I assume that this reflects people’s cautious outlook on future supply-demand conditions, which I assume is also affecting people’s inflation expectations. II. Future conduct of monetary policy A. Introduction of QQE with a negative interest rate More than three years have passed since the introduction of QQE. My understanding was that this measure was a kind of shock therapy intended to influence the formation of people’s expectations by resorting to a bold action. As was indicated by the fact that the time frame of about two years was initially assumed, I at least did not expect that this measure would be continued for a very long time. Therefore, I have had mixed feelings about the expansion of QQE in October 2014 and the introduction of a negative interest rate in January this year. I voted against both of these measures. As for the reason for my opposition to a negative interest rate in particular, I believe that the expansion of the monetary base and the introduction of a negative interest rate are essentially contradictory and their combination lacks sustainability. Moreover, I believe that the negative interest rate policy has the effect of monetary tightening, rather than an effect of easing. In addition, the negative interest rate policy could affect financial system stability. Let me elaborate on this point a little further. Under the current policy framework, a marginal increase in the current account balance at the Bank, which accounts for most of the increase in the monetary base, is subject to a penalty in the form of a negative interest rate. However, maintaining the current pace of increase in the monetary base while imposing such a penalty is illogical. I believe that introducing a negative interest rate would be meaningful only when the monetary base target and the asset purchase target are gradually reduced, namely, when tapering is implemented, so I cited this as the reason for my vote against the introduction of a negative interest rate at the January MPM. I believe that it is desirable to maintain the system in which balances in current accounts at the Bank are divided into three-tiers -- which was adopted at the time of the introduction of a negative interest rate -- from a somewhat longerterm perspective with an eye to a future exit from QQE. I therefore submitted a proposal to that effect at the March MPM. Next, I will explain my argument that the negative interest rate policy has the effect of monetary tightening and may affect financial system stability. Soon after the MPM in January, stock prices plunged, led by bank share prices, while the yen appreciated in the foreign exchange market. In addition, there was a series of suspensions of subscription for and pre-maturity redemption of safe investment instruments, such as money market funds (MMFs) and mediumterm government bond funds. In response, people’s sentiment deteriorated. This is presumably not only because of concerns over a possible erosion of deposits but also because the wrong perception has spread that Japan’s economic conditions worsened so much that such an extraordinary measure as the negative interest rate policy needed to be taken. Financial institutions are facing the risk of a negative spread for marginal assets due to the extreme flattening of the yield curve and the drop in the yield on government bonds in short- BIS central bankers’ speeches to long-term zones into negative territory. When there is a negative spread, shrinking the balance sheet, rather than expanding it, would be a reasonable business decision. In the future, this may prompt an increasing number of financial institutions to take such actions as restraining loans to borrowers with potentially high credit costs and raising interest rates on loans to firms with poor access to finance. There is also the risk that financial institutions that have problems in terms of profitability or fiscal soundness will make loans and investment without adequate risk evaluation. From financial institutions’ recent move to purchase superlong-term bonds in pursuit of tiny positive yield, I detect a vulnerability similar to that seen before the so-called VaR (Value at Risk) shock in 2003. In the meantime, because of the decline in the function of the short-term money market, distortion due to the concentration of funds raised in the call market in banks, trust banks in particular, was seen. As a result, investment trusts and other risk-taking market participants have given up on investing in short-term financial instruments, leading to a loss of diversity among market participants. Such a weakening of the financial intermediary functioning could affect the financial system’s resilience against shocks in times of stress. In addition, an excessive drop in bond yields in the super-long-term zone could also make the financial system vulnerable by increasing the risk of a buildup of financial imbalances in the system. The Bank is responsible for maintaining both price stability and the financial system stability. Therefore, when a conflict is expected in performing these two mandates, it is necessary to consider the respective pros and cons of the two mandates and pursue a finely-balanced policy measure. However, as I already explained, the negative interest rate policy could disturb the delicate balance. B. Economic effects of QQE with a negative interest rate The negative interest rate policy has been highly effective in lowering longer-term interest rates, rather than in achieving the initial goal of further pushing down the yield curve by lowering the short end of the yield curve. However, the steep drop in the yields in the longterm and super-long-term zones reflects the fact that, in pursuit of a positive yield when yields even in the long-term zone are negative, funds that have lost attractive investment destinations are flowing into further longer-term zones, where the yields remain above zero, albeit barely. Unfortunately, this is the opposite of portfolio rebalancing that was an intended purpose of the negative interest rate policy. Opinions are divided on the economic effects of the negative interest rate policy, and this is a factor fueling worries among people over this measure. In this respect, it is a fact that as a result of the decline in market interest rates, housing loan rates and firms’ borrowing rates have already dropped, so it may be possible to ease people’s aversion to this policy measure if they are presented with convincing evidence that it brings positive macro-level income effects by facilitating housing loan refinancing and that it stimulates business fixed investment. However, firms’ fixed investment has long been kept within their level of cash flow and lending rates that have already declined to extremely low levels cannot be expected to drop further on the same scale as the drop in market interest rates. Therefore, I am skeptical about the idea that the negative interest rate policy will stimulate business fixed investment. Rather, if an investment project can only be profitable on the assumption of the continuation of an extremely low interest rate, that is the problem. While the interest rate decline was prominent in the long-term and super-long-term zones, there are only a few private economic agents that are willing or able to raise funds with a maturity ranging from 20 years to 40 years. Rather, the excessive interest rate decline in the long-term and super-long-term zones could not only threaten the sustainability of the social security system as broadly defined, including corporate pensions, through a drop in the discount rate of pension liabilities, but could also undermine people’s confidence by producing significant negative effects on corporate finance. BIS central bankers’ speeches C. Monetary base target and asset purchase target As I mentioned earlier, I believe that it is desirable to aim to achieve the price stability target of 2 percent as a medium-to long-term goal and I expect that the road toward this goal will be long. Therefore, I believe that the challenge from now on is reforming the policy framework, which is intended to provide solutions in the short term, so as to adapt it to a long-term initiative. The first thing the Bank should do for that purpose would be to make the asset purchase operation more flexible and also explore flexible approaches to the monetary base target. Let me cite a specific example. Since the introduction of the negative interest rate policy, there have been some cases in which bid prices for the Bank’s asset purchase offers were unusually high compared with market prices or in which the difference between the minimum successful bid rate and the average successful bid rate was very large. This situation represents the realization of the theory that if the Bank offers a higher purchase price than the market price, the offer always attracts willing sellers. Therefore, it may be said that the buildup of the monetary base is proceeding even amid the negative interest rate environment. However, if we look at the situation from another angle, it can be said that there is a reasonable chance that unless the Bank continues to purchase assets at higher prices than market prices, this will result in undersubscriptions, and the buildup of the monetary base will be impeded. The Bank is taking such measures as eliminating abnormal bids, imposing bidding limits, and excluding issues which were purchased at abnormal prices from eligible assets. I believe that it is appropriate to give consideration to avoid distorting market price formation by flexibly conducting these market operations as necessary. As a result of such operations, the Bank may fall slightly short of its asset purchase target by asset class and the monetary base target of 80 trillion yen. However, if the Bank is to ensure the sustainability of its current policy, I believe that conducting such operations would be inevitable. We must pay sufficient attention to the risk that the failure to achieve the targets will be mistaken as tapering, triggering an unexpected reaction. However, given that the Bank’s asset purchases have proved to be so effective in lowering various interest rates, I take the view that there would be no problem if the Bank’s purchases fall slightly short of the targets as a result of excluding abnormal bids that are far apart from market prices. Rather, it would be desirable if this view gradually took hold in the market. While I voted against the expansion of QQE and the introduction of a negative interest rate, it would not be desirable if concerns over the sustainability of the Bank’s asset purchases grew in the market at a time when the Bank continues to purchase on such a large scale, and if the effects of the policy were undermined by an unforeseen incident. It is my sincere hope that the Bank will conduct monetary policy flexibly under the flexible price stability target while obtaining better understanding by the market. Concluding remarks: economic activity in Eastern Hokkaido My concluding remarks will touch on the economy of eastern Hokkaido. This region has a vast amount of land facing the part of the Pacific Ocean where the Oyashio Current flows. Blessed with rich nature, this region has prosperous agricultural, forestry and fishery industries and is one of the main food supply bases in Japan. Other industries that have a large presence in this region include the food industry, whose main items are dairy and processed fishery products; the civil engineering and construction industry, which undertakes public works and private construction; and the transportation industry, which supports longdistance distribution. Tourism also supports the local economy, as Tokachi, Kushiro, and Nemuro have their respective tourism resources of global value. Looking at the local economic conditions, in relation to fishery, the situation of fishing of major fish such as salmon, trout, and Pacific saury is severe. However, although public investment has been decreasing, business fixed investment as a whole has been increasing against the backdrop of strong corporate earnings. In addition, private consumption has been resilient. An BIS central bankers’ speeches increase in agricultural income and stable fuel prices are also positive factors for this region, so the local economy has been steadily picking up. Under these circumstances, to achieve longer-term growth, the region takes initiatives to enhance productivity and increase added value by taking advantage of its strengths and to invigorate trade and other exchanges both within and outside the region. For example, with respect to distribution, the Doto Expressway, which connects central Hokkaido with eastern Hokkaido, has been extended to the Akan area, representing the improvement of the distribution network and the integration of eastern Hokkaido. In addition, the expansion work of Kushiro Port, which has been designated as an International Strategic Bulk Port, has got into full swing. As for tourism as well, the region’s efforts are bearing fruits. For example, this region has been selected as part of a broad-area sightseeing tour route and as a showcase of Japan’s strength as a tourism-oriented country, and the Food Valley plan is making progress. Furthermore, there are activities led by the private sector, including exporting agricultural and fishery products such as Chinese yams and Pacific saury, and increasing the value added to dairy and livestock products. There are also activities to enhance the region’s growth potential, such as exploring for tourism resources -- including the Hokkaido Garden Path, whale and bird watching, and making use of national parks -- as well as constructing a thermal power plant using the only underground coal mine in Japan. I understand that regional financial institutions are not only providing financial support but also enhancing their own advisory function and helping to search for new customers. I hope that while these initiatives are continued, progress will be made in fostering new leaders and strengthening broad-area cooperation, and that the economy of the eastern Hokkaido will be further invigorated. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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bank of japan
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Akita, 9 June 2016.
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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, Akita, 9 June 2016. * * * Accompanying charts can be found at the end of the speech. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Akita 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 Akita Branch. Today, before exchanging views with you, I would like to first explain the Bank’s view on Japan’s economic activity and prices and then move on to the Bank’s thinking on the monetary policy management. I. Recent developments in and outlook for economic activity at home and abroad Overseas economies Let me start by talking about overseas economies. The Bank somewhat lowered its projections for GDP growth in the April 2016 Outlook for Economic Activity and Prices (Outlook Report) from its projections in the January Outlook Report, due mainly to weaker exports reflecting the slowdown in overseas economies. Overseas economies have continued to grow at a moderate pace, but the pace of growth, especially in emerging economies, has decelerated somewhat. The Chinese economy, looked at from a somewhat longer-term perspective, is in the process of transitioning from manufacturing sector- and investment-driven growth to service sector- and consumption-driven growth. While this transition in itself is desirable, the Chinese economy in the process has decelerated due to downward pressure from adjustments in excess production capacity in the manufacturing sector. Other emerging economies and commodity-exporting economies as a whole also have remained subdued, reflecting the spread of the effects of the deceleration in the Chinese economy and the protracted decline in commodity prices. Against this background, global financial markets – especially since the turn of the year – have been volatile, and given the temporary but significant decline in stock and crude oil prices, economies – particularly commodity-exporting ones – have decelerated, and global trade has been weak. Reflecting these circumstances, the IMF in its April 2016 World Economic Outlook (WEO) revised down its projection for global growth this year from the projection in the January WEO (Chart 1). In contrast, advanced economies have continued to see firm growth. The U.S. economy has been on a recovery trend on the back of household spending supported by a favorable employment and income situation. The European economy also has continued to recover moderately, supported by an increase in private consumption. Looking ahead, it is likely that advanced economies will continue to register firm growth. As for emerging economies, the Chinese economy is likely to broadly follow a stable growth path as authorities proactively carry out both fiscal and financial measures to support economic activity, although the growth pace is expected to be somewhat slower than in the past. Other emerging economies and commodity-exporting economies are expected to remain subdued for the time being, but growth rates are then likely to gradually increase, due mainly to the effects of the economic stimulus measures and the recovery in advanced economies. BIS central bankers’ speeches This is the baseline scenario for overseas economies, but risks are skewed to the downside. Developments in emerging and commodity-exporting economies including China are still particularly uncertain. The fact that volatility in financial markets has not yet been dispelled also warrants attention. Moreover, uncertainty over the timing of the next policy interest rate hike in the United States is affecting global financial markets, particularly emerging markets. In addition, there are various political risks such as the referendum in the United Kingdom later this month regarding a so-called “Brexit” – that is, whether Britain should leave the European Union (EU). Going forward, the Bank will need to continue to closely monitor whether these uncertainties surrounding overseas economies will either clear up or grow. Corporate sector Next, I will touch on Japan’s economy. First, in the corporate sector, profits are at record levels (Chart 2). This is attributable to the fact that the real economy is improving and to factors such as the low crude oil prices and the past correction of the yen appreciation. The pace of improvement in corporate profits is expected to temporarily slow down, especially in the manufacturing sector, mainly because of the slowdown in overseas economies. However, corporate profits are projected to follow an improving trend, given that the past decline in crude oil prices will continue to have positive effects and the rise in demand at home and abroad is expected to raise sales volume growth. On the back of the high corporate profits, firms have maintained their positive stance toward fixed investment. Figures on business fixed investment plans in the March 2016 Tankan (Short-Term Economic Survey of Enterprises in Japan) show that investment by large firms is likely to have increased by about 10 percent on a year-on-year basis in fiscal 2015 and that by small firms by about 4 percent. Moreover, investment plans for fiscal 2016 are vigorous for this time of the year. Going forward, business fixed investment is projected to continue to see a moderate uptrend, mainly due to continued high levels of corporate profits along with the further decline in real interest rates under “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate.” Household sector Next, I would like to explain developments in the household sector. The increase in economic activity and the high levels of corporate profits have led to a steady improvement in the employment and income situation. With the number of employees increasing at a relatively high pace, the active job openings-to-applicants ratio has been 1.34, marking the highest level seen since 1991, while the unemployment rate has been 3.2 percent, the lowest level seen since 1997 (Chart 3). Furthermore, the employment conditions DI in the March Tankan indicates that many firms feel that there is a shortage of labor. These labor market conditions mean that Japan’s economy can be regarded as being at full employment. Because of the continued tightening of labor market conditions, there is growing upward pressure on wages. This clearly can be seen in the relatively large increase in part-time employees’ hourly cash earnings, which tend to closely reflect supply and demand conditions in the labor market. Moreover, regarding the wages of full-time employees, annual base-pay increases – a practice that had disappeared during the period of deflation – were observed for a third consecutive year in the labor-management wage negotiations this spring. Thus, high corporate profits have continued to feed through to employee incomes. Against this background of steady improvement in the employment and income situation, private consumption has been resilient. Since the turn of the year, however, consumer sentiment has become cautious against the backdrop of volatile financial markets, contributing to relatively weak developments in some indicators of private consumption. With the improvement in the employment and income situation likely to continue, the current weakness in private consumption is likely to be temporary, but close attention needs to be paid to developments in private consumption, including by pensioners, who are less likely to benefit from the improvement in the employment and income situation. BIS central bankers’ speeches Outlook for Japan’s economic activity In sum, although exports and production are expected to remain sluggish for the time being, domestic demand is likely to follow an uptrend, with the virtuous cycle from income to spending remaining in place in both the household and corporate sectors, and exports are expected to increase moderately on the back of emerging economies moving out of their deceleration phase. Japan’s economy is likely to be on a moderate expanding trend at a rate generally above its potential. II. Price developments in Japan and the outlook Let me now turn to the developments in and outlook for prices in Japan. Price developments in Japan changed significantly following the introduction of QQE in April 2013. The year-on-year rate of change in the consumer price index (CPI, all items less fresh food), which had been minus 0.5 percent just before the introduction of QQE, increased to as high as 1.5 percent in April 2014, excluding the effects of the consumption tax hike (Chart 4). Since then, the year-on-year rate of change has declined and currently is around 0 percent. This is because private consumption continued to be relatively weak after the consumption tax hike in April 2014 and because there was a substantial fall in crude oil prices since the summer of that year. However, excluding the effect of the decline in energy prices, the underlying trend in inflation has continued to improve steadily. The year-on-year rate of change in the CPI for all items excluding fresh food and energy – which was negative before the introduction of QQE – has remained positive for 31 consecutive months since October 2013, and has been about 1 percent recently. This is the first time since the late 1990s, when Japan’s economy fell into deflation, that sustained price increases have been observed. Looking ahead, how the year-on-year rate of change in the CPI for all items less fresh food will develop in the short run depends on developments in import prices, which are influenced by changes in energy prices and foreign exchange rates, but the most important factor is the underlying trend in inflation. This trend is determined by the output gap of the economy as a whole and by medium- to long-term inflation expectations – that is, views on the outlook for prices. Reflecting sluggish exports and production, the output gap is more or less unchanged; going forward, however, with economic growth likely to be generally above the potential growth rate, the output gap is expected to move into positive territory and gradually increase further from the second half of fiscal 2016. Thus, upward pressure on wages and prices due to the tightening of supply and demand conditions is likely to steadily increase. Meanwhile, although medium- to long-term inflation expectations appear to be rising on the whole from a somewhat longer-term perspective, they have weakened recently. The results of various surveys on inflation expectations as well as developments in break-even inflation (BEI) rates – calculated using the yields of inflation-indexed Japanese government bonds (JGBs) – imply that inflation expectations have been declining since end-2015. Nevertheless, when assessing developments in inflation expectations, it is necessary to also take account of firms’ price- and wage-setting stance and households’ spending behavior. In particular, wage developments warrant attention. Past experience shows that wages and prices move roughly in tandem, so a sustainable rise in prices is unlikely to be achieved without an increase in wages. As mentioned earlier, in the annual labor-management wage negotiations this spring, a rise in base pay was agreed for the third year in a row. Moreover, wage increases have been spreading to small firms. Therefore, the mechanism in which inflation rises moderately accompanied by wage increases has been operating. Consequently, as actual inflation rises, medium- to long-term inflation expectations are likely to follow an increasing trend and gradually converge to around 2 percent – the price stability target. Against this backdrop, firms’ wage- and price-setting stance is likely to shift further toward raising wages and prices. BIS central bankers’ speeches Taking a closer look at the results of the annual labor-management wage negotiations this spring, however, the rise in base pay was somewhat less than that of last year, particularly in large firms, partly because confidence on the side of both labor and management was affected by the heightened uncertainty regarding developments in overseas economies and by the volatility in financial markets since the turn of the year. The Bank will assess carefully how firms’ price-setting stance develops this fiscal year, given the results of the annual labormanagement wage negotiations. In sum, the underlying trend in inflation is projected to continue improving steadily as the output gap is expected to move into positive territory and gradually increase further and as medium- to long-term inflation expectations will follow an increasing trend. Therefore, the year-on-year rate of change in the CPI for all items less fresh food is likely to be about 0 percent for the time being, but the rate of change is projected to accelerate toward 2 percent as the effects of the decline in energy prices dissipate. The Bank’s April 2016 Outlook Report – taking into consideration oil prices in the futures market, which reflect forecasts by market participants – assumes that Dubai crude oil prices will rise moderately from the recent 35 U.S. dollars per barrel to the range of 45–50 dollars per barrel toward the end of the projection period, that is, fiscal 2018. Based on this assumption, the Bank projects that the timing of the year-on-year rate of change in the CPI for all items less fresh food reaching around 2 percent – the price stability target – will be during fiscal 2017. Comparing the projections in the April Outlook Report with those in the January Outlook Report, the projected rate of increase in the CPI for fiscal 2016 is lower, mainly reflecting downward revisions in projections for real GDP growth and wage increases. III. The Bank’s monetary policy management Effects of “QQE with a Negative Interest Rate” I would now like to turn to the Bank’s monetary policy management. The Bank introduced “QQE with a Negative Interest Rate” at the January 2016 Monetary Policy Meeting (MPM). Global financial markets had been volatile since the turn of the year, and there was an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected. “QQE with a Negative Interest Rate” was introduced in order to preempt the manifestation of this risk and to maintain momentum toward achieving the price stability target of 2 percent. “QQE with a Negative Interest Rate” continues with the QQE framework employed so far but enhances monetary easing effects by adding the new dimension of a negative interest rate. The basic concept of transmission mechanisms of the Bank’s policy has not changed. Let me explain in more detail. First, QQE raises inflation expectations through the Bank’s strong and clear commitment to achieving the price stability target of 2 percent and through large-scale monetary easing to underpin the commitment. Second, QQE puts strong downward pressure on nominal interest rates across the entire yield curve through massive purchases of JGBs. These two channels result in a decline in real interest rates. The decline in real interest rates boosts business fixed investment and housing investment through a decline in interest rates on business and housing loans. The boost in economic activity improves the output gap, which together with rising inflation expectations, lifts prices. “QQE with a Negative Interest Rate” exerts stronger downward pressure on interest rates across the entire yield curve by lowering long-term yields through the Bank’s continued massive purchases of long-term JGBs as well as by lowering short-term interest rates through applying a negative interest rate to part of the current account balances held by financial institutions at the Bank. This results in further lowering real interest rates and enhances the transmission of policy effects I just mentioned. BIS central bankers’ speeches The policy has already exerted the intended effects on interest rates. Following the introduction of the negative interest rate policy, a large part of the JGB yield curve has declined substantially, with rates up to a maturity of over 10 years having turned negative. Lending rates, including interest rates on housing loans, clearly have declined. Issuance rates on CP and corporate bonds also have declined to a considerable degree. In the March Tankan, financial institutions’ lending attitudes as perceived by firms improved further following the introduction of the negative interest rate policy, and those for all industries and enterprises were at a level last seen in the late 1980s. Firms’ perception of borrowing costs is that these have declined notably (Chart 5). Going forward, these policy effects on interest rates are likely to steadily spread to both the real economy and the price front. However, it will take some time for the monetary policy effects to spread. In addition, global financial markets – partly due to uncertainties regarding the outlook for emerging and commodity-exporting economies – remain volatile, and this has become a headwind that has restrained the effects of accommodative financial conditions on economic activity and prices from being exerted. As I noted earlier, the projection of the CPI in the April Outlook Report is lower than that in the previous report, mainly reflecting the downward revision of projections for real GDP growth and wage increases. Nevertheless, the Bank did not take additional monetary easing measures at the April MPM because, due to the reasons I just mentioned, the Bank judged it appropriate to examine the extent of the penetration of policy effects. To avoid any misunderstanding, I would like to clarify that there has been no change in the Bank’s commitment to achieving the price stability target of 2 percent at the earliest possible time. Transforming people’s deflationary mindset and raising inflation expectations through this commitment is itself the aim of overcoming deflation, and at the same time the starting point of the effects of QQE and “QQE with a Negative Interest Rate.” Firms’ and households’ inflation perceptions have changed markedly under this commitment. While the Bank at the April MPM judged that it would be appropriate to examine the extent of the penetration of effects of “QQE with a Negative Interest Rate,” this does not preclude additional monetary easing if necessary. As for the outlook for Japan’s economic activity and prices, risks – such as uncertainty over the global economy and volatility in financial markets – continue to be skewed to the downside. Therefore, the Bank will continue to carefully examine these risks at each MPM, and take additional easing measures in terms of the three dimensions – quantity, quality, and the interest rate – if it is judged necessary for achieving the price stability target. The aims of “QQE with a Negative Interest Rate” So far, I have explained the Bank’s thinking on the negative interest rate policy. However, I am aware that there has been a range of criticisms. While these are a variety of issues, I would like to talk about two in particular. The first criticism is that many do not feel the benefits of the negative interest rate policy. It certainly is true that those who have no housing loans and whose financial assets mostly consist of deposits, such as pensioners and the elderly, do not enjoy benefits from the decline in borrowing rates and instead only suffer from a decline in interest income. As interest rates have been low for two decades, I have full sympathy for those who have been disadvantaged as a result. However, what I would like you to understand is that the effects of monetary policy should not be measured by the profits and losses arising from financial transactions with your bank. By pushing real interest rates below the natural rate of interest – that is, the interest rate at which the economy neither accelerates nor decelerates – and stimulating the economic activities of firms and households, monetary easing will increase aggregate demand and push up prices. To give you an example: if a drop in firms’ funding costs were to occur, they will undertake businesses and projects that otherwise would not have been profitable. In this case, firms’ fixed investment increases, and employment and wages will rise as well. Under QQE and “QQE with a Negative Interest Rate,” firms’ funding costs are much lower than the BIS central bankers’ speeches expected return from new businesses and projects. Looking at the Financial Statements Statistics of Corporations by Industry, Quarterly, for instance, firms’ return on assets (ROA) is somewhere around 4 percent, while average interest payments – firms’ funding costs – amount to only about 1 percent (Chart 6). Firms’ ROA exceeds their funding costs by a larger margin than ever before. This means that if a firm borrows money now to start a business, it will gain a return from the business that far exceeds the interest of the loan to pay. The highly accommodative financial conditions stimulate investment by firms in new businesses and projects. If firms increase their investment, the benefits will also spread to households in the form of increases in employment and wages. As monetary policy affects the entire economy in the way I just described, it is necessary to consider its effects from the perspective of the economy as a whole. Meanwhile, with regard to the 2 percent price stability target, I am often asked why it is necessary that prices rise year after year. To answer this question, let me ask you to recall that more than 15 years of deflation have stymied the dynamics of the economy like a chronic disease. You therefore can see why moderate inflation is a good thing. Under deflation, the economy fell into a vicious cycle in which a decline in prices led to a decrease in firms’ sales and profits, which in turn resulted in wage restraint, a downturn in consumption, and a further decline in prices. If we can reverse the deflationary mindset and economic entities started behaving based on the premise that prices will rise moderately, the exact opposite would happen; that is, a virtuous cycle would arise in which firms’ sales and profits increase and wages also rise. What the Bank is aiming to achieve is this kind of virtuous cycle. This will likely benefit a broad range of economic entities. When I provide this explanation, I am sometimes asked: if we try to achieve a rise in prices and prices do rise but wages do not, won’t this be bad for the economy? However, as I mentioned earlier, a rise in prices without a rise in wages is not something that normally happens. If firms’ sales and profits grow through increases in the prices of goods and services, wages paid to workers will increase accordingly. In fact, past data show that the rate of increase in hourly wages and that in consumer prices have generally moved in tandem (Chart 7). The Bank is aiming at a situation in which the economy expands on the basis of mild inflation accompanied by wage increases. After having experienced protracted deflation, it may be difficult to actually imagine such a situation now in Japan. However, I would like you to recall that, until the mid-1990s, people conducted their economic activities on the premise of moderate inflation and took for granted that wages and prices would increase. With this in mind, overcoming deflation as soon as possible through decisive monetary easing is absolutely essential to returning Japan’s economy to a sustainable growth path, while the Bank will be watchful of the various effects of its low interest rate policy including negative interest rates. The impact on the JGB market The second criticism I often hear concerns the impact of “QQE with a Negative Interest Rate” on financial institutions and financial markets. I recognize that the policy has various effects on financial institutions – not only in terms of their profitability, but also on their trading practices as well as their information and computer systems. Moreover, in terms of the impact on financial markets, I am also aware of concerns that, with the Bank continuing with large-scale purchases of JGBs, supply and demand conditions in the JGB market are becoming extremely tight, and that conducting the negative interest rate policy under these circumstances would have distorting effects on the JGB market and thereby cause great damage to liquidity and functioning of the market. I would like to talk about this second point today. Let me start by highlighting that the Bank makes its utmost efforts to ensure the stability of financial markets by conducting its market operations as flexibly as possible while engaging in a close exchange of opinions with market participants. In addition, the Bank carefully BIS central bankers’ speeches monitors the liquidity and functioning of the JGB market from a variety of angles. Last year, it started to conduct and publish the Bond Market Survey, which reports the results of surveys of market participants on the liquidity and functioning of the JGB market. Moreover, the Bank regularly compiles and publishes a wide range of JGB market liquidity indicators in the futures market, the cash JGB market, and the repo market. Some indicators certainly suggest that there has been a decline in liquidity since the start of this year (Chart 8). However, these indicators tend to fluctuate substantially and have shown large changes on occasion. Moreover, as was the case with bid-ask spreads, there are indicators that temporarily widened but improved thereafter. The JGB market is a mirror of market participants’ outlook for economic growth and perception on prices. There is no doubt that this market is significantly affected by the unconventional large-scale monetary easing; therefore, the Bank will continue to carefully monitor the developments in liquidity in and the functioning of the JGB market, so that the mirror will remain clear. Conclusion In concluding, let me touch on the economy of Akita Prefecture. The economy of Akita Prefecture continues to recover moderately as a trend. In terms of employment and income, the active job-openings-to-applicants ratio has been above 1 for 17 months in a row – the longest period ever – and labor market conditions have been tightening. Moreover, against the background of rising labor shortages, moves toward wage increases are continuing. Under these circumstances, private consumption has been firm. Although some weakness in firms’ production activities can be observed due to the deceleration in emerging economies, looking at the Tankan results of the Akita Branch of the Bank of Japan, corporate profits and fixed investment plans for this fiscal year have increased for four years in a row, with the increase particularly strong in manufacturing, suggesting that corporate profits and fixed investment plans are resilient. That being said, business sentiment differs considerably depending on the industry and firm size, and business sentiment among small and very small nonmanufacturing firms has been slow to improve, partly because such firms have fallen behind in capturing demand from outside the region. In addition, Akita Prefecture faces substantial structural changes, such as population aging and decline, which is more severe than in many other prefectures. An urgent issue is to provide a necessary infrastructure that allows the young to be active and settle in the prefecture. Akita’s comprehensive strategy for the future formulated by the prefectural government in October last year contains measures to attract people to settle in the prefecture and to counter the falling birth rate, in addition to measures for the promotion of industry. Although Akita faces a variety of challenges, it is blessed with an abundance of resources that could become a key to regional revitalization; namely, important industrial clusters such as in the electronic parts and devices industry and the machinery industry, ample agricultural and forestry resources, and major potential tourist attractions. In the aviation industry, the prefecture and local firms are cooperating in efforts to establish business relationships with major aircraft manufacturers, and shipments have increased in recent years. In alternative energy, Akita now has one of the largest wind power generation capacities nationwide, and there have been moves toward the commercialization of biomass and geothermal electricity generation. In agriculture, there has been progress in developing competitive agricultural products to reduce Akita’s dependence on rice farming. And in tourism, it boasts a range of unique festivals and events in the various regions within the prefecture. Apart from the Namahage Festival on the Oga Peninsula, which is well known throughout Japan, and the Omagari fireworks, Akita Prefecture offers a great variety of tourist attractions such as the historically valuable samurai residences in Kakunodate and the hot spring resorts of Nyuto Onsen and Tamagawa Onsen. In order for Akita Prefecture’s economy to develop further, it is of great importance to continue to effectively utilize these resources. BIS central bankers’ speeches The Bank, centering on its Akita Branch, hopes to contribute as much as possible to the initiatives in the prefecture to vitalize the region. In closing, I wish all the best for the further development of the economy of Akita Prefecture. Thank you. 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 Keio University, Tokyo, 20 June 2016.
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Haruhiko Kuroda: Overcoming deflation – theory and practice Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at Keio University, Tokyo, 20 June 2016. * * * Introduction It is a great honor to have the opportunity to speak to you today at the Faculty of Economics at Keio University. Founded by Yukichi Fukuzawa in 1858, Keio Gijuku has a history spanning more than 150 years. The Faculty of Economics – the precursor of which, together with the Faculty of Letters and the Faculty of Law, was one of the three original faculties of Keio University established in 1890 – is said to be the oldest economics faculty in Japan. Since then, it has not only been a leading force in economic scholarship in Japan in a wide range of research areas but has also turned out a large number of individuals that have gone on to play prominent roles in the world of politics, business, and finance. Since I have been given the opportunity to speak at such an academic venue, today I would like to talk about the implementation of so-called unconventional monetary policy and their link to developments in academic research, based on the Bank’s experience in implementing quantitative and qualitative monetary easing (QQE). I. QQE with a negative interest rate Japan has struggled with deflation since the late 1990s, and in the process the need for more powerful monetary easing gradually became evident. The Abe administration was inaugurated in December 2012 and launched its so-called “Abenomics” policies consisting of “three arrows,” and I assumed my role as Governor of the Bank of Japan in March 2013. In April, at the first Monetary Policy Meeting after I became Governor, the Bank decided to introduce QQE. QQE comprises two elements designed to break through the bounds to previous monetary policy measures (Chart 1). The first element consists of trying to drastically convert the deflationary mindset that had gained hold among people and to raise inflation expectations through the Bank’s strong commitment to achieving the price stability target of 2 percent at the earliest possible time. The second element consists of exerting downward pressure not only on short-term nominal interest rates but on the entire yield curve through massive purchases of Japanese government bonds (JGBs). The consequence of these elements is that they make it possible to exert greater monetary easing effects on the real economy by substantially lowering real interest rates not only at the short end but also at the long end. Subsequently, the pace of monetary expansion was accelerated in October 2014 both in quantitative and qualitative terms and, in January this year, the policy was augmented in a third dimension by adding an interest rate dimension to the quantitative and qualitative dimensions through the introduction of “QQE with a Negative Interest Rate” (Chart 2). The introduction of a negative interest rate aims to exert further downward pressure on the entire yield curve by lowering the short end of the yield curve, coupled with massive purchases of JGBs. This could be called “enhanced QQE” in that it is an extension of previous QQE policies and further enhances their effects. With regard to massive purchases of JGBs, the Bank initially conducted purchases such that the amount outstanding of JGBs held by the Bank would increase at an annual pace of about 50 trillion yen, and in October 2014 this was accelerated to today’s pace of about 80 trillion yen. Since Japan’s nominal GDP is about 500 trillion yen, an annual increase of 80 trillion yen corresponds to about 16 percent of GDP (Chart 3). As a result of such purchases, the BIS central bankers’ speeches Bank of Japan’s balance sheet relative to nominal GDP increased from about 35 percent at end-March 2013 to about 81 percent at end-March this year and will continue to rise. For comparison, following the three rounds of large-scale asset purchases (LSAPs) in the United States, which now have ended, the Federal Reserve’s balance sheet at end-March this year was equivalent to 25 percent of nominal GDP. I think this shows you just how massive the monetary easing conducted by the Bank of Japan is. II. The costs of deflation As mentioned, the aim of QQE is to overcome the prolonged deflation that has gripped Japan. Even if this deflation has been mild, the fact that it has continued for more than 15 years means that its cumulative costs have been extremely large. Looked at in terms of the price level, an annual inflation rate of minus 0.3 percent over a period of 15 years implies that the price level will fall by around 5 percent, but an annual inflation rate of 2 percent over a period of 15 years means that the price level will rise by around 35 percent. Therefore, I think it is clear that even mild deflation, if it continues for a prolonged period, will have a large impact on the medium- to long-term decision-making of economic entities. The problem with persistent deflation is that it gives rise to a vicious cycle in which firms and households – since they expect prices to fall further and due to heightened uncertainty – postpone various expenditures, which further prolongs weak growth and deflation. Under such circumstances, with falling prices and heightened uncertainty, postponing expenditures may be the optimal response for individual economic entities; however, from a macroeconomic perspective, it is a typical example of the “fallacy of composition,” since it results in prolonging weak growth and deflation. Therefore, to overcome deflation, it is absolutely essential to drastically convert the deflationary mindset. Moreover, merely achieving a positive inflation rate is not sufficient; it is also necessary that a self-reinforcing cycle of strengthening economic activity gains traction with prices increasing moderately. During the period of deflation, Japan’s economy experienced a simultaneous downward shift and flattening of the Phillips curve (Chart 4). If the average inflation rate is low, the opportunity costs of leaving prices unchanged are also low, so that the frequency of price adjustments by firms is likely to fall. Macroeconomic theory suggests that such a decline in the frequency of price adjustments at the micro level is linked to a flattening of the Phillips curve at the macro level. 1 A key question in this context, I think, is whether the flattening of the Phillips curve or, in other words, the decrease in the responsiveness of the inflation rate to economic fluctuations, is simply the result of changes in firms’ price-setting behavior. If we look at Japan’s experience of prolonged deflation, the decline in the frequency of price adjustments can also be regarded as signaling a weakening in the metabolism of the economy, of which the postponement of expenditure activities by firms and households is only a symptom. If this is the case, it is possible that the change in the shape of the Phillips curve reflects a deterioration in the fundamentals of Japan’s economy. Of course, at the moment, this is nothing more than a hypothesis. To examine this hypothesis, we need theoretical and empirical studies taking the interaction of deflation and firms’ behavior into account, but to date there is limited amount of research on this issue. Moreover, when considering the lessons from Japan’s prolonged deflation, it is also essential to deepen our understanding with regard to the link between deflation and macroeconomic performance. Laurence Ball, N. Gregory Mankiw, and David Romer, “The New Keynesian Economics and the OutputInflation Trade-off,” Brookings Papers on Economic Activity, No. 1, 1988, pp. 1–65. BIS central bankers’ speeches III. Formation of inflation expectations Earlier, I mentioned that QQE consists of two elements. One of these was the drastic conversion of the deflationary mindset, and related to this, I would like to consider the formation of inflation expectations in more detail. When considering the formation of inflation expectations, theoretical and empirical research on forward guidance under zero interest rates provides useful insights. With many central banks grappling with the zero lower bound on policy rates not only as a theoretical possibility but as a problem encountered in practice, research on forward guidance has made considerable progress. 2 Such research has helped to elucidate that, even in a situation where the zero lower bound has been reached and it is not possible to lower policy rates further, monetary easing effects can be achieved through forward guidance by committing to maintaining zero interest rates, which can be regarded as a mechanism to borrow monetary easing effects from the future (Chart 5). The first time this mechanism was employed in the actual conduct of monetary policy was with the introduction of the zero interest rate policy commenced by the Bank of Japan in February 1999. At that time, the Bank committed itself to maintaining a zero interest rate until deflationary concern was dispelled, and the impact of that policy was called the “policy duration effect.” Backed by growing theoretical research, similar policies were subsequently adopted by central banks of other major advanced economies and have recently come to be referred to as forward guidance. It is well known that in standard macroeconomic models, macroeconomic variables respond strongly to forward guidance by the central bank, giving rise to substantial policy effects. Thus, from a theoretical perspective, a commitment to continuing with zero interest rates for a prolonged period not only allows borrowing unlimited monetary easing effects from the future, but such policy effects also materialize immediately. However, these predictions are at odds with the effects actually observed in practice – a phenomenon that has been described as the “forward guidance puzzle.” 3 When considering this puzzle, two factors are important. The first is that in standard macroeconomic models, there are no limits to consumption smoothing over time due to the large intertemporal elasticity of substitution and the absence of borrowing constraints. The second is that inflation expectations respond instantaneously to any change in policy. It is this latter point – the speed with which inflation expectations respond – that I would like to focus on next. In theoretical models assuming a forward-looking Phillips curve, inflation expectations respond instantaneously if the commitment regarding future monetary easing is credible. However, inflation expectations observed in practice are highly sticky and change only slowly. This means that in the actual formation of inflation expectations, the backwardlooking component determined by actual inflation rates observed in the past plays a large role. Moreover, in standard theoretical models, it is assumed outright that the commitment to monetary easing is perfectly credible, which potentially gives rise to a discrepancy between such theoretical models and reality. If we consider Japan’s experience, with inflation expectations having declined in the deflationary period, what plays an extremely important role in the process of overcoming deflation is to push inflation expectations back up to close to the target inflation rate and to re-anchor them there. How to do this, including how to deal with the impact of the backwardlooking component of inflation expectations, is a challenge that is not necessarily addressed Gauti Eggertsson and Michael Woodford, “The Zero Bound on Interest Rates and Optimal Monetary Policy,” Brookings Papers on Economic Activity, No. 1, 2003, pp. 139–211. Marco Del Negro, Marc Giannoni, and Christina Patterson, “The Forward Guidance Puzzle,” Staff Reports 574, Federal Reserve Bank of New York, 2012. BIS central bankers’ speeches by theory. Moreover, with not only the Bank of Japan but many other central banks around the world currently having nearly exhausted conventional monetary policy means – that is, lowering short-term interest rates – responding to deflationary pressures and firmly stabilizing inflation expectations at the desired level represents an unprecedentedly difficult challenge. In this sense, the formation of inflation expectations can be regarded as an “old new” issue of debate. IV. Large-scale purchases of financial assets Next, I would like to talk about pushing down the entire yield curve through massive JGB purchases, which is another element of QQE. As is well known, although the market operations of a central bank – by exchanging monetary base for government bonds – are transactions in financial assets that are not perfect substitute, they should be neutral with regard to price formation if arbitrage in financial markets operates fully. 4 However, if arbitrage in financial markets for some reason is imperfect, the market operations of the central bank will affect term premiums. 5 Moreover, it is likely that such financial market imperfection will become more severe during times of financial crisis. In practice, if we look back at the response of central banks in the United States and Europe immediately after the collapse of Lehman Brothers, we find that the most important issue was the stabilization of financial markets and the financial system, and central banks to this end provided large amounts of liquidity and intervened in financial markets that showed signs of malfunction. Subsequently, with financial markets having calmed down to some extent, central banks continued with large-scale asset purchases with the aim of stabilizing the macroeconomy and avoiding deflation by pushing down various premiums in financial markets. Furthermore, another important component of QQE, as mentioned earlier, was to raise inflation expectations by influencing forward-looking expectations formation. A number of studies employing New Keynesian models – the standard type of macroeconomic models employed to analyze monetary policy issues – have sought to incorporate various kinds of financial market imperfections to examine the impact of such quantitative easing. 6 However, I think that to date it is not sufficiently clear under what circumstances and through which mechanisms quantitative easing is effective. In fact, former Fed Chairman Bernanke has quipped that “[t]he problem with QE is it works in practice, but it doesn’t work in theory.” Given that different countries and regions have different financial systems, I think that when examining the impact of quantitative easing it is necessary not only to focus on the financial markets in which large-scale asset purchases are conducted but also to explicitly take into account such differences, for example in the transmission mechanisms in the financial systems. V. Monetary policy rules I would now like to slightly change the topic and consider unconventional monetary policy and monetary policy rules. Neil Wallace, “A Modigliani-Miller Theorem for Open-Market Operations,” American Economic Review, Vol. 71, No. 3, 1981, pp. 267–274. Franco Modigliani and Richard Sutch, “Innovations in Interest Rate Policy,” American Economic Review, Vol. 56, No. 2, 1966, pp. 178–197. See, for example, Mark Gertler and Nobuhiro Kiyotaki, “Financial Intermediation and Credit Policy in Business Cycle Analysis,” in Benjamin Friedman and Michael Woodford, eds., Handbook of Monetary Economics, Vol. 3A, 2010. BIS central bankers’ speeches One of the areas in which there has been considerable progress since the 1990s in theoretical and empirical research on monetary policy is research on policy rules, of which the Taylor rule is a prime example. 7 Studies in this area highlight the importance of systematically setting policy rates in line with changes in the macroeconomy in order to maximize monetary policy effects. Put differently, they indicate that in order to ensure the effectiveness of monetary policy, the important thing is not to cause unanticipated shocks, but to maintain consistent and predictable policy responses (Chart 6). These considerations regarding the conduct of monetary policy essentially also apply to the conduct of unconventional policies. This means that, in order to raise the effectiveness of monetary policy, it is important to show in advance the policy options the central bank can use to address an exogenous shock to the economy large enough for interest rates to hit the zero lower bound. However, looking back at Japan’s experience since the late 1990s and the policy response in the United States and Europe following the collapse of Lehman Brothers, central banks essentially stumbled along in devising new policy measures to respond to the situation and problems facing them at the time. Since in practice the world is full of uncertainty, it is difficult to present policy options for all contingencies in advance. Moreover, because policy responses to unanticipated events are formulated by taking not only financial and economic circumstances but also various structural and institutional constraints into account, they tend to consist of a complex package of policies. The issue of what kind of institutional framework should be built in order to achieve an efficient allocation of resources in circumstances where such uncertainty is great and it is necessary to deal with complex challenges falls into the arena of incomplete contract theory. 8 Research in this field has made rapid progress in recent years and the findings are applied in practice in a growing range of areas, such as firm organization, financial contracts, and legal systems. I think that, by employing the new understanding gained and considering a possible policy framework for comprehensive policy rules – including in response to crises – as well as the application of such rules, it may be possible to expand the research frontier of monetary policy. VI. Long-term equilibrium While it is premature to talk about the timing of an exit from “QQE with a Negative Interest Rate” and how to go about it, I would finally like to take the valuable opportunity of speaking here today to say a few words about the relationship between Japan’s economy and monetary policy once deflation has finally been overcome. Standard models analyzing monetary policy take the trend growth rate and the inflation rate in steady state as given and focus on economic fluctuations around the trend. The central interest of monetary policy analysis employing such models is how to smooth cyclical economic fluctuations and to stabilize the inflation rate near the target level. Standard macroeconomic models generally make simplifying assumptions: short-term models focusing on business cycles take the potential growth rate as exogenously given, while long-term economic growth models examining the determinants of the potential growth rate ignore short-term economic fluctuations, since it is assumed that these are smoothed out over time and do not affect long-term economic growth. The pioneering study in this area is John B. Taylor, “Discretion versus Policy Rules in Practice,” CarnegieRochester Conference Series on Public Policy, Vol. 39, 1993, pp. 195–214. A standard textbook in this field is Patrick Bolton and Mathias Dewatripont, Contract Theory, The MIT Press, 2005. BIS central bankers’ speeches Similar simplifying assumptions are made in the analysis of unconventional monetary policy. When unconventional monetary policies are analyzed using standard theoretical macroeconomic models, it is assumed that even if there is a shock large enough for interest rates to hit the zero lower bound the economy returns to its steady state as the shock dissipates. In other words, such analyses of unconventional monetary policies examine how the impact of a large shock is smoothed out and absorbed over time. However, if there is a downward shift in the steady state and the natural rate of interest, which reflects long-term growth expectations, shifts down permanently, the stimulative effects of a decline in real interest rates on economic activity will weaken and the effectiveness of monetary policy will be substantially hampered. Moreover, if there is substantial uncertainty regarding the level of the natural rate of interest, this would make it difficult to assess the degree of monetary easing or tightening required and it would increase uncertainty over the future course of monetary policy. In addition, since the decline in the potential growth rate is likely to also lower expected permanent incomes, it will give rise to a negative income effect, which likely will exert downward pressure on economic activity. In fact, as seen in the “secular stagnation” debate of recent years, there has been active debate in major advance economies regarding the possibility that, following the large shocks they have suffered, the steady state may have shifted downward due to a variety of factors. 9 Meanwhile, whereas Japan’s potential growth rate until the early 1990s had been in the range of 3 to 4 percent, it subsequently followed a downward trend, falling to around 1 percent in the second half of the 1990s and further to a level below 0.5 percent after the collapse of Lehman Brothers (Chart 7). The natural rate of interest – that is, the interest rate at which the economy neither accelerates nor decelerates – is likely to also have followed a downward trend in line with the decline in the potential growth rate. In this sense, the relationship between uncertainty surrounding the medium- to long-term steady state and the conduct of monetary policy can be said to be an issue faced not only by the Bank of Japan, but by all central banks. In order to consider this issue, it is necessary to devise an analytical framework that takes the interaction between long-term economic growth and short-term business cycle fluctuations into account. Doing so is not only of practical importance but should also present an interesting research topic from an academic perspective. Conclusion Japan’s experience of battling with mild but extremely persistent deflation provides a valuable case study both for academic research on unconventional monetary policy and for the practical conduct of monetary policy by central banks. By making use of this experience, we have made significant progress over the past decade and a half in academic research and the actual conduct of monetary policy. However, it is also true that, as I mentioned today, there still remain gaps between the two. Going forward, I am sure that if academia and central banks continue to join forces in their efforts, this will produce important benefits to both sides. Thank you. Lawrence H. Summers, “Have we Entered an Age of Secular Stagnation? IMF Fourteenth Annual Research Conference in Honor of Stanley Fischer, Washington, DC,” IMF Economic Review, Vol. 63, No. 1, 2015, pp. 277–280. 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 Takahide Kiuchi, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Ishikawa, 23 June 2016.
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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, Ishikawa, 23 June 2016. * * I. Economic activity and prices in Japan A. The Bank of Japan’s view * The Bank of Japan explains its assessment of the current situation and outlook for Japan’s economic activity and prices in the Statement on Monetary Policy, which is released after each Monetary Policy Meeting (MPM), and in the Outlook for Economic Activity and Prices (the Outlook Report), which is published four times each year. Therefore, I will first give you an overview of its assessment of the current situation and outlook based on the latest Outlook Report and Statement on Monetary Policy. Japan’s economy has continued its moderate recovery trend, although exports and production have been sluggish, due mainly to the effects of the slowdown in emerging economies. The outlook through fiscal 2018 envisages that, although sluggishness is expected to remain in exports and production for the time being, domestic demand is likely to follow an uptrend, with a virtuous cycle from income to spending being maintained in both the household and corporate sectors, and exports are expected to increase moderately. Thus, Japan’s economy is likely to be on a moderate expanding trend. As for prices, the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) is likely to be slightly negative or about 0 percent for the time being, due to the effects of the decline in energy prices, and thereafter accelerate toward 2 percent. Meanwhile, assuming that crude oil prices will rise moderately from the recent level, the timing of the year-on-year rate of change in the CPI (all items less fresh food) reaching around 2 percent – the price stability target – is projected to be during fiscal 2017. Thereafter, the year-on-year rate of change in the CPI (all items less fresh food) is likely to be around 2 percent on average. B. My personal view I believe that Japan’s current growth rate and inflation rate are generally stable, in light of the economy’s growth potential, and that there is a relatively high probability of this situation continuing during the projection period in the April 2016 Outlook Report. However, when expressed in figures, my view is fairly cautious compared with the medians of the Policy Board members’ forecasts. This is mainly because I believe that (1) there is not a driving force from the demand side – including in terms of the effects of monetary easing – that will bring about economic growth at a pace clearly higher than its potential; (2) there are downside risks to the medians of the Policy Board members’ forecasts in terms of demand both at home and abroad; and (3) as a result of these factors, the output gap is expected to remain more or less at a neutral level, making it difficult to expect that the underlying trend in inflation will rise markedly. Next, I will mention several points of attention regarding the outlook for economic activity and prices based on my view. 1. Stagnant potential growth rate According to the Bank’s estimates, the potential growth rate of Japan’s economy, which represents from the supply side – the pace of growth that is consistent with the economy’s BIS central bankers’ speeches growth potential, is still at a low level in the range of 0.0–0.5 percent. No notable improvement has been observed in the past several years, either. In particular, in line with the sluggish rate of increase in total factor productivity (TFP), which reflects technological advances, the rate of increase in labor productivity – which considerably affects firms’ wagesetting behavior, which in turn impacts private consumption and prices – has continued to be stagnant. However, the output gap, which represents the degree of utilization of capital and labor, has generally maintained a neutral level over the past several years. This means that Japan’s economy has continued to show stable growth that is more or less consistent with its growth potential. 2. Medium- to long-term growth expectations and business fixed investment Although business fixed investment has been on a moderate increasing trend, it has not grown as strongly as had been expected when considering the high levels of corporate profits. I think that the fact behind this situation is that, while the high levels of profits in recent years had been brought about largely by improvement in price factors that cannot necessarily be considered sustainable – namely, improvement in the terms of trade reflecting changes in the exchange rates and commodity prices – the prospects for future sales volume have not improved. In this respect, the potential growth rate is still at a low level and is expected to improve only very moderately; therefore, firms may not significantly change their cautious stance on business fixed investment in the domestic market. 3. Sluggish private consumption Private consumption has been resilient, but I think that it is still sluggish. It seems that pricerelated factors that once curbed private consumption, such as the consumption tax hikes and price increases for food and daily necessities, have been fading away recently. However, wages have not improved by as much as had been expected, as seen in the fact that the base pay increase resulting from the labor-management wage negotiations this spring seems to have been somewhat lower than the level in 2015. This has led to households’ cautious outlook for wages, which might be one factor restraining private consumption. I would note that these developments in wages might be attributable to persistent concerns among firms that a rise in labor costs, including an increase in base pay, may undermine the future situation for corporate profits amid the lack of a rise in the expected productivity growth rate and in the expected medium- to long-term economic growth rate. In addition to households’ cautious outlook for wages arising from firms’ stance of curbing labor costs, future concerns that are rooted in the fiscal condition and the social security system may be another factor restraining private consumption among a broad range of age groups. 4. Overseas economies and downside risks to Japan’s exports The expectations for a global economic downturn that mounted at the beginning of 2016 have receded somewhat recently, reflecting improvements in U.S. and Chinese economic indicators and the stabilization of crude oil prices. However, it is difficult to expect the U.S. economy in its current status to act as a strong driving force of the global economy. Therefore, the scenario of advanced economies leading the global economic recovery has remained unrealized. In emerging economies, business fixed investment has been weak due to excess production capacity and excess debt, eroding the global economy’s current recovery potential. These problems could destabilize global financial markets, particularly through adjustments in the corporate bond markets in emerging economies that may be triggered by, for example, changes in the flow of funds caused by the U.S. monetary policy. Moreover, I am paying attention to the possibility that, if the global economy shows signs of a slowdown again, BIS central bankers’ speeches resulting in a decline in energy prices, there will be growing risks on the financial front, including (1) adjustments in the markets for high-yield bonds, mainly those issued by energyrelated firms, and (2) heightened credit risk involved in financial institutions’ exposure to these firms. In light of this export environment, I have continued to regard developments in overseas economies and global financial markets as the most serious downside risks to Japan’s economy. 5. Developments in the underlying trend in inflation Since the beginning of fiscal 2016, the year-on-year rate of change in retail prices of consumer goods – mainly processed food – has tended to shift downward. Presumably, this is because at the beginning of the fiscal year, the price increases did not spread as much as in the past two years owing to (1) the depreciation of the yen having come to a pause, (2) private consumption having been sluggish, partly due to the effects of irregularly warm weather, and (3) the pace of wage increases having remained only moderate. Under these circumstances, I expect that the year-on-year rates of change in the indicators of the underlying trend in prices, such as the CPI (all items less fresh food and energy) and the CPI (all items less food and energy), will decelerate somewhat over the next several months. Moreover, I do not assume that the year-on-year rate of change in the CPI (all items less fresh food) will reach the price stability target of 2 percent by fiscal 2018, the last year of the projection period in the April 2016 Outlook Report. Even so, as the expected decline in the underlying trend in inflation for the time being is largely attributable to the disappearance of temporary factors such as the depreciation of the yen, I expect that prices will generally stay stable. While the level of the underlying trend in inflation – represented by, for example, the year-on-year rate of change in the CPI (all items less fresh food and energy) – is lower than the price stability target of 2 percent, I do not believe that this is causing any particular problem for current economic activity because the rates do not deviate widely from firms’ and households’ medium- to long-term inflation expectations. II. Conduct of monetary policy The Bank introduced Quantitative and Qualitative Monetary Easing (QQE) in April 2013 and then QQE with a Negative Interest Rate in January 2016, 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. Against these decisions, I have been insisting on a change to QQE – including a reduction in the pace of the Bank’s asset purchases – and a review of the negative interest rate policy, based on an examination and a comparison of positive effects and side effects of these measures. Furthermore, I think that enhancement of facilities to provide liquidity is important, in order to maintain financial system stability through securing the smooth functioning of financial markets and financial intermediation. I would like to explain the organization of the thinking behind my policy stance. A. Rebalancing of Two Mandates of the Bank’s Policy The two mandates of the Bank’s policy are to ensure price stability and financial system stability. Monetary easing measures in recent years – such as QQE and the negative interest rate policy – have proceeded with emphasis placed on price stability, based on the recognition that financial system stability has been sufficiently secured. I admit that the financial system can be assessed as being generally stable at present. However, potential vulnerability in the financial system has increased under the prolonged BIS central bankers’ speeches low-interest rate environment, and this trend has been augmented by the large-scale monetary easing. Therefore, I think that the outlook is by no means optimistic. From this viewpoint, I have continued to cast a dissenting vote on the negative interest rate policy since its introduction through the most recent MPM held in June 2016. I have considered that negative interest rates would decrease the functioning of financial markets and financial intermediation, as well as impair the stability of the JGB market and smooth conduct of the Bank’s JGB purchases, and therefore an interest rate of 0.1 percent – the same rate as before – should be applied to all current account balances excluding the amount outstanding of the required reserves held by financial institutions at the Bank. Moreover, I think it is time for the Bank to shift the focus of its policy from price stability to financial system stability. I believe that such a shift will eventually benefit the Bank in pursuing the ultimate goal of contributing to the sound development of the national economy through achieving the intermediate objectives, i.e., the Bank’s two mandates, in a wellbalanced manner. B. Necessity to maintain the sound functioning of financial intermediation In recent years, financial institutions’ profitability – represented by operating profits from core business – and loss-absorbing capacity have been declining, particularly among regional financial institutions. Downward pressure on their net income also seems to have increased recently, due in part to the fact that profit taking, mainly through sales of investment trusts, has become difficult in a situation where changes have been observed in the depreciating trend of the yen and the increase in stock prices that continued to be seen over the past several years. Furthermore, there is concern that the profit environment for financial institutions might become increasingly severe, mainly due to a further narrowing of interest rate margins on loans and a greater reduction in yields on securities – both of which followed the introduction of the negative interest rate policy – as well as to a rise in credit costs. In this situation, banks may take excessive risks at a time of profit deterioration in an attempt to increase their profits, but they may become excessively risk averse in the future, mainly because losses will be incurred by a possible worsening of economic and financial developments. This could negatively affect economic activity and financial markets by exacerbating firms’ and households’ borrowing constraints and through banks’ fire sales of assets. Furthermore, from a longer-term perspective, the impairment of banks’ financial soundness might also have negative effects on the efficiency and productivity of the economy. To give an example, banks with declining loss-absorbing capacity might postpone appropriate treatment of borrowers with weak performance amid a continued decline in banks’ profitability. This may cause a situation in which capital and labor are being allocated to inefficient firms, and thus result in pushing down the rate of increase in TFP in the overall economy over the long term. With these points taken into account, the malfunctioning of financial intermediation through the impairment of banks’ financial soundness might further push down the potential growth rate of the economy, which is currently at a low level in the range of 0.0–0.5 percent. Monetary policy is usually thought to affect the demand side of the economy. However, if the policy impairs financial system stability, the supply side of the economy – for example, the productivity growth rate and the potential growth rate – may also be adversely affected, causing losses in social welfare. C. Concerns about the stability of the JGB market and smooth conduct of the bank’s JGB purchases Since the introduction of the negative interest rate policy, the JGB market has been increasingly unstable – as evident from heightened volatility of JGB yields. I consider that this has exerted negative effects on the stability of financial markets as a whole. In this situation, BIS central bankers’ speeches there have been adverse effects on the smooth conduct of the Bank’s JGB purchases. For example, the bid-to-cover ratios of its JGB purchasing operations have declined somewhat and there is a growing tendency for the bid rates to fall below the market rates. Before the introduction of the negative interest rate policy, financial institutions did not face particular problems in selling JGBs to the Bank and in turn increasing funds in their current accounts at the Bank to which an interest rate of 0.1 percent was applied without their taking interest rate risk. However, given that many financial institutions attach more importance to obtaining stable income gains rather than having temporary capital gains, I consider that they have become significantly discouraged to sell JGBs to the Bank and increase funds in their current accounts at the Bank. This is because the difference between the yields of JGBs held by financial institutions and the interest rates applied to current accounts at the Bank has widened with the introduction of the negative interest rate policy. In addition, with the introduction of the negative interest rate policy, the Bank adopted a multiple-tier system in which the outstanding balance of each financial institution’s current account at the Bank is divided into tiers, with different interest rates – including a negative interest rate – being applied to each tier. Because of this, financial institutions, particularly at the beginning of the introduction of the policy, have tended to reduce or not increase the Policy-Rate Balance, to which a negative interest rate is applied. As a result, they are proceeding with purchases of JGBs, particularly those with super-long maturities that are still offered with positive yields, and I think that this is one of the factors behind further tightening of the JGB market conditions and somewhat unstable conduct of the Bank’s JGB purchases. Given this, I consider that the decline in JGB yields, particularly those on JGBs with superlong maturities, since the introduction of the negative interest rate policy is not necessarily evidence that the policy has been exerting positive effects stably. I would like to note that, with the increase in the amount outstanding of its JGB holdings, the Bank is also increasing the amount of reinvestment in JGBs resulting from redemption. Thus, even though the target for the pace of increase in the amount outstanding of its JGB holdings remains the same, the gross amount of the Bank’s JGB purchases has been increasing. Also, fiscal 2016 marks an important point in considering the supply-demand balance of JGBs. It is the year in which the gross amount of the Bank’s JGB purchases is expected to almost reach the gross amount of JGB issuance by the government. This implies that it is becoming difficult for the Bank to maintain the pace of increase in the amount outstanding of its JGB holdings solely by purchasing from the market the equivalent amount of JGBs issued by the government. It is considered that the Bank increasingly will need to purchase JGBs from financial institutions before redemption of such JGBs up to the amount needed for it to maintain the pace of increase in the amount outstanding of its JGB holdings. Given this, it is necessary to sufficiently recognize that it was at this exact timing that the negative interest rate policy – which discourages financial institutions to sell JGBs – was introduced. D. Future conduct of monetary policy My assessment is that QQE, which focuses on JGB purchases, already has exerted a considerable effect, as evidenced by the closing of the negative output gap at an early stage and the subsequent correction of the weak prices. However, I consider that the additional effects of QQE have been diminishing, given that the continued decline in long-term real interest rates, which is considered to be the main source of policy effects, already has come to a halt. On the other hand, numerous side effects of QQE arising from the Bank’s JGB purchases have not diminished; rather, they seem to be increasing steadily. These side effects include (1) various problems stemming from the distortion of the JGB market – for example, a risk of instability in the financial system caused by impairment of the proper functioning of the JGB market in terms of liquidity and the pricediscovery function, and a risk that drastic fluctuations in JGB prices will cause revisions to prices of other financial products and assets; (2) a limit to the Bank’s JGB purchases and increased volatility in the market in case of arising concerns among market participants about BIS central bankers’ speeches such a limit; and (3) deterioration in the Bank’s financial soundness in the course of normalizing monetary policy. Under these circumstances, I believe that, by reducing the pace of the Bank’s JGB purchases – or the annual pace of increase in the amount outstanding of its JGB holdings – the balance between the positive effects and side effects of QQE could be improved while ensuring stability in the JGB market. In the meantime, if the Bank does not reduce the amount outstanding of its JGB holdings, it will be possible to avoid a rise in long-term real interest rates – a factor that leads to a decline in policy effects – thereby firmly ensuring the accumulated effects of the Bank’s JGB purchases. On this basis, I have been proposing since April 2015 to reduce the annual pace of increase in the amount outstanding of the Bank’s JGB holdings. In proceeding with the reduction, I think that it is possible to diminish its effects on financial markets by providing a thorough explanation, or forward guidance, to the markets that the reduction will actually enhance the stability and sustainability of the Bank’s JGB purchases. Moreover, I think that measures such as the review of the negative interest rate policy give due consideration to the stability of the functioning of financial markets and financial intermediation, which are critical infrastructures of economic activity. Implementation of such measures will bring about efficient resource allocation through appropriate operation of said functioning, and thereby support positive efforts by the government and firms toward increased productivity so that such efforts lead to a higher potential growth rate and ultimately to an improvement in people’s lives. Lastly, I believe that improving communication with financial markets and enhancing flexibility are the immediate challenges for the Bank in the conduct of monetary policy. As the Bank has emphasized its stance of achieving the price stability target of 2 percent at the earliest possible time, overly heightened expectations for additional monetary easing tend to be observed in financial markets whenever there is an expectation that the Outlook Report will present a delay in the projected timing of the year-on-year rate of change in the CPI (all items less fresh food) reaching around 2 percent. In addition, since the introduction of the negative interest rate policy, views have become increasingly widespread that the Bank will launch unforeseen easing measures at an unexpected timing. I presume that these phenomena not only have become one of the factors behind reduced predictability of monetary policy and increased volatility in financial markets, but also have led to impairment of the credibility of the Bank’s monetary policy conduct. For this reason, I consider it important that the Bank thoroughly communicate with financial markets regarding its conduct of monetary policy and bear in mind the need to provide a detailed explanation so as to narrow the perception gap between them. In order to achieve the 2 percent price stability target, I think that it is vital to have a positive change in economic structure that would increase the underlying trend in inflation – through, for example, efforts by the government and firms – and that a considerable period of time will be required for this to take place. Therefore, rather than aiming to achieve the 2 percent price stability target through monetary policy alone in the short term, I believe that resetting the time frame for achieving the target to the medium to long term and conducting monetary policy in a flexible manner – coupled with an improvement in communication with financial markets – will lead to maintaining economic and financial market stability. This will result in reaching the Bank’s ultimate goal of contributing to the sound development of the national economy. 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, Kanagawa, 4 August 2016.
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Kikuo Iwata: Japan’s economy and monetary policy – growing uncertainties surrounding overseas economies and enhancement of monetary easing Speech by Mr Kikuo Iwata, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kanagawa, 4 August 2016. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website. Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Kanagawa Prefecture. 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 Yokohama Branch. At the Monetary Policy Meeting (MPM) held at the end of last week, the Bank released the Outlook for Economic Activity and Prices (Outlook Report) and published its projections for Japan’s economic activity and prices through fiscal 2018. At the same time, taking account of heightened uncertainties surrounding overseas economies, including those associated with the United Kingdom’s vote to leave the European Union (EU), the Bank decided to further enhance monetary easing in order to prevent these uncertainties from leading to a deterioration in business confidence and consumer sentiment as well as to ensure smooth funding in foreign currencies by Japanese firms and financial institutions, thereby supporting their proactive economic activities. Today, I would like to first explain the Bank’s view on Japan’s economic and financial developments, followed by the Bank’s thinking on the monetary policy management, including the policy measures taken this time. I. Developments in overseas economies More than half this year has already passed: since the turn of the year, Japan’s economy has been significantly affected by the developments in overseas economies. In early 2016, global financial markets were volatile against the backdrop of the further decline in crude oil prices and uncertainties over future developments in emerging and commodity-exporting economies, particularly the Chinese economy. In order to preempt the manifestation of the risk that conversion of the deflationary mindset might be delayed, resulting from such uncertainties about overseas economies and financial markets, the Bank decided to introduce “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” at the MPM in January. Thereafter, global financial markets gradually regained some calmness and a situation where market turbulence would lead to the substantial slowdown in the global economy was avoided, partly reflecting additional monetary easing by the European Central Bank (ECB) and others and also strong determination shown by the G20 to use all policy tools – monetary, fiscal, and structural – to achieve sustainable growth under price stability. The referendum in the United Kingdom in late June, however, brought the result that a majority of voters supported leaving the EU – the so-called Brexit – which led to global financial markets destabilizing again, manifested in such developments as the rapid depreciation of the pound sterling. In foreign exchange markets, the yen rapidly appreciated; stock prices globally declined considerably, including in Japan. In addressing the situation, the relevant authorities, including those in the G7 countries, swiftly took actions: they issued a statement that they would consult closely on financial stability and cooperate as BIS central bankers’ speeches appropriate, and central banks in major economies also showed their readiness to take steps to ensure adequate liquidity, including U.S. dollar funding. The market developments following the referendum suggest that markets have been regaining their calmness, partly reflecting (1) an improved perception of the outlook for the U.S. economy after the better-than-expected employment data released in early July, and the early start of the new Cabinet of the United Kingdom. However, the impact of Brexit on the global economy still entails uncertainties, which should be carefully monitored going forward. It seems the negotiations between the United Kingdom and the EU for building their new relationship will last a long period of some years. We should be prepared for heightened uncertainties politically and economically for a prolonged period of time. The World Economic Outlook (WEO) Update released earlier by the International Monetary Fund (IMF) revised down the global growth forecast by 0.1 percentage point for 2016 and 2017, respectively, based on the relatively benign assumption that arrangements between the United Kingdom and the EU will avoid a large increase in economic barriers, but it also presented an estimation that the global economy would experience a more significant slowdown under more severe assumptions (Chart 1). We will continue to closely monitor the uncertainties surrounding overseas economies, which could not only directly affect Japan’s economy through exports and imports, but also exert influence on firms’ and households’ sentiment and restrain spending behavior, such as business fixed investment and consumption. II. Economic activity in Japan As explained, uncertainties surrounding overseas economies have heightened; nonetheless, the baseline scenario of the outlook for economic activity in Japan has instead improved compared to the previous Outlook Report in April (Chart 2). In sum, although exports and production have been sluggish, due mainly to the effects of the slowdown in emerging economies, a virtuous cycle from income to spending is being maintained in both the household and corporate sectors, and, looking ahead, Japan’s economy is likely to be on a moderate expanding trend. To start with the corporate sector, despite the headwind from overseas economies explained earlier, corporate profits have remained at high levels, especially in the nonmanufacturing sector, and business fixed investment has been on a moderate increasing trend on the back of such favorable profits. This also was evidenced in the June Short-Term Economic Survey of Enterprises in Japan (Tankan), although most responded to the survey prior to the United Kingdom’s referendum (Chart 3). In the household sector, the employment and income situation has continued to improve steadily. Labor market conditions have continued to tighten and the active job openings-toapplicants ratio stood at 1.37 in June, which is the highest since 1991. The unemployment rate has been at a low level in the range of 3.0–3.5 percent recently (Chart 4). Wages have been rising moderately. In the annual spring labor-management wage negotiations, base pay was raised for a third consecutive year, but to a smaller extent than last year, and wage increases have been spreading steadily to small firms and non-regular employees. Under these circumstances, private consumption has been resilient, although relatively weak developments have been seen in some indicators. This seems to be due to the negative wealth effects brought about by the decline in stock prices since the turn of the year, as well as the negative impact on consumer sentiment resulting from the Kumamoto Earthquake and the United Kingdom’s vote to leave the EU. Given the continued solid increase in employee income, private consumption is projected to pick up with financial markets regaining their calmness. Moreover, a “stimulus package” decided by the Cabinet recently is of a significantly large scale, amounting to over 28 trillion yen in project size, and is expected to stimulate the BIS central bankers’ speeches economy considerably in both fiscal 2016 and 2017. The upward revision to the growth rate compared to the April Outlook Report is mainly attributable to the effects of such economic measures. III. 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 less fresh food) is slightly negative due to the effects of the decline in energy prices, but that in the CPI (all items less fresh food and energy) has remained positive for 33 consecutive months since October 2013. The underlying trend in inflation has steadily improved since the introduction of QQE (Chart 5). However, the year-on-year rate of change in the CPI (all items less fresh food and energy), which reached more than 1 percent in the latter half of last year, saw a deceleration in its rate of increase recently, and was 0.8 percent in June. This is due to the yen’s appreciation and the delay in the timing of improvement in inflation expectations. Inflation expectations have weakened recently, although they appear to be rising on the whole from a somewhat longer-term perspective. Not only market indicators but also survey results regarding inflation expectations have declined. The decline in inflation expectations seems to have been brought about – through an “adaptive formation mechanism” of inflation expectations – by the observed CPI having been at about 0 percent on a year-on-year basis for over a year due in part to the decline in energy prices. In countries such as the United States, people’s inflation expectations are anchored at the level around the target set by the central bank, and medium- to long-term inflation expectations are little affected by the decline in the observed CPI; on the other hand, in Japan, where deflation has dominated for a prolonged period of time, formation of inflation expectations tends to be strongly affected by the observed CPI. In addition, relatively weak developments in private consumption observed recently seem to affect firms’ price-setting stance. Putting off of price increases by some firms has been observed since the turn of the year, mainly in goods such as food products and durable consumer goods. Looking ahead, however, the rate of increase in the observed inflation rate is expected to accelerate again. As explained earlier, the employment and income situation has been improving steadily and the unemployment rate is expected to decline further. Against this background, as employee income increases and private consumption picks up, firms’ pricesetting stance is expected to revert to raising prices. In addition, the “stimulus package” by the government is expected to further tighten the already tight labor market conditions, lead to an increase in wages, and stimulate household spending through the increase in employee income. Many firms want to raise sale prices reflecting the increase in costs such as wage increases, as long as demand such as private consumption can maintain its resilience. Under such circumstances, the mechanism in which inflation rises moderately accompanied by wage increases is expected to continue to operate steadily going forward. Moreover, as downward pressure of energy prices on the CPI is expected to dissipate, the observed CPI is projected to rise, which will likely have a positive impact on inflation expectations. Given these projections, the baseline scenario is that the timing of the year-on-year rate of change in the CPI reaching around 2 percent will be during fiscal 2017. However, this is accompanied by considerable uncertainties, taking account of heightened uncertainties over the outlook for overseas economies and weakened inflation expectations, as I explained earlier. IV. Heightened uncertainties Next, I will touch on risks that warrant attention going forward. Since the Outlook Report discusses these risks in detail, I will explain them briefly and focus on important points. BIS central bankers’ speeches For economic activity, uncertainties regarding developments in overseas economies are most important. At the beginning, I pointed out uncertainties over future developments in emerging and commodity-exporting economies as well as those growing overseas following the United Kingdom’s vote to leave the EU. In addition, the following warrant attention: developments in the U.S. economy and the influences of its monetary policy response to them on the global financial markets, and prospects regarding the European debt problem including the financial sector. For prices, developments in medium- to long-term inflation expectations in particular need to be closely monitored. I explained earlier that, in Japan, formation of inflation expectations still tends to be strongly affected by the “adaptive formation mechanism.” In a case where the rate of increase in the all-item CPI will be low for the time being, the improvement in the expected inflation rates can be contained more than envisaged. Uncertainties surrounding the economic outlook, mainly for overseas economies, can also restrain firms’ willingness to increase prices and wages. As the developments in inflation expectations act as an important factor in defining the underlying trend in inflation, they need to be carefully monitored. V. Thinking behind current monetary policy I would now like to turn to the Bank’s monetary policy. In light of heightened uncertainties surrounding overseas economies, such as those stemming from the United Kingdom’s vote to leave the EU, the Bank at the July 2016 MPM decided to enhance monetary easing in order to prevent these uncertainties from leading to a deterioration in business confidence as well as consumer sentiment, and to ensure smooth funding in foreign currencies by Japanese firms and financial institutions, thereby supporting their proactive economic activities. Specifically, measures taken by the Bank are threefold (Chart 6 [1]). The first is an increase in Bank’s purchases of exchange-traded funds (ETFs). Specifically, the amount of purchases will be almost doubled from an annual pace of about 3.3 trillion yen to an annual pace of about 6 trillion yen. This measure aims at preventing the deterioration in business confidence and consumer sentiment and promoting their proactive risk-taking. The second is an expansion of the size of the Bank’s lending program to support growth in U.S. dollars (the Special Rules for the U.S. Dollar Lending Arrangement to Enhance the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth Conducted through the Loan Support Program). Under this lending program, the Bank will provide back-to-back financing in U.S. dollars to financial institutions by using its U.S. dollar funds in cases where these financial institutions make foreign currency-denominated investments and loans to firms, which contributes to the strengthening of the foundations for economic growth. The duration of the Bank’s lending can be up to 4 years through rollovers. The size of the lending program had been 12 billion U.S. dollars since it was introduced in April 2012, and at the end of 2014, the amount outstanding reached the upper limit. Thereafter, the Bank provided new lending within unused allowances made by financial institutions’ prepayment of lending. As the loans under the program enable firms to receive stable funding in U.S. dollars over the long term, the potential demand for these loans must be substantial. On this basis, with a view to supporting firms’ U.S. dollar funding, the size of the program was doubled and raised to 24 billion U.S. dollars. The third is an expansion in the amount of collateral that can be pledged under the Bank’s U.S. dollar funds-supplying operations. The Bank has been carrying out U.S. dollar fundssupplying operations weekly with U.S. dollar funds raised through a bilateral liquidity swap line with the Federal Reserve. With this operation, financial institutions can raise U.S. dollar funds on a full allotment basis up to the amount of collateral pledged by each institution. The U.S. dollar operations, which were introduced at the time of the global financial crisis, have functioned as a backstop for U.S. dollar funding. At the MPM last month, the Bank decided to establish a new facility in which it lends Japanese government securities (JGSs) to BIS central bankers’ speeches counterparties of these operations against their current account balances with the Bank. Under the current monetary policy, many financial institutions hold a substantial amount of current account balances with the Bank. As these financial institutions become able to borrow JGSs from the Bank – that can be pledged as collateral – against their current account balances, they will be able to raise U.S. dollar funds when necessary without any concern about the amount of collateral they hold. By giving a sense of security, this new facility will further enhance effectiveness of the U.S. dollar funds-supplying operations as a backstop. Half a year has passed since the Bank introduced “QQE with a Negative Interest Rate.” During this period, JGB yields substantially declined across the entire yield curve, and lending rates as well as issuance rates for CP and corporate bonds fell to new record lows (Chart 7). Meanwhile, new developments in corporate finance have been taking place. For example, the amount of issuance of super-long-term corporate bonds, such as 20-year corporate bonds, has been increasing. Positive effects of these highly accommodative financial conditions seem to have been spreading to the real economy gradually. As I mentioned before, business fixed investment plans are firm despite the heightened uncertainties surrounding overseas economies. This is brought about by the significant improvement in overall economic conditions under QQE over the last three years, further supported by the unprecedentedly accommodative financial conditions. Moreover, with regard to housing investment, demand for housing loans has been increasing. This was confirmed by the result of the July 2016 Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks released recently. Going forward, positive effects of the negative interest rate policy on the real economy will become more evident. The Bank will continue with “QQE with a Negative Interest Rate,” 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 risks to economic activity and prices, and take additional easing measures in terms of three dimensions – quantity, quality, and the interest rate – without hesitation if it is judged necessary for achieving the price stability target. Let me also talk about the relationship between the Bank’s monetary policy and the government’s fiscal policy, which has been discussed from various perspectives recently. As I have said, the government has been undertaking fiscal and structural policy initiatives, including a large-scale “stimulus package” that was announced recently. In order for Japan’s economy to achieve sustainable economic growth with price stability, the Bank welcomes these initiatives, which are indeed timely. In addition, the Bank believes that highly accommodative financial conditions under “QQE with a Negative Interest Rate” and the government’s policies will exert synergy effects on the economy (Chart 6 [2]). As you may have learned during an introductory course of macroeconomics, when the government increases fiscal expenditures by issuing government bonds, interest rates on government bonds will rise, discouraging private-sector investment. This effect is called “crowding out.” In this context, if the central bank is pursuing monetary easing at the same time, the rise in interest rates will be contained, thereby preventing “crowding out” effects. This combination of fiscal and monetary policy is called a “policy mix,” which is a widely accepted idea in macroeconomic policy management. This idea can be applied to the current situation in Japan. Market interest rates in Japan have been in negative territory across a wide range of maturities due to the effects of the Bank’s “QQE with a Negative Interest Rate.” In this situation, when the government expands fiscal expenditure, its effects of stimulating the economy will be very powerful due to the synergy effects. This “policy mix” is different from “helicopter money,” which is an expansionary fiscal policy financed by a permanent increase in the central bank’s money, and from “deficit financing,” in which the central bank purchases government debts for the sake of facilitating the government’s financing. As “helicopter money” has been widely debated in the financial market, it is not productive to discuss pros and cons of “helicopter BIS central bankers’ speeches money” without defining it clearly. What is important is the fact that a “policy mix” comprised of flexible management of fiscal policy and QQE has been implemented in Japan over the last three years; this “policy mix” is very powerful among the measures implemented in modern history, and it will be strengthened further with the new large-scale fiscal “stimulus package” in combination with “QQE with a Negative Interest Rate.” At the latest MPM, the Bank acknowledged that there were considerable uncertainties over prices going forward, which could be significantly affected by developments in overseas economies and the global financial market and, reflecting this, developments in medium- to long-term inflation expectations. Against this background, with a view to achieving the price stability target of 2 percent at the earliest possible time, the Bank decided to conduct a comprehensive assessment at the next MPM of the developments in economic activity and prices under “QQE” and “QQE with a Negative Interest Rate” as well as these policy effects (Chart 6 [3]). The Bank’s staff will prepare for deliberation at the next MPM. Let me share with you our thinking and motivation behind this project. Since the introduction of QQE in April 2013, Japan’s economic activity and inflation have improved substantially, and Japan’s economy is no longer in deflation. There is no doubt that a clear commitment to the price stability target of 2 percent and large-scale monetary easing that underpinned this commitment under QQE have been very effective for Japan’s economy to move toward getting out of deflation. That said, the price stability target of 2 percent has not been achieved yet, despite unprecedentedly large-scale monetary easing. With this in mind, we would like to re-examine the transmission mechanism of policy effects and possible factors that may have hampered this mechanism. In addition, “QQE with a Negative Interest Rate,” which was introduced in January 2016, has already exerted substantial downward effects on interest rates through a combination of the negative policy rate and JGB purchases. At the same time, it has had a variety of impacts on financial institutions and markets. We also would like to assess the mechanism of this policy as well as its effects and influences on the real economy and the financial side. This is our thinking and motivation behind the comprehensive assessment. Naturally, the emphasis may vary among Policy Board members depending on his/her view. Let me make it clear that we do not have any specific future directions of monetary policy at this moment. We would like to work with an open mind so that we can make an assessment from various perspectives and have a discussion in a productive manner on what should be done for the price stability target of 2 percent to be achieved at the earliest possible time. We intend that the comprehensive assessment will contribute to planning monetary policy going forward. Let me conclude my speech by touching on the local economy of Kanagawa Prefecture. The prefecture is endowed with a variety of tourist attractions such as the Yokohama Minato Mirai area, Kamakura, Enoshima-Shonan, and Hakone. In addition, I have heard that it is receiving a lot of good news about the prefecture being an international tourism region. This includes the news that it succeeded in bids to host global sports events, such as the Rugby World Cup 2019, and that one of its cities is going to host sailing competitions during the 2020 Olympic Games. In closing, I wish all the best for the further growth and development of the economy of Kanagawa Prefecture, fully taking advantage of its geographic significance – that is, being located in the Tokyo metropolitan area – as well as its wide-ranging potential. Thank you. 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 FinTech Forum, Tokyo, 23 August 2016.
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Haruhiko Kuroda: Information technology and financial services – the central bank's perspective Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the FinTech Forum, Tokyo, 23 August 2016. * * * Introduction It is a great pleasure to welcome all of you to our first meeting of the FinTech Forum. I. Information technology and financial services Today's Forum focuses on information and financial services. Indeed, financial activities make full use of wide-ranging information technologies created throughout human history, and financial industries have almost always developed parallel to advances in various techniques and infrastructure related to information processing. Money, which constitutes the basic infrastructure for financial activities, physically symbolizes information pertaining to value in the form of metal or paper by using relevant technologies, thereby enabling the exchange and preservation of value. Moreover, money attaches information on “price,” which is based on a widely-shared common “scale,” to various goods and services. Such price information has worked as a critical signal leading to efficient resource allocation in the economy. Furthermore, “ledgers” and “double-entry bookkeeping,” whose developments were accelerated by paper and printing technology, enabled efficient and centralized management of information, including various prices. Using double-entry bookkeeping ledgers, firms and individuals became able to share the information necessary for conducting economic activities. Financial services have developed with the support of such information infrastructure. Financial intermediation, such as bank lending, has made full use of borrowers' information shared through ledgers and corporate accounting. Payments and settlements of business transactions as well as financial transactions in modern economies and financial markets have largely been processed through bank deposit transfers and securities transfers based on centralized ledgers and book-entry systems. From the perspective of information processing, payments and settlements relieve economic entities from burdensome information management, such as credit risk management of accounts receivables stemming from past transactions. This allows entities to concentrate their resources in forward-looking economic activities. Through financial intermediation, financial resources are allocated to investment in projects with higher productivity. The bundling and integration of refined mechanisms of information processing into financial services have contributed importantly to the development of economic society. II. Recent innovation in information technology and “FinTech” Today, we are observing very rapid innovation in information technology. Due to the spread of the internet, smartphones and social networks, the amount of data and information disseminated through various networks has expanded exponentially. Innovation in information technology makes it possible to process and analyse such “big data” speedily. Also, information related to retail transactions of goods and services, which was left unused in the past, is now gathered through loyalty cards and e-money cards and utilized for business purposes. Moreover, new forms of economic activities comprising the “sharing economy” have been realized thanks to new information technology. In this process, idle resources dispersed throughout the economy are identified and organized on the micro-level and matched with people's needs. BIS central bankers’ speeches Such innovation in information technology has the potential to generate innovation, especially in financial services, and such financial innovation linked to information technology is expressed in the word “FinTech.” It is not at all surprising that information technology has a major influence on financial services, considering the close and inherent relationship between the two as described above. Payments, settlements, investment judgement and risk management, which constitute the core of financial activities, can be regarded as information processing. Therefore, progress in information technology and AI can be expected to significantly influence them. Moreover, “blockchain” and “distributed ledger technologies,” the flagship technologies in FinTech, challenge the conventional concepts of ledgers kept by a trusted third party in a centralized manner. Given that the development of financial services has been supported by ledgers as the basic infrastructure for information, the dramatic changes in how ledgers are kept may have the potential of significantly changing the structure of financial services. III. Importance of information security While innovation in information technology and FinTech has the potential to extend the frontiers of financial services, we must bear in mind that information security is becoming all the more important due to these innovations. When searching the internet to shop for goods, various related goods and advertisements pop up to recommend associated purchases. As frequency of use increases, these recommendations and advertisements capture more and more information on the tastes and preferences of customers. This is made possible by high-speed processing of big data, and this innovation in information technology enables the development of profiles on individual customers. However, if such information is abused, in the worst case, the abuse can do substantial harm to society, and can cause anxiety among users in general. As such, advances in information processing underscore the importance of information security. Moreover, the development of information technology has simultaneously refined the tactics of hackers and cyber-attacks. Particularly in the financial industries with global networks, once such an attack occurs in one location, its negative influence may spread across the board. The Bangladesh Bank heist in the beginning of this year was the case that abovementioned risk was materialized. For the sound development of FinTech, information security is a key. FinTech has various characteristics, such as advanced information processing utilizing big data and AI. Additionally, FinTech is characterized by an “openness” of networks, with the expansion of new media and instruments, including internet and smartphones, enabling ready access to financial services. This enhanced accessibility to financial services benefits customers and adds to their convenience. On the other hand, as financial networks become increasingly “open,” potential target points for cyber-attacks also tend to increase. Therefore, how to simultaneously manage “openness of financial networks” and “information security” is a big challenge for FinTech. Financial services can be regarded as the processing of information for creating value in the linkages between economic entities over time and space. This is demonstrated in the payments and financial intermediation that connect various entities, such as senders/receivers and lenders/borrowers. In this sense, such activities must always be supported by people's “trust.” Since FinTech is illustrated as a technologically advanced form of financial services, the importance of trust also applies to FinTech. For the development of FinTech, it is imperative to firmly maintain people's trust in financial services while facilitating the creativity and innovation needed to meet the needs of people. If information security problems were to repeatedly occur in a part of FinTech services, public trust toward FinTech in general would be eroded even though such problems are caused by a limited number of entities. People’s anxiety for new services would hinder the sound development of FinTech overall. BIS central bankers’ speeches The information technology behind FinTech, if properly applied, should and can also contribute to enhancing information security and the safety of financial transactions. For example, seal stamps and PINs, which are traditional measures for verification in financial transactions, are accompanied by certain risks, such as theft and identity theft. In this regard, biometric authentication utilizing new technology may contribute to reducing these risks and strengthening the security in financial transactions. Thus, it is critical for relevant parties to make utmost efforts to use technological innovation for enhancing security in financial transactions. FinTech will thrive and grow when users associate it not only with convenience but also with safety and trust. IV. Initiatives at the Bank of Japan FinTech has various implications for central banking. FinTech has a wide influence on payments, settlements and financial services, and could stimulate various economic activities, including e-commerce and “sharing economy” businesses. Also, FinTech can encourage mutual feedback between financial activities and high-end technologies, including cryptographic techniques. Moreover, financial literacy and education are needed to promote the sound development of FinTech. The Bank of Japan is ready to lead research and analysis on FinTech, in view of the possibility that the Bank itself may apply FinTech technologies to its operations in the future. Given the far-reaching implications of FinTech, the Bank established its “FinTech Center” on April 1 in the Payment and Settlement Systems Department. The Bank has also built up a “FinTech network” comprised of a wide range of staff drawn from the relevant departments of the Bank. This FinTech Network, for which the FinTech Center functions as the secretariat, promotes the sharing of information and expertise related to FinTech in a cross-sectoral manner within the Bank. The Bank, as the central bank of Japan, is ready to make its best efforts to support the sound development of FinTech in order to enhance the welfare of financial service users as well as economic activities. In today's Forum, we welcome a rich variety of participants. When we look back at history, we see that communication and positive feedbacks among various entities from different cultures, such as cross-border trading between Europe and the Orient during the Renaissance, led to the development of banking as well as double-entry bookkeeping. In a similar vein, in order to promote the development of the new financial services that we have come to call FinTech, it is extremely important to realize positive and interactive communication among a broad spectrum of entities that go beyond the traditional financial industry to include IT enterprises, retailers, start-ups and others. I sincerely hope that today's Forum will contribute to all the participants in terms of sharing new insights and perspectives. 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 Federal Reserve Bank of Kansas City Economic Symposium "Designing resilient monetary policy frameworks for the future", Jackson Hole, Wyoming, 27 August 2016.
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Haruhiko Kuroda: Re-anchoring inflation expectations via “Quantitative and qualitative monetary easing with a negative interest rate” Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Federal Reserve Bank of Kansas City Economic Symposium “Designing resilient monetary policy frameworks for the future”, Jackson Hole, Wyoming, 27 August 2016. * * * Accompanying charts can also be found on the Bank of Japan’s website. Introduction It is always a great pleasure to speak at the Economic Policy Symposium here in Jackson Hole. I would like to thank Ms. Esther George, President of the Federal Reserve Bank of Kansas City, for inviting me to this panel. Over the past two decades, Japan found itself in several economic difficulties, such as prolonged deflation, declining potential growth, several financial crises, and structural impediments arising from a rapidly aging population and dwindling labor force. Given such experiences, I stress one observation in thinking about the resilience of monetary policy framework; that is, in the long run, low inflation and low nominal interest rates are most likely to coexist. Under such a circumstance, central banks have very little latitude for cutting policy rates due to the existence of the zero lower bound of nominal interest rates. In other words, the resiliency of monetary policy – more precisely, conventional or standard monetary policy – is considerably eroded. Soon after I took office in March 2013, the Bank of Japan introduced Quantitative and Qualitative Monetary Easing (QQE) to overcome mild but protracted deflation. QQE has two key elements that enable the Bank to move beyond the previous monetary policy measures. The first is the Bank’s strong and clear commitment to achieving the price stability target of 2 percent at the earliest possible time, which is underpinned by a large-scale monetary easing, thereby drastically converting the deflationary mindset among people and raising inflation expectations. The second is to put downward pressure on the entire yield curve through massive purchases of Japanese government bonds (JGBs), financed by an equally massive increase of the monetary base (Chart 1). These two elements together have reduced real interest rates and thus have produced strong easing effects. In October 2014, QQE was expanded in both quantitative and qualitative terms. Subsequently, in January 2016, it was augmented by adding a third dimension of negativity in nominal interest rates, as “QQE with a Negative Interest Rate.” QQE evolved into a flexible and powerful policy framework that enables the Bank to make full use of the three dimensions of policy measures: quantity, quality, and interest rates. Today, with this backdrop in mind, I will focus on the two key issues in considering how to ensure a resilient monetary policy framework: (1) the role of anchoring inflation expectations and (2) the transmission channels of a negative interest rate policy. I. Re-anchoring inflation expectations A. Crude oil prices and inflation expectations As many of us well recognized, crude oil prices declined significantly from the summer of 2014. In terms of the inflation forecast, the decline in crude oil prices is generally taken to be temporary. Crude oil futures markets were not broadly anticipating a further decline in crude oil prices over the next year. Consequently, long-term inflation expectations were unchanged, as evidenced by fairly stable developments in 6- to 10-year U.S. inflation forecasts collected by the Survey of Professional Forecasters (Chart 2). In contrast, a BIS central bankers’ speeches puzzling decline in long-term inflation forecasts was observed in Japan. Even considering the technical difference in the details of the data, it is hard to deny that the recent weakening in long-term inflation expectations in Japan was partly caused by the declines in crude oil prices from 2014. The headline consumer price index (CPI) inflation started to fall more or less in reflection of the declines in crude oil prices, which were largely common to advanced economies after 2014. However, a marked difference was observed in terms of the pace of recovery in the underlying trend of the CPI inflation between the United States and Japan. In the United States, the CPI inflation excluding energy rebounded toward 2 percent fairly quickly, while the comparable CPI inflation indicator in Japan has remained relatively low so far: positive but significantly below 2 percent. It could be said that inflation dynamics in Japan are less resilient than those in the United States against significant external shocks, including large swings in crude oil prices. As mentioned earlier, oil price fluctuations should not produce persistent effects on long-term inflation expectations, in that they are typically perceived to be just temporary. This could be the case for the United States while something different must be factored in to understand the case for Japan. An interpretation of different inflation dynamics between the United States and Japan could be that long-term inflation expectations are yet to be anchored around the 2 percent target in Japan while they are relatively well anchored in the United States. The impact of the declines in crude oil prices on realized inflation was amplified by weakening inflation expectations in the case of Japan. The interpretation of the interaction between realized inflation and inflation expectations is still a hypothesis that requires solid empirical analysis. However, some symptoms can be found in the data, which appear to support such interpretations. The U.S. 6- to 10-year inflation forecasts have been broadly stable around 2 percent while the Japanese indicator has been much more volatile. More importantly, it appears that long-term inflation expectations in Japan have been lower than 2 percent since the mid-1990s, although some signs of improvement can be found since early 2013, when QQE started. In line with these observations, a hypothesis worthy of empirical analysis is that Japanese inflation dynamics remained vulnerable to adverse shocks as the economy was halfway through the reanchoring process as of 2014. B. Understanding the learning process of inflation dynamics The contrasting behaviors with regard to long-term inflation expectations between the United States and Japan, as described earlier, lead us to a deeper question: how do people formulate their inflation expectations? There seems to be a consensus, in theory, that full information rational expectation models provide a useful benchmark for monetary policy analysis; in practice, however, firms and households do not update their information sets so frequently. Noticeable disagreements sometimes exist regarding long-term inflation expectations for a considerable period of time. It is often argued that inflation expectations are formed in an “adaptive” or a “backwardlooking” manner. The arguments in favor of departure from full information rational expectation models do not necessarily imply that people formulate their expectations “irrationally.” Existing economics literature demonstrates that rational agents do not necessarily update their information sets in a constant manner if information collection is costly. Looking back at Japan’s experiences from the 1990s, CPI inflation hovered at around zero percent or even slipped into negative territory for some periods, and long-term inflation expectations showed a downward trend with volatile fluctuations (Chart 3). Unstable longterm inflation expectations amplified adverse shocks to the Japanese economy, including several financial crises, and forestalled effects of a variety of policy measures to combat deflation, such as the zero interest rate policy and quantitative easing. BIS central bankers’ speeches In light of Japan’s experiences, anchoring long-term inflation expectations at near-target levels is definitely a prerequisite for a resilient monetary policy framework. As mentioned earlier, the Bank, with its commitment to achieving the price stability target of 2 percent, is currently undertaking QQE with a Negative Interest Rate to overcome deflation. One of the key elements in our policy is to push up inflation expectations toward 2 percent price stability target and to re-anchor them there. II. Transmission channels of negative interest rate policies A. Negative interest rate policy: how it works in practice The other contemporary issue is the implementation of negative interest rate policies (NIRPs) at some central banks, including the Bank of Japan. NIRP has been included most lately in the unconventional policy toolbox. The Bank of Japan introduced QQE with a Negative Interest Rate in January 2016 by applying a negative interest rate of minus 0.1 percent to a marginal increase in the current accounts that financial institutions hold at the Bank. This new policy measure reduced the marginal funding cost for financial institutions, thereby inducing interbank money market transactions to take place with negative interest rates. The JGB market and other financial markets reacted significantly to the introduction of QQE with a Negative Interest Rate. In particular, JGB yields with long- and super-long maturities saw sizable declines (Chart 4). Subsequent declines in long-term borrowing costs have stimulated firms’ demand for long-term funding and households’ demand for mortgage loans, thereby benefiting a wide range of borrowers. Among other factors, new developments in corporate finance are notable as a significant increase in issuance of corporate bonds with a maturity of 20 years or even longer has been observed. As evidenced by the effective implementation of NIRPs at some central banks, the zero lower bound of nominal interest rates is no longer an insurmountable constraint in practice. Competition among financial institutions and arbitrage in money markets stretch the application of negative interest rates into new financial transactions. Of course, removing the zero bound does not necessarily mean that central banks are able to cut the nominal interest rate to an arbitrarily negative level. It is natural to assume that another lower bound exists depending on the cost of holding cash currency, although the current level of the negative interest rate in Japan, at minus 10 bps, is still far from such a lower bound. Even with such a caveat, NIRPs certainly provide more leeway with central banks in coping with a variety of adverse shocks as a practical monetary policy tool. B. Impact of adding a negative interest rate to QQE Japan’s experience of QQE shows that real interest rates declined significantly, reflecting a rise in inflation expectations. But observed declines in JGB nominal yields appeared to be not so large until QQE with a Negative Interest Rate was deployed, partly because nominal yields were already at low levels when QQE started three years ago. So, why did adding a negative interest rate to QQE produce the marked reaction of the entire yield curve? By introducing QQE with a Negative Interest Rate, the marginal deposit rate of the current accounts at the Bank declined by just 20bps, from plus 10bps to minus 10 bps. The resulting spillover to interest rates with longer maturities was considerably large compared with the experiences of the European economies. A natural question we need to address is: what creates the difference in the size of “multipliers,” so to speak? In other words, what factors could determine the size of decline in longer-term yields per unit change in the interest rate applied to current accounts at the central bank? The question remains to be answered. Hypothetically, a multiplier could have been smaller or gone negative. That is, in response to an introduction of NIRP, yields with longer maturities can increase, reflecting some rises in long-term inflation expectations. However, this was not the case for Japan or for most European economies deploying NIRPs. One common observation was a bull-flattening of the yield curves. In theory, declines in term premiums BIS central bankers’ speeches along with longer maturities and possible downward revisions to a future monetary policy path can account for such bull-flattening. While both remain as possible factors to explain the observed broad downward shifts of the yield curves, focusing on a future monetary policy stance subject to the zero bound can provide a plausible interpretation. Namely, suppose that market participants had been expecting that the central bank’s strong easing stance would continue for a lengthy period of time, and as a result, latent interest rates were much lower than the observed interest rates. Deploying NIRP removed the zero bound and uncovered the “true” nominal interest rates unconstrained by the zero bound. In this case, introduction of NIRP has a larger effect if the gap between latent and actual interest rates were large, which effectively means that NIRP’s initial effects depend on the extent to which the zero bound was a binding constraint on nominal interest rates with various maturities. Concluding remarks There is a broad consensus that central banks’ strong commitment to achieving inflation targets influences expectation formations by firms and households. A commitment itself thus remains an important element for establishing a resilient monetary policy framework. Looking ahead, the Bank will continue to carefully examine risks to economic activity and prices at each monetary policy meeting and take additional easing measures without hesitation in terms of three dimensions – quantity, quality, and the interest rate – if it is judged necessary for achieving the price stability target. QQE with a Negative Interest Rate is an extremely powerful policy scheme and there is no doubt that ample space for additional easing in each of these three dimensions is available to the Bank. The Bank will carefully consider how to make the best use of the policy scheme in order to achieve the price stability target of 2 percent, and will act decisively as we move on. Thank you. 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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Kisaragi-kai meeting, Tokyo, 5 September 2016.
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Haruhiko Kuroda: “Comprehensive Assessment” of the monetary easing – concept and approaches Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Kisaragi-kai meeting, Tokyo, 5 September 2016. * * * Accompanying charts can be found at the end of the speech or on the Bank of Japan’s website. Introduction It is my great pleasure to have the opportunity today to speak at the Kisaragi-kai meeting. At the Monetary Policy Meeting (MPM) held at end-July, the Bank of Japan decided to enhance monetary easing by increasing its purchases of exchange-traded funds (ETFs) and by ensuring smooth funding in foreign currencies by Japanese firms. At the same time, against the backdrop of heightened uncertainty over the outlook for prices, with a view to achieving the price stability target of 2 percent at the earliest possible time, it also decided to conduct at the next MPM to be held in late September a comprehensive assessment of the developments in economic activity and prices, as well as of the policy effects, over the past three years since the introduction of quantitative and qualitative monetary easing (QQE). Today, I would like to talk about the concept of and approaches to this comprehensive assessment. I. Background The Bank introduced QQE in April 2013. During the more than three years since then, Japan’s economic activity and prices have improved substantially, and Japan’s economy is no longer in deflation. However, the price stability target of 2 percent has not been achieved yet, despite the unprecedented large-scale monetary easing. How monetary policy has functioned during these years and what factors have possibly hampered achievement of the 2 percent target is the first issue to be analyzed. The second issue is regarding “QQE with a Negative Interest Rate,” which was introduced more than half a year ago. Under the negative interest rate policy, various interest rates, including Japanese government bond (JGB) yields as well as rates for lending and corporate bonds, have declined substantially; thus, the policy already has exerted remarkable effects. At the same time, however, it has had an impact on financial markets’ liquidity and financial institutions’ profits. The effects and impact of this policy also need to be assessed. The Bank will examine these issues in an objective manner, by carefully analyzing observed facts and checking them against the theories underpinning the Bank’s policy. With the results of the assessment, the Bank will discuss what should be done in order to make sure that the price stability target of 2 percent is achieved at the earliest possible time. Let me emphasize that the assessment is conducted with the aim of achieving the 2 percent target at the earliest possible time. A reduction in the level of monetary policy accommodation, which is being called for by some market participants, will not be considered. II. Japan’s economy since the introduction of QQE, and its effects Economic activity and prices during past three years To start with, I would like to take a look back at economic activity and prices since the introduction of QQE. First, in the corporate sector, profits increased considerably, including those of small firms (Chart 1). Corporate profits, measured by the ratio of current profits to sales, marked a BIS central bankers’ speeches record high level in fiscal 2015. Profits are expected to decrease slightly this fiscal year, especially those of manufacturers, but remain high. Second, in the household sector, the employment and income situation has improved significantly. The number of employees has been increasing steadily. The unemployment rate has declined recently to 3 percent, which is virtually full employment. As for wages, the annual labor-management wage negotiations in 2014 resulted in base pay rises for the first time in two decades; base pay rises have continued for three consecutive years. Third, the underlying trend in inflation has clearly improved (Chart 2). As a result of the fall in crude oil prices of more than 70 percent since summer 2014 until the beginning of this year, the latest figure for the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) is minus 0.5 percent. Nevertheless, on a basis excluding fresh food and energy, the year-on-year rate of change in the CPI, which had been in the range of around minus 0.5 to minus 1.0 percent before the introduction of QQE, became positive in autumn 2013, and thereafter has remained in positive territory for two years and ten months. This is the first time since the late 1990s, when Japan’s economy fell into deflation, that the year-on-year rate of change in the CPI has been in positive territory for such a long period. Japan’s economy is no longer in deflation, which is commonly defined as a situation where prices are declining in a sustainable manner. Of course, these changes are not brought about merely by the Bank’s monetary easing policy. The government’s flexible management of fiscal policy, as well as its initiatives for structural reform to enhance growth potential, have contributed to the recovery, and the private sector’s initiatives for promoting innovation have played a big role in bringing the changes. That said, it is unquestionable that the Bank’s unprecedented large-scale monetary easing measures, such as QQE and the subsequent “QQE with a Negative Interest Rate,” have contributed significantly to the positive turnaround in Japan’s economy. Factors that hampered achieving 2 percent price stability target However, despite the Bank’s large-scale monetary easing, the price stability target of 2 percent has not been achieved. I would like to point out three exogenous factors that seem to have had a negative impact: (1) substantial and sequential declines in crude oil prices since summer 2014; (2) weakness in demand, particularly in private consumption, following the consumption tax hike in April 2014; and (3) the slowdown in emerging economies from summer 2015 and volatile developments in global financial markets reflecting that situation. However, what is more important is the mechanism through which these exogenous factors hampered achieving the 2 percent target. A key factor here is inflation expectations; that is, firms’ and households’ outlook for prices. To highlight the importance of inflation expectations, let me remind you about the transmission mechanisms of QQE. QQE aims to raise inflation expectations through the Bank’s strong and clear commitment to achieving the price stability target of 2 percent and through large-scale monetary easing that underpins the commitment (Chart 3). At the same time, the Bank exerts downward pressure on nominal interest rates across the entire yield curve through purchases of JGBs. These two channels together bring about a decline in real interest rates. This decline boosts firms’ and households’ economic activity, which in turn leads to higher inflation rates, supported by higher inflation expectations. As people actually experience inflation, inflation expectations will rise further. Inflation expectations represent the core element of the mechanism of the Bank’s monetary easing. Against this backdrop, we have the dynamics of inflation expectations: how they have been increased by the Bank’s policy and how the aforementioned three exogenous factors have hindered a rise in inflation expectations. This is the first issue to be analyzed in the comprehensive assessment. BIS central bankers’ speeches Developments in inflation expectations Let us take a look at the developments in inflation expectations (Chart 4). Inflation expectations can be measured by market-based indicators including those calculated using yields of inflation-indexed JGBs as well as indicators based on the results of surveys of households, firms, and economists. Although developments in each of these indicators vary, reflecting their own characteristics, those in inflation expectations since the introduction of QQE can be divided into three phases. The first phase is the period after the introduction of QQE through summer 2014. In this period, indicators of inflation expectations rose clearly. The introduction of QQE appears to have had a significant impact on inflation expectations. The second phase is from summer 2014 through summer 2015. During this period, many indicators of inflation expectations were largely unchanged. The fall in crude oil prices since summer 2014 and weak demand after the consumption tax hike in April 2014 seem to have pushed down inflation expectations. In order to preempt the manifestation of a risk that conversion of the deflationary mindset – which had shown steady progress until then – might be delayed, and to maintain the momentum of expectation formation, the Bank expanded QQE at endOctober 2014. Thanks to this response, inflation expectations managed to remain elevated despite the strong headwinds. The third phase is the period since summer 2015 up until now. Many indicators of inflation expectations have weakened during this phase. This is attributable to the slowdown of emerging economies, continued volatile developments in global financial markets amid such a situation, and a further decline in crude oil prices. The Bank introduced the negative interest rate policy in January 2016, but this has not been enough to offset negative effects on inflation expectations amid continued volatility in global financial markets. Mechanism of inflation expectation formation These experiences suggest that the mechanism of inflation expectation formation in Japan is still largely “adaptive,” meaning that, when the observed inflation rate shows sluggishness due to factors such as the decline in crude oil prices and the temporary weakness in demand, inflation expectations tend to decline accordingly, following the course of the observed inflation rate. It is widely accepted that people’s inflation expectations are formed by two factors: a “forward-looking formation mechanism” and an “adaptive formation mechanism.” The “forward-looking formation mechanism” points to the view that, even if the observed inflation rate fluctuates from time to time due to a variety of factors, it eventually will revert to the price stability target set by a central bank, which is 2 percent in many countries. On the other hand, the “adaptive formation mechanism” points to the view that the inflation rate will continue to be around the current level. For instance, if the observed inflation rate has been around 0 percent, people believe that the inflation rate will be around 0 percent going forward. In cases where the “forward-looking formation mechanism” prevails in a sufficiently strong manner, even if the observed inflation rate somehow deviates from the price stability target either upward or downward, people expect it to revert to close to the 2 percent target in due course, and prices and wages are set based on such expectation. Therefore, the actual inflation rate will gravitate toward the target. This situation is phrased as inflation expectations being “anchored,” and this is preferable for central banks having a mandate of price stability. In countries such as the United States, inflation expectations have been anchored at around 2 percent; in Japan, however, as the price stability target has been missed under prolonged deflation, the effects of the “adaptive formation mechanism” seem to have dominated. In other words, the view is entrenched among people that inflation will continue to be sluggish because it has been so for a long time. The Bank, by continuing with QQE, has been trying to enhance the “forward-looking formation mechanism” and thereby to anchor people’s inflation expectations to the price stability target of 2 percent. Unfortunately, however, before the “forward-looking formation mechanism” became strong enough, the BIS central bankers’ speeches observed inflation rate declined due to a variety of factors such as the significant decline in crude oil prices, and inflation expectations also have declined again through the “adaptive formation mechanism.” Going forward, the underlying trend in inflation is expected to rise as the economy continues to grow at a rate above the potential growth rate and the effects of the decline in crude oil prices are expected to dissipate. Therefore, the observed inflation rate is expected to rise gradually. Under these circumstances, inflation expectations will be pushed up by the “adaptive formation mechanism.” For the time being, however, the observed inflation rate is unlikely to accelerate, hovering at slightly negative or about 0 percent. As a result, there is considerable uncertainty about the extent to which inflation expectations will rise through the “adaptive formation mechanism.” Against this background, it is imperative for the Bank to firmly maintain its commitment to achieving the price stability target of 2 percent at the earliest possible time from the viewpoint of the “forward-looking formation mechanism.” III. Effects and impact of the negative interest rate Effects of the negative interest rate Now, let me move on to the second point; that is, the negative interest rate policy, which the Bank decided to adopt this January. The negative interest rate policy, in combination with the Bank’s JGB purchases, has produced substantial effects in lowering interest rates on JGBs across the entire yield curve (Chart 5). It has become clear that the Bank can affect the entire yield curve through an appropriate combination of the negative interest rate policy and JGB purchases. The framework of QQE with the negative interest rate has proven to be extremely powerful. Before the introduction of the negative interest rate policy, some argued that lower risk-free rates, or JGB yields, would not lead to a decline in banks’ lending rates as well as interest rates on corporate bonds and CP, as room is limited for a decline in rates on deposits, the main source of funding for financial institutions. In fact, however, after the introduction of the negative interest rate, banks’ lending rates, as well as interest rates on corporate bonds and CP, fell significantly, each marking historical lows. The pass-through of the decline in JGB rates to these funding rates since the introduction of the negative interest rate policy has been roughly similar to changes in previous episodes of interest rate cuts. Moreover, new developments relating to corporate finance have been taking place recently; both the issuance of corporate bonds with a maturity of over ten years and firms’ borrowings through subordinated loans have increased. The negative interest rate policy thus far seems to have succeeded in lowering funding costs of firms and households. According to the results of surveys such as the Short-Term Economic Survey of Enterprises in Japan (Tankan) and the Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks (often dubbed the Loan Survey), financial institutions’ lending attitudes have continued to be proactive. Thus, we are not in a situation where their intermediary functions are impaired because their profits are squeezed as a result of the negative interest rate. That said, there are two issues we need to consider. The first is that the policy effects that I have just mentioned are what have been observed thus far, and one cannot tell the extent to which such interest rates as banks’ lending rates can be lowered further. The second is that the significant fall in lending rates with a marginal decline in rates on deposits has been achieved at the expense of financial institutions’ profits. This point is closely related to the first one, in that the policy effects on lending rates will also depend on financial institutions’ lending attitudes. Impact on financial intermediation Let me put this in more general terms. In assessing the effectiveness of the negative interest rate policy, the potential impact on the financial intermediation due to its influence on the BIS central bankers’ speeches profits of financial institutions needs to be taken into account. Considering that the profits affect the soundness of financial institutions in a cumulative manner, the impact can vary depending on the duration of the policy. Generally speaking, financial institutions raise short-term funds and invest them in long-term assets as their basic business model. Given that the rates on deposits – which are the main funding tools – rarely become negative, the decline in yields throughout the entire yield curve or the narrowing of the spread between short- and long-term yields will lead to smaller spreads between deposit and lending rates, thereby negatively affecting the profits of financial institutions. For Japan in particular, the impact of the negative interest rate policy on the profits of financial institutions tends to be relatively large, due to such factors as the amount outstanding of deposits far exceeding that of lending, and to the spreads between deposits and lending rates already being extremely small following prolonged competition among financial institutions. As long-term and super-long-term rates have declined significantly since the introduction of the negative interest rate policy, the rates of return on investments of insurance and pension products are expected to decline. Under these circumstances, the sales of some saving-type products are suspended. Some business firms have revised down their profit forecasts due in part to the increase in the net present value of retirement benefit obligations. Although direct impacts of these developments on the entire economy may not be substantial, we should take account of the possibility that such developments can affect people’s confidence by causing concerns over the sustainability of the financial function in a broad sense, thereby negatively affecting economic activity. In sum, in proceeding with “QQE with a Negative Interest Rate,” the Bank should make an appropriate policy judgment by taking account not only of its powerful impact on the yield curve but also its impact on the financial intermediation in a broad sense. Needless to say, there is still ample space for further cuts in the negative interest rate and for an increase in size in the “quantity” dimension. The Bank has a broad range of policy options. It will continue to choose the most appropriate policy actions among those options, depending on the situations for economic activity, prices, and financial conditions. Conclusion: mechanism of monetary policy I have explained several issues related to the forthcoming comprehensive assessment. The ones I have mentioned here are just some of the issues to be analyzed toward the next MPM. The Policy Board members will have an in-depth discussion at the next MPM on these issues, as well as other relevant topics. I will conclude my speech by touching on my views on the challenges in monetary policy. The basic mechanism of monetary policy, whether it is conventional or unconventional, is to drive the real interest rate higher or lower than the “natural rate of interest,” which is the level of the real interest rate neutral to economic activity and prices. In normal times, this can be achieved by adjusting short-term rates; namely, simply lifting or lowering them. But given that monetary accommodation with virtually zero short-term rates did not produce sufficient stimulative effects, central banks around the world have devised a variety of unconventional policy measures to overcome this “zero lower bound.” For instance, “forward guidance” and the “purchases of long-term government bonds” to lower the nominal medium- to long-term rates have been adopted by the central banks in Japan, the United States, and Europe. The “negative interest rate” policy started in Europe, followed by Japan. Measures to lower the real interest rate by raising inflation expectations directly through monetary policy have been introduced as “QQE” in Japan, where inflation expectations have long been at a very low level. In conducting monetary policy, what measures should be adopted and how they are implemented depends on the economic and financial situations of the country concerned. For BIS central bankers’ speeches instance, in the United States, where money market mutual funds (MMMFs) play a pivotal role in financial markets, a negative interest rate policy has not been adopted; instead, the main measure for monetary easing has been to push down long-term rates through the purchases of long-term government bonds. It also has been stressed that monetary easing does not affect inflation expectations because they already have been well anchored. On the other hand, in Japan, where deflation has been persistent for a prolonged period, the most powerful monetary easing measures are needed among advanced economies, and all of the aforementioned measures have actually been implemented. As a result, unprecedented extremely accommodative financial conditions across the major economies have been achieved. I expect firms and households to make the most of such accommodative financial conditions for proactive economic activity, and for that purpose, I would like to reiterate the importance of raising the “natural rate of interest” I explained earlier; namely, raising the potential growth rate by undertaking initiatives for structural reform. It is often argued that there is a “limit” to monetary easing, but I do not share such a view. Needless to say, there is a limit in the sense that there are things that “cannot be done legally” or “should not be done,” such as directly underwriting government bonds and monetizing fiscal deficits. As I said earlier, however, even within the current framework, there is ample room for further monetary easing in either of three dimensions – quantity, quality, and the interest rate – and other new ideas should not be off the table. What we should bear in mind when conducting monetary policy is not its “limit” but a comparison between its “benefits” and “costs,” as is the case with any public policy. There is no free lunch for any policy. Given that we have been implementing such large-scale monetary easing, any additional monetary easing entails “costs,” which negatively affects some sectors. That said, we should not hesitate to go ahead with it as long as it is necessary for Japan’s economy as a whole; namely, if its “benefits” outweigh its “costs.” Furthermore, what is important is that a balance between “benefits” and “costs” can change depending on the situation. Monetary policy should be conducted in a flexible manner. There may be a situation where drastic measures are warranted even though they could entail “costs,” depending on the situations for economic activity, prices, and financial conditions. The central bank should always prepare policy options to address such situations. I would add that the “benefits” of achieving the price stability target of 2 percent at the earliest possible time are enormous as Japan’s economy is finally overcoming deflation that lasted for a prolonged period of time. The Bank will continue to make its utmost efforts to achieve this commitment. Thank you. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Niigata, 31 August 2016.
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Yukitoshi Funo: Economic activity and prices in Japan, and monetary policy Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Niigata, 31 August 2016. * * * I. Recent economic and price developments A. Overseas developments I would like to begin my speech by talking about developments in overseas economies. In global financial markets, uncertainty over the global economy going forward heightened and investors’ risk aversion rapidly strengthened in response to the result of the United Kingdom’s referendum in late June, in which the majority voted to leave the European Union (EU). However, global financial markets have been regaining calmness. In this situation, overseas economies have continued to grow at a moderate pace as a whole, although the pace of growth has somewhat decelerated, mainly in emerging and commodity-exporting economies. As for the outlook, overseas economies are expected to moderately increase their growth rates, as it is likely that advanced economies will see steady growth, and emerging economies in particular will gradually move out of their deceleration phase, mainly through their policy measures. According to the World Economic Outlook (WEO) Update released in July 2016 by the International Monetary Fund (IMF), global growth projections have been revised slightly downward from the April 2016 WEO, particularly for Europe, but the longerterm projection that the global growth rate will moderately increase from 2015 through 2017, from 3.1 percent in 2015 and 2016 to 3.4 percent in 2017, is unchanged. Looking at developments by major region, the U.S. economy has been on a recovery trend on the back of firmness in household spending. As for the outlook, the industrial sector and overseas demand will likely continue to show mixed developments for the time being, but the economy is expected to continue to see firm growth driven by private demand under accommodative financial conditions. The European economy has continued to recover moderately as private consumption continues to increase. As for the outlook, the economy is projected to see a temporary slowdown in its pace of recovery as firms’ and households’ sentiment is becoming cautious due to uncertainty, mainly associated with the United Kingdom’s vote to leave the EU, but is likely to return to a moderate growth path. The Chinese economy has been slightly subdued, particularly in the manufacturing sector, which faces an overhang of production capacities. As for the outlook, the economy is likely to broadly follow a stable growth path as authorities have been proactively carrying out both fiscal and financial measures to support economic activity. Emerging economies have remained subdued, due mainly to developments in the Chinese economy, although the effects of economic stimulus measures have materialized in some economies. Commodity-exporting economies such as Brazil and Russia remain in a severe state but have started to bottom out, mainly because commodity prices have hit the bottom. As for the outlook, the growth rates of emerging economies are likely to increase gradually, due mainly to the spread of the effects of the recovery in advanced economies and to the effects of the economic stimulus measures, although differences across countries and regions are likely to remain for the time being. Risk factors to the overseas economic outlook are wide ranging, as exemplified by uncertainties associated with the United Kingdom’s vote to leave the EU, (2) developments in emerging and commodity-exporting economies including China, (3) developments in the U.S. BIS central bankers’ speeches economy and the influences of its monetary policy, (4) the European debt problem among banks, and (5) geopolitical risks such as those in the Middle East. Therefore, I consider it necessary to closely monitor various risk factors from a broad perspective in making projections regarding the outlook for overseas developments. B. Japan’s economy and prices 1. Economic activity I will now discuss the economic situation in Japan given the overseas developments I have just outlined. Japan’s economy has continued its moderate recovery trend, although exports and production have been sluggish, due mainly to the effects of the slowdown in emerging economies. On an annualized basis, after the real GDP growth rate for the OctoberDecember quarter of 2015 registered minus 1.7 percent, due partly to the effects of irregularly warm weather, that for the January-March quarter of 2016 increased, registering 2.0 percent, and that for the April-June quarter, which was released in mid-August, registered 0.2 percent; this was broadly about the same level as the growth potential when fluctuations are smoothed out. Looking ahead, sluggishness is expected to remain in exports and production for some time, and the pace of economic recovery is likely to remain slow. Thereafter, domestic demand is likely to follow an uptrend, underpinned by a virtuous cycle from income to spending being maintained in both the household and corporate sectors, and by large-scale economic measures, and exports are expected to head toward a moderate increase as overseas economies move out of their deceleration phase. Thus, Japan’s economy is likely to be on a moderate expanding trend. According to the Bank’s July 2016 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the medians of the Policy Board members’ forecasts for the economic growth rate are 1.0 percent for fiscal 2016, 1.3 percent for fiscal 2017, and 0.9 percent for fiscal 2018, and the economy is expected to continue growing at a pace above its potential through the projection period. 2. Prices Next, I will talk about price developments. The year-on-year rate of increase in the consumer price index (CPI) for all items less fresh food and energy has decelerated somewhat recently, as firms’ price-setting stance has become relatively cautious against the background of relatively weak developments in some indicators of private consumption. The rate of change for all items less fresh food has been slightly negative. Looking at annual price changes across all CPI items less fresh food, the share of price-increasing items minus the share of price-decreasing items has maintained its historically high level, but is declining slightly at present. With regard to the outlook, the year-on-year rate of change in the CPI (all items less fresh food) is likely to be slightly negative or about 0 percent for the time being, due to the effects of the decline in energy prices, and, as the underlying trend in inflation steadily rises, accelerate toward 2 percent. Meanwhile, assuming that crude oil prices will rise moderately from the recent level, the baseline scenario is that the timing of the year-on-year rate of change in the CPI reaching around 2 percent will be during fiscal 2017, although this is accompanied by considerable uncertainties including those surrounding overseas economies going forward. Specifically, the medians of the Policy Board members’ forecasts of the yearon-year rate of increase in the CPI (all items less fresh food) presented in the July 2016 Outlook Report are 0.1 percent for fiscal 2016, 1.7 percent for fiscal 2017, and 1.9 percent for fiscal 2018. 1 Individual Policy Board members made their forecasts assuming that Dubai crude oil prices would rise moderately from the recent 45 U.S. dollars per barrel to around 50 dollars per barrel toward the end of the projection period; that is, fiscal 2018. Under this assumption, the contribution of energy prices to the year-on- BIS central bankers’ speeches II. Keys to assessing the outlook for economic activity and prices In what follows, I will discuss several points that I think deserve particular attention in terms of realizing the outlook that I mentioned earlier. A. Employment and income situation First, I will talk about developments in the employment and income situation. Supply-demand conditions in the labor market have continued to improve steadily, and employee income has increased moderately. According to the Labour Force Survey, the pace of increase in the number of employees has been accelerating, and the labor force participation – especially that of women and the elderly – has continued to rise. Against this backdrop, the active job openings-to-applicants ratio has continued to see a steady rise, and a perception of labor shortage suggested by the diffusion index (DI) for employment conditions (the proportion of firms responding that employment was “excessive” minus the proportion of those responding that employment was “insufficient”) in the June 2016 Tankan (Short-Term Economic Survey of Enterprises in Japan) has generally heightened; both indicators are almost at the same levels as around 1991–1992. The unemployment rate has continued on a moderate improving trend, albeit with some fluctuations, and has been in the range of 3.0–3.5 percent. The supply-demand conditions in the labor market are expected to further tighten. On the wage side, hourly cash earnings of part-time employees in particular, which are responsive to labor market conditions, have continued to show relatively high growth at around 1.5–2.0 percent. With regard to the outlook, on the back of the heightening of inflation expectations and the marked tightening of labor market conditions, wages are projected to rise moderately. In light of these prospects for employment and wages, employee income is expected to continue rising moderately. Base pay for fiscal 2016 was revised upward for a third consecutive year, but to a marginally smaller extent than last year. Attention therefore should be given to how funds from profits in the corporate sector will circulate in the economy. B. Private consumption I will now discuss developments in private consumption, which has generally maintained its resilience against the background of steady improvement in the employment and income situation, although relatively weak developments have been seen in some indicators. The Consumption Activity Index is heading toward a pick-up, mainly in durable and non-durable goods, albeit with fluctuations. Looking at confidence indicators related to private consumption, the Consumer Confidence Index has continued to be more or less flat, while the Economy Watchers Survey and the DIs for business conditions of industries related to private consumption in the Tankan have been declining, reflecting effects such as those stemming from the wealthy being less motivated to spend on expensive goods and services, and the sluggish increase in demand from foreign visitors to Japan. With regard to the outlook, private consumption is expected to increase its resilience gradually, supported by an improvement in real employee income and the effects of various policy measures. However, I believe that it is necessary to pay attention to how the virtuous cycle from income to spending – which has been showing lackluster performance recently – will operate in the future. year rate of change in the CPI (all items less fresh food) was estimated to be approximately in the range of minus 0.6 to minus 0.7 percentage point for fiscal 2016. More specifically, the contribution was expected to start to lessen in the second half of fiscal 2016 and reach around 0 percentage point in early fiscal 2017. BIS central bankers’ speeches C. Business fixed investment Let me now explain developments in business fixed investment, which has been on a moderate increasing trend from a somewhat longer-term perspective, as corporate profits have been at high levels. According to the June 2016 Tankan, firmness is seen in business fixed investment plans for fiscal 2016 as a whole, including those of large manufacturers, for which profit projections have deteriorated as the expected exchange rate has shifted toward appreciation of the yen. As for the outlook, business fixed investment is projected to continue to see a moderate uptrend on the back of (1) corporate profits at high levels, (2) extremely stimulative financial conditions such as low interest rates and accommodative lending attitudes, (3) the effects of various policy measures from the fiscal side, and (4) moderate improvement in growth expectations. Investment for maintenance and replacement of equipment and investment in labor-saving machinery and equipment – both of which have been increasing in recent years – as well as investment in growth areas, all tend to be undertaken independently from temporary developments in corporate profits; therefore, the effects on such investment of changes in the environment surrounding corporate profits, such as the yen’s appreciation and the rise in crude oil prices, are expected to be relatively small. Nevertheless, I think that it is necessary to closely monitor whether firms will shift production sites back to Japan for manufacturing products to be sold mainly in overseas markets. D. Prices Next, I will discuss the aggregate supply and demand balance (the output gap) and inflation expectations, which are the main factors that determine inflation rates. First, the output gap has been more or less unchanged at around 0 percent recently. It is likely to remain so for some time, but thereafter is projected to start increasing through the end of fiscal 2016, at which time it is expected that the effects of the slowdown in overseas economies will wane and that the effects resulting from the set of economic measures will become evident. From fiscal 2017, the output gap is projected to continue expanding steadily in positive territory owing to both the capital and labor factors, as domestic and foreign demand increase. Second, medium- to long-term inflation expectations have weakened recently, although they appear to be rising on the whole from a somewhat longer-term perspective. Against the backdrop of relatively weak developments in private consumption, firms seem to be putting off price increases – mainly those of goods such as food products and durable consumer goods – since the turn of the fiscal year. As for the outlook, firms’ price-setting stance is expected to revert to raising prices accompanied by a pick-up in private consumption. Turning to their wage-setting stance, the high corporate profits have continued to positively affect employee income, and the mechanism in which inflation rises moderately accompanied by wage increases has continued to operate. In such a situation, medium- to long-term inflation expectations are also likely to return to an increasing trend and gradually converge to around 2 percent – the price stability target. III. Conduct of monetary policy Let me now turn to the Bank’s monetary policy. At the Monetary Policy Meeting (MPM) held in January 2013, the Bank made a commitment 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, and in April it decided to introduce Quantitative and Qualitative Monetary Easing (QQE) as a necessary measure to underpin this commitment. The main transmission mechanism of QQE is stimulating firms’ investment and households’ consumption by lowering nominal interest rates through large-scale purchases of Japanese government bonds (JGBs), and by transforming people’s deflationary mindset through the Bank’s clear commitment and large-scale monetary easing to underpin the commitment. Thereafter, the Bank decided to expand QQE at the MPM held at the end of October 2014. In BIS central bankers’ speeches January 2016, it introduced QQE with a Negative Interest Rate, which is designed to enable the Bank to make full use of possible monetary easing measures in terms of the three dimensions of quantity, quality, and the interest rate, with the new option of a negative interest rate being added. In addition, at the MPM held in July 2016, the Bank decided on an increase in purchases of exchange-traded funds (ETFs) and measures to ensure smooth funding in foreign currencies, for two reasons: in order to prevent uncertainties that have been heightening against the backdrop of the United Kingdom’s vote to leave the EU and the slowdown in emerging economies from leading to a deterioration in business confidence and consumer sentiment, and to ensure smooth funding in foreign currencies by Japanese firms and financial institutions, thereby supporting their proactive economic activities. Against the backdrop of considerable uncertainty over the outlook for prices in view of uncertainties surrounding overseas economies and global financial markets, the Bank – with a view to achieving the price stability target at the earliest possible time – also decided that it would conduct a comprehensive assessment of the developments in economic activity and prices under QQE and QQE with a Negative Interest Rate, as well as the effects of these policies, at the next MPM. For the good of Japan’s economy, it is necessary to make progress in the conversion of people’s deflationary mindset that has taken hold amid the prolonged deflation, and we are only halfway to achieving the price stability target. The Bank will continue to steadily pursue monetary easing, making full use of all possible measures in terms of the three dimensions of quantity, quality, and the interest rate to achieve the price stability target of 2 percent at the earliest possible time. IV. Challenges for Japan’s economy I would now like to express my thoughts regarding the current situation of Japan’s economy from a longer-term perspective. Japan’s potential growth rate, as estimated by the Bank, has declined to the range of 0.0–0.5 percent, and this reflects that the economy has experienced deflation for a long period of time. Especially recently, it is common to hear that the future of Japan’s economy is bleak because of the decrease in population and other factors. Similar opinions that arouse anxiety are expressed on an almost daily basis through various channels; as a result, a vague anxiety hangs over the society. However, I believe that we can be more reassuring about the future of the economy. It is true that the population decline has a substantial impact on the regional and national economies. Still, in this day and age, there is enough ground for being optimistic about the future. In this age, it is possible to plan broad-based – cross-regional or even cross-border – distribution and sales of goods and services. For example, having inbound customers means that customers from abroad are being attracted. I believe that many firms in Niigata Prefecture have customers not only inside but also outside the prefecture. The use of the internet opens up the possibility of conducting business with overseas customers, in addition to domestic customers outside the prefecture, of course. It should be noted that Japan is in Asia, the world’s most rapidly growing market. If Japanese firms manage to capture such growth, it is reasonably possible to reduce the impact of the demand-side problem, or the demand shortage, caused by the population decline. Let me turn to the supply side. The proportion of the population that is young will surely decrease, but firms are expected to increasingly make use of women and the elderly in the workforce. In terms of utilization of human resources, Japan in fact still has room for better use of personnel compared to the United States and Europe. In other words, there is enough room for further improvement in productivity. Another option is to gradually increase the BIS central bankers’ speeches number of foreign workers in many fields. It is likely that labor-saving initiatives, such as through the use of industrial robots, will advance rapidly in factories and the like. Let me remind you that Japan is a world-class manufacturer of robots. As illustrated, if the demographic challenges are decomposed and examined in detail, it can be said that there is no need to be completely pessimistic. So, how should we address the demographic challenges to a better future? One possible answer is that the private sector should actively pursue structural reforms by taking advantage of the opportunity currently afforded by the bold economic measures of the government and the accommodative financial conditions generated by the Bank. In advancing structural reforms, firms, regardless of whether they are in manufacturing or nonmanufacturing, will pursue changes in operational processes – i.e., scrap and build – in various areas such as production and sales. As a result, substantial costs will be incurred with, for example, new investment, worker retraining programs, and retirement allowances, and it will be necessary to procure funds for such costs. On this basis, cooperation between firms and financial institutions will become very important. In closing, let me underline that firms’ initiatives are essential to addressing these issues facing Japan’s economy. At the same time, the Bank, for its part, has established the Loan Support Program, through which it provides long-term funds at low interest rates so that firms can fully utilize accommodative financial conditions. Moreover, the Bank decided on measures to support firms’ investment in physical and human capital at the MPM held in December 2015. Many firms have become proactive in making investment in physical and human capital. I consider it desirable that these developments spread further. Thank you for your attention. BIS central bankers’ speeches
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Opening remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 3rd Bank of Canada and Bank of Japan joint workshop, Tokyo, 30 September 2016.
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September 30, 2016 Bank of Japan Opening Remarks at the 3rd Bank of Canada and Bank of Japan Joint Workshop Haruhiko Kuroda Governor of the Bank of Japan I am pleased to welcome all our distinguished guests to the 3rd Bank of Canada and Bank of Japan Joint Workshop. In particular, it is our great honor to have the presence of Professor Gianluca Benigno, Professor Marvin Goodfriend, and Professor Lawrence H. Summers as speakers. Last but not least, representing the Bank of Japan, I would also like to thank the Bank of Canada team headed by Mr. Gregory Bauer and Mr. Rhys Mendes for their participation and cooperation right from the organizing phase of the workshop. At the Monetary Policy Meeting held last week, the Bank of Japan decided to introduce "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" by strengthening the previous policy framework with a view to achieving the price stability target of 2 percent at the earliest possible time. The new policy framework consists of two major components: the first is "yield curve control" in which the Bank will control short-term and long-term interest rates; and the second is an "inflation-overshooting commitment" in which the Bank commits itself to expanding the monetary base until the year-on-year rate of increase in the observed consumer price index exceeds the price stability target of 2 percent and stays above the target in a stable manner. In the run-up to the new decision, the Bank conducted a comprehensive assessment of the developments in economic activity and prices under "QQE" and "QQE with a Negative Interest Rate." The assessment includes a number of solid econometric analyses, showing the importance of interaction between policy analysis and policy action, as a basis for better policy making. If you look at the Bank of Canada web site, it is saying, "The Governor of a country's central bank must have a thorough understanding of financial markets and the economy and possess wide experience in international finance." While I greatly respect the high standard set by Canadian people, we recognize that even today central banks are being faced with a number of challenges in fulfilling their given mandates and central bankers are, admittedly, not omnipotent. It is why we hold and cherish opportunities like today's workshop to meet for discussion and to exchange views and wisdom with each other. Today, we will discuss "Challenges to Central Bank Policies for Price Stability and Financial Stability" in this workshop. I am expecting to learn a lot from the four cutting-edge research papers and three insightful lectures to be presented. In the face of many challenges for central bankers, let me quote from Anne of Green Gables by the Canadian writer Lucy Maud Montgomery. I would like to emphasize that it is a well-known masterpiece not only in Canada but here in Japan. Anne says to her stepfather, old Matthew, "Isn't it splendid to think of all the things there are to find out about? . . . It wouldn't be half so interesting if we knew all about everything." Anne's words sound very encouraging to all economists and central bankers who are making numerous efforts to find out new ideas, solutions, and policy tools. With Anne's encouragement in mind, I am hoping that all the participants in today's workshop will be able to find out something -- or many things -- that are interesting, inspiring, and helpful in tackling the challenges ahead. Thank you.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Brookings Institution, Washington DC, 8 October 2016.
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Oct ob er 8, 201 6 Bank of Japan "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control": New Monetary Policy Framework for Overcoming Low Inflation Speech at the Brookings Institution in Washington, D.C. Haruhiko Kuroda Governor of the Bank of Japan Introduction It is a great honor to have the opportunity today to speak at the Brookings Institution, a think-tank with a long history and notable achievements. Since the global financial crisis in 2008, declines in the natural rate of interest and inflation expectations have led to a growing debate about whether monetary policy is becoming less effective. While it is now widely recognized that this is a common challenge for major economies, Japan has faced and addressed such a challenge ahead of other countries. Against this background, it is extremely valuable to share experiences of different countries and to exchange views among academics, market participants, and central bankers during opportunities like this. In order to overcome deflation that has lasted for 15 years and achieve the 2 percent price stability target, the Bank of Japan has conducted large-scale monetary easing by introducing "Quantitative and Qualitative Monetary Easing (QQE)" in April 2013 and "QQE with a Negative Interest Rate" in January 2016. As a result, corporate profits, measured by the ratio of current profits to sales, have been at a record-high level. The unemployment rate has declined to as low as 3 percent. A practice of base pay rises in annual wage negotiations, which was lost during the period of deflation, returned for the first time in two decades and has continued for three consecutive years. On the price front, a measure of underlying inflation -- the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food and energy -- has remained positive for almost three years. Japan's economy is no longer in deflation, which is commonly defined as a sustained decline in prices. However, the price stability target of 2 percent has not been achieved. At the Monetary Policy Meeting held in September, the Bank conducted a "Comprehensive Assessment" of the effects of these policy measures and, based on this assessment, introduced a new monetary policy framework. This new framework reflects the Bank's thinking with regard to the challenges that advanced economies have in common. In advance of our discussion later, I would like to talk about the essence of this new framework. I. Challenges in Japan and the New Monetary Policy Framework There were two major challenges to monetary policy in Japan. To start with, despite unprecedentedly large-scale monetary easing, inflation expectation formation in Japan is still adaptive to a large extent. That is, the expectations are formed in a backward-looking manner. In the wake of the substantial decline in crude oil prices since summer 2014, a reduction in the observed inflation has pushed down inflation expectations. The first challenge, therefore, is in terms of how to lift inflation expectations that had fallen once to an undesirably low level and re-anchor them at the target of 2 percent. The next issue concerns the link between the interest rate level and the effects of monetary easing. When short- and long-term interest rates were well in positive territory, a common understanding was that, so far as the impact on the economy was concerned, the lower the interest rates, the greater the monetary easing effects. However, it is now recognized that, when short-term interest rates are negative and long-term interest rates have fallen to extremely low levels, there could be side effects or costs that weaken the functioning of financial intermediation, which may reduce monetary easing effects. Such observations lead us to the other challenge, which is to explore optimal levels and shapes of the yield curve that can maximize monetary easing effects on the economy and prices. As solutions to these challenges, the Bank recently introduced the new monetary policy framework "QQE with Yield Curve Control." This consists of two major components: (1) an inflation-overshooting commitment and (2) yield curve control. Let me talk about each of these in turn. II. Inflation-Overshooting Commitment I will start by talking about the inflation-overshooting commitment. There is a widespread consensus that anchoring inflation expectations is very important in achieving a price stability target set by the central bank. However, it has not been fully analysed, either theoretically or empirically, how inflation expectations are formed by the public and how they can be raised once they have been de-anchored and fallen to an undesirably low level. QQE introduced by the Bank in 2013 aimed at changing people's perceptions of inflation through a regime shift in monetary policy by combining a strong commitment to achieving the price stability target and the significant expansion of the monetary base. As shown in the "Comprehensive Assessment," this approach has produced positive results. In light of these achievements, the Bank of Japan further strengthened this approach recently with the introduction of an inflation-overshooting commitment, in which the expansion of the monetary base is linked to the year-on-year rate of change in the observed CPI. By committing to continuing to expand the monetary base until the observed CPI inflation exceeds the price stability target of 2 percent and stays above the target in a stable manner, the Bank aims to work on people's perceptions of inflation in a more forceful manner. As a possible policy option to address declines in inflation expectations, prominent economists such as Olivier Blanchard, professor emeritus at the Massachusetts Institute of Technology, and John Williams, President of the Federal Reserve Bank of San Francisco, have proposed that a central bank raise its inflation target from the current 2 percent to, say, 4 percent.1,2 However, based on Japan's experience, the argument that a central bank can lift inflation expectations of various economic entities simply by raising its inflation target seems a little naïve to me. In order to re-anchor inflation expectations, I believe it necessary to strengthen a central bank's credibility that it can achieve its price stability target. For this purpose, making use of forward guidance, or a commitment with regard to the future course of monetary policy, is considered effective. However, designing an effective forward guidance is not an easy task. There is nothing to be gained from promising the obvious; on the other hand, promises that impose excessive constraints on future conduct of monetary policy would not be effective Olivier Blanchard, Giovanni Dell'Ariccia, and Paolo Mauro (2010), "Rethinking Macroeconomic Policy," Journal of Money, Credit and Banking, vol.42, issue s1, pp.199-215. John C. Williams (2016), "Monetary Policy in a Low R-star World," FRBSF Economic Letter, 2016-23. either, because people think that a central bank would end up reneging on the commitment. This is a problem of the so-called time inconsistency. The Bank of Japan's solution to this problem is to make a commitment that is "bold but not excessively binding" by making a commitment to expansion of the monetary base, based on the observed CPI inflation rate, instead of the forecast of them. Given that there is a time lag for monetary policy to have effects on economic activities, it is exceptional for a central bank to make a commitment based on the observed indicators. In the new commitment, the monetary base continues to expand until the condition is fulfilled. That means that the Bank of Japan's holdings of Japanese government bonds (JGBs) keep increasing as well, because they provide a significant portion of the monetary base. By committing to an increase in the core element of monetary easing -- the monetary base -- the Bank demonstrates that the unprecedented monetary easing will be firmly in place until the observed CPI inflation rate exceeds the price stability target of 2 percent and stays above the target in a stable manner. Under our baseline scenario in which the inflation rate increases at a fairly moderate pace, a low-level yield curve will also continue until the condition is met along with an expansion of the monetary base. That said, if inflation were to accelerate suddenly, the Bank would be able to address this by raising the short- and long-term interest rates. Therefore, this commitment can be kept all the time, while giving powerful monetary stimulus. Some economists raise concern that a higher inflation target, even though originally designed to lift inflation expectations, would end up being long-lasting, creating a new challenge of how high of an inflation rate level would be consistent with the legal mandate to achieve price stability. The Bank of Japan's new policy framework is constructed in such a way that it can avoid this problem while maximizing the monetary easing effects. The formation of inflation expectations and policy responses to lift inflation expectations are the subject of an ongoing debate. I strongly expect these issues to be further explored. III. Yield Curve Control Next, I would like to talk about yield curve control. With regard to central banks' ability to control interest rates, the conventional view is that they can control short-term rates but not long-term rates. However, since the global financial crisis, major central banks, having faced the zero lower bound on short-term interest rates, have directly exerted influence on long-term interest rates through large-scale asset purchases. This policy is widely referred to as quantitative easing, or QE. In practice, all of the major central banks set the amount of asset purchases as an operating target, and long-term interest rates consequently are endogenously determined. However, the Bank's analyses in the "Comprehensive Assessment" showed that the impact of government bond purchases by the Bank on long-term interest rates has varied considerably depending on economic circumstances and financial market conditions from time to time. This means that, when the amount of government bond purchases is set as an operating target in advance, actual long-term interest rates could be too high or too low relative to a level considered appropriate by the central bank. Against this background, the Bank of Japan introduced "yield curve control," in which long-term interest rates are explicitly set as an operating target. This is perhaps the first attempt to do so among major central banks. You may think that yield curve control is an ambitious project for a central bank. Let me remind you, however, that major central banks that have been conducting asset purchases must have already faced the question of what shape and location of the yield curve would be appropriate for their policy goals. Without answering this question, the central bank cannot reasonably specify the amount of asset purchases. In a recent post in his blog, Ben Bernanke, former Chairman of the Federal Reserve, referring to discussions at the Federal Open Market Committee's meeting in October 2010, compared QE, in which the amount of government bonds to be purchased is decided in advance, with a peg for long-term interest rates.3 In this comparison, Dr. Bernanke pointed out that, if the Federal Reserve pegged long-term interest rates, it might end up having to buy very large amounts of securities, giving rise to the risk of losing control of the balance sheet; for this reason, the Federal Reserve decided to opt for QE rather than rate-pegging. Ben Bernanke (2016), "What tools does the Fed have left? Part 2: Targeting longer-term interest rates," Ben Bernanke's Blog, Brookings Institution, March 24. While I share such concerns, I have two responses to them. The first is that, in the new framework, the Bank of Japan will set the operating target for long-term interest rates at each Monetary Policy Meeting. That means that it will facilitate the formation of the yield curve that is deemed appropriate by taking account of the economic, price, and financial conditions from time to time so as to provide a sufficient level of monetary accommodation in order to achieve the price stability target. The second is that the Bank has already been conducting very large-scale government bond purchases and, in combination with a negative interest rate policy, has been fairly successful in controlling long-term interest rates. As shown in the "Comprehensive Assessment," this combination has been exerting powerful downward pressure on long-term interest rates. With this in mind, I believe that there will be no significant changes in the management of the Bank's balance sheet going forward under the new framework. Meanwhile, in a recent book, Professor Kenneth Rogoff of Harvard University argues that a negative interest rate policy is more effective than QE, not least because QE has had uncertain impacts so far compared to the conventional interest rate policy and there is difficulty in its calibration and communication. In this context, he calls for abolishment of cash as it would make further policy room for a negative interest rate.4 While I am interested in his argument, the reality is that cash cannot be abolished in the near future. From the viewpoint of policy makers, a negative interest rate policy and asset purchases are not mutually exclusive. Taking account of the existing financial system and financial market structures in Japan, we have come to a conclusion that the Bank of Japan can proceed with more powerful monetary easing by controlling the yield curve through the appropriate combination of a negative interest rate policy and asset purchases. In conducting yield curve control, more detailed analyses -- both theoretical and empirical -on the appropriate level of short- and long-term interest rates are required. In particular, the conventional concept of a natural rate of interest and "monetary policy rules" are not sufficient, as they focus exclusively on short-term interest rates. Research and discussion should be extended across the entire yield curve. Kenneth S. Rogoff (2016), "The Curse of Cash," Princeton University Press. These issues are relevant for the Federal Reserve as well, although it already has discontinued asset purchases except for reinvestment. If one stands on the "stock view" of QE, suggesting that what matters for monetary easing effects is the central bank's holdings of assets rather than the amount of asset purchases during a period of time, the Federal Reserve's massive bond holdings is still providing monetary stimulus. If this is the case, the level of the short-term interest rate that is desirable for the Federal Reserve at present must be different from what would have been the case if the Federal Reserve had not held such massive amounts of bonds on its balance sheet. Moreover, based on the experience in Europe and Japan, it is becoming increasingly evident that an excessively lowered and flattened yield curve could weaken the transmission mechanism of monetary easing by squeezing banks' profit. In addition, a decline in expected rates of returns of insurance and pension products may have an adverse impact on consumers' confidence. These aspects are not only of interest from a macroprudential perspective but also need to be examined in terms of the macroeconomic transmission and influence of monetary easing. In sum, with interest rates at historically low levels, monetary policy design going forward necessitates a new paradigm of monetary economics, by broadening the focus of analysis from short-term interest rates to the entire yield curve. Conclusion Today, I was able to discuss only a couple of topics that are covered in the Bank of Japan's "Comprehensive Assessment." In fact, we have conducted in-depth analyses of hotly debated issues in monetary policy, including the impact of large-scale government bond purchases on long-term interest rates, the mechanisms of inflation expectation formation, and the effects and impact of the negative interest rate policy. As I mentioned at the outset, monetary policy under a low-growth, low-inflation environment is becoming a challenge that major economies around the world have in common. To conclude my remarks, I sincerely hope that the Bank's "Comprehensive Assessment" and the introduction of the new policy framework based on this assessment will contribute to constructive debate in this field. Thank you very much for your attention.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Japan Summit 2016, Tokyo, 21 October 2016.
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October 21, 2016 Bank of Japan New Challenges for Japan's Labor Market Speech at the Japan Summit 2016 in Tokyo Haruhiko Kuroda Governor of the Bank of Japan Introduction It is my great pleasure to have the opportunity today to speak at this Japan Summit 2016. Today's summit brings to the fore the new challenges for Japan's labor market in responding to advances in technological innovation, globalization, and demographic change. Whether Japan's economy will grow in the long-run depends on whether the country's labor market can successfully adapt to this changing environment. Indeed, labor market reform is a vital part of the current government's policy agenda. As for the long-term economic outlook, given Japan's aging population and low birth rate, an increase in labor force participation and a further rise in labor productivity are both essential if Japan is to lift sustainable long-run growth, in other words, to raise its growth potential. Today, I offer my own vision of the future for Japan's labor market, and look at how it will strengthen the growth potential of our economy. Feature of Japan's Labor Market IT-related developments and globalization have affected Japan's labor market. The manufacturing industry, in particular, has seen existing jobs being replaced with machines and outsourcing to other countries, resulting in downward pressure on wages and lost job opportunities. However, there is a view that Japan's labor market as a whole has not undergone drastic changes. Our well-known system of life-time employment and seniority-based wages virtually continues to this day. This practice prevailed among Japanese firms especially throughout the period of high economic growth. Legal norms developed to support this system provided the firm foundations for the job security enjoyed in Japan's labor market. With the Japanese economy entering a period of stagnant growth in the second half of the 1990s, the economic situation underwent dramatic changes. Nevertheless, despite shifts to the use of non-regular workers, the employment and wage system for regular workers remained virtually the same. Indeed, the average number of working years at a specific firm is about 14 years for Japanese male workers, the highest among advanced economies; this compares, for example, with five years for those in the United States and nine years in the United Kingdom. When looking at the evolution of wages over male workers' lifetimes, wages are seen to approximately double after 30 working years compared to when they first started working -- once again the highest such figure among advanced economies. In addition, labor mobility in Japan across firms and industries has been low, especially among regular workers who tend to stay at the same company or within the same industry throughout their careers. The gradual pace of change in the labor market may arise because how we work is closely related to other aspects of our way of life as well as social values and norms. I believe that the rapid socio-economic changes of recent years mentioned here at this summit will, however, bring a significant change to the Japanese labor market over time. Three Challenges for Japan's labor market It is my belief that labor markets should adapt to the changing economic environment in a flexible manner. In this sense, customs and institutions -- which have long structured Japan's labor market -- must be transformed in order to boost our country's growth potential. Although further discussion is needed on the nature of these transformations, today's summit has given us some insightful hints. From now on, I will refer to the three challenges for the labor market which I think are important. The first challenge is how our labor market will respond to further advances in technological innovation. It is often pointed out that recent technological innovations, namely in robots, AI, and big data, will encourage substitution between workers and machines. There are concerns that such substitution may extend into a broader range of fields than we have hitherto experienced -- even into fields previously believed to be "sacrosanct" and reserved exclusively for humans. However, history tells us that technological innovation generates economic prosperity in the long run. Technological progress increases income and purchasing power, as well as demand for new goods and services; furthermore, it creates new jobs. In this situation, we should ensure the smooth transition of labor to growing sectors with new jobs so as to reap the benefits of technological innovation. Japan's labor market is, however, well known for its low labor mobility due to long-standing life-time employment practices. From now on, our labor market should embrace new practices that accommodate workers seeking transition from one job to another, with programs for re-training and a social safety net for the unemployed. The second challenge is how our labor market will change in the face of further globalization. Since globalization often goes hand in hand with innovation, it will accelerate improvements in labor productivity. The next stage of globalization will entail both an increase in the number of Japanese workers abroad and an influx of foreign workers coming to Japan. Indeed, government policy has encouraged highly skilled foreign professionals to work in Japan. Through collaboration and cooperation across borders, firms will take advantage of growth opportunities overseas, generating new innovation and raising labor productivity. This process will be accompanied by increased competition, with domestic workers facing overseas competitors in a much broader range of industries and professions. A labor market characterized by a variety of workers will require a shift in our thinking regarding how people work and how they are paid for taking on particular responsibilities. Workers, as well as goods and services, confront the forces of globalization; the customs and institutions of the labor market will inevitably be exposed to rising pressure in global competition. The final challenge is how our labor market will transform in response to demographic change in Japan. In addition to the policy issues just discussed, I also want to stress the significance of encouraging labor force participation. This is imperative for increasing Japan's potential growth rate; and indeed, promoting labor participation of senior citizens and women is an important pillar of the current government policy. For these policies to be effective, however, we need to acknowledge that we have reached a turning point with regard to norms of working style as well as employment and wage structures; these can no longer exist with the prime-age male worker alone in mind. Japanese firms are already fully aware that accommodating to changes in the demographic profile while maintaining an employment and wage system of life-time employment and seniority-based wages is indeed a challenging task: the aging workforce of baby-boomers has pushed up firms' personnel expenses substantially in recent years. With new entrants to the labor market in the face of the aging population, we need to offer a wide selection of choices in terms of working hours and locations. Furthermore, we should also transform the locus of responsibilities associated with child-rearing and nursing-care. Conclusion The Japanese have long been praised for "working hard," -- in other words, for their diligent work ethic. I would like us to reaffirm our civic pride in this virtue; however, this time, I mean "working hard" to have a different sense. From now on, we need to "work hard" to build and adjust to new customs and institutions that are highly adaptable to a variously changing environment. It is through providing these new institutional foundations for a remodeled labor market that we will form the basis for sustainable long-run growth. Finally, though there is regretfully no time to talk about monetary policy, I can only say that the structural reforms including labor market reform accompanied by the current easy monetary policy will contribute to sustainable development of Japan's economy. Thank you.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a meeting with business leaders, Nagoya, 14 November 2016.
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November 14, 2016 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Nagoya Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is my great pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in the Chubu region. I would like to take this opportunity to express my sincerest gratitude for your cooperation with the Bank of Japan's Nagoya Branch. At the September Monetary Policy Meeting (MPM), the Bank conducted a comprehensive assessment of monetary easing measures implemented since the introduction of quantitative and qualitative monetary easing (QQE) and, based on its findings, decided to introduce "QQE with Yield Curve Control." The new policy framework consists of two major components: the first is "yield curve control," in which the Bank facilitates the formation of the yield curve that is deemed most appropriate with a view to maintaining the momentum toward achieving the price stability target of 2 percent, and the second is an "inflation-overshooting commitment," in which the Bank commits itself to expanding the monetary base until the year-on-year rate of increase in the observed consumer price index (CPI) exceeds the price stability target of 2 percent and stays above the target in a stable manner. Almost two months have passed since the introduction of the Bank's new policy framework, and it appears to have been perceived as positive by market participants. Looking at developments in long- and short-term interest rates, the yield curve for Japanese government bonds (JGBs) has been formed smoothly and stably in line with the guideline for market operations -- in which the short-term policy interest rate is set at minus 0.1 percent and the target level of 10-year JGB yields at around 0 percent (Chart 1). Turning to other developments in the financial markets, the yen has depreciated somewhat against the U.S. dollar in the foreign exchange market, amid the heightening speculation over the policy rate hike in the United States. In this situation, stock prices have been relatively firm. Meanwhile, in response to the outcome of the U.S. presidential election, the yen had appreciated and stock prices had declined, both to a large degree temporarily, but thereafter reverted to situations of a depreciation and an increase, respectively. The Bank will continue to carefully monitor market developments. At the MPM held at the beginning of November, the Bank released its projections through fiscal 2018 in the Outlook for Economic Activity and Prices (Outlook Report). Today, I would like to explain the Bank's projections for economic activity and prices based on this Outlook Report, as well as its thinking on the conduct of monetary policy. I. The Current Situation of and Outlook for Japan's Economic Activity and Prices To begin with, let me make three points on the outlook for Japan's economy. Please refer to Chart 2. The first point is that extremely powerful economic stimulus measures are being implemented, both on the monetary and fiscal sides. The Bank will adhere to powerful monetary easing under the new policy framework in order to achieve the price stability target of 2 percent, while the government will steadily implement its large-scale stimulus measures, amounting to 28 trillion yen in project size, with the Diet's recent approval of the supplementary budget. Synergy effects are produced in a case where a government proactively carries out fiscal spending while a central bank provides accommodative financial conditions with a view to achieving its price stability target; this is known to make the stimulative effects on economic activity more powerful. Indeed, such effects of the so-called policy mix are expected to be seen going forward. The second point is that, on the back of the effects of a policy mix as well as the recovery in overseas economies, Japan's economy is likely to expand moderately, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors. Specifically, as indicated in red in the chart, it is likely to continue growing at a pace above its potential through the projection period -- that is, through fiscal 2018 -- at around 1 percent. Third, on the price front, the year-on-year rate of change in the CPI for all items less fresh food is likely to be slightly negative or about 0 percent for the time being, as shown in blue in the chart. Thereafter, the rate of change is expected to increase toward 2 percent in the second half of the projection period in line with an improvement in the output gap, as will likely be evidenced by a further decline in the unemployment rate, and a rise in medium- to long-term inflation expectations. In what follows, I will explain the outlook for economic activity and prices in more detail. A. The Current Situation of Economic Activity and Its Outlook Developments in the Corporate Sector Looking at developments in the corporate sector, exports and production have been sluggish recently, due mainly to the effects of the slowdown in emerging economies. Exports, mainly automobile-related exports, to advanced economies have remained on a steady increasing trend, whereas those to emerging economies have been sluggish, especially of capital goods. Exports as a whole have therefore been flat. Against this background, production also has been almost flat. In terms of corporate profits, profits of manufacturing firms have been negatively affected by the slowdown in emerging economies and the yen's appreciation (Chart 3). Nevertheless, those of all industries, including nonmanufacturing firms, have been at a level close to record highs, reflecting an improvement in the terms of trade resulting from the low crude oil prices. The diffusion index (DI) for business conditions in the September 2016 Tankan (Short-Term Economic Survey of Enterprises in Japan) has generally stayed at a favorable level. Against this backdrop, firms, including large manufacturers, have maintained their positive fixed investment stance. With regard to the outlook, although overseas economies are projected to remain slightly subdued for some time, they are expected to gradually increase their growth rates as advanced economies continue growing steadily and the effects of such steady growth spread to emerging economies. Against this background, exports and production are expected to start increasing moderately. Business fixed investment may be affected temporarily partly by the slowdown in overseas economies and the past yen appreciation. However, it is likely to continue increasing moderately as the highly accommodative financial conditions continue and growth expectations rise moderately. Developments in the Household Sector Next, I would like to turn to developments in the household sector. Positive developments in the corporate sector have steadily exerted positive effects on the employment and income situation (Chart 4). The tightening trend of labor market conditions has become more evident and the latest active job openings-to-applicants ratio was 1.38 times, marking the highest level seen since 1991. The unemployment rate has been about 3 percent, which is virtually "full employment." A perception of labor shortage suggested by the employment conditions DI in the September Tankan has heightened further. Against this background, wages have increased moderately. Despite such improvements in the employment and income situation, private consumption has lacked momentum somewhat. Looking back, private consumption was relatively weak in the first half of 2016, due mainly to the negative wealth effects brought about by the decline in stock prices. However, various sales statistics show that it has started to pick up recently, despite being affected by bad weather conditions such as typhoons. Confidence indicators related to private consumption also have been picking up (Chart 5). Based on this situation, private consumption is expected to increase moderately on the back of the continued steady improvement in the employment and income situation. B. The Current Situation of Prices and Their Outlook Next, I would like to touch on price developments. The year-on-year rate of change in the CPI for all items less fresh food has been slightly negative due to the effects of the decline in energy prices (Chart 6). Meanwhile, that for all items less fresh food and energy has remained positive for exactly three years since October 2013. This is the first time since the late 1990s, when Japan's economy fell into deflation, that the inflation rate has been positive for such a long period. However, it has slowed recently. This is mainly attributable to the fact that prices, such as for durable goods, have declined due to the effects of the past appreciation of the yen, and that firms' price-setting stance has become slightly cautious, reflecting weakness in private consumption in the first half of 2016. The year-on-year rate of change in the CPI for all items less fresh food is likely to be slightly negative or about 0 percent for the time being, and increase toward 2 percent in the second half of the projection period -- that is, through fiscal 2018. The following four points can be highlighted as the background to this outlook. The first point is with regard to developments in energy prices, such as crude oil prices. The downward pressure of the past decline in energy prices on the CPI is expected to dissipate going forward and the negative contribution of energy items is estimated to reach around 0 percentage point in early 2017 (Chart 7). Therefore, the CPI for all items less fresh food -for which the year-on-year rate of change is currently minus 0.5 percent -- is expected to reduce its rate of decline rapidly and turn positive. The second point is that, as I have explained earlier, private consumption has bottomed out recently on the back of improvement in the employment and income situation, and is expected to increase moderately. With such developments, firms' price-setting stance is expected to revert to raising prices. The third point is that labor market conditions are expected to further tighten, exerting upward pressure on wages accordingly. In this context, how the labor-management wage negotiations next spring develop warrants particular attention. Corporate profits have been at a level close to record highs, and labor market conditions have tightened, as evidenced by the fact that the unemployment rate has declined to around 3 percent. Under these circumstances, the environment for wage increases is certainly well established. The fourth point is that, as the Bank pursues powerful monetary easing under its "inflation-overshooting commitment," inflation expectations will likely rise. I will elaborate on this later. In this manner, it is the Bank's assessment that, despite the recent weakness in price developments, the momentum toward achieving the price stability target of 2 percent seems to be maintained. However, risks to both economic activity and prices are skewed to the downside, particularly those regarding overseas factors. Moreover, the projections for prices in the October 2016 Outlook Report have been revised slightly downward compared with those in July, and the timing of the year-on-year rate of change in the CPI reaching around 2 percent will likely be around fiscal 2018. The momentum toward achieving the 2 percent target is somewhat weaker than the previous outlook, and thus developments in prices warrant careful attention going forward. The major reason behind these downward revisions lies in developments in medium- to long-term inflation expectations. Let me now move on to this point. II. Inflation Expectations and the Conduct of Monetary Policy To put it simply, inflation expectations are people's outlook for prices, or their perception of future price developments. In a situation where the price stability target of 2 percent is achieved in a stable manner, people will share the view that annual inflation will be around 2 percent, and such view will be a key determinant of prices of goods and services, as well as wages. With the aim of dramatically changing the deflationary mindset that had been entrenched among people and raising inflation expectations to 2 percent, the Bank -- under QQE introduced in April 2013 -- has strongly and clearly committed itself to achieving the price stability target and conducted large-scale monetary expansion to underpin this commitment. After the introduction of QQE, inflation expectations increased significantly through around summer 2014 (Chart 8). This clearly shows that monetary policy is effective in raising inflation expectations. Thereafter, however, with headwinds such as a significant decline in crude oil prices, weak demand following the consumption tax hike, and volatility in global financial markets reflecting the slowdown in emerging economies, inflation expectations resumed their decline from summer 2015 and have remained in a weakening phase. In Japan, where deflation has been persistent for a prolonged period, inflation expectation formation still tends to be largely affected by developments in observed inflation rates. As observed inflation rates had actually declined before the conversion in people's perception about inflation toward 2 percent, the decline in actual inflation seemed to have brought inflation expectations down as well. In order to address this situation, the Bank judged it necessary to adopt more forceful measures to raise inflation expectations and introduced an "inflation-overshooting commitment." Specifically, under this commitment, the Bank will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI exceeds 2 percent and stays above the target in a stable manner. The price stability target needs to be achieved on average over the business cycle. Thus, it naturally is assumed that there would be phases when the observed CPI exceeds 2 percent. As it takes some time for monetary policy to have an impact on economic activity and prices, it is exceptional for the central bank to make such a strong commitment that is based on the observed CPI. Through this exceptional commitment, the Bank aims to enhance the credibility of achieving 2 percent among the public. Let me elaborate on this point. Given that the inflation rate in Japan has been lower than 2 percent for a long period, it is necessary for the public to experience the process whereby the inflation rate actually exceeds 2 percent before converging to the 2 percent target. Through such experience, the perception that annual inflation will be around 2 percent will take hold among the public. The Bank committed itself to continue with large-scale monetary expansion until this process is completed. The new policy framework is designed to enable the Bank to pursue monetary easing in a flexible manner through yield curve control. Under "QQE with Yield Curve Control," the Bank will pursue powerful monetary easing and make policy adjustments as appropriate, taking account of developments in economic activity and prices as well as financial conditions, with a view to maintaining the momentum toward achieving the price stability target of 2 percent. As described in the Bank's "Comprehensive Assessment," the annual labor-management wage negotiations in Japan tend to be influenced by the inflation rate in the preceding year, and this is one of the reasons why inflation expectations are affected by the past inflation rate. On the other hand, in Europe and the United States, medium- to long-term inflation expectations that are anchored by central banks' price stability targets are the crucial factor that determines wages. As I mentioned earlier, labor market conditions are likely to continue tightening and the inflation rate will increase steadily toward 2 percent as the Bank pursues aggressive monetary easing. In the course of Japan's economy experiencing such a significant change, making proactive investment in human capital, including determining wages based on the 2 percent inflation benchmark, will benefit individual firms in terms of medium- to long-run management, not to mention that it is crucial for Japan's economy as a whole. Conclusion In concluding, let me touch on the economy of the Chubu region. The economy centered on Nagoya is the core of Japan's manufacturing. Challenges taken by many industries and firms in anticipation of future potential can become the driving force for raising Japan's potential growth rate, which is at a low level currently. For example, in the automobile industry, which is the leading industry of the region, initiatives to introduce next-generation technology -- such as environmentally friendly features as well as automatic- and safe-driving systems -- are proceeding rapidly. In addition, in aircraft-related industries, formation of industrial clusters in the region is starting to make steady progress, and there are increasing numbers of cases where small and medium-sized parts manufacturers are working in an integrated manner in terms of receiving orders and producing parts. Furthermore, such proactive production activities by manufacturers are inducing fixed investment by a wide range of firms, including nonmanufacturers. I would like to close my speech by expressing my sincere hope that these dynamic initiatives by the industrial sector, combined with financial institutions' and the local government's support, will lead to further growth and development of the Chubu region. Thank you. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Nagoya November 14, 2016 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Developments in Financial Markets Changes in JGB Yield Curve 1.0 Exchange Rates and Stock Prices % 20,000 Depreciation of the yen September 20, 2016 (the day before the decision to introduce QQE with yield curve control) 0.8 yen yen/U.S.dollar Nikkei 225 Stock Average (left scale) Yen/U.S. dollar (right scale) 19,000 Appreciation of the yen 0.6 The latest data 18,000 17,000 16,000 15,000 0.4 0.2 0.0 -0.2 -0.4 1 2 year Source: Bloomberg. 7 8 9 10 15 20 residual maturity 14,000 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Chart 2 Outlook for Economic Activity and Prices (as of October 2016) y/y % chg. CPI Real GDP (all items less fresh food) Fiscal 2016 ＋1.0 －0.1 Forecasts made in July 2016 ＋1.0 ＋0.1 Fiscal 2017 ＋1.3 ＋1.5 Forecasts made in July 2016 ＋1.3 ＋1.7 Fiscal 2018 ＋0.9 ＋1.7 Forecasts made in July 2016 ＋0.9 ＋1.9 Note: Figures indicate the median of the Policy Board members’ forecasts (point estimates). Source: Bank of Japan. Chart 3 Corporate Profits and Business Fixed Investment Business Fixed Investment Plans Current Profits (Tankan, Large Enterprises ) s.a., tril. yen y/y % chg. FY 2015 FY 2014 FY 2013 FY 2016 All industries Manufacturing Nonmanufacturing -5 CY05 06 Average of historical data (FY 2000-2015) -2 -4 Mar. June Sept. Dec. Notes: 1. Figures for current profits exclude "Finance and Insurance." Notes: 2. Figures for business fixed investment plans include land purchasing expenses and exclude software investment. Sources: Ministry of Finance; Bank of Japan. Forecast Actual Chart 4 Labor Market Conditions Unemployment Rate and Active Job Openings-to-Applicants Ratio s.a., % Tankan: Employment Conditions DI DI ("excessive" - "insufficient"), % points s.a., times 1.5 Unemployment rate (left scale) Active job openings-to-applicants ratio (right scale) "Excessive" 1.2 "Insufficient" 0.9 -10 0.6 All enterprises -20 Large enterprises Small enterprises CY 05 13 14 0.3 15 16 -30 CY 05 Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; Bank of Japan. Chart 5 Confidence Indicators Related to Private Consumption DI for Judgement of Current Conditions (Economy Watchers Survey) Consumer Confidence Index s.a. s.a., DI DI for judgement of current conditions (household activity) Improved Worsened CY 05 CY 05 Note: There is a discontinuity in the data for the Consumer Confidence Index in April 2013 due to a change in the survey method. Source: Cabinet Office. Chart 6 Consumer Prices y/y % chg. CPI (all items less fresh food and energy) CPI (all items less fresh food) -1 -2 -3 CY 07 Note: Figures for the CPI (all items less fresh food and energy) are calculated by the Research and Statistics Department, Bank of Japan. Figures for the CPI are adjusted to exclude the estimated effects of changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 7 Consumer Price Index and Energy Prices y/y % chg. Items other than energy Energy (petroleum products, electricity, and gas, manufactured & piped) CPI (all items less fresh food) -1 -2 -3 CY 0 7 0 8 0 9 1 0 1 1 1 2 1 3 1 4 Note: Figures for the CPI are adjusted to exclude the estimated effects of changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. 1 5 1 6 Chart 8 Inflation Expectations after the Introduction of QQE 2.0 y/y % chg. Beginning of a Introduction of Consumption downtrend in QQE tax hike crude oil prices 1.8 1.6 Synthetic indicator of firms', households', and economists' inflation expectations ▼▼ ▼ Destabilization of financial markets amid concern about emerging economies ▼ 1.4 1.2 1.0 0.8 0.6 0.4 0.2 CY 07 Notes: 1. Inflation expectations of firms, households, and economists are represented by the Tankan, the "Opinion Survey," and the "Consensus Forecasts," respectively. Notes: 2. Semiannual data from the "Consensus Forecasts" up through 2014/Q2 are linearly interpolated. "Opinion Survey" figures exclude inflation expectations by respondents whose annual inflation expectations were +5% percent or greater and -5% percent or smaller. The output prices DI in the Tankan represents the difference between the share of firms that raised prices in the preceding three months and the share of firms that lowered prices. Sources: Consensus Economics Inc., "Consensus Forecasts"; Bank of Japan.
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Paris EUROPLACE Financial Forum, Tokyo, 5 December 2016.
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December 5, 2016 Bank of Japan Digital Innovation and FinTech Remarks at the Paris EUROPLACE Financial Forum in Tokyo Haruhiko Kuroda Governor of the Bank of Japan Introduction It is a great honor to have this opportunity to speak before the Paris Europlace Financial Forum. When I look back on my teenage years, I was passionate about science and technology, and I dreamed of a future in which people enjoyed traveling to other planets and talking with friends around the world by videophone. After decades of technological development, interplanetary travel is unfortunately still some way off, but innovation in information technology has evolved far beyond people's expectations over half a century ago. As a central banker, I am in a position to closely monitor the financial world, and recent developments in information technology, which are leading to wide-scale innovations in financial services, bring new excitement and challenges. Such innovations have the potential to significantly change the global landscape of finance and economies. Thus, today I would like to talk about financial innovation, which is attracting attention around the world as "FinTech." I hope my remarks will serve as a bridge to the afternoon sessions. Technological Innovation, Economic Growth, and Finance Innovation is undoubtedly a main driver of economic growth, and thus it has always been the focus of economic policy. Historical studies show that global economic growth was considerably slow until the medieval period. The growth rate surged in the modern era when new industrial technologies were widely applied to economic activities. The financial industry, which emerged shortly before the modern era, has played an important role in enabling subsequent technological innovations to drive the growth of various industries and economies. By making use of sophisticated financial infrastructure, people discover promising new technologies. Then, with the support of finance, these new technologies attract money and resources, develop as an industry, and eventually spread widely and are used by many people. Looking back at the history of the automobile and airline industries as examples, the creation of the Ford Model T and the flight of the Wright brothers happened in the early 20th century. Without finance, those industries, as well as many other relevant industries, could not have grown so rapidly and led to strong economic growth in the 20th century. Information Technology and Financial Innovation As such, technological innovations since the Industrial Revolution have generated many new industries. The financial industry has a longer history than even many manufacturing industries, because basic financial infrastructure such as money, ledgers, and accounting came into being before or during the medieval period. Nonetheless, ongoing innovations in information technologies are now expected to have significant impacts particularly on the financial industry and financial services. There are various reasons behind such strong linkages between recent information technologies and financial services. First, finance is a sophisticated system of various information processing such as payment, settlement, investment decisions, and risk management. In this respect, the financial industry can be considered an "information industry." Second, some recent information technologies such as the "blockchain" and "distributed ledger technology," or DLT, have the potential to significantly affect money and ledgers, which are the basic infrastructure for financial activities. Moreover, wide-ranging innovations, which may significantly affect financial services, appeared almost simultaneously around the time of the global financial crisis. First, smartphones such as the iPhone which was invented in 2007, enhanced the accessibility to various financial services. Then, in 2008 the new technologies of the blockchain and DLT were created. Moreover, artificial intelligence, or AI, and big data analytics have evolved greatly thanks to the dramatic increase in computing power. In addition, since the global financial crisis, new entrants to financial services have been welcomed, particularly in those countries where public funds were injected to financial institutions. This environment has also supported the development of FinTech. Promising Potential of Financial Innovation Recent financial innovation, symbolized by the word "FinTech," has huge potential to change the structure of financial services. First, FinTech can "globalize" financial services. Mobile phones and smartphones are now spreading rapidly in developing and emerging economies where financial services are not yet widespread. These new devices could substantially promote "Financial Inclusion," by enabling people in those countries to access financial services such as mobile banking. Indeed, the developing and emerging countries in Asia and Africa are keenly interested in FinTech and mobile banking. Second, FinTech can "personalize" financial services. Mobile phones and smartphones are designed as "personalized" tools because they were originally portable phones. By using these devices as new access points for financial services as well as advanced big data analytics, it is becoming easier to provide customized and personalized services to each user. Third, FinTech can "virtualize" financial services. With innovations in information technology, financial services providers can use the Internet, smartphones, cloud computing, and AI as new tools for their activities. Accordingly, tangible fixed infrastructure such as "brick and mortar" branches and ATM networks are no longer prerequisites for providing financial services. New Issues Stemming from Financial Innovation Although there are many upsides of financial innovation, it also raises new issues and challenges for us. First and ironically, new information technologies have made sophisticated cyber-attacks possible. Moreover, with the widespread use of the Internet and smartphones for accessing financial services, financial networks are becoming increasingly "open." Accordingly, it is becoming much more important to take effective measures against cyber-attacks and maintain information security. Second, financial authorities are extracting various information from the balance sheets of licensed financial institutions such as commercial banks. Furthermore, the authorities use regulatory tools, such as capital requirements and liquidity standards, to impose constraints on these balance sheets in order to maintain financial stability. However, these measures may not be very effective for non-bank FinTech firms, especially if they deal only with payment-related services, or if they match the supply and demand of funds without using their own balance sheet in their Peer-to-Peer, or P2P, lending. Thus, financial authorities are facing new challenges in terms of obtaining information and maintaining financial stability. Third, there are debates on whether and to what extent new types of transactions such as high-frequency trading and algorithm trading enabled by recent information technologies tend to increase market volatility. Theoretically, if technological innovation makes transactions more efficient, it could also contribute to market efficiency by increasing liquidity, for example. Nonetheless, in view of the recent developments in various countries, policymakers must develop a deeper understanding of the impact of these new transactions on financial markets. Even though new technologies bring new challenges, it may not be wise to try to stop technological innovation. I believe that policymakers should try to maximize the benefits and minimize the negative sides of technological innovation. In some sense, technological innovation reflects the basic human nature of "intellectual adventure." I believe that human beings are inherently curious and search for better ideas to resolve problems, and that they have a genuine desire to communicate and share such ideas with other people. Thus, I do not think it is easy to suppress such human characteristics. I believe the reason why smartphones have instantly become popular worldwide is that they were originally designed to be "tools for communication," thus satisfying a basic human desire. Moreover, if new information technologies are truly advanced ones, we should be able to utilize them also for enhancing information security and maintaining people's trust in financial transactions. To ensure that people support financial innovation and FinTech, it is also important to improve biometrics authentication and cryptography technologies. Some people argue that humans will eventually have nothing to do if information technologies advance so far and if computers and AI become more capable, but I am skeptical of such a pessimistic view. The invention of the automobile and airplane substantially reduced the demand for horse-drawn coaches and sailing ships. Nonetheless, if we look at society as a whole, those new technologies clearly have enabled human beings to make more use of their abilities. Today, we have this wonderful forum, connecting France and Japan and with many people attending from around the world. Without technological innovation, we could never imagine holding such an event. Furthermore, I think it is very unlikely that financial innovation will take over the roles of humans. To reiterate, finance is a sophisticated bundle of information processing: it creates linkages between various entities such as between lender and borrower, and between payer and payee. Through such activities, finance enables people to allocate their limited resources to projects with higher productivity and growth potential. Thinking about this nature of finance, I believe that financial innovation will create an environment where everyone can share their creativity with others, thus contributing to economic development, as long as innovation really enhances the efficiency of financial services. For example, if FinTech enables people in developing countries to access financial services, it would also help those people to use e-commerce and e-learning. This would increase opportunities for people wanting to raise their living standard and receive education. Moreover, if new information technology and FinTech help channel financial support to new ideas, it will help new businesses incorporating new ideas to develop. Through such activities, financial innovation and FinTech will eventually contribute to economic growth. Initiatives at the Bank of Japan In view of such potential of financial innovation, the Bank of Japan established its "FinTech Center" on April 1, aiming to facilitate the development of FinTech. The Bank has also built up its "FinTech Network" comprising a wide range of staff drawn from the relevant departments of the Bank. This FinTech Network promotes the sharing of information and expertise related to Fintech in a cross-sectoral manner. Meanwhile, private entities are now testing the application of DLT, which is a technology that symbolizes FinTech. In order for central banks to fulfill their responsibilities such as ensuring the stability of payments and settlements, it is becoming increasingly important to have a profound understanding of new technologies including DLT. Accordingly, the staff in the Payment and Settlement Systems Department of the Bank are deepening their understanding of such new technologies by test-driving distributed ledgers. Note that these trials by the Bank's staff simply aim to understand the mechanics of DLT, rather than applying it to the Bank's own liabilities or its payment and settlement systems. The Bank, as the central bank of Japan, is dedicated to supporting the healthy development of FinTech, in order to enhance the welfare of financial service users as well as economic activities. Concluding Remarks In order to make effective use of financial innovation for developing financial markets and stimulating economic activities, it is important to continuously upgrade the basic infrastructure by using new technologies, while maintaining people's trust in financial services and security. In this regard, both France and Japan have continuously adopted many new technologies while maintaining their cultural heritage. Also, these two countries have always tried to harmonize the old and the new. In my view, this attitude in France is symbolized by the Eiffel Tower, which sparked heated debate in the 19th century but now perfectly matches the landscape in Paris, as well as by the glass Pyramid in the center of the Louvre Museum. Above all, it is fascinating to see the two Triumphal Arches of Caroussel and Etoile, which were built in the age of Napoléon, arranged in a straight line toward the very contemporary Grand Arch of Defense. This wonderful scenery reminds me of the fact that financial services, which supported economic development in the modern age, are now experiencing wide-scale innovations with new information technologies and are poised to develop further. As long as France and Japan actively embrace new technologies, I firmly believe that financial innovation will boost the development of the markets and the economies of France and Japan. Thank you for your attention.
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Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the University of Tokyo - Bank of Japan Joint Conference on "FinTech and the Future of Money", Tokyo, 18 November 2016.
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Hiroshi Nakaso: FinTech - its impacts on finance, economies and central banking Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the University of Tokyo - Bank of Japan Joint Conference on "FinTech and the Future of Money", Tokyo, 18 November 2016. * * * Introduction Undoubtedly, we are living in the age of remarkable innovation in information technology. It is fascinating to consider how it might change the future of finance and economies. In order to address these unprecedented and intellectually-challenging issues, close communication between academics and practitioners is essential. Accordingly, today’s conference focusing on the future of money, jointly held by the University of Tokyo and the Bank of Japan, is of great significance. Today’s conference has been made possible due to the close relationship of trust between the Center for Advanced Research in Finance (CARF) of the University of Tokyo and the Bank. I would like to take this opportunity to express our deepest appreciation to Professor Ueda, Director of CARF, Professor Yanagawa and the staff of the CARF for their support in holding this conference. My speech today will focus on this key word of “trust". I. Innovation in information technology and FinTech Information technology and financial service After the rapid economic expansion in the second half of the 20th century, developed countries all over the world are now facing the common challenge of how to raise their growth potential. Looking back at history, many major companies that supported the economic growth of the 20th century, such as those in the iron and steel, automobile and petrochemical industries, were established after 1900. For example, U. S. Steel was established in 1901, Ford in 1903, Royal Dutch Shell in 1907, and GM in 1908, and they quickly grew to lead the economy. This suggests that, when new technologies reach a take-off stage at which they can be used for business, they have the potential to completely and rapidly change the economic landscape far beyond what could have been expected at the infancy stage of innovation. Compared to those manufacturing industries, financial industry has a relatively old history: some banks’ history can trace their history back to the Renaissance period. This is because, infrastructures such as “money” and “ledgers,” which constitute the basis for financial services, have been around far longer than the basic technologies of the recent manufacturing industries such as automobiles. Nonetheless, many people now expect that rapid innovation in information technology will have a substantial impact particularly on financial services. In my view, there are two reasons behind such possible linkages between recent information technology and financial services. First, the financial service industry can be regarded as “information industry,” since financial services such as payment and settlement, investment decisions and risk management are based on wide-ranging information processing. Second, some of recent inventions in information technology such as blockchain and distributed ledger technology (DLT) have the potential to significantly affect “money” and “ledgers,” which are the basic infrastructure for financial activities. Such possible impacts of information technology on money and ledgers raise many interesting issues from the perspective of 1/7 BIS central bankers' speeches economic theory, as illustrated by the theme of today’s conference. Technological backgrounds of FinTech Next, I would like to focus on the context of technological innovations behind “FinTech.” In my view, these innovations can be categorized into three types. The first category includes “blockchain” and DLT, which were invented in 2008 with the concept of “bitcoin." In the second category, there are artificial intelligence, or AI, and big data analytics, which are evolving in line with dramatic increases in computing power. The third type of technological innovation includes the cellphone and smartphone, which have become new means of accessing financial services. Indeed, the appearance of “iPhone” in 2007 triggered new wave of devices for accessing various financial services and influenced business models of the financial industry. These technologies differ in terms of the degree of application to business. Although blockchain and DLT, which were born in 2008, are attracting attention as a flagship technology in FinTech, most of the efforts toward putting the technology into practice are still at the experimental stage. In contrast, many firms are now competing with each other to provide financial services through smartphones and apps. II. Impacts of FinTech on financial services Next, I would like to focus on the possible impacts of FinTech on financial services. Unbundling and restructuring of financial services First of all, FinTech would have the potential to “unbundle” and “restructure” the existing financial services. Most commercial banks take deposits, and engage in both processing payments and making loans. The consequent “fractional-reserve” banking accompanied by “maturity transformation” can be a cause of bank-runs, which sometimes triggered crises in the past. This is why central banks serve as a “lender of last resort (LoLR)” mainly for banks in order to prevent financial crises. On the contrary, non-bank FinTech companies do not take deposits. Some of them focus solely on payment services, while others provide fund intermediation services such as P2P lending without using their own balance sheets. Moreover, many FinTech companies are trying to realize “economies of scope” through combining financial services with other activities related to ecommerce, sharing-economy businesses and big data analytics in order to deliver new addedvalue. "Globalizing” financial services Moreover, FinTech has the potential to “globalize” basic financial services through enhancing “financial inclusion.” Not only in advanced economies but also in developing and emerging economies where financial services are not yet widespread, cellphones and smartphones are now spreading rapidly, and FinTech has opened up the possibility of providing basic financial services through these new instruments. "Personalizing” financial services Furthermore, FinTech may facilitate “personalized” financial services. Cellphones and 2/7 BIS central bankers' speeches smartphones have characteristics of “personalized” tools, and FinTech now makes it possible to analyze individual customers by utilizing big data. By combining such new tools with analytics methodology, FinTech may make it easier for the industry to provide more customized services. Also, new technologies of FinTech can be used to explore the frontiers of financial services through “dynamic” customization. For example, buying insurance policy can impair the policyholders’ incentives to be sufficiently cautious, and such “moral hazard” is an inherent problem of insurance. In this regards, blockchain technology is expected to enable “smart contracts” for various purposes, such as continuously adjusting automobile insurance fees in accordance with driving behavior of each policyholder. As this case illustrates, smart contracts might have the potential to overcome “moral hazard” by leveraging new information technology. "Virtualizing” financial services In accordance with the development of information technology, hard infrastructure such as brick & mortar branches and ATM machines may not be prerequisites for providing financial services. In this regard, I have found similar characteristics between such changes in business models and the recent “Pokémon GO” boom. Game companies used to focus on popularizing the necessary hardware such as DS, X-BOX and PlayStation before releasing game software. In contrast, “Pokémon GO” suddenly became popular worldwide because people can start playing it simply by downloading the app to their own smartphones. It is technically possible to imagine a “virtual bank,” which owns no tangible infrastructure and instead uses the internet, smartphones, cloud computing, AI, and DLT to provide access to financial services, to make investment decisions and to manage risks. New issues Although FinTech has many upsides, it brings new issues regarding payment, settlement and financial stability. First of all, we need to consider whether and how FinTech will change the structure of settlement and other financial services. At the Pittsburgh Summit in 2009, the G20 leaders agreed that all standardized OTC derivatives contracts should be cleared through central counterparties (CCPs). With the introduction of new technologies such as DLT, how might these new “decentralization-oriented” technologies affect the “tiered” settlement structure with centralized bookkeepers? Also, regulatory and supervisory authorities obtain much information through the balance sheets of financial institutions, and many regulatory frameworks such as capital requirement, leverage ratio and liquidity standards impose constraints on these balance sheets in order to achieve and maintain financial stability. In the case of nonbank P2P lending firms, it is difficult to obtain sufficient information regarding financial intermediation from their balance sheets. Moreover, imposing constraints on these balance sheets may not be very effective for influencing their P2P lending activities. Accordingly, financial authorities need to consider how they can obtain the necessary information for maintaining financial stability. Ironically, innovation in information technology has simultaneously brought about various new tactics for cyber threats. In addition, financial networks are becoming increasingly accessible through open gateways such as the internet and smartphones. This makes it more and more important to take appropriate measures against cyber threats in order to ensure the stability of the payment, settlement and financial systems. III. Economic implications of FinTech Next, I would like to examine the possible impacts of FinTech on the economy. 3/7 BIS central bankers' speeches Obviously, finance is a great creation by humans. By using very sophisticated information processing systems bundled as finance, human beings can continuously allocate a finite resource to productive areas with potential. This, in turn, has served as a dynamic driving force for humans’ building of economic society. Therefore, if innovation in information technology and FinTech enhance the efficiency of finance, it will and should eventually contribute to economic development. "Financial inclusion” stimulated by FinTech clearly illustrates the positive feedback between finance and the economy. If people in developing countries gain new access to financial services through FinTech, they will gain opportunities to expand business such as e-commerce and elearning, which are currently hampered by constrained access to payment services. In this manner, FinTech is expected to contribute to economic development. However, in developed countries where basic financial services are already widespread, it would not be easy to quantitatively assess the impacts of FinTech on the economy through existing economic statistics. For instance, if banks, while reducing the cost of maintaining their bricks & mortar branches, improve services through free apps downloaded to each customer’s smartphone, it would not be very certain how existing economic statistics reflect the economic impacts (i.e., the decrease in fixed investments and the improvement of free apps). Also, if FinTech stimulates the development of sharing-economy businesses, how to reflect the consequent increases in utilization rates of various idle assets, such as unused rooms in individual houses and parked cars in front yards, in economic statistics will be another interesting issue. These examples give rise to the challenging issue of how economic statistics can grasp the increases in economic welfare caused by innovations in information technology. Moreover, if FinTech stimulates economic transactions through the internet and smartphones as well as business applications of DLT, it might become increasingly difficult to identify the physical “location” where transactions take place and the relevant ledgers are kept. This could lead to a variety of issues including those related to regulation and taxation. IV. Central banking and FinTech As stated in the theme of today’s conference, FinTech encourages us to think about the future of money and central banking. "Information” and “Trust" Most central banks were born after the establishment of modern nation-states and have been serving as the single issuer of sovereign currency as their liabilities. These historical facts illustrate that central banks inherently have characteristics as “centralized bookkeepers.” In view of such “centralized” attributes of central banks, people are interested in the issue of how the new “decentralization-oriented” technologies such as blockchain and DLT will influence the future of currency and central banking. Such interest is linked to the specific question of: what happens if virtual currencies such as bitcoin reach a significant circulation? Indeed, if virtual currencies such as bitcoin are to be widely used to purchase goods and services directly, there should of course be influences on monetary policy. At present, however, the consensus view in various international forums is that virtual currencies are unlikely to overwhelm sovereign currencies. This issue is deeply related to “trust,” which is indispensable to all financial activities. Needless to say, finance is an activity of creating added value through making links among multiple entities such as “payer” and “payee” or “lender” and “borrower.” Those financial activities always have to be supported by “trust” among such entities. 4/7 BIS central bankers' speeches In order for any asset to be used and accepted as currency, it must have sufficient “trust” among a wide range of users. In this respect, “bitcoin” attempts to create a “chain of trust” from scratch, but this requires substantial costs for the electric power needed to verify transactions called “mining” and to manage encryption keys. Therefore, if we already have an entity with sufficient trust, it is rational and efficient to make that entity issue the currency as the single issuer as its liabilities. Because of this economic rationality, in most countries today central banks issue sovereign currencies in a centralized manner, even though they are newcomers in the history of finance. Co-existence of “Centralized” and “Decentralized” Frameworks Although the information processing capacity of humans is limited, “trust” dramatically enhances the efficiency of information processing. If we cannot trust others, we must always carry hundreds of keys with us and manage them. This would make life very difficult! Finance has supported economic society by enabling advanced information processing through making effective use of “trust,” such as trust in payment instruments and trust in information managed through ledgers. If such “trust” in financial activities is lost, the efficiency of information processing will be severely damaged, causing huge turmoil in financial markets and the economy. Also, if it is necessary to pay huge costs to maintain trust such as by keeping all the ledgers closely and continuously monitored by all the relevant entities in order to ensure they are not altered, then economic and financial activities would be substantially hindered. In a similar vein, if people have to worry about possible fluctuations of the value of the payment instruments received as settlement of past transactions, it becomes difficult for them to allocate their limited resources to forward-looking activities. In this respect, central banks are legally and institutionally destined to maintain the stability of the value of the currency, and by using the central bank currency people can save their limited resources from being ineffectively spent. Also, in the practice of bitcoin transactions, encryption keys have sometimes been entrusted to a third party in a centralized manner, but there have been some incidents such as the failure of Mt. Gox in 2014. In this case, people tried to avoid the cost of managing keys accompanying decentralized-type information processing by entrusting their keys to a third party, Mt. Gox. But their trust was destroyed by the misconduct of the third party. In this regard, the problem of the Mt. Gox case did not stem from DLT itself but was similar to classic cases of misconduct in the financial industry. As this case illustrates, decentralization-oriented technologies will not eliminate centralized frameworks due to the limited information-processing capacity of financial service users. Furthermore, this incident clearly showed that maintaining “trust” is critically important in any financial services, regardless of the types of applied technologies. I believe that it is entirely possible and desirable to realize the co-existence of “trusted centralized systems” and “decentralized systems,” used as and when necessary. We need to make a great effort to design the optimum framework for economic society through utilizing the available technologies. These frameworks should take into consideration the various incentives of economic entities to ensure people’s “trust,” which is indispensable to financial activities. Information technology and central banking The central bank is the only entity that can provide “central bank money” without constraints. Central bank money has “finality” in the sense that people no longer have to worry about “payment unwinding” or “the issuer’s credit risk.” Formerly, the central bank provided central bank money solely through paper-based and printing-related technologies such as banknotes and paper-based ledgers. With the development of the economy, the central bank has adopted newer technologies, improved its own infrastructure and continuously provided advanced infrastructure such as electronic-based wholesale RTGS systems. If the central bank had rejected digital technologies and only provided banknotes as payment instruments with finality, 5/7 BIS central bankers' speeches then economic development would have been substantially constrained. As this fact illustrates, the central bank must appropriately adopt available technologies so as to provide the optimal core infrastructure for economic society. That means the central bank itself must keep abreast of technological innovation. Banknotes are payment instruments with finality and can be used at any time, by any one, and in this regard some have recently argued that the central bank should issue its own digital currency as a substitute for banknotes. Their argument for central bank digital currency seems to be based on the increased awareness of the costs of processing and storing paper-based banknotes, and they ask the central bank to adopt the newest information technology in order to satisfy the needs of the economy. I guess that this issue will be one of the topics discussed in today’s conference. The Bank of Japan has no specific plan at present to issue digital currencies as a substitute for banknotes. Nonetheless, the Bank will make utmost efforts to deeply understand new technologies including blockchain and DLT. The Bank will also continue to conduct various research and analyses of these new technologies, while seeking the possibility of improving its own infrastructure through applying them in future. The issue of central bank digital currency raises diverse topics that are attracting attention from academics. For example, to whom should the central bank provide its account, as technological innovation changes the financial structure and the list of financial service providers? To what extent should the central bank provide “finality” to economic society? How should the information linked to payment transactions be handled? The Bank, in close cooperation with academics, will make its best effort to deepen its understanding of such issues. Conclusion Looking back at the history of human beings, technological progress has fundamentally helped to increase people’s welfare and develop the economy, though it has sometimes been accompanied by negative aspects such as the use of technologies in wars and environmental pollution. Thus, policymakers should strive to maximize the benefits of technological progress while minimizing its negative aspects. Since recent innovations in information technology have the potential to cause impacts particularly on financial services, how to deal with recent financial innovation symbolized by the word “FinTech” will be the key to designing the economic landscape in the 21st century. In dealing with financial innovation and FinTech, there are many new and challenging issues. In order to overcome those issues, we need to cooperate with a wide-range of entities, including private businesses and academics in particular. Today’s conference, co-hosted by CARF of the University of Tokyo and the Bank, clearly illustrates that new information technology is raising many issues for economic theories and central bank practices. I firmly believe that this conference provides an important opportunity for academics, practitioners and central bankers to tackle the new challenges. I sincerely hope that today’s conference will be a fruitful opportunity for all of you. Thank you for your attention. References Brainard, Lael (2016), “The Use of Distributed Ledger Technologies in Payment, Clearing and 6/7 BIS central bankers' speeches Settlement,” Remarks at Institute of International Finance Blockchain Roundtable, April 14, 2016. Broadbent, Ben (2016), “Central banks and digital currencies,” Speech at London School of Economics, March 2, 2016. Carney, Mark (2016), “Enabling the FinTech transformation: Revolution, Restoration, or reformation?” Speech at Lord Mayor’s Banquet for Bankers and Merchants of the City of London at the Mansion House, June 17, 2016. Haldane, Andrew (2015), “How long can you go?” Speech at the Portadown Chamber of Commerce, September 18, 2015. He, Habermeier, Leckow, et al., (2016), “Virtual Currencies and Beyond: Initial Considerations,” IMF Staff Discussion Note, January, 2016. Iwamura, Mitsuru and Kanda, Hideki (1995), “Data-Hogo No Gijutsu To Hou (Law and technology for data protection),” July 1995. Mersch, Yves (2016), “Distributed ledger technology – panacea or flash in the pan?” Speech at Deutsche Bank Transaction Bankers’ Forum, April 25, 2016. Nakamoto, Satoshi (2008), “Bitcoin: A Peer-to-Peer Electronic Cash System” November, 2008. Wilkins, Carolyn (2016), “FinTech and the Financial Ecosystem: Evolution or Revolution?” Remarks at Payments Canada, June 17, 2016. 7/7 BIS central bankers' speeches
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Speech by Mr Makoto Sakurai, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shiga, 1 December 2016.
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December 1, 2016 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Shiga Makoto Sakurai Member of the Policy Board (English translation based on the Japanese original) I. Economic Activity at Home and Abroad: Recent Developments and the Outlook A. Overseas Economies Let me start my speech by talking about developments in overseas economies. The global economy had been on a gradual decelerating trend for the past few years, recording 3.2 percent growth in 2015 on a year-on-year basis from 4.2 percent in 2011. During this period, advanced economies maintained growth of around 1 to 2 percent, whereas emerging economies slowed to a fair extent, from 6.3 percent in 2011 to 4.0 percent in 2015. This suggests that the global economic deceleration was largely attributable to the slowdown in emerging economies. Amid the heightening uncertainty over emerging economies, global financial markets have shown volatile movements since summer 2015, with the depreciation of currencies and the decline in stock prices mainly being seen in emerging economies. Recently, this decelerating trend in the global economy has been staved off. Among advanced economies, the U.S. economy has maintained its stable growth, led mainly by solid consumption. The employment situation -- which underpins consumption -- has been steadily improving, with the unemployment rate declining to around 5 percent, the level close to full employment. While the entering administration's policy management and the Federal Reserve's monetary policy conduct have been attracting much attention, I expect the economy to continue to grow for the time being at a rate of around 1.5 to 2.0 percent on a year-on-year basis -- which is close to its potential growth rate -- in a situation where accommodative financial conditions will be maintained. The European economy has continued to recover moderately, mainly in the household sector. As for the outlook, it is highly likely that this moderate growth will continue under accommodative financial conditions, although uncertainty -- mainly associated with the United Kingdom's vote to leave the European Union (EU) -- is still a drag on the economy. Among emerging economies, the Chinese economy is likely to broadly follow a stable growth path as the government proactively implements both fiscal and monetary policy measures to underpin economic activity, although the pace of growth has somewhat slowed, mainly in manufacturing, during the process of structural reform. So far, commodity-exporting economies have experienced downward pressure from the decline in commodity prices, but they are likely to gradually pick up going forward as commodity prices hit the bottom. Other emerging economies are also expected to gain momentum for growth as the effects of their governments' economic stimulus measures, as well as those of economic recovery in advanced economies, permeate them. According to the October 2016 World Economic Outlook (WEO) released by the International Monetary Fund (IMF), emerging economies are projected to register relatively high growth of 4.2 percent for 2016 and 4.6 percent for 2017 and continue to moderately increase their pace of growth thereafter. Reflecting such recovery in emerging economies, the global economy is projected to grow at 3.1 percent for 2016, 3.4 percent for 2017, and gradually accelerate its pace thereafter. That said, it is difficult to dispel uncertainties currently surrounding the global economy in a short period of time. Regarding the entering U.S. administration, expectations for expansionary fiscal policies and unwinding of financial regulations seem to be heightening in the markets. However, details of the policy measures are still unclear, and therefore their effects should be carefully monitored. Regarding the United Kingdom's vote to leave the EU, due attention should continue to be paid to developments in the negotiations between the United Kingdom and the EU as well as any influences spreading to other EU member states. Other new global concerns include uncertainty in the banking sector in Europe and the increasing protectionist movements across the globe. It is unlikely that geopolitical risks will diminish anytime soon. Although the global economy has been gradually entering a recovery process, considering the high uncertainty at present, the recovery path is not rock solid. B. Japan's Economy Next, I will touch on economic activity in Japan. The economy has continued its moderate recovery trend, although exports and production have been sluggish, due mainly to the effects of the slowdown in overseas economies. The real GDP growth rate, which was 0.6 percent on average during the period from 2013 through 2015, marked 2.1 percent, 0.7 percent, and 2.2 percent, respectively, for the first through the third quarter of 2016 on an annualized quarter-on-quarter basis, registering positive growth for three consecutive quarters for the first time since 2013. These rates may not seem so high compared to those of other countries, but Japan's economy has continued to grow at a pace above its potential, which is estimated to be in the range of 0.0-0.5 percent. As for the outlook, the relatively high growth is expected to continue given the pick-up in overseas economies and the government's large-scale stimulus measures. Let us look at growth components by expenditure item. Net exports have remained more or less at the same level amid the continuing slowdown in overseas economies. Going forward, the growth momentum in net exports is likely to gradually accelerate as overseas economies -- mainly emerging economies -- start to pick up. Growth in private consumption has been slow after the consumption tax hike to 8 percent in 2014 when people in Japan substantially front-loaded purchases, particularly of durable goods, bearing in mind the subsequent raise to 10 percent that had been scheduled in October 2015. Even before then, demand in durable goods had been brought forward by a tax reduction for environmentally friendly cars and the eco-point system for energy-efficient household electrical appliances. Reflecting these factors, the slowdown in demand following the front-loaded consumption seems to be somewhat prolonged. Since summer 2015, amid highly volatile global market movements, private consumption has been pushed down by the weakening of consumer sentiment and the negative wealth effects brought about by the decline in stock prices. As for the outlook, I expect that private consumption will gradually become robust as such negative external factors gradually dissipate, and as the employment and income situation continues to improve, mainly on the back of the government's large-scale stimulus measures. Business fixed investment has continued to increase, albeit moderately, as corporate profits have been at high levels. It is likely to maintain its increasing trend, supported by accommodative financial conditions and heightening of Olympic Games-related demand. Public investment is projected to expand, due mainly to the government's large-scale stimulus measures, and thereafter remain at a relatively high level as Olympic Games-related demand heightens. The stimulative effects of the fiscal measures are expected to be maximized with financial conditions remaining accommodative. The Cabinet Office estimates that the fiscal measures can push up real GDP by about 1.3 percentage points. In the Bank's October 2016 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the real GDP growth rate is projected to continue growing at a pace above its potential, with the medians of the Policy Board members' forecasts at 1.0 percent for fiscal 2016, 1.3 percent for fiscal 2017, and 0.9 percent for fiscal 2018, although there are differing views on this among the members. C. Prices The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food has declined to a level slightly below 0 percent. The effects of the decline in energy prices have continued to make a relatively large negative contribution, and prices for durable goods, such as household electrical appliances, have turned to a decline, reflecting the yen's appreciation since the middle of 2015. The sluggish private consumption has led firms' price-setting behavior to become cautious. Going forward, the effects of the decline in energy prices are likely to dissipate through the beginning of 2017 and those of the yen's appreciation are also expected to gradually wane. If private consumption starts to recover as the economy continues to grow at a pace above its potential and as the employment and income situation improves further, firms are expected to take a more aggressive stance on setting prices. In this situation, the year-on-year rate of change in the CPI is likely to gradually start picking up. According to the medians of the Policy Board members' forecasts in the October 2016 Outlook Report, the CPI for all items less fresh food is projected to see a steady acceleration in its rate of increase from minus 0.1 percent for fiscal 2016 to 1.5 percent for fiscal 2017, and 1.7 percent for fiscal 2018. In the longer run, prices tend to move almost in parallel with nominal wages: firms try to pass on rises in cost, which are due to wage increases, to sales prices and households try to maintain real purchasing power by demanding wage increases in line with price increases. With the growing expectations that wages will be raised continuously amid continued improvement in the employment situation, the underlying rate of increase in the CPI will likely accelerate gradually with such interactive effects between rises in wages and prices. In this sense, I am paying particularly close attention to the labor-management wage negotiations in spring 2017 in forecasting future price developments. II. Monetary Policy: Comprehensive Assessment and New Monetary Policy Framework At the Monetary Policy Meeting held on September 20 and 21, 2016, the Bank decided to introduce Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control as a new framework for strengthening monetary easing. At the meeting, it conducted a comprehensive assessment of the effects of past policy measures and factors that have hampered the achievement of the price stability target. Next, I would like to give an outline of the Comprehensive Assessment and then explain the new policy framework with my own view. A. Comprehensive Assessment The Bank introduced QQE in April 2013. Since then, the employment situation has significantly improved with the unemployment rate having declined to 3 percent, and corporate profits have reached a record-high level with stock prices having risen. As for prices, the year-on-year rate of change in the CPI for all items less fresh food and energy -for which prices tend to fluctuate widely -- turned positive in autumn 2013 and has remained in positive territory for three years. Japan's economy is no longer in deflation, which is commonly defined as a sustained decline in prices. Thus, QQE has served to improve economic activity and price developments. However, the price stability target of 2 percent has not yet been achieved. When the Bank introduced QQE, it had envisioned a main transmission mechanism of the policy effects through which QQE would lower real interest rates by raising inflation expectations and pushing down nominal interest rates. The main factors behind the delay are as follows. First, since the second half of 2014, the observed inflation rate has stalled due to exogenous developments including the decline in crude oil prices, weakness in demand following the consumption tax hike in April 2014, and volatility in financial markets. Second, amid this situation, inflation expectations weakened, reflecting the fact that they have a strong tendency to move in line with the observed inflation rate in Japan. Meanwhile, the Bank's large-scale purchases of Japanese government bonds (JGBs) under QQE, in combination with the negative interest rate policy introduced in January 2016, have been significantly effective in pushing down nominal interest rates across the entire yield curve. Given this experience, the Bank judged that it was possible to control short- and long-term interest rates under the new policy framework. At the same time, there was concern, such as over the possibility that deterioration in the business environment for financial institutions might negatively affect the financial intermediation going forward. This was because, since the introduction of the negative interest rate policy, the declines in banks' lending rates had been significant compared to those in deposit interest rates, which already had little room to fall, and because long- and super-long-term interest rates also had declined significantly. The Bank considered it necessary to take these points into account when introducing the yield curve control. B. New Monetary Policy Framework Based on the Comprehensive Assessment, the Bank decided to introduce QQE with Yield Curve Control as a new framework for strengthening monetary easing. The framework consists of the two components of yield curve control and an inflation-overshooting commitment. Under yield curve control, the Bank controls short- and long-term interest rates through open market operations, such as purchases of JGBs. It sets the short-term policy interest rate applied to part of financial institutions' current accounts at the Bank (the Policy-Rate Balances) and the target level for 10-year JGB yields. In the past, many central banks have conducted monetary policy by controlling short-term interest rates. Controlling the long-term interest rate is a new challenge, but it seems to be functioning smoothly so far. By adding long-term interest rate control to the tools of monetary policy, I think that it has become possible for the Bank to implement monetary easing measures more flexibly, taking account, for example, of the effects on the financial intermediation, and that the sustainability of these measures has been enhanced. Under the inflation-overshooting commitment, the Bank commits itself to continuing to expand the monetary base until the year-on-year rate of increase in the observed CPI for all items less fresh food exceeds the price stability target of 2 percent and stays above the target in a stable manner. In general, central banks have conducted monetary policy in a forward-looking manner, given that the effects of monetary policy spread to the economy with a certain time lag. In this regard, the Bank's new framework, which is linked to the observed CPI, is an extremely strong commitment. Through this commitment, the Bank aims to enhance the credibility of achieving the price stability target among the public, and to raise inflation expectations. In this manner, the new policy framework consists of measures that could be regarded as extraordinary for a central bank, including control of the long-term interest rate and commitment linked to the observed CPI. The Bank has considered such flexible and decisive policy conduct as necessary in order to dispel people's deflationary mindset that has taken hold due to deflation that has lasted for a long period, and to push up the inflation rate amid a variety of exogenous factors. With this framework, the Bank has shifted the operating target for its monetary policy from the quantitative to the interest rate aspect. However, needless to say, these are two sides of the same coin. Under QQE with Yield Curve Control, the Bank will continue with its large-scale purchases of JGBs in order to control interest rates. On this point, I would like to reiterate that there is no change in the Bank's stance that it will continue with monetary easing from both the quantitative and interest rate aspects. III. Challenges Facing Japan's Economy and Monetary Policy Next, I would like to elaborate on my own thinking regarding challenges facing Japan's economy and the Bank's monetary policy conduct from a somewhat long-term perspective. Over many years, the economy continued to see low growth under a moderate decline in prices. In January 2013, the government and the Bank released a joint statement, and they have worked together since then to achieve sustainable economic growth with price stability. The economy is no longer in deflation, which is commonly defined as a sustained decline in prices, but the price stability target of 2 percent has not yet been achieved. Although the economy has been on a moderate recovery trend, it has not yet fully succeeded in achieving sustainable growth as the potential growth rate has remained at a low level. Under these circumstances, firms and households seem to be conducting their economic activities on the assumption that prices and the economic growth rate will not rise so much going forward. Firms have maintained their cautious stance toward expanding their fixed costs, because they have not been confident regarding whether sales will increase steadily in the future. Growth in business fixed investment and wages -- particularly in base pay, which leads to a permanent increase in wages -- has been slow relative to the improvement in corporate profits and the employment situation. Households have also been cautious in increasing their spending, despite the rise in their incomes, as they see that it seems impossible to project a permanent expansion in income and/or a rise in prices. I view this current situation as a sort of equilibrium. In general, a virtuous cycle from income to spending among firms and households promotes sustainable economic growth and price stability. An increase in business fixed investment raises the potential growth rate through accumulation of capital and improvement in labor productivity. Wage growth exerts upward pressure on prices mainly through expansion of firms' costs, as I have mentioned earlier, and an increase in household spending brings about improvement in the output gap, also leading to price rises. Currently, however, it seems that the expectations for low inflation and low economic growth that have taken hold among firms and households have been hampering the operation of such a virtuous cycle, thereby constraining the economic growth rate and price rises in a self-fulfilling manner. What then, is required to get out of such equilibrium? My answer is that it is not a magical wand, but instead strenuous efforts to be made by a wide range of entities. I think that it is all the more important that the Bank, for its part, pursue price stability through pushing up inflation expectations and maintaining accommodative financial conditions under the new monetary policy framework. At the same time, the government and the private sector should play key roles with regard to moving forward. Their actions toward raising wages strongly support the achievement of price stability. Moreover, in order to achieve sustainable economic growth, I think that efforts such as the following are also essential; namely, the government's promotion of a growth strategy and structural reforms, and the private sector's innovations in areas including human resource development as well as research and development. The Bank will underpin these initiatives by maintaining accommodative financial conditions, thereby contributing to strengthening Japan's growth potential in the long term. Also, I expect that the Bank's measures such as purchases of exchange-traded funds (ETFs) composed of stocks issued by firms that are proactively making investment in physical and human capital, as well as loan disbursement under the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth, will assist initiatives by the private sector. If the outlook for prices and economic growth in Japan brightens, the effects of monetary easing will heighten through a decline in real interest rates and a rise in the natural interest rate. I expect that the endeavors that the government, the private sector, and the Bank are making together as one will bear fruit, and the virtuous cycle of the economy will start to operate vigorously on the new outlook for sustainable economic growth with price stability.
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Statement by Mr Haruhiko Kuroda, Governor of the Bank of Japan, before the Committee on Financial Affairs, House of Councillors, Tokyo, 22 November 2016.
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Haruhiko Kuroda: The Bank'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 Councillors, Tokyo, 22 November 2016. * * * Introduction The Bank of Japan submits to the Diet its Semiannual Report on Currency and Monetary Control in June and December. I am pleased to have this opportunity today to talk about 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 At the Monetary Policy Meeting (MPM) held on November 1, the Bank released the Outlook for Economic Activity and Prices (Outlook Report), which presents its projections for Japan’s economic activity and prices through fiscal 2018. Based on this, I will first explain economic and financial developments in Japan. Japan’s economy has continued its moderate recovery trend, although exports and production have been sluggish due mainly to the effects of the slowdown in emerging economies. With regard to the outlook, it is likely to continue growing at a pace above its potential through the projection period — that is, through fiscal 2018 — with a virtuous cycle from income to spending being maintained in both the corporate and household sectors, on the back of highly accommodative financial conditions and the effects of the government’s large-scale stimulus measures, as well as the recovery in overseas economies. On the price front, the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) has been slightly negative due to the effects of the decline in energy prices. As for the outlook, it is likely to be slightly negative or about 0 percent for the time being, and as the aggregate supply and demand balance (the output gap) improves and medium- to long-term inflation expectations rise, it is expected to increase toward 2 percent — the price stability target — in the second half of the projection period. The timing of the year-on-year rate of change in the CPI reaching around 2 percent will likely be at the end of the projection period — that is, around fiscal 2018. Thus, the momentum toward achieving the price stability target of 2 percent seems to be maintained. However, it is somewhat weaker than the previous outlook made in the July Outlook Report, and thus developments in prices warrant careful attention going forward. II. Conduct of Monetary Policy At the September 2016 MPM, the Bank conducted a comprehensive assessment of the developments in economic activity and prices, as well as of the policy effects since the introduction of quantitative and qualitative monetary easing (QQE). Based on its findings, with a view to achieving the price stability target of 2 percent at the earliest possible time, the Bank introduced “QQE with Yield Curve Control,” which is a new framework for strengthening monetary easing. This framework consists of two major components. The first is “yield curve control.” QQE, which was introduced in April 2013, has brought about improvements in economic activity and prices mainly through the decline in real interest rates, and Japan’s economy is no longer in deflation, which is commonly defined as a sustained decline in prices. With “yield curve control,” the Bank seeks to bring about such a decline in real interest rates by controlling short-term and long-term interest rates. It will work toward the 1/2 BIS central bankers' speeches formation of the most appropriate yield curve with a view to maintaining the momentum toward achieving the price stability target of 2 percent, while taking account of developments in economic activity and prices as well as financial conditions. Specifically, in the guideline for market operations — which is decided at and released after every MPM — the Bank will set two interest rate levels: the short-term policy interest rate to be applied to current accounts held by financial institutions at the Bank, and the target level of yields on 10-year Japanese government bonds (JGBs). It will conduct JGB purchases aiming to achieve the target level of the long-term interest rate specified by the guideline, while indicating the approximate amount of JGBs to be purchased. The second is an “inflation-overshooting commitment.” In order to achieve the price stability target of 2 percent, it is necessary to drastically convert the deflationary mindset among people and raise inflation expectations. On this point, inflation expectation formation in Japan is still largely adaptive, and thus tends to be strongly affected by the observed inflation rate. Against this backdrop, the Bank introduced a very powerful commitment to “continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds the price stability target of 2 percent and stays above the target in a stable manner.” By presenting its strong determination to achieve the price stability target, the Bank aims to enhance the credibility of achieving 2 percent among the public and to raise inflation expectations in a more forceful manner. At the MPM held on November 1, the Bank decided to maintain the guideline for market operations in which the short-term policy interest rate is set at minus 0.1 percent and the target level of 10-year JGB yields is set at around zero percent. It will make policy adjustments as appropriate, taking account of developments in economic activity and prices as well as financial conditions, with a view to maintaining the momentum toward achieving the price stability target. Thank you. 2/2 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, Nagasaki, 7 December 2016.
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December 7, 2016 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Nagasaki Kikuo Iwata Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Nagasaki Prefecture. 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 Nagasaki Branch. Today, I would like to have your views on the actual situation of the local economy, as well as your candid opinions about the Bank's policies and activities. Before exchanging views with you, I will briefly explain the recent economic developments at home and abroad, and then touch on some points regarding monetary policy. I. The Current Situation of Economic Activity and Its Outlook To begin with, Japan's economy is likely to expand moderately, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors, on the back of highly accommodative financial conditions and the effects of the government's large-scale stimulus measures, as well as the recovery in overseas economies (Chart 1). Real GDP is likely to continue growing at a pace above the potential growth rate through the projection period -- that is, through fiscal 2018 -- at around 1 percent. With regard to the outlook for prices, the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is likely to be slightly negative or about 0 percent for the time being mainly due to the effects of the decline in energy prices. As the output gap improves -- as will likely be seen in a further decline in the unemployment rate -- and medium- to long-term inflation expectations rise thereafter, the rate of change is expected to increase toward 2 percent in the second half of the projection period. In what follows, I would like to explain the background to this outlook and the issues that warrant attention going forward. A. Developments in Exports and Overseas Economies Overseas economies have continued to grow at a moderate pace, particularly in advanced economies such as the United States, but the pace of growth in emerging economies has decelerated somewhat. In terms of the outlook, overseas economies are expected to see a gradual increase in their growth rates, as it is likely that advanced economies will continue to realize steady growth and emerging economies will be positively influenced by the developments in advanced economies and emerging economies' policy effects (Chart 2). In this situation, exports are projected to remain more or less flat for the time being, due to downward pressure exerted by the slowdown in overseas economies and the past appreciation of the yen, but to moderately increase from the turn of fiscal 2017 as the effects of the slowdown in overseas economies and the appreciation of the yen are expected to gradually wane. With regard to the economic policies to be implemented under the new administration in the United States, market participants seem to view that the U.S. economy will be boosted by proactive fiscal management. The U.S. economic measures exert great influence not only within the economy but also on the global economy and global financial markets; therefore, the new administration's policy directions and their influence warrant close attention. In assessing overseas economic developments, it is necessary to closely monitor developments in emerging and commodity-exporting economies, particularly China, as well as the consequences stemming from the United Kingdom's vote to leave the European Union (EU) and their effects. B. Developments in the Corporate Sector Profits for all industries and company sizes have been at a level close to the record high, although those of large manufacturing firms have been negatively affected by the slowdown in overseas economies and the yen's appreciation (Chart 3). In this situation, business sentiment has generally been favorable, and business fixed investment has been on a moderate increasing trend. According to the September 2016 Tankan (Short-Term Economic Survey of Enterprises in Japan), firmness has continued to be seen in business fixed investment plans for fiscal 2016 as a whole, including those of large manufacturers, for which profit projections have deteriorated as the expected exchange rate has shifted toward appreciation of the yen. As the background to these developments, we can point to anticipation of firms undertaking fixed investment from a relatively longer perspective, such as that (1) for growth areas, in view of the 2020 Tokyo Olympics, and (2) in labor-saving machinery and equipment in order to deal with labor shortages. C. Developments in the Household Sector Next, I would like to turn to developments in the household sector. Supply-demand conditions in the labor market have improved steadily and employee income has increased moderately (Chart 4). A perception of labor shortage suggested by the diffusion index for employment conditions in the September Tankan has heightened, showing a tightening at almost the same levels seen around 1991-1992. The unemployment rate has been about 3 percent, which is close to virtually "full employment." Wages have been rising moderately, albeit with fluctuations, on the back of the tightening of labor market conditions. The year-on-year rate of change in hourly cash earnings of part-time employees, which are responsive to labor market conditions, has seen a relatively high increase, being in the range of around 1.5-2.0 percent. Summer bonuses of full-time employees also have increased clearly, mainly in nonmanufacturing firms. Private consumption has been more or less flat recently, despite being affected by bad weather conditions such as typhoons (Chart 5). Confidence indicators related to private consumption have been picking up, and such consumption is expected to increase moderately on the back of the continued steady improvement in the employment and income situation. D. Price Developments Next, I would like to touch on price developments. The year-on-year rate of change in the CPI for all items less fresh food has been slightly negative due to the effects of the decline in energy prices. This is largely attributable to the decline in energy prices, as that for all items less fresh food and energy has remained positive for three years (Chart 6). However, the rate of increase in the CPI for all items less fresh food and energy has slowed recently. This is mainly because firms have become cautious about raising prices compared to 2015, reflecting the effects of the yen's appreciation since the middle of 2015 and weakness in private consumption in the first half of 2016. The year-on-year rate of change in the CPI for all items less fresh food is likely to be slightly negative or about 0 percent for the time being, and gradually increase toward 2 percent. The following three points can be highlighted as the background to this outlook. The first point is that the negative contribution of the decline in energy prices to the annual CPI inflation rate for all items less fresh food is expected to dissipate and almost no effects of this are projected to be seen in early 2017. The second point is that firms' price-setting stance is expected to revert to raising prices as private consumption heads toward a moderate recovery. The third point is that upward pressure on wages is expected to rise further as labor market conditions tighten. Inflation expectations are likely to increase again if the observed inflation rates rise with these factors. That being said, a wage increase is extremely important with a view to realizing an environment in which prices follow a rising trend. The Bank -- in pursuing monetary easing to achieve its price stability target of 2 percent -- aims to realize a virtuous cycle in which prices rise moderately accompanied by increases in corporate profits, employment, and wages. In fact, when we take a look at the relationship between prices and nominal wages, there is a stable relationship between the CPI and hourly cash earnings, in that they generally move in parallel from a longer-term perspective. In the United States and Europe, it is often the case that negotiated wages apply for several years, and central banks' price stability targets are thereby the crucial factor that determines wages. In Japan, on the other hand, base pay increase is determined considering the actual price developments, particularly the observed CPI in the previous year (Chart 7). In order to achieve the price stability target of 2 percent in a stable manner, it is important that people share the view that annual inflation will be around 2 percent, and that the price-setting and the annual labor-management wage negotiations are conducted based on such view. II. Thinking behind the Conduct of Monetary Policy Let me now turn to the Bank's conduct of monetary policy. Since the introduction of quantitative and qualitative monetary easing (QQE) in April 2013, Japan's economic activity and prices have improved significantly, and the economy is no longer in deflation. There is no room for doubt that this policy was effective in overcoming deflation. However, it is true that the price stability target of 2 percent has not been achieved yet, unfortunately, despite the unprecedented large-scale monetary easing. Based on such recognition, the Bank, at the September Monetary Policy Meeting (MPM), conducted a comprehensive assessment of developments in economic activity and prices as well as policy effects over the three years since the introduction of QQE, and, based on its findings, decided to introduce "QQE with Yield Curve Control," which is a new framework for strengthening monetary easing. In what follows, I will elaborate on this point. A. Comprehensive Assessment Although the content of the Bank's "Comprehensive Assessment" is wide-ranging, I will now touch on three points that I consider to be particularly important. The first point is the effects of QQE. In more than three years since its introduction, Japan's economic activity and prices have improved significantly, and the economy is no longer in deflation, which is generally defined as a sustained decline in prices. Corporate profits have been at record high levels, and the labor market is in a state that is close to virtually "full employment," as evidenced by the fact that the unemployment rate has declined to 3 percent. Against the backdrop of such tightening of labor market conditions, wages have been increasing moderately. Base pay increases, which had not taken place for many years under deflation, were achieved for three consecutive years. In the financial markets, excessive yen appreciation was corrected and stock prices have risen significantly. It is certain that the Bank's monetary easing has played a large role in economic recovery. In order to achieve the price stability target of 2 percent in a stable manner, it is necessary to drastically change people's deflationary mindset and raise their inflation expectations -- that is, people's perception of future price developments -- to 2 percent. On this point, QQE has been effective in raising such expectations. As mentioned in the Bank's "Comprehensive Assessment," inflation expectations rose significantly through summer 2014, after the introduction of QQE in April 2013. Furthermore, the expansion of QQE in October 2014 played a role in supporting inflation expectations (Chart 8). These facts indicate that, under QQE, the expansion of the monetary base in combination with the commitment to achieving the price stability target have affected people's perception of prices by bringing about a regime change in monetary policy, and have contributed to raising inflation expectations. Second, the main reason for not being able to achieve the price stability target of 2 percent despite such a positive turnaround in economic and price developments is that inflation expectations, which had increased significantly due to a regime change in monetary policy, weakened again. After the introduction of QQE, the year-on-year rate of change in the CPI reached 1.5 percent in April 2014 and inflation expectations increased steadily. Thereafter, however, mainly reflecting weak aggregate demand following the consumption tax hike, a decline in crude oil prices, and the global economic slowdown as well as turmoil in global financial markets, inflation expectations started to decline after having been flat for a while, with the observed inflation rate decreasing. The mechanism of formation of inflation expectations in Japan has tended to be largely adaptive after the prolonged deflation, in that such expectations are influenced by the course of the past inflation rate. Going forward, in order to achieve the price stability target of 2 percent, inflation expectations need to be raised once again by adopting more powerful measures. Third, it was made clear that, with a combination of large-scale purchases of Japanese government bonds (JGBs) and a negative interest rate, central banks can exert strong downward pressure on the entire yield curve. What used to be regarded as the most effective monetary policy measure after the short-term policy interest rate facing the zero lower bound was the central banks' large-scale purchases of government bonds that directly influence long-term interest rates. Based on this recognition, the Bank has been conducting JGB purchases as the main easing measure under QQE. Thereafter, the European Central Bank (ECB) introduced the negative interest rate policy in 2014, and other central banks such as those in Switzerland and Sweden followed suit. This policy seeks the possibility of monetary policy that can lead to overcoming the zero lower bound. After analyzing the experiences of these European economies, the Bank introduced "QQE with a Negative Interest Rate" in January 2016. The experience since then proves that the combination of a negative interest rate and purchases of government bonds is effective in influencing the entire yield curve. Meanwhile, declines in long- and short-term interest rates to unprecedented levels revealed related side effects. One is the effects on the profits of financial institutions. A decline in lending rates accompanying monetary easing has been brought about by reducing financial institutions' lending margins. The other is that an excessive decline in interest rates -especially at the long and super-long end -- will likely lower the rates of return on pension and insurance products, leading to uncertainty regarding the sustainability of financial functioning in a broader sense, thereby exerting a negative impact on economic activity and inflation expectations through a deterioration in people's sentiment. Against this background, with a view to pursuing monetary easing, it is necessary for the Bank to facilitate the formation of a yield curve, which is deemed most appropriate for achieving the price stability target of 2 percent, taking account of developments in economic activity and prices as well as financial conditions. B. QQE with Yield Curve Control In light of these findings of the comprehensive assessment, the Bank introduced "QQE with Yield Curve Control." This new policy framework consists of two components. The first is an "inflation-overshooting commitment." As I mentioned earlier, inflation expectations increased significantly after the introduction of QQE but have remained in a weakening phase since last summer amid the headwinds of various developments in domestic and overseas economies. In order to achieve the price stability target of 2 percent, inflation expectations need to be raised through more powerful means. As described earlier, the comprehensive assessment suggested that the combination of an expansion of the monetary base and a strong commitment is effective in raising inflation expectations. In light of this finding, the Bank decided to introduce a more powerful commitment that it will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI exceeds 2 percent and stays above that level in a stable manner. Achieving the price stability target of 2 percent means attaining a situation in which the observed CPI is 2 percent on average over the business cycle. Thus, it naturally is assumed from the outset that there will be phases when the observed CPI overshoots 2 percent. However, given that there is a time lag before monetary policy takes effect, it is an exceptional and very strong commitment by a central bank to continue with monetary easing until the observed inflation rate exceeds 2 percent and stays above that level in a stable manner. The Bank believes that such a clear commitment to expanding the monetary base going forward can work on people's perception of prices to a more powerful degree. The second component is yield curve control. The Bank will facilitate the formation of a yield curve, which is deemed most appropriate for achieving the price stability target of 2 percent. Specifically, in the guideline for market operations, which is decided at every MPM, the Bank sets the short-term policy interest rate and the target level of the 10-year JGB yields. At present, the former is at minus 0.1 percent and the latter is around 0 percent. The Bank conducts JGB purchases, aiming to achieve the target level of the long-term interest rate specified by the guideline, while providing the approximate annual pace of increase in the amount outstanding of its JGB holdings. Currently, the approximate amount is about 80 trillion yen. On this point, I would like to emphasize that the Bank will continue expanding the monetary base in the future under the new policy framework. The control of long-term interest rates under yield curve control is achieved through large-scale JGB purchases by the Bank. Moreover, with the inflation-overshooting commitment, the Bank commits itself to continuing to expand the monetary base until the year-on-year rate of increase in the observed CPI exceeds 2 percent and stays above that level in a stable manner. Some argue that the Bank's policy focus has shifted from quantity to interest rates under the new policy framework, but such an understanding is inappropriate. Since the introduction of QQE, the Bank has been consistently pursuing powerful monetary easing both in terms of quantity and interest rates, and there is no change in its stance. The Bank will continue with powerful monetary easing under "QQE with Yield Curve Control," aiming to achieve the price stability target of 2 percent at the earliest possible time. Taking account of developments in economic activity and prices as well as financial conditions, it will take additional easing measures without hesitation if judged necessary to maintain the momentum toward achieving the 2 percent target. Concluding Remarks In conclusion, let me touch on the economy of Nagasaki Prefecture. Tracing its history, the prefecture has functioned for a long time as a foothold for cultural interaction between many countries, as evidenced by the history of Dejima, and thus represents a variegated history and culture. The prefecture takes advantage of the tradition of manufacturing, particularly of heavy industry including shipbuilding, and distinguished skill and technique. It also is endowed with tourist attractions including islands, hot springs, and fresh agricultural and fishery products, as well as a fascinating food culture. The shipbuilding industry, which is the key industry of the prefecture, is facing a severe environment surrounding orders, brought about by chronic excess of vessels globally and by sluggishness in the shipping market. There seems to be no influence on business operations for the time being as there is a backlog of orders for the upcoming three years or so, but I have heard that the local companies, including those engaged in shipbuilding, have started to take actions so as to change their business operations. In terms of tourism, the effects of the Kumamoto Earthquake have waned from summer, and I have heard that the number of visitors to major tourist facilities have picked up. Moreover, efforts have been made steadily toward future developments of the prefecture, such as the proposal of "Churches and Christian Sites in Nagasaki" for inscription on the UNESCO World Heritage List, Nagasaki City being chosen as a "tourism nation showcase" by the Japan Tourism Agency, and initiatives to establish Destination Management/Marketing Organizations for sightseeing. On the financial front, changes in the business environment -- such as consideration on integrating regional financial institutions -- have emerged under the idea to contribute to stimulating the region and vitalizing the local economy amid the situation of a declining and aging population. As for economic and financial communities of Nagasaki Prefecture, I believe that forthcoming changes must be addressed appropriately and strategically while gaining a strong footing. The Bank anticipates that determined efforts will be made in the prefecture, and would like to provide as much support as possible going forward as the central bank. Thank you. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Nagasaki December 7, 2016 Kikuo Iwata Deputy Governor of the Bank of Japan Chart 1 Outlook for Economic Activity and Prices (as of October 2016) y/y % chg. Real GDP CPI (all items less fresh food) Fiscal 2016 ＋1.0 －0.1 Forecasts made in July 2016 ＋1.0 ＋0.1 Fiscal 2017 ＋1.3 ＋1.5 Forecasts made in July 2016 ＋1.3 ＋1.7 Fiscal 2018 ＋0.9 ＋1.7 Forecasts made in July 2016 ＋0.9 ＋1.9 Note: Figures indicate the median of the Policy Board members’ forecasts (point estimates). Source: Bank of Japan. Chart 2 World Economic Outlook Released by the IMF Real GDP Growth Rate Projections for Major Economies (as of October 2016) y/y % chg. 3.4 3.2 1.9 2.1 United States 2.4 2.6 Euro Area 1.1 2.0 Japan 0.0 0.5 4.6 4.0 China 7.3 6.9 ASEAN5 4.6 4.8 World Advanced Economies Emerging Market and Developing Economies Projections 3.1 (0.0) 1.6 (-0.2) 1.6 (-0.6) 1.7 (0.1) 0.5 (0.2) 4.2 (0.1) 6.6 (0.0) 4.8 (0.0) 3.4 (0.0) 1.8 (0.0) 2.2 (-0.3) 1.5 (0.1) 0.6 (0.5) 4.6 (0.0) 6.2 (0.0) 5.1 (0.0) y/y % chg. 2004-2007 average: +5.3% +3.4 +3.1 1990-2003 average: +3.3% IMF forecast (Oct. 2016) -1 CY 90 92 94 96 98 00 02 04 06 08 10 12 14 16 17 Notes: 1. ASEAN5 are Indonesia, Malaysia, the Philippines, Thailand, and Viet Nam. Notes: 2. Figures in parentheses are the differences from the July 2016 WEO projections. Source: IMF. Chart 3 Current Profits s.a., tril. yen All industries Manufacturing -5 CY05 Nonmanufacturing Note: Figures for current profits exclude "Finance and Insurance." Source: Ministry of Finance. Chart 4 Employment and Income Situation Unemployment Rate and Job Openings-to-Applicants Ratio s.a., % s.a., times Unemployment rate (left scale) Active job openings-to-applicants ratio (right scale) Employee Income 1.5 y/y % chg. 1.2 0.9 -2 -4 Number of employees 0.6 Total cash earnings -6 Employee income CY 05 13 14 15 16 0.3 -8 CY 05 Notes: 1. Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Figures for 2016/Q3 are September-October averages. Notes: 2. Figures for "employee income" are calculated as the "number of employees" (Labour Force Survey) times "total cash earnings" (Monthly Labour Survey). Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Chart 5 Private Consumption s.a., CY 2010=100 Consumption Activity Index (adjusting travel balance, real) Consumption of households excluding imputed rent (SNA, real) CY 07 Note: Figures for the Consumption Activity Index exclude inbound tourism consumption and include outbound tourism consumption. Sources: Cabinet Office; Bank of Japan; Ministry of Economy, Trade and Industry; Ministry of Internal Affairs and Communications, etc. Chart 6 Consumer Prices y/y % chg. CPI (all items less fresh food and energy) CPI (all items less fresh food) -1 -2 -3 CY 07 Note: Figures for the CPI (all items less fresh food and energy) are calculated by the Research and Statistics Department, Bank of Japan. Figures for the CPI are adjusted to exclude the estimated effects of changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 7 Inflation Expectations and Wages Japan United States y/y % chg. Base pay increase Medium- to long-term inflation expectations y/y % chg. CPI (all items) -1 -1 Base pay increase -2 -2 Medium- to long-term inflation expectations -3 CY 95 15 16 -3 CY 95 CPI (all items) Notes: 1. Figures for the CPI in Japan are adjusted to exclude the estimated effects of changes in the consumption tax rate. 2. Figures for the medium- to long-term inflation expectations are the expectations for the CPI 6 to 10 years ahead and are based on the "Consensus Forecasts." Sources: Central Labour Relations Commission; Japanese Trade Union Confederation (Rengo); Ministry of Internal Affairs and Communications; BLS; Consensus Economics Inc., "Consensus Forecasts." 15 16 Chart 8 Inflation Expectations after the Introduction of QQE 2.0 y/y % chg. 1.8 1.6 Beginning of a Introduction of Consumption downtrend in QQE tax hike crude oil prices Synthetic indicator of firms', households', and economists' inflation expectations ▼▼ ▼ Destabilization of financial markets amid concern about emerging economies ▼ 1.4 1.2 1.0 0.8 0.6 0.4 0.2 CY 07 Notes: 1. Inflation expectations of firms, households, and economists are represented by the Tankan, the "Opinion Survey," and the "Consensus Forecasts," respectively. Notes: 2. Semiannual data from the "Consensus Forecasts" up through 2014/Q2 are linearly interpolated. "Opinion Survey" figures exclude inflation expectations by respondents whose annual inflation expectations were +5% percent or greater and -5% percent or smaller. The output prices DI in the Tankan represents the difference between the share of firms that raised prices in the preceding three months and the share of firms that lowered prices. Sources: Consensus Economics Inc., "Consensus Forecasts"; Bank of Japan.
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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, 26 December 2016.
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December 26, 2016 Bank of Japan A New Phase of the Global Economy and Challenges Facing Japan's Economy Speech at the Meeting of Councillors of Nippon Keidanren (Japan Business Federation) in Tokyo Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is a great honor to have this opportunity to address such a distinguished gathering of business leaders in Japan today. 2017 is now just a week away. Today, to round off 2016, I would like to take a look back at this year's economic developments. Then, from a somewhat longer-term perspective, I would like to talk about the current phase of the global economy, and close my speech by touching on challenges facing Japan's economy, looking ahead to next year. I. The Global Economy in 2016 Reviewing 2016, it started off with volatile global financial markets. Specifically, Shanghai stock prices declined significantly at the beginning of the year, reflecting uncertainties regarding developments in the renminbi, and this led to a rapid worsening of investors' risk sentiment. These developments in emerging economies brought about declines in stock prices and long-term interest rates in major advanced economies. At the Group of Twenty (G-20) Finance Ministers and Central Bank Governors Meeting held in Shanghai in late February, the member countries agreed to cooperate in addressing volatility in financial markets and the heightening of uncertainties in the global economy. Due in part to this, global financial markets had stabilized temporarily. However, a "risk-off" mode in global financial markets continued thereafter through autumn, partly reflecting the United Kingdom's referendum in late June, in which the majority voted to leave the European Union (EU). On the growth and inflation front, the trend decline in the growth rate -- the so-called secular stagnation hypothesis -- and the global decline in inflation rate have been hotly debated. Many of you may have an impression that 2016 was a year in which pessimistic views on the global economy prevailed. However, actual data indicate that the global economy is not as bad as it appears. The pace of growth in advanced economies has accelerated recently, mainly led by the solid U.S. economy (Chart 1). There are increasing expectations of acceleration in the U.S. economy's growth rate going forward, reflecting the outcome of the presidential election. In fact, various economic indicators actually continued to improve steadily even before the election. In emerging and commodity-exporting economies, the growth momentum is picking up, albeit moderately, due in part to the effects of their policy measures. The global economy as a whole appears to be turning upward. Let me remind you of the fact that the International Monetary Fund (IMF), for the first time in a while, did not make downward revisions in its World Economic Outlook (WEO) in October, and that the Organisation for Economic Co-operation and Development (OECD) revised upward its Economic Outlook released last month (Chart 2). From a somewhat longer-term perspective, the global economy seems to have finally moved out of its adjustment phase after the global financial crisis, often dubbed the Lehman shock, and is entering a new phase. In what follows, I will touch on changes underway in the global economy while looking back at developments after the global financial crisis. II. The Global Economy after the Global Financial Crisis After the global financial crisis started in autumn 2008, the growth rate of the global economy significantly decelerated. A salient feature of this recession was the deceleration in growth of the world trade volume, the slowdown in the manufacturing sector, and the decline in business fixed investment. For example, the recent growth in the world trade volume, calculated by summing up the import volumes of the world's countries, has been well below the average growth rate before the global financial crisis (Chart 3). Since the global financial crisis, the level of the world trade volume also has deviated substantially downward from the trend suggested by the globally-aggregated real GDP. This deceleration in growth of the world trade volume is called "slow trade," which well characterizes the global economy after the global financial crisis. Economists and policymakers including the Bank's staff are conducting various analyses on factors behind the slow trade. Although there is no consensus at present, structural factors such as the pause in the expansion of the global supply chain and the progress of internalization in China seem to have played an important role, in addition to a cyclical decline in demand. The breakdown by region and item shows that the decline was conspicuous in emerging economies and capital goods. The downward deviation from the trend in real imports was larger in emerging economies than in advanced economies (Chart 4). Looking at the global real imports by item, the decline in the imports of capital goods is significant. These facts suggest that the deceleration in growth of the world trade volume was largely driven by the sluggish demand in business fixed investment, mainly in emerging economies. The continued decline in global demand for capital goods has had a significant negative impact on the manufacturing sector in Japan, which has a comparative advantage in capital goods. With the slow trade continuing, advanced economies' exports to emerging economies have been sluggish, leading to lower production activities in the manufacturing sector. As the manufacturing sector tends to play a significant role in leading the business cycle in many economies, its slowdown has weighed on the recovery in advanced economies. In this situation, the recovery during the past few years in these economies -- the United States and Europe in particular -- has been led largely by an acceleration in household expenditures amid a lack of momentum in corporate expenditures (Chart 5). Fortunately, there have been signs of improvement recently. Having been weak since 2015, the purchasing managers' index (PMI) -- which represents the overall business conditions in the manufacturing sector -- has improved clearly of late in the advanced economies as well as the emerging and commodity-exporting economies (Chart 6). Looking at imports in emerging economies, those in the Chinese and the ASEAN economies bottomed out and then picked up. Given that the weakness in emerging economies' imports had accounted for the major part of the slow trade, the ongoing recovery in their imports is likely to have a positive impact on a wide range of advanced economies' manufacturing sectors. On the macroeconomic policy front, aggressive monetary easing was introduced mainly in advanced economies by employing so-called unconventional measures such as quantitative easing (QE) -- or large-scale purchases of assets including government bonds -- and the negative interest rate policy. With regard to fiscal policy, the G-20 countries provided strong fiscal stimulus in a coordinated manner immediately after the start of the global financial crisis. Thereafter, some countries -- those in Europe in particular -- conducted fiscal policies in a neutral or somewhat contracting manner for a while. This year, with the heightening of global uncertainties, the G-20 and the IMF agreed to take a three-pronged approach that uses all policy tools -- monetary, fiscal, and structural -- individually and collectively, with a view to achieving strong, sustainable, balanced, and inclusive growth. In fact, the authorities in each economy have been supporting their respective economic growth. Let me summarize the recent developments in the global economy. The growth momentum has been picking up in emerging economies; in advanced economies, reflecting this development, the economic recovery that had been led by the household sector is now spreading to the corporate sector, including manufacturing. Commodity prices such as crude oil prices bottomed out in the first half of the year and turned to an increase thereafter, reflecting the recovery in global demand (Chart 7). The global economy seems to be finally entering a new phase, by putting the negative legacy of the global financial crisis behind it, although considerable uncertainties lie ahead. III. Japan's Economy amid the Global Economic Developments Now, let me turn to Japan's economy amid the global economic developments that I've just explained. The global financial crisis that started in 2008 exerted a considerable impact on Japan's economy. As you all know, it was triggered by concerns over the stability of financial systems as subprime mortgage-related losses spread in the United States and Europe. It should be noted that the downturn in the real economy in Japan was more significant than that at the epicenter of the crisis -- namely, the United States and Europe -although losses at financial institutions were rather limited and the soundness of financial systems was well maintained (Chart 8). There seem to have been two factors behind that development. First, as I mentioned earlier, manufacturing -- in which Japan has a competitive advantage -- was stagnant on a global basis, as seen in particular with the decline in demand for capital goods. Second, the yen appreciated in an excessive manner, exerting a significant negative impact on Japan's economy, mainly on manufacturing. This was because the yen had been perceived as a safe haven currency in the global financial markets, in addition to the fact that there had been little room for further reduction in interest rates in Japan. Under these circumstances, Japan's economy was put in an unfavorable situation. The Bank responded by lowering the short-term policy interest rate -- which already had declined to as low as 0.5 percent -- to 0.1 percent. In addition, it undertook new policy initiatives including the purchases of risk assets such as CP, which we call "comprehensive monetary easing." Despite these efforts, Japan's economy did not get out of deflation, as the Bank was not able to provide sufficient monetary stimulus given the limited room for lowering the short-term interest rates. It was against this background that the Bank introduced in April 2013 an unprecedentedly large-scale monetary easing, quantitative and qualitative monetary easing (QQE), in order to achieve the price stability target of 2 percent at the earliest possible time. The main transmission mechanism of QQE is lowering the real interest rates by (1) exerting downward pressure on the interest rates across the entire yield curve through massive purchases of Japanese government bonds (JGBs) and (2) raising people's inflation expectations through the Bank's strong and clear commitment. Thereafter, the Bank has pursued further monetary easing as appropriate; it expanded QQE in October 2014, followed by the introduction of the negative interest rate policy in January 2016. Thanks to a series of powerful monetary stimulus measures, Japan's economy has improved significantly during a period of more than three and a half years (Chart 9). The excessive appreciation of the yen has been fairly corrected and stock prices have increased substantially. Corporate profits have marked their historical high levels and business fixed investment has recovered. With regard to the employment and income situation, the unemployment rate has declined to as low as 3 percent, which is virtually full employment, and wages have continued to rise moderately. On the price front, Japan's economy is no longer in deflation, which is commonly defined as a sustained decline in general prices, although there remain the effects on inflation of a significant fall in crude oil prices. That being said, in the first half of 2016, private consumption showed relatively weak developments in some indicators, mainly reflecting the negative wealth effects stemming from the decline in stock prices and the deterioration of consumer sentiment. As for business activity, exports and industrial production remained sluggish, reflecting the effects of the slowdown in emerging economies and the yen's appreciation, as well as supply-side constraints that were mainly due to the Kumamoto Earthquake. Against this backdrop, the momentum of price increases slowed moderately. However, the recent economic indicators suggest that the economy has been improving (Chart 10). An increasing number of indicators suggest a pick-up in private consumption. For example, the consumption activity index (CAI) -- which is calculated by compiling various sales and supply-side statistics -has been increasing steadily in recent months, after showing weakness in the first half of the year. Various surveys on consumer confidence, including the Economy Watchers Survey, have been improving. Looking ahead, private consumption is likely to increase moderately as the employment and income situation continues to improve steadily. Regarding employee income, the labor share in the aggregate output has been on a declining trend in recent years, being below the long-term average, with corporate profits staying at high levels. Meanwhile, a variety of indicators for the labor market -- such as the unemployment rate, the active job openings-to-applicants ratio, and the diffusion index (DI) for employment conditions in the Tankan (Short-Term Economic Survey of Enterprises in Japan) -- suggest that the labor market conditions have tightened. Thus, the conditions for wage increases largely have been met. Wages are labor costs for individual firms. From the macroeconomic viewpoint, however, they are employee income, which is the source of households' purchasing power. As wages and employee income rise on a sustainable basis, private consumption will be firmer. With regard to business activity, Japan's exports and production have increased recently, on the back of recovery in demand from emerging economies that I've mentioned. By taking account of these improvements, the Bank has made an upward revision to its assessment of economic conditions at the latest Monetary Policy Meeting (MPM) for the first time in a while. In sum, Japan's economy had struggled against the headwinds of the global economy. As the global economy is entering a new phase, Japan's economy is now able to move further forward, supported by the tailwind. IV. Challenges Facing Japan's Economy: Looking Ahead to 2017 Lastly, I would like to touch on challenges facing Japan's economy, looking ahead to next year. As I have explained today, the global economy is entering a new phase. With the tailwind of the global economy, good business opportunities are arising. In this situation, it is imperative to get ahead of your rivals both at home and abroad. Fortunately, advanced technology, including that related to IoT (Internet of Things), AI (Artificial Intelligence), and big data, will become available for commercial use in a wide range of areas, facilitating new types of products and services. It is understandable that many people still have pessimistic views on the future of Japan's economy from a longer-term perspective after a long period of deflation and low growth. However, it is you in business management who can discover new growth opportunities in any situation. Joseph A. Schumpeter, an economist who emphasized the role of firms' innovation as the fundamental element of economic growth, presents the following statement in his well-known work, The Theory of Economic Development. [I]nnovations in the economic system do not as a rule take place in such a way that first new wants arise spontaneously in consumers and then the productive apparatus swings round through their pressure. It is […] the producer who as a rule initiates economic change, and consumers are educated by him if necessary; they are, as it were, taught to want new things…. As Schumpeter notes, I think it is extremely important for Japan's economic growth that firms be innovative in various aspects and create demand for new products and services, thereby seizing on consumers' potential needs. In terms of macroeconomic policy, it is crucial to create a favorable economic environment in which firms can make the most of the global tailwind. On the fiscal front, the government compiled the Economic Measures for Realizing Investment for the Future in August 2016, and it plans to fully implement the measures in the near future. With regard to the structural policy, the government is working on various initiatives, such as regulatory and institutional reforms to raise Japan's growth potential, including the promotion of working-style reforms in the labor market. These measures provide an environment that promotes firms' innovation and will lead to enhancement of Japan's growth potential in the medium to long run. On the monetary policy front, at the MPM in September, the Bank conducted a comprehensive assessment on monetary easing measures implemented since the introduction of QQE; based on its findings, it introduced a new policy framework called "QQE with Yield Curve Control." This new framework consists of two components: yield curve control and an inflation-overshooting commitment. I believe that it can further strengthen the effects of the tailwind that pushes up the economy and prices. For example, when the government increases fiscal expenditure, the interest rates tend to increase, thereby restraining private-sector investment. This is the so-called crowding-out effect. However, as the Bank contains a rise in short- and long-term interest rates, this effect can be avoided. When higher growth and inflation are expected, thanks to efforts by businesses and the government's initiatives to strengthen economic growth, keeping interest rates low will further push up growth and inflation going forward. In the current globalized financial markets, as improvement in the global economy becomes evident, there would be upward pressure on long-term interest rates in Japan. In fact, since last month, the long-term interest rates in the United States have been rising significantly, having spillover effects on long-term interest rates in many other countries. Under these circumstances, 10-year JGB yields have been stable at around 0 percent. This shows clearly that the yield curve control by the Bank has exerted its intended effects. By implementing this policy framework in an appropriate manner, the Bank can take advantage of the recovery momentum of the global economy to produce an even greater driving force for Japan's economy. As it encourages firms' proactive activities and thereby leads to expectations of higher growth, the driving force can be strengthened further in a virtuous cycle. At the same time, the Bank commits itself to continuing with large-scale monetary easing until the year-on-year rate of increase in the observed CPI exceeds 2 percent and stays above that level in a stable manner. This is what we call the inflation-overshooting commitment -- the other component of the new policy framework. Thanks to three and a half years of monetary easing, Japan's economy is no longer in deflation. I believe most of you share the view that the current state of Japan's economy is better than it was four years ago; that is, at year-end 2012. Nevertheless, the 2 percent inflation goal, which is the global standard, has not been achieved yet. In order to ensure that Japan never falls back into deflation, it is necessary to achieve 2 percent inflation in this round of monetary easing. Some argue that the price stability target of 2 percent is too high considering the current situation of Japan's economy. As I explained earlier, however, Japan's economy had very limited room for monetary easing at the time of the Lehman shock, unlike the U.S. and European economies, precisely because Japan was the only country in deflation. Considering this painful experience, it is essential to secure some room for monetary policy responses by achieving the global standard of about 2 percent inflation and thereby raising the interest rate that is neutral to the economy. In fact, among central banks and academic economists outside of Japan, it is hotly debated whether 2 percent inflation is sufficient to secure room for policy responses, and some even argue that the target should be raised to 3 or 4 percent. This episode shows that the risk of falling into deflation and thereby losing the effectiveness of monetary policy is widely recognized given the experiences in Japan, as well as those in other economies after the global financial crisis. In relation to this, it is argued in Japan that the Bank should aim at a lower inflation rate, instead of the global standard of 2 percent, as Japan's potential growth rate is lower than that of other economies. However, I believe that the logic should work in the opposite direction. In theory, the interest rate that is neutral to economic activity is the sum of the potential growth rate and medium- to long-term inflation rate. In order to secure room for monetary easing, a low potential growth rate should be the reason for aiming at a higher inflation rate. It can never be the reason for being satisfied with a lower inflation rate. The lower the potential growth rate, the greater the risk of falling into deflation, necessitating a larger buffer for monetary policy. Let me reiterate that the Bank's 2 percent target is the global standard and that the inflation-overshooting commitment is designed to clarify the Bank's stance that it certainly will achieve this target. 2016 has been a tough year, both for businesses and the Bank. Fortunately, the headwind is turning into a tailwind. I am convinced that the coming new year will be one in which Japan's economy will take a big step forward toward overcoming deflation. I would like to close by expressing my hope that your business initiatives will make this happen. Thank you very much for your attention. A New Phase of the Global Economy and Challenges Facing Japan's Economy Speech at the Meeting of Councillors of Nippon Keidanren (Japan Business Federation) in Tokyo December 26, 2016 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 World Economic Growth Rate s.a., ann., q/q % chg. -2 World economy -4 Advanced economies -6 Emerging and commodity-exporting economies -8 -10 CY07 Note: Figures are calculated as the weighted averages of real GDP growth rates using PPP-adjusted GDP shares of world total GDP released by the IMF. Sources: IMF; National statistics offices; Haver; Thomson Reuters Datastream; CEIC. Chart 2 IMF World Economic Outlook World Real GDP Growth Rate Projections for Major Economies (as of October 2016) y/y % chg. 3.4 3.2 Advanced economies 1.9 2.1 United States 2.4 2.6 Euro area 1.1 2.0 Japan 0.0 0.5 4.6 4.0 China 7.3 6.9 ASEAN5 4.6 4.8 World Emerging market and developing economies Projections 3.1 (0.0) 1.6 (-0.2) 1.6 (-0.6) 1.7 (0.1) 0.5 (0.2) 4.2 (0.1) 6.6 (0.0) 4.8 (0.0) 3.4 (0.0) 1.8 (0.0) 2.2 (-0.3) 1.5 (0.1) 0.6 (0.5) 4.6 (0.0) 6.2 (0.0) 5.1 (0.0) y/y % chg. +3.4 +3.1 IMF projection (Oct. 2016) -1 CY 90 92 94 96 98 00 02 04 06 08 10 12 14 16 17 Notes: 1. ASEAN5 are Indonesia, Malaysia, the Philippines, Thailand, and Vietnam. Notes: 2. Figures in parentheses are the differences from the July 2016 WEO projections. Source: IMF. Chart 3 World Trade Volume Level of World Trade Volume Growth of World Trade Volume y/y % chg. 2003-2006 average CY 2005=100 -5 -10 -15 -20 CY 95 World trade volume World real GDP CY 95 Trend implied by real GDP World trade volume Notes: 1. The world trade volume is calculated by adding up real imports in each country. Notes: 2. The trend of world trade volume is estimated based on the regression of the world trade volume on the world real GDP for the period before 2007. Sources: CPB Netherlands Bureau for Economic Policy Analysis; IMF; National statistics offices; Haver; Thomson Reuters Datastream; CEIC. Breakdown of World Trade Volume (Real Imports） by Region and Item Changes in Real Imports by Item Real Imports of Advanced Economies CY 2000-2007 average=100 Trend implied by real GDP Primary materials Consumer goods (nondurable) Real imports Intermediate goods (transport parts and accessories) Capital and consumer goods (transport equipment) Fuels CY01 Chart 4 Consumer goods (durable) Real Imports of Emerging Economies CY 2000-2007 average=100 Trend implied by real GDP Real imports CY01 Decelerating Intermediate goods (processed materials) Intermediate goods (chemical processed materials) Intermediate goods (parts and accessories) Capital goods (excluding transport equipment) 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 % points Note: Figures are contributions to the difference in the growth rate of world trade volume between 2012-2014 and 2004-2006. Sources: CPB Netherlands Bureau for Economic Policy Analysis; Haver; CEIC; UN Comtrade. Chart 5 Corporate and Household Expenditures in Advanced Economies y/y % chg. y/y % chg. -1 -10 -2 Corporate expenditures (left scale) -20 -3 Household expenditures (right scale) -30 CY07 -4 Note: Advanced economies consist of the United States, the United Kingdom, and the euro area. Corporate expenditures are business fixed investment and inventory investment. Household expenditures are private consumption and private residential investment. Note: Corporate expenditures for the euro area are gross fixed capital formation. Source: Haver. Chart 6 Manufacturing PMI and Imports of Emerging Economies Imports of China Global Manufacturing PMI y/y % chg. -5 -10 -15 -20 -25 CY 13 s.a., DI Imports of ASEAN s.a., q/q % chg. Total Global economy Advanced economies CY 05 Others NIEs and ASEAN Japan EU United States Total Emerging and commodityexporting economies Others NIEs and ASEAN Japan China EU United States -5 -10 CY10 Notes: 1. Figures for the global economy are the J.P.Morgan Global Manufacturing PMI. Figures for the advanced economies PMI as well as the emerging and Notes: 1. commodity-exporting economies PMI are calculated as the weighted averages of the Manufacturing PMI using PPP-adjusted GDP shares of Notes: 1. world total GDP released by the IMF. Advanced economies consist of the United States, the euro area, the United Kingdom, and Japan. Emerging and commodity-exporting economies consist of 17 countries and regions, including China, South Korea, Taiwan, Russia, and Brazil. 2. Figures for imports show the breakdown by country and region of origin. Sources: IMF; IHS Markit（© and database right IHS Markit Ltd 2016. All rights reserved.); Haver; CEIC. Chart 7 Commodity Prices International Commodity Price Index and Crude Oil Prices $/bbl CY 1967＝100 CRB index (left scale) Dubai oil (right scale) Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Sources: Bloomberg; Nikkei Inc. Chart 8 Real GDP Developments in Advanced Economies after the Global Financial Crisis s.a., 2007/Q1=100 Japan United States Euro area United Kingdom CY 07 Sources: Cabinet Office; Haver. Chart 9 Economic and Price Developments after the Introduction of Quantitative and Qualitative Monetary Easing (QQE) Corporate Profits and Business Fixed Investment Exchange Rates and Stock Prices thous.yen yen/U.S.dollar Yen/U.S.dollar (left scale) Nikkei 225 Stock Average (right scale) Introduction of QQE CY10 Unemployment Rate 5.5 Ratio of current profits to sales (left scale) Private non-residential investment (SNA, real, right scale) Nominal Wages and Prices s.a., % y/y % chg. 5.0 4.5 4.0 -1 3.5 -2 3.0 2.5 CY 10 s.a., ann., tril.yen s.a., % 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 CY10 Hourly cash earnings CPI (all items less fresh food and energy) -3 -4 CY10 Sources: Bloomberg; Ministry of Finance; Cabinet Office; Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications. Chart 10 Current Economic Activity in Japan Indicators related to Private Consumption s.a., CY 2010=100 Consumption Activity Index (real) CY13 s.a., DI CY 13 Economy Watchers Survey (DI for current economic conditions) Indicators related to Exports and Industrial Production s.a., CY 2010=100 CY13 s.a., CY 2010=100 CY13 Note: The Consumption Activity Index is adjusted for travel balance. Sources: Bank of Japan; Ministry of Finance; Cabinet Office; Ministry of Economy, Trade and Industry. Real exports Indicies of Industrial Production
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a meeting hosted by the International Bankers Association of Japan, Tokyo, 20 January 2017.
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January 20, 2017 Bank of Japan Monetary Policy Divergence and Global Financial Stability: From the Perspective of Demand and Supply of Safe Assets Speech at a Meeting Hosted by the International Bankers Association of Japan Hiroshi Nakaso Deputy Governor of the Bank of Japan I. Introduction In February 2008, the Financial Times ran an article describing the Bank of Japan as "Fortress Japan." The article noted that the Bank was functioning as a fortress for Japan, shielding the Japanese financial system from the turmoil in the global financial markets triggered by problems in the U.S. subprime mortgage loan market. As you know, the Bank′s objective of maintaining financial system stability is as important as that of maintaining price stability. In order to fulfill this responsibility, not only is it important to uphold a microprudential perspective, which aims to understand the risks faced by individual financial institutions and encourages management responses thereto, but it also is important to formulate and implement policies from a macroprudential perspective, which aims to analyze and evaluate risks to the financial system as a whole. Following the recent global financial crisis, the financial landscape is radically changing, with U.S. and European banks shrinking their balance sheets and non-banks, such as investment funds, increasing their significance. At the same time, in the sphere of monetary policy, we are now experiencing monetary policy divergence, where interest rates have been kept low for long periods in both Japan and Europe but the United States is entering a rate increase cycle. In order to maintain financial system stability in such a changing global financial environment, it is necessary to ensure that there are no hidden vulnerabilities from both the microprudential and macroprudential perspectives. Today, I would like to approach this issue through the looking glass of the demand and supply of safe assets. II. Three Facts Regarding Global Financial Intermediation by Banks Before going into my main thesis, let me point out three facts regarding global financial intermediation by banks. First of all, there is a close connection between fluctuations in banks' cross-border claims and global economic activity. Looking at banks' cross-border claims by destination, financial cycles have engulfed one region after another (Chart 1). In the early 1980s, there was the debt crisis centered on Latin America. Later in the decade, we saw the bubble economy in Japan. In the late 1990s, we had the Asian currency crisis, and the 2000s started with a credit bubble in the United States and Europe. Most recently, we are worried about debt expansion in emerging Asia. As these examples show, the rise and fall of economic activity coincides with the rise and fall of banks' cross-border claims. Secondly, looking at the nationality of banks extending U.S. dollar-denominated foreign claims, non-U.S. banks overwhelm U.S. banks in terms of market share (Chart 2). Regarding the currency composition of banks' foreign claims, with the exception of intra-European claims, more of which are now in euros, a large part of the claims globally is denominated in dollars; yen use is still not very common.1 In one respect, this reflects the fact that, with much of global trade and financial transactions being conducted in dollars, non-U.S. banks are financially supporting cross-border activities, especially those of national firms. Lastly, regarding the U.S. dollar funding of non-U.S. banks, the reliance on foreign exchange swaps (FX swaps) is trending higher (Chart 2). When non-U.S. banks extend credit in dollars, they have to fund themselves in dollars, and often their on-balance-sheet credit extensions exceed their funding in dollars. This gap in funding is usually covered by FX swaps, which exchange domestic currency with dollars. In an FX swap, the parties to the transaction simultaneously conclude the purchase and sale of two different currencies of equal value on two separate delivery dates in the opposing direction. For example, a Japanese bank would purchase some dollars against the yen in the spot market and yen against the same amount of dollars in the forward market, which is in effect obtaining dollars against yen collateral. The reliance on FX swaps can be approximated by dividing the dollar funding gap by foreign claims. It can be seen that the ratio is trending higher in the long term, with instances of sharp dips during periods of market stress. Putting these facts together, one can conclude that it is important to monitor and analyze carefully the dollar funding environment of non-U.S. banks as a window onto the stability and potential vulnerability of the global economy and the international financial system. Looking also at the foreign claims of non-U.S. banks by nationality, following the recent global financial crisis, European banks are deleveraging while Japanese banks are enlarging their balance sheets (Chart 3). This is one reason why I feel there is a need to be vigilant regarding the international financial intermediation activities of Japanese banks. III. The Foreign Exchange Swap Market and Monetary Policy Divergence Let us now focus on the FX swap market, which offers important clues regarding developments in For developments in bank lending by currency, see the following: Avdjiev, S. and E. Takáts, "Monetary Policy Spillovers and Currency Networks in Cross-border Bank Lending," BIS Working Papers, No.549, March 2016. global financial markets. In textbooks on finance, it is said that "covered interest rate parity" will hold. For example, the effective interest rate when funding U.S. dollars through the FX swap market and the going rate in the U.S. short-term money market (i.e., LIBOR) should be identical. The basis of this textbook view is that, if the former is higher than the latter, there is an arbitrage opportunity, which will be exploited by a bank lending dollars raised in the short-term money market to takers in the FX swap market, until the opportunity is arbitraged away. Increases in Dollar Funding Premia in the Foreign Exchange Swap Market In real life, however, covered interest rate parity does not always hold, contrary to what the textbooks say. We often see periods where U.S. dollar funding costs through the FX swap market exceed the funding costs through the U.S. short-term money markets (Chart 4). Of these periods, in cases like the Japanese financial crisis in the late 1990s, the recent global financial crisis from 2008 onwards, and the euro area debt crisis between 2011 and 2012, the increases in the spreads over LIBOR, or the dollar funding premia in the FX swap market, seem to have been brought about by the deterioration in the creditworthiness of banks trying to raise dollar funds. This happens when (a) banks with shaky credit increasingly rely on funding dollars against home-currency collateral through the FX swap market as they face growing difficulties in obtaining uncollateralized funding in the U.S. short-term money market; (b) banks' counterparties, meanwhile, become increasingly reluctant to lend dollars due to concerns over counterparty credit risk, because those counterparties will incur replacement costs in case of banks' failure even if there was collateral; and (c) as a result, tighter conditions prevail in the swap market and dollar funding premia for non-U.S. banks increase. Having said this, I should note that the recent increases in the U.S. dollar funding premia in the FX swap market are occurring without any obvious problems regarding banks' creditworthiness (Chart 4). This should imply that the mechanism for current increases in the dollar funding premia is different from that of past stress periods. Let me delve a little more into this issue. Consequences of Monetary Policy Divergence and Regulatory Reforms With the low interest rate environment persisting in Japan and Europe, the United States initiated "tapering" and entered a rate increase cycle. Such a divergence in monetary policy outlook influences the return-seeking behavior of financial institutions and investors. Against the background of monetary policy divergence between Japan and Europe on the one hand and the United States on the other, the nominal return on U.S. dollar assets is now higher than the return on yen or euro assets, and financial institutions and investors in Japan and in Europe are increasing their investments in dollar assets (Chart 5). When banks invest in foreign currency denominated assets, they generally hedge foreign exchange risk in view of the high capital charges for such risk. Such FX-hedged investments in dollar assets are economically equivalent to transactions that purchase dollar assets with dollars obtained through FX swaps with yen or euros as collateral. Investments in foreign currency bonds by life insurers are less likely to be hedged compared with banks' investments, but slightly less than 70 percent of investments by Japanese life insurers seem to be hedged in recent years. The pattern of behavior suggests that recent monetary policy divergence is encouraging Japanese and European financial institutions to invest in dollar financial assets and contributing to tighter market conditions in the FX swap market. Meanwhile, this is not the first time that we have experienced monetary policy divergence between Japan and the United States. For example, monetary policies also diverged in the middle of the 2000s, with the Bank of Japan continuing its quantitative easing while the Federal Reserve gradually raised its policy rate, and during this period, Japanese financial institutions increased their purchases of U.S. Treasury paper and agency securities. The U.S. dollar funding premia, however, did not visibly increase during this period; i.e., broadly speaking, covered interest rate parity held (Chart 4). One has to wonder why, in the FX swap market, reactions to monetary policy divergence between Japan and the United States differ between then and now. Of the several likely explanations, I would like to point out the effects of regulation on banks that are active in the global financial market.2 As I noted earlier, if the U.S. dollar funding rate in the FX swap market is higher than the going rate in the U.S. short-term money market (i.e., LIBOR), there is an arbitrage opportunity where a financial institution could definitely profit by swapping dollars obtained in the money market. Nevertheless, when a financial institution wishes to conduct such a transaction, it would have to enlarge its balance sheet. Recently introduced financial regulations, such as the leverage ratio, which have the effect of increasing capital requirements for balance sheet expansion relative to the more traditional risk-based capital ratio, seem to be dampening arbitrage trading. More specifically, even when the swap market conditions tighten due to monetary policy divergence between the Unites States and Japan, U.S. banks and others that used to provide dollars are not prepared to The following paper by Bank of Japan staff analyzes the effects of monetary policy divergence and regulatory reform on market conditions in the FX swap market from both theoretical and empirical perspectives: Iida, T., T. Kimura, and N. Sudo, "Regulatory Reforms and the Dollar Funding of Global Banks: Evidence from the Impact of Monetary Policy Divergence," Bank of Japan Working Paper, 16-E-14, August 2016. increase the supply of dollar funds because of higher costs for arbitrage trading. This is one of the reasons why we now see dollar funding premia.3 Meanwhile, up until the middle of the 2000s, regulatory constraints were less acute than today, and it was easier for banks to conduct arbitrage trading, which in turn seemed to result in a more ample supply of dollar funds and little or no dollar funding premia. IV. Bank Debt and Financial System Stability Recent financial regulation reforms are not only affecting the suppliers of U.S. dollars, as we have just seen, but also the takers of dollars. For the next few minutes, I would like to touch upon U.S. money market fund (MMF) reform, which affected the dollar funding of global financial institutions, from the perspective of Japanese banks. Changes in Debt Composition at Japanese Banks Even in an environment where arbitrage trading by banks supplying U.S. dollars is constrained, the dollar funding premia in the FX swap market may decline if non-U.S. financial institutions (including Japanese banks) can shift their funding from the relatively expensive swap market to the (uncollateralized) U.S. short-term money market. Considering that there are no serious concerns regarding the creditworthiness of non-U.S. banks at this juncture, these banks should be able to increase uncollateralized funding through commercial paper (CP) and certificates of deposit (CDs), for example. This is not the case, however, because a substantial part of CP and CDs issued by non-U.S. banks used to be purchased by "prime" MMFs, and their issue had to be compressed considerably, following the U.S. MMF reform, which came into effect last October (Chart 6). The reform, introduced under new U.S. SEC rules, requires the adoption of floating net asset value (NAV) and imposition of redemption fees, and opens the possibility of restricting redemption. This prompted a huge shift in funds from prime MMFs to "government" MMFs, which invest mostly in U.S. government securities and are exempt from the new rules. This in turn significantly affected The effects of financial regulation are typically observed in the quarter-end spikes of U.S. dollar funding costs, as follows: (a) Since around 2013, U.S. banks have deleveraged, due partly to the stricter leverage ratio in the United States (in which a higher ratio than international rules is required, and is calculated on the basis of daily averaged assets); (b) non-U.S. banks, European banks in particular, which previously had increased positions in the U.S. money market, have started to shrink their balance sheets at quarter-ends since the middle of 2014, partly to hold down the leverage ratio at quarter-ends (in many countries, although not in the United States, banks report only the leverage ratio at quarter-ends); (c) at quarter-ends, U.S. banks increase market-making and arbitrage-trading activities in the money market at higher rates, inclusive of higher costs posed by regulation. the dollar funding of global banks. The effects of the MMF reform were not small, but Japanese banks were able to cope, not by compressing their assets, but by changing the composition of their funding (Chart 7). Looking at the foreign currency denominated balance sheets of major Japanese banks, for approximately six months preceding last October, they actually increased their assets, including an increase of 33 billion U.S. dollars in overseas loans.4 On the liabilities side of the balance sheet, there was a decrease of 62 billion dollars in CP and CD issues, which was more than compensated for by an increase of 67 billion dollars in client-related deposits, reflecting banks' efforts to build up stable funding sources, and an increase of 26 billion dollars in repo funding. These major banks were thus able to avoid increasing their reliance on relatively expensive funding through the FX swap market. Bank Debt and Safe Assets One interesting question here is why major Japanese banks were able to pull off such a significant change in their balance sheets in such short order. Let me reflect on this from the viewpoint of balancing supply and demand of U.S. dollar-denominated financial assets at the macro level. The key phrase is "safe assets." Financial intermediaries perform an important function of investing in risky assets while issuing safe debt. Debt issued by private financial institutions, along with securities issued by governments, constitutes safe assets that are provided to the economy. A prime example of such a function is the bank deposit. Through the results of recent research on safe assets, we are now aware of two empirical regularities over long periods.5 The first point is that the share of safe assets in the whole universe of financial assets including equities is more or less constant. In other words, the demand for safe debt has been relatively constant as a fraction of the total assets in the economy. The second point is that safe debt issued by the government and safe debt issued by private financial intermediaries are substitutes. These two regularities indicate that fluctuations in the stock or price of government debt crowd in or crowd out safe debt issued by financial intermediaries so that the share of safe assets as a whole may be kept constant. When we attempt to assess the market conditions regarding safe assets in the U.S. financial system, the rise and fall of the "yield spread," which is the difference between the stock yield and long-term Given that foreign currency-denominated balance sheets of Japanese banks are predominantly based on U.S. dollars, Chart 7 essentially shows the features of U.S. dollar-denominated balance sheets. See Gorton, G., S. Lewellen, and A. Metrick, 2012 "The Safe-Asset Share." American Economic Review, 102(3): 101-06. government bond yield, is quite illuminating (Chart 8). From the early 1990s to the early 2000s, the stock yield and the Treasury yield moved almost in tandem and the yield spread remained mostly around zero; after that, however, we find persistent and very large spreads. The size of the spread is now beyond a level that can be explained by expected growth in corporate earnings or equity risk premium.6 Such persistently wide yield spreads indicate that the demand-supply balance of safe assets has been much tighter than that of risky assets. An additional demand for safe debt issued by the U.S. government has probably resulted from the need for emerging market authorities to invest their foreign exchange reserves or from the need to comply with regulations that require financial institutions to hold certain amounts of safe assets. With such increase in demand for U.S. Treasuries, the price of Treasuries will rise (and their yields will fall), and following the recent global financial crisis, the demand for safe assets from U.S. investors was fulfilled by debt instruments substitutable for U.S. Treasuries and issued by financial institutions. In particular, dollar-denominated highly rated paper issued by non-U.S. banks, mainly from Canada and Australia, was preferred by U.S. investors.7 In this environment, the U.S. MMF reform, which I mentioned a few minutes ago, had the effect of further increasing demand for U.S. Treasuries.8 As funds shifted from prime MMFs, which invest in CP and CDs, to government MMFs, which invest in U.S. government securities, the yield on U.S. government securities was pushed down (Chart 9). When Treasury Bill yields fall well below LIBOR, which is the benchmark yield for debt instruments issued by private banks, the demand for safe debt issued by banks will increase because substitutable Treasury Bills become relatively expensive. That is, while prime MMFs have become less attractive as safe assets, an increase in demand for U.S. government debt without a concomitant increase in supply could also lead to an increase in safe debt issued by financial intermediaries so that the safe asset share may be kept constant. Such overall rebalancing of the financial asset portfolio in the U.S. dollar financial market enabled major Japanese banks to adjust the liability side of their balance sheets and focus on increasing client-related deposits. See Ichiue, H., T. Kimura, T. Nakamura, and H. Hasebe, "The Supply and Demand of Safe Assets and the Scarcity Premium for Government Bonds," Bank of Japan Review, 12-J-1, January 2012 (in Japanese only). See Bertaut, C., A. Tabova, and V. Wong, "The Replacement of Safe Assets: Evidence from the U.S. Bond Portfolio," Board of Governors of the Federal Reserve System, International Finance Discussion Papers, No.1123, October 2014. The following paper reviews the shift of funds from prime MMFs to government MMFs from the perspective of the supply and demand for safe assets: U.S. Securities and Exchange Commission, "Demand and Supply of Safe Assets in the Economy," memo, March 2014. Safe Assets and Financial Vulnerability At this point, you might wonder why I am deploying as arcane a concept as safe assets in order to explain the changes in the debt composition of Japanese banks. I have done so because the supply and demand of safe assets is an important reference point for monitoring and assessing the stability and potential vulnerabilities of the financial system. Let us look back at the mid-2000s. At that time, as the yield spread suggests, the demand-supply balance of U.S. dollar safe assets tightened. In response, U.S. and European investors searching for yields bought large amounts of highly rated asset-backed securities issued by private financial intermediaries with the perception that these financial instruments were safe but gave yields that were only a little better than U.S. Treasuries. In turn, the issue of asset-backed securities, in particular mortgage-backed securities, rose to meet increased demand from investors. We know that not everybody lived happily thereafter: when problems surfaced in the U.S. subprime mortgage sector followed by the global financial crisis, the asset-backed securities lost their status as safe assets. 9 Furthermore, the increasingly noticeable outflow of wholesale deposits from European banks, which aggressively invested in securitized instruments, could be explained at least in part by doubts over the appropriateness of regarding certain bank deposits as safe assets. The same mechanism seems to have been at work when U.S. MMFs reduced their exposure to CP issued by European banks during the European debt crisis beginning in 2011.10 To sum up, debt instruments issued by private financial intermediaries may be regarded as safe assets substitutable for government securities in tranquil times, but it should be borne in mind that, when the going gets rough, those instruments could lose their status as safe assets. With this in mind, the Bank of Japan conducted stress tests on foreign currency liquidity risk at Japanese banks and published the results thereof in the Financial System Report (most recently in October 2016). According to those tests, even when the availability of foreign currency funding is impaired, in addition to elevated funding premia for foreign currencies in times of stress, Japanese banks would withstand the stress and remain viable. The Bank is also of the view that Japanese banks would be able to maintain sufficient levels of capital, which is a sine qua non of their debt instruments being In addition to securitized instruments backed by residential mortgages (RMBSs), the period saw substantial increases in the issuance of collateralized loan obligations (CLOs) backed by loans financing leveraged buyouts (LBOs), and commercial mortgage-backed securities (CMBSs). In addition, it became increasingly common to see "re-securitized" instruments called asset-backed securities collateralized debt obligations (ABS CDOs), which were securitized instruments backed by (primary) securitized products such as RMBSs. The price of these instruments, even of highly rated ones, fell significantly after the second half of 2007. See Ivashina, V., D. S. Scharfstein, and J. C. Stein, 2015 "Dollar Funding and the Lending Behaviour of Global Banks," Quarterly Journal of Economics, vol. 130, pp. 1241-1281. regarded as safe assets, even under a tail-event scenario depicting the recent global financial crisis. Of course, the Bank encourages individual Japanese banks not to be complacent and pursue enhanced management of liquidity risk, under the assumption that their issued debt is more or less "runnable."11 V. Increasing Importance of Non-Banks in the International Financial System Up until now, I have focused on global financial intermediation by banks, but after the global financial crisis, we cannot ignore the increasing importance of non-banks in the international financial system.12 For the next few minutes, let me focus on this development and the effects on and implications for Japan through the looking glass of the FX swap market. Changes in the Market Structure of Foreign Exchange Swaps As described earlier, major Japanese banks, which can tap a relatively wide range of funding markets, are currently refraining from heavily using the FX swap market for their U.S. dollar funding (Chart 7). Having said that, statistics for Japanese financial institutions as a whole indicate that there are large funding increases in that market (Chart 10). This reflects the increasing demand for hedging dollar exposures from financial institutions that have limited funding options compared with major banks. Looking at the statistics on outstanding external securities investments by financial institutions, non-banks -- such as insurers, pension funds, and investment trusts -- are increasing their investments as fast as banks (Chart 11). While pension funds are not expected to hedge their exposures, life insurers seem to be hedging slightly less than 70 percent of their foreign currency exposures in recent years. Investment trusts also seem to hedge their foreign exchange risk in response to requests from investors, such as banks or households. Against this increased hedging demand, as U.S. banks refrain from engaging in arbitrage trading in response to regulatory requirements, we see increasing relative importance of non-banks -- such as sovereign wealth funds (SWFs), reserve managers of emerging market economies, and private investment funds -- as suppliers of U.S. dollars in the FX swap market. The existence of dollar funding premia in the swap market signifies an opportunity for suppliers of U.S. dollars to obtain yen funding at a very low rate. As a result, overseas non-banks that have dollars to spare can invest As to runnable debt, see Bao, J., J. David, and S. Han, "The Runnables," FEDS Notes, September 3, 2015. For example, see Financial Stability Board, "Global Shadow Banking Monitoring Report," 2015. in Japanese government securities (JGSs), even if the nominal yields on such paper are zero or negative, and secure yields as good as or higher than U.S. government securities without taking on foreign exchange risk. The fact that transaction volumes of FX swaps are positively correlated with inward bond investments underscores the investment patterns of overseas non-banks regarding FX-hedged investments in JGSs (Chart 12). In an environment where the demand-supply balance of dollar safe assets is very tight, FX-hedged investments in JGSs may be viewed by investors as safe assets substitutable for U.S. government securities. The Swap Market and the Amplification of Procyclicality in Global Liquidity One note of caution here is that FX-hedged Japanese government paper is not always a stable substitute for U.S. government paper just as debt instruments issued by banks. In other words, overseas non-banks cannot be regarded as stable sources of U.S. dollar funding. In fact, Japanese inward bond investments statistics tend to decline sharply in times of market stress (Chart 12). That means that, in times of stress, overseas non-banks have a tendency to reduce their FX-hedged investments in JGSs and hence their dollar supply in the FX swap market. For example, when currencies of emerging market economies started to slide after the Chinese stock market crashed in the middle of 2015, market participants talked of emerging market reserve managers, aware of the potential need to defend their currencies, refraining from offering dollars in the fixed-term FX swap market and shifting their dollars into more liquid markets such as U.S. Treasury Bills.13 Similar observations were heard when currencies of emerging market economies weakened following the U.S. presidential election in November 2016. In short, while FX-hedged investments in JGSs are regarded as substitutes for U.S. government securities in tranquil times, this could easily break down in times of market stress. Turning to SWFs of oil-producing economies, one often hears market talk that, when oil prices fall and the country's fiscal position deteriorates, those SWFs tend to reduce their allocation of U.S. dollars to the FX swap market, reflecting the reduced availability of investable funds. Staff analysis at the Bank of Japan confirms that there is a positive correlation between fluctuations in oil prices and transaction volumes in the FX swap market.14 Such patterns, shown by overseas non-banks, of supplying dollar funds in the FX swap market could exacerbate the procyclicality of international financial intermediation (Chart 13). For For example, see Arai, F., Y. Makabe, Y. Okawara, and T. Nagano, "Recent Trends in Cross-currency Basis," Bank of Japan Review, 16-E-7, September 2016. See Iida et al. (2016) in footnote 2. example, when emerging market economies are growing strongly, commodity demand would rise, leading to increases in commodity prices including oil. Emerging market currencies would also appreciate. In such an environment, increases in the assets of SWFs of oil-producing economies would see those SWFs allocating some of the increases for investment in the FX swap market. At emerging market economies, authorities would intervene to prevent the appreciation of their currencies, and at least a part of U.S. dollars purchased in those interventions would be invested in the FX swap market. Consequently, dollar funding premia in the FX swap market would decline and encourage non-U.S. financial institutions to extend dollar credit. If this results in capital inflows and increases in investment in emerging market economies, growth in those economies would accelerate. On the other hand, if growth in emerging market economies were to decline for one reason or another, the currencies of those economies would depreciate and commodity prices would decline, reflecting weaker demand. Subsequently, the mechanism I have just described would go into reverse gear. As SWFs of oil-producing economies and reserve managers of emerging market economies restrain the supply of dollars in the FX swap market, dollar funding premia would rise, non-U.S. financial institutions would cut back on their lending and securities investments in emerging market economies, and growth of emerging market economies consequently would be further adversely affected. An interest rate increase in the United States could amplify such procyclicality in intermediation if such an action brings about rapid and large-scale capital outflow from emerging market economies. Interdependencies between Non-Banks and Banks As I noted at the beginning today, fluctuations in external credit extended by non-U.S. banks significantly affected the global economy (Charts 1 and 2). It also is a fact that, in the past, non-banks such as SWFs and emerging market reserve managers had influenced the U.S. dollar funding and credit activities of non-US banks.15 For example, dollar deposits at European banks were among the preferred destinations of investments by emerging market authorities, who have increased their foreign exchange reserves in the 2000s, in view of the lessons learned during their currency crises of the 1990s. Dollar deposits of European banks also enjoyed inflows of SWF The Latin American Debt Crisis of the early 1980s was heavily influenced by international financial intermediation stemming from abundant oil revenues. More specifically, following the two oil crises, a large amount of oil revenues flowed into the oil-producing economies, and the money was lent to Latin American economies via banks in the developed economies. Meanwhile, during the Japanese bubble economy of the late 1980s, Japanese banks increased offshore funding and significantly increased lending through "impact loans," which were outside the lending volume restrictions imposed by the Bank of Japan through "window guidance." European banks, which were the main lenders to Japanese banks in the offshore market, were sourcing a substantial part of their funding from the Middle East. As such, the impact loans were indirectly supported by oil revenues. money, which benefited from high oil prices until the summer of 2008. Subsequently, with the global financial crisis and euro-area debt crisis, such deposits were withdrawn and contributed to the deleveraging involving dollar assets at European banks.16 The interdependencies between non-banks and banks have a history of procyclically amplifying international financial intermediation in many forms. The developments in the FX swap market represent only one manifestation of the interdependencies between overseas non-banks and Japanese financial institutions. In order to maintain the stability of the international financial system, it is important for the relevant authorities to always monitor and understand such interdependencies. VI. Final Words Let me summarize my key points. Non-U.S. financial institutions play a very important role in international financial intermediation, which is dominantly U.S. dollar based. Monetary policy divergence between the U.S. and other economies is likely to result in an increase of external claims of non-U.S. financial institutions and hence they would be pressed for increased dollar funding. Given that there seems to be excess demand for U.S. government securities, which are safe assets, the demand for debt instruments issued by private financial intermediaries, which are substitutes of U.S. government securities, would increase in tranquil times. Consequently, non-U.S. financial institutions would be able to increase their dollar funding without difficulty. Meanwhile, from the viewpoint of investors holding dollar funds, FX-hedged investments in non-U.S. sovereign securities arising from FX swap transactions are substitutes of U.S. government securities. Here again, non-U.S. financial institutions would be able to increase dollar funding through the FX swap market, although costs could increase. Historically, however, there is evidence that the substitutability of debt instruments issued by private financial intermediaries and FX-hedged investments in non-U.S. sovereign securities might be compromised in times of stress, and this could negatively impact dollar funding liquidity at non-U.S. financial institutions. Considering that the dollar funding of non-U.S. financial institutions could be influenced by the investment behavior of non-banks -- including SWFs, emerging market reserve managers, and investment funds -- we need to be mindful of the For more detail, see Nakaso, H., "Financial Crises and Central Banks′ Lender of Last Resort Function," Remarks at the Executive Forum Hosted by the World Bank "Impact of the financial crises on central bank functions," April 2013. possibility of the behavior of banks and non-banks echoing each other under monetary policy divergence and thus amplifying fluctuations in international financial intermediation and real economic activity. In addition, it is important to closely monitor risk-taking activities of non-U.S. financial institutions. Under monetary policy divergence, U.S. dollar funding premia in the FX swap market could easily spike higher. As such, the Bank of Japan would continue to monitor the activities of Japanese banks so as to ensure that they would not, in response to increased funding costs for their dollar investments, embark on excessive risk taking in terms of both credit risk and liquidity risk. As much as monetary policy divergence itself is a product of central bank policy actions in each economy aiming at price stability, it also is the responsibility of central banks to ensure that such monetary policy actions would not destabilize the international financial system through the behaviors of financial institutions. Today, the Japanese financial system remains stable. The Bank of Japan will continue to encourage financial institutions to maintain a strong financial footing, which prevents risks from materializing, and also strengthen its monitoring and analysis of developments in the international financial system. The Bank, in coordination with other central banks, will also enhance schemes to provide foreign currency liquidity to act as a backstop in case of financial crises. I would like to conclude my observations today by promising you that, consistent with what is in the Bank of Japan Act, the Bank will continue to discharge its responsibilities as "Fortress Japan" and maintain financial intermediation functions in Japan. Thank you very much for your attention. Monetary Policy Divergence g and Global Financial Stability: From the Perspective of Demand and Supply of Safe Assets January 20, 2017 Speech at a Meeting Hosted by the International Bankers Association of Japan Hiroshi Nakaso Deputy Governor of the Bank of Japan Chart 1 Cross‐Border Claims of Banks in the World by Residence of Counterparty 2.5 ratio to world GDP, GDP % 3.0 ratio to world GDP, GDP % to Developing Latin America and Caribbean to Developing Asia and Pacific 2.5 to Developing Africa and Middle East 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 CY 1980 ratio to world GDP, % 0.0 CY 1980 to Japan CY 1980 ratio to world GDP, % ratio to world GDP, % to United States (lhs) to United Kingdom (lhs) to Ireland, Italy, Greece, Portugal, Spain (lhs) to Developing l Europe (rhs) (h ) Notes:1. Latest data as at end-December 2015. 2. Shaded areas indicate major credit cycle phases. Sources: BIS; IMF. CY 1980 USD‐Denominated Foreign Positions of Banks Chart 2 U.S. and non‐U.S. banks' USD‐denominated foreign claims Non‐U.S. banks' cross‐currency funding ratio USD trillions % A‐B A Eurozone sovereign debt crisis Global financial crisis CY 2000 CY U.S. banks’ USD‐denominated foreign claims Non‐U.S. banks’ USD‐denominated foreign claims (A) Non‐U.S. banks’ USD‐denominated foreign liabilities (B) Notes: 1. Latest data as at end-June 2016. 2. "Non-U.S. banks' USD-denominated foreign claims" and "Non-U.S. banks' USD-denominated foreign liabilities" are calculated as USD-denominated foreign claims and liabilities of all reporting countries after excluding those of U.S. banks, respectively. 3. "Non-U.S. banks' cross-currency funding ratio" is calculated as "Non-U.S. banks' USD-denominated foreign claims" less "Non-U.S. banks' USD-denominated foreign liabilities," divided by "Non-U.S. banks' USD-denominated foreign claims." Source: BIS. Foreign Claims by Bank Nationality Chart 3 USD trillions t illi Japanese banks U.S. banks German banks French banks Swiss banks U.K. banks CY Notes: 1. Latest data as at end-June 2016. 2. Euro area claims for German and French banks are excluded. Source: BIS. Chart 4 FX Swap Implied USD Funding Rates and Banks' Creditworthiness FX swap implied USD funding rates （Deviation from USD LIBOR） 1.6 Non‐U.S. banks' default probability (Expected Default Frequency) % % % 1.4 USD/JPY 1.2 EUR/USD Euro area banks (lhs) 1.0 1.4 Japanese banks (lhs) U.K. banks (lhs) GBP/USD 0.8 1.2 1.0 Japan premium (rhs) 0.8 0.6 0.4 0.2 0.6 0.4 0.2 0.0 ‐0 0.2 ‐0.4 CY 1995 CY 0.0 Notes: 1. Latest data as at November 2016. 2. The shaded areas correspond to Japan's financial crisis (November 1997 through March 1999), the global financial crisis (December 2007 through June 2009), and the Eurozone sovereign debt crisis (May 2011 through June 2012). 3. Non-U.S. banks' default probability is the average of the EDF (Expected Default Frequency) of G-SIBs that are headquartered in each jurisdiction. "Japan Premium" is calculated as 3-month USD TIBOR less 3-month USD LIBOR. Sources: Bloomberg; Moody's; BOJ. Outward Portfolio Investment (Euro Area and Japan) Chart 5 Euro area Japan EUR billions Outward portfolio investment to United States to other countries JPY trillions ll Outward portfolio investment to United States to other countries ▲ ▲ FRB rate hike ▲ ▲ ▲ ‐5 ▲ FRB rate hike FRB tapering ‐50 FRB tapering ‐10 ‐100 CY 2009 ECB monetary easing ▼ ▼ ▼▼ ▼ ▼▼ QQE with YCC BOJ monetary easing ‐15 CY 2009 Notes: 1. Latest data for euro area as at end-September 2016, data for Japan as at end-June 2016. 2. In each chart, ▲/▼ indicates the timing and direction of monetary policy changes since 2013. Sources: ECB; Ministry of Finance; BOJ. ▼ ▼ ▼ ▼▼ Prime MMF Holdings of Bank Related Securities As at end‐June 2016 (Bank nationality) (Bankk nationality) SSwitzerland Netherlands N Germany Australia Uniteed Kingdom Canada SSwitzerland Netherlands N Germany Uniteed Kingdom Australia Sweden France Canada Un nited States Japan USD billions Sweden Japan USD billions France As at end‐October 2016 Un nited States Chart 6 Note: Prime MMF holdings of bank related securities are aggregated by country based on the location of banks' global headquarters. "Australia" includes New Zealand. Source: SEC. Chart 7 Japanese Major Banks' Foreign Currency Denominated Balance Sheet As at end‐October 2016 As at end‐March 2016 1,600 USD billions 1,600 1,400 1,200 Client‐related deposits Loans Client‐related deposits 1,400 1 200 1,200 Corporate bonds, etc. 97 1,000 USD billions Loans +33 1,000 Corporate bonds, etc. 106 Medium‐ to long‐term FX and currency swaps 168 Short‐term FX and currency swaps 59 Interbank investments Securities Others 101 Assets Repos Interbank funding (of which: CD・CP 268) Others 54 Liabilities Note: The charts include major banks classified as internationally active banks. Source: BOJ. M di Medium‐ t long‐term to l t FX and currency swaps Interbank investments +13 Securities Others 107 Assets +1 +9 Short‐term FX and currency swaps +67 ‐1 Repos +26 Interbank funding (of which: CD・CP 206) ‐62 Others 58 Liabilities U.S. Yield Spreads Chart 8 % Stock yield (based on expected earnings) Stock yield (based on actual earnings) Long‐term government bond yield % Yield spread (based on expected earnings) Yield spread (based on actual earnings) ‐2 ‐4 1960 65 CY 95 2000 05 ‐6 1960 65 CY 95 2000 05 Notes: 1. Latest data as at end-November 2016. 2. Stock yield = EPS / stock price. "Stock yield (based on expected earnings)" is calculated using EPS (forward twelve months), "Stock yield (based on actual earnings)" is calculated using EPS (trailing twelve months). Yield spread = Stock yield - Long-term government bond yield. 3. S&P 500 for stock price; U.S. 10-year government bond for long-term government bond yield. Source: Bloomberg. The Impact of U.S. MMF Reform Chart 9 MMF assets U.S. short‐term rates USD trillions 0.5 OIS spreads, % Government MMF 0.4 T‐Bill (3M) Prime MMF 0.3 LIBOR (3M) 0.2 0.1 0.0 ‐0.1 ‐0.2 CY Note: Latest data as at end-November 2016. Source: Bloomberg. ‐0.3 CY Chart 10 Amount of Foreign Currency Funding and FX Swap Transaction Volume g currencyy fundingg Amount of foreign via FX swaps and currency swaps by Japanese financial institutions 1 300 1,300 Transaction volume in the FX swap market (USD/JPY) via Tokyo FX market brokers USD billions USD billions Major banks and institutional investors, etc. 1,200 Including regional financial institutions 1,100 1,000 FY 2010 CY Notes: 1. Estimates by the BOJ. Latest data as at end-September 2016. 2. "Major banks and institutional investors, etc." includes major banks, depository institutions with a particular focus on market investment, and life insurance companies. Sources: Bloomberg; The Life Insurance Association of Japan; Published accounts of each company; BOJ. Notes: 1. Latest data as at September 2016. 2.Average transaction volume for each business day (includes outright forwards). 3.Trends are calculated using the two-sided HP filter. Source: BOJ. Chart 11 Japanese Financial Institutions' Outward Investments in Foreign Securities JPY trillions t illi Banks (depository corporations) Insurance and pension funds Insurance and pension funds (including public pensions) Securities investment trusts CY Notes: 1. Latest data as at end-September 2016. 2. The amounts are calculated by adding the flow during each period to the stock as at end-December 1997, to adjust for the impact of exchange rate fluctuations. Source: BOJ. Chart 12 Transaction Volume in the FX Swap Market and Bond Investment Flows Bond invvestment flows into Japan (JPY trillions) Scatter plot (CY2009 ‐ CY2016) Bond investment flows into Japan ‐1 ‐1 ‐2 ‐2 JPY trillions China's stock market crash Greek debt issues Taper tantrum High volatility in global financial markets Global financial crisis ‐3 ‐3 CY Transaction volume in the FX swap market (USD/JPY, USD billions) Notes: 1. Latest data as at October 2016. 2. Figures are 3-month backward moving averages. 3. The transaction volume in the FX swap market (USD/JPY) is the average (via Tokyo FX market brokers) for each business day and includes outright forwards. Sources: Ministry of Finance; BOJ. Chart 13 Global Liquidity Amplification Mechanism through the FX Swap Market US monetary policy (Interest rate hike) ？ spillover Slowdown in EM economies Decline in oil prices While arbitrage trading by banks has declined due to regulations, real money investors have enlarged their footprint in the FX swap market EM Capital outflows SWFs and FX reserve managers reduce d the h supply l off USD in i the h FX swap market Rise in FX swap implied USD funding rate Global banks (non‐US banks) curtail USD‐denominated lending to EMs
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2017 Northeast Asia International Conference for Economic Development, Niigata, 14 February 2017.
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February 14, 2017 Bank of Japan A Next Growth Model for Asian Economy: Beyond "the Workshop of the World" Speech at 2017 Northeast Asia International Conference for Economic Development in Niigata Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) Introduction Thank you very much for inviting me to the Northeast Asia International Conference for Economic Development. I am honored to have the opportunity to speak to all the participants who have long devoted themselves to economic revitalization in Asian countries. I would like to extend my heartfelt gratitude to Representative Director Dr. Masahiro Kawai for giving me this valuable opportunity. In 1993, when the Economic Research Institute for Northeast Asia was established, the world began to search for a new global landscape after the end of the Cold War. I think it was much to the point the reason for the establishment of this institute which focused on Northeast Asia, where former Eastern and Western bloc countries neighbor each other, and which attempted to develop together in a new partnership. Since 1993, as a result of the cooperation among northeast Asian countries, Asia has developed and become "the workshop of the world," leading the global economy. However, the Asian growth model as "the workshop of the world" may have reached a turning point. The growth rate of the Asian economy has slowed since the global financial crisis of the late 2000s. The global trade slowdown works as a headwind to the export-driven growth in Asian countries. The side effects of globalization have also been widely discussed. Today, I will express my thoughts about the Asian economy at this turning point from the medium- and long-term perspective. First of all, I will briefly look back on the development of the Asian economy and review how it has enjoyed growth as "the workshop of the world" over the course of building global value chains (GVCs) after the Cold War. Then, I will point out that this growth model is stumbling at the moment. Finally, I will explain that, in establishing a next growth model for Asian economy, it is important to improve the productivity of the service sector as the next driver of growth. I. Current State of the Asian Economy Let me start with the current state of the Asian economy. Chart 1 shows the growth rate of real GDP for nine Asian countries excluding Japan. The Asian economy had grown at approximately 8 percent per year on average until the middle of the 2000s except for 1998, when the currency crisis hit the economy. However, the growth rate has slowed since the late 2000s and dropped to about 6 percent in 2015. Comparing it with the growth rate of other regions after the late 2000s, the degree of slowdown in the Asian economy is the second largest after that of the Middle East economy, which faced the drop of oil prices and political destabilization. This fact indicates that the slowdown of Asian growth is noticeable even from the global perspective. The decline in the growth rate has brought about a slowdown in the progress toward a high income country in many Asian countries. Chart 2 shows per capita gross national income (GNI) which is one of the barometers of economic development. The World Bank defines those countries with GNI of more than about 12,000 U.S. dollars as "high income countries." At present, many Asian countries are still below this level, in the middle income group. According to research by the World Bank, among 101 middle income countries in 1960, only 13 became high income ones, and the rest remain at the middle income level even today, i.e., more than 50 years later.1 This situation, where a country cannot get out of the middle income level, is called the "middle income trap." Some economies in Asia, such as Singapore, Hong Kong, and Korea, escaped this trap and joined the "high income country club." These economies took about 20 years on average to graduate from being middle income countries. Many Asian countries stay at a middle income level for more than 20 years, raising concerns that they may have fallen into the middle income trap. Next, I will talk about how the Asian economy made its fortune as "the workshop of the world," in order to explore the reasons why the growth rate has recently slowed. II. Economic Growth as "the Workshop of the World" Economic Globalization Let me review the historic transition of "the workshop of the world" in the waves of See World Bank (2013), China 2030: Building a Modern, Harmonious, and Creative Society, Washington, DC: World Bank. economic globalization to see the current standpoint of Asia. The term "the workshop of the world" was originally used to refer to the United Kingdom in the 19th century, which had overwhelmed the world with its industrial power. Then, at the beginning of the 20th century, people began to call the United States "the workshop of the world," rather than the United Kingdom. The United Kingdom and the United States, as "the workshops of the world," had accomplished innovative developments such as steam engines and the telephone, and had created mass production systems by constructing modern factories based on these developments. They also established a manufacturing trade in which they imported materials from all over the world and exported industrial products. The volume of global trade increased as free trade was promoted by "the workshop of the world." Today, though the term "globalization" is widely used in a variety of fields, economic globalization had its origins in the 19th century. Richard Baldwin, a professor of economics at the University of Geneva, points out that in the period of globalization led by the United Kingdom and the United States, people started to trade goods all over the world because the cost of trade had declined due to innovation, and wealth had concentrated in "the workshop of the world."2 From the 1970s to the end of the 1980s, Japan and Germany caught up with them, took over the role of "the workshops of the world," and accumulated wealth rapidly. GVCs and the Economic Growth of Asia A new era of globalization started at the end of the 1980s as the Cold War ended. Foreign direct investment increased globally mainly due to the large capital inflows into the former Eastern bloc countries such as China and those in the former Soviet Union and in East Europe. Also, the establishment of the World Trade Organization (WTO) in 1995 strengthened the institutional framework of free trade. Over this period, many multinational companies, which already had hubs in various regions, evolved their production systems even more. They segmented the process, from planning and development of products to the production of parts, assembly, and sales. They optimally decentralized locations for the production process and services all over the world by seeking economics of scale and See R. Baldwin (2016), The Great Convergence: Information Technology and the New Globalization, The Belknap Press of Harvard University Press, Cambridge, Massachusetts. comparative advantage. By the middle of the 2000s they had constructed a network of international specialization in a finely meshed pattern, which is called GVCs. The development of IT greatly contributed to the establishment of GVCs. This is because IT enables firms to collectively manage and control a large number of geographically dispersed processes. Professor Baldwin, whom I mentioned earlier, notes that the lower cost of information processing due to the development of IT since the 1980s had made it easy to share information between developed and emerging countries, and had therefore fostered the rapid growth of emerging countries. As a result, the share of emerging countries in the world GDP increased while that of G7 countries declined to around 50 percent in the latter half of the 2000s from two-thirds in 1990. The volume of global trade has increased greatly due to the formulation of GVCs. Chart 3 shows the global trade volume relative to the world real GDP. It basically continued to be flat during the 1980s, which means the growth rate of the global trade volume had been almost the same as that of the economy. However, it has soared since the 1990s, and the global trade volume increased faster than real GDP. Multinational companies demand and supply a wide variety of goods internationally to produce final goods under GVCs. So the growth rate of the trade volume is higher than that of the demand for final products. Moreover, they constructed production bases in various regions of the world in forming GVCs. Therefore, the increase in the trade of capital goods, such as machine tools and construction machines, also contributed to the increase in trade volume. You might have noticed that, in Chart 3, global trade volume kinked after the global financial crisis in the late 2000s and became flat again. We will come back to this point later. Asia is the heart of GVCs and, as you know, China has come to be called "the workshop of the world." Multinational firms established the production system, where China is the final place for assembling a product, and the surrounding Asian countries supply capital goods and parts. They chose Asia as a manufacturing base because they can mass-produce and export products at low cost due to the inexpensive and abundant labor force and industrial sites. Also, they expected Asia to become a prospective market of consumer goods, because of its large population. Another reason, I think, is that governments in Asia eased restrictions on foreign investment in the manufacturing sector in order to attract direct investment. So how did the GVCs affect economic growth in Asia? Firms in developed countries have arranged development and production bases through GVCs by seeking the efficiency of each process to reduce production costs and increase value added. Hence, Asian countries became the production bases of GVCs induced by foreign direct investment, and acquired high technology and know-how. On this point, they are different from the cases of the United Kingdom and the United States, which used to be "the workshops of the world." While production in the United Kingdom and the United States was based on their own innovations, Asia, which specializes in the production process, enhanced their technology by introducing the technologies of developed countries. This means that they acquired technologies embedded in imported capital goods and intermediate goods, and shared technologies and knowledge through IT from the firms in developed economies. Asian countries raised their income level by increasing exports based on the increased investment and innovations related to the GVCs after the Cold War ended. Consequently, people in Asia became middle-income consumers and domestic consumption expanded. The increase in the income level and domestic consumption changed Asia into not just a place for production but also a final destination for consumption goods, to which major global companies pay attention. This was the growth pattern of Asian economy after the end of the Cold War. Global Trade Slowdown The Asian growth model based on GVCs seems to have stumbled after the global financial crisis of 2008. One of the main reasons is that the growth of trade has slowed down globally. I mentioned earlier that the global trade volume in the chart kinked after the late 2000s and became flat again. The global trade volume had increased faster than the growth rate of the global economy before the financial crisis, but that has not been the case since the crisis. This may be attributable to the slowdown of global GDP growth. This means that the growth rate of demand for the final goods slows down and growth of the demand for parts of the final goods slows down accordingly. Consequently, the growth of trade slows synergistically. I said earlier that trade volume growth is likely to be higher than economic growth under GVCs, but it is conceivable that the opposite happened after the financial crisis. If that was the case, global trade will pick up again as the growth rate of the global economy increases. Nevertheless, it is not likely that global trade will resume the high pace of growth enjoyed before the financial crisis. This is because structural factors other than cyclical factors are likely to have contributed to the slowdown of global trade. The first structural factor is that the expansion of GVCs has likely paused. Major global companies had mostly finished building up GVCs and development of frontiers with an even cheaper and more abundant labor force and a prospective market of consumption goods by the middle of the 2000s. So the related trade may have been subdued. Chart 4 shows the contribution of each region and each category of goods to the slowdown. A darker shadow shows a larger contribution to the total slowdown. The decline in the growth of capital and intermediate goods in China and the NIEs-ASEAN economies is noticeable. This is consistent with the argument that most global firms had built GVCs by the middle of the 2000s. The second structural factor behind the global trade slowdown is the expansion of in-house production in China. China, which used to not have high-end manufacturing skills, relied on other countries for the supply of high-end parts and specialized in assembling them by making the final goods with the inexpensive labor force. However, this situation is largely changing. Recently, firms in China have been able to produce sophisticated parts as their domestic technologies have improved. Thus, they can complete the production of some final goods, from production of the parts to assembly only in China. Another reason for the change is the fact that Chinese government, setting a goal of being a strong manufacturing country, thoroughly supports business activity through the tax system and subsidies. Owing to this, the other Asian countries which have so far supplied parts to China have missed their major export market, and trade volume has decreased. This is what is behind the decline in the import of intermediate goods in Asia. This may be a factor which requires countries in Asia which have grown thanks to exports to China to rethink their growth model. The third structural factor is that trade liberalization has become sluggish. For example, the world average tariff rate, which was 14 percent in 1990, dropped to 4 percent in 2011 but picked up to about 5 percent in 2013. The IMF points out that the number of non-tariff barriers has been increasing since the financial crisis and protectionism is gradually rising.3 III. Service Sector Expected as the Future Leading Industry Low Productivity of the Service Sector in Asia If the volume of global trade does not increase at its past high pace, Asian countries need to modify their economic growth model. I believe the service sector holds the key to this new growth model.4 This is for the following three reasons. First, the rise of per capita income tends to shift the demand from goods to services. The phenomenon in which an economic development accompanies an increase in the GDP share of the service sector is known as Petty-Clark's law. Further, the saving rate in many Asian countries is high because of insufficient social security and other factors. If improving social security induces a decline in the savings rate and an increase in consumption, demand for services may expand significantly. Second, the service sector plays an important role in the production of higher value-added export goods through making the GVCs more sophisticated. I will mention later that manufacturing firms essentially need to input services in order to produce higher value-added goods and differentiate themselves from competitors. Third, the global trade volume in services still has ample room for expansion, even if the global trade growth in goods remains slow. Let me review the situation of the service sector in Asian countries excluding Japan. The left panel of Chart 5 shows the share of the tertiary sector, or service sector, in the nominal See C. Constantinescu, A. Mattoo, and M. Ruta (2015), "The Global Trade Slowdown: Cyclical or Structural?," IMF Working Paper, No. 15/6. For discussion of productivity and trade in the service sector, see M. Morikawa (2016), Theory of Service-Intensive Country: Frontier for Activating a Mature Economy, Nikkei Publishing Inc. (available in Japanese). GDP. Contrary to popular belief about Asian countries being manufacturing-dominated, the share of the tertiary sector has increased gradually to almost 50 percent in 2014. The share of the tertiary sector in Asian countries is smaller than that in developed countries, which reached around 60 percent, but this shows that the Asian industrial structure is not extremely biased in favor of the manufacturing sector. Therefore, it is evident that Petty-Clark's law also applies to Asian countries whose per capita income has increased steadily. It is, however, somewhat concerning that labor productivity in the tertiary sector is significantly lower than that in the secondary sector in Asian countries. The right panel of Chart 5 shows the ratio of labor productivity in the tertiary sector to that in the secondary sector. In general, labor productivity in the manufacturing sectors tends to be higher than that in the service sectors due to the rapid progress of technology. In developed countries, the productivity in the tertiary sector is around 90 if that in the secondary industry is set equal to 100. However, in China and the NIEs economies such as Korea, productivity in the tertiary sector is around 70, and that in ASEAN countries such as Thailand and Indonesia is around 60. An increase in the share of the service sectors with lower productivity than manufacturing sectors dampens productivity in the overall economy, which brings about a decline in economic growth rate. This is a phenomenon known as Baumol's cost disease, in which advanced countries tend to be trapped. Asian countries are probably in the same situation. GVCs and Modern Services I will now discuss the current situation of the service sectors in Asia in detail. The left panel of Chart 6 splits the share of service sector into two categories: "traditional services" and "modern services." Traditional services consist of daily necessary services such as the retail and wholesale industries and administrative services. Modern services are those services in demand by people with higher income, such as restaurants, education, financial intermediation, and medical services. Modern services are generally said to be higher value-added than traditional services, although the degree of value added differs by country and by type of service. Chart 6 indicates that the share of traditional services in Asian countries is almost same as that in developed countries. On the other hand, the share of modern services in Asian countries is considerably lower than that in developed countries. It is considered that the lower productivity in Asia's service sectors is due to the fact that modern services have not yet fully expanded. The right panel of Chart 6 describes modern services in detail. It indicates that the share of medical services and business services in Asian countries is considerably lower than that in developed countries. It is likely that the lower share of medical services results from the insufficient health care system in Asia. Business services consist of any service accompanying a business activity such as legal, accounting, consulting, and design services. The lower share of business services in Asia is probably related to the development of GVCs which I mentioned earlier. The production process is not composed of only a simple manufacturing process to assemble the parts of a product. Production of final goods consists of not only a manufacturing process but also service inputs like R&D, design, and market research, before the manufacturing process. Further, it needs service inputs such as advertising, sales promotion, and maintenance after the manufacturing process. Service inputs before and after the manufacturing process are important components in the production process. Moreover, this service input largely determines the value-added of final goods. It is generally said that service input, not the manufacturing process, produces the largest amount of value-added in final goods. This is known as the "smile curve," that is, the relationship between the degree of value-added and production process is a U-shaped curve. GVCs made full use of comparative advantages by segmenting each production process. As a result of the development of GVCs, a service process other than a manufacturing process stays in developed countries, while the manufacturing process moved into Asian countries. I think the difference in the share of business services in modern services between developed and Asian countries is a result of whether the production process in each country has a service process to create high value-added and whether business service sectors have evolved enough to support production activities. At the present time when there are many high value-added goods in the world, service inputs become more and more important, and therefore the so-called "servitization of manufacturing" is in progress. Asian countries have realized high economic growth by taking on the responsibility of the world's manufacturing process as "the workshop of the world." However, in the service sector, Asian countries are still behind developed countries. The key element for the next growth of Asian countries is to promote service sectors and produce higher value-added goods. Required Infrastructure Improvement An improvement in infrastructure is essential for raising the labor productivity of service sectors and expanding the share of them in the Asian economy. Infrastructure means a broad range of infrastructures including not only tangible infrastructure, such as electric power, roads, and railroads, but also intangible infrastructure, such as legal restrictions and educational systems. In countries with a higher quality of broadly-defined infrastructure, the productivity of the service sector tends to be higher. Chart 7 shows indices quantifying the strength of legal restrictions, the years of schooling, and the accumulation of social capital in Asian economies, with each country in order of higher labor productivity in the service sector. A colored cell indicates the indices inferior to developed countries, and the deeper the color is, the lower the degree of infrastructure improvement is. The chart suggests several points. First, like developed countries, highly productive economies such as Singapore and Hong Kong have well-developed infrastructure. On the other hand, countries located on the lower end, that is those with lower productivity in service sectors, tend to have more colored cells, which indicate that insufficient infrastructure may lead to low productivity. Second, viewing each category in the chart, we can find out that such countries as Indonesia and the Philippines have room for building more tangible infrastructure such as roads, railroads, and electric power. Improving tangible infrastructure will raise the productivity of administrative service sectors, which directly make use of them such as the energy and transportation sectors. It will also contribute to the enhancement of the productivity of the overall service sector through strengthening the function of metropolitan areas with a concentrated population. Third, most Asian countries can improve intangible infrastructure, such as legal systems and regulations. Regulation on service sectors is generally strict because service industries include many public-oriented sectors such as energy, financial, and communication services. Furthermore, many countries impose restrictions on foreign investment in service sectors to protect domestic industries. This situation in the service sector is quite different from that in the manufacturing industry, for which regulations have been loosened in order to acquire foreign currency and create jobs. The service trade restrictiveness index made by the OECD on the left side of Chart 7 indicates that some Asian countries impose stricter limitations than those in developed countries. Other indices assess as inferior elements of infrastructure (i) a lack of conformity with a law or practice, for example, frequent corruption and deterioration of public order, and (ii) violation of intellectual property rights. In addition, an inadequate social security system such as public health care and pension may bring about increased uncertainty, which disturbs growth driven by domestic demand. Finally, I will touch upon some issues for education. Many Asian countries have raised the enrollment rate of elementary school, which is over 90 percent at present. However, in some Southeast Asian countries, the enrollment rate of secondary school and higher education is still low, which results in fewer years of schooling. Further, according to research on academic ability by the OECD, the rankings of Singapore and Hong Kong are among the best in the world but those of some Southeast Asian countries are below the world average.5 The source of value-added in services is the skill of workers as well as buildings and equipment. Improving education is one of the most important issues for enhancement of productivity in the service sector. Conclusion Today I talked about the growth model and current issues in the Asian economy and presented the importance of raising productivity and competitiveness in the service sector as See OECD (2016), "PISA 2015 Results in Focus," PISA in Focus, No. 67, OECD Publishing, Paris. one of the keys for the next growth model. Whatever the next growth model is, it is necessary for Asian economic growth to keep the free trade system. GVCs, which have brought about prosperity in Asia, are still an important growth engine, although growth in the volume of global goods trade may not be able to recover the past high pace. The labor cost rises in Asian countries where per capita income increases rapidly, and this means that Asia may not continue to be the best place for manufacturing. In fact, some firms have already moved their production bases to other countries in order to reduce production costs. Taking this opportunity of reorganizing GVCs, Asian countries should make an effort to create new comparative advantages by expanding investments and increasing production efficiency. The major premise of this effort is to keep the free trade system, which has supported the growth of the world economy to date. The role of service sectors is important for the world economy to enjoy the fruits of the free trade system. IT developments make it easier to trade services internationally, which results in the "servitization of manufacturing." Consequently, the global trade volume in services tends to expand more than that of goods. These movements, however, are still led by developed countries. The share of Asian countries in global service trade is less than 20 percent, while that in goods reaches around 30 percent. Further, in most Asian countries including China, the trade balance in services remains in deficit. As the level of income in the developing countries increases, the demand for services is expected to grow. In addition, services still have more room for trade liberalization than goods. If the trade liberalization of services is promoted, trade in services will expand between developed and developing countries or between the developing ones, which is expected to contribute to raising productivity and competitiveness in Asia. I feel encouraged by the remarkable IT development in Asia, which is the key for expansion of GVCs including service inputs. Shenzhen, which is known as "China's Silicon Valley," is a very innovative city, where many young Chinese start businesses, and where 270 of the world's largest firms which are listed in the Fortune Global 500 have established business sites, such as research and development centers.6 The Philippines, which is known as a global voice message service site, which includes call centers, is undertaking a large amount of overseas business by using its high proficiency in communicating in English. In addition, using its high level of digital literacy, India has expanded the business process outsourcing such as system development and data management. As a result, it is worth noting that both countries record a service trade surplus. The Asian economy has played a role as a driver of global economic growth to date. It is desirable that, in the future, the Asian economy will lead the global economy in a different way than before and ensure progress toward high-income countries. I hope that the Economic Research Institute for Northeast Asia contributes to further development in Asia through its various activities such as research, economic interchange, and this conference. Thank you for your attention. See C. H. Kwan (2016), "Shenzhen Emerging as China's Leading Innovation Hub: Private-Sector Companies as the Driving Force," http://www.rieti.go.jp/en/china/16060801.html. A Next Growth Model for Asian Economy: Beyond "the Workshop of the World" Speech at 2017 Northeast Asia International Conference for Economic Development in Niigata February 14, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Asian Real GDP Growth Rate y/y % chg. CY 80 Note: The latest data are as of 2015. Asia is the average of China, NIEs (Korea, Taiwan, Singapore, and Hong Kong), and ASEAN (Indonesia, Thailand, Malaysia, and the Philippines). Source: IMF. Chart 2 GNI per capita in Asian Economies 100,000 U.S. dollar Singapore Hong Kong Korea High-income Malaysia China Thailand 10,000 Middle-income Philippines Indonesia 1,000 1,000 Low-income CY70 Note: The latest data are as of 2015. Sources: HAVER; World Bank. Chart 3 Global Trade Volume Relative to global real GDP, CY1960=100 1973: 1st oil shock 1989: Malta Summit 1979: 2nd oil shock 2008: GFC CY 60 Global real export volume Note: The latest data are as of 2014. Source: WTO. Chart 4 Deviation from the Pre-Crisis Trend % points US Euro area UK Japan China NIEs ASEAN Fuels -0.10 -0.10 -0.06 0.02 0.02 0.02 0.01 -0.2 Primary materials -0.00 -0.03 -0.00 -0.02 -0.12 -0.02 -0.01 -0.3 -0.01 -0.06 0.00 -0.03 0.04 -0.03 -0.01 -0.7 -0.05 -0.06 -0.02 -0.03 -0.07 -0.07 -0.02 -0.9 -0.03 -0.07 -0.01 -0.01 -0.22 -0.27 -0.01 -0.9 0.02 0.02 -0.00 0.00 -0.02 -0.04 -0.01 -0.2 -0.14 0.08 -0.07 -0.04 -0.18 -0.20 -0.07 -1.7 0.08 -0.04 0.04 0.01 0.02 -0.03 -0.06 -0.3 -0.08 0.02 -0.04 -0.04 -0.02 -0.05 -0.01 -0.6 0.01 -0.00 -0.01 -0.02 0.01 -0.01 -0.00 -0.2 -0.2 -0.3 -0.2 -0.2 -0.5 -0.7 -0.2 -6.1 Intermediate goods (Processed materials) Intermediate goods (Chemical processed materials) Intermediate goods (Parts and accessories) Intermediate goods (Transport parts and accessories) Capital goods (except Transport equipment) Capital and consumer goods (Transport equipment) Consumer goods (Durable) Consumer goods (Nondurable) Total Latin America Total Note: Based on the elasticity of real import volume to GDP during the period of 2003-2006 for each region, we extrapolate the pre-crisis trend for the period of 2012-2014. The figures show the contributions of the deviation of the realized import growth from the precrisis trend. A darker shadow indicates a lager negative contribution to the total deviation. Sources: UN Comtrade; HAVER. Chart 5 The Tertiary Sector in Asia GDP share of the Tertiary Sector in Asia GDP share, % ASEAN Middle East Latin America NIEs China Labor productivity in the tertiary sector / Labor productivity in the secondary sector, % Advanced Economies CY 80 Labor Productivity in the Tertiary Sector Notes: 1. The latest data of the left graph are as of 2014, and the data of the right graph are as of 2011. 2. Advanced Economies are the average of 27 OECD states. Asia is the average of China, NIEs (Korea, Taiwan, Singapore, and Hong Kong), and ASEAN (Indonesia, Thailand, Malaysia, and the Philippines). Sources: United Nations; World Bank; Penn World Table. Chart 6 GDP Share of the Service Sector GDP Share of the Service Sector GDP Share of the Modern Service Sector GDP share, % Hotels and restaurants Education Financial intermediation Health and social work Business services Others GDP share, % Modern services Traditional services Advanced Economies Asia Advanced Economies Asia Notes: 1. Advanced Economies are the average of G7 members excluding Italy and Germany. Asia is the average of China, NIEs (Korea, Taiwan, Singapore, and Hong Kong), and ASEAN (Indonesia, Thailand, Malaysia, and the Philippines). 2. The classification is based on Eichengreen and Gupta (2013). 3. The data are as of 2015 or the latest available year. Sources: RIETI; CEIC; B. Eichengreen and P. Gupta (2013), "The Two Waves of Service-Sector Growth," Oxford Economic Papers, 65(1), 96-123. Chart 7 Infrastructure Indices in Asian Economies Advanced economies=10 Legal system and regulations Social infrastructure Education Labor market Business environment Quality of Services trade Protection Quality of Years of transportation electricity restrictiveness of property Firing Barriers schooling Corruption3 network4 index2 rights regulations3 to entry3 supply Labor productivity in the service sector Higher Singapore N/A 11.9 11.8 10.2 12.3 12.1 10.6 9.6 Hong Kong N/A 11.5 11.2 10.2 11.4 12.3 10.7 10.1 Taiwan N/A 10.8 3.0 10.0 9.4 10.7 9.8 9.8 Korea 9.9 7.3 3.0 10.0 7.3 10.6 8.8 10.7 Malaysia N/A 9.8 5.0 10.1 8.9 10.5 9.1 9.2 Thailand N/A 7.0 1.6 9.4 5.9 7.9 8.1 7.1 Indonesia 6.5 7.5 0.0 8.3 6.1 7.7 6.9 6.7 China 7.3 7.9 3.0 9.3 6.9 9.0 8.3 7.0 Philippines N/A 7.5 3.0 9.0 5.9 6.2 6.6 7.5 Notes: 1. Items below 8 are colored red, and items between 8 and 9 are colored orange. 2. Services trade restrictiveness index approaches 0 as restrictiveness in service trade increases. 3. Firing regulations, Barriers to entry, and Corruption approach 0 as the extent of regulations, barriers, and the level of corruption increases. 4. The average quality of roads, railroads, ports, and air transport infrastructures. 5. Advanced Economies are the average of 27 OECD states. Sources: OECD; World Economic Forum; R. Barro and J. W. Lee (2013),"A New Data Set of Educational Attainment in the World, 19502010," Journal of Development Economics, 104, 184-198; J. Gwartney, R. Lawson, and J. Hall (2015), "2015 Economic Freedom Dataset," Economic Freedom of the World: 2015 Annual Report, Fraser Institute.
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Speech by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at a meeting with business leaders, Kochi, 9 February 2017.
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February 9, 2017 Bank of Japan Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Kochi Hiroshi Nakaso Deputy Governor of the Bank of Japan (English translation based on the Japanese original) Introduction It is my pleasure to have the opportunity today to exchange views with administrative, financial, and business leaders in Kochi 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 Kochi Branch. Today, I would like to have your views on the actual situation of the local economy, as well as your candid opinions about the Bank's policies and activities. Let me now start by talking about the Bank's outlook for Japan's economic activity and prices as well as its thinking behind the conduct of monetary policy, while outlining the Outlook for Economic Activity and Prices (Outlook Report) released at the end of January 2017. I. Recent Developments in and Outlook for Economic Activity at Home and Abroad Japan's economy has continued its moderate recovery trend. As for the outlook, it is likely to continue growing at a pace above its potential on the back of highly accommodative financial conditions and the effects of the government's large-scale stimulus measures, with the growth rates in overseas economies increasing moderately. Specifically, the medians of the Policy Board members' forecasts of the real GDP growth rates presented in the January 2017 Outlook Report were 1.4 percent for fiscal 2016, 1.5 percent for fiscal 2017, and 1.1 percent for fiscal 2018, above Japan's potential growth rate, which is estimated to be around 0.5 percent (Chart 1). Compared to the previous forecasts released at the beginning of November 2016, the projected growth rates are somewhat higher, reflecting improvement in overseas economies and the yen's depreciation in addition to the effects of the comprehensive revision to GDP statistics. In what follows, I will explain the background to these projections. Overseas Economies First, I will touch on developments in overseas economies. As you all know, in financial markets, a pessimistic view had prevailed regarding the outlook until around autumn 2016. With the benefit of hindsight, however, the momentum for global economic growth seems to have strengthened since mid-2016. In particular, improvement in manufacturing and trade has been notable. An uptrend has become evident recently in indicators related to business sentiment of the manufacturing sector globally, mainly on the back of an increase in IT-related demand led by that for smartphones and of the progress observed in emerging economies in inventory adjustments of materials (Chart 2). In Asian emerging economies, domestic demand has been resilient, reflecting the effects of the economic stimulus measures implemented to date, and IT-related and material-related exports have picked up. The Chinese economy has continued to see stable growth on the whole, supported by policy effects resulting from such factors as a rise in public investment and a sales tax cut on small cars. Meanwhile, a recovery in advanced economies, which had been led by the household sector, has spread to the corporate sector recently. Reflecting such recovery in global demand, commodity prices, including crude oil prices, bottomed out in the first half of 2016 and have started to rise. Since the U.S. presidential election in November 2016, stock prices and long-term interest rates have risen globally. This is certainly attributable to the expectations for the new administration's stimulative economic policy, but improvement in fundamentals also appears to underlie this development. In terms of the outlook, advanced economies are expected to continue growing steadily, and a recovery in emerging economies is likely to take hold gradually on the back of the steady growth in advanced economies and the effects of economic stimulus measures taken by emerging economies. Looking at the weighted averages of projected real GDP growth rates of individual economies and regions released by the International Monetary Fund (IMF) in January 2017, by value of exports from Japan, the growth rates of overseas economies are projected to increase through 2018; compared to the time when the October 2016 Outlook Report was published, the weighted average has been revised upward marginally (Chart 3). Corporate Sector Reflecting such improvement in overseas economies, a pick-up in Japan's exports and production has become evident (Chart 4). Exports and production have started to increase since around last summer, but this had been supported by temporary factors such as an acceleration of automobile production to more than offset the impact of the Kumamoto Earthquake; however, they have maintained their uptrend thereafter and there is a steady rise in the number of items for which volume increased. The recovery in exports and production has been even more persistent, reflecting the progress in inventory adjustments, mainly in capital goods and producer goods, in addition to a moderate increase in demand at home and abroad. As for the outlook, exports and production are projected to moderately increase, with the growth rates in overseas economies increasing moderately. In this situation, corporate profits have been at around the historical high levels and are projected to follow a steady increasing trend on the back of an increase in demand at home and abroad and the yen's depreciation. Against the background of such favorable corporate profits, business fixed investment is expected to rise steadily, backed by an increase in growth expectations and a rise in demand related to the 2020 Tokyo Olympics as well as accommodative financial conditions. According to the December 2016 Tankan (Short-Term Economic Survey of Enterprises in Japan), corporate profits have continued to be at high levels and firmness has continued to be seen in business fixed investment plans as a whole. Household Sector Meanwhile, despite the steady improvement in the employment and income situation, private consumption had been somewhat weak since the beginning of 2016, but it has been on an improving trend recently. As I mentioned earlier, in the first half of last year, consumer sentiment became cautious, reflecting the slowdown in the global economy -mainly the emerging economies -- and a subsequent decline in stock prices, as well as irregular weather. However, it has improved recently, partly reflecting a rise in stock prices, and private consumption has started to overcome the weakness observed before (Chart 5). In addition to services such as dining-out, which had remained relatively firm, an improving trend has become clear in sales of durable goods -- such as automobiles and household electrical appliances -- and sales at supermarkets and convenience stores. The Consumption Activity Index (CAI), which the Bank calculates by combining various sales and supply-side statistics, has picked up since last summer. Going forward, private consumption is expected to increase moderately. What underpins this is the steady improvement in the employment and income situation. With regard to supply-demand conditions in the labor market, the active job openings-to-applicants ratio and the diffusion index (DI) for employment conditions in the December Tankan have improved to almost the same levels seen around 1991-1992 (Chart 6). The unemployment rate has declined to around 3 percent recently, which is virtually full employment. Under these circumstances, wages have risen moderately, albeit with some fluctuations. In particular, the year-on-year rate of change in hourly cash earnings of part-time employees, which are responsive to labor market conditions, has seen a relatively high increase, being in the range of around 1.5-2.0 percent. It is expected that more and more firms will raise wages, partly through a base pay rise. Upside and Downside Risks I have explained so far the baseline scenario of Japan's economic outlook through fiscal 2018. However, it should be noted that the outlook entails risks, and uncertainty regarding developments in overseas economies warrants particular attention. Specifically, first of all, developments in the U.S. economy and the impact of its monetary policy on global financial markets should be noted. The details for economic policy of the new U.S. administration are still uncertain, but it is expected that proactive fiscal measures such as a tax cut and infrastructure investment will lead to rises in the economic growth rate and the inflation rate. In this situation, the short- and long-term interest rates in the United States are expected to rise, and how this affects global financial markets -- including those of the emerging economies -- warrants attention. Other risks to which we need to pay attention include (1) developments in emerging and commodity-exporting economies, particularly China, (2) the consequences stemming from the United Kingdom's vote to leave the European Union (EU) and their effects, and (3) prospects regarding the European debt problem, including the financial sector. These risks, if manifested, are likely to have a negative impact on economic activity. However, they could have a positive impact as well. If market participants and economic entities factor the risks in to a certain extent, the confidence in the economic outlook going forward would be enhanced, leading to an upswing in economic activity, when (1) the view prevails that the actual impact may not be as significant as envisioned beforehand or (2) the probability of manifestation of these risks lessens. What happened after the referendum on Brexit is a case in point. Therefore, we should monitor developments in overseas economies with both upside and downside risks in mind. II. Price Developments and their Outlook Price Developments Next, I will talk about the price developments in Japan. Almost four years have passed since the Bank introduced quantitative and qualitative monetary easing (QQE) in April 2013. During this period, Japan's price developments have improved considerably (Chart 7). Since autumn 2014, crude oil prices have declined significantly, pushing down consumer prices. However, looking at the year-on-year rate of change in the consumer price index (CPI) for all items less fresh food and energy, which had been in negative territory for a prolonged period before the introduction of QQE, it became positive in autumn 2013 and has remained in positive territory for over three years. Japan's economy is no longer in deflation, which is generally defined as a sustained decline in prices. Nevertheless, it is true that there is still a long way to go to achieve the Bank's price stability target of 2 percent. The year-on-year rate of increase in the CPI for all items less fresh food and energy has remained on a decelerating trend since the beginning of 2016; thereafter, the rate of change has been fluctuating. This is attributable to a slowdown in firms' price hikes reflecting sluggish private consumption, and to price declines such as in durable goods, due mainly to the yen's appreciation last year. From a longer-term perspective, people's inflation expectations also have declined, following the course of the observed inflation rate, which has continued to show somewhat weak developments with the decline in crude oil prices that has lasted for about two and a half years. Outlook for Prices While recent price developments have been somewhat sluggish, the Bank judges that the momentum toward achieving the price stability target of 2 percent is maintained. Specifically, the year-on-year rate of change in the CPI for all items less fresh food is likely to increase from about 0 percent and become slightly positive, reflecting a bottoming out of crude oil prices, and thereafter is expected to increase toward 2 percent. The timing of the year-on-year rate of change in the CPI reaching around 2 percent will likely be at the end of the projection period of the Outlook Report -- that is, around fiscal 2018. This outlook for prices is unchanged from that presented in the October 2016 Outlook Report. Going forward, the inflation rate is expected to rise through the following mechanism. First, the output gap has improved steadily, as evidenced by the tightening of labor market conditions, and this will lead to a rise in the inflation rate through wage increases and other channels. Second, a pick-up in commodity prices, including crude oil prices, and the yen's depreciation are expected to push up consumer prices. Third, along with these developments, people's medium- to long-term inflation expectations are likely to rise. The tightening of labor market conditions brings about upward pressure on wages. The Bank aims to achieve a situation where the inflation rate increases moderately, accompanied by rises in corporate profits and wages. The past data show that the rates of increase in wages and prices move almost in parallel. From this perspective, we are very interested in how the labor-management wage negotiations in the coming months will play out, as was the case last year. The conditions for wage increases have been met largely as the labor market conditions have tightened with corporate profits at high levels. The Bank strongly expects that both labor and management will negotiate by making the most of the favorable conditions, leading to a virtuous cycle of the economy. The effects of declines such as that in crude oil prices -- which had been exerting downward pressure on consumer prices -- will dissipate through the end of fiscal 2016 and push up consumer prices thereafter. Specifically, the negative contribution of energy items to consumer prices has lessened gradually and is expected to reach around 0 percentage point in early 2017. The contribution is estimated to be slightly positive in fiscal 2017 on the assumption that crude oil prices will increase at a fairly moderate pace in line with what the futures prices imply. As I mentioned earlier, inflation expectations in Japan tend to be largely affected by the observed inflation rate. This mechanism is called the adaptive formation mechanism of inflation expectations. The decline in crude oil prices since autumn 2014 had exerted downward pressure on inflation expectations through the adaptive formation mechanism. Looking ahead, however, this effect is likely to be neutral to inflation expectations or slightly push them up. The direct impact on consumer prices of a rise in crude oil prices and the yen's depreciation are observed only temporarily and will dissipate after a while. Nonetheless, if these developments lead to a rise in medium- to long-term inflation expectations, there will be a persistent rise in the inflation rate. The Bank expects that people's inflation expectations will follow an increasing trend and converge to 2 percent, supported also by the Bank's strong commitment to achieving the price stability target of 2 percent. III. The Bank's Conduct of Monetary Policy Next, I would like to talk about the Bank's conduct of monetary policy. In September 2016, the Bank introduced "QQE with Yield Curve Control" -- a new framework for monetary easing -- and thereby strengthened the two previous policy frameworks of QQE and "QQE with a Negative Interest Rate." This framework consists of two components (Chart 8). The first is the yield curve control in which the Bank controls short- and long-term interest rates. This is designed to facilitate the formation of short- and long-term interest rates that are considered most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent, taking account of developments in economic activity and prices as well as financial conditions. At present, in the guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and the target level of the 10-year JGB yields at around 0 percent, conducting JGB purchases so as to achieve this target level. The second component is an inflation-overshooting commitment. This is a strong commitment that the Bank will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI exceeds 2 percent and stays above that level in a stable manner. As I explained earlier, taking into account that inflation expectation formation is largely adaptive in Japan, it is crucial that the public actually experience inflation above 2 percent in order to raise inflation expectations to 2 percent and anchor them at that level. By demonstrating its strong determination to achieve the price stability target through this commitment, the Bank aims to enhance its credibility with the public that it will achieve 2 percent and to raise inflation expectations in a more forceful manner. This framework is designed to amplify monetary easing effects when the outlook for economic activity and prices improves. This is because, while there would be upward pressure on interest rates in accordance with such improvement, the degree of monetary easing will increase through a decline in real interest rates against a rise in the natural rate of interest if the Bank contains such upward pressure and thereby maintains the shape of the yield curve. With regard to the future conduct of monetary policy, the Bank decides the guideline for market operations at each Monetary Policy Meeting with a view to facilitating the formation of a yield curve that is deemed most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent, taking account of developments in economic activity and prices as well as financial conditions. Some market participants, taking account of a rise in interest rates overseas, argue that the Bank might consider raising the target level of the long-term interest rate in the near future. However, as described in the Outlook Report, although the momentum toward achieving the price stability target of 2 percent has been maintained, it is not yet sufficiently firm and there is still a long way to go to achieve the target. In addition, the risks to the outlook for economic activity and prices seem to remain skewed to the downside, particularly those regarding developments in overseas economies and medium- to long-term inflation expectations. Under these circumstances, I believe it is of utmost importance at the current phase that the Bank persistently pursue powerful monetary easing under "QQE with Yield Curve Control." Conclusion Lastly, let me touch on the economy of Kochi Prefecture. The economy of Kochi Prefecture is currently recovering moderately. The region is benefiting from the recovery trend of the global economy mentioned earlier, which means that exports to emerging economies are increasing and production is picking up. Looking at the demand side, public investment and housing investment are increasing, and firms are maintaining a proactive business fixed investment stance against the backdrop of high levels of corporate profits. Moreover, positive developments also can be observed in private consumption, such as a pick-up in car sales reflecting the release of new models. Needless to say, the background to this development in private consumption is the improvement in the employment and income situation. The active job openings-to-applicants ratio in Kochi Prefecture surpassed the long-hoped-for ratio of 1 a year ago and has continued to follow an uptrend since then. On this basis, wages are rising and employee income is following a moderate increasing trend. However, the background to this increase in the active job openings-to-applicants ratio is not only the improvement in the business cycle but also labor shortages due to the decline in and aging of the population, which is more than ten years ahead of the national trend. This population decline creates a major issue; namely, a shrinking of the regional demand in Kochi Prefecture. In order to tackle this issue, the prefecture has been forging ahead with the Kochi Prefecture Industrial Promotion Plan since fiscal 2009. Under the slogans "local production for external sales" and "extended reproduction," the plan aims to strengthen the prefecture's food and tourism industries by making use of the agriculture, forestry, and fishery industries, which are the region's forte, and to expand sales channels outside the prefecture and abroad. In line with this plan, efforts toward the "sixth-order industry" utilizing specialties such as yuzu, chestnut, and bonito have been making progress in various places in the prefecture, and the value of production in that industry is also rising. In addition, an increasing number of firms are developing products that take advantage of local uniqueness and traditional technologies and promoting both domestic and international sales channels. These include, for example, firms specializing in disaster-related products utilizing technologies unique to the region, which has a high awareness of the need for disaster prevention, and those making competitive paper products that take advantage of the Tosa Japanese paper tradition. In fact, some of these firms are leaders in their particular niche, holding large market shares both domestically and abroad. In terms of tourism, a variety of initiatives have been producing steady results. Kochi Prefecture is home to a considerable number of important historical figures such as Ryoma Sakamoto, a patriot samurai in the closing days of the Tokugawa shogunate, and is a region endowed with an enterprising spirit. It also is a prefecture rich in touristic resources such as nature, history, and culture, as exemplified by Muroto Global Geopark and Shimanto River. In all parts of the prefecture, the development of touristic resources making full use of the rich nature, as well as of food and a culture unique to Kochi Prefecture, is going ahead and the number of tourists visiting the prefecture, including foreign tourists, is on an increasing trend. This year and next, an expo called the "Shikoku Kochi Bakumatsu Ishinhaku" will be held to commemorate the 150th anniversary of Taiseihokan -- or, returning power to the Emperor -and the Meiji Restoration, and it is expected that this will provide a further boost to tourist numbers and help spread the word about the prefecture's attractions to the whole country. In the words of Emori Ueki, a Meiji era activist born in Kochi Prefecture, "freedom comes from the mountains of Tosa." Given the rapid decline in and aging of the population in Kochi Prefecture, it is no exaggeration to say that it is a mirror that reflects the future of Japan. I think that the development of Kochi Prefecture's economy will serve as a signpost pointing to the future direction of Japan's economy as a whole, such that one might say that "the revitalization of Japan's economy comes from the mountains of Tosa." The Bank of Japan, and especially the Kochi Branch, will make every effort to contribute to the revitalization of the region. In closing, let me express my strong hopes for the further development of Kochi Prefecture's economy and convey my best regards. Thank you. Japan's Economy and Monetary Policy Speech at a Meeting with Business Leaders in Kochi February 9, 2017 Hiroshi Nakaso Deputy Governor of the Bank of Japan Chart 1 Outlook for Economic Activity and Prices (as of January 2017) y/y % chg. Real GDP CPI (all items less fresh food) Fiscal 2016 ＋1.4 －0.2 Forecasts made in October 2016 ＋1.0 －0.1 Fiscal 2017 ＋1.5 ＋1.5 Forecasts made in October 2016 ＋1.3 ＋1.5 Fiscal 2018 ＋1.1 ＋1.7 Forecasts made in October 2016 ＋0.9 ＋1.7 Note: Figures indicate the median of the Policy Board members’ forecasts (point estimates). Source: Bank of Japan. Chart 2 Global Manufacturing Conditions Manufacturing PMI s.a., DI Global economy Advanced economies Emerging and commodity-exporting economies CY10 Note: Figures for the global economy are the J.P.Morgan Global Manufacturing PMI. Figures for advanced economies as well as emerging and Notes:commodity-exporting economies are calculated as the weighted averages of the Manufacturing PMI using PPP-adjusted GDP shares of Notes:world total GDP from the IMF as weights. Advanced economies consist of the United States, the euro area, the United Kingdom, and Japan. Emerging and commodity-exporting economies consist of 17 countries and regions, including China, South Korea, Taiwan, Russia, and Brazil. Sources: IMF; IHS Markit (© and database right IHS Markit Ltd 2017. All rights reserved.); Haver. Chart 3 Real GDP Growth Rates of Overseas Economies y/y % chg. 1980-2015 average for overseas total (4.0%) IMF projection Overseas total -2 Advanced economies Emerging and commodity-exporting economies -4 CY85 17 18 Note: Figures are the weighted averages of real GDP growth rates using countries' share in Japan's exports as weights. Annual GDP growth rates are from the "World Economic Outlook (WEO)" as of January 2017. Since for some countries and regions the IMF does not provide projections in the January WEO, some figures are imputed using information provided in the October WEO. Advanced economies consist of the United States, the euro area, and the United Kingdom. Emerging and commodity-exporting economies consist of the rest of the world economy. Sources: IMF; Ministry of Finance. Chart 4 Exports and Industrial Production s.a., CY 2010=100 Real exports Industrial production CY10 Sources: Bank of Japan; Ministry of Finance; Ministry of Economy, Trade and Industry. Chart 5 Private Consumption DI for Current Economic Conditions (Economy Watchers Survey) s.a., DI Consumption Activity Index s.a., CY 2010=100 DI for current economic conditions (household activity) Consumption Activity Index (adjusting travel balance, real) CY 05 16 17 CY 05 Note: Figures for the Consumption Activity Index exclude inbound tourism consumption and include outbound tourism consumption. Sources: Cabinet Office; Bank of Japan; Ministry of Economy, Trade and Industry; Ministry of Internal Affairs and Communications, etc. Chart 6 Employment and Income Situation Job Openings-to-Applicants Ratio and Employment Conditions DI (Tankan) Unemployment Rate DI ("excessive" - "insufficient"),% points s.a., times s.a., % 1.6 6 "Excessive" 1.4 Employee Income y/y % chg. "Insufficient" 1.2 5 1.0 -2 0.8 4 0.6 -10 -4 Employment conditions DI (all enterprises, left scale) -20 Active job openings-toapplicants ratio (right scale) Number of employees 0.4 3 Total cash earnings -6 0.2 -30 0.0 2 CY 05 06 07 08 09 10 11 12 13 14 15 16 CY 05 06 07 08 09 10 11 12 13 14 15 16 Employee income -8 CY 05 06 07 08 09 10 11 12 13 14 15 16 Note: Figures for "employee income" are calculated as the "number of employees" (Labour Force Survey) times "total cash earnings" (Monthly Labour Survey). Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Figures for 2016/Q4 are those of December. Sources: Bank of Japan; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare. Chart 7 Consumer Prices y/y % chg. CPI (all items less fresh food and energy) CPI (all items less fresh food) -1 -2 -3 CY 07 Note: Figures for the CPI (all items less fresh food and energy) are calculated by the Research and Statistics Department, Bank of Japan. Figures for the CPI are adjusted to exclude the estimated effects of changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" Inflation-Overshooting Commitment Yield Curve Control 1.2 Chart 8 % Inflation Rate Recent shape of JGB yield curve 1.0 0.8 0.6 0.4 Target level of the long-term interest rate "around zero percent" Short-term policy interest rate "minus 0.1 percent" 2% 0.2 0.0 -0.2 -0.4 0 1 year Source: Bloomberg. 9 10 15 20 Residual maturity Expansion of monetary base continues
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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, Tokushima, 1 March 2017.
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March 1, 2017 Bank of Japan Recent Economic and Financial Developments and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Tokushima Takehiro Sato Member of the Policy Board (English translation based on the Japanese original) Introduction Thank you for giving me this opportunity to exchange views with people representing the political, economic, and financial communities of Tokushima 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 Takamatsu Branch and Tokushima Office. In today's speech, I will begin by focusing on recent 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 Tokushima 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. I. Recent Economic and Financial Developments in Japan and Abroad A. Global Financial Markets and Overseas Economies In 2016, the results of the U.K.'s referendum and the U.S. presidential election turned out to be different from the expectations of most market participants, leading to volatile movements in global financial markets. In particular, after the U.S. presidential election, stock prices in major countries soared partly due to expectations for fiscal stimulus measures. Recently, the market exuberance has calmed amid cautiousness about protectionist moves. However, some of the exuberance remains, with U.S. stock prices staying at a record high level. On the monetary policy front, in a situation where some people assume that the slack in the U.S. labor market has been considerably reduced or eliminated, the Federal Reserve has become more active in sending messages since the December FOMC meeting, indicating the possibility of accelerating the pace of interest rate hikes, depending on the contents of fiscal policy, because of concern about the economy overheating due to fiscal expansion. Under these circumstances, among future risk factors is a change in the flow of funds in global financial markets driven by U.S. monetary policy, above all the possibility of an outflow of funds from emerging economies. The huge pile of debts that accumulated in emerging economies during U.S. monetary easing in the past is a chronic disease that takes time to be remedied, so to speak, although it is not attracting much attention for the moment. Meanwhile, although China is heading toward stable growth led by the appearance of the effects of various economic measures, it is necessary to continue to pay attention to structural problems, including the problem of excessive domestic debts. Also, the political situation, especially in Europe, is another major risk factor for 2017, considering that it disturbed global financial markets in 2016. B. Japan's Economy Japan's economy was in a soft patch until around the first half of 2016, reflecting the turmoil in global financial markets and the slowdown in emerging economies in that period. However, the economy turned up through the end of the year in line with the pick-up in emerging economies. Exports are picking up, led mainly by mobile phone parts and other IT-related goods as well as automobile-related goods including parts, while production is also improving in line with the progress in inventory adjustments. Consumption lacks vigor despite somewhat increasing its resilience recently. However, going forward, consumption is expected to continue increasing moderately because household and business sentiment is generally picking up against the background of the solid employment and income situation and because stock prices have stayed firm. If the effects of fiscal stimulus measures under the recent supplementary budget are taken into consideration, Japan's economy is expected to maintain the growth pace of around 1.5 percent in fiscal 2017, as it did in fiscal 2016. Although there are many points to discuss concerning Japan's economy, here, I would like to focus on the relationship between the recent employment situation and wages in connection with the price situation, which will be discussed later. Across Japan, labor shortage is becoming serious and the employment situation is becoming increasingly tight. However, the tight employment situation in local regions is presumed to be partly due to demographic effects. For example, the active job openings-to-applicants ratio before the 2000s varied significantly by region in times of favorable economic conditions, with well-performing regions recording a steep rise in the ratio, while the ratio remained low in regions where the employment situation remained sluggish. In contrast, in the current economic phase, the variance between well-performing and other regions has become small, as the ratio is also rising in regions where it was low. In 2016, the active job openings-to-applicants ratio surpassed 1.0 in all 47 prefectures for the first time. The rise in the ratio in local regions is presumed to be due in part to a decline in the number of job applicants caused by population migration, so it seems not quite right to simply interpret the rise as a result of improvements in the economic situation. Looking at the active job openings-to-applicants ratio by job type, we can see that the degree of the tightness of the employment situation varies significantly. For example, the ratio was over 3.0 for nursing care-related workers and construction workers, whereas the ratio was in the range of only 0.3-0.4 for general clerical workers. The ratio is low, particularly for regular workers engaging in clerical jobs. In other words, the labor supply-demand balance is tightening with respect to nursing care-related workers -- for which wages are kept low as a policy and which are chronically in short supply -construction workers with special skills, and truck drivers in the transportation industry, but there continues to be excess labor with respect to clerical jobs. Although there are variances by industry, hourly wages of non-regular workers increased by about 2 percent compared with the previous year, reflecting the tight employment situation, whereas basic wages of regular workers do not rise easily, reflecting the sense of excess labor. As wages and employee income of non-regular workers are lower than those for regular workers, the rise in wages of non-regular workers is insufficient to raise the overall hourly wages and employee income at the macro level, given the composition effects. There is a broad consensus on the view that this is one reason why prices do not rise easily, as is mentioned below. If business managers view that there is a surplus of labor with respect to regular workers engaging in clerical jobs or if wages not commensurate with the productivity level are being paid, it must be said that the hurdle for raising basic wages of regular workers, which are fixed costs for firms, is high. This is a matter related to the situation of the labor market itself, which I will discuss later, and I believe that it is necessary to quickly forge a consensus among various quarters concerning this matter. C. Prices The consumer price index (CPI, on a nationwide basis, all items less fresh food and energy) for December 2016 remained relatively weak, with the year-on-year rate of change marking 0.1 percent, remaining close to 0 percent. The main reason for the weakness is considered to be because households' preference for lower prices and their cost-saving tendency grew again as people's sentiment became cautious due to the market turmoil in the first half of 2016, putting a drag on consumption, and because firms' price-setting behavior accordingly grew cautious. Recently, as people's sentiment improved due to a recovery in the market environment, consumption has somewhat increased its resilience. The underlying trend in prices is presumed to sensitively reflect the consumption trend, so I am looking forward to a change in the underlying trend in prices, which has remained weak since 2016, in the January-March quarter of 2017 at the earliest. The year-on-year increase in the CPI including energy (all items less fresh food) is expected to pick up further in line with developments in the underlying trend in prices, as the negative contribution of energy prices is likely to dissipate in the January-March quarter and gradually rise to positive territory. It is possible to expect the year-on-year growth rate to surpass 1 percent in the second half of fiscal 2017, although that depends on the assumptions of crude oil prices and exchange rates. For the moment, market participants' outlook for prices does not appear to be so bullish. However, if the year-on-year rate of growth in the CPI rises faster than the consensus pace, the long-term interest rate, which has stayed close to 0 percent due to the Bank's Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, may face increased upward pressure, so I would like to carefully monitor these developments. As a result of our experiences in the four years since the introduction of QQE, we have learned that if people's medium- to long-term inflation expectations decline under prolonged deflation, it is not easy to raise them again even through unconventional monetary policy implemented on a large scale. As was pointed out in the Bank's comprehensive assessment of QQE released in September 2016, the formation of people's medium- to long-term inflation expectations in Japan is considered to be strongly influenced by the past CPI growth rates -- in other words, the formation of inflation expectations is largely adaptive. If people's price perceptions become conservative, the frequency of price adjustments declines, and in particular, services prices, represented by administrative prices, become sticky. The reason why a vicious circle of low services prices leading to a curb on wages at service providers occurs is presumed to be that people's medium- to long-term inflation expectations, namely the norm applied to prices, become excessively conservative and difficult to change. One necessary condition for raising inflation expectations after they have declined due to the adaptive expectations formation in an environment of sticky prices is that the observed CPI rises to some degree due to a shock either on the supply side or on the demand side. The recent pick-up in energy prices is likely to have the effect of raising inflation expectations somewhat in a situation where a change in the underlying trend in prices is expected. However, it cannot be denied that inflation expectations are influenced by the external environment at the time. More fundamentally, I believe that it is desirable to change the wage-setting mechanism in the labor market and shift to a forward-looking expectations formation mechanism like the one observed in the United States and Europe. In other words, in wage negotiations, it is desirable to replace the existing practice of referring to the observed CPI in the past with a method of sharing between labor and management the outlook on the path of price changes over the next several years, or over the medium to long term, and to use the central bank's price target as the basis of the medium- to long-term path of price changes. To do so, it is necessary for people to have sufficient confidence in the central bank's price target and monetary policy. II. Future Conduct of Monetary Policy A. QQE with Yield Curve Control I have been arguing that it is necessary to make patient efforts in the medium to long term in order to raise people's dampened medium- to long-term inflation expectations and overcome deflation, and that to this end, it was essential to transform the framework of the previous QQE, which was a shock therapy solution aiming for quick results, into a more flexible and sustainable one. QQE with Yield Curve Control, which was adopted in September 2016 after the comprehensive assessment, is in line with my argument, so I agree with this framework in principle. Even so, the current guideline for market operations -- to set the short-term policy interest rate of minus 0.1 percent and the target level of yields on 10-year Japanese government bonds (JGBs) at around 0 percent -- could lead to holding JGB yields in negative territory up to a maturity of ten years. In particular, there is a high probability that yields on bonds in the short- and medium-term zones with a maturity of three to five years will stay in negative territory under the current guideline. I have been voting against setting interest rate target levels because such a situation is unlikely to contribute to maintaining financial system stability, which is one of the Bank's two mandates. However, unlike the pegging of long-term interest rates that was adopted in the United States until the 1950s, the framework of QQE with Yield Curve Control is a flexible one under which, at each Monetary Policy Meeting (MPM), the target level for the intermeeting period is determined. Under this framework, regarding the control of the long-term interest rate, the Bank's Policy Board judges what the appropriate shape of the yield curve is while taking into consideration economic activity, prices, and financial conditions at the time and the momentum of changes in the situation. However, regarding the appropriate shape of the yield curve, there is large room for interpretation in the range of the optimal policy interest rate level calculated even through the Taylor rule; currently, there is as much or more room for interpretation. Therefore, even the most advanced economics theories cannot precisely identify the shape of a yield curve at which economic activity neither accelerates nor decelerates. In addition, as the policy practice concerning the control of the long-term interest rate is not necessarily well-established at this moment, I believe that it is important to take due care, for example by avoiding surprises to the market through close communication before conducting market operations although the timing and degree of the control is of course a matter to be decided by the Policy Board. Under the above-mentioned thinking, my view on the policy reaction function concerning the control of the long-term interest rate is as follows: if the Policy Board assesses that economic activity and prices are changing for the better and that market conditions are changing in response to or in anticipation of the improvement, it is appropriate to flexibly adjust the interest rate level in the guideline so that the guideline would reflect market movements. For example, if this policy works well, resulting in higher inflation expectations, it is natural to think that nominal interest rates will come under upward pressure because of awareness about inflation risk premiums. In that case, from my viewpoint, it is uncertain whether the Bank can continue to keep nominal interest rates at around 0 percent through conventional JGB purchases. Even if the Bank can do so, such operation would be undesirable because it could build up financial imbalances when the rates are kept there for too long. Furthermore, although unrestricted fixed-rate purchases may be effective in controlling the market in the short term, I am concerned that the implementation of this sort of operation could undermine dialogue with market participants by constraining subsequent policy management because such purchases will send quite a strong message of commitment by the central bank to a specific interest rate level. In this respect, I understand that fixed-rate purchases are nothing more than an emergency tool. I believe that flexibly and moderately adjusting the targets in accordance with market conditions is prudent policy management even if this approach may be considered behind the curve. In my view, the yield curve that would be most appropriate for achieving favorable conditions in economic activity and prices should be a little steeper. If the yield curve becomes excessively flat and expectations of a continued interest rate decline become predominant, firms and households increasingly tend to defer procurement of funds, which in turn leads to postponement of investment and consumption -- in other words, demand is prone to be deferred. In this respect, a slightly steeper yield curve is rather beneficial for stimulating sound economic activity and is also likely to contribute to enhancing the sustainability of the social security system, thereby stabilizing people's sentiment. As for the negative impact of steepening, I presume that it barely dampens business fixed investment at the macro level because economic entities other than the government that procure funds in the very long term -- a period of 20 to 30 years -- are limited to firms whose cash flow is abundant and stable from the outset. B. A Shift from Targeting the Monetary Base to Targeting Interest Rates One of the key points of the policy shift from QQE with a Negative Interest Rate to QQE with Yield Curve Control is that the operating target for money market operations changed from the monetary base to interest rates, a traditional target. In this respect, the guideline for the Bank's annual JGB purchases of about 80 trillion yen, which was the pillar of the initiative to increase its monetary base, has become an approximate guideline that is not strongly binding for the guideline for money market operations. Consequently, I believe that the purchasing of treasury discount bills, which has been conducted as a complementary measure in preparation for the possibility of failing to reach the monetary base target through purchases of JGBs, is essentially unnecessary. I consider it desirable to further reduce the amount outstanding of holdings of treasury discount bills while paying close attention to the impact on the money market. Even so, it is necessary to continue purchasing a certain amount of JGBs as a precondition for long-term interest rate control regardless of whether or not the annual purchase amount should be about 80 trillion yen. As for the impact of continued purchases of JGBs on the long-term interest rate, it is natural to think that the long-term interest rate will come under downward pressure due to the stock effects as JGBs are accumulated on the central bank's asset side. Theoretically, it is impossible to set targets in terms of quantity and interest rates at the same time, and the actual policy framework is not intended to do so. Therefore, if the long-term interest rate target of around 0 percent is maintained for a certain period of time, it is also natural to think that the purchase amount of JGBs will gradually decrease. In that case, the relationship between the decrease and the approximate guideline for purchasing JGBs totaling about 80 trillion yen per year may become an issue. However, I believe that monetary policy should not be bound by that figure, which is merely an approximate guideline. The prospect that the JGB purchase amount necessary and sufficient to keep the long-term interest rate at around 0 percent will gradually start to decrease in theory could become an important factor that will promote smooth normalization of monetary policy if we are to consider in the relatively long term what the ideal exit from the unconventional monetary policy should be like after deflation is overcome. C. Relationship with Fiscal and Structural Policies Since the recognition of the need to utilize all available measures, including not only monetary but also fiscal policy measures, was shared at the Group of Twenty (G-20) meeting in Shanghai in February 2016, the roles of expansionary fiscal policy and monetary policy supporting it have been discussed in various quarters. "Helicopter money," which calls for fiscal expansion using permanent fiscal finance provided by the central bank, is an extreme example. In addition, the Fiscal Theory of the Price Level (FTPL), which has a more robust theoretical framework, has regained attention in Japan since the Jackson Hole conference in August 2016. The definition of helicopter money differs depending on who is discussing it. In Japan, the central bank is prohibited from engaging in direct financing of fiscal deficits in the first place. Meanwhile, the underwriting of zero-coupon perpetual government bonds by the central bank, which is often mentioned by supporters of helicopter money, is unrealistic even if legal problems are resolved, because the idea of capitalizing something that has no or little economic value is not practical. Concerning the FTPL, even if government debts are assumed to be financed in the future by inflation that will be triggered by fiscal expansion, it is difficult to use it as the basis of macroeconomic forecasts for the purpose of policy formulation because empirical research on this topic is still insufficient. While economic policy is implemented based on a critical decision that takes account of more than just economic gains and losses for various economic entities, it is difficult to obtain the consent of stakeholders based on an economic model which considers future inflation to be inevitable but cannot predict when it will occur. Actual policy management cannot help being prudent because macroeconomic policy is managed under various constraints -- constraints in terms of legal, accounting, and practical affairs, as well as the need for parliamentary consent -- and because policy authorities need to be strongly conscious of these constraints. Because of the limitations of the unconventional monetary policy, fiscal expansion is refocused in the political and academic worlds. My understanding is that this situation occurred because in Japan's case, it has been difficult to feel the benefits of economic recovery despite powerful monetary easing measures implemented on an unprecedented scale. In Europe's case, this was a reaction to the excessive rise in expectations for monetary policy after awareness about the limitations of fiscal policy grew due mainly to the sovereign debt crisis. In particular, the fact that the global financial crisis that broke out in 2008 was overcome through various unconventional measures has led to misunderstanding that monetary policy is the "only game in town." In that respect, the recent spread of expectations for fiscal measures reminds me of this lesson: "History repeats itself." In any case, I feel sympathy with the fact that an orthodox strategy of strengthening growth potential through structural policy while buying time by providing cyclical support for the economy through collaboration of fiscal and monetary policies has started to gain some support not only in Japan but globally, because the strategy has something in common with the concept of the "three-arrows" strategy that was launched soon after the inauguration of the Abe administration. Under these circumstances, the central bank's role is ultimately generating the maximum effects of the fiscal and structural policies by maintaining accommodative financial conditions. Within the scope of this role, the Bank is conducting unprecedented monetary policy, namely, controlling the yield curve. The prerequisite for the control of the long-term interest rate is that the credibility of the JGB market is maintained through the government's efforts toward establishing a sustainable fiscal structure. If fiscal discipline weakens as a result of the Bank guiding the long-term interest rate to around 0 percent, it is possible that the credibility of fiscal management will be undermined and that the Bank will inevitably increase JGB purchases further in order to control the long-term interest rate. In addition, if the long-term interest rate rises due to a decline in the credibility of fiscal management, it is uncertain whether an increase in risk premiums can be contained through the Bank's JGB purchases. In this situation, I believe that it is necessary to keep in mind the risk that this policy could lead to fiscal dominance, depending on the fiscal policy stance. While a substantial portion of newly issued JGBs are purchased by the Bank, I would like to reiterate that the JGB purchases are conducted from the perspective of overcoming deflation and achieving the price stability target, not for the purpose of financing fiscal deficits. Concluding Remarks: Economic Activity in Tokushima Prefecture My concluding remarks will touch on the economy of Tokushima Prefecture. Tokushima Prefecture, facing the Seto Inland Sea and the Pacific Ocean, is blessed with rich natural resources, including mountains, which occupy around 80 percent of its land, small and large rivers, including Yoshino River, and the Naruto whirlpools, as well as historical and cultural heritage items, including the Awa dance and the Shikoku 88 Temples. Looking at the industrial structure of this prefecture, which prospered in the past thanks to its aizome (indigo dye) industry and salt industry, we see that the manufacturing industry, mainly chemicals and electrical machinery, has a particularly large share. In addition, the share of the primary industry is relatively large compared with the national average. In agriculture, Tokushima Prefecture has the largest share of production in Japan concerning many items because of its geographical advantage -- proximity to the cities of Kyoto, Osaka, and Kobe. It is also rich in tourism resources. The annual Awa dance festival held in August is a major summer festival in Japan that attracts more than 1 million people. Tokushima Prefecture's economy has recently continued to recover at a moderate pace. Although growth momentum in business fixed investment has come to a pause, investment has stayed at a relatively high level. Private consumption has continued to pick up, while housing investment is also picking up, albeit with fluctuations, and is at a high level. Public investment has been more or less flat. Production is moderately picking up albeit with fluctuations and has stayed at a high level. However, Tokushima Prefecture is also facing challenges of a population decline and an aging society. In this situation, the following has gained attention: the presence of satellite offices of IT firms taking advantage of the prefecture's superior broadband environment, which is one of the best in Japan; initiatives as seen in "Happa Business," which is led mainly by elderly people; and renewal of communities using the scenic views of unexplored sites and traditional Japanese-style houses. Moreover, Tokushima Prefecture as a whole has recently been conducting initiatives bolder than before, including the "Vs. Tokyo 'Comeback to Tokushima' Comprehensive Strategy," which has been formulated by the local government. In relation to the manufacturing industry, Tokushima Prefecture has continued to actively invite and support LED-relating firms, with the number of such firms operating in the prefecture already exceeding 100. Regarding urban area revitalization initiatives, Tokushima Marche is held every month as an event to sell unique agricultural products and processed products, attracting many visitors. Also, I hear that the Tokushima LED Art Festival, which was held in December 2016, was successful, drawing more visitors than at the previous time. In terms of tourism, the Otsuka Museum of Art and Iya-no Kazura Bashi suspension bridge are attracting an increasing number of tourists from outside the prefecture, including foreign tourists. I hope that these wide-ranging initiatives will bring successful results and further invigorate the economy of Tokushima Prefecture. Recent Economic and Financial Developments and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Tokushima March 1, 2017 Takehiro Sato Bank of Japan Global Economy (1) IMF Projections (as of January 2017) real GDP growth rate, y/y % chg. CY 3.2 3.1 Advanced economies 2.1 1.6 United States 2.6 1.6 Euro area 2.0 1.7 United Kingdom 2.2 2.0 Japan 1.2 0.9 4.1 4.1 6.7 6.3 China 6.9 6.7 ASEAN 4.8 4.8 Russia -3.7 -0.6 Latin America and the Caribbean 0.1 -0.7 Emerging and developing Asia y/y % chg. estimates projection projection World Emerging market and developing economies (2) Real GDP Growth Rate of the World Economy 3.4 (0.0) 1.9 (0.1) 2.3 (0.1) 1.6 (0.1) 1.5 (0.4) 0.8 (0.2) 4.5 (-0.1) 6.4 (0.1) 6.5 (0.3) 4.9 (-0.2) 1.1 (0.0) 1.2 (-0.4) 3.6 (0.0) 2.0 (0.2) 2.5 (0.4) 1.6 (0.0) 1.4 (-0.3) 0.5 (0.0) 4.8 (0.0) 6.3 (0.0) 6.0 (0.0) 5.2 (0.0) 1.2 (0.0) 2.1 (-0.1) Notes: 1. Figures are calculated using GDP based on purchasing power parity (PPP) shares of the world total from the International Monetary Fund. 2. Figures in parentheses are the difference from the October 2016 World Economic Outlook projections. Source: International Monetary Fund. Avg. growth rate (1980-2015): +3.5% IMF projections Emerging market and developing economies -1 Advanced economies World economy -2 CY 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 Note: As of October 2016. Source: International Monetary Fund. "Outlook for Economic Activity and Prices" (January 2017) Forecasts of the Majority of Policy Board Members y/y % chg. Fiscal 2016 Forecasts made in October 2016 Fiscal 2017 Forecasts made in October 2016 Fiscal 2018 Forecasts made in October 2016 Real GDP CPI (all items less fresh food) +1.2 to +1.5 -0.2 to -0.1 [+1.4] [-0.2] +0.8 to +1.0 -0.3 to -0.1 [+1.0] [-0.1] +1.3 to +1.6 +0.8 to +1.6 [+1.5] [+1.5] +1.0 to +1.5 +0.6 to +1.6 [+1.3] [+1.5] +1.0 to +1.2 +0.9 to +1.9 [+1.1] [+1.7] +0.8 to +1.0 +0.9 to +1.9 [+0.9] [+1.7] Notes: 1. Figures in brackets indicate the median of the Policy Board members' forecasts (point estimates). 2. The contribution of energy items to the year-on-year rate of change in the CPI (all items less fresh food) is estimated to be approximately minus 0.6 percentage point for fiscal 2016 and reach around 0 percentage point in early 2017, becoming slightly positive thereafter. Source: Bank of Japan. Japan's Economy: Real GDP s.a., q/q % chg. s.a., q/q % chg. Q3 Q4 Q1 a Q2 -1.8 -0.2 0.6 1.4 -0.1 Inventories b 1.0 -0.4 -0.2 Imports c 0.8 -0.3 -0.2 -0.1 Final demand d= a-b-c -3.6 0.5 1.0 -1 Real GDP e -1.8 -0.2 Trading gains/losses f 0.2 -2 Real GDI g=e+f -3 Income from/to the rest of the world h 0.1 Real GNI i=g+h -1.4 Real GDP Private demand -4 0.6 Q2 Q3 Q4 Q1 Q2 Q3 Q4 0.2 -0.3 0.6 0.4 0.3 0.2 0.4 -0.2 -0.1 -0.2 0.2 -0.3 -0.1 0.5 -0.5 0.1 0.2 0.2 0.0 -0.2 0.9 -1.0 0.9 -0.3 0.6 0.0 0.6 0.5 0.6 1.4 -0.1 0.2 -0.3 0.6 0.4 0.3 0.2 0.1 0.3 0.8 0.1 0.3 0.1 0.5 0.2 -0.1 -0.2 -1.6 -0.1 0.9 2.2 0.0 0.5 -0.2 1.1 0.6 0.3 0.4 -0.4 0.3 0.0 0.2 1.3 1.7 0.3 0.5 -0.1 0.7 0.3 0.1 Real GDP -0.3 -1.1 -0.3 -0.1 1.8 2.1 1.1 0.3 0.9 1.1 1.7 Real GDI -0.5 -1.3 -0.1 1.4 3.1 3.7 2.4 1.5 2.0 1.8 2.0 Real GNI -0.9 -0.8 1.9 3.6 3.9 2.3 1.4 1.3 1.1 1.2 0.2 0.1 -0.3 -0.3 -0.1 -0.1 Net exports Real GDP -6 CY 07 0.0 y/y % chg. Public demand -5 0.1 0.6 Source: Cabinet Office. Exports and Production (1) Real Exports (2) Industrial Production s.a., CY 2010 = 100 s.a., CY 2010 = 100 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 CY 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Sources: Ministry of Finance; Bank of Japan; Ministry of Economy, Trade and Industry. Economy Watchers Survey s.a., DI Current conditions CY 11 Future conditions Current conditons (level) Source: Cabinet Office. Propensity to Consume on Compensation of Employees Basis s.a., % Private consumption divided by compensation of employees (SNA) 10-year average (2006-15) CY 94 Source: Cabinet Office. Active Job Openings-to-Applicants Ratio by Region 2.5 s.a., % Nationwide Tohoku Northern Kanto and Koshinetsu Tokai Chugoku Kyushu 2.0 Hokkaido Southern Kanto Hokuriku Kinki Shikoku 1.5 1.0 0.5 0.0 CY 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Source: Ministry of Health, Labour and Welfare. Active Job Openings-to-Applicants Ratio by Job Type times, 10 thousand people [reference] Active job openings-to-applicants ratio Active job openings-to-applicants ratio (including part-time employees) Effective job offers Effective job seekers (excluding part-time employees) 0.42 0.38 0.33 0.29 Service 3.28 2.67 Professional and engineering 2.20 2.19 Sales 1.92 1.67 Manufacturing process 1.48 1.40 Transport and machine operation 2.21 2.14 Construction and mining 3.84 4.03 Carrying, cleaning, packaging and related 0.73 0.49 Total (including others) 1.36 1.27 Nursing care-related 3.60 2.97 Clerical General clerical Notes: 1. Figures are those for regular workers that refer to either work without a fixed employment term or work with a fixed term of more than four months (excluding seasonal work). They are as of December 2016, and not seasonally adjusted. 2. "Nursing care-related" consists of "Welfare facility guidance professionals," "Other social welfare specialist professionals," "Housekeepers, home helpers," and "Care service workers." Source: Ministry of Health, Labour and Welfare. Consumer Prices 2.0 y/y % chg. 2015 base 1.5 All items less fresh food 1.0 All items less fresh food and energy 0.5 0.0 -0.5 -1.0 -1.5 CY 11 Note: Figures from April 2014 onward are estimated by adjusting the direct effects of the consumption tax hike. Source: Ministry of Internal Affairs and Communications. Consumer Prices (Continued) 2.0 y/y % chg. 1.5 2015 base 1.0 0.5 0.0 -0.5 Items other than energy Energy -1.0 CPI (all items less fresh food) -1.5 CY 13 Note: Figures from April 2014 onward are estimated by adjusting the direct effects of the consumption tax hike. Source: Ministry of Internal Affairs and Communications. Contribution of the Observed Inflation to Inflation Expectations in Advanced Economies (1) Contribution of the observed inflation to inflation expectations 1 year ahead (2) Contribution of the observed inflation to inflation expectations 6-10 years ahead 1.0 1.0 More adaptive More adaptive 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 0.0 Japan United States Euro area United Kingdom Japan United States Euro area United Kingdom Sources: Bank of Japan; Consensus Economics Inc., “Consensus Forecasts”; Ministry of Internal Affairs and Communications; BLS; Eurostat; ONS. The Impact of the Negative Interest Rate Policy (NIRP) and JGB Purchases on Interest Rates (1) 2-year JGB Yields (2) 5-year JGB Yields % 0.75 0.50 0.25 0.00 -0.25 -0.50 -0.75 -1.00 -1.25 -1.50 -1.75 CY 05 Introduction of NIRP Expansion of QQE Introduction of QQE % 0.75 0.50 0.25 0.00 -0.25 -0.50 -0.75 -1.00 -1.25 -1.50 -1.75 CY 05 06 (3) 10-year JGB Yields % 0.75 0.50 0.25 0.00 -0.25 -0.50 -0.75 -1.00 -1.25 -1.50 -1.75 CY 05 (4) 20-year JGB Yields % 0.75 0.50 0.25 0.00 -0.25 -0.50 -0.75 -1.00 -1.25 -1.50 -1.75 CY 05 06 Note: The graphs show the residuals obtained when regressing JGB yields (for 2 years, 5 years, 10 years, and 20 years) on 10-year U.S. Treasury bond yields, the year-on-year rate of change in the CPI (all items less fresh food), and the active job openings-to-applicants ratio as a proxy for the output gap. Sources: Bank of Japan; Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; Bloomberg. Bank Lending Rates (2) Euro Area (1) Japan 4.5 % 4.5 4.0 4.0 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 Short-term rates Long-term rates 1.5 1.5 1.0 1.0 0.5 0.5 0.0 CY 11 % Note: Figures are domestically licensed banks' average contract interest rates on new loans and discounts. Source: Bank of Japan. Short-term rates 0.0 CY 11 Long-term rates Note: Figures are interest rates on new loans. Source: European Central Bank. Yield Curve Control (YCC) 1.0 % 1.6 0.8 1.4 Current yield curve 0.6 1.2 Introduction of QQE with YCC 0.4 0.2 0.8 0.0 0.6 Range of changes in interest rates after the introduction of QQE with YCC -0.2 0.4 -0.4 -0.6 year 0.2 Source: Bloomberg. Economic Activity in Tokushima Prefecture (1) Business Conditions DI (Tankan) % points "favorable" - "unfavorable" (2) Industrial Production s.a., CY 2010 = 100 (3) Sales at department stores and supermarkets Tokushima prefecture Tokushima prefecture Nationwide s.a., CY 2010 = 100 Nationwide -10 -20 -30 -40 All industries Manufacturing Nonmanufacturing -50 -60 -70 CY08 09 10 11 12 13 14 15 16 17 CY08 09 10 11 12 13 14 15 16 CY08 09 10 11 12 13 14 15 16 Sources: Bank of Japan; Ministry of Economy, Trade and Industry; Shikoku Bureau of Economy, Trade and Industry; Tokushima Prefectural Government.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Deposit Insurance Corporation of Japan (DICJ)-International Association of Deposit Insurers (IADI) International Conference, Tokyo, 16 February 2017.
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February 16, 2017 Bank of Japan Building a More Robust Financial System: Where Are We after the Global Financial Crisis and Where Do We Go from Here? Speech at the DICJ-IADI International Conference Haruhiko Kuroda Governor of the Bank of Japan Introduction It is a great pleasure for me to be invited to the DICJ-IADI International Conference and to address all of you. Thank you very much for this opportunity. It is almost ten years since the onset of the Global Financial Crisis. At this juncture, I would like to look back on the efforts and results at the global level with the aim of preventing the return of the Crisis, and offer my thoughts on the challenges ahead if we are to maintain the stability of the global financial system. In retrospect, the Global Financial Crisis was triggered by problems in the U.S. subprime mortgage market. Initial losses incurred by financial institutions and investors in that market led to a severe liquidity shortage through loss of confidence among market participants. Subsequently, following the collapse of Lehman Brothers in September 2008, we had a full-blown crisis that destabilized the whole global financial system. Responding to the ever worsening situation, economies around the world unleashed aggressive macroeconomic measures, injected massive liquidity into financial markets, and provided taxpayers' support to financial institutions, including capital injection, and these measures prevented a contagious amplification of the Crisis. These efforts were complemented with measures developed through international cooperation so as to prevent the incidence of another crisis. As a result, the robustness of the global financial system has been greatly enhanced by, for example, higher capital and liquidity reserve levels at financial institutions, more options for liquidity provisioning by central banks, better legal frameworks for resolving financial institutions, and enhanced communications and cooperation among authorities. In the meantime, many central banks in the developed economies are pursuing extremely accommodative monetary policy, including unconventional policy measures, in order to extricate economies from low growth and low inflation. While these measures themselves are utterly essential responses to the conjunctural macroeconomic challenges, the resulting "low for long" environment is eroding lending margins, which are the sources of profits for financial institutions. Considering that financial institutions in the developed economies have faced increasing pressures on their revenue streams, reflecting structural changes in the financial system, the low profitability of financial institutions has become a global problem to be reckoned with. Building on these observations, for the rest of the time that I have today, I would like to explain how I understand the efforts aimed at strengthening the financial system following the Global Financial Crisis and what the remaining issues are, from three perspectives: (a) international financial regulation, (b) macroprudential policy, and (c) the "lender of the last resort" function of central banks. I will then conclude by offering my views on an emerging challenge regarding the stability of the financial system; that is, the profitability of financial institutions. Stronger International Financial Regulations Let me start with international financial regulations (Chart 1). In the period leading up to the Global Financial Crisis, the financial sector, especially in Europe and the United States, took on excessive leverage and the quality and level of capital were in decline. At the same time, many financial institutions depended on short-term market funding, which was also a contributing factor to the Crisis. These experiences led to the adoption of the Basel III set of rules, the main thrust of which was to oblige internationally active financial institutions to enhance their capital levels and to hold safe liquid assets. The final details of the framework are still being worked out. Furthermore, from the lesson of the dangers of moral hazard emanating from implicit public support of systemically important financial institutions, the so-called too-big-to-fail problem, these institutions are now required to hold additional capital to maintain total loss-absorbing capacity (TLAC) and to draw up recovery and resolution plans (RRPs) in case they face financial difficulties. These enhanced rules I have just described clearly have made the global financial system more robust. For example, looking at capital levels of financial institutions, the capital ratios of major European and U.S. banks have increased significantly (Chart 2). Japanese financial institutions, while they did not directly suffer much from the Crisis, also have increased their capital levels, in line with the stricter requirements at the global level. Under the powerful monetary easing by the Bank of Japan, they are actively taking risks in lending and securities investment, thereby positively influencing the Japanese economy and prices, which reflects in part their increasingly robust capital base. This clearly shows that the stability of the financial system is essential for monetary policy to be fully effective. Having said this, I also should stress that stronger regulation ought not to lead to excessive restrictions on financial intermediation. As I said, details of Basel III are still being worked out, and I recognize that the discussions should be wrapped up as soon as possible so as to minimize uncertainties over the business environment surrounding financial institutions. Any final agreement on the level of required capital, however, needs to balance the need to maintain the stability of the financial system and the functioning of financial intermediation. Keeping this in mind, the Bank of Japan will participate in the international deliberations leading to the finalization of Basel III. If and when there is an international agreement, the main thrust of international efforts will turn to evaluating the effects of the strengthened rules, ensuring that such rules are working as initially envisioned and there are no unintended consequences -- for example, whether liquidity in financial markets is impaired as a result of stricter rules such as the leverage ratio, and whether entities beyond the scope of regulation in the "shadow banking" sector are expanding. In addition, it is important to review whether the whole set of rules has not brought about overregulation or inconsistency, notwithstanding the desirability of individual rules. Whenever it becomes apparent through these assessments that there are problems in the rules, it is appropriate to make necessary adjustments. Developing a Macroprudential Policy Framework I will now move on to macroprudential policy (Chart 3). During the Global Financial Crisis, the issue of procyclicality became evident; i.e., the interactions between the financial system and the real economy amplifying the instability of the financial system. In response, macroprudential policy instruments have been introduced; for example, the countercyclical capital buffer (CCyB), which adjusts the level of required capital in accordance with the degree of excesses in the financial system, and the loan-to-value (LTV) regulation, which regulates the level of the minimum haircut for real estate collateral according to the state of the real estate market. Moreover, we also see the development of institutional frameworks for the implementation of macroprudential policy. For example, in jurisdictions with multiple regulatory and supervisory authorities involved in the safeguarding of financial stability, there has been establishment of interagency committees that aim to coordinate the views of relevant authorities, to make policy decisions, and to implement any decisions. In this regard, in Japan, the Financial Services Agency and the Bank of Japan created the "Council for Cooperation on Financial Stability" in 2014 and have been holding semiannual meetings since then. In the meetings, the two authorities have been exchanging views on the state of the financial system and financial markets, and through such interactions, the Financial Services Agency and the Bank of Japan are reinforcing their ties regarding macroprudential policy. As I have just noted, we are now seeing the development of macroprudential policy tools and institutional frameworks, but ensuring effective and timely implementation of policy measures in real life would be challenging. For that to happen, supervisory authorities and central banks must first be able to properly observe the signals that point to excessive activity or inactivity in the financial system. Once moving into action, there are still unresolved issues, such as the following: the lag between the imposition of measures and the manifestation of the effects of those measures; leakage of the effects into sectors that are outside the scope of macroprudential measures; and the necessity of taking into account other public policy areas, such as residential tax policy, in the case of the real estate market. All in all, the effects of the newly introduced macroprudential policy measures have not been fully verified, and we need to enhance our understanding through application and review. In any case, supervisory agencies and central banks charged with macroprudential policy must make every effort to improve their analyses of macro-level risks in the financial system and be on the lookout for any symptoms of financial instability evident in the activities of individual financial institutions. In this regard, the Bank of Japan will be enhancing its micro- and macro-level diagnostic capabilities through its on-site examinations and off-site monitoring of financial institutions and analyses published in the Financial System Report. A New Horizon for the "Lender of the Last Resort" Function As the third perspective regarding developments since the Global Financial Crisis, I would like to touch upon the "lender of the last resort" function of the central bank (Chart 4). Traditionally, the "lender of the last resort" function of the central bank has been a tool to be used when systemic risk manifests itself through contagion; in other words, the deteriorating health of one financial institution tainting other financial institutions through inferences made by depositors and/or links in payment networks. Generally, it was regarded as an operation to provide domestic currency funding to "solvent but illiquid" financial institutions. In contrast, during the recent Global Financial Crisis, systemic risk manifested itself in a different way: increasing concerns over counterparty risk among market participants resulted in a dramatic contraction of market activities. In response, central banks of major economies injected liquidity to financial markets through purchases of commercial paper and corporate bonds, and thus supported the continued functioning of markets. In this regard, the "lender of the last resort" function of central banks morphed into something broader by incorporating the "market maker of the last resort" function. Meanwhile, it also became evident during the Crisis that liquidity shortages in foreign currencies -- for example, resulting from the freezing of the currency swap market -- were extremely problematic, as the expanding global reach of financial institutions promoted financial intermediation in foreign currencies. Accordingly, in 2007, the European Central Bank and the Swiss National Bank each entered into a swap arrangement with the U.S. Federal Reserve, enabling the two European central banks to supply U.S. dollar funds to financial institutions in their jurisdictions. After the collapse of Lehman Brothers, the Bank of Japan, the Bank of England, and the Bank of Canada also entered into swap arrangements with the Federal Reserve, and in 2011, the individual arrangements evolved into a multilateral arrangement covering not only U.S. dollars but also other major currencies. One can say that, with the development of such a multilateral swap arrangement to supply foreign currency liquidity, the "lender of the last resort" function has developed into a "global lender of the last resort" function. This quick overview shows that the central bank is playing a bigger role with its "lender of the last resort" function. It could be safely said that we now have a more robust backstop as regards liquidity provision in the major currencies during market turmoil. The challenge ahead is to devise frameworks to deal with the case where a financial institution with a global reach faces foreign currency liquidity shortages for idiosyncratic reasons and the case involving non-major "local" currency liquidity shortages. For the Bank of Japan, potential systemic instability caused by shortages of foreign currency liquidity is an issue that requires prompt attention, in view of the fact that Japanese financial institutions are expanding their global businesses, including in Asia, while these institutions are still broadly enjoying good access to foreign currency funding. Reflecting on these challenges, the Bank of Japan has decided to provide U.S. dollar liquidity to individual banks facing temporary dollar funding difficulties utilizing the Bank's U.S. dollar-denominated assets. As to local currencies, the Bank established swap arrangements for Australian and Singaporean dollars with the respective central banks last year, which should enable the Bank to supply Australian and Singaporean dollar liquidity secured through these arrangements to Japanese financial institutions facing funding difficulties in these two currencies. Though the Bank must be careful in avoiding moral hazard at financial institutions, it will continue to develop backstop frameworks for foreign currency funding in conjunction with relevant authorities. The New Challenge of Low Profitability at Financial Institutions As we have seen today, much has been learned from the Global Financial Crisis and various measures have been put in place to prevent the return of the Crisis. While there are still gaps to be filled in every area, I should say that the global financial system has become significantly more robust than before the Crisis. However, this does not mean that there are no more areas that require attention regarding financial stability. Over the longer term, it is becoming important to cope with the potential risk of low profitability at financial institutions eroding financial stability. Faced with low growth and low inflation in the years following the Global Financial Crisis, many central banks of major economies adopted extremely accommodative monetary policy, including unconventional measures. As I noted at the beginning, such a policy stance itself reflects macroeconomic necessity, but the resulting plunge in nominal interest rates is negatively impacting profits at financial institutions through compression in interest rate margins. At this very moment, financial institutions around the world are still reporting respectable levels of profits, benefiting from lower credit costs in an improving economy and increased profits from selling securities for which prices appreciated as interest rates fell. Having said this, if the low interest rate environment persists, interest rate margins will be further eroded and the profitability of financial institutions will suffer as a result. In Japan, for example, financial institutions face structural headwinds including an aging and decreasing population (Chart 5). In Europe, low profitability is regarded as a risk to financial stability in the context of a non-performing loans problem at some financial institutions. This shows that the problem is more or less global. There are various channels through which low profitability at financial institutions could adversely affect financial stability. One channel is the inability of financial institutions to accumulate sufficient capital due to low profitability. That would heighten the risk of banks' capital being eroded when large credit losses occur or when securities investments incur large losses in a volatile market. With thin capital buffers, financial institutions could become too risk averse and not effectively perform their function as intermediaries. On the other hand, if financial institutions try to avoid such a predicament by taking excessive risks to increase revenues, such actions themselves would introduce new sources of instability to the financial system. All in all, in order for the financial system to ensure future stability, it is becoming more and more important in the long term to think about possible responses to low profitability at financial institutions. The starting point would be to have individual financial institutions accurately recognize the business environment that they are in, and formulate business models that appropriately take account of the environment. Financial institutions have a range of options and can, for example, step up efforts to find new SME and household lending opportunities, take risks in the securities markets, strengthen fee-collecting business lines, and cut costs including extensive restructuring of the branch network. Individual financial institutions must choose approaches that are best suited to their individual needs. In some cases, mergers or consolidation between financial institutions could be an option. In order for financial institutions to enhance profitability, authorities would play an important role. In that context, given that the business environment of each financial institution is different, and that forward-looking responses regarding the changing environment are essential, it may not be appropriate to adopt one-size-fits-all regulatory measures. Instead, a "soft" approach through supervision and guidance may be more effective in encouraging financial institutions to apply individually tailored solutions. In view of this, the Bank of Japan, through its on-site examinations and off-site monitoring, aims to encourage financial institutions to step up their risk management efforts in areas where the institutions are taking on increasing risk, and to deepen discussions with institutions regarding profitability enhancement. In addition, the Bank will actively support the efforts of financial institutions through the hosting of seminars targeted at enhancing the value of financial services. Concluding Remarks Today, I have taken a look at the efforts and results at the global level in aiming to prevent the return of the Global Financial Crisis, particularly in terms of policy areas that are closely related to the role of the central bank. Specifically, these are international financial regulation, macroprudential policy, the "lender of the last resort" function of central banks, and low profitability at financial institutions. Of course, I must admit that this is not the whole story: laws and regulations to deal with a failure of systemically important financial institutions have been greatly improved, and the international cooperative framework for crisis management has been significantly strengthened. In the meantime, deposit insurance schemes, which will be extensively discussed at this conference, now insure higher amounts under strengthened financial foundations, thereby contributing significantly to a more robust financial system. All in all, over the last ten years or so, the robustness of the global financial system has been steadily enhanced in many areas. Accordingly, the risk that we could fall into the same kind of crisis as the last one is probably lower to a considerable degree. Having said that, I must point out that the environment surrounding the financial system is undergoing rapid changes, including the development of FinTech and the rapid growth of the shadow banking sector. In addition, as I just noted, a new challenge has emerged in the form of low profitability at financial institutions. These developments suggest that a different kind of financial crisis could happen in the future. There will always be room for efforts to enhance the stability of the financial system, and authorities must continue to respond to changes in the environment. Fortunately, we now have a framework for global cooperation built up during the ten years since the Global Financial Crisis, and that framework was successfully applied to enhance the robustness of the financial system. There will be challenges ahead, but we are prepared to meet them with confidence. Thank you for your attention. Building a More Robust Financial System: Where Are We after the Global Financial Crisis and Where Do We Go from Here? Speech at the DICJ-IADI International Conference February 16, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 International Financial Regulations Dealing with the "too-bigto-fail" problem Basel III Strengthening the quality and quantity of capital (numerator) Improving risk coverage (denominator) ✔ Quantity: introducing the Common Equity Tier 1 capital and raising the minimum requirement ✔ Interest rate risk in the banking book ✔ Quality: adopting a stricter definition of bank capital ✔ Operational risk Capital ratio ＝ ✔ Credit risk Bank capital Risk-weighted assets Regulations on large exposure ✔ Liquidity coverage ratio (promoting the short-term resiliency under stressed scenario) ✔ Net stable funding ratio (securing stable funding structure for long-term investments) Effective bank resolution framework for G-SIBs Development of legal framework Establishment of recovery and resolution plans (RRPs) Supplementary tools: three new regulatory measures Liquidity measures Additional capital charge for GSIBs (G-SIB surcharge) Leverage ratio requirement Introduction of total lossabsorbing capacity (TLAC) Chart 2 Capital Adequacy of Financial Institutions in Major Countries Japan Europe United States % % % % FY08 09 10 11 CY08 09 CY08 09 Tier 1 capital ratio FY08 Common equity Tier 1 capital ratio Notes: 1. Figures for Japan are weighted averages of internationally active banks. 2. Figures for the United States are simple averages of five U.S. banks (Bank of America Merrill Lynch, Citi, Goldman Sachs, J.P. Morgan, and Morgan Stanley). 3. Figures for Europe are simple averages of six European banks (Barclays, BNP Paribas, Credit Suisse, Deutsche Bank, HSBC, and UBS). Sources: Bank of Japan; Bloomberg. Chart 3 Macroprudential Policy Macroprudential policy tools ✔ Countercyclical capital buffer (CCyB) ✔ Loan-to-value (LTV) regulation, etc. Institutional frameworks for the implementation of macroprudential policy ✔ Establishment of interagency committees in jurisdictions with multiple regulatory and supervisory authorities, etc. ✔ Creation of the "Council for Cooperation on Financial Stability" in Japan Chart 4 A New Horizon for the "Lender of Last Resort" Function The traditional "Lender of Last Resort" function ✔ Responding to the risk of the deteriorating health of one financial institution tainting other financial institutions through inferences made by depositors, etc. "Market Maker of Last Resort" function ✔ Responding to the contraction of market activities resulting from concerns over counterparty risk among market participants "Global Lender of Last Resort" function ✔ Responding to foreign currency liquidity shortages faced by globally active financial institutions Chart 5 Core Profitability of Japanese Financial Institutions Lending margins Operating profits from core business Major banks 3.0 % Major banks Regional banks Shinkin banks 2.5 tril. yen Second half of the fiscal year Shinkin banks Regional banks tril. yen tril. yen 2.5 1.0 2.0 0.8 1.5 0.6 1.0 0.4 0.5 0.2 0.0 0.0 0.0 FY89 91 93 95 97 99 01 03 05 07 09 11 13 15 FY89 91 93 95 97 99 01 03 05 07 09 11 13 15 4.5 4.0 First half of the fiscal year 3.5 3.0 2.0 2.5 2.0 1.5 1.5 1.0 1.0 0.5 0.5 FY04 Source: Bank of Japan. FY89 91 93 95 97 99 01 03 05 07 09 11 13 15
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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, Yamanashi, 23 February 2017.
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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, Yamanashi, 23 February 2017. * * * I. Economic Activity and Prices in Japan A. Current Situation of Economic Activity and Prices and the Baseline Scenario of the Outlook The Bank of Japan explains the current situation of Japan’s economic activity and prices and the baseline scenario of the outlook in the Statement on Monetary Policy, which is released after each Monetary Policy Meeting (MPM), and in the Outlook for Economic Activity and Prices (the Outlook Report), which is published quarterly. Next, I will provide an overview of the current developments in and outlook for economic activity and prices based on the latest Outlook Report released in January 2017. Japan’s economy has continued its moderate recovery trend. As for the outlook, it is likely to continue growing at a pace above the potential growth rate through the projection period — that is, through fiscal 2018 — on the back of highly accommodative financial conditions and the effects of the government’s large-scale stimulus measures, with the growth rates in overseas economies increasing moderately. Comparing the current projections with the previous ones, the projected growth rates are somewhat higher, mainly reflecting improvement in overseas economies and the yen’s depreciation, in addition to an upward revision to the GDP due to the comprehensive revision to GDP statistics. The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food has been about 0 percent. Regarding the outlook, it is likely to increase from about 0 percent and become slightly positive, reflecting developments in energy prices. Thereafter, it is expected to increase toward 2 percent as the aggregate supply and demand balance (the output gap) improves and medium- to long-term inflation expectations rise. Comparing the current projections with the previous ones, the projected rates of increase in the CPI (all items less fresh food) are more or less unchanged. The timing of the year-on-year rate of change in the CPI (all items less fresh food) reaching around 2 percent will likely be at the end of the projection period — that is, around fiscal 2018. B. My Outlook I believe that Japan’s current growth rate and inflation rate are generally stable, in light of the economy’s growth potential, and that there is a high probability of this stable situation continuing during the projection period in the January 2017 Outlook Report. However, it can be said that my view continues to be fairly cautious compared with the medians of the Policy Board members’ forecasts. Let me explain the reasons behind my view. First, there is not a driving force — including in terms of the effects of monetary easing — that will bring about economic growth that is sustainable at a level clearly higher than the potential growth rate, as the phase of economic recovery has been prolonged and the output gap has already almost closed. The economy is therefore likely to continue growing generally at about the same level as the potential growth rate, which is estimated to be around 0.5 percent. Second, as a result of these factors, the output gap is expected to remain more or less at a neutral level. Therefore, in my view, price conditions will remain consistent with the economy’s growth potential, as it is difficult to expect that there will be 1/8 BIS central bankers' speeches a marked rise in the underlying trend in inflation, which excludes factors causing temporary fluctuations, such as in fresh food prices and energy prices, as well as in import prices that are affected by changes in foreign exchange rates. 1. Considerations regarding the economic outlook I consider that Japan’s economy is likely to continue growing generally at about the same level as the potential growth rate throughout the projection period that covers through fiscal 2018. In my view, however, risks are skewed to the downside, especially at the end of the projection period. I will now explain risks to the economic outlook to which I pay particular attention. a. Overseas economies and exports Points to be considered regarding overseas economies include (1) the U.S. fiscal policy and its global impact, (2) the possibility of protectionist policies spreading around the world, (3) China’s lagged response to structural problems such as excess debt and excess production capacity, and (4) the vulnerability of the banking sector in Europe. Among these, I am particularly paying attention to the U.S. fiscal policy and its global impact. Since fall 2016, the possible implementation of large-scale fiscal policy in the United States has been factored into financial markets, which has in some way contributed to the improvement in the economic sentiment worldwide. However, the detail and scale of such fiscal policy are still unclear, and it may take considerable time for them to be revealed. Moreover, reflecting the decline of the U.S. economy’s presence, due mainly to growth in emerging economies, the effects of the U.S. fiscal policy on the global economy may actually be less than what financial markets expect. On the other hand, it is also possible to say that, due to the worldwide rise in long-term interest rates, which was triggered by a rise in U.S. long-term interest rates, the “crowding out” effect of the U.S. fiscal policy has been produced on a global scale. Ultimately, if negative effects — such as (1) the downward pressure exerted by the worldwide rise in longterm interest rates on each economy and (2) the destabilization of financial markets caused by an outflow of funds from emerging markets in response to the appreciation of the U.S. dollar — outweigh the positive effects of the U.S. fiscal policy on each economy, this could cause a negative impact on the global economy as a whole. In addition to such developments in overseas economies, it should be noted that Japan’s economy has been increasing its momentum on the back of the pick-up in exports since the latter half of 2016. I therefore consider that the export environment poses the most serious downside risks to Japan’s economy. In relation to this, my understanding is that there is a possibility that the potential volatility of yen exchange rates has risen toward both appreciation and depreciation in the foreign exchange market after the introduction of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control in September 2016, and I am paying attention to the possible effects of these developments on the export environment. b. Business fixed investment The first point to be considered regarding business fixed investment is developments in foreign exchange rates. Specifically, if the yen appreciates in the foreign exchange market as a result of investors’ risk aversion having increased globally, due in part to developments in overseas economies, this could in turn deteriorate corporate profits, thereby having the effect of constraining business fixed investment. The second point is that medium- to long-term growth expectations for Japan’s economy might not be raised as much as expected, depending on, for example, the progress made with respect to promotion of labor force participation of women and the elderly as well as the government’s growth strategy and the private sector’s initiatives in strengthening the economy’s growth potential. 2/8 BIS central bankers' speeches c. Private consumption The first point to be taken into account regarding private consumption is price developments. Namely, given that nominal wages continue to grow only moderately, there is a possibility that, if there are increases in prices — such as a surge in fresh food prices, a rise in energy prices, and an increase in import prices due to the yen’s depreciation — households’ outlook for real wages will deteriorate, thereby exerting downward pressure on private consumption. Second, if corporate profits decrease due to the yen’s appreciation, or if the economy’s potential growth rate and firms’ growth expectations for the domestic market wind up being lower than expected, firms might become more cautious about wage raises, which could in turn restrain private consumption. 2. Thinking behind the outlook for prices Let me turn to the year-on-year rate of change in the CPI (all items less fresh food). The Bank’s baseline scenario is that the timing of the rate of change reaching around 2 percent will likely be at the end of the projection period — that is, around fiscal 2018. On the other hand, my view is much more cautious than the baseline scenario: the year-on-year rate of change in the CPI (all items less fresh food) will likely remain well below 2 percent throughout the projection period through fiscal 2018. I therefore have been casting a dissenting vote on the description on the price outlook in the Statement on Monetary Policy and the Outlook Report and submitting a proposal to change the description at MPMs. I will explain what lies behind the difference between the Bank’s baseline scenario and my view. The first is the difference in the outlook for the output gap. The baseline scenario assumes that the output gap will improve as a trend and upward pressure on prices stemming from demandsupply conditions is likely to be exerted noticeably. As I mentioned, however, economic growth that is clearly above the potential growth rate is not easily sustainable, and therefore I consider that the notable improvement in the output gap is unlikely. The second is the difference in the outlook for medium- to long-term inflation expectations. The baseline scenario is that medium- to long-term inflation expectations are likely to follow an increasing trend and gradually converge to around 2 percent. However, the inflation rate is still at a low level, and this most probably will restrain the rate of increase in wages resulting from the wage negotiations between workers and management this coming spring. I therefore take the view that medium- to long-term inflation expectations will be more or less unchanged from the current level for the time being. The third is the difference in the outlook for services prices. Administered prices and some services prices seem to be not particularly responsive to the changes in demand-supply conditions, and these prices continue to show dull responses even amid the tightening of labor market conditions. In particular, housing rent has declined at a moderately accelerated pace recently, and it is my view that this might possibly constrain the inflation rate. The fourth is the difference in the outlook for the effects of the yen’s depreciation. According to the baseline scenario, the observed inflation rate is expected to rise, due in part to the recent yen depreciation. In this regard, I consider that, in light of the experience since 2013, although foreign exchange rates seem to have an increasing impact on inflation through import prices — reflecting structural changes such as the rise in import share of electrical parts that are used for the domestic production of electrical appliances — such rates will affect inflation for only a relatively short time and have a limited impact on the underlying trend in inflation. The fifth is the difference in the outlook for wages. In my view, it is unreasonable to expect a noticeable rise in the rate of increase in wages from the wage negotiations between workers and management this coming spring. I also consider that, if the yen’s depreciation and other factors 3/8 BIS central bankers' speeches cause a temporary rise in prices of items with high price volatility — such as energy-related products, food products, and electrical appliances — this more likely could result in a repeat of the situation in which a deterioration in consumer sentiment will result in weaker-than-expected private consumption, thereby restraining the inflation rate. II. Conduct of Monetary Policy In September 2016, the Bank conducted a comprehensive assessment of the developments in economic activity and prices as well as the policy effects since the introduction of QQE. Based on its findings, the Bank decided to introduce QQE with Yield Curve Control, which is a new monetary policy framework. In my view, the introduction of yield curve control largely aimed at addressing some concerns that had arisen since the introduction of QQE with a Negative Interest Rate. These include the possibilities that the flattening of the yield curve at a low level might excessively squeeze banks’ profits and that a substantial decline in interest rates at the long and super-long end will lower the rates of return on insurance and pension products and thereby might have a negative impact on economic activity through a deterioration in people’s sentiment. I consider that there is a positive aspect to yield curve control. For example, the Bank now has some latitude in terms of the pace of its purchases of Japanese government bonds (JGBs) because it changed the target for money market operations to short- and long-term interest rates upon the introduction of yield curve control. This leads to the possibility that the pace of JGB purchases will be reduced, thereby increasing the sustainability of such purchases. However, as I will elaborate on shortly, my view is that there also are many negative aspects to yield curve control. Based on my examination and comparison of positive and negative aspects, I have been casting a dissenting vote on yield curve control since its introduction in September 2016 through the most recent MPM held in January 2017. A. Assessment of Yield Curve Control 1. Issues regarding long-term interest rate control I view the following as issues with regard to long-term interest rate control. First, under yield curve control, it is uncertain whether the pace of the Bank’s JGB purchases will slow to an extent that would be sufficient to enhance the sustainability of such purchases; instead, there is a risk that the Bank might need to further increase the pace of its purchases. Since “quantity” and “interest rate” are generally determined simultaneously, my understanding is that it is difficult to conduct smooth money market operations while setting explicit targets for both dimensions. When the interest rate dimension is to be controlled, control over the quantity dimension could be lost. Therefore, the Bank’s new policy framework can be explained as having taken this point into consideration, and non-rigid targets have been set on both the quantity and interest rate dimensions — indicating that an annual pace of increase in the amount outstanding of the Bank’s JGB holdings should be “about” 80 trillion yen, and the target level of 10-year JGB yields is set at “around” zero percent. However, I regard this as entailing a high possibility that neither target will be achieved. Such a possibility is likely to materialize when there are external shocks to the JGB market. I therefore consider that the current upward pressure on Japanese long-term interest rates, which has been stemming from the rise in such rates in the United States since November 2016, is posing the first challenge for the Bank in controlling long-term interest rates. Second, of the elements that constitute nominal long-term interest rates, only term premiums are considered to be directly affected by the adjustments in the pace of JGB purchases. However, since term premiums have been reduced to a considerable degree due to the Bank’s JGB purchases to date, room for a further reduction is likely to be limited. On this basis, in order for the Bank to smoothly control nominal long-term interest rates while avoiding large fluctuations in 4/8 BIS central bankers' speeches the pace of its JGB purchases, one option is to make use of forward guidance regarding the future path of short-term interest rates. However, I believe that the longer the term of interest rates, the more likely the credibility of such forward guidance is lessened, thereby making it more difficult to control interest rates. Third, controlling long-term interest rates at a certain level could undermine the automatic stabilizer function of the economy, which operates through fluctuations in interest rates. Compared with when long-term interest rates are not controlled, controlling these rates could increase the volatility in the economy and destabilize it. For example, in a case where a negative shock hits the economy and inflation expectations decline, if the Bank conducts an operation so that nominal long-term interest rates do not decline, such rates in real terms would rise in turn, thereby causing restraints on economic activity. In contrast, in a case where there is a positive shock to the economy and inflation expectations rise, if the Bank conducts an operation to constrain a rise in nominal long-term interest rates, such rates in real terms would decline in turn, thereby possibly producing an excessive stimulus to economic activity. In this regard, the Bank’s monetary policy framework allows the Bank to make policy adjustments as appropriate, taking into account developments in economic activity and prices as well as financial conditions. However, I consider that, in reality, changing the target level of 10-year JGB yields is not easy. That is, if the target level is reviewed frequently, there is a risk that the credibility of the target might decline, leading to possible market volatility. Let me also note that, considering that the Bank is controlling not only short-term interest rates but also long-term ones in order to achieve the price stability target of 2 percent in a stable manner, it would be unreasonable to raise the target level of 10-year JGB yields in the near future when the inflation rate remains at a low level. Fourth, if the Bank continues with its current pace of JGB purchases, I consider that there is a risk of falling into a spiral in which the liquidity in the JGB market will decline substantially and a resultant increase in the liquidity premium would lead to a rise in long-term interest rates, thereby causing the need for the Bank to further increase the pace of its JGB purchases. Fifth, in my understanding, although the fixed-rate JGB purchase operations and fixed-rate fundssupplying operations with a long-term maturity could contribute to raising the Bank’s ability to control interest rates, they could destabilize the JGB market through significant impairment of market functioning, as well as distort the pricing mechanism in overall financial markets. That is why I dissented from introducing these tools of market operations. 2. Adverse effects of the negative short-term policy interest rate With regard to the adverse effects of guiding the short-term policy interest rate in negative territory, there is a risk that the financial intermediation function would be impaired through a deterioration in financial institutions’ profits. I am concerned about such a risk, although it has not yet materialized, as this should be kept in mind if the negative short-term interest rate policy is to be prolonged. Specifically, banks may take excessive risks at a time of profit deterioration in an attempt to increase their profits, but they may become excessively risk averse in the future, mainly because losses will be incurred by a possible worsening of economic and financial developments. This could negatively affect economic activity and financial markets by exacerbating firms’ and households’ borrowing constraints and through banks’ fire sales of assets. Furthermore, from a longer-term perspective, the impairment of banks’ financial soundness might also have negative effects on the efficiency and productivity of the economy. To give an example, amid a continued decline in banks’ profitability, banks with declining loss-absorbing capacity might postpone appropriate treatment of borrowers with weak performance. This may cause a situation in which capital and labor are being allocated to inefficient firms, and thus, in terms of the overall economy, result in pushing down the rate of increase in total factor 5/8 BIS central bankers' speeches productivity over the long run. In consideration of these points, let me mention the following. Monetary policy is generally thought to affect the demand side of the economy. However, if the policy impairs financial system stability, the supply side of the economy — for example, the productivity growth rate and the potential growth rate — may also be adversely affected, causing significant losses in social welfare. B. My Proposal Aimed at Enhancing the Stability and Sustainability of the Bank’s JGB Purchases I have been submitting a proposal, which includes the following: the Bank should set the amounts of its asset purchases as the target for money market operations, and with regard to the guidelines for asset purchases, it should purchase JGBs so that their amount outstanding will increase at an annual pace of about 45 trillion yen. Next, I will explain the idea behind the proposal. The Bank has been purchasing large amounts of JGBs under QQE, and the share of its JGB holdings already has reached about 40 percent of the total outstanding amount of JGBs issued. On the other hand, financial institutions in Japan need to hold JGBs for a variety of reasons. For example, banks need to hold a certain amount of JGBs for such purposes as collateral for transactions and compliance with financial regulations. Pension funds are required to hold a certain portion of their investment assets as safe assets, like JGBs, with a view to structuring an appropriate portfolio. It is necessary for life insurance companies to hold a fair amount of JGBs, particularly super-long-term ones, for the purpose of asset-liability management (ALM) and of meeting accounting requirements, as they have very-long-term liabilities because of their life insurance products. Therefore, it is not the case that the Bank is able to hold all of the JGBs issued. In my understanding, if the Bank continues with the current pace of JGB purchases, it inevitably will have difficulty in continuing to make such purchases. Moreover, there is a concern that the more difficult the JGB purchases become, the more easily interest rates will be volatile, as uncertainty over the future monetary policy increases and the liquidity in the JGB market declines excessively. This could have a serious impact on financial markets and economic activity. In order to prevent such incidents from occurring, I have been proposing since the MPM held in April 2015 to reduce the annual pace of increase in the amount outstanding of the Bank’s JGB holdings from the current pace of about 80 trillion yen to about 45 trillion yen. My understanding is that, since the introduction of yield curve control in September 2016, given that the Bank has temporarily reduced the pace of purchases of super-long-term JGBs, for example, market participants widely share the view that the Bank might proceed with the reduction in the pace of its JGB purchases as long as circumstances permit. It should be noted that one of the reasons why financial markets have stayed relatively calm despite such a view is that market participants are to some degree accepting the stock view — that is, the idea that the reduction in long-term interest rates and resultant monetary easing effects depend on a central bank’s holdings of government bonds (stock) rather than the pace of bond purchases (flow). Under these circumstances, I believe that the Bank should set the amounts of its asset purchases as the target for money market operations, and for the time being incrementally reduce the pace of its JGB purchases to the level at which the amount outstanding will be unchanged, instead of conducting yield curve control under which the controllability of the amount of its JGB purchases seems uncertain. This alternative measure will contribute to making the Bank’s asset purchases more sustainable and enhancing market stability. By doing so, the Bank can keep long-term real interest rates stably at low levels and thereby secure the accumulated monetary easing effects seen so far, which I believe is most important for the Bank’s monetary policy. 6/8 BIS central bankers' speeches C. My View regarding the Price Stability Target and the Role of Monetary Policy 1. Need for the flexibility of the 2 percent price stability target In addition to the proposal to change the guidelines for money market operations, I have been submitting a proposal to reset the time frame for achieving the price stability target of 2 percent to the medium to long term. I consider it appropriate to implement these two proposals together. Next, I will explain my view regarding the price stability target that lies behind my proposals. First of all, I believe that the optimal inflation rate is at a level where households and firms can engage in economic activity in a stable manner without worrying about price developments. This rate is mostly consistent with medium- to long-term inflation expectations of households and firms. However, I should note that a wide range of indicators suggest that medium- to long-term inflation expectations have been clearly below 2 percent for a long time. I therefore consider it inappropriate at this point to aim at achieving the 2 percent price stability target in a short period of time — whereby the inflation rate will be maintained at around 2 percent in a stable manner — not only because this is unfeasible, but also because this will have a negative impact on the economic activity of households and firms. 2. Economic structure and the underlying trend in inflation I would note that the underlying trend in inflation is considered to be determined by various factors, including the supply and demand balances in goods and services, developments in the labor market, the observed inflation rate, and the level of a central bank’s inflation target. From a somewhat long-term perspective, it seems to be largely influenced by structural factors of the economy, such as the productivity growth rate and the potential growth rate. For example, in a situation where the economy’s potential growth rate and firms’ growth expectations for the domestic market are at low levels, it is natural for firms to take a cautious stance toward raising base pay as such a raise could squeeze their profits in the future, and workers seem to acknowledge such a stance. In this situation, medium- to long-term inflation expectations of households and firms seem likely to be formed at low levels, thereby restraining the observed inflation rate at a low level as well. If, under these circumstances, the inflation rate were to rise temporarily due in part to the effects of monetary policy, consumers might restrain spending given concerns over the possible slower rate of increase in real wages, and as a result the observed inflation rate could decline in a short period of time. In fact, it is difficult for monetary policy to directly bring about a positive change to the economic structure. To achieve such a change, it is necessary for firms to make efforts to enhance innovation and for the government to create initiatives for structural reforms, including deregulation that will encourage firms to make utmost efforts in that regard and measures to respond to the population decline. In order for the public to be able to enhance the quality of life in a sustainable manner, it is absolutely necessary that Japan’s growth potential be strengthened through an improvement in the productivity growth rate and the potential growth rate. 3. Future role of monetary policy If Japan’s economy is able to achieve strong growth with further positive changes in economic structure going forward, households’ and firms’ medium- to long-term inflation expectations will rise to around 2 percent, and this will support the observed inflation rate continuing to be stable at around 2 percent. In this situation, it can be expected that it will become appropriate to set the price stability target at 2 percent. However, as it is difficult to project the time frame in which such a positive change in the economy will occur, I believe that the price stability target of 2 percent should be set as the target to be achieved in the medium to long term and be regarded as a kind of symbol in the Bank’s aim, along with the government and firms, to realize a strong economy 7/8 BIS central bankers' speeches that is consistent with the 2 percent price stability target. That being said, it seems difficult for the government and firms to make efforts to promote a positive change in economic structure under unstable financial and economic conditions. In this sense, my understanding is that the Bank’s role is to ensure financial and economic stability, thereby consistently providing indirect support for efforts by the government and firms so that the economy’s growth potential — which is represented mainly by the potential growth rate and the productivity growth rate — will increase to the level consistent with the 2 percent inflation rate. To this end, rather than aiming to strengthen monetary easing at any cost, it is more important to maintain the stable financial and economic environment by keeping long-term real interest rates at low levels in a stable manner and securing the monetary easing effects seen so far. My proposal to change the guidelines for money market operations, which I have been submitting at MPMs, is based on such a viewpoint. I believe that this proposal is in fact a quicker way of achieving the 2 percent price stability target. 4. Importance of flexible monetary policy conduct It is important that the Bank, with the stance of aiming at achieving the price stability target of 2 percent in the medium to long term, conduct monetary policy in a flexible manner while paying close attention to risks such as an emergence of financial imbalances, in view of ensuring economic and price stability in the medium to long term. In fact, 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. Specifically, 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 the longer term, various risks that are most relevant to the conduct of monetary policy aimed at achieving sustainable growth under price stability. In particular, financial imbalances will be examined as a risk that could 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 implemented. I consider it necessary to recall the background and idea behind why the framework of assessing economic activity and prices from the two perspectives was established. 5. Responsibility of the Bank Lastly, I will touch on the Bank’s responsibility. I believe that the Bank has an important responsibility to make every effort to maintain financial and economic stability under the flexible price stability target and policy conduct. To this end, the Bank needs to normalize, at an appropriate timing, the unprecedented monetary policy that has been implemented since the introduction of QQE. The Bank also should carefully address various possible adverse effects of monetary easing — such as (1) turmoil in the JGB market stemming from a decline in liquidity, (2) a malfunctioning of financial intermediation under the low interest rate environment, and (3) a deterioration in the Bank’s financial soundness in the case of a rise in the short-term interest rate while having a massive balance sheet — so as to prevent such adverse effects from materializing and having significant negative effects on Japan’s economy and people’s lives. 8/8 BIS central bankers' speeches
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Speech by Ms Takako Masai, Member of the Policy Board of the Bank of Japan, at a Seminar, hosted by the Embassy of Japan in Switzerland (Zurich), 6 March 2017.
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March 6, 2017 Bank of Japan Economic and Financial Developments and Monetary Policy in Japan Speech at a Seminar Hosted by the Embassy of Japan in Switzerland (Zurich) Takako Masai Member of the Policy Board Introduction It is a great honor to have the opportunity today to be invited to this seminar hosted by the Embassy of Japan in Switzerland, and to exchange views with such a distinguished gathering of people representing the economic and financial communities in Switzerland. Today, I will first touch on economic and financial developments in Japan. After that, I would like to explain the Bank of Japan's monetary policy and then share my views on the challenges and future for the economy. I. Economic and Financial Developments in Japan I will start by presenting my overview of the current economic and financial situation in Japan, in order to provide a broad picture. Then, I will give a summary of the latest Outlook for Economic Activity and Prices, or the Outlook Report, published in January 2017. The Outlook Report presents the Bank's assessment of the current situation and the outlook for economic activity and prices, and is published quarterly. A. My Overview of Economic and Financial Developments 1. Household sector Favorable employment situation and household sentiment The current situation for Japan's economy is characterized by tight labor market conditions. The average unemployment rate for 2016 declined to 3.1 percent, a level close to so-called full employment. The active job openings-to-applicants ratio for 2016 rose to about 1.4 times on average, which is the highest level in 25 years. It has risen, for example, not only in metropolitan areas but also in all other regions (Chart 1). I believe that such a favorable employment situation undoubtedly has supported household sentiment. Individuals can feel great confidence when they do not need to be concerned about whether their wages will be cut, even if corporate performance underperforms to some extent, or whether they can find another job. This sense of reassurance is crucial in Japan, where the mobility in the labor market is said to be relatively lower than in other countries. Such improvement in household sentiment can be seen, for instance, in the remarkable improvement in the Nippon Research Institute (NRI) Consumer Sentiment Index, which measures the outlook among consumers for financial conditions over the next one year from now. Looking back at 2016, Japan's economy continually faced several destabilizing factors, such as the turbulence in global financial markets from early in the year and situations at home -- namely, the Kumamoto Earthquake and irregular weather in summer. Despite these circumstances, household sentiment showed resilience. I consider that one of the factors of this is likely to have been the tightening of labor market conditions (Chart 2). Private consumption has shown some signs of improvement, driven by a moderate increase in employee income. On the back of tightening labor market conditions, a modest increase in employee income has been seen (Chart 3). In Japan, the action of increasing annual wage levels by revising the pay table is referred to as "base up." This is a general wage increase made across all employees, apart from wage increases due to promotion, based on age, and/or the number of working years. This is a practice that was introduced during the rapid economic growth period. However, from the late 1990s, firms stepped up their efforts to contain labor costs. As a result, most firms stopped using base up from the 2000s. Meanwhile, in the wage negotiations in 2014 and thereafter, this practice has been widely resumed among firms for the first time in more than a decade. This year is the fourth one since such trends have been visible, but some are concerned that the results of the negotiations this year would be disappointing given that the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) has been slow to increase recently, due mainly to the fall in energy prices. Even so, now that employees' concerns are not over a wage cut, but rather how much wages will increase, we are at least heading in the right direction considering the fact that hardly anybody had talked about base up as an issue for nearly 20 years until a few years ago. Private consumption has shown some signs of improvement recently, given household sentiment being supported and improved employee income. My impression is that a virtuous cycle from income to spending has been maintained in the household sector. However, there are the following points to consider: (1) wage increases are weak despite tightening labor market conditions, and (2) consumption is rather lackluster despite the steady improvement in employee income. That is to say, consumption has shown some signs of improvement but has lacked momentum. Therefore, the virtuous cycle from income to spending should become a little more promising. 2. Corporate sector Corporate profits have been at record high levels, but firms have been taking a cautious view on the outlook. Corporate profits in Japan reached record highs from fiscal 2013 through fiscal 2015, and have remained at high levels thereafter. Under these circumstances, business fixed investment has been on a moderate uptrend, and the virtuous cycle from income to spending seems to be maintained in the corporate sector as well. That being said, despite the expansion in profits, it is true that the growth in business fixed investment is slower. As background to this, it has been pointed out that the expansion in corporate profits in the current recovery largely owes to the improvement in the terms of trade rather than the increase in sales volume, which tends to lead to a rise in growth expectations. As a result, the business fixed investment expansion was not strong enough.1 However, it also has been pointed out that, even if the increase in corporate profits was based on the improvement in the terms of trade, there would likely be a positive impact on business fixed investment if such an improving trend is confirmed. In addition, highly accommodative financial conditions have been encouraging firms to invest. As with the household sector, it is important to raise growth expectations to further reinforce the virtuous cycle in the corporate sector. I will go into the details on this point later. The stabilization of energy prices has a positive impact on Japan's economy. The high volatility of exchange rates, if it continues, can deteriorate business sentiment. Let me make two additional points with regard to the corporate sector. First, it is important to note that the outlook for energy prices, including crude oil prices, improved since late 2016 -- namely, that they would remain stable. This should have a For the background to firms' prolonged cautious fixed investment stance despite their profits at record high levels, see "Corporate Profits and Business Fixed Investment: Why Are Firms So Cautious about Investment?," Bank of Japan Review Series, No. 2016-E-2, April 2016. positive impact on the global economy as well as Japan's economy. Given this, my view is that the downside risks to the economy have been reduced compared to the second half of 2016. Second, large swings in foreign exchange rates can be a cause for concern. Looking at the dollar/yen exchange rate fluctuations in 2016, volatility was a bit high and exchange rate levels fluctuated markedly up and down, with the yen appreciating roughly in the first half of the year and depreciating in the second half. Looking back, 2016 was a year in which there tended to be infrequent trading at around the yearly average exchange rate. I assume that these marked exchange rate fluctuations within a relatively short period have made it difficult for firms to steer management. I believe that this is readily imaginable among people representing the economic and financial communities in Switzerland, which tend to be affected significantly by fluctuations in foreign exchange rates, as with Japan. There is concern that these kinds of large swings in the exchange rates, if they continue, might have a negative impact on business sentiment. So far, I have given a broad picture of Japan's economy. In short, both employee income and corporate profits have been increasing and the virtuous cycle from income to spending has been maintained both in the household and corporate sectors; however, more should be done to further strengthen it. Next, I will look more closely at the current situation and the outlook for Japan's economy by presenting the main contents of the latest Outlook Report. B. Current Situation and Outlook 1. Current situation The Bank's assessment is that Japan's economy has continued its moderate recovery trend. On the domestic demand side, business fixed investment has been on a moderate uptrend as corporate profits have been at high levels and business sentiment has improved somewhat. Against the background of steady improvement in the employment and income situation, private consumption has been resilient, and housing investment has continued its pick-up. A rise in exports seems to have been even more persistent recently. Amid an improvement in business sentiment of manufacturing firms on a global basis, there is a steady rise in the number of items for which export volume increased, particularly backed by expansion in IT-related demand and by inventory and capital stock adjustments in emerging economies. Industrial production has shown signs of improvement, reflecting these developments in demand both at home and abroad, as well as inventory adjustments. On the price front, the year-on-year rate of change in the CPI (all items less fresh food) has been at around 0 percent on the whole, as the negative contribution of energy prices that reflect past developments in crude oil prices and the positive contribution of prices other than energy largely offset each other. 2. Outlook I will now look at the outlook for Japan's economy during the projection period, which covers from fiscal 2016 through fiscal 2018. The Bank's assessment is that Japan's economy is expected to turn to a moderate expansion. Domestic demand is likely to follow an uptrend on the back of highly accommodative financial conditions and fiscal spending through the government's large-scale stimulus measures. Meanwhile, exports are expected to follow a moderate upward trend on the back of improvement in overseas economies. Reflecting this outlook, Japan's economy is likely to continue growing at a pace above its potential through the projection period. Looking at the medians of the Policy Board members' forecasts in the January 2017 Outlook Report, the real GDP growth rate is projected to be 1.4 percent for fiscal 2016, 1.5 percent for fiscal 2017, and 1.1 percent for fiscal 2018 (Chart 4). Let me explain the outlook in detail by major component. As for business fixed investment, with some time lag, the past slowdown in emerging economies and yen appreciation are likely to exert downward pressure for the time being, mainly in manufacturing firms. However, throughout the projection period, it is likely to continue to see a moderate uptrend. This is because, in a situation where extremely stimulative financial conditions -- such as low interest rates and accommodative lending attitudes -- have been maintained, fixed investment will be positively affected by the effects of fiscal measures including projects conducted under the Fiscal Investment and Loan Program and tax reductions for capital investment, as well as by moderate improvement in growth expectations. Moreover, corporate profits are projected to improve, but even if they become weaker than expected to some degree, business fixed investment is likely to be supported in particular by investment (1) in redevelopment projects in view of the 2020 Tokyo Olympics, (2) in research and development for growth areas, (3) in labor-saving machinery and equipment in order to deal with labor shortages, and (4) for maintenance and replacement of equipment to address deterioration from aging. Private consumption is expected to increase moderately, supported by a steady improvement in employee income, as well as the wealth effects stemming from a rise in stock prices and the effects resulting from the set of stimulus measures. Housing investment is likely to continue improving. Exports will likely continue their pick-up trend for the time being, as the effects of the slowdown in emerging economies wane, and thereafter are projected to increase moderately. This is because it is forecasted that the growth rate of the world trade volume will accelerate gradually with the further recovery in overseas economies, and that Japan's share of exports will increase moderately, due in part to a worldwide recovery in the sector of capital goods. Industrial production is projected to increase modestly, reflecting a rise in demand at home and abroad, with the effects of the slowdown in emerging economies waning and those of the set of stimulus measures becoming evident. As for prices, the year-on-year rate of change in the CPI (all items less fresh food) is likely to increase from about 0 percent and become slightly positive, due mainly to the negative contribution of energy prices dissipating. Thereafter, it is expected to increase toward 2 percent as the aggregate supply and demand balance improves and inflation expectations rise. Looking at the medians of the Policy Board members' forecasts in the January 2017 Outlook Report, the year-on-year rate of change in the CPI (all items less fresh food) is projected to be minus 0.2 percent for fiscal 2016, 1.5 percent for fiscal 2017, and 1.7 percent for fiscal 2018 (Chart 4). II. The Bank's Monetary Policy Next, I will talk about the Bank's monetary policy. I would like to start with a brief review of the Bank's monetary policies, which have been conducted in various unconventional ways for nearly 20 years. A. The Bank's Monetary Policy under Deflation Japan's economy had been suffering from deflation for more than 15 years, since the late 1990s, with the year-on-year rate of change in the CPI being about zero or slightly negative. Of course, the Bank did not merely stand by during that period. In 1998, Japan's policy interest rate -- which at that time was the uncollateralized overnight call rate -- already had been lowered to close to zero, at 0.25 percent. Given that economic activity and prices did not improve even in this situation, in February 1999, the Bank introduced a zero interest rate policy, and in April of that year, introduced what is now called forward guidance, stating that it would continue with the zero interest rate policy until deflationary concern is dispelled. Thereafter, in March 2001, it introduced a quantitative easing policy, in which the operating target was the outstanding balance of current accounts at the Bank. I would note that, at the same time, the Bank introduced forward guidance that was linked to the observed CPI. Later, it also implemented a comprehensive monetary easing policy in October 2010, in which it purchased assets such as CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). The Bank continues to make these asset purchases to the present, and with respect to ETFs and J-REITs, it has significantly increased the amount of purchases since 2013. Meanwhile, it also introduced the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth as well as the Fund-Provisioning Measure to Stimulate Bank Lending, and these also continue to this day. As illustrated, the Bank has pursued monetary easing by making full use of various means. As a result, accommodative financial conditions have been realized in Japan, as seen in, for example, the fact that long-term interest rates since the 2000s had generally been at a low level of around 1-2 percent and that the rates during the one year before Quantitative and Qualitative Monetary Easing (QQE) began in 2013 were around 0.8 percent on average. Such accommodative financial conditions have underpinned the economy, and the Bank's large-scale fund-provisioning measures have contributed -- in certain phases -- to maintaining financial system stability and preventing the economy from falling into a deflationary spiral. Nevertheless, it is true that at the same time there continued to be mild deflation. Therefore, the Bank made a strong and clear commitment to ensuring the economy's exit from deflation -- which had lasted for nearly 15 years -- and began large-scale monetary easing to fulfill the commitment. This is QQE, which continues through to the present. B. Introduction of the Price Stability Target of 2 Percent and QQE The Bank introduced the price stability target in January 2013 and set it at 2 percent in terms of the year-on-year rate of change in the CPI. Until then, it had judged 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 had set a goal of 1 percent for the time being. At the same time, the government and the Bank released a joint statement, in which they emphasized their policy coordination. I view this as extremely important, because it indicated the determination by the government and the Bank to work together in order to overcome deflation and achieve sustainable economic growth. The Bank then introduced QQE in April 2013. After increasing the amount of its asset purchases further in 2014, it adopted a negative interest rate policy in January 2016 and introduced QQE with Yield Curve Control in September of that year. 1. Basic mechanism of monetary easing Since the introduction of QQE in April 2013, the basic mechanism of monetary easing itself has not changed; that is, (1) pushing down the entire yield curve through the Bank's large-scale purchases of Japanese government bonds (JGBs), and (2) raising inflation expectations through the Bank's strong commitment to the 2 percent price stability target. The transmission mechanism envisaged by the Bank is that these factors will lead to a reduction in real interest rates, thereby producing positive effects on Japan's economic activity and prices (Chart 5). 2. Positive effects of QQE In 2016, the Bank conducted a comprehensive assessment of the developments in Japan's economic activity and prices as well as policy effects since the introduction of QQE. The findings of the assessment are that the mechanism just described has been operating firmly, such that even long-term real interest rates have been in negative territory, and that economic activity and prices have largely improved. The underlying trend in the CPI (all items less fresh food and energy) turned positive and has been in such territory for more than two and a half years; this also leads to the judgment that, through the achievement of highly accommodative financial conditions, Japan's economy has reached a state of being no longer in deflation, which is commonly defined as a sustained decline in prices (Chart 6). It is reasonable to regard this as achievements accomplished under QQE. 3. Aims of QQE with Yield Curve Control Despite the fact that QQE has proven to be effective in this manner, why did the Bank introduce last year QQE with Yield Curve Control as a means of strengthening the framework for monetary easing? My understanding is that there are two points as the background to this. First, although QQE has produced its intended effects, the price stability target of 2 percent has not been achieved, and therefore a more effective framework was necessary. Second, while it was confirmed that the combination of large-scale purchases of JGBs and the negative interest rate policy was effective in influencing the entire yield curve, there was concern over a possibility that this combination could in some cases push down the yield curve more than necessary, thereby having a negative impact on financial functioning. Let me briefly elaborate on this second point. In Japan, because the level of interest rates -including long-term ones -- has remained low, as I mentioned earlier, and lending competition has been severe amid a decreasing trend in loan-to-deposit ratios, financial institutions' loan-deposit interest margins have been on a declining trend since the 1990s. In that sense, this has been a challenge faced by financial institutions' management even before the introduction of the negative interest rate policy. Since the introduction, it is true that the decline in deposit rates has been smaller than the decline in lending rates. Therefore, the excessive declines in long-term and super-long-term rates should have spurred on the declining trend in interest margins. It was confirmed that, if the situation were to continue, financial institutions' profits could be affected to some extent. The excessive declines in long-term and super-long-term rates lower the rate of return on insurance and pension products; therefore, it is possible that such developments can cause uncertainty regarding the sustainability of financial functioning in a broad sense, thereby having a negative impact on economic activity through a deterioration in people's sentiment. Given such issues to be considered, the Bank decided that it was appropriate to shift to a policy framework that would enable it to conduct monetary policy in a flexible manner. 4. Yield curve control Under "yield curve control," which is the major component of the new framework, the Bank is able to conduct monetary policy in an effective and flexible manner by taking account of the economic, price, and financial conditions, as it directly targets long-term interest rates. To put it simply, nothing has changed in terms of the Bank's commitment, in that it is continuing with large-scale JGB purchases; however, while the Bank used to set the paces of increase in the monetary base and the amount outstanding of its JGB holdings as its operating targets, in the new framework it has set the short-term policy interest rate and the target level of the 10-year JGB yields as its operating targets. Under the past framework, it was clear how JGB purchases are conducted, but there was a possibility that the purchases could push down yields either insufficiently or excessively, in comparison with an appropriate yield curve. I would note that the new framework enables the Bank to conduct monetary policy while also paying due attention to the impact on the financial functioning. 5. Inflation-overshooting commitment Another component of QQE with Yield Curve Control is an "inflation-overshooting commitment." With this commitment, the Bank aims to raise inflation expectations by demonstrating its strong determination. Inflation expectations are formed through the following two mechanisms: (1) an adaptive formation mechanism, in which the formation is influenced by the course of the past inflation rate, and (2) a forward-looking formation mechanism, in which the formation is based on the idea that the observed inflation rate will, in due course, meet the price stability target set by the central bank. On this point, the mechanism of formation of inflation expectations in Japan tends to be adaptive, and considerably more so than in other countries (Chart 7). The Bank has attempted to make expectation formation more forward-looking through QQE. In reality, however, before the forward-looking expectation formation fully took hold, the observed inflation rate declined, due mainly to the fall in crude oil prices. As a result, people's inflation expectations also declined in an adaptive manner. Therefore, I consider that, in order to achieve the price stability target of 2 percent, it is absolutely necessary to raise inflation expectations and promote a shift in expectation formation toward a more forward-looking direction. The inflation-overshooting commitment is a means to this end. Although the momentum toward achieving the 2 percent price stability target has been maintained, it continues to lack firmness. The Bank will make policy adjustments as appropriate, taking account of developments in economic activity and prices as well as financial conditions, with a view to maintaining the momentum toward achieving the price stability target. III. Reinforcement of the Virtuous Cycle As I mentioned earlier, the challenge facing Japan's economy is to further reinforce the virtuous cycle from income to spending in both the household and corporate sectors. Let me reiterate that consumption has not increased as much in the household sector, considering the tight labor market conditions and the increase in employee income. Several factors have been pointed out as the cause of such sluggishness in private consumption; for example, (1) temporary factors such as the effects of a decline in stock prices and the effects of irregular weather, and (2) pressure from stock adjustments of durable goods. In addition, my impression is that a vague uneasiness among people about the future cannot be ignored. This uneasiness has a great impact on private consumption in Japan, where the population is aging rapidly and consumption by elderly households whose heads are aged 60 years and older is estimated to account for about half of total consumption. Turning to a related but different subject now, I would like to introduce a survey result, which reveals that concerns among the elderly about their living during retirement are noticeable in Japan compared to some other countries. According to a survey on the daily lives and attitudes of the elderly conducted by the Cabinet Office in 2015, nearly 60 percent of the elderly in Japan consider that they do not have enough savings and assets to provide for retirement. This percentage is the highest among countries surveyed (Chart 8). Meanwhile, the percentage of the elderly in Japan who responded that they had made no special effort to prepare for retirement until they reached 60 years old was more than 40 percent, which is also remarkably high compared to other countries (Chart 9). I think what is necessary to relieve such anxiety is to enhance the sustainability of a wide range of social security systems, including pension and medical systems, as well as change the attitudes of the people and step up their financial literacy. Meanwhile, I believe that an increase in growth expectations is what it takes to drive the virtuous cycle from income to spending in the corporate sector. In this context, the government decided the Japan Revitalization Strategy 2016 in June 2016 and launched the 10 strategic public-private joint projects, in which the public and private sectors share knowledge and strategy, and cultivate new promising markets (Chart 10). Looking at the list of projects may leave an impression that it is an all-around list of challenges facing Japan's economy. I believe that what the economy needs now is to implement various initiatives simultaneously to overcome many such challenges. These challenges are closely interrelated, and working on one often plays an essential part in dealing with another. For instance, efforts toward realizing the fourth industrial revolution, which is the first of the key policy measures, are likely be centered on bringing about innovations by using technological breakthroughs from the Internet of Things (IoT), big data, and artificial intelligence. Needless to say, this is also an essential element for improving productivity in the service industry and bringing about an industrial revolution among small and medium-sized firms, as well as micro firms. Furthermore, the working-style reform, promoted under the Japan Revitalization Strategy, will help facilitate smooth movements of human resources into growth areas. In addition, this reform is also important from the viewpoint of stimulating domestic demand for tourism by facilitating the taking of long enough holidays. What I mean is that, while these initiatives may look like "a little bit of everything," firmly promoting them in order to achieve economic revitalization in an omnidirectional manner, and thereby revitalizing Japan's economy, is necessary. I think that this will lead to an increase in growth expectations, and ultimately to a rise in inflation expectations. For Japan's economy, the third largest in the world, ending deflation and returning to a sustainable growth path will also have significant meaning for the global economy. The Bank will maintain highly accommodative financial conditions, with a view to achieving the price stability target of 2 percent, and ensure the overcoming of deflation. I believe that highly accommodative financial conditions, combined with the initiatives of the public and private sectors just mentioned, will give a boost to firms' investment and efforts for improving productivity. Let me conclude by emphasizing that ensuring the exit from deflation in Japan will lead to a more dynamic and stronger economy. Thank you for your attention. Economic and Financial Developments and Monetary Policy in Japan Speech at a Seminar Hosted by the Embassy of Japan in Switzerland (Zurich) March 6, 2017 Takako Masai Bank of Japan Chart 1 Labor Market Conditions (2) Tankan: Employment Conditions DI (1) Unemployment Rate and Active Job Openings-to-Applicants Ratio s.a., % s.a., times 1.5 Unemployment rate (left scale) Active job openings-to-applicants ratio (right scale) DI ("excessive" - "insufficient"), % points "Excessive" 1.2 "Insufficient" 0.9 -10 0.6 All enterprises -20 Large enterprises Small enterprises CY 05 13 14 15 16 0.3 -30 CY 05 Sources: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; Bank of Japan. Chart 2 Confidence Indicators (2) NRI Consumer Sentiment Index (1) Consumer Confidence Index 55 s.a. Improved s.a., DI Improved Worsened Worsened CY 05 16 17 CY 05 Note: There is a discontinuity in the data for the Consumer Confidence Index in April 2013 due to a change in the survey method. Sources: Cabinet Office; Nippon Research Institute (NRI), "Consumer Sentiment Survey." Chart 3 Employee Income and Household Spending (2) Private Consumption (1) Employee Income y/y % chg. (3) Housing Investment s.a., CY 2010 = 100 s.a., tril. yen Consumption Activity Index (real) Private residential investment (SNA, real) -2 CY CY 10 CY Notes: 1. Employee income (Monthly Labour Survey) = number of regular employees (Monthly Labour Survey) × total cash earnings. 2. Q1 = March-May, Q2 = June-August, Q3 = September-November, Q4 = December-February. Sources: Ministry of Health, Labour and Welfare; Cabinet Office; Bank of Japan. Chart 4 Outlook for Economic Activity and Prices （as of January 2017） y/y % chg. Real GDP CPI （all items less fresh food） Fiscal 2016 +1.4 -0.2 Forecasts made in October 2016 +1.0 -0.1 Fiscal 2017 +1.5 +1.5 Forecasts made in October 2016 +1.3 +1.5 Fiscal 2018 +1.1 +1.7 Forecasts made in October 2016 +0.9 +1.7 Note: Figures indicate the median of the Policy Board members' forecasts (point estimates). Source: Bank of Japan. Chart 5 Mechanism of QQE Quantitative and Qualitative Monetary Easing (QQE) Large-scale purchases of JGBs Decrease Strong and clear commitment to achieve the price stability target of 2 percent Increase ⇒ ⇒ ⇒ Nominal interest rates － Inflation expectations ＝ Real interest rates Decrease Improvement in the economy and increase in prices Chart 6 Consumer Prices y/y % chg. CPI (all items less fresh food and energy) CPI (all items less fresh food) -1 -2 -3 CY 07 Notes: 1. Figures for the CPI (all items less fresh food and energy) are calculated by the Research and Statistics Department, Bank of Japan. 2. Figures for the CPI are adjusted to exclude the estimated effects of changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 7 "Adaptive" Mechanism of Inflation Expectation Formation Contribution of Observed Inflation to Inflation Expectations (1) 1-Year-Ahead Inflation Expectations (2) 6-10 Years Ahead Inflation Expectations 1.0 1.0 More adaptive More adaptive 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 0.0 Japan U.S. Euro area U.K. Japan U.S. Euro area U.K. Notes: 1. The observed inflation rates used in the estimation are CPI (all items). 2. For the estimation method, see Appendix Chart 3 in "Comprehensive Assessment: Developments in Economic Activity and Prices as well as Policy Effects since the Introduction of Quantitative and Qualitative Monetary Easing (QQE)" published by the Bank of Japan on September 21, 2016. Sources: Consensus Economics Inc., "Consensus Forecasts"; Ministry of Internal Affairs and Communications; BLS; Eurostat; ONS; Bank of Japan. Chart 8 Concerns among Elderly about Retirement Asked If They Have Enough Savings and Assets to Provide for Retirement (1) Percentage of Elderly Who Consider That They Do Not Have Enough % (2) Percentage of Elderly Who Consider That They Have Enough % Japan U.S. Germany Sweden Japan U.S. Germany Sweden Notes: 1. Population of the survey: males and females who are aged 60 years and older (excluding those in nursing care facilities). 2. "Do not have enough" comprises "do not have so much" and "have far from enough." "Have enough" comprises "have enough" and "have only just enough." Elderly who considered neither that they "do not have enough" nor that they "have enough" responded either "no need to have assets, as social security should cover expenses for basic daily life" or "don't know." Source: Cabinet Office, "International Comparison Survey of the Daily Life and Attitudes of Elderly Persons," 2015 (available only in Japanese). Chart 9 Concerns among Elderly about Retirement Asked How They Prepared for Retirement before They Reached 60 Years of Age (1) Percentage of Elderly Who Responded That They Had Made No Special Effort to Prepare % (2) How Elderly Prepared for Retirement % Deposits Pension Bonds, stocks, and investment trusts Real estate Acquisition of job skills for retirement Others Japan U.S. Germany Sweden Japan U.S. Germany Sweden Notes: 1. Population of the survey: males and females who are aged 60 years and older (excluding those in nursing care facilities). 2. Multiple answers were allowed for the question of how they prepared for retirement. Source: Cabinet Office, "International Comparison Survey of the Daily Life and Attitudes of Elderly Persons," 2015 (available only in Japanese). Chart 10 The 10 Strategic Public-Private Joint Projects toward GDP of 600 Trillion Yen 1. The fourth industrial revolution 2. Toward a world leading healthcare country 3. Overcoming environmental and energy constraints and expanding investments 4. Changing sports to a growth industry 5. Revitalizing markets for transaction of existing houses and reform 6. Improving productivity in the service industry 7. Bringing about revolution among small and medium-sized firms and micro firms 8. Promoting proactive agriculture, forestry and fishery, as well as reinforcing exports 9. Realizing Japan as a tourism-oriented country 10. Taking measures to stimulate domestic consumer sentiment Source: "Japan Revitalization Strategy 2016" (Cabinet Decision, June 2, 2016)
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Remarks by Ms Takako Masai, Member of the Policy Board of the Bank of Japan, at the Ninth Japan Securities Summit, London, 8 March 2017.
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March 8, 2017 Bank of Japan Japan's Economy and Monetary Policy Remarks at the Ninth Japan Securities Summit in London Takako Masai Member of the Policy Board It is a great honor to have the opportunity today to be a panel member at the ninth Japan Securities Summit. Japan's economy had been suffering from deflation for more than 15 years, since the late 1990s, with the year-on-year rate of change in the consumer price index (CPI) being about zero or slightly negative. In such circumstances, the Bank of Japan has been conducting monetary policies in various unconventional ways for nearly 20 years (Chart 1). Looking back, in 1998, now nearly 20 years ago, Japan's policy interest rate -- which at that time was the uncollateralized overnight call rate -- already had been lowered to close to zero, at 0.25 percent. Given that economic activity and prices did not improve even in this situation, the Bank introduced a zero interest rate policy in February 1999. Thereafter, it introduced a quantitative easing policy, in which the operating target was the outstanding balance of current accounts at the Bank. Later, it also implemented a comprehensive monetary easing policy, in which it purchased assets such as CP, corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). The Bank continues to make these asset purchases to the present, and with respect to ETFs and J-REITs, it has significantly increased the amount of purchases since 2013. Meanwhile, it also introduced the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth as well as the Fund-Provisioning Measure to Stimulate Bank Lending, and these also continue to this day. As illustrated, the Bank has pursued monetary easing by making full use of various means. As a result, accommodative financial conditions have been realized in Japan. Such accommodative financial conditions have underpinned the economy, and the Bank's large-scale fund-provisioning measures have contributed -- in certain phases -- to maintaining financial system stability and preventing the economy from falling into a deflationary spiral. Nevertheless, it is true that at the same time there continued to be mild deflation. Therefore, the Bank made a strong and clear commitment to ensuring the economy's exit from deflation -- which had lasted for nearly 15 years -- and began large-scale monetary easing to fulfill the commitment. This is Quantitative Qualitative Monetary Easing (QQE), which continues through to the present. The Bank also introduced the price stability target in January 2013 and set it at 2 percent in terms of the year-on-year rate of change in the CPI. At the same time, the government and the Bank released a joint statement, in which they emphasized their policy coordination. I view this as extremely important, because it indicated the determination by the government and the Bank to work together in order to overcome deflation and achieve sustainable economic growth. The Bank then introduced QQE in April 2013. After increasing the amount of its asset purchases further in 2014, it adopted a negative interest rate policy in January 2016 and introduced QQE with Yield Curve Control in September of that year. Since the introduction of QQE, the basic mechanism of monetary easing itself has not changed; that is, (1) pushing down the entire yield curve through the Bank's large-scale purchases of Japanese government bonds (JGBs), and (2) raising inflation expectations through the Bank's strong commitment to the 2 percent price stability target. The transmission mechanism envisaged by the Bank is that these factors will lead to a reduction in real interest rates, thereby producing positive effects on Japan's economic activity and prices (Chart 2). Under QQE, the underlying trend in the CPI (all items less fresh food and energy) turned positive and has been in such territory for more than two and a half years; this leads to the judgment that Japan's economy has reached a state of being no longer in deflation, which is commonly defined as a sustained decline in prices (Chart 3). Furthermore, the Bank introduced last year QQE with Yield Curve Control as a means of strengthening the past framework for monetary easing. My understanding is that there are two points as the background to this decision. First, although QQE has produced its intended effects, the price stability target of 2 percent has not been achieved, and therefore a more effective framework was necessary. Second, while it was confirmed that the combination of large-scale purchases of JGBs and the negative interest rate policy was effective in influencing the entire yield curve, there was concern over a possibility that this combination could in some cases push down the yield curve more than necessary, thereby having a negative impact on financial functioning. Under "yield curve control," which is the major component of the new framework, the Bank is able to conduct monetary policy in an effective and flexible manner by taking account of the economic, price, and financial conditions -- including the impact on the functioning of financial intermediation -- as it directly targets long-term interest rates. Another component of the new framework is an "inflation-overshooting commitment." With this commitment, the Bank aims to raise inflation expectations by demonstrating its strong determination. The Bank has attempted to make expectation formation more forward-looking through QQE. In reality, however, before the forward-looking expectation formation fully took hold, the observed inflation rate declined, due mainly to the fall in crude oil prices. As a result, people's inflation expectations also declined in an adaptive manner. Therefore, I consider that, in order to achieve the price stability target of 2 percent, it is absolutely necessary to raise inflation expectations and promote a shift in expectation formation toward a more forward-looking direction. The inflation-overshooting commitment is a means to this end. Inflation expectations are, so to speak, the sense of price trends among individuals and firms, and to change such expectations is not an easy task. This is even more the case with a country like Japan that has experienced protracted deflation. When QQE was introduced, the Bank set a time frame of about two years to achieve the price stability target in order to emphasize its strong and clear commitment to ensuring the economy's exit from deflation. Therefore, it may seem like it has taken a long time for the Bank to achieve this target. On the other side of the coin, only four years have passed since the target was set. Needless to say, this does not mean that taking a long time to meet the objective is acceptable. First, it remains important to have the Bank's strong commitment to achieving the price stability target and express it in various different ways. Then, under the highly accommodative financial conditions maintained by the Bank in addition to the large-scale economic stimulus package implemented by the government, I consider it essential to enhance private demand by further accelerating efforts in both the public and private sectors to strengthen the growth potential. In fact, such efforts already have been undertaken by both the public and private sectors. In this context, the government decided the Japan Revitalization Strategy 2016 in June 2016 and launched the 10 strategic public-private joint projects, in which the public and private sectors share knowledge and strategy, and cultivate new promising markets (Chart 4). Looking at the list of projects may leave an impression that it is an all-around list of challenges facing Japan's economy. I believe that what the economy needs now is to implement various initiatives simultaneously to overcome many such challenges. What I mean is that, while these initiatives may look like "a little bit of everything," firmly promoting them in order to achieve economic revitalization in an omnidirectional manner, and thereby revitalizing Japan's economy, is necessary. I think that this will lead to an increase in growth expectations, and ultimately to a rise in inflation expectations. For Japan's economy, the third largest in the world, ending deflation and returning to a sustainable growth path will also have significant meaning for the global economy. The Bank will maintain highly accommodative financial conditions, with a view to achieving the price stability target of 2 percent, and ensure the overcoming of deflation. I believe that highly accommodative financial conditions, combined with the initiatives of the public and private sectors just mentioned, will give a boost to firms' investment and efforts for improving productivity. Let me conclude by emphasizing that ensuring the exit from deflation in Japan will lead to a more dynamic and stronger economy. Thank you for your attention. Japan's Economy and Monetary Policy March 8, 2017 Takako Masai Bank of Japan Chart 1 1999年2月 「ゼロ金利政策」の開始 Changes in the Bank's Monetary Policy Management Feb 1999 Introduction of the zero interest rate policy （- Aug 2000） Mar 2001 Introduction of the quantitative easing policy（- Mar 2006 ） Mar 2006 Release of "The Bank's Thinking on Price Stability" Dec 2009 Release of "Clarification of the 'Understanding of Medium- to LongTerm Price Stability'" Oct 2010 Introduction of the comprehensive monetary easing policy Feb 2012 Introduction of the "price stability goal in the medium to long term" Jan 2013 Introduction of the "price stability target" of 2 percent 〃 Release of "Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth" Apr 2013 Introduction of Quantitative and Qualitative Monetary Easing (QQE) Oct 2014 Expansion of QQE Jan 2016 Introduction of QQE with a Negative Interest Rate Sep 2016 Introduction of QQE with Yield Curve Control Chart 2 Mechanism of QQE Quantitative and Qualitative Monetary Easing (QQE) Large-scale purchases of JGBs Decrease Strong and clear commitment to achieve the price stability target of 2 percent Increase ⇒ ⇒ ⇒ Nominal interest rates － Inflation expectations ＝ Real interest rates Decrease Improvement in the economy and increase in prices Chart 3 Consumer Prices y/y % chg. CPI (all items less fresh food and energy) CPI (all items less fresh food) -1 -2 -3 CY 07 Notes: 1. Figures for the CPI (all items less fresh food and energy) are calculated by the Research and Statistics Department, Bank of Japan. 2. Figures for the CPI are adjusted to exclude the estimated effects of changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 4 The 10 Strategic Public-Private Joint Projects toward GDP of 600 Trillion Yen 1. The fourth industrial revolution 2. Toward a world leading healthcare country 3. Overcoming environmental and energy constraints and expanding investments 4. Changing sports to a growth industry 5. Revitalizing markets for transaction of existing houses and reform 6. Improving productivity in the service industry 7. Bringing about revolution among small and medium-sized firms and micro firms 8. Promoting proactive agriculture, forestry and fishery, as well as reinforcing exports 9. Realizing Japan as a tourism-oriented country 10. Taking measures to stimulate domestic consumer sentiment Source: "Japan Revitalization Strategy 2016" (Cabinet Decision, June 2, 2016)
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at a Reuters Newsmaker event, Tokyo, 24 March 2017.
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March 24, 2017 Bank of Japan "Quantitative and Qualitative Monetary Easing with Yield Curve Control": After Half a Year since Its Introduction Speech at a Reuters Newsmaker Event in Tokyo Haruhiko Kuroda Governor of the Bank of Japan Introduction I would like to express my sincerest gratitude for the opportunity today to explain the Bank's monetary policy. Half a year has passed since the Bank introduced "Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control" in September 2016. This new framework has been working smoothly. Today, looking back at developments in the global economy and the global financial markets since 2015, I would like to explain the background to and thinking behind the adoption of the new policy framework, following the introduction of a negative interest rate. Then, I would like to talk about the current situation of and outlook for Japan's economy, as well as the Bank's stance on monetary policy going forward. I. The Background to the Adoption of "QQE with Yield Curve Control" and Thinking behind It A. Turbulence in Global Financial Markets and the Introduction of a Negative Interest Rate Turbulence in Global Financial Markets Let me look back at developments in the global financial markets since summer 2015. Investors' risk sentiment started to worsen against the background of the slowdown in emerging economies, including China, and uncertainties regarding those economies. In particular, after the turn of 2016, the global financial markets rapidly became destabilized due to heightened concerns regarding emerging economies, which were triggered by the significant decline in the Shanghai stock prices (Chart 1). The decline in commodity prices, including crude oil prices, exacerbated the situation. Under such circumstances, pessimistic views about the outlook for the global economy prevailed, such as the "secular stagnation" hypothesis. Major economies faced the common policy challenges of how to address low growth, as well as low inflation under low interest rates, and this topic was hotly debated at international fora such as the Group of Twenty (G-20) Finance Ministers and Central Bank Governors Meeting. Naturally, such headwinds for the global economy had a significant negative impact on Japan's economy as well. In financial markets, the yen appreciated and stock prices declined. On the inflation front, the year-on-year rate of change in the consumer price index (CPI) excluding fresh food turned negative in 2016 for the first time in three years, due to the effects of the decline in crude oil prices since summer 2014. Inflation expectations -- which play a key role in achieving the price stability target of 2 percent -- weakened, reflecting the headwinds for the global economy that I mentioned earlier, after having remained more or less flat amid the significant decline in crude oil prices (Chart 2). The Introduction of a Negative Interest Rate and Its Effects It was against these backgrounds that the Bank introduced "QQE with a Negative Interest Rate" in January 2016 in order to address these strong headwinds and achieve the price stability target of 2 percent. To reduce real interest rates amid weakening inflation expectations, nominal interest rates needed to be lowered further. The negative interest rate aimed at an additional reduction in the levels of short- and long-term interest rates by pushing down the short end of the yield curve, in combination with purchases of Japanese government bonds (JGBs). The introduction of a negative interest rate produced significant effects in terms of lowering nominal interest rates. Specifically, JGB yields declined considerably across the entire yield curve (Chart 3). As a consequence, lending rates as well as issuance rates for CP and corporate bonds also declined clearly. The lending attitude of financial institutions became more positive. There was no doubt that the negative interest rate made financial conditions more accommodative, supporting firms' and households' economic activities in Japan against the headwinds for the global economy. At the same time, however, it became necessary to take account of the impact of the negative interest rate on the functioning of financial intermediation in a broad sense as the yield curve had headed toward flattening by more than expected. Specifically, Banks' basic business model consists of raising short-term funds and investing in long-term assets, and there was little room for declines in interest rates on deposits, which are the main funding tools. This means that the flattening of the yield curve at a low level reduces the spread between deposit and lending rates, thereby squeezing banks' profits. If profits were squeezed for a long period of time, this would affect their financial soundness cumulatively and exert adverse effects on the functioning of financial intermediation. In addition, an excessive decline in the levels of interest rates such as those with long and super-long maturities lowers the rate of return on insurance and pension products and might have a negative impact on economic activity by leading to a deterioration in people's sentiment. B. Thinking behind "QQE with Yield Curve Control" Based on such recognition, the Bank conducted in September 2016 a comprehensive assessment of developments in economic activity and prices as well as policy effects since the introduction of QQE. In light of the findings of the assessment, it introduced "QQE with Yield Curve Control" as a means of enhancing and strengthening the previous policy frameworks. The new framework consists of two components (Chart 4). The first is an inflation-overshooting commitment. Specifically, this is a commitment that the Bank will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI exceeds 2 percent and stays above that level in a stable manner. The key point is that the commitment is based on the observed CPI, and not the outlook. The price stability target needs to be achieved on average over the business cycle. Thus, it naturally is assumed that there would be phases when the observed CPI exceeds 2 percent. Considering that it takes some time for monetary policy to have an impact on economic activity and prices, it is exceptional for a central bank to make such a strong commitment that is based on the observed CPI. Since the global financial crisis, the Federal Reserve in the United States and some other central banks introduced "forward guidance," in which a central bank provides information about the future course of monetary policy. It is common for a central bank to design the forward guidance based on its forecast. However, in Japan, where the observed CPI has been below 2 percent for a long period, in order to raise inflation expectations to around 2 percent and anchor them firmly at that level, it is essential that the public actually experiences inflation at or above 2 percent for some time and thereby the perception takes hold among them that prices of goods and services tend to go up every year by around 2 percent. With this in mind, the Bank committed itself to continue with large-scale monetary expansion until such situation is achieved through this unique inflation-overshooting commitment. The second component of the new policy framework is yield curve control. Under this framework, the Bank sets the levels of short- and long-term interest rates as the operating targets in the guideline for market operations, instead of the amount of increase in the monetary base and the amount of JGB purchases in the previous frameworks. It will facilitate the formation of a yield curve that is considered most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent, taking account of developments in economic activity and prices as well as financial conditions. In the current guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and the target level of the 10-year JGB yields at around 0 percent. Yield curve control is designed to enable the Bank to conduct monetary policy in a more flexible manner, depending on the situation, compared to the previous frameworks in which the amount of JGB purchases was fixed. For example, the impact of a unit amount of the Bank's JGB purchases on long-term yields varies depending on the economic and inflation conditions as well as the state of the JGB market. In the previous frameworks that set the amount of JGB purchases as the operating target, the yield curve could deviate either upward or downward from the one that the Bank deemed appropriate. In contrast, yield curve control -- by setting the specific target level of the 10-year JGB yields -- enables the Bank to conduct JGB purchases in a flexible and effective manner to achieve the target, making the policy framework more sustainable. It often is argued that the Bank's JGB purchases are approaching the limit. My response to this argument is as follows. First of all, the Bank has been conducting JGB purchases smoothly so far, and I do not think it will face difficulties in the near future. Even if JGBs to be purchased by the Bank become scarce at some point in the future as the supply-demand conditions in the JGB market tighten, the impact of a unit amount of its JGB purchases on long-term yields accordingly should become more significant, with all else being equal. Put differently, the Bank can have the same degree of effect in lowering interest rates with a smaller amount of JGB purchases. In financial markets, some argue that the Bank will have difficulties with JGB purchases in the future and lose its control over long-term interest rates eventually. That will not happen. In fact, yield curve control is designed to be highly sustainable. II. Improvement in the Global Economy and Current Situation of and Outlook for Japan's Economy A. Current Business Conditions and Outlook Next, I would like to talk about developments in the global economy since the second half of last year, as well as the current situation of and outlook for Japan's economy and prices amid these global economic developments. Up until around last autumn, financial markets were dominated by pessimistic views regarding the outlook for the global economy. With the benefit of hindsight, it appears that the global economy hit bottom in the first half of last year. Since the middle of last year, various economic indicators have improved, and a salient feature is that improvement in manufacturing activities and international trade has become clear in both advanced and emerging economies (Chart 5). The global economy since the outbreak of the global financial crisis has been characterized by what has been labeled "slow trade," a phenomenon of the trade volume having remained sluggish relative to the economic growth rate, but this trend now appears to be changing. In addition, following the presidential election in the United States, business sentiment -- especially among U.S. firms -- has greatly increased, reflecting expectations that the growth rate will accelerate on the basis of proactive economic policies by the new administration. As a result, the growth momentum of the global economy is steadily gathering pace (Chart 6). Amid these favorable developments in the global economy, improvements have been observed in Japan's economy as well. One is that a pick-up in exports and production is becoming evident. Against the backdrop of strong global IT-related demand and progress in inventory and capital stock adjustments in emerging economies, the range of items in which exports are increasing has steadily widened and the growth in exports is gradually becoming more sustained. Production is picking up as well, reflecting moderate increases in domestic and overseas demand as well as progress in inventory adjustments. Under these circumstances, corporate profits are improving and business fixed investment is on a moderate increasing trend. Another is that private consumption is picking up. Despite steady improvements in the employment and income situation, such as the drop in the unemployment rate to about 3 percent and moderate wage growth, private consumption showed relatively weak developments in the first half of last year. This was likely due mainly to the impact on consumer sentiment of the negative wealth effects resulting from the decline in stock prices. In recent months, consumer sentiment has been improving steadily, partly due to the recovery in stock prices, and the Consumption Activity Index (CAI), which the Bank compiles by combining various sales and supply-side statistics, has picked up since last summer (Chart 7). Japan's economy is more firmly making steps toward a recovery. Going forward, with the virtuous cycle from income to spending being maintained in both the corporate and household sectors, the economy is likely to continue growing at a pace above its potential. B. The Current Situation of and Outlook for Prices Next, I would like to turn to inflation. As mentioned earlier, partly as a result of the decline in crude oil prices, the year-on-year rate of change in the CPI excluding fresh food had been in negative territory during 2016, and most recently it is 0.1 percent. However, looking at the year-on-year rate of change in the CPI excluding fresh food and energy, while this was around minus 0.5 percent before the introduction of QQE, it turned positive in autumn 2013 and has remained so for more than three years since then. This is the first time this has occurred since Japan's economy fell into deflation in the late 1990s. Japan is no longer in deflation, which is commonly defined as a sustained decline in general prices (Chart 8). That being said, even in terms of the CPI excluding fresh food and energy, the rate of increase in prices has been slowing since the beginning of last year, and stagnant in recent months. This is perhaps because firms have refrained from revising prices upward in response to the lackluster private consumption mentioned earlier, and because the yen's appreciation during last year affected the prices of consumer durable goods and other items. As a result, recent price developments have been somewhat sluggish, but we believe that the momentum toward achieving the price stability target of 2 percent has been maintained and the year-on-year rate of change in the CPI excluding fresh food is likely to increase toward 2 percent. Let me mention three channels for higher inflation going forward. First, improvement in the output gap, as seen in the tightening of labor market conditions, will lead to an increase in the inflation rate mainly through wage increases. Second, energy prices will start to push up the CPI, while the downward pressure of the past yen appreciation will gradually abate. Third, these developments, with the Bank's strong commitment to achieving the price stability target of 2 percent, will lead to higher medium- to long-term inflation expectations among the public. Let me elaborate on these factors. The tightening of labor market conditions is exerting upward pressure on wages. As I have mentioned repeatedly, the Bank aims at a moderate rise in the CPI inflation accompanied by a rise in corporate profits and wages. Recently, private consumption is picking up amid the steady improvement in the employment and income situation. If this situation continues, firms are expected to be more proactive in their price setting again. Meanwhile, the contribution of energy prices to the year-on-year rate of change in the CPI, which was more than minus 1 percentage point, has been shrinking gradually and is currently more or less neutral. Going forward, assuming that crude oil prices will remain roughly flat, as indicated by prices in futures markets, the contribution will turn slightly positive in fiscal 2017. It should be noted, however, that this will be temporary and fall off again in fiscal 2018. The Bank does not intend to achieve the 2 percent target by simply depending on rising energy prices. In order to achieve the 2 percent price stability target in a sustainable manner, it is necessary for actual increases in prices to lead to higher medium- to long-term inflation expectations through the adaptive formation mechanism, resulting in an increase in the underlying trend of the inflation rate. III. The Bank's Stance on Monetary Policy Going Forward Lastly, I would like to explain the Bank's stance on monetary policy going forward. As I explained earlier, yield curve control can facilitate the formation of the yield curve that is deemed most appropriate for maintaining the momentum toward achieving the price stability target of 2 percent, taking account of developments in economic activity and prices as well as financial conditions. The Bank will continue to conduct monetary policy based on this principle. Let me elaborate on this point. In assessing developments in economic activity and prices, the Bank takes into account both its outlook for those developments and risk factors as presented in the Outlook for Economic Activity and Prices (Outlook Report). Regarding financial conditions, it takes into consideration the effects of the prevailing interest rate environment on the functioning of financial intermediation. Based on this framework, the current situation can be explained as follows. With regard to economic and price developments, there is still a long way to go to achieve the price stability target of 2 percent, although an improvement has been observed. As described in the January 2017 Outlook Report, the momentum toward achieving the 2 percent target is maintained but not yet sufficiently firm. As for risk factors, risks to both economic activity and prices are skewed to the downside, and developments in medium- to long-term inflation expectations warrant particular attention. According to the Policy Board members' forecasts for prices presented in the Outlook Report, which are higher than those of private-sector economists, the timing of the year-on-year rate of change in the CPI reaching 2 percent will likely be around fiscal 2018. Taking all of these elements into account, there is no reason to reduce the level of monetary accommodation at the moment in terms of economic and price developments. In this regard, let me add that the Bank's monetary policy should be designed to achieve the price stability target of 2 percent, responding to the situation in Japan's economy. The Bank will not raise the target level of the long-term interest rates just because of a rise in such rates in other countries. Next, let me make an assessment of the current situation in terms of financial conditions, or the effects on the functioning of financial intermediation. There is no need for now to raise interest rates, either in terms of the short-term policy interest rate or the target level of the long-term interest rates. The investment environment for insurance and pension products has become more favorable as super-long-term interest rates have increased compared to those in September 2016 (Chart 9). Banks have maintained their positive lending attitude, although yields in the short- to medium-term zone -- which affect banks' profits to a large extent -- have remained negative and the spread between deposit and lending rates has been on a declining trend (Chart 10). The amount outstanding of bank lending has been increasing at an annual rate of around 2.5 percent to 3.0 percent. These developments show that the functioning of financial intermediation for supporting economic activity has not been impaired. Nevertheless, the effects of low interest rates on the functioning of financial intermediation would be cumulative with the passage of time. The Bank will continue to examine such effects while keeping in close communication with financial institutions. Let me summarize our assessment. From any of three aspects -- the economy, prices, and financial conditions -- it is obvious that the Bank should maintain the current yield curve and thereby make the most of the improvement in the global economy, with a view to achieving the price stability target of 2 percent at the earliest possible time. I would like to add one thing on this point. The guideline for market operations is decided at each Monetary Policy Meeting in line with the thinking that I have just explained. The conduct of market operations including JGB purchases is determined practically to implement the guideline in a smooth manner. As a result, such factors as the amount of JGB purchases at each individual auction may vary depending on financial market conditions. However, this has no implications for monetary policy going forward. Conclusion Since the introduction of QQE in April 2013, the Bank has reviewed the framework of monetary easing several times, in response to changes in the environment. However, there has been absolutely no change in its commitment to achieving the price stability target of 2 percent at the earliest possible time. I believe that "QQE with Yield Curve Control," consisting of an "inflation-overshooting commitment" and "yield curve control," is the best possible framework that we can devise at present, given the situation in Japan -- the formation mechanism of inflation expectations, transmission channels of monetary easing, and the conditions in the financial system. Under this framework, the Bank will realize the maximum effects of monetary easing. Thank you very much for your attention. "Quantitative and Qualitative Monetary Easing with Yield Curve Control": After Half a Year since Its Introduction Speech at a Reuters Newsmaker Event in Tokyo March 24, 2017 Haruhiko Kuroda Governor of the Bank of Japan Chart 1 Developments in International Financial Markets Crude Oil Prices (WTI) Stock Prices in Major Economies The beginning of 2014=100 Japan (Nikkei 225 Stock Average) United States (S&P 500) $/bbl Europe (EURO STOXX 50) Jan-14 Jul-14 Source: Bloomberg. Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Chart 2 Inflation Expectations after the Introduction of QQE 2.0 y/y % chg. Beginning of a Introduction of Consumption downtrend in QQE tax hike crude oil prices 1.8 Synthetic indicator of firms', households', and economists' inflation expectations 1.6 ▼▼ ▼ Destabilization of financial markets amid concern about emerging economies ▼ 1.4 1.2 1.0 0.8 0.6 0.4 0.2 CY 07 Notes: 1. Inflation expectations of firms, households, and economists are represented by the Tankan, the "Opinion Survey," and the "Consensus Forecasts," respectively. Notes: 2. Semiannual data from the "Consensus Forecasts" up through 2014/Q2 are linearly interpolated. "Opinion Survey" figures exclude inflation expectations by respondents whose annual inflation expectations were +5% percent or greater and -5% percent or smaller. The output prices DI in the Tankan represents the difference between the share of firms that raised prices in the preceding three months and the share of firms that lowered prices. Sources: Consensus Economics Inc., "Consensus Forecasts"; Bank of Japan. Chart 3 Changes in JGB Yield Curve since the Introduction of QQE with a Negative Interest Rate 2.0 % April 3, 2013 (the day before the decision to introduce QQE) January 28, 2016 (the day before the decision to introduce QQE with a Negative Interest Rate) 1.5 July 27, 2016 (the bottom of 10-year JGB yields) 1.0 0.5 0.0 -0.5 year Source: Bloomberg. Residual maturity Chart 4 QQE with Yield Curve Control Inflation-Overshooting Commitment Inflation Rate Yield Curve Control % 1.2 Recent shape of JGB yield curve 1.0 0.8 0.6 2% Target level of the long-term interest rate "around zero percent" Short-term policy interest rate "minus 0.1 percent" 0.4 0.2 0.0 -0.2 -0.4 0 1 year Expansion of monetary base continues 9 10 15 20 Residual maturity Source: Bloomberg. Chart 5 Manufacturing Conditions Manufacturing PMI s.a., DI Global economy Advanced economies Emerging and commodity-exporting economies CY 10 Note: Figures for the global economy are the J.P.Morgan Global Manufacturing PMI. Figures for advanced economies as well as emerging and Notes:commodity-exporting economies are calculated as the weighted averages of the Manufacturing PMI using PPP-adjusted GDP shares of Notes:world total GDP from the IMF as weights. Advanced economies consist of the United States, the euro area, the United Kingdom, and Japan. Emerging and commodity-exporting economies consist of 17 countries and regions, including China, South Korea, Taiwan, Russia, and Brazil. Sources: IMF; IHS Markit (© and database right IHS Markit Ltd 2017. All rights reserved.); Haver. Chart 6 World Economic Outlook Released by the IMF World Real GDP Growth Rate y/y % chg. 2004-2007 average: +5.3% ＋3.6 ＋3.4 + 3.2 + 3.1 1990-2003 average: +3.3% IMF projection (Jan. 2017) -1 CY 90 Source: IMF. Chart 7 Consumption Activity Index s.a., CY 2010=100 Consumption Activity Index (adjusting travel balance, real) CY 05 Note: Figures for the Consumption Activity Index exclude inbound tourism consumption and include outbound tourism consumption. Sources: Cabinet Office; Bank of Japan; Ministry of Economy, Trade and Industry; Ministry of Internal Affairs and Communications, etc. Chart 8 Consumer Prices y/y % chg. Introduction of QQE (April 2013) -1 CPI (all items less fresh food and energy) CPI (all items less fresh food) -2 CY10 Note: Figures for the CPI are adjusted to exclude the estimated effects of changes in the consumption tax rate. Source: Ministry of Internal Affairs and Communications. Chart 9 Super-long-term JGB Yields 2.5 % Introduction of QQE 10-year Introduction of QQE with a Negative Interest Rate 20-year 30-year 2.0 40-year Introduction of QQE with Yield Curve Control 1.5 1.0 0.5 0.0 -0.5 CY 13 Source: Bloomberg. Chart 10 Lending Attitudes of Financial Institutions Lending Policies of Large Banks Lending Attitude of Financial Institutions as Perceived by Firms (Tankan) DI ("accommodative" - "severe"), % points Large enterprises (Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks) DI for credit standards, % points Eased credit standards over the past 3 months Small enterprises -10 Large firms Small firms Households -20 CY 06 -10 CY 06 Notes: 1. Data from the Tankan are based on all industries. Notes :2. DI for credit standards is calculated as follows. DI = ( percentage of respondents selecting "eased considerably" + percentage of respondents selecting "eased somewhat" × 0.5 ) - ( percentage of respondents selecting "tightened considerably" + percentage of respondents selecting "tightened somewhat" × 0.5 ) Source: Bank of Japan.
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Speech by Mr Takehiro Sato, Member of the Policy Board of the Bank of Japan, at Yale University, New Haven, USA, 28 March 2017.
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March 28, 2017 Bank of Japan Lessons of Japan: Focusing on Issues regarding Long-Term Inflation Expectations Speech at Yale University in New Haven Takehiro Sato Member of the Policy Board Introduction First of all, I thank Senior Fellow Stephen Roach for giving me the opportunity to talk to this esteemed audience at Yale. I understand that he teaches macroeconomic policy issues, focusing on the lessons Japan learned from deflation. The Bank of Japan is the frontrunner in combating deflation. As one of its board members, I hope that my remarks today will help stimulate academic discussion. Deflation has prevailed for almost a quarter century in Japan. To overcome deflation, theory and practice were introduced and tested, and the policy effects were examined. As a result, a range of knowledge and wisdom has been acquired. The Bank, on its part, conducted a comprehensive assessment of quantitative and qualitative monetary easing -- or QQE for short -- in September last year, and learned some important lessons. Among these, I will today focus on the issues regarding long-term inflation expectations. This is because they are the key factor in overcoming deflation. I admit that conceiving such expectations is a somewhat elusive task, but it is worth discussing. I. Lessons of Japan A. Determinants of Long-Term Inflation Expectations Japan's experience refutes the premise for monetary policy that long-term inflation expectations are determined by a central bank (Chart 1).1 This is because monetary policy effects are asymmetric when a central bank decreases long-term inflation expectations toward the target and when it raises them toward the target. In other words, once long-term inflation expectations -- the norm of prices -- are de-anchored, a central bank's ability to influence inflation is constrained significantly due to the zero interest rate bound. Those in academia might feel that this is somewhat troublesome. In fact, however, when a central bank re-anchors long-term inflation In its Statement on Longer-Run Goals and Monetary Policy Strategy (adopted effective January 24, 2012; as amended effective January 26, 2016), the Federal Reserve indicated that "The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation." See Board of Governors of the Federal Reserve System (2016). expectations toward the target, there will be a limit if monetary policy is the only game in town. What is needed, in addition to continued powerful monetary easing, is a raise in the potential growth rate, which roughly equals the natural rate of interest. This should be achieved through structural policies including labor market reform.2 Academic discussion is seriously needed on this point. This is because Japan is not the only country that has learned lessons on deflation. Namely, simultaneous declines in the potential growth rate and long-term inflation expectations have been observed in many countries since the latest global financial crisis (Chart 2). B. Negative Effects of Excessively Low Long-Term Inflation Expectations Let me elaborate. The more fundamental lesson we learned was that central banks should not allow long-term inflation expectations to decline to excessively low levels. Central banks can lower excessively high long-term inflation expectations because of the credibility they have earned through the past achievements. The fight against inflation is easier and the strategy can be simpler compared with combating deflation. There is a premise for economic theory that holds true with the fight against inflation; namely, long-term inflation expectations are determined by inflation targets set by central banks. By contrast, an inflation target will not be the basis for an economic model when set by a central bank that has lost credibility due to excessively low inflation. For example, the declines in the potential growth rate and long-term inflation expectations occurred simultaneously in Japan. However, the academic side of economics has yet to provide an answer as to whether it is possible to raise excessively low long-term inflation expectations through monetary policy. This is because of the present unique situation in Japan -- as I will touch on later -- that long-term inflation expectations are at virtually 0 percent and the potential growth rate is at slightly above 0 percent, while there is a zero nominal interest rate bound to usual economic transactions. The original "three-arrows" strategy of the Abe administration had a positive implication that fiscal and monetary policies combined would support structural policies. In reality, even under a large-scale unconventional monetary policy, both the mechanism of Friedman's quantity theory of money and the New Keynesian model of a jump in expectations have operated insufficiently so far. In terms of re-anchoring long-term inflation expectations, the glass is both half full and half empty. If the potential growth rate and long-term inflation expectations had not declined to the current low levels, monetary policy would have been more effective. Next, I will discuss long-term inflation expectations in the following aspects: (1) their formation mechanism; (2) reasons for low expectations in Japan; (3) the relationship with Japan's financial crisis; and (4) the relationship with labor market reform. II. Issues regarding Long-Term Inflation Expectations A. Formation Mechanism In economics theory, long-term inflation expectations are irrelevant to the potential growth rate. However, I doubt that this holds true in reality, in light of what is happening in Japan. Rather, I think that long-term inflation expectations and the potential growth rate do have a correlation, although it may not be strong (Chart 3). Long-term inflation expectations declined sharply in Japan, before and after the financial crisis in the late 1990s. Economic fundamentals already had been weak before the crisis because of the negative interaction between demand and supply conditions; specifically, a negative financial accelerator on the demand side due to the dire asset price deflation, and (2) the impairment of the financial intermediary function, as well as the distortion of economic resource allocation caused by the bubble economy on the supply side. The financial crisis triggered further weakening of economic fundamentals (Chart 4). In this situation, pessimism about the future led to a decline in people's expectations for mediumto long-term growth, and the potential growth rate remained low over a long period of time. As a result, people's perception of prices became excessively conservative. In other words, long-term inflation expectations turned downward. B. Reasons for Low Expectations in Japan Next, let us take a look at developments in survey-based measures of expected long-term inflation in Japan. A survey-based rate marked a sharp decline during the period of the financial crisis in the late 1990s, and then leveled out at around 1 percent. Since then, even throughout the period of the global financial crisis and the European sovereign debt crisis, it has been more or less unchanged at around 1 percent (Chart 5). However, I am somewhat doubtful about this figure.3 I believe that it is more persuasive to say that long-term inflation expectations in Japan have actually declined to around 0 percent, for the following four reasons.4 First, the frequency of micro-level price changes suggests that the mode value remains zero. In other words, the year-on-year rate of increase in the prices of sample items concentrated on 0 percent. Therefore, people are likely to consider that zero inflation is a steady and constant state. It is helpful to see the comparison with the U.S. situation (Chart 6).5 Second, administered prices are excessively sticky (Chart 7).6,7 For example, the starting subway fare in Tokyo has been unchanged for over 20 years since 1995 -- disregarding the effects of the consumption tax hikes. Market-based measures of long-term inflation expectations -- such as the 5-year, 5-year forward inflation swap rate -- have less credibility than survey-based ones in Japan, due to a lack of market liquidity and depth, and therefore do not represent a useful reference. On this point, it seems intuitively unlikely that many of the surveyed economists project that the inflation rate will remain at about 0 percent over the next 5-10 years. On the other hand, there might be a disparity between the perception of prices of economists and that of households and firms, i.e., long-term inflation expectations of households and firms might be lower than those of economists. See Watanabe and Watanabe (2016). In reality, amid the prolonged economic stagnation in Japan, a mechanism was established firmly in which the rise in costs for administered prices was compensated for by fiscal deficits reflecting the increasing political pressure to avoid the rise in administered prices. Such a process itself suggests a decline in long-term inflation expectations, which is the norm of prices. See Shintani, Kurachi, and Nishioka (2016). Third, the rate of increase in wages resulting from the wage negotiations between labor and management continued to be 0 percent for a long time. Even after the recent resumption of base pay increases, the rate is less than 1 percent (Chart 8).8 Fourth, Japan's deflation equilibrium cannot be theoretically explained on the basis of the 1 percent long-term inflation expectations (Chart 9). I will elaborate on the fourth point. Let us assume that there is a zero nominal interest rate bound. Even if that is the case, as long as long-term inflation expectations are meaningfully positive, the real interest rate will fall below the natural rate of interest, which is around 0 percent, by making the real interest rate negative. In this case, monetary policy should be effective, and Japan's economy should be able to get out of deflation equilibrium. This suggests that, if long-term inflation expectations are at least around 1 percent, monetary policy can be more effective. C. Relationship with Japan's Financial Crisis Looking back, if Japan's financial crisis in the late 1990s had been settled more promptly with ample liquidity provision and capital injection, the large-scale credit crunch could have been avoided, and thus the subsequent path of Japan's economy might have been different. This widely shared lesson was put to good use at the time of the global financial crisis afterwards. I note that it is important to address the private sector's solvency problem through provision of a massive scale of liquidity and through credit enhancement by means of swift capital injection. In Japan, the bailout of financial institutions with taxpayers' money experienced a strong backlash from the public. It took a considerable amount of time before public funds were actually injected into financial institutions. In the aftermath of the financial crisis, the injection of public funds was carried out several times. However, it actually took several years before concern about the stability of the financial system subsided (Chart 10). It also can be said that the resumption of base pay increases under the Abe administration might prove that long-term inflation expectations have started to rise from 0 percent. It was only after the introduction of the zero interest rate policy in 1999 and the introduction of quantitative monetary easing in 2001 that the market's liquidity concern was alleviated through the Bank's provision of ample funds (Charts 11-1 and 11-2).9 Quantitative monetary easing was a pioneering attempt in increasing the predictability of monetary policy. It was conducted both by lowering market interest rates to virtually 0 percent through the provision of ample funds surpassing the required reserves and by introducing forward guidance. Nevertheless, I have a feeling that the Bank could have addressed liquidity concern in the late 1990s at a much earlier stage. In that regard, I somewhat have understanding toward the criticism that the Bank's monetary easing was insufficient at that time, and as a result the financial crisis was prolonged and the economy fell into a deflationary trap.10 I also note that the Bank paid particular attention to the negative feedback loop between asset price deflation and the real economy. It did not pay due attention to mild deflation for a long period. In fact, the Bank repeatedly explained that the deflation was mild and the economy was not falling into a deflationary spiral, unlike at the time of the Great Depression in the 1930s.11 It is true that the Bank's provision of ample funds and the government's capital injection helped avoid a deflationary spiral, although these were somewhat delayed. Long-term inflation expectations were declining, but not much attention was paid by the Bank or those in academia to their potential effects on monetary policy. In response to Japan's financial crisis in the 1990s, the Bank expanded its balance sheet and conducted both funds-supplying and funds-absorbing operations -- i.e., it actively provided funds to money markets and at the same time absorbed excess reserves by selling bills. However, this does not mean that the Bank provided excess reserves and allowed the decline in market interest rates to 0 percent. After all, there was no such concept of quantitative easing at that time. Another significant lesson was that the excessive monetary easing before the financial crisis was the source of the huge economic bubble. In the United States as well, large-scale monetary easing after the bursting of the IT bubble and subsequent moderate tightening at a measured pace became the source of the housing bubble, which led to the global financial crisis. See Bank of Japan (2006). With hindsight, the Bank at least should have clarified its firm determination not to allow the decline in long-term inflation expectations, as was done by the Federal Reserve after the global financial crisis and by the European Central Bank after the sovereign debt crisis. D. Relationship with Labor Market Reform In my view, as a measure to raise long-term inflation expectations that already have declined to a low level, it is important to have structural policies, particularly labor market reform. If long-term inflation expectations have some kind of relevance to the potential growth rate, it is necessary to raise both at the same time. To this end, one important measure is labor market reform. If such reform leads to rises in labor productivity and the labor force participation rate, the potential growth rate will increase from a longer-term perspective and firms' expected rates of return and households' permanent income also will increase. This will strengthen monetary easing effects and the inflation rate will increase. Then, the adaptive formation mechanism of inflation expectations, which is unique to Japan, will bring about a positive influence on long-term inflation expectations. In Japan, some labor market practices could be constraints on raising long-term inflation expectations. Therefore, labor market reform should be actively pursued. Given that there is an increasing sense of labor shortage caused by the population decline, now is an ideal time to take a step forward in labor market reform. I will next focus on three possible reform measures. First, a more flexible adjustment mechanism should be implemented in Japan's labor market. Let me elaborate on this point. The way people form their expectations could be affected by how labor market adjustments are made during periods of recession -- i.e., whether to have quantity adjustments in terms of headcount or price adjustments in terms of wages. For example, in the U.S. labor market, quantity adjustments are mainly made in the form of layoffs. Japan's labor market mostly makes price adjustments and layoffs tend to be avoided (Chart 12). Let me add a few things about wage adjustments in Japan. In the face of the past shocks, including oil crises during early 1970s and 1980s, Japan's labor unions had a practice of prioritizing the job security of regular workers and accepting management's proposal to set lower wages. Under such coordination between labor and management, restraining wage increases of regular workers was effective in controlling inflation. Afterwards, the base pay of regular workers significantly shifted downward following Japan's financial crisis, and then became sticky at low levels. Since then, non-regular workers have acted as a buffer against wage adjustments as they are outside the protection of labor unions. As illustrated, Japanese-style employment and wage practices of prioritizing the job security of regular workers and restraining wage increases may have influenced long-term inflation expectations to shift downward. If that is the case, the solution is to implement dynamic U.S.-style employment practices and allow the compensation of regular workers to reflect risk premiums. I note that, in Japan's labor market, job mobility and a social safety net are not necessarily sufficient. In this situation, the U.S.-style employment system is unlikely to be socially acceptable. In fact, it has been difficult to reach a consensus between labor and management, and thus progress in labor market reform has been moderate. I believe that a key to success in labor market reform is to implement dynamic U.S.-style employment practices while modifying them to fit Japan's own circumstances. For example, it is important to gain the understanding of labor unions by establishing a social safety net that leads to economic growth. One option is to build a framework for employment and reemployment assistance in coordination with the government, labor, and management. Second, a forward-looking wage negotiation system should be established. Let me elaborate on this point. In Japan's wage negotiations, the observed rate of increase in the consumer price index (CPI) of the previous year is used as a benchmark in determining the rate of increase in wages for the following year (Chart 13). For this reason, even when a decline in the CPI is attributed to external factors, including a decline in crude oil prices, the low inflation rate tends to be referred to in wage negotiations. That said, such a price decline is a positive factor in corporate profits with an improvement in the terms of trade at a macroeconomic level.12 In my view, it is necessary to replace the existing practice of referring to the observed CPI in the past and negotiating the wage increases for only one year in an adaptive manner. Instead, it is necessary to implement the practice of negotiating wage increases for several years in a forward-looking manner by sharing the outlook on the path of price changes over several years, or over the medium to long term.13 Third, there should be a change in the practice of applying the result of labor-management wage negotiations at large manufacturers to other industries. In Japan, the result of wage negotiations at large manufacturers -- especially automobile, steel, and other major manufacturers -- tends to be used as a benchmark for such negotiations in other industries, including non-manufacturing. Therefore, even when the terms of trade at a macroeconomic level improve due to the yen's appreciation, if a higher yen causes major manufacturers to have lower profits and depress the rate of wage increases, such a rate for non-manufacturers also tends to be depressed accordingly. In Japan, the share of manufacturing in gross output is less than 20 percent. Therefore, it is not suitable at this time to use wages at major manufacturers as a benchmark for wage negotiations in other industries. I believe that wage increases should reflect individual firms' profits with forward-looking inflation expectations being used as a basis. III. Addendum: Recent Discussion on Fiscal Policy Measures The roles of fiscal policy measures have regained attention in Japan recently, following the insufficient increase in expectations even with the large-scale unconventional monetary The Bank has conducted a quantitative analysis on this point. See Appendix 4, Bank of Japan (2016). The Japanese government also recognizes the importance of forward-looking wage negotiations. At the Council for the Realization of Work Style Reform, Prime Minister Abe has asked the business community for wage increases that take inflation expectations into consideration. policy. "Helicopter money" and the Fiscal Theory of the Price Level (FTPL) are examples of this (Chart 14). The issue they have in common is whether or not additional fiscal expenditure will exert positive effects on the way people form their positive expectations in a sustainable manner. Households do not act as rationally as Ricardian equivalence assumes. Meanwhile, it also is plausible to assume that their concerns over possible tax hikes and an increase in social security tax burden provide a reason for their cautious outlook. These arguments might have given rise to the idea that it is desirable to have permanent fiscal policy expansion without an accompanying future tax hike. Even if government debts are assumed to be financed in the future through inflation that will be triggered by fiscal expansion, empirical research on related theoretical models is still insufficient. Therefore, the models cannot be applied to the actual policy formulation, nor used as the basis for macroeconomic forecast for such formulation. Economic policy is implemented based on a critical decision that takes account of more than just gains and losses for various economic entities. This is because it is difficult to obtain the consent of stakeholders based on an economic model that considers future inflation to be inevitable but cannot predict when it will occur. Let me also note that actual policy management cannot help being prudent. The reason for this is that the policy authorities have to strongly recognize various constraints. In fact, macroeconomic policy is managed under various constraints -- such as those in terms of legal, accounting, and practical affairs, as well as the need for parliamentary consent. Concluding Remarks I will close by noting the lesson learned from the 4-year experience since the introduction of QQE. Once long-term inflation expectations decline, it is not easy to raise them, even through the large-scale unconventional monetary policy. Given that monetary policy on its own has limited effects, it is vital to make steady efforts, such as through the labor market reform that I discussed earlier, in order to change conservative inflation expectations that are deeply rooted in people's mindsets. In particular, I consider it important to produce a change in the wage determination mechanism. In the process of wage determination, it is desired that inflation targets set by central banks be the basis for the medium- to long-term path of inflation. For this purpose, central banks' inflation targets should gain sufficient credibility with the public. To this end, it is necessary to see achievements that prove monetary policy is able to change the inflation trend. It is not easy to regain credibility. As the frontrunner in combating deflation, however, the Bank of Japan will continue to endeavor to do so, always deliberating on what can be accomplished through monetary policy. Thank you. Bibliography Bank of Japan. "The Bank's Thinking on Price Stability." March 2006. http://www.boj.or.jp /en/announcements/release_2006/data/mpo0603a1.pdf. ———. "Comprehensive Assessment: Developments in Economic Activity and Prices as well as Policy Effects since the Introduction of Quantitative and Qualitative Monetary Easing (QQE)." September 2016. http://www.boj.or.jp/en/announcements /release_2016/k160921b.pdf. ———, Research and Statistics Department 調査統計局. "Tokyo Daigaku Kin'yu Kyōiku Kenkyu Sentā to Nippon Ginkō Chōsa Tōkei Kyoku dai rokkai kyōsai konfarensu: 'Bukka Hendō to sono naka deno Keizai Shutai no Kōdō Henka' no moyō" 東京大学 金融教育研究センター・日本銀行調査統計局第 6 回共催コンファレンス： 「物 価 変 動 と そ の 中 で の 経 済 主 体 の 行 動 変 化 」 の 模 様 [Minutes of the sixth conference co-hosted by the Center for Advanced Research in Finance of the University of Tokyo and Research and Statistics Department of the Bank of Japan: Price Movements and the Resultant Behavioral Changes of Economic Entities]. BOJ Reports and Research Papers 日本銀行調査論文, January 2016. http://www.boj.or .jp/research/brp/ron_2016/data/ron160121a.pdf. Board of Governors of the Federal Reserve System. "Statement on Longer-Run Goals and Monetary Policy Strategy." January 2016. http://www.federalreserve.gov /monetarypolicy/files/FOMC_LongerRunGoals_20160126.pdf. Bullard, James. "Seven Faces of 'The Peril'." Federal Reserve Bank of St. Louis Review 92, no.5 (September/October 2010): 339-52. http://files.stlouisfed.org/files/htdocs /publications/review/10/09/Bullard.pdf. Endo, Yushi, Takushi Kurozumi, Takemasa Oda, and Kenichirou Watanabe. "Monetary Policy: Its Effects and Implementation: Summary of the 2015 BOJ-IMES Conference Organized by the Institute for Monetary and Economic Studies of the Bank of Japan." Monetary and Economic Studies 33, November 2015. http://www.imes.boj.or.jp /research/papers/english/me33-1.pdf. Fukui, Toshihiko. "New Framework for the Conduct of Monetary Policy: Toward Achieving Sustainable Economic Growth with Price Stability." Bank of Japan. March 2006. http://www.boj.or.jp/en/announcements/press/koen_2006/ko0603a.htm. Nakaso, Hiroshi. "The Conquest of Japanese Deflation: Interim Report." Bank of Japan. June 2014. http://www.boj.or.jp/en/announcements/press/koen_2014/data /ko140619b1.pdf. Okina, Kunio, Masaaki Shirakawa, and Shigenori Shiratsuka. "The Asset Price Bubble and Monetary Policy: Japan's Experience in the Late 1980s and the Lessons." Monetary and Economic Studies 19, no. S-1, February 2001. http://www.imes.boj.or.jp/research /papers/english/me19-s1-14.pdf. Okina, Kunio, and Shigenori Shiratsuka. "Asset Price Bubbles, Price Stability, and Monetary Policy: Japan's Experience." Monetary and Economic Studies 20, no. 3, October 2002. http://www.imes.boj.or.jp/english/publication/mes/2002/me20-3-2.pdf. Okina, Kunio, and Shigenori Shiratsuka. "Asset Price Fluctuations, Structural Adjustments, and Sustained Economic Growth: Lessons from Japan's Experience since the Late 1980s." Monetary and Economic Studies 22, no. S-1, December 2004. http://www .imes.boj.or.jp/english/publication/mes/2004/me22-s1-8.pdf. Shintani, Kohei, Yoshiyuki Kurachi, Shinichi Nishioka, and Takashi Okamoto. "Administered Prices in Japan: Institutional Comparisons with Europe and the United States." Bank of Japan Review Series, no. 16-E-9, July 2016. http://www.boj.or.jp/en /research/wps_rev/rev_2016/data/rev16e09.pdf. Shirakawa, Masaaki. "Monetary Policy Cannot Substitute for Structural Policy." Bank of Japan Working Paper Series, January 2000. http://www.boj.or.jp/en/research/wps_rev /wps_2000/kwp00e01.htm. Watanabe, Kota, and Tsutomu Watanabe. "Price Rigidity at Near-Zero Inflation Rates: Evidence from Japan." CARF Working Paper Series, March 2017. Watanabe, Tsutomu 渡辺努, and Kota Watanabe 渡辺広太. "Defure-ki ni okeru kakaku no kōchokuka: Geiin to gan'i" デ フ レ 期 に お け る 価 格 の 硬 直 化 ： 原 因 と 含 意 [Increased price rigidity during the deflationary period: Causes and implications]. Bank of Japan Working Paper Series 日本銀行ワーキングペーパーシリーズ, no. 16-J-2, February 2016. http://www.boj.or.jp/research/wps_rev/wps_2016/data /wp16j02.pdf. Yamaguchi, Yutaka. "Monetary Policy and Structural Policy: A Japanese Perspective." Bank of Japan. November 1999. http://www.boj.or.jp/en/announcements/press/koen_1999 /ko9911a.htm. Yamada, Hisashi 山田久. "Defure-ki chingin geraku no gen'in to jizokuteki chin'age no jōken" デフレ期賃金下落の原因と持続的賃上げの条件 [Causes of decline in wages during the deflationary period and the conditions for sustainable wage increases]. Special issue 特別号, Nippon Rōdō Kenkyu Zasshi 日本労働研究雑誌, no. 667, January 2016. Lessons of Japan: Focusing on Issues regarding Long-Term Inflation Expectations Speech at Yale University in New Haven March 28, 2017 Takehiro Sato Bank of Japan Today's Topics Introduction I. Lessons of Japan 1. Determinants of Long-Term Inflation Expectations 2. Negative Effects of Excessively Low Long-Term Inflation Expectations II. Issues regarding Long-Term Inflation Expectations 1. Formation Mechanism 2. Reasons for Low Expectations in Japan 3. Relationship with Japan's Financial Crisis 4. Relationship with Labor Market Reform III. Addendum: Recent Discussion on Fiscal Policy Measures Concluding Remarks Chart 1 Statement on Longer-Run Goals and Monetary Policy Strategy Board of Governors of the Federal Reserve System Adopted effective January 24, 2012; as amended effective January 26, 2016 "The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation." Chart 2 Potential Growth Rate and Inflation Expectations in Advanced Economies (1) Potential Growth Rate 2.5 (2) Inflation Expectations y/y % chg. 4.0 Japan United States Euro area y/y % chg. Japan 3.5 United States Euro area 2.0 3.0 2.5 1.5 2.0 1.0 1.5 1.0 0.5 0.5 0.0 CY 05 0.0 CY 05 Note: As for inflation expectations, figures for Japan are the expectations for the CPI 6-10 years ahead and are based on the "Consensus Forecasts." Those for the United States and euro area are 5-year, 5-year forward inflation swap rates. Sources: OECD; Bloomberg; Consensus Economics Inc., "Consensus Forecasts." Today's Topics Introduction I. Lessons of Japan 1. Determinants of Long-Term Inflation Expectations 2. Negative Effects of Excessively Low Long-Term Inflation Expectations II. Issues regarding Long-Term Inflation Expectations 1. Formation Mechanism 2. Reasons for Low Expectations in Japan 3. Relationship with Japan's Financial Crisis 4. Relationship with Labor Market Reform III. Addendum: Recent Discussion on Fiscal Policy Measures Concluding Remarks Chart 3 Japan's Inflation Expectations and Potential Growth Rates y/y % chg. y/y % chg. 3.0 Inflation expectations (left scale) 2.5 Potential growth rate (right scale) 2.0 1.5 1.0 0.5 -1 0.0 CY 90 -2 Note: Figures for inflation expectations are the expectations for the CPI 6-10 years ahead and are based on the "Consensus Forecasts." Figures for potential growth rate do not include those of 2011, in which the Great East Japan Earthquake occurred. Sources: Cabinet Office; Consensus Economics Inc., "Consensus Forecasts." Chart 4 Japan's Asset Price Deflation 0.2 1989/Q4 = 0, in log-scale 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 -1.2 -1.4 Land price -1.6 Stock price CPI (all items less fresh food) -1.8 -2.0 CY 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Note: The CPI (all items less fresh food) is seasonally adjusted by X-12-ARIMA with options of (0 1 2) (0 1 1) ARIMA model and level shifts when the consumption tax was introduced in April 1989 and subsequently raised in April 1997 and April 2014. Sources: Okina, Kunio, and Shigenori Shiratsuka. "Asset Price Fluctuations, Structural Adjustments, and Sustained Economic Growth: Lessons from Japan's Experience since the Late 1980s." Monetary and Economic Studies 22, no. S-1, December 2004; Bank of Japan; Ministry of Internal Affairs and Communications; Japan Real Estate Institute. Chart 5 Japan's Inflation Expectations y/y % chg. 3.0 Consensus forecasts 2.5 5-year, 5-year forward inflation swap rate 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 CY 90 Note: Figures for consensus forecasts are the expectations for the CPI 6-10 years ahead and are based on the "Consensus Forecasts." Sources: Bloomberg; Consensus Economics Inc., "Consensus Forecasts." Chart 6 Frequency Distribution of Price Changes in Individual CPI Items (1) Changes after the Introduction of QQE (2) Comparison of Japan and the United States (as of March 2014) ％ ％ Japan Dec. 2012 United States Dec. 2016 -11-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 (year-on-year rate of price changes in individual CPI items, %） -11-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 (year-on-year rate of price changes in individual CPI items, %） Sources: Watanabe, Tsutomu 渡辺努, and Kota Watanabe 渡辺広太. "Defure-ki ni okeru kakaku no kōchokuka: Geiin to gan'i" デフレ期における価格の硬 直化：原因と含意 [Increased price rigidity during the deflationary period: Causes and implications]. Bank of Japan Working Paper Series 日本銀 行ワーキングペーパーシリーズ, no. 16-J-2, February 2016; Ministry of Internal Affairs and Communications. CY 2000 = 1 1.9 Chart 7 Comparison of Administered Prices among Advanced Economies 1.8 Japan 1.7 Europe United States 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 CY 00 Note: Figures for Japan are aggregates of "public services" and "electricity, manufactured & piped gas & water charges" in the CPI. Figures for Europe are weighted averages of administered prices in the harmonized index of consumer prices (HICP) of OECD member countries in the EU. Sources: Shintani, Kohei, Yoshiyuki Kurachi, Shinichi Nishioka, and Takashi Okamoto. "Administered Prices in Japan: Institutional Comparisons with Europe and the United States." Bank of Japan Review Series, no. 16-E-9, July 2016; Ministry of Internal Affairs 9 and Communications; U.S. Bureau of Labor Statistics; Eurostat. Chart 8 Base Pay Increases in Advanced Economies y/y % chg. Japan (base pay increase) United States (employment cost index for union members) Germany (negotiated hourly earnings) -1 CY 95 Sources: Central Labour Relations Commission; Japanese Trade Union Confederation (Rengo); U.S. Bureau of Labor Statistics; U.S. Congressional Budget Office; Federal Statistical Office of Germany; Deutsche Bundesbank. Chart 9 Inflation and Deflation Equilibrium Nominal interest rate (%) Non-linear Taylor Rule i = F(π) U.S. Euro area Fisher relation i=r+π where r = 0.5%. Japan Deflation equilibrium Inflation equilibrium U.S. 2017/1 -2 -1 -1 -2 Japan 2017/1 Core CPI inflation rate (%) Euro area 2017/1 Note: Nominal interest rate and core CPI inflation rate are in terms of realized rates. Core CPI inflation rate is in terms of CPI excluding food and energy. Figures for Japan exclude effects of changes in consumption tax. Source: Bullard, James. "Seven Faces of 'The Peril.'" Federal Reserve Bank of St. Louis Review 92, no. 5 (September/October 2010): 339-52. Chart 10 Bank Stock Prices at around Time of Japan's Financial Crisis Nov. 1997 Failures of Sanyo Securities, Hokkaido Takushoku Bank, Yamaichi Securities, and Tokuyo City Bank Mar. 1998 Capital injection （21 banks, 1.8 trillion yen） Oct. 1998 Temporary nationalization of Long-Term Credit Bank of Japan Feb. 1999 Introduction of the zero interest rate policy Mar. 1999 Capital injection （15 banks, 7.5 trillion yen） May 2003 Capital injection into Resona Bank Aug. 2000 Termination of the zero interest rate policy Mar. 2001 Introduction of the quantitative easing policy CY 89 Note: TOPIX Banks Index. Source: Bloomberg. Balance Sheet of the Bank of Japan at around Time of Japan's Financial Crisis Chart 11-1 tril. yen Others Assets LLR lending, credit facilities & equities Short-term fund-supplying operations TBs JGBs -50 Bills sold and reverse repos Currency in circulation -100 -150 Liabilities and net assets Other liabilities & net assets Current account balances -200 Source: Bank of Japan. Chart 11-2 Current Account Balances and Call Rate % tril. yen 0.6 Current account balances (left scale) 0.5 Uncollateralized overnight call rate (right scale) Policy rate (right scale) 0.4 0.3 0.2 0.1 -0.1 -0.2 CY Note: Figures for policy rate before October 2010 are targets for uncollateralized overnight call rates, those from October 2010 to January 2016 are interest rates applied to excess reserves, and those from January 2016 onward are interest rates applied to Policy-Rate Balance. Source: Bank of Japan. Chart 12 Phillips Curve in Japan and the United States (1) Rate of Inflation and Unemployment Rate (2) Rate of Wage Inflation and Unemployment Rate rate of inflation, y/y % chg. rate of wage inflation, y/y % chg. United States United States Japan Japan -2 -1 -4 -2 -6 -3 unemployment rate, % unemployment rate, % Notes: 1. The wage is the hourly wage. Figures for wages in Japan are calculated as "total cash earnings (establishment with 30 or more employees)" divided by "total hours worked." Those in the United States are "average hourly earnings of production and nonsupervisory employees: total private." 2. Rate of inflation for Japan is indicated in terms of the CPI for all items less fresh food and that for the United States is in terms of personal consumption expenditures excluding food and energy. 3. The CPI in Japan is adjusted to exclude the effects of the consumption tax hikes. Sources: Ministry of Health and Welfare; Ministry of Internal Affairs and Communications; U.S. Bureau of Economic Analysis; U.S. Bureau of Labor Statistics, Bloomberg. Chart 13 Base Pay Increase and Prices y/y % chg. Base pay increase CPI (all items less fresh food) -1 -2 -3 CY 95 Note: As for the CPI (all items less fresh food), effects of the consumption tax hikes are not adjusted. Sources: Central Labour Relations Commission; Japanese Trade Union Confederation (Rengo); Ministry of Internal Affairs and Communications. Today's Topics Introduction I. Lessons of Japan 1. Determinants of Long-Term Inflation Expectations 2. Negative Effects of Excessively Low Long-Term Inflation Expectations II. Issues regarding Long-Term Inflation Expectations 1. Formation Mechanism 2. Reasons for Low Expectations in Japan 3. Relationship with Japan's Financial Crisis 4. Relationship with Labor Market Reform III. Addendum: Recent Discussion on Fiscal Policy Measures Concluding Remarks Chart 14 Recent Discussion on Fiscal Policy Measures • Helicopter Money • FTPL (Fiscal Theory of the Price Level) Today's Topics Introduction I. Lessons of Japan 1. Determinants of Long-Term Inflation Expectations 2. Negative Effects of Excessively Low Long-Term Inflation Expectations II. Issues regarding Long-Term Inflation Expectations 1. Formation Mechanism 2. Reasons for Low Expectations in Japan 3. Relationship with Japan's Financial Crisis 4. Relationship with Labor Market Reform III. Addendum: Recent Discussion on Fiscal Policy Measures Concluding Remarks
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Speech by Mr Yukitoshi Funo, Member of the Policy Board of the Bank of Japan, at a meeting with business leaders, Shizuoka, 22 March 2017.
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Ma rch 2 2, 2 01 7 Bank of Japan Economic Activity, Prices, and Monetary Policy in Japan Speech at a Meeting with Business Leaders in Shizuoka Yukitoshi Funo Member of the Policy Board (English translation based on the Japanese original) I. Recent Economic and Price Developments A. Overseas Developments I would like to begin my speech by talking about developments in overseas economies. An improvement in business sentiment of manufacturing firms has become evident on a global basis, mainly on the back of an increase in IT-related demand and of the progress observed in emerging economies in inventory adjustments of materials. In this situation, overseas economies have continued to grow at a moderate pace. As for the outlook, the growth rates of overseas economies are expected to increase moderately, as it is likely that advanced economies will continue growing steadily and a recovery in emerging economies will take hold gradually. According to the World Economic Outlook (WEO) Update, released in January 2017 by the International Monetary Fund (IMF), global growth projections have factored in the effects of expansionary fiscal policy expected to be taken in the United States and other elements compared to those made in the October 2016 WEO, and the global growth rate is projected to increase from 3.1 percent in 2016 to 3.4 percent in 2017, and to 3.6 percent in 2018. Looking at developments by major region, the U.S. economy has continued to recover firmly, mainly in household spending, owing to a steady improvement in the employment and income situation. As for the outlook, the economy is expected to continue to see firm growth driven by domestic private demand. The European economy has continued to recover moderately, mainly in the household sector. As for the outlook, the economy is projected to follow a moderate recovery trend, while uncertainty -- associated with political issues and the European debt problem, including the financial sector -- is likely to be a burden on economic activity. The Chinese economy has continued to see stable growth on the whole, supported by policy effects resulting from such factors as a rise in public investment. As for the outlook, the economy is likely to broadly follow a stable growth path as authorities proactively carry out measures to support economic activity. Emerging economies other than China and commodity-exporting economies have continued to pick up on the whole, reflecting in particular a bottoming out of commodity prices and the effects of economic stimulus measures of those economies, although some economies have remained subdued. As for the outlook, the growth rates of emerging economies other than China and commodity-exporting economies are likely to increase gradually, due mainly to the effects of the economic stimulus measures and the spread of the effects of steady growth in advanced economies. Risk factors to the overseas economic outlook are wide ranging, as exemplified by developments in the U.S. economy and the impact of its monetary policy on global financial markets, (2) developments in emerging and commodity-exporting economies, particularly China, (3) the consequences stemming from the United Kingdom's vote to leave the European Union (EU) and their effects, (4) prospects regarding the European debt problem, including the financial sector, and (5) geopolitical risks. Therefore, I consider it necessary to closely monitor various risk factors from a broad perspective in making projections regarding overseas developments. B. Japan's Economy and Prices 1. Economic activity I will now discuss the economic situation in Japan given the overseas developments I have just outlined. Japan's economy has continued its moderate recovery trend. On an annualized quarter-on-quarter basis, the real GDP growth rate for the October-December quarter of 2016 registered 1.2 percent, representing an increase for four consecutive quarters. The rate continued to rise, due mainly to an increase in external demand, although domestic demand was somewhat sluggish. With regard to the outlook, Japan's economy is likely to turn to a moderate expansion. Domestic demand is likely to follow an uptrend, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors, on the back of highly accommodative financial conditions and fiscal spending through the government's large-scale stimulus measures. Meanwhile, exports are expected to follow a moderate increasing trend as the growth rates of overseas economies increase moderately. According to the Bank's January 2017 Outlook for Economic Activity and Prices (hereafter the Outlook Report), the medians of the Policy Board members' forecasts for the economic growth rate are 1.4 percent for fiscal 2016, 1.5 percent for fiscal 2017, and 1.1 percent for fiscal 2018, and the economy is expected to continue growing at a pace above its potential through the projection period of fiscal 2016-2018.1 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 has increased, reflecting a rise in energy prices, and has been about 0 percent. The rate of increase for all items less fresh food and energy had remained on a decelerating trend, following the peak of 1.3 percent in November 2015; thereafter, the rate of change has been fluctuating. Looking at annual price changes across all CPI items less fresh food, the share of price-increasing items minus the share of price-decreasing items has continued on a moderate declining trend, although it remains in positive territory. With regard to the outlook, as the positive contribution of energy prices increases, albeit with fluctuations, and as the aggregate supply and demand balance (the output gap) improves and inflation expectations rise, the year-on-year rate of change in the CPI (all items less fresh food) will likely reach around 2 percent in around fiscal 2018; nevertheless, it is necessary to closely monitor downside risks. Specifically, the medians of the Policy Board members' forecasts of the year-on-year rate of change in the CPI (all items less fresh food) presented in the January 2017 Outlook Report are minus 0.2 percent for fiscal 2016, 1.5 percent for fiscal 2017, and 1.7 percent for fiscal 2018.2 Under a specific methodology, Japan's potential growth rate is estimated to be around 0.5 percent, revised upward from being in the range of 0.0-0.5 percent due to the comprehensive revision to GDP statistics. However, the estimate of the potential growth rate varies depending on the methodologies employed and could be revised as the sample period becomes longer over time. Thus, it should be regarded as being subject to a considerable margin of error. From the January 2015 interim assessment through the October 2016 Outlook Report, each Policy Board member made their forecasts based on the same assumption about crude oil prices due to the fact that such prices had been exerting a considerable impact on consumer prices. In the January 2017 Outlook Report, each member made an assumption about crude oil prices individually in making their forecasts in light of the fact that the contribution of energy prices to the year-on-year rate of change in the CPI (all items less fresh food) had lessened. The contribution was estimated to be approximately minus 0.6 percentage point for fiscal 2016 and reach around 0 percentage point in early 2017, becoming slightly positive thereafter. II. Keys to Assessing the Outlook for Economic Activity and Prices In what follows, I will discuss several points that I think deserve particular attention in terms of realizing the outlook that I mentioned earlier. A. Employment and Income Situation First, I will talk about developments in the employment and income situation. Supply-demand conditions in the labor market have continued to improve steadily and employee income has increased moderately. According to the Labour Force Survey, the rate of increase in the number of employees has remained at a high level of about 1.5 percent. Against this backdrop, the active job openings-to-applicants ratio has followed a steady uptrend, and a perception of labor shortage suggested by the diffusion index (DI) for employment conditions (the proportion of firms responding that employment was "excessive" minus the proportion of those responding that employment was "insufficient") in the December 2016 Tankan (Short-Term Economic Survey of Enterprises in Japan) has heightened further; both indicators show a tightening at almost the same levels seen around 1991-1992. The unemployment rate has continued on a moderate declining trend, albeit with some fluctuations, and has been about 3 percent recently. The supply-demand conditions in the labor market are expected to further tighten. On the wage side, the rise in hourly cash earnings has accelerated moderately, albeit with fluctuations. Specifically, the year-on-year rate of change in hourly cash earnings of part-time employees, which are responsive to labor market conditions, has seen a relatively high increase, being in the range of around 1.5-2.0 percent when fluctuations are smoothed out. With regard to the outlook, the pace of increase in full-time employees' cash earnings is expected to accelerate, as corporate profits improve and a heightening of inflation expectations becomes evident. The rate of increase in hourly cash earnings of part-time employees is also likely to accelerate steadily in response to the marked tightening of labor market conditions and an increase in minimum wages. In light of these prospects for employment and wages, the rate of increase in employee income is expected to continue rising at around the same rate as nominal GDP growth. However, there is a risk that firms will remain cautious with their decisions, particularly on wage setting. In this context, how the labor-management wage negotiations in spring 2017 will develop warrants particular attention. B. Private Consumption I will now discuss developments in private consumption, which has been resilient against the background of steady improvement in the employment and income situation. The Consumption Activity Index (CAI) had continued to be somewhat weak in part since the beginning of 2016, against the background of the negative wealth effects brought about by the decline in stock prices and of irregular weather; however, the CAI has picked up recently. As the employment and income situation has continued to improve, factors such as the wealth effects resulting from a rise in stock prices and the dissipation of the effects of irregular weather are considered to be supporting the pick-up in the CAI. With regard to the outlook, private consumption is expected to increase moderately, supported by a steady improvement in employee income, as well as the wealth effects stemming from a rise in stock prices and the effects resulting from the set of stimulus measures. C. Business Fixed Investment Let me now explain developments in business fixed investment, which has been on a moderate increasing trend as corporate profits have improved. According to the December 2016 Tankan, firmness has continued to be seen in business fixed investment plans for fiscal 2016 as a whole, although developments such as delays in the construction progress and postponement of opening new shops, both triggered by labor shortages, have been observed in some small nonmanufacturing firms. As for the outlook, business fixed investment is likely to continue to see a moderate uptrend, mainly on the back of (1) an improvement in corporate profits, (2) extremely stimulative financial conditions, such as low interest rates and accommodative lending attitudes, (3) the effects of fiscal measures including projects conducted under the Fiscal Investment and Loan Program and tax reductions for capital investment, and (4) moderate improvement in growth expectations. D. Prices Next, I will discuss inflation expectations and the output gap, which are the main factors that determine inflation rates. First, medium- to long-term inflation expectations have remained in a weakening phase since summer 2015 as the adaptive formation mechanism has played a large role, reflecting the observed inflation rate having been slightly negative. As for the outlook, firms' price-setting stance is expected to revert to raising prices as private consumption is expected to continue increasing moderately, and their wage-setting stance is likely to shift toward raising wages driven by the tightening of labor market conditions; against this backdrop, medium- to long-term inflation expectations are likely to follow a sustained increasing trend. Second, the output gap had been more or less unchanged at around 0 percent, but has shown some improvement recently. It is projected that it will turn slightly positive toward the end of fiscal 2016, and from fiscal 2017 continue expanding moderately in positive territory owing to both the capital and labor factors, as domestic and foreign demand increase in a well-balanced manner. III. Conduct of Monetary Policy Let me now turn to the Bank's monetary policy. At the Monetary Policy Meeting (MPM) held in January 2013, the Bank made a commitment 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, and in April of that year, it decided to introduce Quantitative and Qualitative Monetary Easing (QQE) as a necessary measure to underpin this commitment. In January 2016, the Bank decided to introduce QQE with a Negative Interest Rate in order to pursue monetary easing in terms of the three dimensions of quantity, quality, and the interest rate. Furthermore, in September 2016, the Bank conducted a comprehensive assessment of the developments in Japan's economic activity and prices as well as policy effects since the introduction of QQE, and decided to introduce QQE with Yield Curve Control as a means of strengthening the two previous policy frameworks I just mentioned. The framework of QQE with Yield Curve Control consists of two major components. The first is yield curve control in which the Bank facilitates the formation of short- and long-term interest rates that are considered most appropriate for maintaining the momentum toward achieving the price stability target, taking account of developments in economic activity and prices as well as financial conditions. Specifically, at present, in the guideline for market operations, the Bank sets the short-term policy interest rate at minus 0.1 percent and the target level of the 10-year Japanese government bond (JGB) yields at around 0 percent, conducting JGB purchases so as to achieve this target level. The second component is an inflation-overshooting commitment in which the Bank continues with the monetary easing framework, aiming to achieve the price stability target, as long as it is necessary for maintaining that target in a stable manner. On this point, the Bank makes clear that it will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds 2 percent and stays above the target in a stable manner. As shown in the comprehensive assessment, I consider that the main factor that hampers achieving the price stability target of 2 percent is as follows. In the course of the Bank's attempt to raise inflation expectations toward 2 percent, observed inflation rates declined due to a variety of exogenous factors such as a substantial fall in crude oil prices. Under these circumstances, inflation expectations declined, as the adaptive mechanism has been playing a relatively large role in the formation of inflation expectations in Japan. Taking this into consideration, the Bank decided to adopt a commitment that allows inflation to overshoot the price stability target so as to strengthen the forward-looking mechanism in the formation of inflation expectations, enhance the credibility of achieving the price stability target among the public, and raise inflation expectations in a more forceful manner. As for the future conduct of monetary policy, the Bank will continue with QQE with Yield Curve Control, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. Currently, the momentum toward achieving the price stability target is being maintained, and the year-on-year rate of change in the CPI is expected to increase toward 2 percent. Nevertheless, the momentum is not yet sufficiently firm, and we are only halfway to achieving the price stability target. Some market participants, taking account of a rise in interest rates overseas, argue that the Bank might consider raising the target level of the long-term interest rate in the near future, but considering the current developments in economic activity and prices as well as financial conditions, I believe that it is important that the Bank continue to steadily pursue powerful monetary easing under QQE with Yield Curve Control. IV. Challenges for Japan's Economy I would now like to express my thoughts regarding the current situation of Japan's economy from a longer-term perspective. In order to achieve the Bank's price stability target in a stable manner, one of the necessary requirements is to raise the potential growth rate, which indicates the "basal metabolism" of an economy. Japan's economy has achieved growth through the process of securing resources and making full use of them, as well as developing high-quality products and services and providing them to markets. Through this process, Japan has contributed to global economic growth as well. I believe it is possible to further expand Japan's growth and contribution to global economic growth in various areas. We should continue with proactive efforts to increase Japan's growth potential, rather than being overly pessimistic about structural changes such as the population decline. To secure and make use of resources, measures have been taken in the public sector, for example, to tackle the problem of the population decline -- such as support for childcare and for women and the elderly to become part of the workforce. In the private sector, in addition to the efficient use of human resources, it is vital to enhance the training of managers and the efficiency of administrative operations. From a global viewpoint, expanding the network for securing such resources as raw materials is highly desirable. Moreover, increasing the number of foreign workers in many fields could be an option. With regard to developing and providing products and services, Japan needs to develop high-value-added products and services with good reputations and explore new sources of domestic demand through initiatives such as advancing financial technology. It also is important to expand the channels for capturing overseas demand in neighboring economies, mainly in Asia, where high growth is expected. This includes attracting inbound demand. In light of the current situation, I believe that Japan should secure demand necessary for its economic growth, both at home and abroad in a balanced manner. At a time of uncertainty regarding such factors as developments in overseas economies, it also is vital to enhance the autonomy of Japan's economy while paying due attention to overseas risk factors. One good example is the situation for exports in 2016, when they remained resilient despite the appreciation of the yen. I see this as evidence that the autonomy of Japan's economy has strengthened, reflecting the heightened non-price competitiveness in which the volume of exports is not directly affected by foreign exchange movements. Going forward, continued efforts are needed to establish a system for developing and providing unique products and services that are not susceptible to economic developments at home and abroad, nor to foreign exchange movements, and to further accelerate innovation that promotes establishment of such a system. In closing, let me underline that these initiatives toward raising Japan's potential growth rate require a comprehensive approach that includes structural reforms in addition to monetary and fiscal policies. Structural reforms of Japan's economy have been progressing to a certain extent, but further acceleration is required. I expect that growth strategies will bear fruit as smooth procurement of funds proceeds under accommodative financial conditions, and as these are invested in labor-saving machinery and equipment, research and development, and mergers and acquisitions at home and abroad. Thank you for your attention.
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Remarks by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Conference on "AI and Financial Services/Financial Markets", Tokyo, 13 April 2017.
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April 13, 2017 Bank of Japan AI and the Frontiers of Finance Remarks at the Conference on "AI and Financial Services/Financial Markets" Haruhiko Kuroda Governor of the Bank of Japan (English translation based on the Japanese original) Introduction Today's conference focuses on the overlapping areas of new information technology, such as artificial intelligence (AI) and financial services, which now constitute the frontier of finance. Indeed, the fact that experts in various fields are gathering in this meeting room of a central bank symbolizes the current trend in finance. I. AI, Big Data Analytics, and Finance Information processing as a basic function of financial services Today, concepts such as AI and big data analytics are seen ubiquitously on the news and in magazines. These new information technologies have been utilized in the marketing of consumers' attribute analysis and applied in various areas such as system control, bio-medical sciences, economic analytics, and weather forecasting. The financial field is also attracting significant attention as promising areas in which AI and big data analytics are expected to explore new frontiers. Indeed, various measures have been taken to utilize these technologies in a wide range of financial businesses, such as providing innovative services called "FinTech," high-tech oriented trading in various markets, risk management, and the operation of call centers for retail customers. It is not at all surprising that such new information technologies are expected to be utilized in various financial services, considering that the basic function of finance is information processing. Financial infrastructure, including financial markets and payment systems, efficiently processes large amounts of information. For example, it is impossible for a single individual to assess the risks and returns of a vast number of projects spreading all over the world. In financial markets, the assessment of projects by many market participants are aggregated and shared in the form of "price," where each participant is able to use the assessment made by many other participants. In this way, financial services, through efficiently processing large volumes of information, continuously allocate limited economic resources to promising projects, thereby supporting economic development. In this respect, AI and big data analytics is considered to have a great potential for making the information processing function -- which is the fundamental function of finance -- even more efficient and advanced, as they enable to generate new value added through processing large volumes of information. Further data utilization Another motivation for applying AI and big data analytics to various financial services is that finance activities generally accompany large data volumes, which have great potential to be utilized in wide-ranging businesses. For example, if transaction data associated with payments and settlements -- in terms of "who bought what, when, and where" -- could be collected and analyzed, such data would have significant value for various businesses. In this circumstance, recent innovation in information technology and consequent business developments, such as the popularization of loyalty cards, have made it even easier to collect and analyze big data related to payments and settlements. Response to changing environment The third source of motivation for applying AI to financial activities is that the environment surrounding financial markets and services continuously changes, reflecting the complex mutual interactions of various factors. For instance, financial markets do not always show similar responses to similar news. Financial markets of today may strongly react to the news it did not react to at all yesterday. The risks and returns of various projects, as well as the needs of financial service users, change from day to day in accordance with the changes in the economic environment. AI is expected to support efficient responses to changes in the environment surrounding market transactions and financial businesses by swiftly providing guidance based on the analysis of large volumes of new information observed in economy and markets. II. New Issues Impact on market structure and price formation Although AI and big data analytics are expected to provide multiple benefits, new issues have been identified for market stakeholders and policymakers when applying such technologies to financial activities. High-frequency trading (HFT) and algorithmic trading, which use high-speed communications and computer programs, have already been employed in financial market transactions. There are arguments that these types of trading improve market liquidity. At the same time, there are also concerns that HFT and algorithmic trading may increase market volatility, especially if massive trading is based on a similar algorithm, or that a possible exiting of market participants who cannot employ HFT would ultimately reduce its diversity. As such, the application of AI and big data analytics to HFT and algorithmic trading might intensify these negative impacts. In view of these various opinions, policymakers should carefully monitor the impacts of possible application of new information technologies on market structure and price formation. Ensuring "information security" and "data privacy" As previously mentioned, one of the motivations for applying AI and big data analytics to financial services is the potential benefits obtained through effective and efficient use of data associated with financial activities. This implies that information security and data privacy would be even more critical in providing financial services. In this respect, the sincere efforts of stakeholders would be key to ensuring users' trust in innovative financial services utilizing new information technologies, and promoting the developments of such services. Ensuring "trust" and "governance" There is also concern voiced about whether the extensive application of AI might take financial market infrastructure beyond the control of human beings. Such a concern might be based on human beings' ambivalence toward AI, which was elegantly described in "2001: A space odyssey," a film released almost half a century ago. The reason why such concern arises in the application of AI to financial services, is probably because "trust" is a critical factor in financial services, along with several other sectors, such as medical services. Although we already have highly intelligent and skilled robots, few individuals welcome, without hesitation, undergoing completely robotic surgeries without any human intervention, as we cannot completely get rid of tail risks. To facilitate the application of AI to financial services, it would be important for relevant entities to establish reliable structures for effective governance and responsibility in case of tail events to ensure public trust to innovative financial services. III. AI and the Frontiers of Finance Keeping these issues in mind, new information technologies such as AI and big data analytics have the potential to broaden the frontiers of finance and contribute to the economy. Ever since the creation of money, finance has continuously developed through utilizing available technologies such as minting, printing, telecommunication, and computers. For instance, securities were originally based on paper and printing technologies. Although the developments in information technology have replaced paper securities with digital signals, the securities market continues to contribute to the economy. Rather, as securities have been dematerialized by digital signals, their market has further developed, since dematerialization freed securities from geographical limitations. Now, advanced securities markets have become a core financial infrastructure, linking the supply and demand of funds not only domestically but also across borders. In the economy, finance functions to connect various economic entities, wide-ranging goods and services created by them, as well as investors and projects beyond time and space. I believe such a function of finance will become more important in view of globalization and technological innovation. Since AI and big data analytics enable advanced information processing, they inherently have the potential to strengthen the functions of finance. For example, they could contribute to the growth of the global economy through matching investors and projects worldwide more effectively, and increasing the number of projects to be carried out. Additionally, new information technologies would enable financial service providers to offer more personalized and customized services to users, thereby increasing economic welfare. In view of such potential benefits of new technologies to the economy, public authorities, including central banks, should be cautious not to deter the development of new information technologies by focusing solely on their negative side effects. We, policymakers, should always try to maximize the benefits of new technologies while minimizing their negative impacts, and I firmly believe we can do so by taking the appropriate actions. Moreover, it is also essential for us to constructively consider desirable ways in which humans and AI complement, rather than confront, each other. For instance, human judgment is not completely free from existing paradigms, and thus is sometimes negligent to changes. In this regard, AI could adjust our bias by neutrally analyzing and finding new correlations among a myriad of data. Meanwhile, humans could compensate for AI's weakness with their intuition, common sense, and imagination. IV. Concluding Remarks When I think about AI and human beings, I think of Blaise Pascal, a French philosopher and mathematician of the 17th century, as the forerunner who expressed advanced ideas, such as automated processing of large numbers of data and innovative algorithm, which took the lead in developing today's information technology. Almost 400 years ago, Pascal invented the first computing machine, an ancestor of today's computers. Pascal also came up with an idea of an omnibus coach as the first public transportation in the world. This was based on an algorithmic idea to efficiently transport many people by establishing routes that crisscrossed and surrounded the city of Paris. This should have been a much more epoch-making idea in those days than today's idea of car-sharing. At the same time, Pascal emphasized the importance of independent thinking for human beings in his famous phrase: "Man is a reed, the weakest of nature, but he is a thinking reed." I believe this phrase has great implications for us in dealing with new technologies. If there is any risk the role of human beings are overwhelmingly replaced by AI, that would be when human beings stop thinking independently and autonomously. From a financial perspective, it is most important for us to think independently and positively on how to make an efficient and effective use of new technologies such as AI and big data analytics to further develop and improve financial markets and services. From this viewpoint, today's conference is a great opportunity, where numerous experts with various backgrounds gather to discuss the most advanced issues in finance, such as the interactions between AI, financial services, and markets. I would like to close by hoping that today's conference will generate fruitful discussions, and that the exploration of financial frontiers by utilizing new information technologies, including AI, will greatly contribute to the development of the economic society. Thank you for your attention.
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Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Forum Towards Making Effective Use of the BOJ-NET, Tokyo, 21 April 2017.
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Hiroshi Nakaso: Future of central bank payment and settlement systems under economic globalization and technological innovation Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Forum Towards Making Effective Use of the BOJ-NET, Tokyo, 21 April 2017. * * * Introduction I would like to express my deepest gratitude and appreciation to all delegates for coming to the Forum Towards Making Effective Use of the BOJ-NET today. Central bank payment and settlement systems are facing big changes amid the wave of economic globalization and innovation in information technology. Today, I would like to introduce these topics. I. Payment and settlement systems as a core of central banking History of central banking and payment and settlement infrastructures Looking back at history, many central banks were established with the aim of ensuring or restoring stability in payments and settlements after the creation of nation states and during the transition from the modern era to the postmodern era. On the other hand, monetary policy as a macroeconomic policy to influence aggregate demand attracted broad attention from the public only after the Great Depression in the 1930s. The effectiveness of monetary policy and “lender of last resort” (LLR) functions are based on the fact that the liabilities of central banks – Yen in Japan – are used for payments by the people. The history of many central banks only goes back 100 years or so, which is not very long. Today in most countries, however, the central banks have the sole authority to issue banknotes and operate central bank payment and settlement systems such as high value payment systems and securities settlement systems. These facts imply that there is a strong economic rationale, which is common in countries worldwide, for central banks to provide these infrastructures. In each country, the central bank is the only entity able to provide central bank money with “finality,” which is free of credit risks and “unwinding” of settlements. The settlements through central bank money play a critical role in the economy, since they relieve economic entities from the risks regarding payments and settlements stemming from past transactions and thereby enable them to allocate their resources to promising economic activities for the future. Banknotes and central bank payment and settlement systems There are some differences between banknotes and central bank payment and settlement systems such as the BOJ-NET, although both are settlement infrastructures with finality provided by central banks. Banknotes are payment instruments that can be used by anyone 24/7. Banknotes do not carry any information other than “value,” and so information attached to payment activities such as “who pays whom and when” is not grasped by the central bank, which is the issuer of banknotes. From the perspective of information sharing, banknotes can be regarded as a “distributed” or “de-centralized” infrastructure. On the other hand, central bank payment and settlement systems such as RTGS systems can be deemed as a “centralized” framework in the sense that the information is likely to be concentrated to central banks, which manage the centralized ledgers 1/4 BIS central bankers' speeches as trusted third parties. In most central bank payment and settlement systems, the operating hours of these systems are limited and the participants are restricted to commercial banks and other particular types of entities. It may be an interesting topic to point out that there are such differences between banknotes and central bank payment and settlement systems. Banknotes have conventionally depended on paper, although there has been technological progress such as printing technologies for preventing counterfeiting. On the contrary, central bank payment and settlement systems have changed continuously and substantially incorporating the latest available technologies and reflecting changes in economic and financial environments. In the early days, central banks used paper-based ledgers to manage their accounts. Then, central banks replaced paper-based ledgers with digital systems. Also in terms of settlement methods, central bank payment and settlement systems, which used to be based on “designated-time net settlement,” recently adopted “real-time gross settlement” (RTGS). Such developments suggest that central bank payment and settlement systems will continue to change in the future. II. Globalization, innovation in information technology and central bank payment and settlement systems Globalization and central bank payment and settlement systems Central bank payment and settlement systems are once again facing significant environmental changes stemming from recent economic globalization and innovation in information technology. Central banks now need to deal with challenging policy issues: To what extent in terms of both “space” and “time” should central banks facilitate settlement with finality through central bank money in economic society? Reflecting economic globalization, cross-border economic activities are increasing, and some companies operating in multiple countries try to manage liquidity in a centralized way. These activities may lead to new demand for cross-border remittance services that can also be used at night. Also, as financial institutions inject more resources into cross-border activities, funding liquidity in foreign currencies is becoming very important for the operation of Japanese banks. Moreover, under financial globalization, the Global Financial Crisis showed that liquidity crises can spill over to other jurisdictions. It is therefore important to ensure liquidity sources through collateralized transactions such as repos, also from the viewpoints of controlling moral hazard, deterring overdependence on central bank LLR and maintaining global financial stability. Financial institutions, including Japanese banks, typically hold large amounts of government securities issued by their home countries. Accordingly, it is becoming important to establish a facility by which banks can raise foreign-currency liquidity in host countries through collateralizing government securities issued by home countries. Under such circumstances, central banks need to consider how and to what extent they provide their own infrastructures including high-value payment systems and securities settlement systems in order to support such collateralized transactions. For example, in terms of the “space” dimension, central banks will have to consider whether and to what extent they should respond further to facilitate settlements with finality also on a cross-border basis. In retail payments, increased economic activities at night and on weekends are requiring initiatives called “24/7 instant payments” that enable real-time payments to be made 24 hours a day, 365 days a year. Retail payments made at night and on weekends may cause an increase in unsettled amounts among commercial banks and other entities. There are risk-management methodologies to deal with such unsettled amounts through collateral and credit limits. As an ultimate measure to reduce such unsettled amounts, however, a central bank might be able to take decisive action in terms of time and provide settlements with finality also at night and on weekends. Indeed, such action is now being considered in Europe and Australia. 2/4 BIS central bankers' speeches Innovation in information technology and central bank payment and settlement systems Meanwhile, innovation in information technology is making the cost of handling cash more visible. In addition, while virtual currencies such as Bitcoin have emerged under the trend of FinTech, some people argue that central banks should consider issuing digital currencies, which could partially replace banknotes. Such arguments would mean applying digital technology even to banknotes, which have always been based on paper-based technology. This could have a substantial impact on the traditional concept of banknotes. At the same time, central bank digital currency (CBDC) is one of the issues in considering the role of banknotes and central bank payment and settlement systems. If CBDC is directly issued to the general public, it would allow wider access to central bank payment and settlement systems both in time and space. In an extreme case in which CBDC provides the same functionality as banknotes as an alternate measure, it could enable everyone to access central bank accounts 24/7, year-round. Some overseas central banks have started to consider the rationale for or to conduct researches and analyses on CBDC. Also, amid the global trend of FinTech, some non-bank companies and their services, such as PayPal in the United States and WeChatPay in China, have built up a large presence in payment and settlement services, and the structure and composition of payment service providers are now changing rapidly. Accordingly, some overseas central banks have started to reconsider to whom they should allow access to their payment and settlement systems. As economic globalization and technological innovation advance, the environment surrounding central bank payment and settlement systems is entering a new phase. III. Initiatives taken by the Bank of Japan The Bank of Japan has been continuously improving its infrastructure. We established the BOJNET in the 1980s, and then introduced RTGS and liquidity-saving features. In 2015, we started full-scale operation of the new BOJ-NET. Although economic globalization and technological innovation are causing dramatic changes in payment and settlement infrastructures, we are confident that the BOJ-NET can keep up with such changes and continue serving as a core infrastructure in the new era. At the same time, regarding how central banks should provide their infrastructures under the changing environment, we need to consider various issues. First, there is the issue of how to strike an appropriate balance between central bank money and private-based money in the economy, and between the stability in settlements and private-led innovation. These are classical issues. Nonetheless, as new FinTech players have increased their presence in payments and settlements, big-data attached to payment and settlement transactions is becoming more important as a source of added-value in various businesses. We will need to focus not only on the classical issue of “desirable sharing between central bank money and commercial bank money,” but also on new payment instruments carrying additional information provided by new players such as “non-bank FinTech firms.” The emergence of these new payment instruments will make things far more complicated. Second, it is crucial for central banks to ensure the security of central bank payment and settlement systems, which are the core infrastructure of the economy. We may also need to consider how to manage the information attached to payment and settlement activities, especially if such information is concentrated to central banks. Moreover, we should try to grasp the possible impacts of new technologies, such as blockchain and distributed ledger technology, on payment and settlement infrastructures including central bank payment and settlement systems. We need to bear in mind that central bank payment and settlement infrastructures are operated 3/4 BIS central bankers' speeches by using the nation’s resources. Therefore, when central banks consider how and to what extent they should provide their infrastructures, they must examine whether doing so would contribute to the economy. In order for central banks to make appropriate decisions on such matters, it is extremely important to engage in sincere and constructive communication with a wide range of users. The Bank of Japan highly respects the opinions of users. Bearing these opinions in mind, the Bank has considered very carefully how and to what extent it should provide its settlement infrastructures to the economy, and has taken decisive action. In terms of the time dimension, since February 2016, the Bank has extended the operating hours of the BOJ-NET until 9 o’clock in the evening, and will continue to consider appropriate operating hours through discussions with users. In terms of the space dimension, the Bank announced today that it will permit the BOJ-NET to be accessed from terminals overseas, which is called “global access." The Bank will continue to make utmost efforts to advance our payment and settlement infrastructures with the changes in economic environments in order to provide the optimum functions. To help us achieve this, we always appreciate constructive dialogue with all of you. 4/4 BIS central bankers' speeches
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Keynote speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the Global Think Tank Summit 2017, co-hosted by the Asian Development Bank Institute and the University of Pennsylvania, Tokyo, 2 May 2017.
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May 2, 2017 Bank of Japan Toward Inclusive Growth in Asia Keynote Speech at the Global Think Tank Summit 2017 in Yokohama Haruhiko Kuroda Governor of the Bank of Japan Introduction It is a great pleasure to have the opportunity to make one of the keynote speeches here at the Global Think Tank Summit 2017 marking the 50th anniversary of the Asian Development Bank (ADB). Over the next couple of days, a number of key topics related to growth and sustainable development will be discussed. All the discussions today can be orientated more or less to the same goal: "inclusive growth." "Inclusive growth" has become a key objective for global policy makers including the G20. "Inclusive growth" is typically defined as economic growth in which growth opportunities and benefits will be delivered to all people, regardless of their various socio-economic and gender attributes. Today, I would like to shed light upon an economic attribute; that is, income level. I do so because poverty remains in Asia, in spite of the remarkable growth in per capita GDP over the past 50 years. This fact points to the necessity for Asian economic growth to enhance its inclusiveness. Financial inclusion can contribute greatly in this regard. I. Economic Growth and Inclusiveness in Asia During the 50-year history of the ADB, many of the ADB's Asian member countries transformed from low-income countries to middle-income countries. Indeed, a few member countries have succeeded in joining the category of high-income countries. As the status of Asian countries has improved in terms of per capita GDP, the standing of Asia in the global economy has been enhanced. The percentage share of world GDP accounted for by the ADB's Asian members, excluding Japan, Australia, and New Zealand, increased from 8 percent in 1966 to 25 percent in 2015.1 Furthermore, the increase in per capita GDP in Asia has been accompanied by a 20-year extension of Asian people's life spans. Comparing 2014 with 1964, the average life span increased from 49 to 74 years in the East Asia and Pacific region, while in South Asia it increased from 45 to 68 years.2 See the first chapter of ADB (2016). ADB through the Decades: ADB's Fifth Decade (2007-2016). Mandaluyong City, Philippines: ADB. The source of data on life spans is the World Bank's World Development Indicators. High-income countries are excluded for the East Asia and Pacific region. In the past few decades, Asia's economic growth has accelerated. Asian economies appear to have benefitted from the strengths of globalization. Dating back 50 years, Asian developing countries' participation in world trade was quite modest. The mode of their trade participation was simple in many cases -- exporting primary products. In the following years, companies in advanced countries expanded their international operations and some of them grew to become giant multinational companies. Since then, they have developed global value chains with a geographic focus upon the Asian region. This is one reason why per capita GDP grew at a faster pace in Asia than in other developing regions. Comparing 2015 with 1996, per capita GDP in developing countries increased by a factor of five in Asia, while this was two and three in Latin America and sub-Saharan Africa, respectively.3 Economic growth in Asia has been accompanied by a narrowing income gap between developing countries in Asia and high-income countries around the world. Specifically, 50 years ago, real GDP per capita was about 50 times larger in high-income countries than in developing countries in the East Asia and Pacific region. It was about 45 times larger in high-income countries than in developing countries in South Asia. Recently, such scaling factors have decreased to 7 times and 26 times respectively, in these two regions.4 There is no doubt that the ADB has made a significant contribution to economic growth and the extended life span in Asia. This contribution can be compared to the weaving of a cloth by the ADB. The warp is the financial capital that the ADB has provided for member countries to finance their development projects. The ADB's loans and grants have long continued to make those projects successful, even in the face of wide-ranging differences in developmental needs and circumstances among the members. What has made this possible? This is where the woof becomes important. The woof is the ADB's intellectual capital, consisting of underlying thought, specific knowledge, and creative ideas. The ADB has offered this type of capital to individual member countries so that their development projects The source of the scaling factors is the first chapter of ADB (2016). ADB through the Decades: ADB's Fifth Decade (2007-2016). Mandaluyong City, Philippines: ADB. The scaling factors in this paragraph are calculated using the World Bank's World Development Indicators. They compare 2015 with 1966. are carefully planned and well-managed. An indispensable part of this woof has been the ADB Institute, co-host of this symposium. In addition, based on my experience at the ADB, this long-standing adaptive weaving has been made possible by the ADB's organizational and operational flexibility. To continue with my analogy, the ADB will need to continue its work of weaving a cloth suitable and strong enough to wipe away the persistent problem of poverty. In contrast to the relative economic progress made in the international sphere, domestic income inequalities have increased in some Asian countries. Among the 30 countries with comparable Gini coefficients, income inequality has increased in recent decades in twelve countries, accounting for about 80 percent of their total population. In most of these countries, the top income group has increased its income share. 5 A recent survey concludes that when a deterioration of income equality occurs by benefiting mainly the rich, it undermines the poverty-reducing effects of economic growth.6 Unfortunately, poverty remains in Asia. There are a variety of possible explanations as to why Asian people in the bottom income group continue to live in poverty in spite of strong macroeconomic growth. One explanation is that it is more difficult for growth opportunities and benefits to reach people whose residential locations, industries, and skills have not been incorporated into global value chains. It will be essential for policy makers in Asia to continue to introduce domestic policies that can enhance the inclusiveness of their hard-earned economic growth. II. Poverty in Asia Nonetheless, the history of the Asian economy shows quite clearly that economic growth is a key driver of poverty reduction. In the past 50 years, extreme poverty has significantly decreased in Asia. Here, I refer to the World Bank's current definition of extreme poverty – living on less than 1.9 U.S. dollars a day. Looking at selective countries with comparable See Zhuang, J., Kanbur, R., and Maligalig, D. (2014). "Asia's Income Inequalities: Recent Trends," in Kanbur, R., Rhee, C., Zhuang, J. (eds.), Inequality in Asia and the Pacific: Trends, Drivers, and Policy Implications, pp. 21-36. Oxon: ADB and Routledge. See Škare, M., and Pržiklas Družeta, R. (2016). "Poverty and Economic Growth: A Review," Technological and Economic Development of Economy, Vol. 22 (1), pp. 156-175. data, averaged headcount ratios for extreme poverty decreased from 68 percent in the 1980s to 8 percent in the five-year period of 2010-2014 in South East Asia and China.7 In South Asia, the extreme poverty ratios decreased from 50 percent to 19 percent.8 However, poverty continues to be a considerable burden in Asia. People falling into extreme poverty still exist. Furthermore, based on the definition of "multidimensional poor," which takes into consideration levels of education and health as well as living standards, the number of such poor people is globally 1.5 billion, and about 60 percent of them live in Asia.9 In South Asia, the number of the multidimensional poor is disproportionately large relative to its population. Wide-ranging measures are beneficial for poverty alleviation. For example, providing the poor with education and employment opportunities has the potential to interrupt the vicious cycle of poverty. When poor parents cannot afford to provide their children with education, their children in turn grow up to be uneducated workers with the great risk of becoming poor parents themselves. Breaking such a negative cycle enables the accumulation of human capital, thereby strengthening the potential for economic growth in the long run. A precondition of breaking this cycle of poverty is to push poor parents to recognize that the future benefits of enabling their children to receive education are significant, and that they will far surpass any immediate profit from using their labor in housework and part-time jobs. III. Contributions of Financial Inclusion Among a wide range of poverty-reducing polices, I would like today to focus on policies which promote financial inclusion. According to the Consultative Group to Assist the Poor housed at the World Bank, "financial inclusion means that households and businesses have access and can effectively use appropriate financial services. Such services must be provided responsibly and sustainably, in a well regulated environment." The G20 has been keen to Data for South East Asia consist of those for Indonesia, the Philippines, and Thailand. The headcount ratios in this paragraph are calculated using the World Bank's Poverty and Equity Database. The source of the figures on multidimensional poor is the United Nations Development Programme's Human Development Report 2016: Human Development for Everyone. advance financial inclusion with the dual aims of benefiting the poor and activating smaller businesses. Regarding financial inclusion for individuals, many poor people engage in financial activities in their daily lives, such as saving and borrowing money, but they tend to lack access to well-regulated and appropriate financial services. Getting such access helps the poor escape from poverty through a number of channels. The first channel is reducing the cost of obtaining and managing funds by low income households. Borrowing loans from regular financial institutions enables the poor to avoid obtaining funds from informal moneylenders at very high costs. By using a safe savings account, they would not need to worry about protecting their physical cash. The second channel is stabilizing the daily lives of the poor. Deposits and loans make it possible for them to absorb negative financial shocks, including sickness and injury, as well as changes in the frequency and size of cash inflows. This shock-absorbing effect helps the poor smooth their consumption over time. The last channel is exploiting growth opportunities. Absorbing negative financial shocks also helps poor parents allow their children to receive education rather than being incorporated into the labor force. In developing countries, some poor people are informal business owners. Access to financial services can enable them to invest in their own businesses. However, progress in financial inclusion for individuals appears to have been slow in developing Asia. In 2014, the percentage share of adults with savings accounts was 48 percent in developing East Asia and Pacific, and 44 percent in South Asia. In high-income countries around the world the figure was 108 percent, and in Latin America it was 70 percent.10 The source of the figures on account ownership is the World Bank's Global Findex. To encourage the poor to open savings accounts and make deposits, it is necessary to introduce hands-on policies that reflect the specific needs of individual countries. Economic factors are not the only reason why poor people often do not save money; there are also social constraints, regulatory barriers, low financial literacy, and psychological factors. A recent empirical finding shows that factors preventing poor people from opening savings accounts include high charges, distant bank outlets, weak legal rights, and political instability. 11 Even when the poor do open accounts, whether or not they actually save money in those accounts is a separate question. They need to have other incentives to do so. Such incentives may vary by country. For example, a field experiment in rural Kenya finds that effective incentives include earmarking the poor's deposits for emergency use, encouraging them to save money in a group setting, and providing them with credit conditional upon saving money.12 Financial inclusion is important for small companies as well. In general, small companies are informationally opaque with regard to their business and financial conditions. Also, they are often short of collateral. Therefore, they are at a disadvantage when it comes to borrowing money. However, it is mainly small companies that create jobs for the poor. Their investments and innovations can support macroeconomic growth. Also in the context of small businesses, progress in financial inclusion has been slow in developing Asia. The recent percentage share of small companies that borrow from banks was 15 percent in developing Asia, while it was 32 percent in non-Asian developing regions.13 One statistical finding clearly shows the benefits of reducing this gap. That is, the level of bank credit relative to GDP can positively explain an income increase for the bottom See Allen, F., Demirguc-Kunt, A., Klapper, L., and Martinez Peria, M. S. (2016). "The Foundations of Financial Inclusion: Understanding Ownership and Use of Formal Accounts," Journal of Financial Intermediation, Vol. 27 (1), pp. 1-30. See Dupas, P., and Robinson, J. (2013). "Why Don't the Poor Save More? Evidence from Health Savings Experiments," American Economic Review, Vol. 103 (4), pp. 1138-1171. See the first chapter of ADB (2013). ADB-OECD Study on Enhancing Financial Accessibility for SMEs: Lessons from Recent Crises. Mandaluyong City, Philippines: ADB. income group.14 Efforts are on-going in developing Asia to enhance the accessibility of credit to small firms beyond their informational opaqueness. One approach is a centralized approach. An example is to establish a credit bureau for small companies. Such a bureau is an important financial infrastructure and is managed by a public agency in eight of the 20 developing Asian countries surveyed by the ADB.15 An additional example is to use a public credit guarantee scheme, which has been established in 16 of the 20 countries. These institutional supports have the potential to encourage banks to provide loans for small businesses, thereby promoting financial inclusion. Another approach to deal with the informational opaqueness of small businesses is a more individual approach. A prominent example is microfinance. The ADB and other multilateral development banks have supported the rapid growth of microfinance institutions by providing them with loans, grants, and technical assistance. In terms of the number of borrowers, microfinance is more active in developing Asia than in any other developing region. 16 Although further work is necessary, studies show that microfinance provides expanded access to credit which in turn increases business activity of microentreprenuers. Results also suggest that it provides people with more flexibility in choosing their occupation and affords them the possibility of being more self-reliant.17 Advances in information and communication technology, or ICT, have the potential to help financial inclusion continue to expand in developing Asia, in some cases beyond traditional banks. For example, crowd-funding schemes enable small businesses and poor individuals to See Beck, T., Demirguc-Kunt, A., and Levine, R. (2007). "Finance, Inequality, and the Poor," Journal of Economic Growth, Vol. 12 (1), pp. 27-49. See ADB (2015). "Regional SME Finance Update," Asia SME Finance Monitor 2014, pp. 9-28. Mandaluyong City, Philippines: ADB. See Microcredit Summit Campaign (2015). The State of the Microcredit Campaign Report, 2015. See Banerjee, A., Karlan, D., and Zinman, J. (2015). "Six Randomized Evaluations of Microcredit: Introduction and Further Steps," American Economic Journal: Applied Economics, Vol. 7 (1), pp. 1-21. borrow money from the general public and even across borders. On deposits and remittances, mobile phones and digital money enable companies and individuals at home and abroad to transfer funds, in some cases regardless of whether or not they have bank accounts. Financial inclusion in the digital economy has the great potential to help users enter new goods markets and new credit markets. I look forward to seeing the positive impact of such digital financial inclusion on poverty reduction and economic growth in the near future. Financial inclusion has implications for the institutional foundations of banking and finance. To introduce new financial services, or to permit new entities to provide traditional services, the relevant financial business laws would need to be updated appropriately. The emergence of new service providers, including ICT companies, may call for improvements in monitoring and regulations. At the same time, financial policy measures would need to strike the right balance between dealing with possible issues regarding financial stability and consumer protection, and facilitating the innovation of service-providers. Concluding Remarks It is 50 years since the establishment of the ADB. In spite of the region's remarkable economic development, poverty does remain in developing Asia. We need to enhance the inclusiveness of Asia's economic growth, and financial inclusion can play an important role in tackling the stubborn poverty problem. Policy makers need to find and eliminate obstacles to such inclusion and create positive incentives, taking into consideration each country's specific circumstances. Enhancing financial literacy is also essential. The ADB's revised "Strategy 2020" sets forth a vision of both poverty reduction and inclusive growth amongst its strategic priorities and financial inclusion is a key area. I am confident that the ADB will continue to lead work in this area by providing two kinds of capital -financial and intellectual -- and through close collaboration with member countries. Thank you.
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Speech by Mr Haruhiko Kuroda, Governor of the Bank of Japan, at the 2017 Institute of International Finance (IIF) Spring Membership Meeting, Tokyo, 9 May 2017.
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May 9, Bank of Japan The Global Economy and the Global Financial System: In an Era of Revival and Metamorphosis Speech at the Institute of International Finance (IIF) Spring Membership Meeting Haruhiko Kuroda Governor of the Bank of Japan Introduction: Ten Years On from the Global Financial Crisis Thank you very much for giving me the opportunity to address the Spring Membership Meeting of the Institute of International Finance (IIF). This year, we will be entering the ninth year since Lehman Brothers collapsed. That event in September of 2008 was one of the most visible flashpoints of the Global Financial Crisis, but if we count from what should be seen as the foreshock -- severe disruptions in the U.S. subprime mortgage market in 2007 -- we are marking the tenth anniversary of the Crisis. We have indeed come a long way. Since the Crisis, the global community has put considerable efforts into rebuilding the financial system, and such efforts have contributed to greatly enhancing the stability and resilience of the international financial system, compared with what we had before the Crisis. The list of achievements regarding the reform of the international financial system since the Crisis is quite long. Basel III was introduced. The over-the-counter (OTC) derivatives market was reformed. Risk management at central counterparties (CCPs) was strengthened. The process of resolving financial institutions was improved, and so on. Of these reforms, Basel III, which applies to internationally active banks, ushered in significant changes to the existing framework of banking regulation in terms of both capital and liquidity. After almost seven years of negotiations, we are now crossing the t's and dotting the i's. The fact that we have reached this stage for a very complex framework, which must accommodate conflicting national interests, proves that financial authorities and banks, which experienced perhaps the worst turbulence since the Great Depression of the 1930s, have worked together, sharing a firm commitment not to see a repeat of the Crisis. This is a notable achievement in the annals of international financial cooperation. Obviously, financial regulation is a means to an end. That end is financial stability, which is one of the fundamental underpinnings of sustained growth of the economy. Many of the new international prudential regulations that were agreed in the wake of the Crisis, such as the enhanced capital levels, the liquidity coverage ratio, and the countercyclical buffer, are now being introduced in steps, and more regulations, such as the leverage ratio, total loss-absorbing capacity (TLAC), and net stable funding ratio (NSFR), are on the way, again in steps. Since all these new internationally agreed rules are part of a bigger package, they must unfalteringly come into effect as envisaged if the rules are to have the desired effects. Having said that, we also must be mindful of the danger of the means becoming an end unto itself. If compliance to rules becomes an overarching goal, there could be unintended effects on the functioning of financial intermediaries. Financial regulation must not be the Procrustean bed of Greek mythology. Accordingly, financial authorities and banks must closely monitor the effects of the new rules on the macro economy and financial markets without prejudice and from the broadest of perspectives. I. Global Economic Developments: Adjustment Ending but Fragility Lurking Global Recovery and the Waning of Pessimism As the global financial system is generally returning to a surer footing, the global economy is also regaining its momentum since the second half of last year. In the World Economic Outlook (WEO) published last month, the International Monetary Fund (IMF) expects the global economy to grow by 3.5 percent this year. The developed economies -- Japan, the United States, and Europe -- are all envisaged to enjoy robust domestic demand growth, while the forecast for Chinese growth is around 6.5 percent. At the same time, with the strengthening of major economies and the bottoming out of commodity prices, nascent recovery is observed in the growth momentum of developing countries and resource-rich economies. All in all, the prevailing pessimism since the Global Financial Crisis, which fostered colorful language such as "secular stagnation" and "low growth trap," is clearly on the wane. Such a sea change probably could be attributed in part to the anticipation over the economic policies of the new U.S. administration. Having said that, more fundamentally, I would note that the global economy has finally reached escape velocity. Support from various policies during the ten years since the Crisis is now finally bearing fruit. Looking back, during the last few years, the global economy suffered weak corporate investment and there was talk of the C-suite losing its animal spirit. While the huge negative demand shock resulting from the Crisis inevitably depressed investment, it also seems difficult to deny that the cloud of pessimism rising from the shocks cast a pall over the economy, resulting in a negative feedback loop delaying autonomous recovery. Cognitive psychology tells us that perception creates reality. The prevalence of skewed negativism from the damaging demand shock could have dampened investment and new hires, and that in turn could have depressed potential growth. One can interpret this as one form of hysteresis, as described in economic textbooks. Fortunately, various measures of business and consumer confidence are on an upswing everywhere, and what I might describe as a chain reaction of pessimism is almost a thing of the past. Meanwhile, we are beginning to see active debate on the desirable policy mix for sustaining the recovery, and more generally on a possible new economic policy framework. If these discourses catalyzed by the launch of the new U.S. administration are uplifting business and consumer sentiment in one way or another, I would view this as a clearly positive development. A Caveat regarding the Global Financial System: Circularity of Offshore Dollars Even as the global economy improves, there are still fragilities that should not be overlooked. One that I would like to point out is the dollar-denominated debt of some emerging economies, which has been repeatedly called to attention by observers including economists at the Bank for International Settlements (BIS). These economies -- especially firms in these economies -- have increased the levels of dollar-denominated debt under the accommodative global monetary environment following the Global Financial Crisis. Now, as the United States embarks on monetary policy normalization, we now need to monitor the debt dynamics of these economies from two perspectives: increasing interest payment burden and exchange rate depreciation. Mentioning the dollar-denominated debt of emerging market economies calls to mind the 1980s debt crisis in Latin America, which shook the world and led to the establishment of the IIF to deal with the problem. The origins of the debt crisis could be traced back to the recycling of excess dollars at oil-producing economies, which ballooned in the 1970s, to Latin American economies through U.S. and European banks. When the United States began monetary tightening and the dollar began appreciating under the new Reagan administration in 1981, the Latin American economies suffered deteriorating debt dynamics and soon fell into arrears on their external payments. Reflecting on their experiences during the Asian Monetary and Banking Crisis of the 1990s, many emerging market economies today have adopted flexible exchange rates, strengthened risk management at banks, and built up firewalls such as foreign exchange reserves. Accordingly, emerging economies are generally more resilient in the face of stress. Nevertheless, with the increased capital mobility across borders and ever more complex geopolitical risks, we should continue to pay attention to the issue of dollar-denominated debt and currency mismatch at emerging market corporates. If I may add a few more words here, currency mismatch is also an issue that cannot be ignored by financial institutions of the major economies. For example, over the last few years, Japanese financial institutions have taken pains to ensure stable funding of dollars as they expanded their overseas activities. Even so, they still depend on foreign exchange swaps for some portion of their dollar funding. The foreign exchange swap market has been described as the black box of the international financial market, because it was difficult to pin down the details of its structure.1 The increasing level of interest rates in the United States would result in higher dollar funding costs through swaps. Furthermore, if emerging market economies reduce the investment of dollar reserves in anticipation of currency support operations, financial institutions would also experience tighter dollar financing conditions in terms of availability.2 The issues of repaying dollar-denominated debt by emerging economy corporates and of stable dollar funding at non-U.S. financial institutions are, in a sense, two sides of the same coin. They are the manifestation of the circularity and recursivity of the dollar as the exceptional reserve currency. In view of the sometimes extreme fluctuation of dollar demand and supply in the offshore markets, we should perhaps not forget a comment by a former U.S. Treasury Secretary: "The dollar is our currency but your problem."3 Nevertheless, recent efforts -- for example, by various foreign exchange market committees -have resulted in enhanced data collection regarding this market. See Hiroshi Nakaso (2017), "Monetary Policy Divergence and Global Financial Stability: From the Perspective of Demand and Supply of Safe Assets." Attributed to John Connally, U.S. Treasury Secretary (February 1971-June 1972). II. Financial Business Environment: Profitability and Digital Innovation Profitability of Financial Institutions Under these conditions that I have just described, how is the environment evolving for financial institutions in the major economies? During the last few years, U.S. and European financial institutions, which bore the brunt of the Global Financial Crisis, had to slim down and restructure their balance sheets in response. However, this is not the end of the story for financial institutions in the developed economies. Since well before the Crisis, these economies have been confronted with long-term structural challenges, such as stagnating potential growth and changing demographics. More recently, risks arising from climate change have been added to the list. These challenges are forcing financial institutions to fundamentally review their business strategies. In this context, if I may touch upon the situation in Japan, changes in business models at Japanese banks have been less visible compared with U.S. and European banks, reflecting to an extent the relatively limited impact of the Crisis. Nevertheless, the low interest rate environment that has persisted for a quarter of a century and accelerating aging of the population are significantly weighing down on domestic interest margins and loan-to-deposit ratios, and pressure from these two directions is reducing the underlying profitability of Japanese banks. In response, Japanese banks have been actively attempting in recent years to enhance profitability through measures such as expanding overseas business, shifting assets and taking non-yen and equity risks, and diversifying non-interest revenues. Given the variety of business models for financial institutions, there is no single panacea that could improve profitability. There are good, rational reasons for how various models have evolved. For example, in the United States, where there is a deep capital market, investment banking has evolved, and in Europe, where firms and households are relatively more dependent on banks, there is a preference by tradition for universal banking or bancassurance.4 Having said that, with due respect to the differences in weighting of factors between economies, attempts by financial institutions to sustainably enhance their profitability must clear higher hurdles that now exist, such as the low-for-long environment, increasing compliance costs, and intensifying competition. Financial institutions must build business models that can flexibly accommodate any changes in environment and at the same time enable them to proactively take risks supported by strong capital foundations. This is a common challenge for all financial institutions in every economy. As a footnote, I would like to note that, from the perspective of maintaining the stability of the financial system, authorities are paying close attention to the profitability of financial institutions, because higher profitability is one route for financial institutions to organically generate their capital. At the same time, authorities need to closely monitor the robustness of risk management at financial institutions so that these institutions do not take excessive risks in pursuit of profits; in other words, not endanger financial stability via an overheating channel. FinTech: A New Wave of IT Innovation In such an environment, FinTech, which is fast emerging worldwide, could potentially be an "enabler," opening up new business frontiers and allowing financial institutions to free themselves from the yoke of low profitability. Looking at the current state of the global economy, we find the rise of "connected businesses," which tie together information and services almost instantly over a wide horizon, against the backdrop of advances in digital communications technologies and epitomized with terms like "the fourth industrial revolution" and the "Internet of Things (IoT)." "Sharing economy" is one example of such development that is gaining traction everywhere, and broadly speaking, FinTech can be understood in the same context. A business model where banks develop and sell insurance products. It became popular in Europe (France, Italy, and Spain in particular) from the 1990s onward, involving mainly life insurance products. However, there have been signs of deemphasizing this model recently, reflecting doubts on synergies achieved. This trend is probably changing the nature of innovation from the longstanding emphasis on improving individual products to an emphasis on transforming how services are provided; in other words, the distribution channel of services. In adapting to such a change, firms that can perform meticulous customer analytics will be able to more appropriately and promptly provide individual customers with services that are tailored to their attributes and preferences. Such "personalization of services," as it often is called, is making rapid inroads, especially in fields such as healthcare and development of new drugs. 5,6 It also could become more prevalent in finance, leveraging on advances in FinTech, in areas such as retail payments, remittances, and lending, as well as in less capital intensive areas such as transaction banking and wealth management.7 Here, it is interesting to note that trends in the two of the most heavily regulated activities -- medicine and finance -- are pointing in the same direction with the personalization of services. Meanwhile, financial institutions cannot shy away from improving their cost structure in meeting their profitability goals, and here again, FinTech can make significant contributions. For example, it is a well-known fact that the return on equity (ROE) of financial institutions is materially higher in the Nordic economies, where online banking is prevalent and branch network density is generally low. Furthermore, while financial institutions have been spending more on compliance with various regulations following the Global Financial Crisis, we are now seeing efforts to apply IT technologies in this area, which are referred to as RegTech, following FinTech. The use of RegTech is still in its infancy, but I must say that it was a groundbreaking endeavor by the IIF to release a report on this issue as early as it did.8 "Personalization of services" could be regarded as a tailoring of services at a more granular level than previously possible. For example, in everyday application, monitoring of physical conditions through censor-based wearable devices, and in a more rarefied setting, gene therapy taking account of individuals' DNA readings. Examples of transaction banking are cash management, trade finance, and supply-chain finance. IIF (2016), "RegTech in Financial Services: Technology Solutions for Compliance and Reporting." Circumspection and Innovation at Financial Institutions Although there are opportunities, some leading thinkers argue that banks should distance themselves from innovation and return to a simpler business structure focusing on deposit taking and lending. Such a view is one reflection of the situation that existed before the Global Financial Crisis, at which time banks were jokingly described as "too complex to succeed." In fact, in places like Europe following the Crisis, we can observe trends in banks' lending and funding, which might be described as back to retail. Nevertheless, I cannot buy the idea that banks should be dull, boring, and far removed from innovation. Such a view seems too extreme and ignores, among other things, the extensive information gathering ability of banks. If banks distance themselves from cutting-edge innovations, that could affect their business models. For example, if retail deposits begin to move around more frequently due to FinTech, intermediary services performed by banks, for which funding is reliant on relatively sticky deposits, would be forced to change. In the United Kingdom and the United States, debate is now underway on the appropriateness of granting banking licenses and central bank access to FinTech enterprises, and this shows that a new horizon of cooperation and competition is being opened up between banks and FinTech enterprises. Once upon a time, the U.S. economist William J. Baumol noted that the number of musicians needed to play a Beethoven string quartet was four in the 19th century and remained so in the 20th century. That illustrated the Baumol effect, which observed that it was difficult to raise productivity in labor-intensive service industries. However, such a view as Baumol's is now beginning to be a thing of the past, reflecting the widespread deployment of technologies such as artificial intelligence (AI) and robotics in many industries, not only in transportation and logistics but also in medicine and care-giving. While we must not forget that there are still issues with FinTech in areas such as customer protection and security, we also should recognize its value as a "sandbox," where financial institutions can test innovations according to their respective competitive advantage. We should not let ourselves fall into complacency. After all, as the saying goes, "the stone age did not end for the lack of stone." III. Conclusion: the Changing Face of Globalization and Multilateral Engagement Up to now, I have discussed recent developments in the global economy and financial institutions. For the remaining few minutes, let me offer some personal observations on the bright and the not-so-bright sides of globalization, on which debate is now raging in every direction, drawing in part on my experiences at the Asian Development Bank (ADB), where I served as its president until a few years ago. Increasing Uncertainty in a Multipolar World Over the last few years, we have seen growing momentum around the world for anti-globalism, which argues that the globalization of the economy is exacerbating income inequality. However, such a view overlooks the unmistakable fact that global economic integration is mitigating global poverty, most obviously in places such as China and East Asian economies. It also is safe to say that access to financial services is improving significantly in emerging economies, as a result of developments such as the widespread adoption of mobile banking. Therefore, it is slightly ironic to find that anti-globalism is becoming more acute in the developed economies. I believe that there is no future in an inwardly obsessed movement turning its back on globalization. Economies of the world are now strengthening their mutual ties through many channels, including the establishment of value chains transcending national borders. Digital innovations taking place in cyberspace are also accentuated by openness to the outside world. Any ring-fencing attempt that ignores such global interdependencies is inconsistent with the reality of the 21st century in both the real and virtual worlds. It is true that, in today's world, people's values are fragmenting, leading to increased uncertainty in politics and economic activities, as attested to by anti-globalization movements. Just as a degree of stress is useful in maintaining our personal health, uncertainty will act as a brake on our unwarranted optimism or complacency. Nevertheless, that is true only up to a point. If everyone is saying, as in today's financial markets, that the only certainty is uncertainty, it is not difficult to imagine that decision making is becoming increasingly difficult for economic agents. The Importance of Multilateral Cooperation As the world becomes more and more fragmented and uncertain in a mutually reinforcing cycle, we must maintain the stability of the global financial system in the face of inescapable international flows of capital. For this purpose, economies must overcome their narrowly-defined self-interest so as to cooperate and coordinate from a broader perspective. This is to mitigate to some extent the so-called financial trilemma, through multilateral cooperation, and it requires a well-functioning institutional framework such as the IMF, multilateral development banks (MDBs), and the G20.9 The financial reforms that I have referred to earlier would not have been possible without confidence building among stakeholders through various international fora, including the G20, the Financial Stability Board (FSB), and the IIF. Since the IIF came into being in the first half of the 1980s, its membership has expanded more than tenfold and now covers more than 70 economies. This underscores the fact that financial institutions were both the driver and beneficiary of globalization. Building on the experiences of the most extreme financial crisis of the last decade, central banks around the world have strengthened their defenses against acute liquidity problems involving foreign currencies, through cooperative measures such as multilateral swap lines. Obviously, reinforcing the safety net like this takes into account the fact on the ground that financial institutions now operate more broadly and deeply across borders. For the last 30 years, the world economy was engulfed by a strong homogenizing current of globalization. Having said that, I must also note that every trend has an inflection point. As polarization and fragmentation are becoming more evident, globalization may have reached a turning point of sorts. I would thus like to conclude my remarks today with the sincere hope that every one of you gathered here in this room, who are the leaders in international finance, will continue to play the role of inspirators regarding the direction of the global economy. Thank you very much for your attention. Financial trilemma is the term for noting that it is impossible to pursue the following three policy objectives alongside one another: financial stability, global financial integration (free movement of capital across borders), and domestically oriented financial policy. For a more detailed explanation, see D. Schoenmaker (2011), "The Financial Trilemma," Economic Letters, 111, pp 57-59.
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